Stewart Dougherty delivers some disturbing observations about the impact of the financial crisis. This is unpleasant fare but important for understanding where we are.

Link: The Metastasis of Moral Hazard and its Effect on Gold - by Stewart Dougherty    

There is accumulating evidence that the Washington – Wall Street moral hazard experiment has gone disastrously wrong, and that just like any other accidental discharge of a deadly virus, the moral hazard virus is now loose and swiftly propagating throughout society. By so blatantly colluding with Wall Street, Washington has lost all moral authority, and the people now have only one place to turn: themselves. An ethic of, “If they can do it, so can I,” is spreading, as people realize that fabric of American society has been shredded and replaced by a free-for-all mentality whereby everyone must fend for oneself in order to survive.

If this is so, it is a serious game changer for America.

Evidence of the spread of moral hazard is noticeable everywhere. Despite government reports that the economy contracted only 1% last quarter and is now stabilizing, 13% of all home mortgages were either delinquent or in foreclosure in the second quarter, 2009, an all-time record. Credit card write-offs hover near 10%, also a record. Automobile, home equity and personal loan defaults are at or near record levels. Fiscal year 2009 federal personal tax receipts have declined 22% and corporate receipts have plunged by 57%, even though the economy has supposedly declined by only a fraction of that amount. Compared with January through April, 2008, state personal income tax receipts have plummeted by 26% in 2009, with eight states seeing declines ranging from 30% to 54.9%. Prime and Alt-A mortgage delinquencies and foreclosures are climbing rapidly, and are the true canaries in the banking industry mineshaft. Homeowners evicted by foreclosure trash their homes in rage on the way out the door, with an estimated 50% of such dwellings damaged. Looters and squatters destroy many of the rest, stealing copper pipes, wiring, granite counter tops and anything else of value. Dozens of Internet sites such as “youwalkaway.com” provide calculators to help homeowners decide whether or not to “strategically” default on their mortgages.

The people, whose predictive instincts have been uncannily accurate throughout this crisis, sense that trouble is coming: 80% of them say they expect crime to increase due to the deteriorating economy.

As average American citizens lose their jobs by the millions, become mired in financial distress and are crushed by the largest debt increase in the history of civilization to pay for government bailouts and fiscal stimulus programs, several Wall Street firms, in actions so arrogant they beggar and defy belief, have announced that they will pay record bonuses in 2009. These bonuses commonly amount to 20 – 200+ times the median American wage, in other words, 20 – 200+ times the earnings of the citizens whose taxes were spent only a few months ago to keep the Wall Street firms from imploding.

Nurses, police officers, school teachers, store clerks, truck drivers, gas station attendants, firemen, flight attendants, ambulance drivers and everyday workers of every other description, many of them struggling to provide only a humble, basic lifestyle for themselves and their families, were asked to reach deep into their pockets to help Wall Street survive. Now that Wall Street has taken their money, it will use it to lavish huge bonuses upon itself, in a callous Roman orgy of excess.

The American psychological landscape has been parched by the searing winds of financial desperation, surging inequality and dying hopes. And the tinder of the desiccated American Dream, once the great calling and aspiration of a nation, is now piled so high that a spark igniting it would unleash raging flames reaching up to and scorching an astonished Sun. Yet politicians and the press are so divorced from reality that when the people express at town meetings and other venues their deep, legitimate frustration over the loss of their hopes and nation, they are viewed as whiners, or paid political activists. As noted earlier, denial is very dangerous drug.

Civilized society requires a foundation of morality, decency and justice to survive. The spread of moral hazard, should it happen, will have a disastrous effect on America’s institutions. Few investment classes will be safe in an environment of elevated moral hazard, because both legal and illegal counterparty risk will surge. Legal counterparty risk occurs when, for instance, a corporate executive at a public company is awarded excessive, unwarranted pay at shareholder expense. (Abercrombie and Fitch recently reported that its CEO was paid $70 million this year, as the company’s performance deteriorated and the stock price plunged by 70%. This is an example of legal counterparty risk. It is a disgrace.) Illegal counterparty risk occurs when there is fraud. (Enron and Madoff are just two of many possible examples.)

In the emerging social climate, common stocks will face powerful headwinds from a suffering economy made worse by the corrosive costs of theft, fraud, false executive enrichment, phony insurance claims and frivolous lawsuits. Bank deposits, yielding near-zero percent interest rates, are basically no better than cash in mattresses. Corporate bonds carry serious interest payment and default risks. State, county and municipal bonds will become increasingly stressed as deficits grow and proposed tax increases stoke voter anger, making it difficult to close funding gaps. The real estate sector faces a spike in taxation risk, due to deteriorating local and county government finances. It is also subject to interest rate risk, as surging government debt becomes difficult to sell, resulting in higher coupons. The reputations of hedge and private equity funds have been compromised by large losses, the imposition of redemption restrictions, and high fee structures. Algorithmic, black box trading has been largely discredited. Annuities carry heavy fees and important counterparty exposure, as seen by the industry’s bailout by government. Commodities prices are volatile, and price manipulations by large traders are legion. CFTC oversight is lax to non-existent, so small investors are without protection. While there are many good commodities funds, they carry counterparty risk. Derivatives markets are opaque and out of control, in addition to being nuclear waste sites of counterparty risk, and are certainly no place for individual investors. Art, diamonds, numismatics, collectibles and other highly specialized asset classes have large transaction costs and are best suited to experts. As we can see, investment safety is hard to find even in normal times, which these are not.

In the recent crisis, virtually every investment “truism” has been discredited as a myth. Buy and hold; Stocks for the long term; Efficient market theory; Housing prices only go up; Buy land, they’re not making any more of it; Municipal bonds offer safe, tax advantaged returns; Treasurys are guaranteed by the full faith and credit of the United States; the dollar will remain strong because it is the world’s reserve currency; A diversified portfolio offers protection; Demand for serious art works is unquenchable; and on and on. The current markets have laid waste to every one of those theories, and many others.

Gold is the antithesis of the investment classes described above. Physical gold represents pure wealth of a very finite quantity with absolutely zero counterparty risk. Because of this distinguishing fact, it is immune to the costly effects of moral hazard.

Jim Jubak as MSN Money looks at the financial crisis from the perspective of an investor. He’s not optimistic about getting easy gains from investing in the tough times coming up.

In the excerpts below he describes why we won’t see a recovery for several years.

Link: 5 rules for post-recovery investing – MSN Money – Jubak’s Journal

The Congressional Budget Office predicts the U.S. economy won’t return to full-trend growth until 2015. And full-trend growth — sustainable economic growth without rising inflation — even then isn’t going to be what it was before the global financial crisis.

…a lot of evidence argues in favor of a very slow and tepid recovery:

• In the boom, the economy got the benefit of the wealth effect as families spent part of the gains in the value of their houses and investment portfolios. Now the economy is facing a negative wealth effect as lower home values and smaller investment portfolios cut into household spending. Household net wealth was down 20% from mid-2007 to the end of 2008.
• Like U.S. businesses, American families are going to have to deleverage their balance sheets by paying down debt. That means having less to spend on consumption. Household debt had climbed to 130% of income by the end of 2008.
• Losses in the financial sector of an estimated $2 trillion (only $1 trillion realized to date) will cut the amount of capital available for lending and raise the price of that capital.
• Any recovery will send the price of oil and other raw materials higher, which will act as a drag on the economy. Taxes will climb as governments around the world try to repay some of the debt they had piled on to end the crisis. In the United States, interest rates will climb as overseas investors demand a better return on all the U.S. debt they hold.
• Finally, many companies used cheap money to offer incentives to keep their customers buying. Even in a recovery, sales won’t bounce back to boom-year levels.