The Regulation and the Recession


November 15, 2007, mark the date.

On this day came the regulation that finally brought the recession.

Yes, up next is a recession, a major credit crunch. It is way overdue and much needed. The underlying forces of globalization, the rise of Asia and productivity gains from new technology will however soon pick the economy up again, given a few years. It will be a recession, probably not and hopefully not a full blown depression.

The main reason for the recession is the inflationary policy of the world's central banks. Nixon left the gold standard on August 15, 1971; that's one month before I was born, merely one generation ago. We are now about to pay a major installment on the price for these 36+ years of reckless monetary policy. This policy has massively distorted capital resources and mental resources worldwide. A recession is needed to somewhat reallocate capital and people’s attention. My generation has been misled and misdirected. The lure of freshly printed money has distorted the best and the brightest among us into Wall Street and real estate deals when really they should have put their energies into productive industry.

For now the question begs, how long shall this recession last? When shall this recession bottom out? Let us analyse this by focusing on how the losses will show up in accounting, in the books and the balance sheets of the institutions involved in the upcoming credit crunch. This is not an exact science; I will not claim to have exact answers. I will, based on some observations of time delay in the financial industry, say something about the possible length of this recession. I can guarantee you that it will not play out as suggested here; there will be wildcards.

This recession began showing its face in the summer of 2007 when the sub-prime losses increasingly became apparent. Libertarian economic historians will however mark November 15. 2007 as the important regulatory date. This is when the new Financial Accounting Standards Board (FASB) Statement No. 157 regulations for valuation of securities came into effect.

Here is the new Statement No. 157 by the FASB.

It basically says that assets shall be valued according to three levels. Level 1 are directly measurable and marketable assets, Level 2 indirectly so and Level 3 are non-marketable assets where previously there has been room for various valuations practices based on arbitrary "assumptions," no longer so. Now Level 3 assets will have to be strictly revaluated and losses taken into the books. Level 3 are where the massive hidden losses are. Yet the hidden losses in Level 3 will trickle over to losses in Level 2 and Level 1 as they are revealed.

Pay attention to:

The Effective Date of This Statement

This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year.

The provisions of this Statement should be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied.

The regulations become effective for financial statements issued for fiscal years starting after November 15, 2007. Most companies have fiscal years corresponding to the calendar year, so this means the calendar year of 2008.

The provisions call for the new rules to be applied PROSPECTIVELY, that is BEFORE the beginning of the fiscal year. For most companies that means from January 1, 2008 or in Q4 2007, or possibly delayed to Q1 numbers reported in April 2008. We can expect massive, I emphasise massive losses to be reported in January 2008 and in April 2008.

Keep in mind that accountants and money managers have known about this regulation for some time already. They have been busy all summer and fall preparing for this new regulation. They have been "in the know" about the coming massive losses. Also keep in mind that as financial insiders they are not allowed to tell anyone what they find; they'll go to jail if they do. This is the veil everything seems to be behind, that is why no one really knows for sure; no one actually really knows for sure, they are forbidden to talk to each other. However over the restaurant tables and in bars on Manhattan, on the golf courses, the Yacht Clubs and in the gentleman's clubs they have carefully tipped off their buddies in the other departments, their MBA classmates, that something big and bad is about to unfold. The news in the media this fall is what has leaked about the scary stuff they have seen behind the veil.

Naturally then the masters of the universe, the big boys on Wall Street, now partly "in the know," have been busy all fall moving the losses at par value from their own books over to their customers. This will all become apparent in due time; there will be massive lawsuits. Former Wall Street heroes will go to jail for transactions done in late 2007, from cufflinks to cuffs.

All the financial institutions on Wall Street are closely intertwined; the banks, the financial houses, the funds, everything owns pieces of everything else, one company's losses will show up as the next company’s losses in the next reporting cycle, and so on all the way towards the bottom. This ripple-down effect, the losses on other’s losses, will come into play as the institutions report and take into account their losses on each other; there is a significant delay here, cycle after cycle, quarter after quarter, fiscal year after fiscal year.

Losses will come in two varieties. There are the direct losses on assets that have a ready price, Level 1 and Level 2. As shares and other assets with an observable price fall they will be written down immediately that very quarter. As the recession evolves the asset bubble will deflate and prices go down across the board for these assets. Then there are the Level 3 losses that will have to be "taken" in, that is losses that someone, or rather a committee of former geniuses, has to sit down and take in on their holdings. The Level 3 losses will be taken in wave after wave as they are unveiled. This will meet major resistance; meetings and endless meetings, board room fighting, outing of top executives who will be paid plenty to keep their big mouths shut.

Losses will thus become apparent in a zigzag motion back and forth between different institutions holding them and between assets in Level 1,2,3. This all will take time. Most large institutions report quarter by quarter, but many less public institutions report year by year.

There will be several attempts to finally clean it all out and get the losses in the open. There will be false bull runs from that, but the cleaning out will only reveal even more losses for others.

The last waves of regular reporting based on the November 15, 2007 regulations will come as late as 2009; most however will become apparent in 2008, fully reported early 2009. Bankruptcies will follow in the wakes. Then in 2009 we will see increased ripple-down losses as the losses on the losses become apparent and taken in. The full effect of the ripple-down effect, the losses on the losses will thus first become fully apparent during 2009, fully reported in books presented in 2010.

Then politics: the new US president's first priority in the new job in 2009 will be the financial crisis on his (or god forbid; her) hands. The new President will have enormous demands to do something, and do something he will (President Paul changes these assumptions totally). You can bet the new President will work to show confidence and action. The action steps won't come right away, but the eventual solution will for sure be to print more new money. There will be a new phase of money supply expansion sometime in late 2009 onwards through the first presidency.

The new President will have his eyes solidly set on the next election in 2012: he must make sure the economy has picked up by 2011 to ensure his re-election. The entire government apparatus of the world's only superpower will be aligned to get things going again by 2011. This can be done by printing new money, and will therefore be done by printing new money.

Sometime in 2009/2010 most bad news is known. The new President has started "doing something." That is when things might level off.

In the meantime liquidity will be scarce; blown up asset prices will deflate across the board; houses, shares, oil, art, silver and gold. Sell your capital assets now, sit put on diversified currency cash and bonds until the implosion has levelled off before re-entry.

November 21, 2007