DEADLY FREEDOM - Welcome

This is the companion site for my new novel DEADLY FREEDOM.

Imagine a world that has moved to a Carbonless Electric Economy, severing its dependence on fossil fuels and reducing the value of imported oil to nearly zero. Then imagine the geopolitical ramifications of that event. How would the oil companies react? How would the OPEC countries react at the loss of trillions of dollars? How would every industrialized nation behave given this new-found freedom? This is the world that Doc Davidson and his team of researchers at USF have triggered and now they have to deal with the consequences.

If you’ve read my book and haven’t had a chance to write a review on Amazon.com, I’d appreciate it if you would take a few minutes to do so by clicking here and hitting the “Create your own review” button. Your feedback will be incorporated in future works. I have now established a Facebook page for additional communications with the Facebook generation in addition to a Twitter account. These are the people who are fighting and dying in our current oil war that is being entirely funded by Chinese debt. It seems appropriate to open a channel of communications with those who will also be saddled with repayment of that debt. The Electric Economy will be able to help fund those payments…

The goal of this site is to discuss DEADLY FREEDOM and also discuss what the book is about—getting this country back on track by eliminating our addiction to fossil fuels and turning our energy problem into a national opportunity to become the “Saudi Arabia” of renewable energy technology. This is the place to discuss the characters (what does the future hold for Doc and Sandra?), the plot (could a rogue CIA group like “The Club” really come into being?), and the technology (how quickly could we have the “Electric Economy” in place). By scrolling down to the “comments” section at the end of this article, or clicking here, you can ask a question or enter a comment. You can still influence the sequel.

Political discussion will be unavoidable. When it comes to energy policy, our two candidates tend to rattle off a list of solutions including: hydrogen, biofuels, wind, and solar. The republicans also tend to favor “drill baby drill” with McCain’s recent flip-flop. The problem is that neither understands the ramifications of implementing a multiple-choice solution of incompatible technologies, thinking that lashing together a set of technologies that don’t work individually will somehow work together…hoping for a negative synergy perhaps! I will have some posts on this issue that I hope will generate spirited debate. The first is my “Help Wanted” ad for a president entitled Help Wanted: A President for the Issue of Our Time. My second is an appeal to the person I believe will win the election—which doesn’t mean I’m voting for him—if he is able to avoid any serious missteps: Senator Obama, Real Leaders Have a Strategy.

And now oil billionaire T. Boone Pickens is getting in the act and while his plan will make him a lot of money, it won’t help us at all.

I’ve had a number of readers tell me the book is prophetic, others have said it’s a sign…

Dave Spicer


V1.11

Dave Spicer: An Electric Economy

The Facts within the Fiction of DEADLY FREEDOM



DEADLY FREEDOM is a fictional story about a real cause. This is that cause.

Do we really want our children and theirs to inherit a world of energy shortages, pollution, global warming, climate change, terrorism and wars purported to defeat terrorism like the current conflict in Iraq? Add to these concerns the fear that Iran is developing a nuclear capability, an impending conflict with China over remaining oil reserves, and the mounting debt our heirs will inherit. The burdens we are placing on future generations beg for leadership and new thinking.

Unfortunately, when we’ve needed statesmen and patriots, we’ve had politicians—in both parties—who have shown themselves to be ineffective leaders, spending billions of dollars and thousands of lives with no perceptible impact on these issues and no discernable strategy for the future.

It’s time to recognize that our expensive, seemingly solutionless fears are not really problems but merely symptoms of the real problem that does have a solution: our continued use of fossil fuels and, more immediately, our dependence on imported oil. The geopolitical well-being of the industrialized world hangs on the irrational whims of a few Middle Eastern countries who by simply pricing their oil in euros instead of dollars could decimate our fossil fuel-based economy.

The debate over global warming is over; the earth is sending a wake-up call. Greenhouse gases, primarily carbon dioxide, have been increasing the amount of heat trapped within our atmosphere. While the number of climatologists in denial has been decreasing, the remaining dissenters are reminiscent of those denying cigarettes were a carcinogen. Such denials in the face of the facts discredit them as well as their science of climatology.

A 6.3 pound gallon of gasoline contains 5.5 pounds of carbon. When each of those carbon atoms combines with two heavier oxygen atoms, that 5.5 pounds of carbon forms 20 pounds of carbon dioxide. If we assume the average car gets 20 miles per gallon, then we are producing one pound of carbon dioxide for every mile driven, an average of 3 trillion pounds per year in the US alone! It doesn’t take a climatologist to understand this cannot be good for our planet. It took billions of years for our planet to sequester fossilized carbon underground. It’s taken just hundreds of years for us to remove it and place it in our atmosphere.

The other pollutants from burning gasoline including nitrogen oxides, carbon monoxide, and particulate matter are visibly obvious to those who live or work in Los Angeles. They are even worse in cities like Sao Paolo Brazil and Mexico City, places where pollution controls are essentially non-existent. The short-sighted view is that countries with pollution need to take care of their own problems. But unlike Las Vegas, when it comes to pollution, what happens in Mexico City does NOT stay in Mexico City!

The world currently consumes oil at the rate of 80 million barrels per day. For those who like numbers, that works out to 1000 barrels per second—clearly not a sustainable level of usage! Not surprisingly, energy shortages and ever-increasing prices for oil and gasoline have become commonplace. We just accept them and anticipate continued increases.

There was a time when OPEC was able to control the price of crude oil, and thus prices at the gas pump, by controlling the output of their oil fields. Tightening the spigots would decrease supply and increase the price; opening them would do the opposite. For the last forty years they have been walking a delicate balance between maximizing their revenues and making sure the price of oil stays just below the level that would encourage development of alternative fuels.

Two things have happened recently to limit their ability to control prices. China and India have been experiencing industrial growth at historic rates, and world oil reserves have reached what a now-famous Shell geologist called “Peak Oil.”

China and India are two of the fastest growing economies, growth that manifests itself in increased demand for energy in the form of oil and gas. It is anticipated by many that China will surpass the United States in GDP within ten to fifteen years. The United States leads the world in oil consumption using 20 million barrels per day, and that number is projected to go to 30 million barrels in ten years. So China, a country that is now using over 6 million barrels per day, can also be expected to be using 30 million in ten years. The near-term ramification of this growth is that OPEC can no longer adjust the price of oil downward. The demands placed by China and India are consuming what was once excess capacity.

The longer term ramifications will be dictated by Peak Oil. In the 1950’s, Shell predicted that US oil production would peak in the 1970’s, and it did. The same forecast showed world oil production peaking in the 2000-2010 timeframe. It appears that this prediction may also have been correct.

The concept behind Peak Oil is that as oil is retrieved from a field, the least expensive barrel to extract occurs when the field is one-half depleted. After that, each barrel of oil will be more expensive to retrieve than the last. The ultimate end of life for an oil field occurs when the energy it takes to retrieve a barrel of oil exceeds the energy in a barrel of oil! In practice, economic limitations will occur before energy limitations. It’s ironic that there will always be a considerable amount of oil in the ground; we just won’t be able to reach it. This means reserve forecasts—as if we could trust them anyway—will need to be adjusted downward to account for “unreachable oil.”

A world experiencing a shrinking supply of a crucial commodity such as oil in the face of increasing demand is vulnerable to war and terrorism.

Since the 1940’s the foreign policies of industrialized nations have been driven by oil. When the United States talks about “protecting its vital interests” in the Middle East, the only vital interest that matters is oil. Oil dictates the behaviors of countries and has been the cause of more than one war. Why did Japan attack Pearl Harbor? Was it because they wanted to vacation in Hawaii? Hardly. During that period, 20 years before OPEC, the majority of the world’s oil came from Texas and Oklahoma. As retribution for Japan’s invasion and occupation of China, we embargoed our oil exports to them. The result was Pearl Harbor.

Today, Iran is developing their nuclear capability. Everyone knows that it will ultimately be used for weapons development yet we are reluctant to take any action, even though we know they are also funding terrorists. Why? Because Iran is a large oil producer and we cannot afford to disrupt our vital interest! And we do not need another Iraq war.

So how is a backward country like Iran able to develop sophisticated nuclear technology? Easy, China is providing it to them in return for oil rights, mortgaging the future of the civilized world for guarantees to the commodity that is their economic lifeblood. As the oil runs out, history will repeat itself and desperation will lead to a conflict between the world’s oldest and newest superpowers.

Terrorism is a very real threat and we do need to defeat it. But if there is one lesson we should learn from the Iraq war it’s that we cannot defeat terrorism militarily. Terrorists do not wear uniforms, do not abide by—or even acknowledge the existence of—the Geneva Convention, and they are willing to kill themselves to kill us. Bullets provide little deterrent to those seeking their own death.

Terrorism is an ideological conflict and the root of the word “ideology” is “idea.” It’s time for a nation of innovators to innovate a better idea that can defeat terrorism without firing a shot. Sixty percent of our oil is imported and sixty-seven percent is used for transportation. Fortunately, one-third of our imports come from Canada and Mexico leaving forty percent from countries that would do us harm. The process of eliminating oil from transportation will drive the value of imported oil to zero, completely eliminating civilized society’s dependence on the Middle East, effectively quarantining them.

Our addiction to oil can be seen for what it really is: the root cause of many of our geopolitical worries. So how can we eliminate this dependence and still keep our economies growing? Clearly, we need to get on a different energy technology curve and many ideas have been advanced; let’s start with false promises and end with one that isn’t.

There have been many handwringing books and articles written on the issues we’ve been discussing. Conservation is often mentioned as the solution. Simply stated, let’s just use less energy to somehow lessen the problems. All we need to do is turn down the thermostat and wear a sweater to bed. Remember Jimmy Carter?

There are two things wrong with this approach, the numbers don’t work, and some of our problems, e.g. terrorism, need complete solutions. Remember, we currently use 20 million barrels of oil per day and if we do nothing, in ten years we will be using 30 million barrels per day. Let’s assume that over the next ten years we find a way to conserve 50 percent of our usage. No one is suggesting this is even possible, but for the sake of argument, suppose we could achieve this lofty goal. That would mean in ten years we would be able to cut our consumption from 30 million barrels to 15 million, just 25 percent less than we use today! The other major consumers would not be able or willing to cut their consumption which means we would not have advanced our position at all. In fact we would weaken it with respect to our influence on oil providers. Conservation may provide some personal satisfaction and may lower your energy bill for a little while, but as a real solution it’s a dead end.

The agriculture industry periodically promotes ethanol as being the way to energy independence, but it, too, has problems. First, we could not possibly distill enough ethanol from corn or other plant material to make a significant difference. Of the 42 gallons of oil in a barrel, the refining process creates 20 gallons of gasoline. Since we are consuming 20 million barrels of oil per day, that says we are consuming 400 million gallons of gasoline per day.

An acre of corn can produce 362 gallons of ethanol per year, or roughly one gallon per day. The energy content of ethanol is just two-thirds that of gasoline, so a car that gets 20 miles on a gallon of gas will require 1.5 gallons of ethanol to travel that same 20 miles. Eliminating oil for transportation would require the production of 600 million gallons of ethanol per day which would require 600 million acres of corn. There are 640 acres in a square mile so this would be just less than a million square miles of corn. The United States has 3.7 million square miles of land area, so to eliminate oil from transportation would require planting more than 25 percent of our country in corn; and this requirement would increase to 40 percent in ten years.

The other problem with ethanol is pollution. The distillation process in volume is highly polluting; and ultimately, burning ethanol as a fuel results in many of the same carbon-based pollutants as burning gasoline.

Despite promotion by the agriculture industry and their strong lobby in Washington, ethanol is another false hope.

When the discussion turns to non-polluting energy alternatives, hydrogen invariably comes up. The oil and automotive industries are spending millions of dollars promoting the Hydrogen Economy; this fact alone should raise eyebrows.

Today, commercial hydrogen is created from natural gas, which tends to lessen its attractiveness, a perverse way to get “renewable energy.” It can also be produced when an electric current is passed through water, a process known as electrolysis. When hydrogen is combined with oxygen in a fuel cell, the result is an electric current and the waste product is the water we started with. A battery is defined as a device that converts chemical energy into electrical energy. In spite of the auto industry’s Fuel Cell Vehicle (FCV) hype, a fuel cell is simply a battery and a Fuel Cell Vehicle is just an electric car powered by a battery.

The problems with hydrogen are with its handling and distribution. The only way to distribute hydrogen in bulk is in its liquid state. Unfortunately, liquid hydrogen is 423 degrees below zero Fahrenheit, or 20 degrees Kelvin, one of the coldest substances on earth. Any attempt to pipe liquid hydrogen through existing oil or gas pipelines would cause them to rupture from the very high pressure and extremely low temperature. Hydrogen suffers from a terrible “chicken or the egg” problem: cars powered by hydrogen will need to wait for hydrogen distribution infrastructure, but that infrastructure is waiting for enough hydrogen powered cars to justify the expense! The oil and automotive proponents of the Hydrogen Economy almost gleefully admit that the infrastructure required is decades away. It’s not surprising that these are the same people who will profit from no change at all.

Perhaps not all the ideas in a Hydrogen Economy are bad. The notion of using batteries and electric motors to power our ground transportation is a good one. Enter the Electric Economy.

The Electric Economy will eliminate carbon from our energy diet and needs three things to solve the problem: clean sources of electricity generation, electric transportation, and a distribution channel to connect them.

Electricity is the cleanest form of energy. It’s universal in that it can be used to run our factories, power our homes, cook our food, and power our transportation. It’s also a “common denominator” since it can be produced from any other form of energy that can create the heat necessary to generate steam to turn a turbine.

The problem with today’s electricity generation is that it comes primarily from the burning of fossil fuels, mostly coal and natural gas. We use some nuclear and we have already tapped most of our hydroelectric generation capability, but there is one untapped renewable source with the capacity to provide all of our peak electricity demand, the sun.

Our country currently uses 4 trillion Kilowatt Hours, or KWH, of electrical energy per year and we can generate all of this energy from the sun. We have two ways of doing this. The first is to convert sunlight to electricity directly using photovoltaic panels like those you see on rooftops in some locations today. The problem with solar energy, even in the desert southwest, is that it only shines eight hours per day. Intermittent energy sources are not a problem as long as you have a way to store energy for use in the evening. Unfortunately, we have no way of storing the many gigawatt hours required for a large-scale grid application.

The other way to generate electricity from the Sun is to do so thermally, using sunlight to heat water that in turn is used to power existing steam turbines. We still have the problem of storing large amounts of energy, but thermally, this is possible using water storage tanks.

It would require 12,000 square miles to provide our current 4-trillion KWH of electricity. If 12,000 square miles sounds like a lot, keep in mind that the state of Arizona has a land area of 115,000 square miles, much of it uninhabitable. So by utilizing just 10 percent of the state of Arizona, we could produce 4 trillion KWH of electricity. And we have much more space than that available to as we can see on this AccuWeather.com map of locations with 80-100 percent sunshine, an area of about 150,000 to 200,000 square miles, a “solar furnace” that can power our country for many generations.





In fact, we have enough solar thermal capacity to completely replace our current nuclear generation capability after we build the infrastructure needed to support our electric LDV fleet.

An Electric Economy mandates a move to electric transportation. In the past, electric vehicles were seen as glorified golf carts, with limited range of less than 100 miles. Today, with recent advances in lithium-based battery technology we can see electric cars like those from Tesla Motors and ZAP in the US and Lightning Car Company in the UK that provide all the performance and amenities we expect in cars and with ranges between 200 to 250 miles. And the capacity of lithium battery technology is increasing at 8 percent per year driven by applications such as laptop computers. On average, electric vehicles get 5 miles per KWH which translates into 1 to 2 cents per mile of operating cost. Unlike today’s gasoline motors with hundreds of moving parts that can fail and need servicing, electric motors have just one moving part, the rotor. That means there would be no tune-ups or oil changes required, no emission checks, and no service to exhaust or cooling systems.

So how much additional electricity would we use if all cars and light trucks were electrically powered? About 0.4 trillion KWH or 10 percent more per year than we currently use.

Connecting sources of electricity to the usage of it, including recharging electric vehicles, is the existing electrical grid that already distributes electricity to every home and business in the country.

Fortunately, the Electric Economy does not suffer from “chicken or egg” problems, in fact, the three components are quite independent: We can begin deploying electric cars immediately. These vehicles will typically be charged in the evening, off-peak from the perspective of the current electrical grid. And we can begin building High Voltage Direct Current transmission lines from our “Solar Furnace” in the southwest to each of the eight North American grid regions while we are building the solar collection infrastructure.

What would it take to accomplish the Electric Economy? The work comes in displacing our gasoline powered transportation with electric transportation. To do this we need to mandate that all new cars sold will be electric vehicles, perhaps introduced at the rate of 20 percent per year. With gasoline at $4/gallon, each of these cars would save the owners $2300 per year. These savings would be used to build the solar collection infrastructure in our desert southwest and the distribution from the desert to our existing regional distribution centers. Unlike other alternatives, the Electric Economy is completely self-funding.

Given an Electric Economy, what would our world look like in five years? We would have driven the value of imported oil to essentially zero. The foreign policies of industrialized nations would focus on real economic growth instead of securing oil. We would have no strategic interests in the quarantined OPEC countries other than humanitarian. China would no longer be interested in trading nuclear technology for oil with Iran and we could take the appropriate actions in dealing with Iran’s ambitions.

We would have no gas stations on street corners. Instead we would charge our vehicles in our garages or driveways. As with our cell phones we would always start the day with a full “tank.” Trips over 250 miles would require rapid recharging at stations located along interstate highways, where such distances would be traveled.

There would be no possibility of ecological disaster from oil spills. And we could stop transporting dangerous fuels on the highways and railroads.

Oil is currently the largest component of our trade deficit which would be erased. Instead, we would be exporting our Electric Economy technology to the industrialized world providing a positive trade balance and enormous wealth for this country. This wealth could be used to fund the upgrading of our aging infrastructure and better health, education and lifestyles for our children and theirs.

The Greatest Generation earned that name by their accomplishments and sacrifices for succeeding generations. While ours is not the Greatest Generation, it’s not too late to be great.

V1.12 Page - 1


The Great Bailout Bank Heist—and a Review of 2008 Frustrations

We know it’s happening, we can’t do anything to stop it, and it’s perfectly legal! What is it? The largest bank heist in history. No, don’t worry, the bank’s money is secure, they’re now stealing from us!


As 2008 winds to a close, it’s time to reflect on this year’s self-inflicted maladies that confound our country. I’ll start with the “Great Bank Heist” and you’ll see how it’s connected to a variety of other concerns, right up to, and including, the real estate collapse and the auto industry bailout; and how the auto problem can actually be turned into an opportunity to reclaim our automotive leadership.


Ever wonder where the $700B Bailout money went? It would be tempting to ask Barney Frank, the head of the House Financial Services Committee. Problem is, he looks like someone who might have trouble balancing his checkbook, much less tracking the whereabouts of our billions! Fortunately, there’s a forensic trail that led us into this crime scene, now it’s a job for CSI Washington!


The Great Bank Heist plot began in November of 2007 when the SEC decided to institute a new accounting rule known as “Mark to Market” (M2M), formally known as FAS-157 that changed the way banks were allowed to value mortgage-backed securities (MBSs) causing them to spiral downward. These are the same people who allowed Bernard Makoff to “make off” with $50B in a pyramid scheme he ran right under the nose of Chris Cox, the head of this vaunted organization. Fortunately, Mr. Cox will be looking for a new job come January 20th.


To solve this problem, Henry Paulson and the treasury pushed through the $700B bailout TARP (Troubled Assets Relief Program) only to find out their TARP had a large hole in it: banks, holding MBSs that were paying 98% of their interest were unwilling to sell them at fire sale prices and be labeled “in trouble,” a scarlet letter that would blacklist them from future loans from other banks.


So instead of purchasing assets, Mr. Paulson and his treasury decided to buy the banks instead—at least a large percentage of those chosen—by purchasing equity investments, presumably so these banks could begin making loans to individuals, companies, and other banks. At least $350B has been spent this way, but unlike you buying stock in these banks from other stock holders, this was new equity on which new stock would be issued. Normally, when one invests in a company in this fashion, the investor negotiates a “term sheet” detailing the transaction including the amount invested, and the percentage of ownership purchased. Somehow, Mr. Paulson neglected to get (or at least publish) these term sheets; there should be one for each bank.


So now the banks have heisted $350B of our money without any documentation of where it went or how it will be used. And why would they tell us how the money will be used (just because they insist on YOU answering that question when you borrow money from them!) since nothing in the Bailout Bill stipulated they should! But that’s just the beginning; not happy with just $350B, they want ten times that much!


So what are they doing with the money? Wisely, they are using it to acquire smaller banks not so “gifted” with TARP largess. The reason? It goes back to those pesky MBSs and the Mark-to-Market mistake. Remember, the MBSs held by the banks they are acquiring have been knocked down to 10% of their original value by the new M2M valuation rules. The large banks receiving TARP funds are smart enough to know that ultimately, the dichotomy of MBSs that are paying 98% of their interest (only 2% of mortgages are in foreclosure) yet are valued at 10-cents on the dollar must be rectified. And when this paradox is removed by the SEC in 2009 after their “study,” these MBSs will magically be restored to 98% of their original value, resulting in a 10-fold increase in the value of their investments. That’s how they can take the $350B they’ve stolen and turn it into $3.5 TRILLION! Talk about a full Christmas stocking…


So, as I said in my opening statement: we know what’s going to happen, we can’t stop it, and it’s perfectly legal. And if that’s not ironic enough for you, let me now add that this theft is ultimately in our best interest!


What did he say????!!!!


M2M has created a situation where a Fair Value accounting theory intended for liquid assets does not agree with the reality of illiquid MBSs that in the eyes of the holder are worth 98% of their original value. In other disciplines in which I am familiar, e.g., physics and engineering, when theory doesn’t agree with reality, the theory must be changed, reality can’t. But that’s physics, not finance. Ironically, in this case, if we don’t change the M2M theory, reality COULD change since M2M will ultimately bring down all real estate values and thus their mortgages, be they part of an MBS or not. I believe we are seeing the beginnings of this already.


Auto Bailout


So what does all this have to do with the auto industry bailout? The vast majority of new car purchases are financed through bank loans, or through the lending arms of the automakers themselves (e.g., GM has GMAC). The banks aren’t making loans, and the lending arms, like GMAC, that used to securitize (bundle) their loans into Asset-Backed Securities find few takers given that they are forced to be written down like MBSs. With no one to take on the debt, GMAC is running out of money to loan. No loans, no new car sales. This leads to a fundamental problem that seems to have escaped the auto industry bailout discussion: in recent years, the US market for new vehicles was about 20M units per year. For 2009, estimates are between 10 and 12M vehicles (I actually believe this is optimistic). It doesn’t take an accounting major to understand that if your revenue is cut in half (or more given the desperation sales that are going on), to remain profitable means you need to cut your costs in half—quickly.


So why did we loan the big three $17B when we know they will burn through that by March of next year and come back looking for more? They have to cut their costs in half, and the only way to do that quickly, while staying afloat, is through a Chapter 11 reorganization that would allow them to restructure debt with their creditors, close excess capacity (GM’s 18 US factories vs Toyota’s 4), shed their onerous legacy benefits and move to non-union labor. Only then should we have invested. We should have insisted on such a plan, but, as demonstrated in our earlier investments in the banks, our leaders(?) seem prone to a ready-fire-aim strategy when it comes to throwing our money around.


We should look at the US auto industry problem as an opportunity to reinvigorate an aging industry into one that produces the highest technology electric vehicles that would leapfrog the rest of the world, allow our environment to heal itself, and put us in the lead in the race toward building a carbonless energy economy, one that every industrialized nation in the world will need—and pay for. Unfortunately, with our premature bailout we have just continued to feed the problem—and delay the solution—for another three months.


Summary


2008 is the culmination of almost six years of self-inflicted disasters that started with our invasion of Iraq for completely unsubstantiated reasons. We then turned the whip on ourselves and in a fit of domestic self-flagellation introduced a misapplied esoteric accounting rule that has had the effect of nearly destroying our economy and those of the industrialized world. M2M is a financial cancer that must be removed. Until that is accomplished, anything else that we do, like purchasing banks or bailing out auto makers, amounts to just “rearranging the deck chairs on the Titanic.”


We can’t blame the bankers for our real estate/financial crisis, that honor goes to the Mr. Paulson, the SEC and Mr. Cox. However, the bankers have done a great job of taking advantage of the situation for their own advantage at the expense of ours.


Clearly, assets cannot have two different values at the same time, one dictated by the misapplication of an accounting rule and the other based on the real value of 98% of mortgages that are paying interest. And therein lies a way out of this paradox. Every MBS has an average interest rate and the total principle balance of mortgages within an MBS that are paying interest to the holder(s) can be computed based on the interest received, which becomes the value of the MBS. This would be a good starting point and immediately restore these securities to 98% of their original value and restore sanity to the credit markets. And when we do finally restore sanity to the credit markets, the banks that took $350B of our money will turn that into $3.5 Trillion…and we will all be better off for it! Of course the bankers who took advantage of this irony will be smiling all the way to the…bank. It’s traditional this time of year to talk of New Year’s resolutions, perhaps we need a national one; mine would go something like, “As a great nation, we need to stop making dumb mistakes—and correct those already made.” To quote Pogo, a long-defunct cartoon character, “We have met the enemy and he is us!”


If this message is as disturbing to you as it is to me, then I apologize for disturbing you. But if you are disturbed enough, you may want to disturb ten of your closest friends by sending them the link to this message: tinyurl.com/BankHeist-2008, which could ultimately disturb enough people in Washington—or soon to be in Washington—to do something about it; in which case I can stop writing these. Until then, when you see these things happening, remember that “Dave-Told-You-So.”


Happy(er) New Year,


Dave Spicer


V1.3




Solve It: We Don't Need a Bailout...And Never Did!

All we need to do is roll back the FAS 157 “Mark to Market” valuation rule from November 2007!

The last presidential debate between Obama and McCain left me with the feeling that neither of these candidates is very presidential! We have a financial crisis in full bloom. The stock market will continue to slide until the credit crisis is resolved…today’s businesses need credit to function and the market is recognizing that fact. Yet neither of our candidates has presented any creative ideas for solution. Neither even mentioned our most pressing issue in their lackluster performances.

Perhaps it’s time for citizens to begin offering solutions.

Ever wonder how Paulson came up with $700B and if that’s enough (it’s not if we stay on the current track)? Ever wonder why the bailout bill that was passed said that the money would be used to purchase mortgage-backed security assets from the banks…and why that hasn’t been done? Ever wonder why the $700B is instead being used to purchase equity in just nine banks…and if we are now the the majority stockholders of those nine banks are they really just one new bank…and why would this new bank make loans to banks that didn’t get an equity injection? And how does either buying the assets of, or investing in banks address the issue of the damaged banking assets (they don’t)?

I too began wondering and decided to do some research. The results are in the following four video segments I posted on YouTube that cover: 1) A way to think about and model the behavior of banks that can be used to evaluate “rescue” scenarios; and then using that model, 2) How we got into this mess, 3) The $700B bailout option(s) and why they won’t work, and 4) A rescue scenario that I call “Back to the Future” that rolls back “mark to market” asset valuation that can solve the financial crisis without spending a dime!

These videos are in their first unedited release. I targeted a few individuals in advance and have received some feedback; I would appreciate yours. When I have enough new material I will re-release the set. Please leave comments in the section below the last video or contact me directly at: GeopoliticsOfEnergy@gmail.com. If you want to reference this article in emails, you can do so with this link: tinyurl.com/solve-it

Banking System Flow Model:

How we got into this mess:



The $700B Bailout Scheme(s)…and why they won’t work:



Back to the Future,” Unwinding the Mark-to-Market Mistake:



V1.1

Dave Spicer: Bailout: Shame on (the) US, Let’s Get Back to Work

As you know, the first bailout proposal was rejected by Congress by 12 votes. The bill then went to the Senate where they attached $150 Billion in “sweeteners” which they then passed and sent to the House. This time the House also passed the bill (here’s the entire document) with flying colors. So what kind of “entitlements” were added to the bill? Here’s the complete list.

I defy anyone to tell me what the excise tax exemption for “Wooden Arrows Designed for Children” has to do with solving our credit crisis. Not even the writers for David Letterman or Jay Leno could have made this stuff up! The tragedy, of course, is that we have a real problem to solve while our “leaders” in Washington play games with legislation. And our credit “virus” has proven contagious, jumping across the Atlantic where it’s impacting European banks. Since the bill’s passage, the stock market has become less than impressed when investors realized the effects of the introduction of $700B into the market would take longer than they would like. Paulson indicated he needed several weeks to develop a plan for deploying the money. Apparently, spending $700B is a big job…where do I sign up to help?

The Shame

The portion of the bill having to do with the credit problem is essentially unchanged, which tells you Congress was more interested in their entitlement programs than solving the real problem. And here’s the irony, we really didn’t need the bailout bill at all…

Our fractional reserve banking system has worked well for decades. When a large and complex system such as this breaks down, it’s useful to look back to see what, if anything, has changed. In the case of our current banking crisis, what changed most recently was the introduction of a new set of accounting rules regarding mark-to-market asset valuation, formally known as FAS 157, in November of 2007. See my previous post for more depth on FAS 157.

The story of FAS 157 begins with the Enron disaster in an attempt to correct specious asset valuations that hid the problems within a company that truly demonstrated capitalism run amok. Enron was playing fast and loose with the valuation rules in effect at the time, and FAS 157 was the SEC and FASB’s answer. Arming the SEC with a stronger FAS 157 rule was like giving them a hammer, and once they had a hammer everything started to look like a nail…including mortgage-backed securities. The result decoupled the valuation of these thinly-traded securities from their component mortgages and collateral properties. The estimates I’ve seen say banks have had paper losses of $500B in assets due to this uncoupling which translates into $5 Trillion lost in lending capacity! Many of these securities had to be written down to zero in the collapsing market for them following the rules of FAS 157. But wait a minute, the intrinsic value of the mortgage balances and collateral property contained in these securities certainly hasn’t gone to zero!

Contrary to what you’ve probably heard about needing more regulation, ironically, FAS 157 represented the application of too much regulation. If we want to free up our credit system and re-energize the stock market we just need to take the following steps:

1. Rollback the asset valuation rules for mortgage-backed securities, FAS 157, to those that existed before Nov 2007. This will allow these securities to regain their lost value on balance sheets and immediately free banks to begin lending again. No central plan or infrastructure to deploy billions of dollars will be needed, just a rule from the SEC. This step will free up credit “instantly” and won’t cost us a dime.

2. Establish “Mark-to-Reality” valuation rules. In deference to the SEC, the asset valuation rules prior to Nov 2007 were not as accurate as they should have been, in many cases allowing assets to be valued based on their purchase price…which would not be accurate during the life of these securities. But instead of playing “Whack-a-Mole” with FAS 157, all we need are “Mark-to-Reality” rules that would require banks holding mortgage-backed securities to mark each individual mortgage and property to current assessed valuation and do this on a periodic basis, say quarterly. While this would be a lot of work, if you had an asset like a mortgage-backed security worth $100M, don’t you think it would be worth the effort to protect that asset?

3. Changes going forward. We can’t undo the mortgage securities that currently exist. We can, however, establish more conservative guidelines for new mortgages that require “old-fashioned” rules like…having a down payment!

Summary

By analogy, our situation is like you waking up one morning, turning on your PC and discovering it doesn’t start up. You have some important work to do so you call in expensive consultants and they proceed to dismantle your machine looking for the problem. It’s then that you discover the machine wasn’t plugged in…

The SEC didn’t need an act of Congress to get us into this problem; we don’t need one to get out of it. It’s time to realize we can free up the credit markets in relatively short order so we can focus on our energy issue that is costing us $700B every year by eliminating our dependence on foreign oil through a Carbonless Electric Economy. If you agree, you might want to do what I did and write to your representatives in Washington telling them to rollback FAS 157 for mortgage-backed securities, it’s just that simple. Using this website, you can enter your address and obtain the contact information for your representatives, including their email addresses. If you want to reference this article, simply copy this link into your message: http://tinyurl.com/rollback-fas157


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Dave Spicer: Economic Tailspin: The Disaster Aboard FAS 157

No, FAS 157 is not an airline flight number in a disaster movie, it’s something much worse when it comes to the disaster that has become our economy; FAS 157 is an Accounting Rule we’re riding straight into the ground—an Accounting Rule!

FAS 157 is the “mark-to-market” accounting rule created by the Financial Accounting Standards Board (FASB) that I spoke of in my original post that decoupled mortgage-backed securities from their underlying real estate assets back in November 2007 and simply stated, FAS 157 must be repealed or we will experience a rerun of this credit disaster movie. Can it really be that simple? Read on…

The 110-page congressional “Rescue Bill” is now available online for your reading enjoyment. It’s the result of a week’s worth of Washington legislative shenanigans that served as the best advertisement for congressional term limits I’ve seen. These are the people we’ve put in charge of our country! Makes me want to vote this election season for the people with the least amount of time in Washington…how about an Obama/Palin ticket!

An Example: SampleBank

To understand the mark-to-market issue we need to climb into our time machine and travel back to pre November 2007 and the value of a mortgage when a bank sells it to another bank. The value of that mortgage is simply the unpaid principle along with the risk that the homeowner will default (in which case the value is that of the underlying property) or that the homeowner will prepay and thus lessen the interest part of the return. To keep the example simple, let’s assume neither of those occurs because both are a rarity.

Enter mortgage-backed securities (MBS), which are bundles of mortgages, and in some cases thousands of them. And for the sake of this example, let’s have an MBS bundle of 1,000 mortgages with an average principle balance of $100,000 which means the value of our MBS is $100M dollars.

Now let’s assume that SampleBank buys this MBS with the intent to hold it until maturity. This is the bank’s capital and if we assume they have the leverage to loan out 10 times their capital, this means they can make loans up to $1B based on this asset. They also begin to process the individual loans in the bundle, sending out coupon books, receiving monthly payments, and producing statements.

Along comes November 2007 and the requirements of FAS 157, mark-to-market valuation of mortgage-backed securities. FAS 157 says SampleBank must no longer value its MBS based on the unpaid principle, but instead must value it at the price of other MBSs that have been recently traded! Well, mortgage-backed securities are not the most liquid of securities given the infrastructure needed to process them. This concerns the president of SampleBank who decides he now has additional uncertainty as to the value of his MBS and thus the credit leverage it provides, so he decides to sell it. Over time, so do a lot of other banks, which drives the value of the MBS down, and thanks to FAS 157, when the price goes down, so do the values of every other MBS even though the intrinsic value of the underlying unpaid principles and backing real estate have not actually decreased. The result is panic selling and complete uncertainty of the value of a bank’s MBS portfolio and thus the amount of money they can lend…so they stop lending! An estimate from William Isaac, former chairman of the FDIC, is that since FAS 157 was enacted, banks have had to artificially write down $500B in assets which means they have lost $5 Trillion in lending capacity.

In contrast to what the talking-heads on your television say, this is not just a problem for homeowners… it’s a problem for anyone who directly or indirectly depends on credit which includes homeowners, renters, children living with parents, every man, woman and child in the country. It certainly does decrease the availability of new mortgages and thus the number of potential buyers of real estate which lowers the price of that real estate, but it also impedes the purchase of everything else.

Repealing FAS 157

So what would happen if we simply repealed FAS 157? The value of SampleBank’s MBS would resort to it’s pre November 2007 value. The winner would be the bank that bought it at an artificially distressed price and the loser would be SampleBank that sold it at that price. Banks that held their portfolios—in some cases because they couldn’t sell them—would have their portfolios restored, and in all cases, capital would magically return freeing up ten times that amount of credit. This means that if we (the government) start purchasing these distressed MBS portfolios according to the “Rescue Bill” and THEN repeal FAS 157 we would have a windfall profit when we put them back on the market.

If you read the HR Rescue Bill in it’s entirety (have an ample amount of No-Doz handy) you will find buried in Section 132 “The Authority” to suspend FAS 157, and in Section 133 the initiation of a “Study on mark-to-market accounting” which implies they are considering the issues just discussed. They need to do more than “study” and consider, they need to act! It’s interesting that we don’t really need a bill of any kind to solve the credit problem since FASB didn’t need one to cause it. They can repeal FAS 157 as easily as they created it.

This credit meltdown was triggered by the stroke of a pen, the penning of FAS 157. It can be rectified by another stroke of the pen that repeals this absurd rule as applied to mortgage-backed securities. This is Henry Paulson’s task and he just needs to overcome the major proponents of FAS 157 who architected this disaster, the largest being, ready for this… Henry Paulson himself! Talk about a movie plot!

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Dave Spicer: The Bailout: We Have Met the Enemy and He is Us

What country poses the greatest threat to the United States?”

I heard this question being asked of several politicians on some of last Sunday’s morning talk shows. In each case, the politician would pause for a few minutes of thoughtful deliberation and then respond with either “Iran,” “Iraq,” or “Pakistan” and elaborating on their concern. It seems to me they’ve missed the point. Given our perennial lack of leadership when it comes to the issues we face, and with the addition of our recent “mortgage meltdown,” we may be our own biggest threat. It’s sad when the “smartest person in the room” is Pogo, a retired cartoon character who said, “We have met the enemy and he is us.”

With regard to the mortgage crisis I believe, as with other issues we face, we have been poorly informed as to its causes and even less well informed regarding the proposed $700B “bailout.” I recommend everyone read Paulson’s short document to establish a grounding in his proposal.

It’s clear that our politicians never took a Marketing 101 course since their first problem is calling what’s being discussed, a “bailout.” That word is never mentioned in Paulson’s document and has strong negative connotations. The real objective is to restart the credit markets through investments in mortgage-backed securities. In addition to a turnaround, if properly handled, these investments will provide considerable profit for our treasury. Instead of calling it a bailout, we should be calling it a “restart” for our economy. What they also should have said is that $700B is the cap on the investment. If handled correctly, it could turn out to require a much smaller number as I’ll discuss below. The only people who will not benefit are those who do not depend on credit and do not depend on companies that do depend on credit. I know of no one in that situation.

Let’s understand what’s required:

  1. We need to make funds available for new credit, be it commercial loans or new mortgages to keep the wheels of our economy turning.
  2. We need to make sure the situation that caused this disruption is never allowed to occur again.
Our financial infrastructure is broken not because people borrow money to buy homes, but because of the way in which their loans were packaged and securitized. Loan originators lured people who should have known better into taking loans they couldn’t afford. These companies took the origination fees (points) and promptly sold bundles—up to thousands of these loans—called Mortgage-Backed Securities (MBSs) to banks, thus passing the risk to them. The banks, unsure of the quality of these securities, bought insurance from companies like AIG, thus passing the risk to them. When the music stopped, AIG didn’t have a chair. Banks can only lend up to a multiple of their capital. Because of the freefall in the value of their mortgage assets they now find themselves in the position of not having enough capital to cover the loans they’ve made, not to mention new loans they need to make—be they mortgages or just regular commercial loans—to keep the economy going.

No market means no value

According to SEC accounting rules, mortgage-backed securities are valued on a mark-to-market basis meaning that the value of these instruments is based on their trading value, a change the SEC instituted in November 2007. When the world became suspicious of some of these mortgages, MBS mark-to-market value fell, causing the value of these securities to fall even further, until we are at the point where there is no market thus there is no value.

Here’s the irony. The ultimate value of an MBS is the intrinsic value of the real estate covered by its component loans and 80% of those loans are solid. However, by valuing on a mark-to-market basis, instead of on, say, an assessed valuation basis, the market price of these valuable assets has been driven to zero.

Pushing the “reset” button

What’s needed to restart the credit markets is a “market maker” who will step up and take a long position in these securities, and that long position can be something conservative, say 10 cents on the dollar relative to assessed valuation. Once traders know that there is someone willing to buy, that will restart trading. Over time, these securities will begin to move toward their intrinsic value, say 80 cents on the dollar and along the way, the market maker can sell at a profit. So who should be the market maker? It needs to be someone with deep pockets and staying power…and the only candidate with those credentials is the US government. This is the crux of the use of the $700B that is proposed to be allocated. We may never require that entire sum be invested before traders feel confident that the market is back in operation, but the market needs to know we can “go deep.” And again, we stand to make a considerable profit in the process.

Making sure it doesn’t happen again

An important piece missing from the Paulson proposal, and something we should insist on, is a plan to ensure that essential credit transactions like mortgages do not cause a repeat of this debacle. Remember, we got into this mess by writing shoddy mortgages and allowing the people holding them to sell them off at a profit while passing the risk to someone else. For existing mortgages it may mean reverting to a more stable set of accounting rules, moving away from mark-to-market. For new mortgages we may need to establish a new set of rules: these mortgages CAN NOT BE SOLD, the originator must process them and live with them which will encourage originators to scrutinize borrowers more carefully and get back to reasonable terms including greater-than-zero down payments. This means the under-capitalized fly-by-night originators “The greatest deal since the history of earth...” will go out of business and borrowers will get loans from banks that will process them to maturity, just as we used to.

Summary

Basically, we need to become the MBS market maker by purchasing some of these securities at a low price to kick-start trading. This will provide capital for new credit, both commercial and mortgage, with mortgage loans under a new (actually old) set of rules that will ensure we don’t revisit this situation again. The credit markets are in cardiac arrest. Picture Paulson and Bernanke each holding one paddle of a financial defibrillator to the chest of our economy and yelling, “Clear!”

It’s time to get this done so we can get our country back to work solving the real issue of our time, our continued dependence on imported oil. If we think a one-time expenditure of up to $700B is upsetting, we should keep in mind that that is the same amount we spend annually on imported oil. Imagine what we could do if that capital was retained in our economy!

Addendum – 9/26/2008

Since my original posting of this article I’ve had a great deal of supportive feedback asking that I add to the discussion the following issues:

Executive Compensation

Much of the discussion by the team of politicians negotiating the “restart” plan are concerned with executive compensation for companies that have failed their customers and investors. This is a red herring. While I agree that underperforming CEOs should not be rewarded, relative to the many trillions of dollars at stake, a fee million is a nit. That problem can be deferred until after we get the patient stabilized. It’s like having a cardiac patient on the gurney and debating if we should trim his fingernails before applying the paddles!

Purchasing securities above market value

I have seen comments concerned that the government will begin purchasing these securities at above-market prices. When the current value of these securities is zero, it will be difficult NOT to begin purchasing above that price!

Nationalization

Some reports are claiming that the Paulson plan amounts to nationalization of the companies in trouble. Anyone who reads the document will understand that nowhere does it state we will be taking an equity interest in these companies. What’s being proposed is an investment opportunity for taxpayers—us—that will restart the credit markets and if properly executed, a nice profit for our country.

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