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It's about the international fiat monetary regime's denouement, and of course the Ron Paul presidential campaign.

Even the popular name of this "crisis" — implying that the whole problem is "subprime" borrowers with sketchy credit histories — is really just more disinformation. Shaky American borrowers defaulting on their home loans are indeed a great danger, but in the same way that a free press is a danger to despotic government. It is the danger of exposure. It is the end of plausible deniability. If the "markets" of the world perceive — finally — that the emperor has no clothes, the nearly century old game may be over.

First, a little background. Forgive all the quotation marks, but it's important to maintain a healthy skepticism when considering this subject.

When a "lender" (usually a bank) makes a "loan" to a "borrower," the borrower executes a legal instrument known as a "note," sometimes also called a "bond." The "note" or "bond" is the borrower's promise to repay the "loan" at such and such an interest rate, over such and such a period of time, consisting of monthly payments in such and such an amount.

There's a lot more to explain here, but first, before we go there, pull out your wallet and take a look at any currency you have in there. You will notice that the currency is also called a "note." Just like the "note" the "borrower" executes to the "lender," the currency is a promise to pay, but in the case of currency it is minus the interest rate or period of time. Currency notes are "payable to the bearer on demand," also called "bearer paper" and "demand notes."

But if one kind of note functions as currency — money, really — why can't another? Why indeed. No reason at all. In fact, since in the absence of a gold standard currency "notes" are ultimately unredeemable promises, other kinds of notes are arguably better than currency. Particularly if they are "backed" by something of "tangible" value — like, say, real estate — which is something government currency can't claim.

This reasoning — and it is valid reasoning — led to a state of affairs in which home mortgage loan paper (the "notes"), primarily from the United States, began to "circulate," just as currency circulates among individuals. This paper, and derivatives of it like CDO's, mortgage-backed securities, CLO's, SIV's, have by now gone all over the world and for all intents and purposes function as "money" in the world's banking systems, constituting financial "assets" on their books. The nominal aggregate value of all this American mortgage loan paper is many, many trillions of dollars. This actually — and somewhat ironically — dwarfs the nominal value of all official but un-backed US government paper currency in circulation.

Notice I say "nominal" value. This is important. Because while the essence of the international fiat monetary regime is that nothing can have a fixed, permanent or finally determined value, everything must have a "nominal" value, otherwise buying and selling — that is, trade and economic activity itself — would be impossible.

Yet the "market," like the human beings who comprise it, craves precisely assets of a fixed, permanent and finally determined value. This is the basis of the great financial asset game of the 20th century just past: the hoi polloi chasing and acquiring assets they believe to be of permanent value; and the rulers — sometimes slowly, sometimes abruptly — then destroying the value of those assets, in part because not to do so would undercut the regime itself.

The regime is a jealous god.

So the home loans of the hoi polloi, and the homes themselves "backing" the loans, were eventually transformed into "financial assets" like everything else, then sold and marketed all over the world at their nominal value. The current "crisis" is the result of this nominal value being called into question and tested at its very foundation, through the only true "mark-to-market" events that can ever apply to such assets: default, foreclosure and auction of the "collateral" — the homes of the "borrowers."

The problem is, if there's one thing we've learned in the world of financial assets over the last 20 years or so, it is this: the process of questioning and testing their value invariably reveals a cesspool of scandal and fraud. Mortgage-backed paper is no different.

In truth, lenders have been systematically concealing the market value of this paper through a fairly simple and universal manipulation of the foreclosure process: when a property is foreclosed and "publicly" auctioned, the lender itself bids in the amount it claims to be owed at the auction, thus insuring that there is never a loss on the loan itself, since the loan is always "paid in full" at the auction.

When it is the successful bidder — as it almost always is — the lender then winds up owning the property. When the property is finally sold by the lender, there is normally a loss; but technically, that is not a loss on the loan itself. That does not damage the value of the original "paper."

In this way mortgage paper and its many derivatives can be and have been marketed as very "safe" investments, providing a "good return" with "no risk of loss." But of course there is no such thing. There is a risk of loss; it has just been hidden.

Now that risk is materializing. As defaults and foreclosures increase, the lenders have to pay out more and more to hide the losses. But the lenders can only make this up by making more loans, because this is how they increase their cash flow; and now it is clear they can make more loans, and thereby increase their cash flow only by simultaneously increasing their losses, since their "loans" are proving to be losers. So no one wants their "paper" anymore, because — well — it's the financial equivalent of toxic waste. The "subprime" stuff is just the first surge: the tidal wave is close behind. Because all of it, the subprime, the prime, the AAA and everything in between, is the product of a previously hidden, but now obvious…Ponzi scheme. A Ponzi scheme that is in the process of unraveling, as all Ponzi schemes eventually do. And what person wants to be the last idiot to buy into a Ponzi scheme?

So now the lenders are squeezed on all sides: they have defaults bubbling up from underneath; they can't access credit on their now questionable paper; and it appears their whole business is structurally geared to lose money. One by one they begin firing their CEO's, warning their investors (closing the barn door after the horses are gone, but what else is new?), being investigated, probed, etc. We all know the drill. Some very big names are already involved.

This is all supposedly "very scary." The credit markets are "seizing up." The Federal Reserve is doing this and that, but even they can't fix problems in the tens of trillions of dollars. Oh sure, they can goose the stock market, but only temporarily. They put the money in but it all comes back out within a few days. The whole idea is just to get the lemmings to jump in after them. But it only takes what — $40 billion max? — to pull that stunt. The mortgage backed paper problem is many, many times bigger, and can't be solved in a few days of goosing.

Now. Why is all this a threat to the international monetary regime?

It's really very simple: debt cannot be money, this whole debacle is showing emphatically that debt cannot be money. But the regime is built entirely on the principle that debt is money.

It's an elegant deception. In the world of accounting, my debt is an "asset" on the books of my creditor. There is nothing really wrong with looking at it this way, and indeed it is a useful fiction to "account" for economic relationships. But we cannot lose sight of the fact that it is a fiction. A "receivable" based upon someone's promise to pay is not the equivalent of a hard asset that does not depend upon someone's promise. A "promise to pay" cannot be "payment" — by definition.

But because the regime says otherwise a worldwide home mortgage paper market with a nominal value in the tens of trillions of dollars — all debt — exists, though it appears not for much longer. And compared with that market the Federal Reserve System itself, with all of its regional branches, its Board of Governors, its "congressional mandate," its annual reports and so on, is a mere trifle. We could so easily be rid of it.

And that brings us to Ron Paul. Talk about being in the right place at the right time.

November 14, 2007

The Best of John M. Regan, Jr.