What happens when you create credit out of thin air... - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 18 August 2014
What happens when you create credit out of thin air... A  A  A

Ouzilly, France

Assumption Day

Dear Diary,

Today is a holiday in France. You wouldn't know it. No one is working, but that is just like every other day in August.

"This country is completely f***** up," says our handyman. "Nobody works. Everybody expects something for nothing."

Damien deserves description. His parents gave him to an orphanage 44 years old. At 16, he began smoking and went to work; he's been smoking and working -- as a truck driver, day laborer, gardener, and handyman -- ever since. He always has a cigarette in his mouth. Even as we are about to move a piece of heavy furniture up the stairs, he stops:

"Wait, I've got to light a cigarette."

He's a good-hearted fellow. But he has faults. He has a preternatural dislike for plants, especially flowers; which is a defect in a gardener. He mows them down; gases them with Roundup; withholds water in dry periods, and otherwise neglects them. Often he allows so many weeds to grow up around them that they are starved for sun and water. Then, he announces that they "didn't do very well this year," and cuts them all down with the weedwacker.

He has serious limitations as a handyman, too. The main one is that he is not very handy.

We normally defend Damien against criticism. For he is a stout worker and loyal companion. There is nothing he won't try to do. And when the bell rings for drinks at 7pm, often he brings his own homemade 'pineau'...or something stronger, such as his 'eau de vie,' distilled illegally from local plums. He fills and refills our glass, as well as his own, for as long as we are able to keep going.

But this week an incident occurred that caused us some concern. Details to follow. First, we must do our duty as your financial scout:

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The Dow rose again yesterday, up 61 points. The major sell-off that seemed to be underway last week has petered out.

This will allow the credit bubble to grow even larger and more menacing. When you create credit out of thin air...and then price it too cheaply...you have to expect that people will find ways to take advantage of it. They will find new ways to borrow and lend. In the last major bubble, sub-prime mortgage debt was the most volatile gas. This time, we are seeing innovations and absurdities in sovereign debt, corporate debt, the art market, technology stocks and many other areas. Here's just one item that appeared on our laptop screen lately, from Bloomberg:

    JPMorgan Joins Goldman in Designing Derivatives for a New Generation

    JPMorgan Chase & Co. is offering a swap contract tied to a speculative-grade loan index that makes it easier for investors to wager on the debt. Goldman Sachs Group Inc. is planning as much as 10 billion euros ($13.4 billion) of structured investments that bundle debt into top-rated securities, while ProShares last week started offering exchange-traded funds backed by credit-default swaps on company debt.

    Wall Street is starting to return to the financial innovation that helped extend the debt rally seven years ago before exacerbating the worst financial crisis since the Great Depression. The instruments are springing back to life as investors seek new ways to boost returns that are being suppressed by central bank stimulus. At the same time, they're allowing hedge funds and other investors to bet more cheaply on a plunge after a 145 percent rally in junk bonds since 2008.
The general idea in '07 was turn debt into an asset, by 'securitizing' it. This would make it easier to lend more money to more people who couldn't pay it back. But the innovators work on the demand side too. What, you can't borrow because your credit score is too low? Hey, the credit industry has a solution. The Wall Street Journal:
    FICO Recalibrates Its Credit Scores

    A change in how the most widely used credit score in the U.S. is tallied will likely make it easier for tens of millions of Americans to get loans.

    Fair Isaac Corp. said Thursday that it will stop including in its FICO credit-score calculations any record of a consumer failing to pay a bill if the bill has been paid or settled with a collection agency. The San Jose, Calif., company also will give less weight to unpaid medical bills that are with a collection agency.

    The moves follow months of discussions with lenders and the Consumer Financial Protection Bureau aimed at boosting lending without creating more credit risk. Since the recession, many lenders have approved only the best borrowers, usually those with few or no blemishes on their credit report.
Did you notice that last remark? Reworking credit scores are intended to boost "credit without creating more credit risk." Good luck with that!

Okay...we've put our head up over the parapet. All quiet on the Western front. We saw nothing. So, let's go back to Damien...and why we're ratting him out.

The other day, Elizabeth asked him to move some things out of the house, in anticipation of our big party. Rain was in the forecast, so the house had to be cleaned out to accommodate guests.

Damien went at the job with his customary 'bull in a china shop' finesse. He loaded Elizabeth's delicate antiques onto a rickety wheelbower and bumped along to the garage. There, he pulled out a pair of feeble trestles...made a table...and piled the boxes and furniture on top.

We walked by and saw that the trestles were listing dangerously...and were about to fall over.

"Damien, we have to fix this. They're going to fall over.'

"Ah no...it's all right."

"I don't think so...let's put in another trestle, just in case."

"Okay...you lift it up and I'll stick this other one underneath."

I tried to lift it. But it was too heavy.

"This isn't going to work. We need more manpower."

With that, Damien grabbed the side of the table top with one hand...holding the free trestle with the other. But the mass on top was too heavy...and the effect of Damien's intervention was to destabilize the whole thing...which promptly crashed to the ground, breaking one of Elizabeth's heirloom teapots.

Later, when Elizabeth discovered the wreckage, she remarked to Damien.

"Oh no...you've broken the teapot I got from grandmother."

"No, it wasn't me. It was Monsieur Bonner. I told him to leave it alone."

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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