let. me say. good afternoon and welcome to capital account i'm laurin the star here in washington d.c. these are your headlines for monday july ninth two thousand and twelve bank of england governor paul tucker faces u.k. lawmakers over the barclays libre scandal saying his borrowing cost comments to the bank c.e.o. was documented in the c e o's nodes were misunderstood. the only thing that is ruled out in the. central. gives the role in question. meanwhile wormers circulate the barclays board may be looking at how to spin off the bank's investment banking business the sunday times reported it but its bigger feuded to look at the role derivatives play in this scandal and enabling many more

bad decisions at systemic lee dangerous banks plus banish shields rise above seven percent today that critical level deemed unsustainable as eurozone finance ministers reportedly meet again and investors continue to display skepticism the e.u. can solve the crisis so why is this so for carious all the time is it because the financial system today is really a faith based initiative our guest will explain and talk about what happens once faith is lost and if you're one of the. cast of the too big to fail banks or you want to cast them as a cartel you may be interested to hear about the actual criminal drug trafficking cartel the f.b.i. says one of the biggest u.s. banks has gotten mixed up with we'll tell you about it let's get to today's capital account.

all right today it was the turn of u.k. officials to answer to lawmakers in the u.k. library scandal obviously culminating with barclays bank in the center of it now as far as whether officials knew it was going on they say no their comments were misinterpreted but what do we know about what is going on in terms of price manipulation in the economy and what this means for price signals that are used for everything from where an investor puts their money to what policymakers think they can do or not do in regards to policy or the deficits well let's bring in our guest because he is just the person to ask simon behala vich is a co-managing member of i.d.s.

this capital i read about him in grants interest rate observer which many of our viewers are likely for milieu with because jim grant has been a very popular guest on this show so we're very lucky to have mr mckay and of it's in our new york studio today so first thank you so much for being on the show welcome to capital account thank you very much for having me lauren absolutely so let's first touch on this library scandal because today we heard from u.k. regulator from the bank of england mr tucker what do you think this attempted manipulation means more broadly about the manipulation of price signals going on in the financial system these days. well aside from all the potential issues of dust certainly rigging that's going on in the financial system and a complete lack of integrity the really important fundamentally important thing is that price signals of the lifeblood of the free market economies they send signals to investors whether something is perceived to be risky or not essentially these

are canaries in the coal mine what we're learning now is that the canaries are being muzzled and that creates a situation where investors can be surprised or maybe surprised by lightning events in the markets that absolutely are not preceded by any price action where people can see them coming and potentially take some actions and that is very disturbing well and you're sitting there as an investor but when we don't have accurate price signals india economy this impacts everyone from investors like you sitting there trying to figure out where to put your money where it's safe what risk really is and policymakers are on the other hand is sitting in governments trying to figure out what to do about deficits what kind of leeway they have to do have with deficits for example so this impacts everyone right. absolutely that's a very good point all financial assets and generally are priced based on a formula that's called capital s. the pricing model it's a present value of future cash flows and the two key inputs into this model is

a risk free rate and the risk premium and that is what determines the costs money to a company to a particular burra and that is what determines the cost or i should say the value of these financial assets so from the investor standpoint if the signals are wrong and if investors are putting wrong values on virtually all financial assets then we are having tremendous misallocation of resources right now that is very difficult to see in real time but that can have devastating consequences probably would have different devastating consequences when prices return to their librium from the standpoint of regulators they're not seeing the real cost of funding and so where they perceive they may have room to borrow more and where they perceive they have let's say a rope to go down and stimulate the economy with more borrowed money in fact they may not have room at all but that is not apparent because they're seeing very low boring costs and they think that they can afford to worry more money and to fund

the stimulus projects now as we can see with spain it has run out of room and it's now the cost of funds to it is seven percent and if it goes higher it becomes unsustainable situation the problem with manipulating rates is instead of rates steadily indicating to all the participants what is actually going on you are heading for a situation where you everybody gets a surprise overnight and then things start happening and it's very difficult to manage or the point aha and i want to get more to that but i do want to touch on one other aspect of this library scandal which was that with then now barclays scandal you have something that many just average folks at home may be thinking of a synonymous with the financial crisis which is derivatives derivatives played a role. traders were reportedly trying to manipulate lie bore in order to maximize profits or minimize losses with regard to their derivatives positions so derivatives here like they have to be in every scandal but my question to you is

how have derivatives really been a game changer in your view because we were talking about this before the show in terms of allowing massive risk taking in the financial system to allow expanded leverage massively while also hiding risks. yes i mean to a couple of minutes this is a obviously a very complicated question. but to put it simply the derivatives have become what's called disruptive technology or breakthrough technology if you think of debt in general there are three stages of life. of debt the origination phase the servicing phase and the repayment face so in the origination phase there are certain inputs that are required to create that debt that is you need a credit worthy borrower you need some collateral and you need capital to lend and then you need an institution that has room on its balance sheet to make a loan so what derivatives have been able to do is they have been able to in the

first phase of debt origination of debt creation to break through virtually all the barriers and dramatically decrease the need the inputs so all of a sudden we were able to borrow sorry to lend money to people who had no credit worthiness let's say this in the case of subprime for example we were able to lend tremendously higher amounts of money because the rating agencies came and wrapped all of the high risky debts into traunch is where the vast majority of these risky debts were converted into investment grade securities and then once it got in the balance sheet of the banks the banks were able to buy insurance from other banks in the form of credit default swaps to show that they have very low net exposure in other words exposure leverage net of hedges but if you understand how these hedges work you would realize insurance in general you would realize there's no such thing as insurance against systemic risk that's why if you look at your

homeowner's policy and everybody who has one with it is welcome to go and find the clause insurance companies normal insurance companies do not sell insurance against what's called highly correlated risks war in so. correction. those are always excluded because if everybody suffered a loss simultaneously insurance industry cannot cover a loss so the problem with credit default swaps is they are essentially under reserve unreserved insurance where institutions are selling each other protection which cannot really be covered if the event occurs the best example real life example of how that happened was in two thousand and eight sensually was called out for having sold a tremendous amount of volume. of insurance against sub prime defaults now the faults were not expected insurance was mispriced and energy had no reserves and the united states government had to step in with almost two hundred billion dollars of

capital to support a g.'s ability to pay its counter parties because what happens is when everybody has bought insurance against something and then somebody can get paid then he can not pay the other person he promised courage and then it's a chain reaction it's a daisy chain where everybody goes down together and that's essentially where we are with all these sovereign obligations and sovereign credit default swap that's exactly what i want to talk about today looking at the euro zone and the european sovereign debt crisis our viewers are looking right now at a chart looking at how interconnected european sovereign debt is so that they can feed this web of where it's more worrisome and less worrisome it's a few months old but nonetheless it just portrays this web can you talk about in this situation how c.d.'s ties the banks together. well that's essentially what i explained i mean when the banks reported that exposures well let's go let's go back for a second you would remember that greece last spring this past spring yeah greece.

whatever you want to call it rearranges that's where some of the lenders where whatever you want to call it cram down the war their potential payouts were reduced and the organization that governs credit default swaps called is the international swap deal association it alone determines what is a credit event and what is not a credit event and it took a very long time and many many discussions for is that to come clean and say yes greek default is a default and therefore it would trigger payments on the credit default swaps now the reason there was such a consternation on the part of is that to do it and the reason in the end is the decided to do it this is my personal belief is because they realized that if they were not to admit that this were a default regulators and investors very quickly would go forward and say ok if it is that is not going to rule this

a default then we need to look at the exposures of the banks who are reporting their net position and gross it up to see what would happen to them if insurance did not pay their offsetting against their risk and i am sure that at the time it was decided that greece was a small enough situation that it could be handled and it would not be productive to invite scrutiny to raise the potential question of so what happens when spain italy rain or another country you know defaults then there's no insurance covering that right and so in that situation but now we are into spain which is an much bigger problem right and everybody's very quiet i mean there's not much discussion about of the moment what will that's my question and that's why we're in the that's my question before we could before we go to break i just want to ask a follow up just on. systemic risk and c.d.s. in the euro zone crisis is what you're basically saying that if this is why bailouts are so important because if one bank fails it's not one bank failing it's

setting off a daisy chain that would have a massive amounts of banks failing or at least a massive set off counterparty risk going to way that would cause a systemic risk is that what you believe. absolutely to refreeze what you just said that's why bailouts have become indispensable first policy choice and that's a horrible situation because if everybody if nobody can fail that means that everybody is at risk of failing it's the highest correlation interconnectedness in the history of the financial world ever in the history of mankind and that is extremely extremely disturbing extremely disturbing so when we get back we're going to look at if there's any way around it we know the risks so what do you do if you want to invest the money or save some money or not lose all your money so hang tight right there we'll have more with you in a few minutes i'm in mckayla vege commanding member of i.d.s. this capital also still ahead as i said what do you do to protect yourself from

what you could call the faith based initiative of the financial system you have to believe in it for it to succeed what happens in that if that breaks down and how can you not be a loser we'll talk about it after the break but first your closing market numbers. what drives the world the fear mongering used by politicians who makes decisions to break through it's already been made who can you trust no one who is you who view you with a global missionary see where we had a state controlled capitalism is called sasha's when nobody dares to ask we do our tea question more. you know sometimes you see

a story and it seems so you think you understand it and then you glimpse something else here sees some other part of it and realized everything you thought you knew you don't i'm sorry is a big. very good. luck in the loan if so you'll get a real headline with none of them are the problem with the mainstream media today is that they're completely disconnected from the viewers and for what actually matters to those viewers and so that's why young people just don't watch t.v. anymore if they want news they go online and read it but we're trying to take those stories that people actually care about and transfer them back to t.v. .

welcome back before the break i promised we would talk about what to do in a situation where you cannot escape risk in the financial system before we get there i just want to point out with our guest how it's not just derivatives portfolios that are creating risk in this system very simple risk free funds suddenly we're realizing are not so i want to talk to some of the hill of it's more about that is co-managing member of i.d.s. is capital and i want to talk to you about money market funds before we get to where you do think you might be able to safely invest because money market funds are considered risk free or they try to portray themselves as risk free but at the end of the day how are they not that unlike c.d.'s for example in the sense that they really don't have a lot of reserves and they're not risk free. well if

i may correct you are yes at least you don't have any reserves they have no reserves there are no resorts that i know that you know it's on reserve reserve it's on reserve promise to pay on demand with no restriction whatever. it is assumed that all of the assets held in the money market funds are redeemable at par by the money more are sellable at par by the money market fund and essentially there is no margin of error and in fact there is a negative margin of error because we know that money market funds from time to time do lose money and so far the sponsors have been making up the losses but in the case of a reserve fund in two thousand and eight the sponsor could not make up the losses and the so called book was broken in that case it's a very dangerous situation it's all part of what we've been talking about before. libraries being rigged libraries directly connected to money market fund industry because a lot of the assets that money markets buy a commercial paper but

a lot of them a based on my board and so to the extent that they're being on just to give you the scope of the libel or mispricing potential mispricing yeah i've heard numbers anywhere from four hundred trillion to five hundred trillion of derivatives contracts that are priced off of live war what that means it's a trillion that hundred really and that's kind of money that it i don't think people can even better and average people can really even fathom how much money that it is a ton of money. keep going let me tell you how much it is one trillion dollars is one million dollars per day for twenty seven hundred years that's how much one trillion dollars is so that's five hundred million dollars per day for twenty seven hundred years so the point that i'm making is one basis point one basis point of mispricing one way or another triggers forty to fifty billion dollars of over or under payments by someone to someone that's the scope of this scandal but in the

case of money markets as we started if they have no reserves and essentially they're another muzzled canary in the coal mine everybody thinks that their money is safe but their money is subject to market risk just like everything else. and it's another note of systemic correlation right and just i do want to touch on one aspect of it which is how money market funds are not getting returns there's no yield interest rates are so low and i just want to show a chart to our viewers of how the yields have been shrinking so extensively since two thousand and seven so why are these funds closing i mean they're not able to make money. some of them are meeting in morning as if they were. as paul isaac likes to say it's risk and sorry it's return free risk it's not risk free return it's return free risk well the reason they don't want to return the money is because they want to preserve the business franchise for whenever the

money comes back once you give up the customers. you don't usually get or you often don't get them back that's a problem when the asset management industry in general managers don't return the money even when they don't have any good opportunities to invest in and that's why investors really need to pay attention and think for themselves because whoever is selling them something has a vested interest in doing it usually and it's not necessarily the best advice write something for yourself so so totally think it for it think think it through for yourself that's one of the messages i feel i hear over and over again hosting this show so when you think for yourself what do you think for yourself because we've gone through how high risk investments are risky and risk free investments are potentially risky so how do you get out of this how to get away from this. well if you think in terms of by the way going back to the first part of the show we were talking about three stages of debt are three phases in the life of debt right the first is the origination and technology has broken through the barriers there

the second part is servicing the debt and the fact that the rates of managed is making servicing unnaturally cheap which allows support of naturally high levels of debt well the unfortunate problem is nobody had figured the solution to the final part which is repayment and that is one part of that cannot be solved through technology somebody has got to have to pay the debts and that's either going to be the borrowers or the lenders or the borrowers have to come up with the money or the lenders are going to have to take the write down and that's and that's a problem and so in this situation you have to think. in the most simplistic way the way people have always thought of risk management which is you don't put all your eggs in one basket so what we're discovering here and what is new and different this time around is that financial assets all reside within the financial system and because financial system is so interconnected and so highly correlated different asset classes that used to be deemed to be uncorrelated or local local

relation before have become extremely highly correlated and they're essentially sitting all in one systemic basket so the way to address this problem and you have to look for baskets that are not in the financial system you have to look for assets that are not only physical assets let's say hard assets that are not financial instruments that not only the assets themselves are not in the financial system but the way you own them is not related to the financial system in other words direct physical ownership of non financial assets and you say the main one is gold i have about a minute tell us why physical gold you believe is the answer to the problems you've laid out. it's very simple it's the most liquid it's the most ubiquitous material with a worldwide market it should be own physically outside the financial system and hopefully with geographic diversification so you can excess liquidity during tough times and in fact we've seen the sort of the breach in the market there are missing service

and we've started the fund that enables people to do just that hold physical gold outside the financial system with global diversification it just happens to be the most ubiquitous in the most liquid material and that's not financial and it's outside the system right and that's your solution for people want to escape what you called the faith based initiative of the financial system it's based now on faith you have to believe in it what happens when that dries up i appreciate you being on the show thank you so much for giving us all of your insight he's simon mckay live it co-managing member of the i.d.f. this capital. all right let's wrap up with loose change dimitri is off today the beautiful

amazing christine for that now from r.t. america is failing and so christine shannon first christine thank you for being here let's talk about this because we often talk about how the too big to fail banks are in and of themselves a cartel but maybe i don't know are they learning something from actual drug cartels because an affidavit received in federal court in texas first of all says that the mexican cocaine trafficking cartel known as lows that us longer drug money into a u.s. race horse business so that's first take a look at this. put it this way more spurn manager was not surprised to learn about the allegations the laundered millions of dollars buying breeding and raising american quarter horses. and who helped them high money and basically get up and if arius activities well according to f.b.i. bank of america the money was hidden in accounts with bank of america so christine

freeze out does this make you go ok the banking cartels are actually working with cartels according to allegations from the f.b.i. i mean i'll be honest none of this story surprises me whatsoever of course bank of america is happy to have any customer that's going to keep one to five ten million dollars in accounts with them is that is not shocking at all you're from southern california i'm from southern california we know that these drug cartels will always operate make tons of money it's a little upsetting because you know there's nothing you or i could do about the fact that they are going to have all this money why do they need to put it in horse racing i want to go back on the horses to know that i'm competing with that kind of money is ridiculous they are from mexico this country is falling apart why don't they anonymously donate all this money i mean this is what it says the report says you know in some cases they just don't know what to do with all this money they want to hide it they want to hide this i have it anonymously donate it to schools or something obviously they're going to keep making this kind that is you have.

that is so sweet and helpful of you christine one thing i want to point out does this make you angry or bank of america because i think that your new year's resolution was to close your account at b. of a because you were upset with the. business and i accounted b. of a has been closed i have left i'm going to be honest though i don't think they missed me if i was in a member of this that says and i was depositing all this money in the millions of dollars they would probably miss me so it doesn't surprise me at all that you know bank of america helped them cover this up they're learning from the best bank of america learned from the actual drug cartels which are maybe more valuable than you or i let's move on really quickly before we go i just want to get to the next story which is. there's been a saying rap songs that more money really leads to more problems well in a boring moment moment by moment emo problems well maybe that's really true according to a new book by a canadian wealth advisor the book claims relationships between kids and their rich parents often leads to scenes like this. ok that's my turn to tell you no yes

no yes no the discussion is terminated going to me. so we don't have a lot of time but seventy percent of family businesses fail to pass successfully to the next generation and usa today reports the answer lies in emotional issues and bad relationships that were brewing inside wealthy families so is the so-called economic money multiplier broken when it comes to wealthy families and passing that along and keeping their licensure i mean you see this kind of thing and it's not just reality t.v. shows that you see this and you see it in wealthy families across this country and you can't always just blame the kids for acting like spoiled brats they're exposed to these lavish lifestyles and then their parents try to impose discipline when they're eighteen twenty one years old why are you failing out of college maybe because mom and dad you never made me work for anything in my life and i don't know how well just like central banks maybe the lesson is money is not the solution to everything it doesn't always work out that's all we have time for there thank you

so much and thank you for watching don't forget to come back tomorrow and in the meantime you can always follow me on twitter at lauren lyster and give us feedback at youtube dot com slash capital accounts have a great night. there hasn't been anything good on t.v. . it is to get the maximum political back. to the source material is more soaps journalism on the way. we want to present. something or.