The Heart of Financialization: Counterfeiting Risk-Free Assets   (December 7, 2012)

Greece is merely prelude; the global chain of risk recognition lies just ahead.

The essence of financialization is also the heart of our economy: the counterfeiting of risk-free assets.

Think about what is totally dependent on the counterfeiting of risk-free assets:

1. The mortgage market and thus the housing market

2. The derivatives market and thus the entire hedging-risk mechanism of the global financial market

3. The sovereign debt market, i.e. government bonds that support deficit spending on a massive scale

Think about what happens in each of those markets when the real risk is recognized.

Consider housing. The housing bubble was predicated on the fabrication/ counterfeiting of risk-free assets and debt based on the phantom collateral of those assets.

For example: a no-down payment, no-document "liar loan" mortgage is issued to an unqualified buyer for a house with an inflated appraisal--i.e. phantom collateral. The buyer's level of risk is masked, as is the collateral's inflated value.

Given that the buyer cannot actually afford the house without a heavily gamed mortgage (interest only, etc.), the mortgage is toxic, i.e. doomed to default from its origination.

The lender takes this high-risk mortgage and bundles it in with higher quality mortgages and then sells them as a AAA-rated, essentially no-risk mortgage-backed security (MBS).

This risk-free asset is entirely counterfeit.

The same can be said of all the derivatives based on credit default swaps and other financial instruments with phantom collateral and masked levels of risk.

Everyone claims their government bonds are risk-free until they're suddenly not. Greek bonds were risk-free until they were suddenly not, and Japanese government bonds are risk-free until they are not. The same can be said of U.S. Treasuries: they are risk-free until the risk that is being suppressed by the Federal Reserve suddenly breaks free of manipulation/suppression.

The same can be said of the stock market. The "Bernanke Put" has supposedly rendered the stock market nearly risk-free, as the Fed will always act to prevent any serious decline.

Enron and Lehman Brothers stock were essentially risk-free, for example--until they weren't.

Counterfeiting risk-free assets inflates increasingly fragile bubbles of trust, phantom collateral and risk. When the counterfeit risk-free assets are recognized as intrinsically risky, the entire house of cards collapses: stocks, real estate, government bonds and the deficit spending those bonds supported.

Greece is merely prelude; the global chain of risk recognition lies just ahead.

NOTE: I will be taking a few days off from online work, so I will be unable to respond to email. Thank you for your understanding.

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