i post this again as a forewarning

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    Sun Aug 3, 2003
    Weapons of Mass Destruction In the Market For Mortgage Backed Securities
    Author: Jim Sinclair


    Conversations Between:
    Warren Pollack & Jim Sinclair.

    I know quality when I see it, and Warren Pollack is that rare combination of intellectual and practical.

    The following are the notes of a conversation we had recently concerning the growing concern we both have that a little understood panic is at hand in the bond market. I feel the US Treasury has no idea of the scope and immense nature of the problem; the staff of the Chairman of the Federal Reserve has been underestimating the dollar involved and the derivative domino effect on other asset derivatives. They were lulled into underestimations because of the Chairman's public praise of the derivative instrument supposedly transferring risk from the few to the many. What was not considered is when the risk is so high and mathematically convoluted; the risk takers are fewer than the few. Therefore the definition of risk from the few to the many is simply illogical and non-functional in this case.

    It is the fundamental foundation to my statement to let the hot shot gold shorts, Gold Cartel of Common Interest, and Prechterites sell all the gold they want to by my personal invitation. They are about to self immolate, IMO, right in front of your eyes.

    This problem is so big, so immediate, and so systemic that it could explode as soon as Monday morning. Gold is going over $400, and I pray not $529 without eating up some time. Read on a carefully, because all the gold you can own cannot protect you fully from what is coming directly at us. It is like an unstoppable financial global-killing asteroid.

    The reason for this is the apparent counter-intuitive action between the central bank and mortgage related interest rates. It suggests that Mortgage Backed Securities (MBS), which are aggregated mortgages offset by over-the-counter derivatives, do not conform to the natural risk model envisioned when they were created.

    The bond market is saying that the artificial corollary between US Treasury instruments and Mortgage Backed Securities (MBS) has been forever broken, and to the shock of the collegiate derivative traders, all risks are not created equal.

    Given the new immense scope and size of the mortgage market, participants (now also auto makers) will be unable to absorb the dollar cost in the difference in risk between US Treasuries and MBS. They are now a universal derivative money cost, and therefore a risk mismatch. This is the nuclear material the madness of the derivative crowd has produced that is about to shake the entire mountain of derivative paper. It now totals USD$140 Trillions notional value - replacement cost.

    You have not read this anywhere in any publication before except here in my warning about the derivative problem of global implication. It will take birth from the top in the 30 year and then 10 year US treasury markets. From that day forward, long term and generational interest rates are going to rise on balance regardless of deflationary forces at hand. The US dollar is in extremely deep trouble and therefore gold is preferable. Watch the world wake up to this as the root cause of the awful bond market comes to light.

    Mortgages, thanks to the determined help of public pronouncement by the Federal Reserve's management in no less than televised congressional testimony of the Chairman, have become viewed as the modern day equivalent of what a bank account was in the last century. This is also before deceit economics and the amoral financial ethics of Sodom now practiced. The improper definition of a mortgage has taken birth by the modern features such as the ease of drawing out liquidity, perception of continual-compounding, an implied Federal guarantee for MBS securities, and the role as a primary saving instrument for the majority of people in the US. It speaks for itself. The impact of the derivative disaster now in progress in the market for MBS is going to hit the US and the US dollar harder than the tech bust hit investors in March of 2002. The wealth effect that will be lost here is the SECOND ICEBERG that I have been warning the captains of this ship of state about. I have been saying it was directly in the path of US no policy and lack of economic leadership. Leadership anticipates a problem and acts to prevent it. Leadership does not say as the Fed is saying "We will act if Deflation occurs," while doing nothing much to prevent it.

    We are standing right in front of a mess so terrible I have waited to explain to you what it was exactly. It is as Warren Buffet warned: those damn derivatives that were invented in a math class and sold to a professional public (and indirectly to every one of you depending on the value of your home) to survive. You will not survive without gold. These minutes are your last to stock up because money is going below the "Velocity of Money" at 1 and that is the functional failure of the US dollar to function as money. For your sake do not use margin on any gold item you have because the volatility could move to infinite, and the "Velocity of Money" tries to achieve zero. It is the "Velocity of Money" that is in danger of zero bound. It is because of a mountain of unfunded sewage paper calling for specific financial performance that none of it is funded so as to perform. The shaking of this fraudulent (contracted to perform but not funded to perform) mountain which is 20 times the size of the US National debt is going to literally shake the life out of the US dollar because of what government intervention or lack of it means. I see no alternative but to own not leveraged gold under these circumstances. A little will go a significant way.

    No amount of gold will go all the way. This is because safeguards present to protect against bank failure and loss of savings are lacking in the highly leveraged real estate mortgage market with derivatives attached. The real estate market has the potential energy to destroy wealth on an unprecedented scale not seen since the bank failures of the Great Depression. Real Estate can fail catastrophically without a safety net. The guarantee of bank deposits is more a guarantee that Bernanke will get a chance to fire up his electronic printing press to make lots of Monopoly game dollars. This is why the blame is going to fall right at the foot steps of the Fed and the present administration. Where are the smart Republican money men that should warn their boss that this is coming right now?

    In the near time there is little the Fed can do interest rate-wise because PRONONUNCEMENT will not make interest rates in this market now. All rates are made in the market place, so reduction of the window dressing Discount Rate means very little. The government could allow the MBS to fail, or they can print money as fast as possible, entering the market to buy MBS with Federal Reserve blank checks.

    Can you imagine holding dollars as China does? $290 billion of them, as the Fed is forced to manufacture more dollars in the shortest period of time in their history? Also think about the Secretary of the US Treasury engaging the Chinese in discussions that would now cut off their buying of Treasuries at this time. The Harley Davidson plant was a perfect place for that speech. How do you think foreign governments feel about the MBS they have purchased to replace Treasury instruments in the dollar reserves attracted by higher interest rates? The bigger they are, the more stupid they can be.

    The US government could purchase the risk by taking up the last risk of the derivatives on future mortgage financing, but with all eyes watching them, the immense assessment of the risk assumed would be a dollar liability with no offsetting asset. That type of transaction can only send the dollar lower long-term, even if it helped future mortgages. If the government took this position it would be functionally the same as bailing out a bank, but as always, the stockholders do not survive. If this was done, the government would become the direct market maker and guarantor of mortgages to consumers of mortgages. Based on the present balance sheet of the US, no assurances exist that foreign holders would want medium ten year to long 30 year US Treasury instruments, even at much higher rates of return, as they then would carry clear housing commercial risk.

    The balance sheet of the US has always had a currency value imperative, and therefore gold in period of extremes always attempts to balance it. A government rescue of the MBS, which may well be required, would serve to explain why some technical tools call for gold between $1250 and $1700.

    Warren Pollack felt that intervention would be interpreted as equity positive and markets would react that way. I felt that any such reaction, if it affected gold from higher levels, would be quite short lived if it occurred at all. This is because of balance sheet impact and huge extension of monetary aggregates produced by the Fed to steady the MBS market, or to function in a bail out of the failed entities. The government is already considered to be somewhat of the guarantor of MBS. Saying they were the guarantor, being a sort of a "No change - only performance" would also require huge purchases in the market to steady it.
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