The full consequences of what I termed The Rot Within: Our Culture of Financial Fraud and the Anger of the Honest (October 15, 2010) are now unfolding: the well has been poisoned. One of my most astute correspondents made a critical observation that I've seen nowhere else: once a market has been poisoned by fraud which goes unpunished, then institutional players will avoid that market as untrustworthy.

Without institutional trust and participation, the market then withers on the vine-- exactly what has happened to the U.S. mortgage securities market. The market for mortgage-backed securities has vanished, except for one player: the Federal Reserve, which has bought a staggering $1.2 trillion in the past 18 months to create the facsimile of an active market.

The well has been poisoned. The only mortgages being traded are those 100% guaranteed by the U.S. government: in effect, the risks intrinsic to a corrupted market have been shifted to the taxpayers, while the criminals who profited from the fraud and embezzlement got away scot-free.

Here are the correspondent's comments:

RE: Will bankers Go to Jail for Foreclosuregate?:

When I was in the Wall Street game, our small-cap fund was for a time in the top 5% of performers. I got bored and left, which is a longer story. Anyway, I observed a phenomenon about fraud. First it happened. Then it was widely publicized. Then it was prosecuted, and some big names were jailed. At that point, it was safe to go back into the water.

This happened in a few industries prior to the mid-1990s, at which point basic law enforcement was neutered and there were no more fraud prosecutions that mattered. I have always thought that the lack of fraud prosecutions for Internet/telecom fraud was a significant reason why the NASDAQ has never made a significant recovery to anything close to its peak reached in March 2000.

Watch carefully on the foreclosure frauds. If real jail terms are handed out to some (doesn't need to be all) big players, that will be a green flag. The public at large won't see it or believe it, but the professionals will. I am not predicting that this will happen. In fact, I'm quite skeptical that it will. However, any intelligent skeptic considers all the possibilities.

This is why no institutional investor will touch private-market mortgage securities with a 10-foot pole. The U.S. government and the Fed had a stark choice: either impose the rule of law and indict and convict hundreds, if not thousands, of people who perpetrated and profited from the systemic fraud and embezzlement at the heart of the mortgage and mortgage-securities industries, or socialize the corrupted, poisoned markets and use taxpayer funds to prop up the wizened shell of a stripmined market and reward the criminals with freedom.

They chose to reward the criminals and prop up a simulacrum market with only one buyer: the Federal Reserve. You can go to the the Fed's balance sheet and see the $1.2 trillion in mortgage-backed securities it owns. There is no effort to hide the brazen socialization of what once was a private-sector, free market.

When the well has been poisoned, the only players dumb enough to drink from it are the taxpayers, who have no choice as the politico toadies of the investment banking/financial Power Elites have funneled some $13 trillion in cash, backstops and guarantees into their "partners" who fund their campaigns and write the laws via their lobbyist proxies.

The Fed isn't dumb--it's desperate. The markets, systemically riddled with collusion, cronyism, fraud, embezzlement, misrepresentation and outright lies, have no participants except Central State proxies and "marks" who sadly still believe the ceaseless propaganda about "rising corporate profits," "recovery" and "a free-market economy." Hahahahaha--free market! Please don't make me laugh that hard, I might hurt myself.

If you are so confident in the "transparency" and trustworthiness of the mortgage securities market, please tell us how many private institutional investors are buying mortgage securities which aren't 100% guaranteed by the Central State.

The same distrust has poisoned U.S. stock markets. The high keening cry to "get into the market while stocks are cheap" which has been spewed daily for months on end on network TV and other channels of raw propaganda has been ignored by the "retail investor," a.k.a. the top 20% of Americans who have financial wealth to preserve and invest.

For 24 straight weeks, retail investors have been pulling tens of billions of dollars out of U.S. mutual funds and plowing hundreds of billions into low-yield Treasury bonds.

Why? Because they sense the stock market is hopelessly, deeply corrupt and by comparison Treasuries are trustworthy. You won't make a lot of yield in Treasuries, thanks to the Fed's zero-interest rate policy (ZIRP) which is designed to drive money into risky assets, but then you won't lose 40% like you did in 2008-09 or 2000-2002 in the stock market.

We can also see how insiders are responding to the knowledge that the well has been poisoned: they're selling 500 shares for every share they buy. This unprecedented cascade of insider selling has been noted elsewhere many times, as has the declining expectations for the "recovery" of U.S. CEOs.

Those who know the most are selling their shares as fast as they legally can, and are publicly expressing their lack of faith in the tricked-up "recovery."

The U.S. financial markets have been poisoned, with long-term negative consequences. Only crooks, fraudsters and "marks" (those who still believe the propaganda about the "recovery" and "stocks are cheap" poison) will be left in a stock market propped up by the same socialization of risk which keeps the flimsy facade of a mortgage market from crumbling. High-frequency trading machines create the illusion of a market, and State intervention via proxies and other corrupt games provides the liquidity needed to fund the facsimile of a "rising market" and a "recovery" in the U.S. economy. But the public isn't buying the fraud any longer; they finally "get it": The well has been poisoned and only a fool drinks from a poisoned well.

This is why we can safely anticipate a hollowed-out stock market which trades at a steep discount to its present propped-up levels in the years ahead--until the crooked players are indicted and the financial markets thoroughly cleaned. That will take political will which is completely lacking in the Demopublican-Republicrat status quo. For more on this, please read:

The Loss of Trust and the Great Unraveling To Come
(October 18, 2010)

The Normalization of Sociopathology in America
(October 16, 2010)

The Rot Within: Our Culture of Financial Fraud and the Anger of the Honest
(October 15, 2010)

The Coming Collapse of the Real Estate Market
(October 14, 2010)

Runaway Feedback Loops, Wealth Concentration and Gaming-The-System
(October 13, 2010)

Bernanke's QE2 Heading for the Shoals
(October 11, 2010)

Look Out Below (I've got a bad feeling about this)
(October 8, 2010)


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Special podcast: Steve over at Two Beers with Steve was kind enough to let me ramble semi-coherently for an hour; we had a great time and I think I should have interviewed him.... Check it out if you have an hour of sitting in traffic to invest: Two Beers with Steve podcast.


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