Is the Market About to Crash?


In true contrarian fashion, I wondered here on January 30 if the market was poised to rebound: We Told Ya So--But So What?. We all know the credit/debt financial bubble is popping, and that its demise is long in coming and richly deserved--but as observers, we also have to look at the stock market stripped of "fundamental" beliefs about what it "should" do.
Here is the chart I posted on January 30. Since then, the market has more or less continued to noodle around:



Courtesy of frequent contributor Harun I., here is an updated chart of the Dow in a shorter time frame. Please note Harun is not responsible for my interpretive comments on the chart:



The most striking points about this chart are (in my amateur opinion):

1. the close correlation of recent price action to fibonacci projections

2. the divergence of MACD, ADX and DMI. That is, these indicators of trend have reversed from downtrends into uptrends. If price confirms that divergence, then that reversal bears close scrutiny.

3. a wedge (or flag) has formed around a key support/resistance level (about 12,700). Price tends to break up or down in a new trend from such a formation.

In correspondence with Harun, I noted that market participants seem indecisive--the decline of the green DMI (strength of trend) line certainly suggests this.

Harun made these cogent observations:

"The decline of the green ADX line and the historical peaks of DMI in many of the markets we are watching is indicative of a non-trending state and a cyclical peak and therefore counter-trend strategies have a higher probability of success. This also means that support are resistance areas are now significant in terms of timing and time frame.

The most important observation though is your understanding of the psychological state of market participants, i.e., they are indecisive. This may cause, as you say, certain things to consolidate or rally unexpectedly as market participants react disproportionately to the news. Weak shorts will cover and cause the market to surge higher unmasking more stops. Of course the opposite is possible and should be guarded against.

Price is now oscillating in a range set at the beginning of the previous year which indicates that the gains of last year were lost."

If the market drops below that February 2007 low (about 12,000), then that would suggest the next leg down had begun. Alternatively, if the DJIA rises above the 12,700 resistance, that would suggest a near-term uptrend is in place.

How on Earth could the market rally when the U.S. is in recession and the financial house of cards is toppling? Good question, and I don't claim to have an answer.

But in the spirit of inquiry and contrarian exploration, let's consider what it's like for managers of serious money--not just hedge funds, but insurance portfolio and mutual fund managers.

The Fed is lowering interest rates by half-point shots every meeting, it seems, driving short-term yields ever lower. To leave your money in short-term cash is a good way to get near-zero or even below-zero returns. That may be a winning strategy in the long run, but you're not here "for the long run"--you're here to beat alpha, or you'll get fired for "underperformance." That's the way the game is played.

The bond market's had its big run from last summer, and the emerging markets--hot as a pistol the last few years--seem to have caught the flu when the U.S. markets sneezed. Europe? Looks topped out and vulnerable. Japan? Some exposure might be good, but as a manager you need some place to plant serious dough, not 5% of your portfolio.

So what's the largest, most liquid stock market on the planet? The U.S. market. And were there any reason to suspect it might have bottomed, and a positive return could be gained... you'd be all over it. Given the dearth of alternative opportunities in the $5 billion to $100 billion range, you'd have to be all over it if you wanted to keep your job.

But who's got cash to invest? Well, somebody has over $3 trillion under the mattress, so to speak--this is from Credit Bubble Bulletin, by Doug Noland, courtesy of frequent contributor U. Doran:

"Total Money Market Fund assets (from Invest Co Inst) jumped $26bn last week (6-wk gain $275bn) to a record $3.388 Trillion. Money Fund assets have posted a 29-week rise of $804bn (56% annualized) and a one-year increase of $995bn (41.6%). "

So we have the players, and the cash. Now why invest in selected U.S. companies? From the money managers' point of view, consider how few major U.S. multinationals have exposure to this credit/debt meltdown. IBM? Zero. Apple? Nada. Proctor and Gamble? Not worth mentioning given its global reach and size. Most of these corporations earn more overseas than they do in the U.S., and they have no credit risk worth mentioning.

Sure, we know the world economy will follow the U.S. into recession, but on a relative performance basis, you could certainly make the argument that major U.S. multinationals and tech companies will weather the downturn much better than other global firms, and perhaps better than commodities, which are exquisitely sensitive to drops in demand--which is precisely what happens in recessions.

Would you like to bet that the winter wheat crop will disappoint, and wheat will double to $20/bushel? What if the crop exceeds expectations? The it's $5/bushel wheat, here we come. In any event, most managers of serious money are precluded from even speculating in commodities and currency futures.

So what's my point? Only that in times of uncertainty and high volatility, then active portfolio management is necessary to catch the trends. Take a look at this chart of the DJIA in the 70s. Note its extreme fluctuations in price:



Now in nominal terms, the 1966 "buy and hold" investor was made more or less whole again in 1973 and 1977--that is, the DJIA returned to about 1,000. But adjusted for dropping purchasing power, the "buy and hold" investor lost 2/3 of their money by the time the Bear Market finally ended in 1982.

Was ignoring trends a wise investment/preservation of capital strategy? It's something to ponder as we look ahead and try to conserve what investments/purchasing power we still have.

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Saturday Quiz: 19th Century French Author

Question: Which French author scandalized 19th century France with his naturalistic depictions of Parisian slums and their rough-talking, drunken, dissolute, often-promiscuous residents?
Here's the answer.

As you might have guessed, I am reading one of his most admired books (in translation).

Readers Journal is updated! Check out the stimulating array of experiences, commentaries and ideas from twelve fellow readers.

To whet your appetite, here are some brief excerpts from various contributors:

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Fast forward to today. I recently had a falling out with a good friend, with whom I've played music with for almost ten years, The reason? I made the statement that behind each foreclosed home is a real estate agent who didn't do their job and failed in their fiduciary relationship with the buyer....

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You nailed it again. Throughout the mass delusion my wife and I have been aghast as old freinds, neighbors and family bought into the morally bankrupt rational of "its just monopoly money" or "its different this time"... I think you have hit upon the criminal nature of our mass delusion. We have to admit our mistake in order to move on....

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As with everything I read about this topic, though, I want to tear my hair out about the ten-ton elephant in the room that is being ignored. No one ever mentions or tries to seek out what I think would be a very telling statistic: How many of these defaults are Single-Family Owner-Occupied dwellings? (Not merely listed that way for under-writing purposes, but in actuality.)
The Mortgage Bankers Association of America estimates that anywhere between 30 and 70 percent of properties now in default are NOT S-FO-O. That is a crazy point spread which tells two different very different stories....

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However, there is a broader issue here we must face, which goes beyond the individuals who were actively engaged in some degree of fraud. Namely, the entire credit bubble would never have occurred if society itself wasn’t complicit....

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I have been following the posts and indeed things are becoming increasingly unstable. But from our studies in nature, i.e. chemistry, we should understand that all things are seeking equilibrium. In some cases equilibrium is achieved through an exothermic reaction....

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On the subject of Government waste, I can't even began to tell you the frustration I face everyday on needless waste of our Government. I think there is a fatal flaw in the way system was designed. It forces us to be wasteful rather than thrifty. All departments are awarded for spending the budget not saving it....

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Have a headache? (short satirical video with music)

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I agree with your moral argument, but you might as well rail against the tide. The "your loss is my gain" ethic is already firmly embedded - witness the growth in popularity of poker and gaming, or trading existing financial assets (as opposed to issuing IPOs of productive new companies)....

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Looking at life (mine) with the reasonable honesty I do, I learned along time ago that the only true way to really learn things is to immediately admit your mistakes or misconceptions and own up to the mistakes and drop the misconceptions....

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And if that isn't enough to spark your thinking, here is a stunning new essay by Protagoras: Letter from a Constituent .

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We are honored to host Protagoras' many insightful and satiric essays here on oftwominds.com.

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Ethics: a Non-Issue in America


I find it curious that lying, fraud, sins of omission and misrepresentation play absolutely no part in the national debate on how best to "save" at-risk homeowners and lenders.

This is curious for a number of reasons. Certainly one is the high degree of religious conviction and belief Americans report to hold.

According to author Richard Bitner's website The Mortgage Insider, "Nearly three out of every four subprime mortgages originated by brokers were misleading or fraudulent." (Bitner's book Greed, Fraud & Ignorance: A Subprime Insider's Look at the Mortgage Collapse was recommended here this week.)

Never mind expecting calls that fraud should be pursued as a crime--how about expecting someone to simply voice that it was wrong?

As outlined in Bitner's excellent book, fraud and misrepresentation of risk was the game played by everyone from the anxious-to-get-rich-quick borrowers to the anxious-to-make-billions investment banks which packaged the risk under the phony guise of low-risk AAA ratings issued by a handful of powerful fraudsters, a.k.a. the ratings agencies.

Yet pundits and politicos are falling all over themselves in a frenzy to "save" the players large and small from any consequences of their fraud.

Since I am tired of waiting for some well-regarded pundit or politico to state the obvious, then I have to: everyone who committed fraud, omitted the truth or misrepresented the risks of a debt instrument committed a serious ethical breach (and a crime). Each person who did so deserves the consequences of their unethical conduct. They do not deserve to be "saved" by taxpayers.

I am not suggesting criminal charges, though those would be richly deserved by players large and small alike. I am simply suggesting that we as a nation should state that fraud is wrong and should not be rewarded. The market will deal out the consequences if we just don't intervene.

I want to reiterate a point made earlier this week in Greed, Fraud and Duplicity: How the Housing/Lending Bubble Inflated, which is fraud can be quantified by the dollar amount but the ethical lapse/moral bankruptcy is the same regardless of the fraud's dollar cost.

Thus, the person with no assets and modest income cheated on their subprime loan application. The Wall Street investment banker had the opportunity to cheat on a much larger scale--purposefully packaging high-risk debt into CDOs willfully misrepresented as"low-risk" AAA instruments--but the truth is, each player cheated and lied to gain wealth or credit which they would not have gained had the truth been told. In this way each player, rich and poor, are equivalently morally bankrupt.

Plenty of people refused to lie or misrepresent the truth, and of course they were unable to borrow vast sums of money or sell misbegotten CDOs for millions in profit. So why should honest people be punished by being taxed to save their willfully fraudulent fellows? Isn't this Completely Backward Justice? Shouldn't those who knowingly misrepresented the facts for their personal financial aggrandizement realise some consequences? Or is "do the crime, serve the time" only for petty drug criminals?

Again, what I find most curious is how a supposedly religious society which claims high ethical standards is concerned not with questions of lapsed ethics or condemnations of outright fraud but with a frenzied rush to shield the wrongdoers from any consequences of their actions.

I wonder if a complete cleaning-of-the-slate financial depression which wipes out trillions of dollars of wealth might eventually re-set the nation's broken moral compass.

I know the standard line is "oh, heck, lying and cheating for personal gain is just human behavior, and this bubble was no different." Nice, but should we then accept grand-scale moral bankruptcy as the "natural state" of this Union? Should we collectively sigh and dismiss it with, "Oh well, everybody cheats on their taxes." Actually, not everyone cheats on their taxes. So who is quickest to forgive the cheater? Another cheater, of course, for he/she has already excused his/her own moral bankruptcy.

As a counter to this "we accept human greed and ethical weakness as really OK because we're all equally morally bankrupt" I quote from Lincoln's Second Inaugural Address. Lincoln was referring to God's punishment for the sins of slavery:

"Yet, if God wills that it (the Civil War) continue until all the wealth piled by the bondsman's two hundred and fifty years of unrequited toil shall be sunk, and until every drop of blood drawn with the lash shall be paid by another drawn with the sword, as was said three thousand years ago, so still it must be said 'the judgments of the Lord are true and righteous altogether'. "

Financial fraud does not hold a candle to the immense sin of slavery, yet the principle--that perhaps this nation has earned the destruction of wealth that has just barely begun--is something worth pondering. Call it God's judgment or Karma with a capital K, but if you believe in a moral Universe then the unrestrained greed, corruption and fraud of the past seven years will have consequences no matter how many Americans scurry around excusing each other, begging to be saved from the consequences of their financial crimes and ethical bankruptcy.

Please note I am not calling for or hoping for Financial Armageddon. I am simply positing that the consequences of systemic fraud may well play out regardless of the machinations underway to "protect" and "save" those who lied and misrepresented.

In non-moral terms, the obvious consequence is a loss of trust in institutions such as credit agencies and eventually in the entire U.S. credit/financial structure. To restore that trust requires invoking something analogous to ethics, even if you prefer to call it some other word.

"Trust, but verify" was the operative phrase of the Reagan years. How can a buyer of a CDO or credit-swap derivative based on hundreds of loans which are riddled with fraud and misrepresentation from the application on up to the credit rating "verifiy" the AAA-rating of the risk they are about to purchase? They cannot. Read these two books and you'll understand just how bankrupt the entire system truly is:

Fiasco: The Inside Story of a Wall Street Trader

Greed, Fraud & Ignorance: A Subprime Insider's Look at the Mortgage Collapse

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A Systemic Waste of Taxpayer Treasure


Frequent contributor Dorothy S. recently wrote about her experience of needless waste in the Veterans Administration. Like the elephant in the room nobody talks about, we all know our Federal and local government agencies are often larded with just this sort of heedless waste. Even more galling, when this is pointed out, we're often told, "it's not worth our time to be more efficient."

"This letter is to gripe about our government's waste problem. Now keep in mind that this particular incident is small in nature, but multiply it out and you have a lot of wasted money.
My father died last October from ALS. He was a veteran and the Veterans Administration took excellent care of him. As the disease progressed the VA gave us many special devices to help our father with his disabilities. Two items in particular were a top of the line, brand new wheelchair and an electronic communication device (a mini computer basically). My father's disease progressed rapidly and both items were never used.

After he died we called the VA and asked where we could send the items back. To our surprise they didn't want them back. We were shocked. I'm sure other vets could use these things. So I went online to see how much they cost. The wheelchair was $375.00 and the communication device was $3000.00.

So my mother and I donated both items to other ALS patients and we're happy they're being used by people who need them, but it upsets me that the VA didn't want them back. This is our money after all. Our taxes go for every expenditure our government makes. I would never run my household like this although I know that most American households do run like our government does. Which is how we have come into our current national crisis.

Which brings me to the topic of the upcoming tax rebate we are suppose to get this year which will miraculously make all of our problems go away. All my friends are tickled pink about it and I'd like to strangle them. It's not that I don't like getting money. But this money is not free like most Americans think. I know that this "rebate" is really our goverment going into more debt which will cause one of four things to happen: (emphasis added-CHS)

1) I will have to pay more taxes in the future to pay down this debt.
2) Watch the goverment try to inflate it's way out of it while eating away at my savings.
3) A combo of options 1 and 2.
4) Option three plus the added bonus of our goverment collapsing causing either Russia or Dubai to take over. I'm thinking this is probably the most likely outcome.

Quite frankly, I'd rather they keep my $600. I don't want to learn to speak Russian.

Thanks for letting me vent."

Great commentary, Dorothy--thank you.

The ways governments blow money are legion. The list is tiresomely long: fraudulent contracts, bridges to nowhere, goods left to rot in warehouses, sprawling computer systems which never work, outdated-the-day-they-fly weapons systems like the B-1 bomber, medicines which don't work for most patients, operations which do more harm than good, and on and on in a mind-numbing profusion. To note but two examples:

Proposal to curb waste in government contracts would not apply to overseas work:

"The number of companies reporting internal fraud in their handling of government contracts has declined sharply. In 1987, contractors voluntarily reported 44 instances of fraud or abuse to the Justice Department. By 2002, the number had dropped to eight. Last year, contractors reported three instances of fraud.

The more notorious recent cases of overseas contract fraud involve:

--Bribes of jewelry, computers, cigars and sexual favors for military personnel by Philip H. Bloom, a U.S. businessman living in Romania whose companies made more than $8 million in Iraqi reconstruction money. Three U.S. Army Reserve officers were later indicted or accused of steering contracts to Bloom between 2003 and 2005 in return for an estimated $1 million in cash and gifts.

--Anthony J. Martin of Houston, a former manager for Kellogg, Brown & Root Services Inc., who pleaded guilty to accepting $10,000 in kickbacks for awarding a $4.67 million project to a Kuwaiti subcontractor in 2003.

--John Allen Rivard, a retired U.S. Army Reserve officer from central Texas who pleaded guilty to conspiracy and bribery after helping steer $21 million worth of contracts for tractor-trailers in Iraq to a government contractor. He admitted taking $220,000 in bribes.

--Terry Hall, a caterer from Rex, Ga., who has been charged with bribing an Army major to help secure contracts worth $20 million for supplies, including bottled water, to military forces in Kuwait. "

Our taxes are really being put to fine use overseas, eh?

Everybody loves Medicare when they're collecting benefits, but what about the poor taxpayers who foot the outrageous bills?

When Geography Influences Treatment Options:

"Dartmouth researchers estimate that as much as one in three dollars spent by Medicare goes to unnecessary care. In that sense, variations in back surgery in South Florida provide a glimpse of Medicare's inefficiencies.

"It's highly improbable that Medicare retirees living in Fort Myers prefer back surgery two times as often as residents of Miami," Weinstein said. "So if it's not the patients, what is it?"

My favorite widespread "government waste" is the mad rush at fiscal year end to spend every last dime of the budget lest the department allotment be trimmed the following year. If you work in a governmental agency, you know the drill: buy something, anything, new desks, more PCs, whatever, but spend that money before it's discovered your department didn't really need its full budget.

Incompetence is an especially pernicious type of waste--of time and thus money. A non-U.S. friend of ours (from Scandinavia) whose husband works at a high-security lab here in the U.S. recently reported her frustration with multiple layers of bureaucratic nonsense. All she wanted to do was open a bank account at a major U.S. bank.

First, a bank employee told her she needed a Social Security number, and she should call the I.R.S. (As a recent arrival, she had no way to know this advice was nonsensical.) She went to the local I.R.S. office as listed on the website, and found an office with a faded sign which read: "The IRS has not had an office here for two years. We have asked them to update their website."

Somebody finally told her to go to the Social Security Administration office, where she was told she didn't need a number to open a bank account. When she called the bank back, she was told that yes, she did not need a Social Security number. Nice.

The bank employees didn't "waste" time or money--yet their incompetence cost the customer a huge amount of valuable time. Though this is a small example, extrapolate the endless time (and money) spent shuffling through the agonizingly slow and stupendously idiotic immigration process, and then you begin recognizing the true cost of systemic incompetence.

No job is superfluous--especially if it's yours. The ratio of school district administrative staff to teachers in the classroom has been dropping for decades. Not that anyone isn't busy--there are meetings to attend, reports to file, etc.

But you have to wonder: are all those mandated reports and meetings and conferences all actually necessary to the teaching? Or are they essentially unproductive lard which has been loaded on by legislatures and school boards? Even well-meaning attempts to "buy American" can end up costing more than the effort is worth when custom-made objects or "special requisitions" (the famous $700 hammer) are the result.

Our politics tend to define what we define as waste. Leftist types always focus on the Pentagon, conveniently overlooking the fact that Medicare is on track to surpass the Defense Department in cost. Rightwingers focus their attention on "welfare queens" and liberal educational frauds (Ebonics, etc.) Anti-pork barrel types look at the bridges to nowhere. Few look at Medicare or Social Security, though both are larded with fraud and undeserved payouts.

And almost everybody ignores the biggest waste of all, which is interest on the National Debt--a debt which has increased by $3 trillion in the past eight years of bogus "prosperity" (and since March 19, 2003, a war in Iraq).

Here are the top budget items in the Federal 2007 budget. Note that both Medicare and Interest on the National Debt are rising far faster than Defense or Social Security:

$586.1 billion (+7.0%) - Social Security
$548.8 billion (+9.0%) - Defense
$394.5 billion (+12.4%) - Medicare
$367.0 billion (+2.0%) - Unemployment and welfare
$276.4 billion (+2.9%) - Medicaid and other health related
$243.7 billion (+13.4%) - Interest on debt
$89.9 billion (+1.3%) - Education and training


President Bush just proposed a $3.1 trillion Federal Budget for the next fiscal year. State and local governments spend around $1.8 trillion. So government sucks up about $5 trillion (and borrows insane amounts of additional money via municipal and state bonds which are usually listed off-budget).

The U.S. is entering or has entered a recession which is sure to reduce tax revenues by staggering sums. Government employees and their unions are sure to demand tax increases to cover the shortfall ($14 billion in California alone, and the recession has barely started.) Private businesses and wage earners, already groaning under high tax rates and rapidly rising "junk fees" for governmental services which are paid by taxes, are certain to refuse all new taxes.

Does anyone else think at least $1 trillion of the $5 trillion is pure waste? Not just bridges to nowhere and crooks in Iraq (I mean the American crooks--the Iraqi crooks have cost us billions more) but meetings that accomplish nothing, positions which are unproductive but protected by union contracts, Social Security payments to people who never paid a dime in U.S. taxes, Medicare operations which enrich the clinic but didn't benefit the patients, interest being paid on money we shouldn't have borrowed, and on and on.

In the real world, inefficient businesses larded with unproductive positions and useless busywork eventually go out of business. Yes, "everybody's working hard" but that doesn't mean much of the budget isn't unproductive.

I once worked for a non-profit organization which employed one fulltime person and 7-8 halftime people for administration. When push came to shove in the last recession, the entire organization's fairly complex admin workload ended up being performed very adequately by one person on 3/4 time. How? No endless meetings, no agendas, no arguments over budgets, no supervisory issues, no conferences and no training.

That seems difficult to believe--unless you're a sole proprietor. Then you're used to running the entire show and wearing however many hats as needed. The most efficient workforce is always one motivated person--even on a project as large as building an entire house. One good carpenter only needs a hand occasionally to set beams and such; the other 95% of the time, other workers just create inefficiencies and mistakes.

Walk into any bureaucratic office, and a significant percentage of the people could be laid off if the inefficiencies and useless meetings and redundancies were sliced away. If you've worked in such an office your entire career, you will probably protest "it's not possible"; but if you're run a business "in the real world" in tough times, then you know what I mean.

Will government be forced to become truly entrepreneural, with the citizen as the customer? If the taxpayers rebel and refuse to pay higher taxes and fees, then government will have only two choices: either become entrepreneural in spirit and practice, or get even less accomplished with fewer people.

When I discuss these issues with employees of universities and government contractors, they generally say that bureaucracies are inherently inefficient. Yes, managing thousands of people requires a complex structure; but why must that be inherently inefficient and wasteful of resources?

Businesses hire people by the thousands when everything's rosy (for instance, Yahoo!) and nobody suggests even one position of thousands is inessential. Yet when things tighten up then suddenly Yahoo! management realizes 1,000 positions, are, well, inessential. Easy come, easy go.
We as a nation may be about to start a grand experiment in "reinventing government" not because it's a noble-sounding goal but because the money's finally run out.

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System Instability, Redundancy and the Domino Effect

The potential for a systemic collapse of the global financial system is finally hitting the mainstream. For instance, this from the Wall Street Journal: New Hitches In Markets May Widen Credit Woes :

"A widening array of financial-market problems threatens to trigger a new phase in the global credit crunch, extending it beyond the risky mortgages that have cost banks and investors more than $100 billion in losses and helped push the U.S. economy toward recession.

In the past few days, low-rated corporate loans -- the kind that fueled the buyout boom of recent years -- have plummeted in value. As a result, banks are expected to try to unload some of those loans this week at fire-sale prices.

Nervous buyers also have retreated in recent days from the market for securities backed by student loans and municipal bonds, roiling some corners of the short-term money markets. Similarly, investors have recoiled from debt backed by commercial real estate, such as office buildings."

In the blogosphere, many analysts have warned of this possibility. For example, Nouriel Roubini posted this on rgemonitor.com: The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster. Michael Panzner over at Financial Armageddon has written a sobering book on the topic and provides blog updates on the meltdown's progress.

Even your amateurish correspondent here at OTM could see it coming a few years ago:



As we discussed yesterday, the entire system is built on a series of incentives to obfuscate or hide risk and then pass the risky asset on to the next player.

--The borrower lies about income and creditworthiness, hiding the true risk.
--The broker happily goes along, otherwise the loan won't fund and he won't get paid.
--The lender goes along in order to reap a fat profit from selling the loan to Wall Street.
--The ratings agencies go along in order to earn their fat fees for masking risk-laden debt with a AAA rating.
--Wall Street goes along to sell the bundled loans and derivatives constructed from the loans to investors seeking a "safe, AAA investment."
--Traders and sales reps distribute the asset as "safe" around the globe in order to reap huge commissions/trading profits.
--Politicians look the other way as Wall Street ponies up big-bucks contributions.
--The Mainstream Media gloss over the layers of risk so as not to offend their big-bucks real estate/banking advertisers.

These incentives to cloak the true risks of loans aren't just built into the home mortgage market--they're built into all loans which have been bundled and sold as "low-risk": student, auto, commercial real estate, corporate buy-outs, you name it.

Consider a spacecraft as a metaphor for a system which is designed not to fail. There are two basic ways the spacecraft can fail: a single essential component can fail, or a single failure can trigger a domino-like cascade which leads to the entire craft failing.

If the craft's single oxygen tank ruptures, the crew dies. 99% of the spacecraft is still working perfectly, but the system failed in its primary purpose: keeping the crew alive.

If an electrical failure causes a cascade of subsystem failures, you end up with the same result: a powerless craft and a dead crew.

Redundant systems--as in Nature, two eyes, etc.--are one safeguard against catastrophic system failure. Thus having the oxygen in two separate tanks minimizes the risk that a tank leak could kill the crew.

Inserting breaks in dependent systems, e.g. "spacing the dominoes far apart" also works to stop a subsystem failure from cascading into others. Thus an electrical breaker wills top a short circuit from bringing down the entire electrical system.

In a way, this is the idea behind the "checks and balances" of modern republics. A bicameral legislature provides a kind of "breaker:" if one legislative body passes some harebrained scheme, hopefully the other house will kill it or at least water it down. Similarly, the President can veto the lamebrained idea. If he/she fails to do so, then as a final "breaker" the Supreme Court is supposed to step in and protect the Constitution and the Republic by striking down the law. (The Patriot Act shows how even this system can fail.)

So where is the redundancy in the global financial debt machine? Where are the checks and balances, or breakers? There are none. Here and there, you find a bit of redundancy, but nothing on a global scale.

For instance, there are still small local banks and credit unions in the U.S. which fund and service their own home mortgages. (Yes, they do exist.) But the number of mortgages funded and serviced by such responsible lenders is small compared to the trillions in risky mortgage debt dumped on the world markets.

Theoretically, there are government regulators who are supposed to act as checks or breakers against abuses or fraud in the system. But in the past seven years we have seen a wholesale surrender of responsibility by the Federal Reserve, the SEC, the FDIC, etc. Individuals within each agency issued clarion calls of concern, but their political masters didn't want to rock the boat. The breakers failed to go off, insuring systemic failure.

There is little or no regulation which requires transparency of risk or even the market valuation of loan-based assets such as CDOs. The ratings agencies were supposed to objectively assess risk, but with their fees dependent on issuing AAA ratings to 90% of all debt instruments, this supposed "check" failed catastrophically.

Here then is a system close to the perfection of instability: the risks are cloaked, and there is no redundancy or breakers in place to stop the dominoes once the first one falls. The subprime domino fell last year, and now other dominoes are falling rapidly, as described in the above quote from the Wall Street Journal article.

Roubini's article describes 12 dominoes; you can choose whatever number you prefer, but they're all falling, and there is nothing to stop them except more attempts at masking the risks of default or masking the defaults themselves.

All such attempts will of course eventually fail.

It would be better for all of us if the whole rotten structure collapsed in a month: Moody's, Fitch, et. al. confessed their liability and declared bankruptcy, investment and money-center banks admitted their insolvency by marking all the "off-balance sheet" assets they've been hiding to actual market, 10 million homeowners who can't afford their mortgages demanded market valuations on their houses and lower rates from lenders, monoline bond insurers gave up the delusion they will ever be solvent and declared bankruptcy, etc.

Yes, trillions would be lost/written off. But the trillions have already been lost. All we're doing is stretching out the pain. Such a confession of reality by all players would clear the decks of bad debt and allow regulators to start from scratch. No more appraisers paid by those whose only interest is a falsely high appraisal; another model would be put in place.

No more ratings agencies paid by investment banks for masking the real risks of debt being packaged. A new rating system could be put in place, perhaps based on the subscription model which worked well until the SEC abolished it. No more CDOs, CLOs, etc. No more hiding of assets off-balance sheet, "marked to myth"; all assets will have to be stated and marked to market at the end of each trading day.

Such reforms are just common sense; nothing fancy or arcane is required.

Will it happen? No. There are too many powerful players hoping the trillions can be restored with some fancy footwork, i.e. "restoring faith in the system." They will continue to obfuscate the risk and mask the bad debt, for years if necessary. Only when the entire system finally implodes will a reckoning take place.

When will that occur? Nobody knows. Some think it might happen soon, in a matter of months. My best guess is four or five years hence, for it will take that long for the "crew" to try twirling every useless knob in the hopes of staving off system failure.

You can't restore stability to an inherently unstable system.

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