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October 29, 2007



Several of the previous administrations went out of their way to destroy the feedback loops that would have prevented another 1929 crash. Instead of regulations (negative feedback), we've removed as many regulations as possible to push our financial system into using positive feedback. Doing so means we're going to return to boom/bust cycles that are going to be very painful for most people. Someone will figure out a way to make a buck when there is blood in the streets, I haven't yet.

Orange County took a bloodbath on derivatives, and I am certain that a large number of other municipalities got clobbered by the Bear Stearns funds that were shut down this year. Investors in one fund lost 91% of their investments. Investors in the other fund, well, their losses were capped at 100% of their investments. And this was even after a $1.6Billion bailout.

The key scheme used to hide the mess from what little regulation remains lies in understanding the terms "mark to market" and "mark to model." Sadly, FASB Statement 157 adds a new level to this, which I call "mark to make believe." Starting at page 25 (38 of the pdf), they call mark-to-market "Level 1 inputs." These are regularly visible items, like the closing price of a stock. Mark-to-model, or Level 2 inputs are things that can't be directly measurable, but they are a function of directly measurable inputs - which is what derivatives are. The new one, Level 3 inputs is the one where they just pull numbers out of the air, so I call those mark-to-make-believe.
Sample Bloomberg article:

Conservatives hate FDR even more than they hate Clinton (both Hillary and Bill). So everything that was introduced by FDR has to go. Glass-Stegal is gone, and political appointees have defanged many of the remaining control/regulatory systems. Social Security is the next big target that has to go (in their minds).

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