The Financial System is Facing a "Red Pill" Moment

The financial blogosphere is kind of quiet today after the drama of yesterday. I think most participants are taking a breathe and trying to make heads or tails of the crazy situation.
A question for the readers, is this the most exciting and volatile time you remember? I mean with the Turkey attacks northern Iraq story, the drunk hostage taker at Clinton's election office in New Hampshire, the creepy police Sargent that probably killed his last 2 wives, anything with Britney Spears, the mortgage rate freeze program, economic issues, and oil/gas prices high it seems every facet of the news has "hot" item in it. It certainly seems to me that things are getting a bit crazy out there. Any thoughts? Leave a comment if you like.

The Way Out of This Mess is....The Same Way We Got In!?
I was able to catch the business block on FOX TV today. The mortgage reset freeze was the main topic for most of the shows, as it should be. While it is becoming increasingly hard for me to be stunned by what some so called "professionals" say, today was pretty harsh.
On "Bulls and Bears" the almost unanimous view was that the way to fix the housing mess was to lower interest rates to 1-2%! Of course! It is so simple after all. The current meltdown was caused by never before seen low interest rates and easy money via the FED which forced the banks into "creative loan programs" to unload all the cash they were flush with. Wall Street helped by designing complex packages for the mortgages that could be sold off as high quality no matter what the package held. Artificial demand due to easy loan qualifications made it easier to get a $500k loan for a home than a $10k loan for a car for the same applicant. Home prices skyrocketed as a result, way out of line with any historical or fundamental value that is sustainable. Finally, things have come undone in a big way. The solution from the "professionals"? Recreate that speculative environment where taxi drivers were buying multiple homes. Recreate the very same atmosphere where everyone thinks that their home will appreciate 25% a quarter for the next 10 years making everyone a millionaire. Recreate the process where trillions of dollars that could be invested in new factories, new worker training, new industries, etc and instead plow that cash into a non performing asset like homes. Wonderful. Simply wonderful. Oh yeah, the financials like CFC, BAC, MS, GS, and BSC are all STRONG BUYS here! It would be funny if it wasn't so sad.

The Financial System is Facing a "Red Pill" Moment
"You take the blue pill, the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill, you stay in Wonderland, and I show you how deep the rabbit hole goes."- Morpheus to Neo in "The Matrix"

The treasury department led by Hanky Panky Paulson right now is trying to force a plan to freeze mortgage rates at low introductory levels (teaser rates) for up to 5 years. Nothing like this has even been attempted before in history. The cover story is the plan is designed to help financially uneducated buyers stay in the homes that they can no longer afford due to their loans resetting to a fully indexed rate (ie real world rate). By keeping mortgage rates at artificially low levels, massive foreclosures may be slowed down and folks will not be forced out of homes. It's a nice story, but also disingenuous. Paulson used to be a bigwig at Goldman Sachs and he knows what the real issue is. Banks and lending institutions simply cannot absorb the losses from the sour loans that they wrote. This is the single most important fact that is causing all the panic in the credit markets.
Through the wonders of fractional reserve banking and the mighty use of leverage, major banks are facing losses that far exceed what actual capital (cash and assets) the have. This means that even a small number of foreclosures or a seemingly small loss on loan value, even as small as 10%, effectively renders the bank insolvent (bankrupt). That is the true nature of the problem, and it has a ripple effect that is not being discussed anywhere.
In the film "The Matrix" the character Morpheus gives the hero figure Neo a choice: he can go back to his normal life (blue pill), or he can learn the reality of what the matrix is (red pill). From the proposed SIV Superfund all the way to the Rate Freeze program being rolled out, I submit that the financial system is having it's own red pill moment. How much money is going to be lost due to mortgage paper losing value? I don't know, and neither do the banks. It is fair to assume that the number is large enough to scare even the FED and treasury department. How far down the rabbit hole do the wonders of "creative financing", mortgage repackaging, interest only loans, inflated appraisals, fraudulent loan applications, and HELOC's go? We may have to find out.
The FED often cites "confidence" in the markets as a main concern for them. It is very true. Only through the suspension of disbelief can true fiat currency and fractional reserve banking function. The minute the actual numbers are crunched, the whole charade is over. During most times, the system has no problems and nobody wants to know what is going on. The current debacle will serve as a reason to "check under the hood" and when the average person sees that the engine is not a 426ci HEMI with a Weiand supercharger, but a little lawnmower engine things could get dicey.

Or maybe things are and will be just fine. Perhaps all the coverage and fretting over the mortgage meltdown is overblown and pointless. Maybe housing makes up such a small part of the vaunted US economy that it simply will make no difference. Perhaps. But consider the following before you think this may be no big deal:

• Home prices are dropping on a national scale. This has not been seen since The Great Depression. Seriously.
• Home sales numbers and unsold inventory of homes are at levels approaching records.
• The FED wants to cut rates to save the markets, but the DOW, the SP500, and the Nasdaq are POSITIVE on the year!
• The government has never tried a workout plan like the one proposed before.
• Through Fannie Mae and Freddie Mac the US taxpayer is on the hook for over a Trillion dollars in guarantees.

There are a multitude of other once in history kind of things going on, and I think that speaks volumes about how dire the situation is.

Ok, enough financial drudgery! It is Saturday and we want entertainment!

The moon orbiter Kaguya from Japan is HD equipped and it has been sending back some truly amazing footage from space:

I know I have put this up before, but It's so much fun. Ry Cooder and Steve Vai do the guitar work for the contest scene in the movie "Crossroads". Too good.

Have a good night.