Guest Post: The Collapse Of Our Corrupt, Predatory, Pathological Financial System Is Necessary And Positive

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

The Collapse of Our Corrupt, Predatory, Pathological Financial System Is Necessary and Positive

We are being throttled by the Big Lie: we're told that if the predatory financial system implodes, we'll all be ruined. The opposite is true: the only way to save our economy is to let the corrupt, pathological and flawed financial system implode.

I was recently challenged by a contributor to write something positive, and so I decided to write about the single most positive outcome of the current financial crisis in Europe: the complete collapse of the corrupt, predatory, pathological global banking sector and its dealers, the central banks. Exploring why this is so reveals the insurmountable internal conflicts in our current financial system, and also illuminates the systemic political propaganda which is deployed daily to prop up a parasitic, corrupting, pathologically destructive financial system.

Our first stop is modern finance itself. Modern financial "products" and "instruments" are often highly complex and abstract, but the entire edifice can be distilled down to this: the system is based on the assumption that all risk can be hedged, and the difference between the initial position's yield/gain (i..e. placement of capital at risk for a gain) and the cost of hedging the risk of the wager to zero can be skimmed from the system risk-free.

That is the entire system in a nutshell, and we can immediately see the advantages of this system over traditional Capitalism, where risk can be hedged but never to zero, and the return is correlated to the risk taken on.

In modern finance, high-risk "investments" (wagers) with high returns can be taken on without worry because any and all risk can be hedged to zero, even in super high-risk wagers.

And since even high-risk positions can be seamlessly hedged to zero, then there is no reason not to borrow money to increase the size of your wagers: since you can't lose, then why not? Wagering in risk-free skimming with borrowed or leveraged money is simply rational.

Put these together and we see how a system based on risk-free skimming eventually leverages itself to the point that the slightest disruption can bring down the entire over-leveraged, over-extended system.

Why is this so? Every hedge has a counterparty who is supposed to pay off if the initial wager blows up. A system based on risk-free hedging is ultimately a self-organizing system which maximizes return by increasing bet sizes, leveraging/borrowing to near infinity and hedging every hedge as well as every wager.

This creates long chains of hedges and counterparties. Here's an example based on an asset we all understand, a house. Let's say someone buys a house for $1,000 down, something that was common in the housing bubble. That $1,000 is leveraged up to buy a $200,000 house via a $200,000 mortgage.

The "owner" of the house then buys a hedge to protect himself from the house losing value, so the risk is reduced to zero: if the value rises, the owner reaps the gain and if it declines, then he collects the payoff of the hedge from the counterparty, for example, a Wall Street investment firm.

The counterparty calculated the risk of real estate declining and then priced the hedge accordingly. There is some small risk that the loss will exceed the cost of the hedge, so the issuer of that hedge bundles similar bets and then buys a hedge or "insurance" from another player, who makes the same calculations of risk and return.

Meanwhile, the mortgage has been tranched (sliced into principal and interest and into various pools of risk) and bundled with other "low-risk" mortgages and sold to investors, who also buy a hedge against any loss in the tranch, for example, a credit default swap (CDS) which pays out if a borrower defaults. Those hedges are sold or "insured" with another hedges.

All of this debt and all of these hedges are based on a mere $1,000 of actual capital. The players who originated each hedge are similarly leveraged, because since risk can be lowered to zero, who needs capital?

So what happens when one counterparty (issuer of a hedge) somewhere in the chain runs into trouble? The entire chain collapses. With razor-thin capital to cover any losses, then each link in the chain dissolves into insolvency if their counterparty fails to pay off.

This is how we get hundreds of trillions of dollars in "notational" derivatives: every hedged is hedged with another "instrument," "products" are bundled and insured, and so on. The system is based on the principle that risk can be reduced to zero, and so there is no need for capital.

Unfortunately, that premise is demonstrably false. Benoit Mandelbrot dismantled the notion that risk can be reduced to zero in his prescient masterpiece, The (Mis)behavior of Markets. The founder of fractal geometry showed that markets are fractal in nature, and are thus intrinsically prone to unpredictable disruptions. Simply put, risk cannot be massaged away.

Thus the fundamental premise of all modern finance is flat-out wrong, and this explains why systemic risk, rather than being eliminated, actually rises with every ratchet up in debt, leverage and counterparty hedging.

The entire global financial system is thus based on the equivalent of a perpetual motion machine: money can be borrowed or leveraged into existence in essentially unlimited quantities, and then deployed in risk-free skimming operations to harvest unlimited wealth.

What does this promise of using leveraged capital to skim risk-free fortunes do to the "real economy" of production and investment in plant and technology? It guts it. The risk of industrial Capitalism is real and cannot be hedged away; high-risk investments may blow up or they may return high yields. It literally makes no sense to risk real capital in productive Capitalism when a zero-risk skimming operation can be developed that essentially needs near-zero capital.

Thus financial capital has come to completely dominate industrial or productive capital. The pernicious consequences of this dominance have poisoned the economy and culture on multiple levels.

In the political sphere, the aggregation of hundreds of billions of dollars in skimmed profits gave Wall Street and the banking sector unlimited budgets to buy political influence. This created a monstrously pathological feedback loop: the more political influence Wall Street bought, the higher their returns on financialization skimming.

Consider housing as an example. Housing was once a simple, barely profitable long-term investment for both the buyer, who had to place substantial capital at risk (20% down payment) and the holders of mortgages, who took a modest yield for 30 years in trade for low risk.

Wall Street and the banks financialized housing via political influence. opening up a vast new territory to be exploited via skimming. Since capital wasn't necessary in no-risk skimming, then down payments were dispensed with to increase the pool of debtors, as they are the foundation of all skimming operations.

the cost of servicing that debt was manipulated via "teaser rates" and "interest only" loans, further leveraging up American home buyers' modest income streams. Mortgages were bundled, tranched and hedged, and the mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) were sold to trusting investors aroudn the world.

It was a bonanza of unprecedented wealth creation from financial skimming. $1,000 down and a few hundred dollars a month for a "teaser rate" interest-only loan was leveraged into a global chain of "products" and counterparties that could be skimmed all along the chain.

That deepened the political corruption that fed the skimming operation, and introduced the "no risk" pathology into Mainstream America. Since real estate never went down in value, then buying a second, third or fourth home on leverage was simply rational; in a Federal Reserve-controlled world of near-zero yields on cash, it was irrational not to.

But there were two intrinsic flaws in the skimming operation: while the Wall Street players were hedged (or so they reckoned), the average Americans buying homes with near-infinite leverage were not hedged. That meant that when their razor-thin capital went to zero, they were insolvent. Once they defaulted, then the income stream feeding the chain of skimming went away and the chain collapsed.

Once one counterparty failed in the chain, the entire chain collapsed as well. As Mandelbroit explained, such disruptions were an intrinsic feature of the system; though the timing of a systemic disruption could not be predicted, the fact that disruptions would occur on a regular basis could be predicted.

Some players knew this, of course, but that led to another pathology: those investment players who avoided the "no risk" skimming casino could not generate the yields being "earned" by the leveraged skimmers with legitimate investing, and so their investors abandoned them for the fully rational reason that "no risk" yields were higher elsewhere.

This too created a feedback loop, where the capital available to be leveraged grew rapidly, while the pool of capital available for "patient" risky investments in actual productive assets declined. Capital available for productive investment thus became costly and scarce, while capital available for leveraged skimming became cheap and abundant.

The Federal Reserve bankrolled the skimming to the hilt. Indeed, the entire pathology of low-interest, unlimited leverage skimming was based on the Federal Reserve's manipulation and intervention. That remains true today.

What happens when the whole chain blows up and the foundation of debt is impaired? Since the whole system is based on the debt and the income streams devoted to servicing it, the entire edifice collapses when the debt is impaired--debtors default and the system clogs with bad debt, i.e. uncollectable debt.

In a transparent Capitalist system, the debt would be written down and all the insolvent borrowers, lenders and counterparties would be wiped out. But the political corruption that enabled modern finance to poison the American economy and culture has stopped that cleansing from occurring.

Such a systemic writedown of bad debt in a system with only razor-thin capital to support a mighty edifice of leverage and debt would wipe out Wall Street and the banks and reveal the skimming operation of modern finance as an impossible perpetual motion machine rigged to enrich a thin crust of citizenry at the expense of the rest. And since they skim enough money to buy political protection, Capitalism has been strangled and tossed in a shallow grave lest it disupt the skimming and the political corruption that keeps the machine running.

What we end up with is artificial valuations, endless propaganda and a zombie economy. When borrowers are left dangling in default and the assets left on the books at full value, you end up with zombie debtors, zombie lenders, a zombie government that only has one lever to pull to keep the whole corrupt pathology going--borrow and squander more money-- and ultimately a zombie economy, drifting and decaying in a fetid pool of lies, shadow banking, ceaseless official propaganda, jury-rigged "fixes," manipulated statistics, corruption, predation, exploitation and pathology.

That's the U.S. economy, and indeed, the economies of the E.U., China and Japan in a nutshell.

The only way to clear a zombie economy is to write off uncollectable debt and liquidate all the assets, loans and hedges. That would collapse our financial system, but since it is the cause of our political and economic dysfunction, that would be the highest possible good and extremely positive.

There is a great final irony in the scare-mongering threats of the skimmers and their political toadies. If the taxpayers don't bail out the skimmers, then we'll have martial law by the weekend, the smouldering fires of Europe will rekindle into open warfare, and so on.

The irony is the propping up of a deeply, intrinsically pathological and destructive financial system is not saving the economy, it's the reason the economy is imploding. The Big Lie technique of propaganda is to reverse the polarity of reality: we are told up is down until we believe it.

We are told that liquidating the overhang of bad debt, leverage and hedges would "destroy the world as we know it." The truth is that keeping the zombie system from expiring and covering up the corruption with propaganda is what's actually destroying the world as we know it.

Thus the collapse of the current financial system of central banks, pathological Wall Street and insolvent banks would be the greatest possible good and the greatest possible positive for the global economy and its participants.

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vast-dom's picture

yeah yeah yeah.........just get back to me when the hopium bull run unwinds...........i'm short the planet and my calcs have showed end of August for Great Crash and yet here we are writing and reading about collapse and purge etc etc.


give me a time bc we all know it's over and yet the game somehow goes on..... 

The Big Ching-aso's picture

Depending on the crappiness of the players, a game of Monopoly can go on for a long, long, time.   Typically the crappier the players the longer the game.  

Hence where we are today.

CH1's picture

Right. Timing is virtually impossible: Too many states that can steal unlimited money from millions of obedient serfs, central bankers pulling unknown tricks, investment houses in unknowable deals, fickle confidence, no-think sheep... How can you make sane calculations based on such variables?

vast-dom's picture

CH1: you are absolutely correct! My calcs, even factoring in some insanity a la QE to the Nth, have clearly missed the mark due to GENERAL (and specifically EUROZONE) INSANITY AND FINANCIAL FUCKERY to da Nth!

I am just as insane for thinking I could ever comprehend what kinds of machinations and plots and scams insane people would concoct in their diseased heads!


Ever get recorded by an insane person while chatting on the phone with them? How does it feel, when you're left alone to deal with CRAZY?

Raskolnikoff's picture

for the last few years I was very impressed with the fact that every morning the European markets would be off to the races before the US market opened up. The only honest market seems to be in Shanghai, LOL. One day, a few years back I heard Glenn Beck say something like 'it worries me with all the bad news that the market continues to go up.' And then we get earnings from a company like Goldman Sachs who rarely if at all loses money 'trading'. People are going to look back on our times the same way they looked back on the people in Germany in the twenties and thirties and scratch their heads saying, what were these people thinking?

nuinut's picture

... and they'll likely conclude, correctly, that there was precious little actual thinking going on.


Fortunately, thanks to our example, they will have remedied that, or they wouldn't be equipped to contemplate it.



Michael's picture

People say they think I'm a lot more positive about the outcome of a complete and total worldwide economic collapse because, I think the result will be a starved and dead beast that has only served to pillage the sheeple.

I just thank God every day for the complete and total worldwide economic collapse, because I know the result.

No need to go to war over it, it's only money.

AldousHuxley's picture

positive for MF Global shorts.


regime system is bringining it to the fascists. Get off of your high horse banksters. MS Excel can do what you do already.

dehdhed's picture

free ebook - designing the future

describes how quickly we could transition from a monetary based economy to a resource based economy

great read for the open-minded


jekyll island's picture

The ability to extend and pretend is directly proportional to the amount of fairy tale capital that exists in the marketplace. 

traderjoe's picture

Just like PM price suppression, the delay in the coming reset is a GIFT - I.e. more time to prepare. And more time for more people to wake up...

UP Forester's picture

Doc:  I have good news and bad news.  What do you want first?

Patient:  The bad news.

Doc:  Your rectal cancer has spread to your penis.

Patient:  From Ass Cancer to Dick Cancer?!?  What the fuck's the good news?!?

Doc:  It's in remission....

zwscott33's picture

the best way to make a fool out of yourself is to put a deadline on your predictions. of course if your right you look like a prophet.

Dec. 21 2012, that is the day it all comes crashing down

MayIMommaDogFace2theBananaPatch's picture

Dec. 21 2012, that is the day it all comes crashing down

Sorry - somebody already took that square in the pool.

Ganja Jane's picture

...and they pissed in it. Watch out for the yellow cloud.

Seasmoke's picture

crappy monopoloy games are TORTURE

Ted K's picture

I love sitting there with St. Charles Place and $9 fucking with people. Then I put little Star Wars action figures on free parking and tell them its NYPD bribed by JPMorgan. Then just when I think they can't take it anymore, I grab Chewbacca and pretend it's Sarah Palin giving a Tea Party speech. My Palin imitation is totally killer.

hidingfromhelis's picture

Always wondered what you did on days when the post offices are closed.

nope-1004's picture

The game goes on because it's obvious:  The banks are all insolvent and will fail overnight if the the truth comes out.

The lie goes on and there are plenty more Corzines out there stealing other peoples' money as we speak.


LeonardoFibonacci's picture

  Treasonist cowards with their constant after-close margin manipulation. Erect the gallows. It becomes obvious its time to use them again.  Guillotine them all, fucking bastards.  Don  Corzinello would be a good start

sabra1's picture

one thing i know, once all this comes to rest, and all those responsible are hung, don't think for a second that their family members will be able to walk the streets safely. what we don't hear about are all the innocent families, who had someone close, commit suicide.

Tedster's picture

The correct usage is "Hanged". Please make a note of it.

That is all. Carry on.

UP Forester's picture

I heard Janet Napolitano is hanged like a horse.

Ganja Jane's picture

Grammar police: Hung.

Hanged, as a past tense and a past participle of hang, is used in the sense of “to put to death by hanging,” as in Frontier courts hanged many a prisoner after a summary trial. A majority of the Usage Panel objects to hung used in this sense. In all other senses of the word, hung is the preferred form as past tense and past participle, as in I hung my child’s picture above my desk.

Although this doesn't cover the usage in this instance, I refer to the urban dictionary for consensus:

fockewulf190's picture

Just so no one forgets....(D) Jon Corzine.  Someone should mark that letter onto his forehead ala Inglorious Basterds. 

Gully Foyle's picture

Jesus fucking christ!

You can neither prove that a collapse would be either necessary nor positive.

It's like those assholes who postulate if Gore had won none of the wars would have happened.

I'm so fucking tired of people making false assumptions designed to fit with their preconceptions and biases.

But worse are the goddamn idiot cheerleaders that can never consider the implications of any statement and merely follow the crowd. You know the 99% of ASSHOLES!


Absalon's picture



We are teetering on the edge of civil collapse and a military coup in Greece and the bad stuff has barely started.


Collapse of the banking system would bring real suffering and death to many.


We need fundamental reform of the big banks but the nihilist approach of first we burn it down then we build something better is not going to work.


fockewulf190's picture

How in the world is it possible to reform any financial institution of any kind when every financial thing on earth is hotwired to the $600 trillion dollar+ derivatives anti-matter bomb? 

It isn´t possible to diffuse this thing.  This sucker is going to blow and millions upon millions of people are going to be wiped out.  All you can do is try and prepare as much as you can to ease your journey through the turbulent times after it blows. 

It is really going to suck on planet Earth for at least a few years, and those people who currently have next to nothing, will be howling like banshees.   As Gerald Celente always says; "When people lose everything and have nothing left to lose - they lose it".

And lose it they will.

Absalon's picture

Evey bank claims that they are hedged on their derivatives and they might be right in that most derivatives are probably just sham trades done to avoid taxes or government regulations.  


Some banks will have taken large positions that put them at risk if there is a black swan and more generally there could be serious liquidity problems leading to a contagion effect.  It is not inevitable that derivatives will blow up but every day there is some finite probability they will blow up that day and you know what happens if you keep rolling those dice for long enough.


Given that there are $600 Trillion in derivatives in a $60 Trillion global economy we know that most derivatives are "naked" (not based on an underlying right or obligation).


Derivatives are time limited.  They expire.  You unwind it by banning new naked derivatives.  Or governments could declare naked derivatives to be illegal gaming contracts and unenforceable. 

UP Forester's picture

So, we can't call that guy from the Oscar-winning movie the other year to defuse the derivative bomb?

Bolweevil's picture

"More stringent reform." You of the androgynous handle are either complicit or complacent. Which is it?  And you freakin' agree with Gully then drop the "banking collapse brings death and suffering" in the next sentence? You're banned from posting for a week.

Absalon's picture

I am hardly complacent.  They are talking about the collapse of the monetary system.  The banks, including central banks, failing.  The clearing system disappearing.  The money markets seizing up.  In 2007,  the US government stepped into the money markets so major corporations that relied on the money markets for working cash could make freaking payroll.


Collapse means no pay checks.  No pension checks.  No credit cards.  No bank accounts.  No checks.  No debit cards.   


The economy is like a shark - if it stops moving it dies.

Bolweevil's picture

I appreciate your reply.  

Let it rain.  I agree in that things may be difficult following said collapse, but I welcome the departure from increasingly brazen disregard for the rule of law espoused by banksters.  I wish for a smoothe, orderly transition where TBTB(TM)* have a come to Jesus moment and realize the err of their ways and reform like the trusted stewards they portray, but I am relegated to this dimension where unicorns pooping skittles are merely fantasy.  I already don't get a paycheck and am moving toward all the others you list. Yes I do have a job type job, but I be the captain of this here ship.  Let the shark rot and I also welcome well-meaning people like you to help us reshape the future I just don't think it happens through the conventional channels available to us.


Raging Debate's picture

Absalon, I agree. The foundation itself can evolve from 3d to 4d very easily while laying a few bricks for a 5d model. Rothschild's model was built as a 4d construct. His intent of using it for conquest sucked but even if he meant well the tech tools were not available in his day and his model would have reverted to a pyramid. Same deal for US government. Use 4d tools and a 4d model. The tools now exist so building another pyramid at this point is leaders purposely pursuing a model of tryanny.

The model dictates behavior. Pouring new wine into old winseskins won't work this time. But the solutions do exit. Time for a new plan.

SPONGE's picture

Uhhhh, what?

Care to expound?

What's 5d and how many d's does one need to RULE THE FREAKIN WORLD!

krispkritter's picture

Da Bankers, Da Fed, Da ECB, Da IMF, etc.

dolly madison's picture

I'd say the biggest problem will be the sudden loss of oil.  When the economy melts down, it will probably be nearly impossible to buy oil anymore, and people are so dependent on it for food.  I wish more people would get a clue that they need to be prepared for the food supply to come to a sudden end.

I'm glad I don't live in a city.  It will be very ugly if we don't have oil.

Scorpio69er's picture

No argument that the financial system needs to be reformed and reigned in. But it is assumed in this article (and by many good people) that something better would naturally follow an outright collapse. This is a horribly naive assumption. What will surely follow is death and destruction for millions, if not billions, of people. What comes out of the ashes is anyone's guess, but if history is any guide, it ain't gonna be pretty. When chaos reigns, societies turn to "strong men" to restore a sense of stability and security. So, it is very likely that the near-police state under which we now live will become much worse under a crisis scenario.

Bolweevil's picture

I don't necessarily disagree with you, but would you be so kind to list your historical references for the carnage you envision?  

Miss anthrope's picture

my dear scorpio, that is their plan.  IMHO

Miss anthrope's picture

my dear scorpio, that is their plan.  IMHO

Peter K's picture

To all you asswipes who 'down twinkled' the above post, I say this: "You can't handle the truth":)
PS Socialism es muerte

Fibz's picture

My calcs show that if you trade the opposite of ZeroHedge sentiment, your survival rate might never drop to zero.

Hook Line and Sphincter's picture

"Past performance is not a guarantee of future results."

This was once in the Constitution, printed in invisible ink.

Flakmeister's picture

Yes, the Hedge is an awesome contrarian indicator.....

Hephasteus's picture

Yes zerohedge readers kick the dog crap out of fed primary dealers and bond market bigwigs on returns just by bying gold and silver and holidng.

Eurodollar's picture

One approach to understand "the game" that I take is to map: Who are the players, what is their agenda, how are their relationships to each other. What mandates do they have? Then apply game theory, adjust with behavioural finance and apply to the current perception of fundamentals and common sense perception of fundamentals.

I know that I am an amateur plankton in a big ocean of predators, but doing the above excersise to the best of my limited ability I tend to believe that this game will continue to go on for quite some time if everything plays out as normal. Of course, as the future isn't pink and predictable one can't overlook that random events can send the game, that is very fragile at this stage into implosion mode. Black swans are in the water. Are they heading our way? Who knows. All I know is that I will stay alert and react to them based on my model as quick as I can :)

A small note before you all slaughter my thoughts :) I might be an amateur, but over many years I have worked with assessing probabilities on the fly for imperfect information type of activities. I managed to make a very good life for myself doing that in my own humble opinion. I know finance is the entertainment park for the big boys and that it will be virtually impossible to beat this game. However, I intend to give it a go :) Good Luck to me!


Stay tough, stay focused and invest well!