[tip of the iceberg] preconditions now in place

Click on pic and scrutinize.

"Insanity in individuals is something rare - but in groups, parties, nations and epochs, it is the rule." [ Friedrich Nietzsche]

People of my ilk who never got beyond Economics 101 will be lost. People in the know know all this already. If you're a small punter, you'd best read this – if I understood it, you can too:

First the news

Bank of America Corp., the nation's second biggest bank, said Tuesday it will take a $3 billion debt-related writedown in the fourth quarter and warned its losses could grow as the market wrestles with the fallout from the housing and mortgage-lending slump.

Mortgage-related writedowns across the banking industry were more than $40 billion in the third quarter, and the fourth quarter could end up being worse.

OK, so all that is known. So is this.

Investors have been bracing for fourth-quarter writedowns for a while, but the amount was larger than many were prepared to hear. As a result, volatility has returned to virtually all corners of Wall Street.

There's more

You'll remember Bear Stearns bailed out its two defaulting hedge funds, pouring $2.3 billion dollars of its own money into the hedge funds.

In the last few weeks, the ratings agencies -- Moody's, Fitch and S&P -- have been re-evaluating their ratings on hundreds of Collateralized Debt Obligation contracts, including securities that they'd previously given AAA ratings to.

Now, on Thursday evening, ratings agency Standard & Poor's slashed its ratings of the securities in Carina CDO Ltd, a CDO managed by State Street Bank.

State Street are going to let the assets be liquidated. Now, a widespread fire sale of securities by CDOs could further exacerbate declines in sub-prime-mortgage bonds.

Minor blip, no?

There's widespread fear that if there's a major sale of CDOs, then a "market price" will be established, and that will force other institutions to "mark to market" -- write down their assets to the market price, which in many cases is "nearly worthless."

Many investors may only invest in AAA but if these are downgraded to CCC minus, they lose all. This bears remarkable similarities to 1927-29.

More for the mix

FASB Statement 157 becomes effective on November 15, requiring companies to clearly designate which of its assets are "marked to market," and which are "marked to model" Level 3, valuated by computer algorithm.

In the following months, companies are going to be required by this accounting rule to clearly identify how much they have in "Level 3" marked to model assets, and this will further pressure these companies to provide realistic prices for them.

And what?

It means that with a set market price, the overinflated buying and selling is going to be seen for what it is and confidence will fly.

The bubble has started to deflate

When comparing these international financial crises, the details are always different, but they're all remarkably similar in the following ways, as described in "The bubble that broke the world":

A debauched and perverted use of credit, occurring at exactly the time that the survivors of the previous financial crisis have all died or retired; a huge asset bubble; the securitization of credit; and an upsurge in corruption. All of those elements are enormously present today.

Example of the mentality

On the sub-prime securitization market’s difficulties, Fitch answered some questions [don't know who FPA is, doesn't matter]:

FPA: “What are the key drivers of your rating model?”

Fitch: FICO scores and home price appreciation (HPA) of low single digit (LSD) or mid single digit (MSD), as HPA has been for the past 50 years.

FPA: “What if HPA was flat for an extended period of time?”

Fitch: The model would start to break down.

FPA: “What if HPA were to decline 1% to 2% for an extended period of time?”

Fitch: The models would break down completely.

FPA: “With 2% depreciation, how far up the rating’s scale would it harm?”

Fitch: It might go as high as the AA or AAA tranches."

We have here serious incompetence, arrogance and greed, all mixed in together, like the Billionnaire Boys Club. This is the key factor in the whole unravelling which is about to hit the world financial markets and goes part way to explaining Japan's flight from the dollar.

Russia, with its oil, is also keenly interested in the health of the dollar and doesn't like what it sees.

Why can't the players see what is happening?

There is an intrinsic optimism to players of the markets, a belief in the immutability of the market, of the essential economic theories they learned at university and honed in practice.

Above all, there is a firm belief that “the situation can be handled”. Tweak here, tweak there and it comes back on track.

I have a different model to work on and it says that rampant greed and clever little CDOs will not only come back in their faces but will bring everyone else down as well. This model of mine also says that there are those hanging around in the shadows ready to snap up the pieces.

Another take of some interest

Three familiar features of the universal delusion include:

* First, the idea that the panacea [cure-all] for debt is credit.

* Second, a social and political doctrine, now widely accepted, beginning with the premise that people are entitled to certain betterments of life.

* Third, the argument that prosperity is a product of credit, whereas from the beginning of economic thought it had been supposed that prosperity was from the increase and exchange of wealth, and credit was its product.

* When you add to that the securitization of credit [which in itself is bad enough], then financial markets are heading for a fall.

One last aspect from that article

Markets tend to go into severe crisis when the last of those who went through the last one are dead and gone. The new crisis, therefore, is a new one to the participants, who will go to great pains to point out the "historical differences", whilst not dwelling on the similarities.

Like Calvin Coolidge did, they'll talk up the recovery whilst not accepting the root cause - the delusionary greed and the arrogance that they can play the market and continue to win.