Financial Crisis - How the flows work

What is going on? How big a problem do we face? here is Rob's simple guide for the perplexed.

It's all about flows.

The money leaves America through two main channels:

Our addiction to oil which is priced in dollars.

Our addiction for stuff - which is mainly made in Asia and paid for in Dollars. Americans hardly make stuff anymore we just do important things like marketing and working in McDonalds.

We buy so much stuff in dollars that the makers of stuff are loaded with dollars. So are the folks who have oil.

They have mountains. They have oceans of US cash. So they push it back into the banking system that is now awash with cash.

The banking system is floating in money - they have to get a return. So what do they do - they lend it to people. But most of the good risks have all the credit they want. So they find a way of lending to people who should not be borrowing.

They think that they are reducing their risks by financial engineering. They take a block of shit mortgages, credit card debt or car loans and package them up and add a "layer" of insurance equal to what they think the normal risk of default might be. The insurer is AAA and the rating agencies rate the package AAA. This works - for a while - when there is not too much of this paper around. But when the market is flooded with this type of paper, the underlying idea of the "normal Risk" covered by the insurance goes out of kilter.

When all the housing market stops going up, then all this paper is under water and the insurance cover is not enough. What was AAA is now shit. Meanwhile, this late in the cycle, everyone has loaded up on the paper.

Everyone wanted a high return when there was so much liquidity that this was impossible. Lender A got rid of its shit but bought Lender B's shit. So did your town and your pension fund.

Worse it was not just the subprime mortgages but the sub prime credit cards and auto loans.

Now what do you do if you are an Oil Sheikh or the Chinese. The value of the dollars that you own is going down as the full extent of the mess becomes visible.

Simply owning the cash is of no value. Selling your dollars will increase your losses. What do you do?

You "Invest" in the underlying assets in America. As you buy in effect control of the banks, you get control of their underlying assets. You buy prime real estate. You buy mines and forests.

What we will see soon is a fire sale of prime assets and a transfer of real wealth - not just cash - from America to China and the oil producers. What we are seeing is a huge transfer of power.

I don't think there is any way to put the pieces back - we are just going to have to live though this.

PS My name is Rob and I was such a banker for 23 years