Bubble Trouble

M-5 Money

What Is a Bubble?

A Bubble will occur whenever there’s a disproportionate, upside-down relationship between the purchase price of a thing, and the actual value of that thing. Upside-down? The value of the thing will never be as high as the price paid to buy it.

Buy ‘low.’ Sell ‘high.’ One joins a bubble by betting that the current price to buy-in will always be less than the future profit to sell-out. On its best day, a bubble is a pyramid scheme. Those who buy-in early have a greater chance to make a profit than those who buy-in late. Those who buy-in late also buy-in high, then the bubble bursts and they lose. Those who buy-in early, but fail to recognize when it’s time to get out, also lose.

‘Early’ and ‘Late’ seem to be important keywords, but they’re not. This is because ‘speculation’ doesn’t have a fixed timeline. The life of a Bubble doesn’t have an easily defined start and end-point.

“The existence of a Bubble is seldom recognized until after it blows up.” At least, that’s what the ‘experts’ say. I say the experts are wrong. The truth is: you CAN see a Bubble forming; you CAN watch the inflation of cost over value; you CAN see the un-put-off-able moment in the future when the Bubble will burst, scattering the remains of the bank-account-bodies of all who participated; and scattering with such wide dispersion that no effort to rake back the remnants can ever succeed.

Recognition is easy, and common sense always sparks an early warning. The inner still-small-voice is actually very loud when it shouts, “This is a bad idea! This is wrong! This can’t continue! This is crazy! Don’t do this! STOP, STOP, STOP!!!!” The problem with human nature is that the voice called Still-Small is easily overwhelmed by the voice called Greed.
Still-Small says, “This is bad.”
Greed answers, “But, I want this.”
Still-Small emphasizes, “This is crazy.”
Greed retorts, “So what. I want it.”
Still-Small insists, “It won’t work. You’ll lose everything.”
Greed rejects, “I don’t care. I still want this.”
Still-Small shouts, “STOP, STOP, STOP!!!”
Greed shouts back, “Shut up! We’re doing it!!!”
The owner of both voices agrees with Greed, and says, “Okay.”

Later, probably much later, when it turns out that Still-Small was right all along, Owner will helplessly say from a destitute position, “Uh-oh. That didn’t work. I’ll never repeat that mistake.” Then, Greed will quietly suggest, “Let’s do it again;” and Owner, though given the chance to be wiser and more resolute from the previous failure, will instantly answer, “Okay.”
Your training begins now. After studying what follows, you’ll be better able to see a Bubble forming; watch the inflation of cost over value, as it happens; and foresee the approximate moment in the future when the Bubble will burst.

Sample Bubbles

To better understand the formation of the mentality that goes with a Bubble, here are only a few instances when Greed got people to say, “Okay.”
Tulip Bubble 1634-1638
Great Depression Bubble 1920-1941
Sub-Prime Mortgage Bubble 2000-2007
Ghost Bubble 2009 – still in progress

TULIP BUBBLE – “Tulipmania” (1634-1638)

In the early 1630’s the modest tulip was imported into Holland. It was brought from China, where it was so plentiful as to be nearly worthless. But, Dutch flower sellers figured out how to make it worth more in Europe, so they could make more money. They created a ‘standard’ by which various tulip varieties and colors could be graded, or assigned a value.

But, the standard was based on more than color and type. It was also based on supply and demand. This is how the flower sellers made their money: they would charge more for tulips in short supply. This was highly profitable as long as demand outran the supply of specific bulbs on hand.

To keep demand high, the sellers propagated speculation on bulb value. It was suggested to buyers that if a particular variety of bulb, called the Viceroy, was purchased as soon as it arrived from China, it could be resold in a few months for a high profit. A runaway buying binge began. Unnoticed, the bubble began to inflate. However, the profits were noticed.

The rich noticed the profits. At first, because they had cash on hand, only the wealthiest people, aristocrats, nobility, and royalty, could afford to buy-in. But, buy-in they did; and money they made. Soon, the attractive profits possible from betting on the increase of the future value of tulip bulbs reached beyond the rich.

The gentry noticed the profits. Land and factories were mortgaged to raise cash to buy and hold tulip bulbs – one never planted a bulb, because they were too valuable – for the purpose of reselling to make money. It worked.

The middle class noticed the profits. To raise the buy-in money, mortgages were initiated against homes and farms. Paintings, furniture, rugs, and jewelry were added to the collateral. Even their children’s college tuitions, already financed by loans, were diverted to increase investment capital.

The poor noticed the profits. Those who were more resourceful combined all they had in cooperatives, which would buy-in on their behalf. Though their possessions and homes were too meager to mortgage, they simply sold everything they had, then combined the proceeds, which were immediately and completely invested. Living in the street was a small price to pay in exchange for the rich return.

The flower sellers re-noticed the profits. The very people who had created the flower frenzy in the first place saw everyone else making lots of money, fast. By now, the bubble, still unrecognized, was about to reach maximum capacity, but no one could see it. Late in the game, the flower sellers, overcome by their own hype, risked all the profit they had already made, and plopped it on a plant.

All across Europe, everybody, everywhere, risked everything they had to invest in ‘tulip futures.’ As long as the price continued to rise, the profits kept rolling in. This could continue as long as the perception of value continued. Value was based on the idea that all the bulbs included in the investment frenzy were one variety, the Viceroy; and all bulbs could be presented as the Viceroy, as long as there was no proof otherwise, as long as no bulbs were ever planted.

Then, a terrible thing happened. In the spring of 1637, for the purpose of creating a private supply to expand sales to investors, someone planted their bulbs. A few weeks later, sprouts rose from the furrow, then blossomed. The Viceroy was not among them. …Uh-oh!

A state of panic swept over the continent, ignoring borders and personal stature, alike. Bulb-wise, no one knew what they had. Was it the Viceroy, or not? Consumer confidence collapsed.

Charles Mackay, in his definitive history of early financial bubbles, Extraordinary Popular Delusions and the Madness of Crowds (1841), reported: “hundreds who, a few months previously, had begun to doubt that there was such a thing as poverty in the land, suddenly found themselves the possessors of a few bulbs, which nobody would buy, even though they offered them at one quarter of the sums they had paid for them.” In 1638, only unprecedented government intervention stopped the bleeding.
I believe that at some point within the mind of every single one of those tulip investors, there was a common early thought, “This is a bad idea, even crazy. I think I’ll stop. Why would I risk everything I have, hoping that someone else will pay more for my root?” Then you-know-who replied, “Shut up! We’re doing it anyway!!!”……… “Okay.”

Great Depression (1920 to 1942)

Everyone living now has been affected by the Global Mortgage Meltdown of 2008. But, few realize this catastrophe had a rehearsal – 1929.
Often referred to as The Wall Street Crash of 1929, the temptation is to think of it as a stock broker problem, which occurred over a period of weeks. Even some economic historians usually attribute the start of the Great Depression to the sudden devastating collapse of U.S. stock market prices on October 29, 1929, known as Black Tuesday. But the dark truth is: the stock crash was a symptom, rather than a cause, of the Great Depression. Symptom of?……………a nine-year-old bubble.
Here’s How It Happened : By 1920, mass production had come of age in America. In the early 1920’s the U.S. had developed great production capacity for consumer goods, such as refrigerators, washing machines, automobiles, radios, telephones, and the like. These were very expensive for the average worker at that time.
Then, from the mid-1920’s to the late 20’s, there was an explosion of installment credit. For the very first time, people could borrow to pay for all the new modern machines and appliances.

The natural order was :
Greater sales meant an increased need to manufacture more goods,…
…which led to a greater need for expansion of manufacturing facilities,…
…which led to a need for investment,…
…which meant selling stock to people who borrowed money to buy the stock.

There was a rapid rise in credit, as more and more people of all economic strata sought to buy-in to the profits of investments based on rising stock prices, until a point was reached when it was known that there was more credit than cash. Scattered among those people were thinkers whose still-small-voice was loudly warning, “This is crazy! Stop borrowing right now!” But the warning was ignored, and the system collapsed.
Prior to 1933, there was one other major contributing factor, which depleted the bank accounts, even of people who were not dallying in the stock market, or the credit frenzy. At that time, banks were not restricted from using its patrons’ checking and savings accounts as investment capital for the benefit of the bank, without the patron’s knowledge. This was the primary cause of so many bank failures, as well as the ruin of millions of people who had trusted the banks to take care of their money. As long as there was money in a bank’s vault or credit line, those who owned the bank could ‘invest’ as much as they wanted.

New legislation, the Banking Act of 1933, was enacted by congress. Within the Banking Act was formed the Federal Deposit Insurance Corporation to provide deposit insurance guaranteeing the safety of a depositor’s accounts in member banks; then up to $100,000; now up to $250,000.

Portions of The Banking Act are referred to as the Glass-Steagall Act, two provisions of which prevented affiliations between commercial banks and securities firms. In other words, banks could no longer dip into the vault to buy stock. Neither could investment and securities firms accept money on deposit, as if a bank. As long as Glass-Steagall was in effect, the economy had a chance to stabilize. Remember this. In a following section, the repeal of Glass-Steagall has dire consequences.

In 1934, as a direct response to the crash of ’29, the federal government enacted The National Housing Act to insure mortgages. This meant that if a bank issued a mortgage to a borrower, but the borrower couldn’t pay back the mortgage, then the bank was paid, anyway, by the insurance.

To oversee the implementation of standards for home mortgages, the Federal Housing Authority (FHA) was also created. The first task of the FHA was to set standards for the criteria of what makes a good mortgage, so the insurer could be better protected. This standardization had the unexpected result of changing the home mortgage from a stand-alone debt into a commodity which could be bought, re-sold, and traded, just like stock, or any other investment.

These actions were great for the future, but right then, they were too little too late. Sadly, as we all know, the value of the stocks collapsed. The banks had no way to get their invested money back. The vaults were empty.

Full bank vaults, at least the belief in full vaults, was the only thing keeping the economy percolating. The confidence in the ‘full vault’ in 1920’s America, was equal to the assurance in 1636 Holland that every bulb was the Viceroy. When the empty vaults were exposed, boundless panic overshadowed every corner of the nation. Along with that panic came the revealed reality that the common goal, easy riches with borrowed money, wasn’t real.

Home Mortgage Bubble (1999-2008)

In the 1980’s the concept of Managing Mortgage Securities began. Banks which initiated mortgages didn’t want to hold on to them, because it took too long to realize the financial yield. These banks could make money faster by selling the mortgages, or even trading against the future value of the mortgages. This was an early use of the Mark-to-Market form of accounting.

Before 1990, the debt that a bank could hold was proportional to the cash in the vault. This cash had to be either in the bank’s vault, or in the vault of another bank, or invested in the Federal Reserve, or stored as gold in Fort Knox. It was real money, with real, immediate value, and it could be physically touched and counted by a human being.
By the 1990’s, banking regulations were relaxed to allow debt that is owned by a bank, such as credit cards and home mortgages, to be counted as cash-on-hand. The removal of restrictions allowed banks to create more instruments of debt without balancing that debt with cash. This was setting up the time when banks would once again be able to legally empty the vault without permission.

1999 saw the repeal of the main provisions of the Glass-Steagall Act, the ones preventing banks and securities companies from fraternizing and pretending to be one another. With Glass-Steagall out of the way, there was no longer a system of oversight or accountability. This was the end of the time when banks had to have actual cash on hand to back up their customer’s deposits. The vaults were empty, and no one cared.

Banking, Investment, and Lending regulations were quietly side-stepped, then legally removed. With all restraints off, the unthinkable was possible. Imaginary money from the future could be counted as if it was real cash in the present. Enter Mark-to-Market accounting.

Mark-to-Market accounting allows that once a long-term contract is signed; income is estimated as the present value of net future cash flow. Believe it or not, this was actually approved by the United States Securities and Exchange Commission.

While using M2M, projected future cash flow can be recorded in the present books, and counted as profit, and counted as cash-on-hand in the vault. This profit might not ever be received as actual money, but projected profits based on imaginary, future, pretend cash, are shown on the present books, as if they are real.

A trait unique to M2M accounting is: even if a future project fails, or results in a loss, all projections of future earnings already associated with that project, though that project proves to be a total loss, are still reported as present gain. This system requires all who buy-in to consciously submit to pure fantasy, just like 1920’s stock market borrowers, and 1630’s tulip bulb buyers.

A weakness of M2M is: in future years, projected profits can’t be included when they actually happen, because they’ve already been counted in the past. So, new and additional income has to be cultivated from more future projects in order to develop additional growth, and keep that growth expanding……like a bubble.

The Application of M2M to Home Mortgages – Unchained, banks and securities companies were free to apply M2M to every investment instrument they could invent. Mark-to-Market allowed the future repayment of every type of debt to be counted as profit in present balance sheets. This allowed banks to say they had full vaults, even though the vaults were ‘filled’ with imaginary money from the future, which was the same as empty; but they were no longer required to say that. A ‘full’ vault from the future could balance any present dollar amount the bank wished to hold in debt instruments, whether credit cards, student loans, payday loans, or home mortgages.
Home mortgages held the promise of greatest return. Using mortgage grading standards established by the Federal Housing Act of 1934, gave great credibility to actions of financial institutions in the twenty-first century. They could look like they were following the rules, when actually, there were – are –no rules.

As a side note : This is still happening, right now. There are no rules, because those who stand to make the greatest profit from illicit practices, like M2M, are the same ones who are in political control. They are the ones who keep rules from being made. Even so Glass-Steagall is back in the news, touted this way by Peter Schroeder of THE HILL: “A Depression-Era banking law is helping to shape the 2016 presidential field, as Wall Street critics push hard for its return.”

Presidential candidates are dancing on the thin line of popular opinion trying to give the appearance of guarding the empty bank vaults of the nation. Democratic and Republican rivals are trying to find the sweet spot at dead-center to tap into public unrest over Wall Street without turning off Wall Street’s spouting fountains of fundraising. So, as long as they can look like they care without actually doing anything, those who can make rules won’t.

Under the Federal Housing Act, mortgages were graded as Triple A (AAA): absolutely will be repaid; Double A (AA): very likely to be repaid; Single A (A): will sometimes be repaid; and Sub-A: will NOT be repaid. Some current grading systems use A, B, C, and D; or AAA, AA, and A for “good” mortgages; and BBB,B,B for not so “good” loans.
There are no set standards. It’s important to know that the grading is done by the lender of the loan. Grading is an on-the-fly opinion process, not a fact based method.
Mortgages are graded in groups, not against a universal standard, but only within that particular group. Any given mortgage in the group is scored, by credit rating, in comparison to only others in that same group. The highest third in the group is graded AAA. The middle third is AA. The lowest third is A.

To make the most money, financial institutions buy and sell as many AAA mortgages as possible, the object being to be able to report as profit on the present books, with certainty, the cash flow which those paid-off mortgages will bring in the future. This same process can be applied to AA and A debt.

An interesting twist with this system is that the same thing can be done with a group of all Sub-A loans, the bad stuff. After comparison within the group, the top third of the Sub-A loans will be graded AAA. These faux AAA loans can be sold to institutions looking to bolster their future-present balance sheets, and the value of their corporations.

Because there’s no universal standard in grading debt, there’s no way to tell whether one AAA group was created from actual AAA mortgages, or if it was dredged from sub-A trash.

For the system to keep working, everyone had to believe that every mortgage in their future portfolio was real, true, AAA gold. If not, Uh-Oh!

Also, for the system to be kept working, more debt had to be cultivated. Since the future has a bad habit of becoming the present, and the used-to-be future profits had already been counted in the present-become-past, new debt had to be raked in, in any form, to keep the wheels turning. But, only certain people who made a certain amount of money, and with certain credit scores, could qualify for a home mortgage; and their number was finite. Once all those people had been accounted for, debt-creating-and-selling institutions had to find another source. Enter SPM, the Sub-Prime Mortgage.

Sub-Prime Mortgages –

‘The Prime Rate’ is the amount of interest lenders pay to the Federal Reserve to borrow the money they will turn around and loan to customers. Around the year 2000, financial lenders found a new group to include in their home mortgage portfolios. It was people with low credit scores who couldn’t qualify for a standard mortgage, based on standard interest rates. ‘Being unable to qualify’ was removed as an obstacle to buying a home. If a buyer couldn’t qualify at the regular interest rate, then the rate would be lowered below cost, below ‘prime,’ sub-prime.

It worked. Millions of people were drawn – duped is more like it – into signing up for loans with very low interest rates. Then the new mortgages could be sifted, and sifted again, even thrown like loaded dice to always come up AAA.

But, sub-prime loans weren’t just for those with low incomes, and bad credit. Anyone could qualify. Millions of people refinanced old loans for new, not just reducing payments, but also taking thousands of dollars in cash away from the ‘closing.’ They would use those extra thousands for lavish lifestyles – cars, jewelry, clothes, dining, travel, – anything but house payments. Life seemed so good.

It was so good in fact, that it seemed to have no end. Houses got bigger and bigger, because sub-prime loans made the payments so affordable. As more people bought-in, others wanted to buy-in. No one wanted to be the only one not living an expanded life. But ‘expanded’ is the wrong word. In a short time the correct word would be ‘exploded.’
Here’s a slogan you should memorize: “Nothing is free.”

There was a sinister side to sub-prime loans. Though it seemed like free money to many, in reality the rate had been artificially lowered below the amount the lender had to pay to get the money in the first place. The lenders had no intention of sacrificing profit, but were able to wait patiently for that profit, even if it was a few years.

The sinister part even had a name. Lenders and agents and brokers alike said it, right out loud, “Balloon Note.” But, it’s the way they said it that softened its evil nature.
This is a typical pitch and conversation addressing the sub-prime loan and its balloon note :
Lender: “We’re letting you borrow this money at a super low rate, to keep your payments low enough so you can buy a house, and get lots of cash, at the same time. You just need to also sign this extra little balloon note, which says that in five years your interest rate will jump from two percent to……oh, somewhere around twelve percent,…..or maybe sixteen……twenty….twenty-two tops….maybe. At that time your payment will jump from a few hundred dollars a month to several thousand a month, then stay that high for the next twenty-five to thirty years. But, don’t worry. All you have to do is sell the house in less than five years, before the balloon note matures, then it won’t be your problem anymore, and-everything-will-be-fine-sign-here.”
Still-Small-Voice: “Don’t do it! This is crazy. It will never work. STOP. STOP. STOP!”
Greed: “Shut up! We’re doing it anyway!”
Borrower: “Okay.”

The national slogan became, “Okay! I’m in!”

The availability of lots of cheap money, real or not, just waiting to be used to build an expensive house, which could be sold quickly for high profit, became the scheme of things. Ultimately, everyone was drawn into the scheme, captivated by the glistening beauty of a housing market in which homes and condominiums appeared to be made of pure gold.

The lending of sub-prime mortgages hit its stride in 2001 and 2002. For the next five years people lived a lavish lifestyle, by spending borrowed money; though confidence in the economy was higher than ever; though it seemed life would keep getting better and better, expanding forever; an urgency was beginning to form.

The balloon notes were coming due.

By 2006, the sub-prime loans issued in 2001 had reached their five year low-payment limit. Those who had borrowed the money, because the payments were so low, had two choices: make huge monthly payments, or sell their house to someone else. Those who signed the dotted line for artificially cheap mortgages and the promise of easy riches – something from nothing; the ones trying to live too high, too fast, too soon, needed to sell their home at a high profit, before the balloon payments started.

Since, at about the same time, almost everyone in the housing market had signed up for cheap, sub-prime mortgages, this meant their balloon notes were all coming due………together. To sell-out and remain financially healthy, they all needed to sell to each other, at the same time, for the same high profit.

But, too many people were in the same situation. When it was time to sell, there were no buyers, just sellers. The owners were stuck with impending, financial doom, as the balloon note’s maturity date neared.

When balloon-day arrived, overnight, mortgage payments increased so much, that homeowners were unable to make the monthly payments, and the foreclosures began. The banks, which made real loans with pretend money from the future, failed; and that failure rippled – no, it tsunamied – through the entire economy.

‘Bubble’ & ‘Burst’ – When lots of people sell something back and forth to each other, at ever increasing prices, which are supported by borrowed money…..that’s a bubble. But, when everyone is involved, and has borrowed from everyone else who is involved, and the borrowed money doesn’t even exist; and everybody needs to sell to somebody, but nobody can buy, because everybody owes everybody else more money that there actually is …that’s a bubble about to burst.

This in itself was cataclysmic. However, it was only the tip of the iceberg. The ‘iceberg’ was made, not just of individual borrowers for homes and businesses, but also lending institutions, investment groups, and stock traders, all of whom saw and sanctioned a series of events going back to 1920:
The alteration of banking regulations to allow possible future earnings to be counted as real profit, in the present, instead of in the future, when – or if – it actually happened.
The manipulation of financial products into position, so their possible future earnings could be bought, sold, and traded.
The attitude of acceptance, by the public at-large, to desire more and more, even if it meant financial disaster.
A dynamic shift in the global, cultural mind-set from patience to instant satisfaction.

This manipulation occurred within the heart and mind of every business entity and individual. There was no one to blame but ‘self.’

For the business entities, in late 2007, things unraveled. The unravelling was caused by the single most obvious trait of ‘debt.’ A debt has an actual value of zero.

Even when a monthly payment is made, the debt can’t be worth more than that payment, at that moment. Then, all the remainder of that debt has the remaining value of zero. If you symbolically put a ‘debt’ in a paper sack, all you have is a bag full of ‘nothing.’

As long as traders believed the ‘sack’ was full of ever expanding mortgage money from the future, everything could keep going. This was equal to the belief, in the 1630’s, that all tulip bulbs were the Viceroy; and in the late 1920’s, that stock prices would rise forever.

Whether it was 1633, or 1929, or 2007, money from the future did not and cannot exist or be counted in the present. But that lesson, apparently, can’t be learned. Misguided as it was, the confidence of investors that the future was made of money, had been the only thing causing the bubble to expand.

The owners holding balloon notes were unable to make their mortgage payments. Lenders and banks could foreclose, but they couldn’t liquidate the mortgages, because there were no buyers. This made the mortgages officially worthless. No amount of siphoning from the future could save worthless debt.

The sudden realization by investment institutions, that the ‘mortgage futures’ they had built empires upon were worthless, caused a frenzy of selling-off in an attempt, if not to salvage profit, to at least stop the bleeding. But the whole system was hemorrhaging, and bled to death in a matter of days.

Individuals failed. Banks failed. Investors failed. Retirement Funds underwritten by the same future-frenzy-fantasy failed. The whole economy failed.

Still-Small-Voice was right after all. It was crazy. This was a time, when investors, home buying speculators, and stock traders took ‘nothing,’ and called it ‘something,’ then sold it to others who knew they were buying ‘nothing,’ but bought it anyway. The entire economy of the nation was balanced on the razor’s edge of ‘owning something from the future, costing nothing in the present.’

‘Nothing’ yields nothing but ‘nothing’. All those millions of people who bought-in, expecting to reap lots of ‘something’ from practically ‘nothing,’ but had agreed to dedicate every penny to the payment of balloon notes, or the high price of worthless-debt investment packages, were surprised, amazed, dumbstruck, when, just like the bank vaults, the “sack” was finally opened, and found empty.

The expanded life exploded. The bubble burst.

A sensible conclusion would be that a lesson was learned, a behavior tempered, an impulse stemmed. Sadly nothing has changed. Bankers behaving badly haven’t gone away, just into the shadows. Not only are the policies and principles (or lack of) which led to the collapse of 2008 still alive, but they are more honed for sharper precision, carving debts and loans into sell-able pieces of ever growing CDO packages. Even worse, a new more sinister form of lending escalating around the world.

Right now, in the American Dwelling Industry, there’s a new bubble growing, hovering invisibly over the nation. It has so little form as to make it almost impossible to identify. It appears in two places at once, a different form in each, with so little association made between either of its forms, that it can’t even be given a name.

In one place it shrouds its victims in a haze of self-doubt and fear of failure, emotions so strong, that to be free of them, those affected will do anything, pay anything, borrow from anyone, and spend any amount, even though total failure is obvious. In the other place it clouds the judgement of its victims, making irrational decisions appear to be the best choices, even when, in plain sight, in reality, those choices obviously cause the cash reserves, resilience, and self-reliance of everyone involved to be diminished to less than zero.

It’s almost invisible, and almost formless. It causes doubt, fear, and failure. It silently sucks away everything of value, leaving only a dark, cold void. How like a ghost.

Continue reading in GHOST BUBBLE by Andy Bozeman, a Kindle e-book, available HERE.


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