The Reserve Primary Fund, which held $785 million of Lehman's debt obligations, had to immediately write down the value of its Lehman holdings. The following day, Sept. 16, 2008, the fund "broke the buck" by declaring the par value of its shares had fallen to 97 cents.

"Breaking the buck" is a cardinal sin for money market funds. Whatever the mix of debts and maturities any fund holds, and no matter how little interest they pay, at an absolute minimum investors park their cash in these funds for safety. The measure of safety is every fund's ability to maintain at least a dollar per share par value.

When the buck was broken at one fund, money market investors at all "prime" funds panicked. Only one day later investor redemptions exceeded $169 billion.

While investors were panicking about the par value of their fund holdings, the Federal Reserve, the U.S. Treasury and world financial markets feared the collapse of U.S. money funds would take the global financial system over a cliff.

Since short-term government securities don't pay a lot of interest, portfolio managers juice up fund yields by buying commercial paper (short-term funding instruments issued by corporations and financial firms) with more attractive yields.

The crux of the crisis, which nobody saw coming, was that not only did banks and investment banks issue hundreds of billions of dollars in commercial paper, but their off-balance sheet "conduits" also known as SIVs (structured investment vehicles) were also issuing commercial paper to finance the purchase of hundreds of billions of dollars of mortgages and other asset-backed securities.

As investors pulled out of prime money market funds, commercial banks, investment banks, asset-backed holding vehicles and every top-rated corporation in the U.S. that relied almost daily on functioning commercial paper markets were all unable to finance themselves.

The panic in the money markets was driving America's corporate elite and the rest of American businesses to an abyss.

To stem the "run" on money market funds, the Federal Reserve announced the creation of the Commercial Paper Funding Facility (CPFF) on October 7, 2008. The CPFF effectively extended access to the Fed's discount window to issuers of commercial paper, including those not chartered as commercial banks, to act as their lender-of-last-resort.

In addition to directly lending to commercial paper issuers, the Fed introduced the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility and the Money Market Investor Funding Facility.

According to the Fed, "All three facilities supported short-term funding markets and thereby increased the availability of credit through various mechanisms."

In other words the Fed saved investors and credit markets from an almost certain death.

But, not much changed in the commercial paper market. The same contagion and systemic issues that led to the money market crisis are still inherent in the system.

Making Money Market Funds in the Image of Banks

Behind the scenes, banks are now working to level the playing field.

Banks have restrictive capital reserve requirements; they have to pay FDIC insurance fees, and are subject to far greater scrutiny than funds.

They complain that money market funds don't have those restrictions and the full backing of the Fed affords funds an insurance backstop that they don't have to pay for, but benefit from because lower costs allows them to offer higher yields.

From the moral hazard perspective, critics point to the Fed's backstopping money market funds as a license for them to take more risks as they divert deposits from the more regulated banking system.

The SEC staff's proposals level the playing field between funds and banks by essentially requiring money market funds to re-make themselves more in the image of better regulated banks.

Although the recommendations are meant to lessen the likelihood of another taxpayer-funded bailout in the future, money market fund sponsors are up in arms that they are being disadvantaged by regulatory overreach.

Fund sponsors claim the future of the commercial paper market is at stake.
They say increased regulatory costs will raise financing charges for commercial paper issuers to the detriment of the entire economy and that their own businesses will be destroyed.

The battle ahead is bound to get ugly.

"Free market capitalists" (as "socialists" might call them) will make their usual case that if left alone, bruised fund sponsors and commercial paper issuers will adjust to the complex realities that nearly caused their collapse. And investors should be free to chase yield and face free market consequences for decisions they make based on their own due diligence. They will argue that moral hazard will disappear if individuals, businesses, and banks are allowed to fail.

Of course, the "socialists" (as "free market capitalists" might call them) who want the American financial system to be safe for everybody will point to how free market capitalists are the first ones to cry for bailouts when their greedy schemes overwhelm the economy's capacity to absorb their losses. And that bailouts, which are increasingly necessary because deregulation unleashed the wrong kind of animal spirits, are the root cause of moral hazard.

The battle for the soul of America's financial and economic future hangs in the balance.

Related Articles and News:

• Money Morning:
  The New Money Market Fund Rules You Could Face
• Money Morning:
  Money-Markets, CDs, and Bonds: The Ups and Downs of Stashing Your Cash
• Money Morning:
  Bankers Committed Fraud to Get Bigger Bonuses
• Money Morning:
  Robo-Signing is the Tip of the Iceberg for the Banks
• Money Morning:
  Don't Be A Wall Street Patsy

Questionable bank documentation submitted to courts may be the reason JPMorgan Chase & Co. (NYSE: JPM) abruptly abandoned over 1,000 debt collection lawsuits in April 2011.

However, debtors whose pending cases were dismissed aren't out of the woods yet. All of Chases' suits were dismissed "without prejudice," meaning Chase can re-file the cases in the future.

A Debt Collector's Dirty Trick

The only relief long-delinquent borrowers have is the statute of limitations imposed by most states on debt collection.

Statutes of limitation, which are typically between two and 15 years, are by themselves no guarantee that debt collection agencies, which buy accounts from banks, won't try to still collect.

Some debt collection companies entice delinquent borrowers who are beyond their statute of limitation requirements to make payments by offering to reduce the whole amount owed.

Their aim is to get the borrower to make even a single payment. It's an old trick.

By paying anything on a debt that is past the statute of limitations, the debt is brought back to life again and the statute of limitations clock starts all over from the date of the new payment.

It's why debtors are browbeaten and enticed to make payments through mailings, harassing calls, and "transfer of balance" offers for new credit cards, which requires old debts to be rolled into the new credit agreement.

The industry term for restarting the clock on old debts is called "re-aging."

The Federal Trade Commission's Bureau of Consumer Protection calls it illegal and abusive.

Last month the FTC and the Justice Department settled with one of the country's biggest debt collection companies in a case with repercussions for the entire debt collection industry.

Asset Acceptance Capital Corp., which the FTC had charged with violations of federal law - including that it "failed to tell debtors they couldn't be sued" when they tricked them into making payments to "re-age" old debts - was fined $2.5 million without admitting or denying wrongdoing.

I contacted Erik Kardatzke of the Coral Gables, FL, law firm Debt Defense, P.L., a prominent debtor-rights defense attorney who was quoted in a June 2011 Wall Street Journal article about Chase's dismissed suits, to ask about new pending lawsuits.

"I don't see any pending suits by JPMorgan Chase or any of the attorneys or law firms that usually work for them," he said. "I mean, not a single one. This is highly unusual."

Kardatzke is a former debt collection attorney who became disillusioned with the practices of credit card companies and debt collectors preying on consumers.

"I would see victims of predatory lending who would charge $300 on a credit card, and be sued for $3,000 four years later based upon late charges, over the limit fees and 30% interest. I noticed that there was rarely an attorney defending consumers and decided to fill that need," he told me.

The FTC, upon fining Asset Acceptance, announced additional enforcement actions are pending.

They are now joined by the Consumer Financial Protection Bureau, which has the authority to go after banks for abusive collection tactics.

Another Headache for Bank Stocks

All this attention on banks' credit card collection efforts isn't going to help their revenues and earnings.

Not only could credit card borrowers stop paying if they don't believe banks have proper documentation to go after them, but debt collection companies could sue banks for knowingly providing them inadequate or falsified debtor information when they bought uncollected accounts.

The big banks haven't been able to settle charges over their robo-signing of foreclosure documents, which by some estimates could amount to over $25 billion in fines and consumer remuneration in some form or another.

Now, with charges of illegal robo-testimony being used to win court judgments in credit card collection cases, the banks now face another huge legal battle with potentially enormous bottom line consequences.

Robo-signing is just the beginning for the banks. News and Related Story Links:

• Money Morning:
  JPMorgan Chase (NYSE: JPM) Earnings: Don't Be Misled by Sagging Banking Sector
• Money Morning:
  Goldman Sachs Group Inc. (NYSE: GS) Earnings: How the Mighty Have Fallen…
• Money Morning:
  It's 2007.2, and Our Next "Lehman Moment' Is Coming Fast
• Money Morning:
  How Banks Are Using Your Money to Create the Next Crash

The same short sellers who are driving the price down.

"Decimalization" is another idea Wall Street pushed on the markets under the guise of helping investors.

Stocks used to be priced in increments of eighths of a dollar, they are now priced in pennies.

So who really benefits from decimalization? Wall Street does.

The net effect of decimalization was to lower spreads at the cost of lowered liquidity.

That's because fewer large investors were willing to put down orders on exchanges to buy and sell at set prices when specialists and market-makers could "front-run" them and risk only a penny if they were wrong. Standing orders were withdrawn and the markets (willing buyers and sellers) became thinner.

Interestingly, as these markets became thinner, Wall Street started to open private trading venues and "dark pools" to cater to big institutional clients because they were afraid to put down orders at exchanges or with market-makers.

Needless to say, retail investors aren't invited and the splitting up of orders across multiple venues works against those who don't have access to dark pools and private trading venues.

The catchword here is volatility. Everything Wall Street has done has increased volatility.

What's so great about volatility? Volatility is what makes trading profitable. Without volatility traders wouldn't have the same opportunities for the quick profits they enjoy.

But, of course, this same volatility puts retail investors at a complete disadvantage.

Only you don't have to be patsies. Retail investors can play a lot of the same games that Wall Street does.

Here's How to Play the Markets Like a Pro

First of all, unless you're getting excellent advice from your broker and you don't mind paying the fees they charge, move your portfolio over to a discount broker.

And don't get caught up in the myth that mutual funds are the answer to beating the market. They're not. Most of them buy and hold a lot of the same stocks and end up trailing general market performance.

Check out the fees they charge. Are they worth it? Are you paying fees to lose money because you believe mutual funds have a leg up?

Remember, mutual funds are Wall Street businesses, run on the same assets under management for a fee principle.

Second, realize that buy and hold is dead. While it's great to buy and hold onto winning positions, it's holding onto losers that will kill you.

The only time you should hold onto a losing position is if you actually plan to add to it when prices come down, and only because you understand why the stock has dropped in price.

It's okay to add to that position if it's fallen because the rest of the market fell, but only if the company's business model and fundamentals are sound and growing. Otherwise it's a sell.

Just make sure you have an out or a price at which you say to yourself, "That's it, I've reached my limit on this position." And then promptly get out.

The way to play the Wall Street game is to do what they do, not what they say you should do. In other words: Trade.

Trading doesn't mean day-trading. It means thinking like a trader. Know what entry points are good places to buy. Know what points are good selling points. Trading means having a plan.

First pick the stocks or exchange-traded funds (ETFs) you want to trade. It's important to diversify by building a portfolio of stocks that represent different asset classes, like U.S. big-cap dividend-paying stocks, tech stocks, materials stocks, emerging markets ETFs, or commodity-based ETFs.

What matters is that you have a handful of stocks that you know and watch and that when you hold them you are diversified. Learn how they move and why they do what they do.

Trading is the first step in investing. You have to take a position, and that means putting on a trade.

But don't fall in love with any position unless it keeps doing what you expect it to do and you're making money holding it.

Even then, don't be greedy. Pick a point to take some or all of your profits.

Finally, always have an exit plan.

Every trader I know has one - and after 30 years as a Wall Street trader I know a lot of them. Whether they are winning or losing, every single one of them has plan. You should, too.

It's not hard to play the Wall Street game. Don't try and beat them, you can't.

Just play the game the way they set it up for themselves and you'll figure out pretty quickly that volatility can be your friend, and that you can make money trading from both the long and short side of rapidly rising and falling markets.

Otherwise, you'll just end up as one of their patsies.

News and Related Story Links:

• Money Morning:
  It's 2007.2, and Our Next "Lehman Moment' Is Coming Fast
• Money Morning:
  These Four Investing Lessons Mean Everything Today
• Money Morning:
  Paul Krugman is Dead Wrong: Debt Matters

A leveraged buyout is really nothing more than a financing technique.

Typically, a public company, a division of a public company, or a closely held non-public company is taken "private" by a group of investors who put up some equity to demonstrate they have skin in the game, and who then hypothecate the target company's assets as collateral for debt they pile onto the target company.

Sometimes borrowed money is raised in the junk bond market. Since the acquirers are leveraging the target company's balance sheet by borrowing a lot of money against the company's assets, lenders demand high rates of return knowing the company is being "leveraged."

The borrowed money is then used to pay shareholders, or as is more often the case, to pay off the "mezzanine" lenders who float enough cash for the acquirers to buy the company initially, and whose short-term loans are paid off from the issuance of junk bonds.

Not all the debt is junk. Sometimes debt issues are better quality. It's all a matter of how much leverage is necessary to make the deal happen and to make it profitable for the acquirers.

Once the target is acquired it's up to management, which often includes existing executives who are part of the buyout team, to streamline the company and make it profitable.

Loaded Down With Debt

Since the target company is now buried in debt, expenses are cut as judiciously and quickly as possible.

For instance, maybe the acquired company has too many corporate jets that are a balance sheet drag. Or, maybe they have too many employees that add to expenses.

Usually it means laying off workers, which is what gave leveraged buyouts their bad reputation.

But, that's not all that creates controversy. LBO shops charge the target company all kinds of fees.

There are investment banking fees for doing the deal, financing fees for leveraging the company, and other fees that go directly to the LBO shop.

Sometimes, the company takes on even more debt to pay a dividend to its new owners. That's a way for the LBO shop to get its equity back quickly. So much for skin in the game.

The LBO shops also pay themselves a 2% management fee out of the capital that their backers, investors like pension funds, endowments and high net worth individuals put into them so they can scour the planet for target companies to leverage up and buy.

And, they take at least 20% of the profits they make, too. It's a nice club to be a member of.

But while leveraged buyouts are the bread and butter of private equity shops, they can also dabble in venture capital financing of start-ups and other capital raising and financing opportunities.

Mitt Romney's Bain Capital Problem

Mitt Romney was a founder of Bain Capital, which grew out of Boston-based global management and consulting giant Bain & Co. He ran the LBO shop from 1984 to 1999.

Romney was very successful running Bain Capital and amassed an estimated fortune of over $250 million.

Needless to say, as Romney gets closer to becoming the Republican nominee, his role at Bain and his claim to have created 100,000 jobs are going to be heavily scrutinized.

Now personally, I'm not against leveraged buyouts.

However, I do think it's fair game to question LBOs that end up turning to bankruptcy protection to shed themselves of their pensions (which are often taken over by the taxpayer funded Pension Benefit Guaranty Corporation) so they can re-emerge under the guise of becoming streamlined companies.

This class warfare debate will find fertile ground in the rich rewards bestowed upon LBO kings who claim to create jobs while simultaneously eradicating others through creative destruction.

In the real world, c reative destruction is just part of the natural and organic birth and death cycle of businesses.

But to claim that layering mountains of debt on the shoulders of companies (companies are people too, you know) to pay private equity companies fat fees so they can generate generous returns for themselves and their investors (many of whom are public sector pension plans) seems inordinately lopsided and more destructive than creative.

Not only will Romney be cast in that dark light, he's also going to have to face the added knock that private equity managers' earnings from their operations isn't ordinary income (obviously not based on how many mega-millionaires and billionaires there are in the PE club), but are taxed at the much lower capital gains rate.

Private equity guys are bankers. So, Romney will be the poster child for everything bad that bankers have been blamed for since time immemorial. Not that he's going to be the first or last banker ever to run for the presidency of the United States.

But, given the politically charged atmosphere in Washington and around America, drawing class warfare lines to make the case for political candidates will be front and center this year.

So far, President Obama and the Democrats haven't had to weigh-in for the fight. Republican candidates are doing a good job on their own bashing each other's capitalist credentials and throwing stones from inside their glass house to the dismay of traditionally stalwart pro-business Grand Old Party regulars.

According to the Pew poll, 55% of Republican respondents, 68% of Independent respondents and 73% of Democrat respondents think class conflicts are strong, or very strong.

You can expect that these political lines will only darken as Romney emerges. News and Related Story Links:

• Money Morning:
  It's 2007.2, and Our Next "Lehman Moment' Is Coming Fast
• Money Morning:
  These Four Investing Lessons Mean Everything Today
• Money Morning:
  Paul Krugman is Dead Wrong: Debt Matters
• Money Morning:
  An Investor's Guide to the 2012 Iowa Caucuses

What keeps me up at night now, however, is the echo of 2007. I call where we are now 2007.2. If we are facing 2007.2, then 2008.2 will follow with a vengeance.

I'm guessing the breakdown could come in the first or second quarter of this year (although it could also take as long as 18 months to develop, which would only make it 10-times as bad when it does come).

Think about what I'm about to lay out for you, and ask yourself, what if he's right?

In the spring of 2007, U.S. Treasury Secretary Henry Paulson, when addressing problems surfacing in the subprime mortgages arena said things "appear to be contained." Fed Chairman Ben Bernanke said: "We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited."

Comforting words, right?

Then, speaking to members of the Federal Reserve Bank of Chicago in May of 2007, Bernanke said, "Importantly, we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market."

Comforting words, right?

Even before two Bear Stearns hedge funds imploded in June of 2007, the Fed Chairman was touting the virtues of derivatives and the widespread sale of mortgage-backed securities when he stated, "The key thing to remember is that these losses are not just held by American banks, as the bad loans were in Japan (referring to Japan's lost decade), but they are dispersed."

Comforting words, right?

Then, on August 9, 2007, after one Bear fund was shut down and the other fund temporary propped by an injection of some $3.2 billion from Bear itself, and the seemingly contained fallout from subprime and AAA mortgages hitting "dispersed" banks in Europe, the European Central Bank's (ECB) Website quietly announced that the ECB would provide as much funding as banks might wish to borrow at only 4%.

What was happening was that European banks weren't lending to each other. The commercial paper market was at a standstill, and there was no short-term funding facility open wide enough to finance their longer-term mortgage positions. And they couldn't sell their positions because after the Bear funds imploded, there were no buyers for mortgage bonds, even the super-senior AAA tranches many European banks and all the big American banks were holding.

Two hours later, 49 banks borrowed three-times what they were usually asking to borrow. And by the time trading closed in the United States on that same day, gold had spiked higher, as had safe-haven U.S. treasuries.

Of course, the equity markets were doing their own thing and were rising that summer, nearing new all-time highs (which they would reach in September 2007).

It took another year before we got our "Lehman moment." But, boy did it hurt.

Fast-Forward to Now....

We're being told by the Fed that our banks are in good shape. We're being told by bank CEOs that they are in good shape and their European exposure is limited. We're being told that there won't be any significant hit to our economy from events in Europe. We're being told that there won't be any significant spillover because European debts are dispersed and banks have derivatives hedges.

These are all lies.

Exactly like what happened in 2007, banks in Europe aren't lending to each other. The commercial paper market over here is closed to them. That's why the ECB announced it would effectively execute unlimited three-year term repos at 1%. And, by the way, they are taking just about anything for collateral, really.

Did 49 banks step up like in 2007? No, in 2007.2 (meaning now) some 500 banks stepped up and took $620 billion (489 billion euros) the following day. And they've been adding to that.

What's happening to gold in 2007.2? After selling off as part of the initial risk-on grab for equities a couple of months ago, it's rising again, and fairly quickly.

What about safe-haven bonds? U.S. bonds have been rising rapidly in price as investors clamor for safety. The 10-year closed Friday at a 1.87% yield, only 20 basis points from its all-time low yield, which it saw in September as European woes were strangling global markets.

How panicked is a lot of smart money? Yields on German and U.S. short-duration bills are less than zero. That means investors have bid up the price of these short-term safe government instruments that the premium they are paying is greater than their yield. Put another way, people are paying to place their money in safe government securities.

Comforting, right?

No, it's not.

Talk about concentration build-up. First of all, most U.S. banks and most European banks are still sitting on tons of mortgage-backed securities that they can't unload. And the U.S. housing market isn't getting any better, nor is Spain's, Ireland's, or China's.

Sure, foreclosures are down lately. But that's because of foreclosure moratoriums resulting from lawsuits. There are estimated to be 10 million homes for sale and over 11 million homeowners holding onto upside-down mortgages. What's going to happen when banks get on with foreclosing and start dumping houses again? It's about to happen.

All that nonsense about dispersed risks - don't believe it. There is no dispersion that matters because all the big banks in the U.S. and Europe and plenty of others hold the same asset mixes, the same duration mortgage pools, and the same sovereign debts.

But in the place where things are smoldering and there's kindling everywhere, European banks are buying more of their sovereign's toxic debts to stave off a collapse of the prices of the debts already on their books. It amounts to a crazy leveraging up on the same bet that sovereign debts will pay off 100 cents on the dollar.

And where are they getting the money to buy more of this crap? From the ECB, which is printing it against the backstop of the same countries who need banks to buy their constantly rolled-over debts.

It's musical chairs, and sooner or later the music is going to stop. Greece looks like it will be the first one standing, or in this case, falling down. Portugal could be next, or Spain, or Italy.

Greece has more than $1.26 trillion (1 trillion euros) of public sector debt outstanding. Do you think that a real default isn't going to crush a lot of banks? Wake up. And if you think that Greece defaulting (or even forcing a 50% haircut on private investors, that would be banks, folks) wouldn't spill over into other countries and across the globe... wake up.

Talks in Greece over private investors taking a 50% haircut - meaning they will only get 50 cents on the dollar on the 100 cents they lent out previously and the other 50% they are giving up will be replaced with longer-term bonds yielding less interest - aren't going well. Most analysts and even central bankers believe the haircut needs to be closer to 75% than 50%. Comforting words to be spoken while negotiations are ongoing, right?

Ah, then there's that little downgrade thing that happened on Friday after European markets were closed. Just because the downgrade of the U.S. from AAA to AA+ didn't cause our borrowing costs to rise doesn't mean it isn't going to happen in Euroland.

It will happen. Downgrades will trigger new capital calls as margin requirements will increase to offset the lower quality of collateral, we're talking about the same collateral folks, the same sovereign bonds. It's an increasing pile, make that pyre, and it's going to self-ignite.

We have a big week ahead; we have Citigroup Inc. (NYSE: C), Goldman Sachs Group Inc. (NYSE: GS), and Bank of America (NYSE: BAC) reporting fourth-quarter numbers. We have housing starts (homebuilders are up 60% since their October lows) and new home sales. And Spain and Italy are auctioning off bonds on Thursday.

Our markets have risen nicely. And on Friday, after selling off hard on the S&P downgrade news, they rallied back impressively. I tell you, it's 2007.2.

Stocks are going one way, and credit markets are signaling trouble ahead.

Sovereign debt has replaced subprime as the powder keg. That makes the brewing storm infinitely more powerful than the subprime dust-up was. It's a question of how long before we get the Lehman moment.

We've survived, even thrived, on a series of "liquidity puts," which is what I call all central banks' stimulus and "free and easy" money thrown at banks to keep them afloat. In a politically charged 2012, that could change.

Keep this in mind. If we're facing 2007.2, then 2008.2 is coming right around the corner. It's just a matter of time.

That's why I say play the equity market diligently; we could scrape higher for a while, as we did in 2007. But, when the fat lady sings, it's going to be deafening.

And everyone knows the opera isn't over until the fat lady sings.

News and Related Story Links:

• Money Morning:
  Should You Worry About Europe's Back Door Bank Run?
• Money Morning:
  Those "New" E.U. Fiscal Rules Aren't So New
• Money Morning:
  Latest Eurozone Debt Crisis Plan "Another Grand Illusion"
• Money Morning:
  One of These Banks is Europe's Lehman Bros. - And We're Going to Profit From Its Collapse

Just like the government, as long as their creditworthiness is intact and money is available, at whatever cost, homeowners can refinance their mortgages over and over. That's no different than how the government rolls over its own debts.

We saw this phenomenon play out in stark reality during the housing bubble.

Not only were homeowners refinancing their homes to take out money for consumption purposes, they leveraged themselves to buy more homes to multiply the wealth effect they were already experiencing.

In the case of the housing crash, borrowers were counting on rising property values to finance their expanding debts. That's the same as what Krugman says governments should do: make sure debt expansion doesn't outpace revenue growth, in this case taxes.

In the end, though, didn't the bursting of the housing bubble prove that debt eventually matters?

To me, the housing bubble was a pretty darn good analogy as to what happens when mounting debts aren't repaid. When it happens on a systemic basis, the entire economy suffers.

Doesn't our nation's expanding debt and deficit in the face of falling tax revenues and worse, a lower base, portend similar problems on an even larger scale?

Of course, Krugman has it all figured out.

We just have to grow our debt at a slower pace than our tax base grows. Who knew the answer was so simple...

We'll just meet our expanding debt obligations by raising taxes faster. Perfect!

Second, to claim that U.S. debt doesn't matter because we owe it to ourselves, and that homeowners' debts do matter because they owe them to someone else, is absurd.

It is as if we are all going to say to the government, "It's okay you took all of those taxes from us and spent them on stuff we'll mostly never see, wipe the slate clean, we're good. And all the stuff you promised us that you didn't budget for, or worse, those set aside budgets you stole from, it's okay, we're good, we relieve you of what you owe us." It's just stupid.

Also, if you are a homeowner you are paying yourself too, in a sense.

While you are paying the mortgage to your bank you are also paying into a capital asset known as your home. You end up with something of fairly equal value, or more when home prices appreciate.

The Truth about Debt

But we screwed that all up because debts do matter.

Too much debt leads to depreciation and deleveraging, which leads to lower demand, lower production, fewer jobs and a lower tax base.

The last piece of Krugman's argument that our World War II debts were never repaid and that the huge deficits to pay for the war effort led to an extraordinary peacetime expansion is also frighteningly off the mark.

Of course, the savings bonds issued to fund the War have matured and been paid off. And the portion of our national debt brought on by the War was paid off a long time ago.

Just because the U.S. continues to add to its deficit and has to continually rollover debts doesn't mean that we're rolling over debts from 70 years ago.

Mr. Krugman's own argument even addresses that. Rising incomes and our rapidly expanding economy in the postwar period generated a vastly rising tax base and led to prosperity.

But, that had nothing to do with deficits not mattering.

That had everything to do with soldiers returning home and being educated under the G.I. bill, being able to find work in revved-up manufacturing facilities, and the ensuing baby boom that would lead to a substantial increase in the population and tax base.

A Political Axe to Grind

There are a lot of problems with Professor Krugman's argument that deficits don't matter.

But, the biggest problem I have is that instead of addressing deficits in an organic, holistic and objective way, Mr. Krugman addresses these important issues from his political perspective rather than a purely economic perspective.

Bashing conservatives who say deficits matter and spending cuts along with a smaller government are the best way to solve our long-term fiscal problems, and arguing that "responsible governments -- that is governments that are willing to impose modestly higher taxes when the situation warrants it" are the answer to deficits that don't matter much, is polarizing at best and dangerous at worst.

What economists should be advocating is an apolitical approach to both our short-term and long-term problems.

We need smaller deficits over time and a smaller, more responsive government in the long-term.

In the short-term, we need real infrastructure spending, not quantitative easing for banks to increase their bonus pools. We need a massive investment in education and we need an industrial policy that promotes manufacturing and job growth - not the exportation of our capital to less developed countries where labor cost advantages fatten up public corporations that don't pay enough U.S. taxes and hide the money from Uncle Sam in the loopholes Congress digs for them.

Both deficits and politics matter.

And if we don't figure out how to bridle both we are all going to end up in the dirt being trampled by stampeding emerging economies everywhere.

News and Related Story Links:

• Houston Chronicle:
  Krugman: Debt matters, but not that much
• Money Morning:
  The One Question We Must All Ask Ourselves
• Money Morning:
  Let's Play Insights & Indictments Jeopardy!
• Money Morning:
  The Script for 2012 - And Your Part In It
• Money Morning:
  A Brave New (Broken) World
• Money Morning:
  Subject Banks to the Free Market or Turn Them into Utilities

Nearly half of all members of Congress are millionaires. Most of them have gotten much richer in office over the past six years while the country has become much poorer.

Whether it's perks like generous medical and extraordinary pension (full salary) benefits, or taxpayer and constituent financed "fact-finding" trips to places like Hawaii, the Caribbean, Europe, or other luxurious destinations, they enjoy financial rewards that are unavailable to ordinary Americans.

[Note: You can help eliminate Congressional perks like these by clicking here.]

And, as if that's not enough, we now know that they trade stocks on inside information and sell our trust in them along with the privileges of their offices to hedge funds for cash.

Politicians are addicted to money and power. And it's at that busy intersection that they collide with bankers and hedge fund billionaires all too eager to pave a superhighway upon which they all race ahead of all other honest, hard-working Americans.

It makes sense for bankers and financial flyboys to grease the wheels of power. After all, they make incomprehensible amounts of money with the help of politicians who make laws and break laws and insert thousands of loopholes into whatever seemingly sensible laws exist, mostly for the benefit of their paymasters.

To be or not to be honest about business-as-usual in America, that is the question we must ask ourselves.

Whether it is noble to pretend that we are an honest country or to put our arms around the nexus of money and power that has corrupted our integrity, our morals, and our future, and by opposing them, crush them, is what all Americans should be actively debating.

The New Year is the perfect time to make resolutions. And since everyone who has ever tried to stick to a New Year's resolution knows, it's almost impossible unless you declare to the world your goals and are supported by everyone around you.

So, how about we all make a resolution, the same resolution, and all support each other?

How about we resolve to dissolve Congress by voting all of them out over the next two election cycles?

How about we resolve to elect honest people whose first mandate is to revolutionize Congress by enacting laws that strip them of their un-American privileges, inordinate power to pander to bankers and their ability to hide behind their offices as if they are above every other American?

How about we hold them accountable for all their actions and make everything they do transparent?

How about we the people get to vote on whether they have engaged in criminal behavior while in our employ? And, we the people get to determine their punishment by voting on the outcome of public trials of public officials!

And, while we're at it, how about we break up all the big banks once and for all so they don't control Congress, the President, and the regulators who are supposed to be minding the public's interest but are stuffing bankers' back pockets?

America is in desperate need of a revolution.

It's our God-given right, and we better exercise it before our ability to save ourselves from what we have become destroys the magnificent experiment our Founding Fathers and our heroic soldiers have fought for. News and Related Story Links:

• Money Morning:
  The Script for 2012 – And Your Part In It
• Money Morning:
  A Brave New (Broken) World
• Money Morning:
  Occupy Wall Street, Consider This My Gift to You…
• Money Morning:
  Subject Banks to the Free Market or Turn Them into Utilities
• Money Morning:
  Those "New" E.U. Fiscal Rules Aren't So New
• Money Morning:
  A Simple Solution to One of the World's Most Complicated Problems
• Money Morning:
  How JPMorgan Aided and Abetted the Largest Municipal Bankruptcy in U.S. History
• Money Morning:
  The Inside Story of How Our Financial Regulators Let Us All Down

"The Hangover."

That's what 2012 is going to feel like - a bad hangover.

There are fewer workers working in America today than there were in March 2000. One reason is that there are 6.6 million fewer jobs in the U.S. today than there were just four years ago.

Some 23 million people want to work full time, but can't find a job. Half of the unemployed in America are long-term unemployed, meaning they've been out of work for more than a year.

Not only is it hard to find jobs, most of the unemployed don't have the skills to fill the jobs that are out there. And, structurally, the mobility of workers in America has crumbled as homeowners can't sell their houses to move to where jobs are or might be. Need I mention that rents are rising too?

Average household income in the U.S. is less than 1% greater than it was back in 1989, according to the U.S. Federal Reserve. And over the past six years, household net worth relative to disposable income is lower by 20% as a result of overleveraged and declining home values.

Meanwhile, more than 2 billion workers from Asian and Eastern European countries have joined the global labor pool.

While on the surface, a larger labor force may be good for producers, at the other end of the supply chain, lower wages mean less purchasing power on an aggregate basis.

It's not inflation that we have to worry about, it's the continuing deleveraging of households and countries, and the threat of deflation that will make 2012 a sad act to follow.

The stimulus in the U.S. and in Europe that was gifted to banks in the hopes that they would spread the wealth has been an abject failure.

Asset prices, including commodities, rose as excess liquidity remained in speculators' hands instead of being funneled into long-term investment projects to rebuild crumbling infrastructure.

Now, with budget-busting deficits and massive long-term structural debts, we are being led by combative politicians to the wishing well of productive spending and being told there is no more water in the well.

If our collective thirst for productive long-term investment - okay, call it stimulus spending - is not slaked, we will dehydrate our economy and cause another dust bowl, only this one will be worse than the Great Depression.

So, how are you going to act?

It would be wise to continue to be defensive - that is, until Act III seems to be coming to an end, which may be possible by the end of the third or the beginning of the fourth quarter of 2012.

If deleveraging continues -- and you'll know if that changes (watch for any significant and sustainable uptick in inflation) -- then commodities and risk assets should stay on the shelf.

There'll be plenty of time to go shopping for risk-on assets, especially commodities. If by the first quarter of 2012 there is no resolution to Europe's debt issues, and if China continues to slow, risk-on assets will be shed with increasing speed and volatility.

I like big-capitalization, high-dividend paying (preferably 4% to 5%, or more) stocks of companies sitting on huge capital reserves and NOT spending them on buybacks.

I like selling calls on these stocks and I like selling puts, too.

I want income from selling premium. If your appreciated stock gets called away, good, you're ringing the cash register. If the puts you sold cause you to have to buy more stock at a lower price, good, you are averaging down into great stocks whose dividend yields are only increasing (as long as they are not cutting payouts).

The way to act in this tragic environment is as if your most important role is preserving capital, because that's what's going to make you shine when there's a new play to act in.

News and Related Story Links:

• Money Morning:
  2012 Oil Price Outlook: How to Profit From $150 Oil
• Money Morning:
  The Five Stocks You Have to Own in 2012
• Money Morning:
  U.S. Economy 2012 Forecast: Where to Find the Biggest Gainers and Avoid the Biggest Losers in This Year's Rocky Markets
• Money Morning:
  Gold Price Outlook 2012: Miners Will Shine as Prices Soar
• Money Morning:
  Why the U.S. Economy Will Be Weaker Than Expected in 2012
• Money Morning:
  Rising Wages in China Good for Glocals, But Few Jobs Coming Back

You can't do that unless you have nerves of steel, tons of capital, and a generational approach to holding your positions. Even then, I say, good luck with that.

So, from the perspective of psychology, if it's not safe to be an investor, but being in the markets is still a tremendous wealth-generating endeavor, trading will remain the tail wagging the old dog.

For me, that's all well and good. I'm a trader. I always have been. Sure, I used to have a bunch of long-term investments that I expected to always weather short-term trading and fluctuating economic cycles. But those all ended up being a 50/50 proposition. Meaning I lost on about half of those investments and made money on the other half. I'm talking about maybe eight positions that I'd keep on the books for years.

Not any more. Why? Now I use that capital to trade bigger positions, because holding a diversified (I'm not including the few mutual funds that I used to own, that I jettisoned a long time ago) portfolio, even a well constructed, concentrated one, didn't work out.

My point is, think about how you look at the markets. Ask yourself if you are an investor or a trader. Ask yourself how much time you have, how much capital you have, and what kind of constitution you have... and do the math yourself.

2) Credit Default Swaps

The other thing that's broken that's really huge - as in hundreds of trillions of dollars worth of huge - is the credit default swaps market.

Credit default swaps are nothing more than over-the-counter (there's no real exchange, these are essentially bilateral contracts) insurance policies on pools of underlying assets.

Greek sovereign debt is exactly where I want to go with this. If you are an investor (then you're probably being dishonest) or a trader (more likely) who bought Greek government bonds (hopefully you're not Jon Corzine), chances are, you're loving the yield but scared as all get-out about the risk.

Say you're a big trader, say you're one of the hundreds of European banks that bought Greek bonds, maybe you're even the European Central Bank (ECB), and you've been buying Greek bonds to prop up that market.

Chances are, you would also be buying some insurance against a default on your extensive holdings.

Chances are you didn't buy your insurance from Allstate (AIG, maybe). No, you didn't because insurance companies (AIG is another story) don't sell insurance on sovereign debts.

But other banks do sell that insurance, hedge funds sell that insurance. You can buy insurance in the form of credit default swaps.

Now you can sleep at night, right?

No. You just woke up to the worst nightmare you've ever had. Only it's not a dream.

I'm not going to complicate this (although it is complicated). The short version is that the insurance you bought and paid for isn't worth the paper it's written on.

The last deal proposed to bail out Greece called for creditors (buyers) who hold Greece's debts to take a 50% haircut. And they were being asked to do that "voluntarily" as in, "please" do it. That means they were being asked to swap the bonds they held, which they expected to get 100 cents on the dollar for (eventually) and replace them with new bonds that they would only get paid 50 cents on the dollar for, when they mature.

Investors, make that traders (think "banks"), would lose half their money. But, they weren't all that worried because they had insurance. They had bought all these CDS deals.

They were going to be made whole when they got paid off on the insurance they bought.
Well, wouldn't you know it. That ain't gonna happen now.

The ISDA, the association that makes the rules that all the CDS players abide by, has said that technically, because Greek holders were voluntarily asked to haircut their holdings by 50%, that's not a default, and the insurance is no good. You can't collect.

Two things are extraordinarily frightening here.

What is really going to happen to the balance sheets of all those banks that bought CDS insurance and marked their books like they were all good and comfy because they had insurance? What accounting horror stories are buried deep in the bowels of banks' books? How much capital will they really need if they have been fake-marking their exposure because they said they were "insured" and would be made whole?

Second, what's the value of CDS insurance now on any underlying holdings of any bonds or debts (think Italy!) if it's here today, gone tomorrow?

If I'm an investor (sorry) or a trader, and I want to buy Italian bonds but don't want the risk, just the other day I would have bought CDS on my Italian bonds.

Today, I don't trust the sanctity of my bilateral insurance contract, so I won't waste my money buying any more CDS.

What I will do is demand a heck of a lot more interest from Italy to buy their bonds, since I'm at open risk of their defaulting.

Let's see, what will it take for Italy to sell its bonds now?

Oh, this is not going to be good for Europe...

Markets are broken. Welcome to the brave new world of volatility squared.

News and Related Story Links:

• Money Morning:
  Subject Banks to the Free Market or Turn Them into Utilities
• Money Morning:
  A Simple Solution to One of the World's Most Complicated Problems
• Money Morning:
  It's Time to Overhaul the Fed

If that's not a palatable solution for the industry, then why don't we treat banking like we do utilities? After all, that's what banks are. They are utilities - although their profits are not capped, nor is their leverage, nor is the disaster they can wreak on all of us.

Fixing America, and the world for that matter, isn't complex. It's just hard because banks control us, not the other way around.

The only way to get around the global banking cabal is to dismantle all the too-big-to-fail banks everywhere and let the world see what's on every bank's books. Let the world see how leveraged they are, how much they have to borrow to cover holes in their balance sheets and their capital reserves, and make all regulators findings, admonishments and help known to the public fairly immediately.

Transparency is next to godliness, even if you don't believe in God. News and Related Story Links:

• Money Morning:
  It's Time to Overhaul the Fed
• Money Morning:
  Are You Outraged Yet?
• Money Morning:
  The Goldman Rule: Don't Let This Puppet Master Pull Your Strings
• Money Morning:
  Mortgages for the 'Middle-Rich' Are Class Warfare Ammunition
• Money Morning:
  Bank Stocks Are Bad Investments – But Excellent Trading Opportunities
• Money Morning:
  These Three Men Represent Everything That's Wrong with Wall Street

Second, we need one uniform set of bank capital requirements and measures.

The good news is that the Bank for International Settlements (sort of the central bank for central banks) has been convening meetings in Basel, Switzerland for years. From those meetings have come what the world knows generally as the Basel Accords, or Basel Agreements.

Again, there's plenty to argue about when it comes to what capital requirements should be, how to make any of the necessary measurements attendant to calculating them correctly, or who may or may not benefit by them. But, that's not the point. Those things can and will get worked out through tough negotiations.

The point is that we need a singular set of rules for all banks.

We need bank transparency so regulators, analysts and investors can compare them to one another and measure their health and risk to the financial system.

Is it so hard to ask our government to demand that the banks it is responsible for safeguarding the public from are transparent enough to measure?

By having transparent uniform accounting standards and transparent bank capital requirements and metrics, global capital markets would become more stable because investors could far more accurately price risk and reward.

Sometimes the best solutions to complex problems are the simplest ones. Transparency as a starting point has to be goal number one. But uniform accounting standards and capital standards in an increasingly interconnected world would also be a huge step forward. News and Related Story Links:

• Money Morning:
  Are You Outraged Yet?
• Money Morning:
  Honesty is the Best Policy…
• Money Morning:
  The Goldman Rule: Don't Let This Puppet Master Pull Your Strings
• Money Morning:
  How JPMorgan Aided and Abetted the Largest Municipal Bankruptcy in U.S. History

The Truth Comes Out

How deep is the scheme to keep banks growing and their power expanding? The numbers speak for themselves.

The Fed did everything it could to hide its books from public view, but Bloomberg LP sued the central bank, and in so doing, forced the Fed to comply with the Freedom of Information Act.

Thank you, Bloomberg, this nation owes you a debt of gratitude.

What was revealed were little items - things like the Fed having actually shelled out some $7.77 trillion to prop up both domestic and foreign banks, even though some either didn't need the money or should never have gotten it in the first place.

Why would banks or corporations take money they didn't need? Because it was essentially free - well not exactly free, since they had to pay about 1% interest in some cases and one-tenth of one percent in other cases.

Still, you can make good money borrowing practically for free and investing that money in anything interest bearing. That includes the toxic assets on many borrowers' books that they didn't have to sell because they got financing to keep them on their books. Oh, and that's still happening, a lot.

You see, part of the big lie was that it would take $700 billion of Troubled Asset Relief Program (TARP) money to aid our stricken banks. Of course, that was front money, or money that the public could see. What the public couldn't see was how bad things really were, because it couldn't see how much taxpayer money the Fed was shelling out.

Nor could Treasury officials see it, nor could legislators writing new bank regulatory rules to ensure this wouldn't happen again.

But it will happen again. It's just a matter of time.

Fixing the Fed for Good

There is only one solution to our banking problems, which are the root of our economic problems.

The Fed needs to have only one mandate, which is price stability. It should be an open, audited, and transparent apparatus serving the public - not banks.

And, as far as banks go, the more the merrier. Break up all the too-big-to-fail institutions. No bank should be able to hold more than 5% of the whole industry's assets, and if that gives any one bank too much power, cut the number later on.

It's time we woke up to the lies we're being told by the Fed and the banks. It's time to break the chains that enslave us as a free-market nation.

News and Related Story Links:

• ABC News:
  Fed Loaned Banks Trillions in Bailout, Bloomberg Reports

• Money Morning:
  The Goldman Rule: Don't Let This Puppet Master Pull Your Strings

• Money Morning:
  Are You Outraged Yet?

• Money Morning:
  The Inside Story of How Our Financial Regulators Let Us All Down

What's Really Going on in Washington

On Nov. 13, CBS News aired a "60 Minutes" titled "Insiders."

If you didn't see the segment, it was about "How politicians and their friends get rich off insider stock tips, land deals, and cronyism that would send the rest of us to prison."

By the way, that's not a quote from "60 Minutes." That's the subtitle of "Throw Them All Out," a just-released book by Peter Schweizer. "60 Minutes" "broke" its inflammatory story based completely - 100% - on Schweizer's book.

I read "Throw Them All Out" in just one quick sitting. I couldn't put it down. It's not long, but it is absolutely, unequivocally, full of explosive revelations about what is really going on in Washington. You have to read it. You owe it to yourself. You owe it America's future.

If everyone in America read this book before next year's elections, we would collectively Throw Them All Out...

As soon as I finished the book, I contacted Peter.

Turns out, besides being the William J. Casey Fellow at the Hoover Institution at Stanford University, and the author of "Do As ISay, Not As I Do;" "Reagan's War;" and "Architects of Ruin," he is also a very cool guy who happens to be hot under the collar about what's happening in America.

We have a lot in common - being steamed about the pain that Americans are feeling, that is.

Peter said to me - and this is a direct quote - "It's outrageous that the permanent political class in Washington is able to skirt the rules and laws that apply to the rest of us. This is not about a few corrupt politicians. This is about an entire system that has been compromised."

You're going to want to read the book, even if you saw the "60 Minutes" segment, because there are many more unbelievable, very, very juicy exposés in the book than the segment could have possibly served up.

And since it's Thanksgiving, I thought I'd roast a few turkeys - here and now.

A Thanksgiving Day Feast

What follows are excerpts taken directly from "Throw Them All Out" (with Peter's permission):

"Throughout 2009, Washington was consumed by the Patient Protection and Affordable Care Act, or what became commonly known (at least to its critics) as Obamacare. The health care industry and pharmaceutical companies employed thousands of lobbyists to shape the legislation.

"One of those at the center of shaping the bill was Senator John Kerry of Massachusetts. He serves as a member of the Health Subcommittee on the powerful Senate Finance Committee. As the bill snaked its way through the House and Senate, where Kerry was actively pushing it, the Kerrys began buying stock in the drug maker Teva Pharmaceuticals. In November alone they bought close to $750,000 in the company.

"Senator Kerry wasn't the only congressional trader in pharmaceuticals. John Tanner, a member of the House Ways and Means Committee bought up to $90,000 worth. Also buying Teva were Senator Jim Webb of Virginia and Congressman Vern Buchanan of Florida. Senator Tom Carper of Delaware sat next to Kerry on the Senate Finance Committee's Health Subcommittee. Carper began buying health care stocks that would benefit from the legislation he was supporting. He bought...Nationwide Health Properties...Cardinal Health and CareFusion. Congresswoman Melissa Bean of Illinois...along with her husband...are active traders (however) the only stock purchases they made during 2009 were in the health care sector. They bought shares in Cardinal Health, CareFusion...Mylan and Teva.

"Congressman Jared Polis of Colorado...was a tireless advocate for Obamacare. While Polis was praising the benefits of health care overhaul, he was buying millions of dollars' worth of a private company called Bridge Health International. One of the things Bridge Health offers is medical tourism: providing less expensive medical procedures in countries such as China, Mexico, India, Thailand, Costa Rica and Taiwan. Polis put between $7 million and $35 million into the company. (Note from Shah: There's a lot more on what Polis did, but you're going to have to read the book, because it just gets better...)

"Congressman John Boehner, who was leading the opposition to Obamacare in the House of Representatives, may have been fighting John Kerry on policy matters, but he was entirely allied with him when it came to investment decisions. On December 10, 2009, Boehner bought numerous health insurance company stocks, including tens of thousands of dollars in Cardinal Health, Cigna, and Wellpoint...Boehner purchased shares in Big Pharma companies Amgen, Johnson & Johnson, Forest Labs, Covidien, and Pfizer. He also bought shares in CareFusion."

To see who else bought what and how much they made - you'll be very jealous - read the book.

These weren't lucky trades. They were sure bets.

And that's just what happened around one bill working its way through Congress.

Of course, before the advent of Obamacare, we were dealing with the credit crisis, and Congressmen were dealing their way into some lucrative positions and very much out of harm's way, long before the public was told how bad things really were becoming. Take a look:

"One of those who played a central role in government decisionmaking during the crisis was Congressman Spencer Bachus, then the ranking Republican on the House Financial Services Committee. Bachus was regularly involved in private meetings and phone conversations. As he was having those high-level discussions, however, he was aggressively buying and selling stock options.

"From July 2008, when the first rumors of the crisis were heard, to the dark days of November, with international markets in near free fall, Bachus engineered no less than forty options trades, betting that the market, a sector of the market, or an individual company would go up or down at critical times. On September 8, Hank Paulson received a disturbing call from General Electric CEO Jeffrey Immelt. GE was having trouble selling its bonds, Immelt quietly told him. Just two days later, Bachus shorted General Electric options. He did so four times in a single day...and more than doubled his money."

There were others who made money on the crisis using their inside information, but even more insiders saved tens of millions of dollars by dumping stocks while the public was told not to panic.

Not being the type to name names, I'm just going to spill a few here. Congressman Jim Moran, Democrat of Virginia. John Kerry, again. Sheldon Whitehouse. Dick Durbin. Representative Shelley Capito. Rahm Emanuel. And others.

It's getting late, and you may be hungry for more turkey stories, but I don't want to ruin your appetite for the book. So I'll just leave you with these gems:

• You will love reading how Nancy Pelosi manipulated the legislative agenda to make money on the Visa Inc. (NYSE: V) initial public offering (IPO), one of at least 10 lucrative IPOs she and her husband has enjoyed so far in her Congressional career.
• You will really love the one about the runway near her house in Napa Valley's wine country. It's just out-of-control.
• Or, how Pelosi, Dennis Hastert, and Judd Gregg "earmarked" hundreds of millions of dollars of taxpayer money to put in roads, a six-mile rail system for almost a billion dollars, or improve a project near a property they owned and wanted to see appreciate, or that they owned and had earmarked money to improve personal projects.
• And when it comes to "green innovation," you will literally be sick to learn how many TENS of BILLIONS of dollars have just been wasted - excuse me, invested - in companies controlled by campaign donors, including ones owned or controlled by several billionaires and the likes of the ubiquitous Goldman Sachs Group Inc. (NYSE: GS).

I'm getting ready for some turkey myself, so forgive me if I don't have time to get into the mystery man I alluded to in Sunday's issue of I&I. If you read "Throw Them All Out," you will figure it out.

Otherwise, I'll give him up next Thursday. (So please make sure you're signed up to receive Wall Street Insights & Indictments. Don't worry, it's free.)

So again, Happy Thanksgiving.

And while you're giving thanks, don't forget to thank Peter Schweizer for having the guts to name names and uncover some of the mounting garbage in Washington stinking up America.

Get the book, and help me and Peter THROW THEM ALL OUT!

News and Related Story Links:

• Money Morning:
  It's Not Just Congress - the System Has Failed
• Money Morning:
  Your Vote Will Help Us Put the Squeeze on Congress

How about Robert Rubin - the former Goldman co-CEO who became Treasury Secretary in the Clinton administration? From that post, Rubin squashed all regulations pertaining to derivatives, and ended Depression-era laws like the Glass-Steagall Act (which separated commercial banks from investment banks) so giant Citicorp could be formed by the merger of Travelers and Citibank. Rubin then went to Citigroup Inc. (NYSE: C), where he made some $119 million while leveraging the bank up with derivatives before it had to be bailed out.

Bailed out by whom? Bailed out by then Treasury Secretary Henry M. "Hank" Paulson, himself a former Goldman CEO.

And bailed out how? With the help of the Federal Reserve Bank of New York, whose chairman was Steve Friedman, a former Goldman partner, still on Goldman's board.

That's the same Steve Friedman who bought $3 million worth of Goldman shares based on allegedly inside information he garnered at the Fed and from Goldman's board meetings, profited handsomely, and had to resign from the Fed board -- but not give any of his profits back.

And finally, Goldman itself had to be bailed out when it ran to the Fed on a Sunday in September 2008 to beg to be turned from an investment bank to a bank holding company so it could get Fed cash.

The Usual Suspects

There are innumerable connections and fascinating stories. So, I won't bore you with the one about Goldman arranging a currency swap at an apparently "fictitious" exchange rate for the government of Greece. Nor how that swap facilitated Greece hiding its debts to get into the Eurozone, so it could then borrow euros ad nauseam until it had to be bailed out - again and again.

I'm not going there. Because if I did I'd have to get into how precariously positioned the new "technocrats" -- who are supposed to save Italy with the help of the ECB -- actually are.

And who are they?

Well, there's Mario Draghi, the new president of the ECB. Super Mario, it turns out, was Vice Chairman and Managing Director of Goldman Sachs International, and a member of the firm-wide management committee from 2002 to 2005. He claims to have not been responsible for the Greek currency swap, saying it was arranged before he went to Goldman. But he's never denied it.

That's comforting.

If he runs the ECB the same way Goldman runs its business, there might be some areas where transparency may not be the order of the day. And isn't that exactly what a central bank is supposed to be about?

If I had more time here I'd mention that Mario Monti, prime minister-designate of Italy, not only was a European Commissioner, but an international adviser to Goldman Sachs.

I'm just comforted to know that these old buddies are all still manipulating global finances for the betterment of our interests and the Goldman bonus pool this fiscal year or next.

Customer Service

I'm also not going to get into how Goldman set American International Group Inc. (NYSE: AIG) up to fail, or how the New York Fed made the firm whole on the credit default swaps it had written on AIG. Nor will I get into how Goldman board member Rajat Gupta allegedly passed along boardroom secrets to his friend and Goldman customer Raj Rajaratnam (now serving time for insider trading), or how the Justice Department is looking into how Goldman teed-up millions of investors and hit a hole in one when the mortgage market failed and they were short.

I'm only going to point to one small incident that proves Goldman really does have the interest of its clients at heart.

Back in 2007 Goldman constructed a little billion-dollar deal for a customer named John Paulson. Only the firm didn't tell its other customers, the ones to which it sold the Paulson deal known as Abacus 2007-AC1, that the deal was designed to fail.

Paulson made out like a bandit because he bet against the deal. Now that's good customer service.

Goldman didn't admit any wrongdoing and paid a paltry $550 million fine, which in terms of its 2009 earnings amounted to 15 days worth of register ringing.

So, let me get this right: Goldman, and the rest of its big bank brethren, are all about their customers. And they want their customers to go to bat for them with the regulators.

I suppose it was those nasty regulators that caused the whole credit crisis and the Great Recession in the first place.

And I guess that means that if Goldman, with the help of its customers, can get all those pesky regulators out of the way, we'd all finally be free to do business and live happily ever after - especially Goldman and the rest of big banks, of course.

News and Related Story Links:

• Money Morning:
  Dangerous Liaisons and Dirty Laundry
• Money Morning:
  Mortgages for the 'Middle-Rich' Are Class Warfare Ammunition
• Money Morning:
  How JPMorgan Aided and Abetted the Largest Municipal Bankruptcy in U.S. History
• Money Morning:
  The Inside Story of How Our Financial Regulators Let Us All Down
• Money Morning:
  European Contagion Turns Positive, Will it Last?
• Money Morning:
  Bank Stocks Are Bad Investments - But Excellent Trading Opportunities

Still, not everything is broken. As it stands now, the government does not guarantee the jumbo loans wealthy Americans need to purchase expensive homes. Private lenders and private pool packagers do their own due diligence and investors buy pools of jumbo mortgages based on market-based risk realities. That's how it should be.

So, why are the middle-rich, who presumably can afford to buy a home costing $729,750, being backstopped by government guarantees?

Forget the higher limit. The previous limit was $625,000. I call that middle-rich too.

Why do I call that middle-rich?

Because according to the U.S. Census Bureau in March 2007 (at the peak of the housing boom) the median price for a home in the United States was $262,600 and the average price was $329,400.

As of September 2011 the median price is down to $204,400 and the average price is down to $243,900.

It makes no sense to have taxpayers guarantee mortgages for homebuyers that can afford a house that's three-times the price of a home sold at the national average - or actually, at any price.

Let me make something clear. The government isn't backstopping homeowners, who can and do lose their homes. The guarantee programs are for investors that buy pools of these GSE- stipulated "conforming" mortgages.

The point is that if there weren't guarantees at all, investors would take a much harder look at what's in the pools they're buying. And mortgage originators, who should be the first to take losses on the bad mortgages they create and that get put into pools, would do a much better job in the origination process.

Phasing Out Fannie and Freddie

It's not that Fannie Mae and Freddie Mac are doing so well that they can afford to continue to backstop homebuyers -- they can't. In fact, they're both insolvent wards of the government. They have to be phased out, eventually.

Fannie Mae just reported a third-quarter loss of $5.1 billion, considerably higher than last year's third-quarter loss of $1.3 billion. So they ended up taking another $7.8 billion from the U.S. Treasury to cover their loss - which included $2.5 billion the company already owes the government in dividends on what it's already borrowed.

That gives new meaning to the phrase "robbing Peter to pay Paul" doesn't it?

Fannie so far has borrowed $111.6 billion and paid the Treasury $17 billion in dividends. And Freddie Mac is no better. To date it's had to borrow $71 billion and only paid the Treasury dividends of $15 billion.

And people wonder what broke the housing market. Government guarantees broke it.

Backstopping the middle-rich's mortgages broke the housing market, just as much as backstopping subprime borrowers (which wasn't always allowed by Fannie and Freddie) broke the housing market.

Now, the poor are poorer, the rich are richer, and the middle-rich are making a comeback. That's good for the wealthy and the recovering middle-rich, but pretty bad for everybody else.

Still, it is possible to fix the broken housing market. It may take some time, but if it's fixed properly, the middle-class will truly benefit - even more so than the rich and middle-rich. That's because members of the middle-class traditionally have more of their net worth tied up in their homes.

How can this be accomplished? Write your congressman and tell him or her to vote against raising the conforming limit for mortgages.

We need to phase out all government guarantee programs that have been distorting the housing market. If the government wants to help the middle-class, let it come up with tax breaks for investors who invest in private mortgage pools holding medium- to average-sales priced homes.

In other words: Absolutely no taxpayer guarantees for investors. If they get it wrong, let them lose, or if there's fraud involved, sue the mortgage pool packagers and sellers.

Giving tax breaks to spur investors to take risks isn't exactly free market stuff, but it's pretty far from a guarantee and at least lends a hand to the middle- class when it needs it most.

News and Related Story Links:

• Money Morning:
  How JPMorgan Aided and Abetted the Largest Municipal Bankruptcy in U.S. History
• Money Morning:
  The Inside Story of How Our Financial Regulators Let Us All Down
• Money Morning:
  These Three Men Represent Everything That's Wrong with Wall Street
• Money Morning:
  A Guide to Getting Rich in a Bear Market

You see, JPMorgan overcharged Jefferson County by some $100 million in fees (according to an advisor subsequently hired by the county) and jointly with its co-conspirators paid out some $8.2 million in bribes.

But what's truly appalling is that JPMorgan actually imbedded the cost of the bribes it paid into the finance deal it constructed.

In other words, taxpayers and bondholders paid the bribes JPMorgan conveyed to get to run the county's financing of the sewer system.

It doesn't end there, either. Before JPMorgan came to run things, some 95% of Jefferson County's debt was in fixed rate obligations. JPMorgan turned that around to the point that the County ended up with some 93% of its outstanding debt being variable and floating rate debt, subject to interest rate hikes.

Then JPMorgan created a neat little swap deal so the county was "protected." It didn't work out that way, and interest costs on the county's debts rose as high as 10%.

In the end, JPMorgan admitted no wrongdoing. Yet, amazingly - considering it did nothing wrong - the firm paid some $75 million in penalties to settle a fraud complaint with the Securities and Exchange Commission (SEC).

JPMorgan paid $25 million in penalties to the SEC and $50 million to Jefferson County. It also agreed to decline a $648 million "termination fee" that it was due when the county backed out of the swap deal that helped bankrupt it.

No one at JPMorgan went to jail - although others were convicted of conspiracy and fraud, with some folks going to jail for 48 months, 52 months and even15 years.

But no one from JPMorgan. And as much as I'd like to think this case is unique, I know it's not. Sadly, this is just one of many cases of corruption plaguing our financial system.

In fact, there's too much to even cover here. That's why I recently launched a new, free newsletter: Wall Street Insights & Indictments. I intend to blow the top off of more scandals just like this, and in the process, show average investors how they can level the playing field and make real money. You can sign up to receive it by clicking here.

News and Related Story Links:

• Money Morning:
  A Brave New (Broken) World
• Money Morning:
  The Inside Story of How Our Financial Regulators Let Us All Down
• Money Morning:
  These Three Men Represent Everything That's Wrong with Wall Street
• Money Morning:
  Dear Occupy Wall Street: Will You Stand with Me?
• Money Morning:
  The Insidious Truth About Federal Reserve Policy