This is a posting that might offer a clearer picture of the financial mess. I’ll use a column from a highly recommended economist along with some canine common sense to tame those ferocious hounds the banks unleashed on us. Either way, brace yourself for a big bite – maybe $2 trillion.

Since September, we’ve realized one thing. No one can really figure out how to solve the economic solution.

One economist told me that a recession is like a hang-over. “You tell yourself two lies. The first is that you’re going to die. The second is that you can do something right now to end it.”

So, time is one solution. Some of us don’t have time, though, as jobs and our savings evaporate.

But there may be a sign that a solution is here.  (You’re not going to like this.)  It’s when all those crazy financial instruments – derivatives, credit default swaps, and hedge funds – come back.

Don’t click delete yet. I can hear what you’re saying.

 

So, Daly, what you’re saying is we need to allow the idiots who got us into this problem to go back out on the streets and do what they did before? That’s like saying you want the drunk drivers back out driving again.

Hear me out. I’m not nuts. And I am not a cheerleader for Wall Street. Sure, we need to crack some of the Wall Street higher-ups in the back of the head for spending money on retreat spas and office redecorating. These knuckleheads are really a small minority. And like it or not, we need them. And we need them to get back to work.

Some simple background is needed. The problem appears to be that the banks aren’t lending – despite the billions in TARP money. True, but banks don’t just lend money. They lend money and then they sell those loans to other institutions who sell them to investors. The banks then get paid and have more money to lend.

This is best described by John Mauldin, an economist who consults for investing firms. His newsletter, Thoughts from the Frontline, is quite good. It’s free. Yes, you have to weed through some pitches and personal stuff about John and his family and his travels.

But he will offer some gems. The most recent came in his column from January 23, 2009.

The real problem is that we vaporized an entire Shadow Banking System that bought securitized debt in a wide variety of forms: autos, homes, student loans, credit cards, etc. That industry exists no more.

Mauldin explains further what we took for granted.

A pension fund in Norway (or wherever) would look at the rating from Moody’s, see AAA, and buy it. Or banks would create off-balance-sheet vehicles (SIVs) to buy their debt and leverage it up, and book some nice profits. In any event, the debt did not end up on the banks’ balance sheets for very long.

Those off-balance sheet vehicles are like pit bulls. Everyone is frightened of pit bulls. They’re perceived as killers. But they’re not killers. Pit bulls are only killers when they’re trained to be killers. A good owner and trainer can turn these dogs into loving, friendly, and gentle pets.

It’s the same with these sophisticated financial instruments. They’re actually brilliant devices that help balance markets – if done correctly. The problem was they weren’t regulated and they lacked transparency. In short, no one trained them and they came back to bite us.

Remember the Michael Vick dog fighting chapter. Many of those dogs had to be destroyed since they were either so damaged or they were beyond being retrained. The same might be true for these financial instruments. It’s going to take a while to find some new dogs.

Now that process is broken, and it will not be fixed this year or next year or the year after that. We are going to have to come up with new ways of credit creation and debt processing. You can’t go to Goldman and tell them to start making auto loans. They simply don’t have the people to do that. Now, they used to be able to take auto loans from other actual originators and package them and sell them, but they did not make the loans. And the buyers for much of that securitized auto loan paper are gone. And they are not coming back any time soon without greater transparency and real capital guarantees and higher returns. A Moody’s (or any rating agency) rating is not worth the paper, as far as the markets are concerned.

Thus you understand President Obama’s desire to start regulating the financial markets right away. We need them back and running – but with transparency and regulation that we all understand.

If we can get that Shadow Banking system in place again, we will start to see lending and economic growth.

The economic activity might also increase the value of those toxic assets on the books of the banks and other financial institutions. Mauldin echoes what I wrote in some previous columns. The toxic assets being held by our financial institutions are far worse than we thought or the banks will tell us – and they’re only getting more worthless.

Mauldin, like me, believes we will need somewhere between $1 trillion and $2 trillion in this or future stimulus packages. Presidential Economic Advisor Larry Summers hinted at that this morning on Meet The Press. Economist and columnist Paul Krugman has been begging for something bold as well.

Either way, folks, prepare yourselves for more than a big bark from President Obama.  And yes, he will need to feed our financial institutions with money and a tight leash.

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