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Anatomy of a Quadrillion Dollar Scam

By someone else following x   2009 Jun 26, 5:51am 2,360 views   5 comments   watch   sfw   quote     share    

By Zeus Yiamouyiannis, Ph.D.
published on patrick.net with permission of the author


Debts are never assets, yet debts have been defined as assets by banks, investment houses, credit card companies, and brokers. If these entities or persons loan you money, they call the resulting debt on your part an asset for them, because you will ostensibly pay them back the principal, with interest, creating profit for them. If you give them money, they must pay you interest (no matter how small), and hence they consider your money a liability. They offset that liability by loaning your money to others at higher interest and pocketing the difference. This used to be what banks did and how they made their money.

With the massive deregulation of financial markets, banks began to effectively merge with investment houses and insurance companies under a rubric of "complete financial services," leveraging and investing money in higher and higher interest ventures, with greater and greater risks, involving huge theoretical profits. These new ventures tended to involve something other than lending, i.e. providing "services" or "guarantees" in the form of default insurance and other promises.

None of these new ventures and products were or are necessary to the credit market, day-to-day business, or efficient economies. Some of these vehicles could, if managed correctly with adequate capital reserves, do some positive things like distribute risk. However, most appear to be simply a boondoggle-- siphoning real value, adding nothing, and substituting a promise of astronomical theoretical future riches for actual ability to pay out. Most have not been managed correctly and have neither had the necessary capital reserves nor prudent investment strategies to shore up those reserves. Predictably, the world financial market is now in free fall.

In this debacle, a profound metaphysical error has emerged viewing debt itself as an asset. This has fateful and far-reaching practical consequences we are just now beginning to see and assess. Debt adds nothing. It does not produce anything or hold any value. Debt is not the asset but rather the lendee's ability to /pay/ that debt, interest and principal, and, failing that, provide something of real value (collateral) that covers the full amount of the debt. /Those/ are the assets, which the debt-extender holds claim to through a legal contract.

This error of debt-as-asset has spawned a series of wide-ranging and false assumptions about worth resulting in a massive financialization of markets, where derivative financial vehicles based in abstract and theoretical models for assigning value have gained an eerie and superseding reality over actual government managed money supply and concrete value production (stemming from labor, commodities, creativity, intelligence, property improvement, technological innovation, etc.) Let me state this again: This financialization and its vehicles have no basis in actual, concrete assets. Their only power lies in their ability to trade theoretical, non-real value (what I call /counterfeit value/), for things of real value.

This financial "shadow market" is able to do this by deliberately infiltrating and integrating itself into a healthy economic system. Like a parasitic invader, it protects itself from detection by lobbying successfully to subvert government regulation, scrutiny, and enforcement, by claiming itself as "private" and thus immune from public transparency requirements, and by developing mechanisms that are so complex that no one knows exactly what they do or what they might be worth. It works just like any confidence game.

The more financial vehicles one could create, the more "innovative," abstract, and complex they could be, the more fees and profits one could take in, and the less people could question what these entities were selling, the more people had to trust institutional "experts" and their assertions of value, profit, etc. Financial institutions were essentially creating their own counterfeit money through these exotic vehicles as if they had the printing presses right there in their offices.

This is confirmed by widespread statements in the financial press that the value of these vehicles are not "unknown" but rather "unknowable". Many cannot even be traced back to the real assets they were meant to service or represent, including actual deeds to properties that were packaged into "complex" securities. Though the actual dollar value of complex so-called derivatives is not known, the amount in transactions on so-called "derivatives" has been estimated by some reports at over one /quadrillion/ dollars, that is 1,000,000,000,000,000.00 dollars. If only a conservative 2 % fee were charged on these transactions, that alone would amount to a 20+ trillion dollar skim job, and that is laying aside the profit-skimming and greater fees charged in many hedge fund arrangements (i.e. 20% of profits and 5 % fees in one case).

The Macro View:

Oddly enough, given the fatal metaphysical error I have mentioned (debt = asset), almost all the concoctions stemming from that error have been "rationally consistent" with the irrational premise. Too bad logical consistency with false premises will virtually guarantee disastrous conclusions. Let us spell out in detail this "rational" behavior stemming from irrational assumptions.

First let us recast traditional debt in tune with the new, false assumptions mentioned above. In traditional economics, "good" debt would be a loan extended to someone with sterling credit, with a healthy income or revenue stream, and collateral that far exceeds the value of the loan. Collection is fairly simple. Risk is transparently low. The interest rate charged would be correspondingly relatively low. "Bad" debt would be someone with a low to middling credit rating, with borderline income or revenue, and with collateral that flirted with being equivalent to the loan. Risk is transparently higher. The interest rate charged would be correspondingly higher to offset the greater risk of default and failure to recoup the full value of the loan. "Insane" debt, would be someone with an incredibly low or no credit rating, whose income or revenue is well below what is necessary to pay off the loan, and whose collateral property has no, or even negative, equity in it (think of houses bought with liar loans, balloon loans, negative amortization loans).

In a traditional system, people with "insane credit" would never get a loan, because they have no way of paying it, and they do not have collateral worth anything near value of the loan. In the new system, debt is "equivalized" /so that what I have called "insane" debtors actually become the most sought after market!/ Why? Think about it: No distinction is being made between debts that can be paid and those that cannot possibly be paid (at least without completely fantastical projections of increasing value in the property, commodity, stock, etc. upon which the loan is being drawn). All debt is seen as asset. Insane debt = bad debt = good debt = asset. This is confirmed empirically in Moody's rating of absolute junk as secure AAA investment.

The lousier and more untenable the loan, the greater the "risk", therefore the greater interest and fees one can charge on it, and therefore the greater the ostensible return and/or profit! Combine this with the ability to externalize or pass on the liability by selling the insane loan or insuring it against default, a lender or servicer has every incentive to hand out the worst possible loans because they generate the highest fees and interest rates. "But," you may protest, "there are no foundations or fundamentals underneath these deals. They are completely irrational." In this new system, there don't need to be fundamentals because mathematical models can now simply create and assign present value based on theoretical projections of future values accepted as if those future values were fact.

So all the incentive is toward expanding the market for heavy, pervasive debt that is impossible to pay, and then to further spawn lucrative financial derivatives (including servicing and guaranteeing loans) from that market. Add consumer industries to this balloon, like housing and automobile manufacturing that benefit from this false creation of equity based on future value, and you have a juggernaut. This house of cards is perpetuated by its own "new era" mythology ("values will always go up," "deficits don't matter") and the fact that everyone seems to be getting richer from the loan originator to the lendee/investor the brokers, the servicers, the appraisers, the realtors, the county property tax assessments, the furniture store owner, the homeowner.

If this situation weren't bad enough, a new hyper-catalyst enters the picture leveraging. Two major problems emerged here to magnify many thousand or millions fold the damage already levied by fraudulent and fantastical lending. First, unregulated private companies (equity firms, hedge funds, etc.) were able to fabricate wealth and inflate their holdings and net worth to either further invest or buy outright real companies, as Cerberus did with Chrysler. Their unregulated "money" was based in "equity" based on "marked to model" theoretical value.

Second, unregulated financial instruments like credit default swaps had no effectively no reserve requirement at all, because their reserve "money" was also based on "assets" based on "marked to model" theoretical value. Furthermore, this unregulated, self-assigned value could be, if they so desired, leveraged into investments in ratios that could defy infinity. As we know, zero multiplied by a million is still zero. Imagine if you or I could assign a 200 billion dollar asset value to our dog's house, and use this assigned value to buy a major international conglomerate.

When people say that this is "unthinkable," what they are really saying is, "I don't want to think about it. I don't want to acknowledge this happened or can happen." However, just connect the dots. It's simple. Is there anything preventing this from happening. No. Applicable regulations have been removed, and those still on the books have not been enforced. Is there any reason not to do it given the incentives and principles at play? No. Therefore, it will happen.

What we have is essentially private, unregulated money creation prompting hyperinflation in certain markets. We have an intensely large, and at this time, unknown amount of counterfeit money and value mixed in with the real. Apparently we cannot tell real money apart from counterfeit money very easily, and/or we are trying to hide the counterfeit cash through deficit bailouts from the taxpayers.

We also know that we cannot keep these fraudulence-based markets (i.e. housing) artificially inflated because they are so out of line with reality-based fundamentals and facts. However, we also largely do not have the grit to face the consequences of this rip off. So our interim strategy appears to be to try to ease into austerity by hiding the deficits, allowing companies to continue to mark to model, holding foreclosed houses off the market, etc. It is a common and understandable (but not excusable) human response. It won't work, and it will both deepen and elongate the painful coming to terms.

Even money markets fell below 100% of principal. Think about that. That's unprecedented in its scale and severity. You don't need a canary to tell you what is going on. There has been a massive liquidity drain. Money has disappeared and been replaced with fraudulent substitutes of value. I've mentioned in other essays that this situation will eventually require massive debt forgiveness. Fraudulent or concocted wealth begets fraudulent debt. So we should come to terms with the necessity of debt erasure for larger swathes of the globe. The instigators have unfortunately, not only already been forgiven, but been rewarded with hundreds of billions of dollars of bailout money. Accountability, if it ever happens would demand these instigators go bankrupt, face criminal prosecution, and supply restitution, including returning their private, ill-gotten gains.

The Micro View:

How does this profoundly twisted macro mentality play itself out on the micro level? Let's look at some examples:

/Credit card companies/

Many people are aware that those consumers who pay off their credit cards every month are a liability to the credit card company. They get a short-term loan at no interest on a no-fee credit card (though the credit card company does charge a fee to the vendor). So credit card companies don't like those who pay off their cards. Furthermore by paying up, you, the borrower, have wiped out the credit company's "asset" debt. They need someone who preferably misses a payment, so the effective interest rate can kick to 30 -- 35%, someone who only makes the minimum payment, so the principal debt increases over time (enlarging the "asset"), and someone that will always pay the minimum payment even if they can never pay off the card.

Again the most desirable client is one who has the worst financial habits, not the one with the best. There is a reason that someone who carries a balance gets a higher credit score than someone who pays off the balance. All is swell at least until that underwater client defaults with thousand of others. Not even the industry written bankruptcy "reform" will hold the tide as that happens in increasing numbers.


Banks, in this "new era," expanded their traditional lending operations into broader "financial services." There was more money to be made and more market share to grab by creating a whole new host of products built around "servicing" loans (rather than just collecting them), providing financial advice, and establishing credit lines. Especially as money becomes cheaper and cheaper (i.e. the Federal Reserve sets effective bank lending rates near zero), the effective marginal profit from straight lending dwindles. Banks cannot pay anything lower than a quarter percent to savers, and competition forces the lending percentages down. Since traditional reserves are based on capital from savings (considered a liability), the pressure mounts to find a way to "capitalize" through debt.

So banks "branched out" in tune with "successful" lobbying and deregulation. This created both conflicts of interests and dangerous precedents, effectively merging banking with insurance and investment brokering. Maintaining capital reserves became a quaint notion because money lying around was so "unproductive." A myth arose that money would always be there and interest always low. This myth has proven, of course, false. Even with low interest, there is now a liquidity crisis, because real wealth was siphoned off by unproductive and no-value-added services, either stored as private wealth in opaque Swiss bank accounts, invested in worthless crap (like credit default swaps), or dumped into plunging markets (like housing).

/Credit default swaps (CDS's)/

I've already written many essays on this subject, so I will only summarize the transparent fraud perpetrated under these "vehicles." CDS's are unregulated insurance against defaults on loans. Though the mechanisms have not been officially investigated and audited, it does not take a genius to conclude that AIG and others could "guarantee" loans and receives premiums for nothing, that is, without actually possessing any reserve capital or exchange service at all. Using their once respected reputation as collateral, and dubious investments conveniently and generously assigned value by their own accountants, these institutions could create cash flow without providing anything in return except assurances. No wonder these vehicles were so attractive.

This would be like you or me receiving nice batches of money from our neighbors to insure against their houses being destroyed by fire, using our own house as collateral, with all of us living in the middle of a tinder-dry pine forest. The fire simply is going happen sooner rather than later with these conditions (akin to the poor fundamentals in the economy), and you and I won't have anything left with which to pay others. However, we will have a huge private stash created by the fees and premiums we have charged and the bonuses we've given ourselves. This, at least, could help us rebuild our own mansions.


According to any kind of fundamental analysis (see Patrick.net for a good summary) the transparent irrationality of house prices could not have been clearer. Real incomes have been flat or declining over the last decade, even though productivity rose substantially. Purchased houses in overheated markets required monthly payments three times what is would cost to rent the same house. Some people were paying as much as 10, even 20, times their salaries to buy a house. (I remember a newspaper report of a 750,000 dollar house bought on a 40,000 dollar/year salary.) Reporting and underwriting requirements simply disappeared on the false conviction that "housing prices will always go up in the new era." Of course this could not be sustained, any more than an actual house could be supported on a foundation of air (without the fitting metaphor of balloons as in the new Pixar movie "Up").


Stocks were bound to fall as well, since they were being inflated by a number of factors related to the outright greed and entitlement created by this "new era" thinking. First, many companies who once only manufactured products decided to financialize themselves, i.e. GM, which went from only manufacturing cars to providing GMAC financing. Second, chief executives found their huge bonuses tied to stock prices, so they found ways to manipulate demand/value, and thus stock prices, by buying up their own stock, or better yet by leveraging their assets 30 to 1 to expand business, merge with other companies in huge multi-billion dollar deals. Great paper profits mean great bonuses even when you are cannibalizing stability.

Third, housing and other irrationally inflated sectors provided stockpiles of illusory consumer equity and short-term job growth, encouraging a consumer spending orgy on a range of goods and services that buoyed the economy. Fourth, for eight years a presidential administration and its entire executive branch allowed industries to write environmental laws allowing for indiscriminant toxification of the environment, waste in energy, and pliant, absentee oversight in agencies like the Security and Exchange Commission. We are now coming to terms with the fact that environmental and economic limits are and will continue to force a decline in manufacturing and sales. Those cut GM dealerships and factories are not coming back.


Believe it or not, the exposure of these falsehoods and a return to real economy should be the basis for optimism not pessimism. I, for one, am only too eager to leave behind the anxiety mixed with empty hedonism of a debt-driven economy. We now have a pressing need to commit to creativity, transparency, honesty, accountability, and real prosperity. Our Greek tragedy lies not only in the economic hole our irrational binging has left us with, but the moral, physical, environmental, and character hole. It is no surprise to me that skyrocketing obesity, approval of torture, toxic crap from China, the burying of a perfectly functioning electric car (GM's EV-1), and the out-of-control cost of sick profiteering (mistakenly called health care) all happened to attend this delusional phase of our economy.

We now have a chance for real quality of life based in those important things we have been neglecting love, friends, family, community, healthy eating and farming, breathing clean air, drinking clean water, making an honest living, working hard, and learning about our world and each other. We are recovering from a long illness symptomized by a suicidal, selfish, unreflective, and exploitative egoism. If we take advantage of this opportunity, refuse to listen to self-interested "experts" who seem to care about nothing but their own obsolete authority, money, and power, we can move toward single-payer health insurance, sustainable, organic, community-focused agriculture, demilitarization, economic equity, more leisure time, and a diverse, interconnected global citizenry. For too long "national interest" has been associated with using others instead of respecting them, foisting consequences on future generations instead of working together to co-create a healthy, vital world. Now we have a choice. It is time, given our current and profound lesson about the alternative, to make the right one.


1   someone else   ignore (0)   2009 Jun 26, 5:56am   ↑ like (1)   ↓ dislike (0)   quote        

> It's great! May I publish it on my own site? I especially appreciate the
> reference, because I think a lot of people will refer to this essay in
> the future.
> One point you didn't cover is that debt is used as a control mechanism
> over labor. If workers are in debt, they must keep working or suffer
> some loss, maybe their house or car. Employers love this of course.
> The flaw in this modern-day slavery model is default. If workers realize
> how they are being captured and used by the debt system without any hope
> of paying it all off, they may simply default and walk away. They
> perhaps lose their house or car, but they gain their freedom, and that's
> dangerous to the established order.
> Patrick

2   someone else   ignore (0)   2009 Jun 26, 5:56am   ↑ like (1)   ↓ dislike (0)   quote        

> Patrick,
> Feel free to post this on your site. Given your perceptive comments
> below (to which I add my whole-hearted agreement), you may want to
> provide an addendum or follow-up essay, on the important points you
> highlight below. You are 100% correct. It isn't just that insurance
> companies don't want a public, transportable option in health care, it's
> that the whole business apparatus does not want any change that may
> interrupt their stranglehold over American households.
> Of course, that capsizes even business interests in the medium to long
> terms by eroding the very ability of anyone to pay for anything. Choice
> and a strong middle class are essential to a sound economy that can
> produce healthy long-term profits. But restricting choice and
> destroying livelihood for short-term profits and the creation of
> debt-slaves, it all looks great on paper, but, as I explained, only sets
> up a situation of either necessity or disgust, prompting regular
> citizens to walk away from "obligations."
> I still get most of my progressive friends telling me it is immoral to
> walk away from a house that you owe money on.. I counter with, "Well,
> everyone of you has no problem when a corporation sets up a subsidiary
> that does the exact same thing to any investment.." If it goes sour, a
> corporation walks away because it is not making money, so why not
> regular people. (And the answer is... because we need some "moral"
> suckers to support our immoral control.)
> It is only in civil disobedience to this system (walking away as a moral
> choice to confront this injustice, among other actions) that we actually
> erode the injust basis of the economy. Otherwise we are simply
> co-dependent enablers of a very corrupt and damaging organization of
> power.. You and I get this. I hope that more will begin to get this.
> If my essay can help in its own humble way, viva la democratic uprising
> and return to sanity.
> Regards,
> Zeus

3   MarkInSF   ignore (1)   2009 Jun 26, 6:31am   ↑ like (0)   ↓ dislike (0)   quote        

June 26th, 2009 at 12:56 pm | top | quote | email

> It’s great! May I publish it on my own site? I especially appreciate the
> reference, because I think a lot of people will refer to this essay in
> the future.
> One point you didn’t cover is that debt is used as a control mechanism
> over labor. If workers are in debt, they must keep working or suffer
> some loss, maybe their house or car. Employers love this of course.
> The flaw in this modern-day slavery model is default. If workers realize
> how they are being captured and used by the debt system without any hope
> of paying it all off, they may simply default and walk away. They
> perhaps lose their house or car, but they gain their freedom, and that’s
> dangerous to the established order.

At least in the current system bankruptcy is an option, and most mortgage are non-recourse.

A mortgage lender is really no different than a pawn shop lender other than interest rates. They extend credit against collateral. If you pawn your watch, and don't meet your payment terms for reclaiming possession (title) to the watch, they pawn shop sells it. If they can't sell it for the the loan amount, they lose money.

Amazingly, some people think that the goverment should force the pawn shop customer to pay a "deficiency" if the pawn shop screwed up and lent to much money. They want the pawn shop to have risk free profits with the force of goverment behind them.

OK, maybe not pawn shops, but mortgage lenders, which are exactly the same thing, different collateral.

The housing bubble was basically people bidding on houses with their promises to pay. Whoever was willing to enslave themselves to debt the most got the house.

Like the OP said, that debt is somebody else's "asset", much of it ultimately "money" in the form of bank deposits.

That's why I have almost all my savings in FDIC insured deposits. Because I think a lot of "assets" will turn out to be nothing of the sort.

The funny thing is, all these goverment programs to "keep people in their homes" really just keeps them on as debt slaves so they don't bring down the system. The rational economic choice for most of these people is to walk. The goverment isn't helping them, it's helping those with the "assets".

4   Brand165   ignore (0)   2009 Jun 26, 10:45am   ↑ like (0)   ↓ dislike (0)   quote        

All mass insanity is consistent with its irrational premise. How else can you explain Communism?

5   Brand165   ignore (0)   2009 Jun 27, 9:21am   ↑ like (0)   ↓ dislike (0)   quote        

Forgive our debt? Why? The debts are in our own currency. Even if we inflate it badly, it's still worth *something*.

The Housing Trap
You're being set up to spend your life paying off a debt you don't need to take on, for a house that costs far more than it should. The conspirators are all around you, smiling to lure you in, carefully choosing their words and watching your reactions as they push your buttons, anxiously waiting for the moment when you sign the papers that will trap you and guarantee their payoff. Don't be just another victim of the housing market. Use this book to defend your freedom and defeat their schemes. You can win the game, but first you have to learn how to play it.
115 pages, $12.50

Kindle version available

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