30 June 2008

Goldman is Bearish on Europe


Pot notices the deep dark color of the kettle.


Buy `Crash Protection' Puts on European Stocks, Goldman Says
By Alexis Xydias

June 30 (Bloomberg) -- Investors should buy ``crash protection'' against a plunge this year in European stocks because losses are likely and insurance costs are low, according to Goldman Sachs Group Inc.

The world's most-profitable securities firm recommended Dow Jones Euro Stoxx 50 Index puts that expire in December and have a strike price of 3,000, or 11 percent less than the measure's closing level today.

`High inflation/low growth is an increasing downside tail risk,'' London-based derivatives analysts at Goldman, which had the second-ranked equity derivatives research team in Institutional Investor magazine's 2007 survey, wrote in a report dated June 26. ``If that risk crystallizes, we think it means material rather than modest downside.''

The Euro Stoxx 50 plunged 24 percent to 3,354.20 in 2008 and closed at the lowest since November 2005 last week. The December 3,000 puts on the index fell 6.7 percent to 83.50 euros today. They cost as much as 189.30 euros in March.

European-style puts convey the right to sell a security for a certain amount, the strike price, on a given date. Some investors buy or sell options to guard against changes in the prices of securities they already own. Others use the contracts to bet price swings, or volatility, will increase or decrease.

To contact the reporter on this story: Alexis Xydias in London at axydias@bloomberg.net.



BIS: Dr. Greenspan, in the Ballroom, with a Printing Press


BIS points finger at easy credit
Monday, 30 June 2008 11:46
RTÉ Ireland

The world's top central banking body has said the world economy could be in for an unexpectedly severe downturn. The Bank for International Settlements blamed lax credit for fuelling the current financial crisis.

The bank, known as the central bankers' central bank, suggested that interest rates should tend towards vigilance even in good times in order to discourage excessive borrowing.

While it was difficult to predict the severity of a downturn, it appeared that a 'deeper and more protracted global downturn than the consensus view seems to expect' was on the way, the BIS said.

It dampened hopes that booming emerging markets would offset the slowdown, saying that many of these markets were significantly dependent on external demand, notably from the world's largest economy the US.

The BIS argued that the sub-prime mortgage market - loans given to borrowers with poor credit ratings - was not a root cause of the turmoil on financial markets, but only a trigger.

The bank said years of cheap borrowing had led to an extraordinary accumulation of debt. It pointed out that in the US, the ratio of household savings to disposable income was about 7.5% in 1992. The ratio fell sharply in the early 2000s. By 2005, it had plunged to almost zero.

29 June 2008

Larry Summer's Design for an Economic Maginot Line


Larry Summers is an old general among the Keynesian-statist crowd. His playbook is right out of command and control economies, fighting a new type of war with the old tactics and weapons.

Don't get us wrong, we believe that something must be done and we have laid out broad plans months ago. But what Larry is proposing is a repugnant continuation of the same old game, which is the same prescription the Fed has been following since 1987.


What we can do in this dangerous moment
By Lawrence Summers
Financial Times
June 29 2008 18:10

It is quite possible that we are now at the most dangerous moment since the American financial crisis began last August. Staggering increases in the prices of oil and other commodities have brought American consumer confidence to new lows and raised serious concerns about inflation, thereby limiting the capacity of monetary policy to respond to a financial sector which – judging by equity values – is at its weakest point since the crisis began. With housing values still falling and growing evidence that problems are spreading to the construction and consumer credit sectors, there is a possibility that a faltering economy damages the financial system, which weakens the economy further.

After a period of intense activity at the beginning of the year with the passage of fiscal stimulus legislation, strong action by the Federal Reserve to cut rates and provide liquidity and the introduction of anti-foreclosure legislation, policy has again fallen behind the curve. The only important policy actions of the past several months have been those forced on the Fed by the Bear Stearns crisis. It would be a mistake to overstate the extent to which policy can forestall the gathering storm. But the prospects for a more favourable outcome would be enhanced if four actions were taken promptly.

First, the much debated housing bill should be passed immediately by Congress and signed into law. It provides some support for mortgage debt reduction and strengthens the government’s hand in its troubled relationship with the government-sponsored enterprises – Fannie Mae and Freddie Mac. While it is an imperfect vehicle – too limited in the scope it provides for debt reduction, insufficiently aggressive in strengthening GSE regulation and failing to increase the leverage of homeowners in their negotiations with creditors through bankruptcy reform – it would contribute to the repair of the nation’s housing finance system. Failure to pass even this minimal measure would undermine confidence.

Second, Congress should move promptly to pass further fiscal measures to respond to our economic difficulties. The economy would be in a far worse state if fiscal stimulus had not come on line two months ago. The forecasting community is having increasing doubts about the fourth quarter of this year and beginning of the next as the impact of the current round of stimulus fades. With long-term unemployment at recession levels, there is a clear case for extending the duration of unemployment insurance benefits. There is now also a case for carefully designed support for infrastructure investment, as financial strains have distorted the municipal credit markets to the point where even the highest-quality municipal borrowers are, despite their tax advantage, paying more than the federal government to borrow. There are legitimate questions about how rapidly the impact of infrastructure spending will be felt. But with construction employment in free fall, there will be a need for stimulus tied to the needs of less educated male workers for quite some time. Fiscal stimulus measures must be coupled to budget process reform that provides reassurance that, once the crisis passes, the fiscal policy discipline of the 1990s will be re-established.

Third, policymakers need to make a clear commitment to addressing the non-monetary factors causing inflation concerns. Though this could change rapidly and vigilance is necessary, it does not now appear that there are embedded expectations of a continuing wage price spiral. Rather, the primary source of inflation concern is increases in the price of oil, food and other commodities. Even if structural measures to address these issues do not have an immediate impact on commodity prices, they may serve to address medium-term inflation expectations. Appropriate steps include reform of misguided ethanol subsidies that distort grain markets to minimal environmental benefit, allowing farm land now being conserved to be planted; measures to promote the use of natural gas; and reform of Strategic Petroleum Reserve Policy to encourage swaps at times when the market is indicating short supply. Major importance should be attached to encouraging the reduction or elimination of energy subsidies in the developing world.

Fourth, it needs to be recognised that in the months ahead there is the real possibility that significant financial institutions will encounter not just liquidity but solvency problems as the economy deteriorates and further writedowns prove necessary. Markets are anticipating further cuts in financial institution dividends; regulators should encourage this to happen sooner rather than later and more broadly to reduce stigma. They should also recognise that no one can afford to be too picky about the timing or source of capital infusions and rapidly complete the review of regulations that limit the ability of private equity capital to come into the banking system. Most important, regulators should do what is necessary, including possibly seeking new legislative authority, to assure that in the event of an institution becoming insolvent they can manage the resolution in a way that protects the system while also protecting taxpayers. It was fortunate that a natural merger partner was available when Bear Stearns failed – we may not be so lucky next time.

Unfortunately we are in an economic environment where we have more to fear than fear itself. But this is no excuse for fatalism. The policy choices made in the next few months will matter to the lives of millions of Americans, to America’s economic strength and to the global economy.

The writer is Charles W. Eliot university professor at Harvard University and a managing director of D.E. Shaw & Co

28 June 2008

An Interview with Peter Schiff from Barron's


Peter Schiff is an interesting character, with an interesting perspective which he is quite articulate in expressing despite significant bias on numerous financial interviews. We disagree with him on a number of points, in particular with the 'cure' to our economic ills. We enjoy reading various perspectives as long as they are based on facts and stated intelligently. Peter Schiff does this quite well and we hope you enjoy this interview with Barron's.


Gloom and Doom? Nah; Just for the U.S.
By Lawrence C. Strauss
Barron's

The U.S. wouldn't be afloat without help.

Peter D. Schiff is an extreme bear when it comes to investing in the U.S., and he's made a name for himself selling his point of view with considerable zeal, often on television but also in print. Schiff, 43, has contributed articles to Newsweek International and other publications, and he is the author of the recently published Crash Proof: How to Profit from the Coming Economic Collapse. Our own Alan Abelson cited his musings in a recent column.

However, comparing Schiff's performance with a benchmark is impossible because he does not run a fund; instead, he recommends stocks for clients' brokerage accounts. Schiff, who holds a degree in finance and accounting from the University of California at Berkeley, is president and chief global strategist of Euro Pacific Capital, a brokerage he founded in the mid-1990s that emphasizes international stocks, preferably with dividends.

Not everybody is a fan. Schiff has been criticized for aggressively courting publicity to tout his doomsday message relating to U.S. equities and the domestic economy. But he has been right on several key calls, notably the weakening greenback and his emphasis on international stocks, and he has helped his clients make money. Barron's caught up with him recently.

Barron's: When did you turn bearish on the U.S.?

Schiff: A long time ago I worked as a retail broker at Shearson Lehman Brothers and I was selling tech stocks, and I was generally bullish. I had difficulties with some of the problems in our economy, but I was recommending U.S. stocks. I left Lehman in 1991. In the mid-1990s, when I was working for a small broker-dealer in California and then for my own firm, I started getting concerned about the dollar. So I began getting some clients invested in some foreign stocks -- just to get out of the dollar a bit. The dollar had a big drop, and then it started to rally in the late-1990s, in conjunction with the tech bubble. It was all part of foreigners' efforts to try to participate in the Nasdaq's bubble.

What kinds of stocks did you like in those days?

Traditional value stocks with dividend yields. I also liked commodities, so I was buying international oil stocks back when oil was under $20 a barrel. The stocks I recommended weren't doing very well in '98 or '99, especially after the Asian crisis, but they started doing better around 2000. I turned really, really bearish on the U.S. when I saw what the Federal Reserve was doing to prevent a recession in the early part of this decade, notably pumping a lot of liquidity into the system.

You continue to be very bearish on the U.S. But haven't there been other times when there was lots of negative sentiment toward the U.S., only to see another era of prosperity emerge? Such as the late 1980s, when there was concern that Japan would take over the U.S. economy. Look at how that turned out.

Yes, but we haven't been through anything like what we are going through now. The United States has really been living in a fool's paradise, or a phony economy, probably for more than 20 years. But our economy has been growing and getting bigger and bigger. We have been able to convince the world to lend us money and to provide us with goods that we don't produce and that we can't afford to pay for with exports. And it has gotten to the point now where the problem is so big, especially since the real-estate bubble. We've now borrowed so much money from abroad. Our trade deficits are now very big, and our industrial base and our infrastructure have been allowed to decay for so long, that we are now at a point that we can only survive as an economy thanks to the charity of the rest of the world. They have provided us with all the goods that we can no longer produce because we lack the industrial capacity. And they have to lend us the money because we don't have any savings anymore.

What's your take on oil prices?

As oil prices are going up in the U.S., they are not rising nearly as fast in other countries because their currencies are strengthening. Ultimately, when currencies like the renminbi that are pegged to the dollar are allowed to float, I see the Chinese currency rising five-fold against the dollar. That would make oil a lot cheaper in China relative to what it would cost in the U.S.

Speaking of China, how do you see things developing there and its impact on the U.S. economy?

The whole science of economics, as I see it, is how do you satisfy unlimited demand with limited resources? China has more than one billion people. It is not as if Americans are unique in wanting things. It's not as if the Chinese don't want dishwashers. The reason they don't have those possessions is because they don't have the purchasing power. But they do have that power; it's just that their government is taking it away from them and giving it to us. But it is Americans who can't afford these goods, because we can't produce them. So if the renminbi is allowed to rise, then Chinese factory workers will be able to afford the products they are producing instead of shipping them over here. That's going to be a major, major boon for their economy.

So it sounds as if the U.S. will be relegated to second- or third-tier status.

The U.S. is in trouble. We are a post-industrial society, which is the same as a pre-industrial society; our manufacturing base has disintegrated. It's not nonexistent; we still make some things and we are still competitive in some areas. But on the whole, as a nation we are not competitive. We are mainly a nation of a service sector and consumers, and that's going to have to change. Nor do we have the savings that we need to fund the transition.

What could go wrong with your scenario?

Somehow, the U.S. could buy itself some additional time. We could convince the world -- Europe and Asia -- that they need us, and that while propping up the U.S. economy is going to hurt them with more inflation, letting the U.S. collapse is going to be even worse. Of course, none of that is true. The truth, in my view, is that the cost of propping us up far exceeds the cost of letting the U.S. economy collapse. But I think we are already in a pretty severe recession.

But isn't there an argument that once we clean up this housing mess -- along with the credit bubble, whenever that occurs -- the U.S. will be a lot closer to a bottom, where the outlook begins to improve?

I don't think that's true. The resolution to the housing problem is going to mean housing prices are going to be a lot lower than they are now, and most Americans are not going to have any home equity. It's going to mean that trillions of dollars will have been lost by the lenders. When the home equity is gone, Americans are broke, as they don't have any savings. All they had was their home equity. They were counting on their home equity, without which they will be unable to pay off their credit cards.

But don't U.S. companies that do business abroad benefit from all of the trends you have outlined?

Yes, they are going to benefit to the extent that they can generate higher sales abroad. But ultimately the shareholders are not necessarily benefiting just because a multinational company earns more dollars. If the dollars have less purchasing power, they are not necessarily better off. The way I see it, we are just putting our goods on sale to sell more of those goods. But if you want to look at U.S. corporate earnings in terms of euros, barrels of oil or gold bullion, these companies are not necessarily seeing a real increase in earnings.

Plenty of investors and financial advisers have decreased their allocations to U.S. stocks in recent years. Why not do that instead of completely writing off the world's largest economy?

Individuals can make their own decisions. I don't see a way for the U.S. economy to avoid a major retrenchment. There's no way that U.S. assets are not going to be marked down relative to foreign assets. Therefore, I would rather invest in the rest of the world. There are plenty of people who for the whole decade of the 1990s were investing everywhere but Japan, which is the second biggest economy in the world. Why were they excluding Japan? It was obvious that it was in decline. I'm saying the same thing about the United States. I don't care if it is the biggest economy in the world; it is in decline. There are going to be a lot of losses in the United States, so why don't I avoid it? Worst-case scenario: I miss out on the U.S. market. But what are the odds that it is going to outperform all the other major markets that I am investing in? And I can't see how the dollar is going to be moving up over time.

Why keep your business open here? Why not set up shop in Asia?

Right now my business is helping Americans to preserve their wealth from a collapse of the U.S. dollar. If I were to go to a different country, obviously I would have to come up with a different business. I don't think people in China need to protect their wealth; they are going to do great. My business works better here. I could try to run the business from overseas, say the Cayman Islands or Australia, but I have friends and family here. I'm optimistic.

I've supported political candidates in the U.S., including Ron Paul, who ran for the Republican presidential nomination this year. I'm not writing America off. But I'm trying to educate people so that they understand that when this economy does collapse, it is not because of capitalism but that it's because of too much government.

What kinds of stocks do you look for?

The dividend is the most overlooked and important component of equity investing. Capital appreciation is great, but that's the icing; the cake is the dividend yield. I look for good dividend yields, but I want to get them in currencies that are gaining in value so that my clients can maintain their purchasing power here. These companies are playing into the growing purchasing power of the rest of the world -- not the shrinking purchasing power of the United States. The rest of the world has been selling us goods and hoarding our Treasuries and mortgage-backed securities. They are not going to be doing that anymore. They are going to spend their earnings on themselves.

How about a few stocks that you like?

One of the mining stocks that I have been buying, although it has pulled back a lot, is Oxiana [ticker: OXR.Australia]. Oxiana and Ziniflex, another Australian mining company, just merged. Another holding is an infrastructure play called Road King Infrastructure [1098.Hong Kong], which is listed in Hong Kong. It's also pulled back quite a bit. I also like Singapore Petroleum [SPC.Singapore]. Those are three names I've have been buying recently. One is a play on the growing infrastructure in China, while the other two are ways to invest in resources. A lot of people look at me and say, "Peter you are gloom and doom." I'm not gloom and doom.

Well, you are pretty gloomy on investing in the U.S.

I'm very negative on the U.S. economy. But I'm very optimistic on a lot of other economies. A lot of people tell me, 'Peter, this doesn't make any sense. How can you be so dire and gloomy on the U.S. and yet so positive on the rest of the world?' That shows you I'm not just gloom and doom. I recognize that contrary to popular opinion, the U.S. economy has been a drag on the global economy, and that when the rest of the world stops subsidizing us, growth abroad will actually improve as a result.

Surely you see some light at the end of the tunnel for the U.S.?

It is a long tunnel and the light is far away. But, yes, in the end I'm still optimistic that we can one day dig ourselves out of this hole. Look at the Germans and Japanese. They lost World War II, but here they are. We didn't lose a war, but in many respects we did in that our factories have been destroyed even though they weren't bombed.

What's a reasonable plan for the U.S. to right the economic ship?

We are going to have to replenish our savings. We are going to have to rebuild our industry. We are going to have to repair our infrastructure. All of that is possible, though it's not easy. It's going to be very difficult given the current level of government we have, along with the types of taxation and regulations we have. To really rebuild the economy, we are going to need cooperation from government and the government is going to have to get out of the way and make itself a much smaller burden on society, which means major reductions in government spending, taxes and regulations.

Thanks, Peter.


The US Bear Market as Seen from the Shoulders of Giants


US stocks are in a bear market which started from the last highs in October 2007.

The 'correction' became a bear market when the declines originally surpassed twenty percent in March. It does not matter that a few of the broader markets did not confirm. Once two of the major markets crossed that was it.

Since then we have had a corrective bounce which retraced approximately half the decline, and then turned sharply lower once again. Notice how all the index moves are starting to become more 'synchronized' although the broader markets are still lagging.

It would be classic bear market action to see this leg decline down to the thirty percent level, with perhaps a little bounce back up.

The US is also in an economic recession, despite the games being played by the Bureau of Labor Statistics with the GDP and inflation numbers. All the classic signs and co-indicators are there. Slapping paint on a falling building does not make it stronger or keep it from collapse.

The financial sector is in disarray. The investment banks have turned into predators in the speculative markets, and are engaging in little productive activity or efficient capital allocation. What we are seeing is the final transfers of wealth from the many to the few as the Republicans exit the Beltway.

We are also seeing a 'changing of the guard' from the leadership of the Cold War generation to Aquarian Agers and Generation X. A shift in attitude will be noticeable especially as the last of the Depression - World War generation fade away. They bore heavy burdens, they accomplished many great things, and had many flaws as a result of their harsh environment, but they also are of the past, and their time is done, and new challenges lay ahead. The US presidential election could not be more representative of this change.

It will not be easy, as for example the change of this type that occurred with the demise of the Victorian era and ushering in of the twentieth century.

As such this is more than a bear market, but one of those generational cyclic changes that are quite painful and sometimes violent, but which often lead to a more sustainable equilibrium.

Certainly there will be new schools of economic thought to supplant those which have gone before, but all of which are echos of the past.

Who was it that said we look and move forward 'standing on the shoulders of giants?' Isaac Newton in the 17th century comes to mind, but before that Bernarnd of Chartres in the 12th century, and before that the Greeks in the myth of the blind giant Orion carrying Cedalion. So it is that we have a debt of gratitude and preservation to the past, but a obligation of achievement and advancement to the future.




More Warnings from Europe: Fortis Bank Forecasts a US Financial Market Meltdown


We won't disagree with the forecast, although timing may be another matter, and we do have our 'talking their book' filters in place.

As background, Fortis has been making some moves to raise 8 billion euros in capital, and the stock was sold sharply in a share offering last week, out of fears of shareholders dilution and further troubles at the bank.

Interestingly enough, Fortis is part of the tripartite acquisition of ABN Amro, along with Banco Santander and the Royal Bank of Scotland, the largest bank takeover in history. The US retail operations were separately taken by Citigroup. ABN Amro was one of the largest banks in Europe and had operations in about 63 countries around the world.

RBS issued a similar dire prediction of the US financial crisis around 17 June. We just thought it was striking that both banks issued such forecasts about this time. Barclays issued a similar forecast last week. Something ugly in those balance sheets?

Warnings from Europe ahead of a US crash which is ignored by the American media and dismissed by the financerati have an historic resonance, as in the case of the stock market crash of 1929.

We think there is a strong probability of a dead cat bounce that may turn into a multi-day short squeeze relief rally within the next two weeks, barring fresh disclosures and confessions from the corporate crowd.

There are a number of pros expecting the same thing, as they did on Friday past. So you can see we are cautious, and back into our short term 'advantageous' trading posture. The narrower index charts show the breakdowns are in progress, and we may be over the edge, but the broader market indices are inconclusive. This may actually be quite bearish since the bulk of the market shows little fear yet and the VIX is at moderate levels for this bear market leg.

Oil is an interesting market. Is it a bubble driving by 'speculation' or a flight to safety haven for those disaffected by the US dollar, and without further desire for the euro? Is oil a sustainable world 'currency?' Perhaps its industrial demand is a two-edged sword in this discussion.

One thing we like about gold and silver is that they keep only one set of books, and nothing is off balance sheet, although the same might not be said of the Central banks that often muddy their markets.

Fortis Story roughly translated into English

American 'Meltdown' Reason for Capital Raising - Fortis
28th of June, 9:10
De Financiële Telegraaf

Fortis Bank predicts US Financial market meltdown within weeks...

BRUSSELS/AMSTERDAM - Fortis expects a complete collapse of the US financial markets within a few weeks. That explains, according to Fortis, the series of actions by the bank of last Thursday to raise €8 billion. "We have been saved just in time. The situation in the US is much worse than we had thought", says Fortis chairman Maurice Lippens. Fortis expects bankruptcies amongst 6000 American banks which have a small coverage currently. But also with Citigroup, General Motors, a complete meltdown in the US is beginning."

Amerikaanse ’meltdown’ reden geldinjectie Fortis - De Financiele Telegraaf


Fortis expects no more capital raising
Sat Jun 28, 2008 9:59am BST

BRUSSELS, June 28 (Reuters) - Measures taken by Fortis to shore up its finances should be sufficient, the Dutch-Belgian bank's supervisory board chairman told Belgian financial daily L'Echo on Saturday.

Chairman Maurice Lippens, asked if there was a chance that further capital-raising measures will be announced, replied: "Normally, it's sufficient. Of course, if this is a return to 1929, then we are in a different ball game."

Fortis raised 1.5 billion euros ($2.36 billion) from a heavily discounted share issue this week, part of a package of measures to shore up its finances by more than 8 billion euros.

Lippens said Fortis has been the victim of speculators and wondered how much money certain -- unnamed -- hedge funds made.


"Besides, Thursday's step was completely successful," Lippens said.

He also backed Fortis Chief Executive Jean-Paul Votron.

"You don't kill the captain in a storm," Lippens said.

The drop in Fortis' share price -- down more than 40 percent so far this year -- has not made the company a takeover target as other banks also have their problems, he added...


27 June 2008

Barclays Warns of an Oncoming Financial Storm


It was the Royal Bank of Scotland that issued a similar warning on 17 June RBS Warns Its Customers of a Financial Storm.


Barclays warns of a financial storm as Federal Reserve's credibility crumbles
12:01am BST 28/06/2008
UK Telegraph

US central bank accused of unleashing an inflation shock that will rock financial markets, reports Ambrose Evans-Pritchard

Barclays Capital has advised clients to batten down the hatches for a worldwide financial storm, warning that the US Federal Reserve has allowed the inflation genie out of the bottle and let its credibility fall "below zero".

"We're in a nasty environment," said Tim Bond, the bank's chief equity strategist. "There is an inflation shock underway. This is going to be very negative for financial assets. We are going into tortoise mood and are retreating into our shell. Investors will do well if they can preserve their wealth." (Hmmm. Let's see, what is renowned through the ages as a safe store of wealth in troubled times especially of inflation? Celery futures? Google? - Jesse)

Barclays Capital said in its closely-watched Global Outlook that US headline inflation would hit 5.5pc by August and the Fed will have to raise interest rates six times by the end of next year to prevent a wage-spiral. If it hesitates, the bond markets will take matters into their own hands. (The bond vigilantes are all retired to keeping bees in Sussex. These must be imports. - Jesse)

"This is the first test for central banks in 30 years and they have fluffed it. They have zero credibility, and the Fed is negative if that's possible. It has lost all credibility," said Mr Bond.

Strategists at Barclays accuse Ben Bernanke of a policy blunder

The grim verdict on Ben Bernanke's Fed was underscored by the markets yesterday as the dollar fell against the euro following the bank's dovish policy statement on Wednesday.

Traders said the Fed seemed to be rowing back from rate rises. The effect was to propel oil to $138 a barrel, confirming its role as a sort of "anti-dollar" and as a market reproach to Washington's easy-money policies.

The Fed's stimulus is being transmitted to the 45-odd countries linked to the dollar around world. The result is surging commodity prices. Global inflation has jumped from 3.2pc to 5pc over the last year.

Mr Bond said the emerging world is now on the cusp of a serious crisis. "Inflation is out of control in Asia. Vietnam has already blown up. The policy response is to shoot the messenger, like the developed central banks in the late 1960s and 1970s," he said. (If China were wise they might move to place their currency in a foundation of gold and silver to anchor it in this storm. - Jesse)

"They will have to slam on the brakes. There is going to be a deep global recession over the next three years as policy-makers try to get inflation back in the box." (Where did we hear a specific and strong stagflation forecast for this time period? Oh yes, in our predecessor blog last year. - Jesse)

Barclays Capital recommends outright "short" positions on Asian bonds, warning that yields could jump 200 to 300 basis points. The currencies of trade-deficit states like India should be sold. The US yield curve is likely to "steepen" with a vengeance, causing a bloodbath for bond holders.

David Woo, the bank's currency chief, said the Fed's policy of benign neglect towards the dollar had been stymied by oil, which is now eating deep into the country's standard of living. "The world has changed all of a sudden. The market is going to push the Fed into a tightening stance," he said.

The bank said the full damage from the global banking crisis would take another year to unfold.

Rob McAdie, Barclays' credit strategist, said: "The core issues have not been addressed. We're still in a very large deleveraging cycle and we're seeing losses continue to mount. We think smaller banks will struggle to raise capital. We're very bearish - in the long-term - on high-yield debt. The default rate will reach 8pc to 9pc next year."

He said investors had taken their eye off the slow-motion disaster engulfing the US bond insurers or "monolines". Together these firms guarantee $170bn of structured credit and $1,000bn of US municipal bonds.

The two leaders - MBIA and Ambac - have already been downgraded as the rating agencies belatedly turn stringent. The risk is further downgrades could set off a fresh wave of bank troubles. "The creditworthiness of many US financial institutions will decline in coming months," he said.

The bank warned that engineering and auto firms we're likely to face a crunch as steel and oil costs surge. "Their business models will have to be substantially altered if they are going to survive," said Mr McAdie.

A small chorus of City bankers dissent from the view that inflation is the chief danger in the US and other rich OECD countries. The teams at Société Générale, Dresdner Kleinwort, and Banque AIG all warn that deflation may loom as housing markets crumble under record levels of household debt. (Interesting that the French are preoccupied with deflation. - Jesse)

Bernard Connolly, global startegist at Banque AIG, said inflation targeting by central banks had become a "totemism that threatens to crush the world economy".

He said it would be madness to throw millions out of work by deflating part of the economy to offset a rise in imported fuel and food prices. Real wages are being squeezed by oil, come what may. It may be healthier for society to let it happen gently.


Charts in the Babson Style for Market Close 27 June 2008








US Dollar Long Term Chart with Commitments of Traders as of June 24


US Dollar Long Term Chart in Babson Style with COT



US Dollar Long Term Chart with Moving Averages



MBIA On the Edge of a Cliff


MBIA Position `Tenuous' After Moody's Downgrade, Fitch Says
By Christine Richard
June 27, 2008 12:55 EDT

June 27 (Bloomberg) -- MBIA Inc. faces a ``tenuous situation'' as the bond insurer seeks to cover payments and collateral calls on $7.4 billion of securities triggered by a credit-rating downgrade, Fitch Ratings analyst Thomas Abruzzo said.

MBIA may need to tap assets pledged to back other commitments as it comes up with the money, potentially opening the company up for further downgrades, said Abruzzo, who yesterday withdrew his rating on MBIA and Ambac Financial Group Inc. after the companies refused to give him information.

MBIA, based in Armonk, New York, is being forced to post collateral and make payments to some investors after Moody's Investors Service cut its insurance rating five levels to A2 from Aaa last week. Some of that money may come from assets backing an $8.1 billion medium-term note program, potentially creating a new liability for MBIA's insurance company, Abruzzo said. MBIA may be forced to sell some securities at a loss to fund the collateral payments, he said.

``It exposes the company to event and market risk,'' Abruzzo said in a telephone interview. Abruzzo cut MBIA to AA from AAA in April. ``It wasn't something that was envisioned when the company was AAA with a stable outlook.''

Jim McCarthy, a spokesman for MBIA, said he didn't have an immediate comment.

``We have more than sufficient liquid assets to meet any additional requirements arising from any terminations or collateral posting requirements,'' MBIA said in a statement last week in response to the Moody's downgrade.

Global Funding

In addition to its main business of insuring bonds, MBIA also manages assets for clients such as municipalities.

The asset management unit issued guaranteed investment contracts and medium-term notes, which carried AAA ratings because they were backed by the company's insurance unit, according to company filings. The unit makes a profit by investing in lower-rated securities that have higher yields, filings show. The downgrade of the insurance subsidiary triggered provisions in the investment contracts requiring MBIA to post collateral or repay investors, who include cities and states.

The asset management unit has $15.2 billion ``available to satisfy'' the demands, the bond insurer said in its statement. Those assets, though, also back the medium-term note program run by MBIA Global Funding LLC, the filings show. Taking $7.4 billion as collateral and cash payments would leave $7.8 billion to back the $8.1 billion program, a gap of $300 million that could widen if assets are sold at a loss, Abruzzo said.

``It's a concern that the liquidity in the asset management business has been further encumbered,'' Abruzzo said. ``It's a bit like robbing Peter to pay Paul. Ultimately, the insurance company is on the hook for any shortfalls.''

`Volatile' Credit

Abruzzo said he withdrew all his ratings on MBIA and Ambac because the companies refused to provide him private information, making it impossible for him to accurately rate them. MBIA said Fitch directly rated only about 30 percent of its portfolio so couldn't produce accurate assessments of its potential writedowns.

The recent downgrades ``impact the companies' business prospects and the companies' reactive strategic and capital management planning creates a volatile credit variable,'' Abruzzo said in the report.

Should MBIA's ratings fall to BBB or lower, the guaranteed investment contracts terminate and MBIA would be forced to repay holders.

Standard & Poor's, which cut MBIA's insurance unit to AA from AAA on June 5 and is reviewing it for another downgrade, isn't concerned about the holding company's liquidity, David Veno, an S&P analyst said in an e-mailed statement.

Even if MBIA is required to sell assets, Veno said he's not concerned ``given the apparent strong quality of the investments.''

Moody's spokesman Abbas Qasim said no one was available to comment.

Regulators

At the end of the first quarter, 48 percent of the assets backing the medium-term notes and investment contracts were invested in corporate bonds, 11 percent in asset-backed securities and 8 percent in non-agency residential mortgage backed securities, according to an MBIA presentation on May 12. About 20 percent of the assets were insured by MBIA or another bond insurance company, also according to the presentation.

The New York State Insurance Department is also monitoring the possibility of a claim on the insurance unit to make up a shortfall in the medium-term note program, Deputy Superintendent Michael Moriarty, said in an e-mailed statement.

Further ratings cuts or a slowing economy which ``may adversely impact the investment portfolio, could stress the asset-liability match of MBIA's investment management business,'' Moriarty said.

MBIA has an additional $1.4 billion of cash at the holding company that could be used to cover shortfalls, the company said last week. That includes $900 million it decided against giving to its insurance unit to shore up its capital after Moody's said it was likely to downgrade the insurer regardless.


Significant Deterioration in Alt-A Mortgage Debt Performance


It might be time to check what debt categories are being held by your money market funds if you have not done so lately.

How secure is that $1.00 NAV?

You should know what they are holding if you have any significant amounts parked in them. We have become complacent while the regulatory process in the US was functioning relatively effectively, even though we might not have realized it.

It was deteriorating under Clinton and became virtually ineffective under Bush II.


Alt-A Performance Gets Much Worse in May
By PAUL JACKSON
June 26, 2008
Housingwire.com

Problems are continuing to grow sharply among Alt-A borrowers, despite a dearth of pending rate resets, underscoring just how much home price depreciation is affecting borrowers in key housing markets nationwide.

A new report released by Clayton Fixed Income Services, Inc. on Wednesday afternoon found that 60+ day delinquency percentages and roll rates increased in every vintage during May among Alt-A loans, while cure rates have declined only for 2003 and 2007 vintages.

The picture being painted for Alt-A is increasingly beginning to look a whole lot like subprime, as a result, even if peaking resets in the loan class aren’t expected until the middle of next year. In particular, loss severity continues to ratchet upward — a trend that portends some likely further reassessment of rating models at each of the major credit rating agencies, as they catch up with the data.

Loss severity — the average amount lost relative to unpaid principal balance — reached 41.4 percent for all Alt-A first liens in REO during the most recent rolling six month period through May, Clayton said; that was up from a 37.6 percent rolling average one month earlier, and compares to a similar 49 percent loss severity average for subprime first liens liquidated in REO through May.

Those numbers make Standard & Poor’s Ratings Services latest assumption of 35 percent loss severity on Alt-A loans, only one month old, already start to look a little too conservative. The rating agency’s updated loss severity assumption was one key reason the agency cut ratings of 1,326 Alt-A residential mortgage-backed securities in late May — and put another 567 AAA-rated tranches on negative ratings watch.

We’d speculated in May that S&P’s loss assumptions were yet too conservative; given the data now available, a ratings cut for any AAA classes deemed at risk one month ago would seem to be a foregone conclusion for most investors.

Add in soaring borrower defaults, and the picture doesn’t get much better. Clayton reported that the 2006 vintage saw 60+ day borrower deliquencies among Alt-A first liens reach 21.22 percent in May, up 10.5 percent in a single month; 2007 fared even worse, with 60+ day delinquencies ratcheting up 22 percent to 18.55 percent.

Even the 2004 Alt-A vintage, what’s left of it, is defaulting at a fast pace: 60+ day delinquencies in the vintage shot up by nearly 24 percent in just one month.


The problem isn’t rate resets of adjustable-rate mortgages, either, a point we’ve been hammering for some time. Rather, rapidly falling home prices and a weakening economy are the chief culprits here.

“Amid all the attention being paid to rate adjustments, however, it’s important to note that out of all the active delinquent ARM loans in Clayton’s portfolio, approximately 70 percent were already delinquent prior to the first rate change date,” analysts at the firm noted in their report.

Off Balance Sheet Antics Hit the Insurance Giant AIG


The Cat: By-the-bye, what became of the baby? I'd nearly forgotten to ask.
Alice: It turned into a pig.
The Cat: I thought it would.

This is provided as background to help you understand why the Net Asset Value of your uninsured money market funds takes a healthy single digit hit in the near future.

By the way, AIG used to speculate in the silver markets and was one of the short seller cartel. Wait until that anti-bubble blows up.


AIG Poised to Absorb $5 Billion Losses From Securities-Lending
By Miles Weiss

June 27 (Bloomberg) -- American International Group Inc. plans to absorb losses for a dozen insurance units after their securities-lending accounts suffered $13 billion of writedowns tied to the subprime-mortgage collapse during the past year.

The world's largest insurer will assume as much as $5 billion of any losses on sales of the investments, up from a previous commitment of $500 million, said Christopher Swift, vice president for life and retirement services, in an interview. AIG also will inject an undisclosed amount of capital into some of the subsidiaries, he said.

Moody's Investors Service and A.M. Best Co. both cited the writedowns in May when they downgraded New York-based AIG's credit ratings. State regulators in Texas said they didn't know AIG was investing cash collateral from the securities-lending business in subprime-linked assets and were concerned the insurance units hadn't put aside enough capital to cover potential losses.

``We were aware of this portfolio, but we didn't have transparency on what was in it because it was off-balance sheet,'' said Doug Slape, chief analyst at the Texas Department of Insurance in Austin, which oversees three AIG insurers that have suffered about 60 percent of the writedowns. (You are a regulator you great prune. You go ask for it and get it from them - Jesse)

The reduction of asset values in the securities-lending portfolio was part of the $38 billion in pretax writedowns that AIG reported during the past three quarters. That total included reductions of $20 billion on guarantees known as credit-default swaps and $18 billion on mortgage- and asset-backed securities, including some tied to subprime home loans. Most of the mortgage-related holdings are in the securities-lending pool.

Recovery Expected

The securities-lending business caters to banks and brokerages that borrow for themselves and clients to hedge trades, cover bets that a stock will fall and avoid trade- settlement failures. AIG's life-insurance subsidiaries invest their premiums in stocks and bonds. To make extra money, they lend out those securities through a central pool that invests cash collateral.

AIG said in regulatory filings that about $9 billion of the markdowns on mortgage-backed securities resulted from temporary market-value declines that it expects to be reversed. Those unrealized losses don't affect earnings.

In the meantime, its support for the insurance subsidiaries relieves pressure to sell the holdings at a loss should the banks and brokerages close out their loans, said Laura Bazer, a senior credit officer at Moody's in New York.

``At that point the AIG life insurance companies would have to make a decision to find cash elsewhere or sell the securities at a loss, which nobody wants to do,'' Bazer said. ``If you think those securities are money good, you want to hold them until maturity.''

`Adequate Liquidity'

AIG's securities-lending program hadn't experienced a ``significant'' decrease in loan balances as of March 31, according to a May 8 filing with the U.S. Securities and Exchange Commission. Swift said in an interview last week that AIG has ``adequate liquidity'' to fund any required returns of collateral.

Securities lending has traditionally been perceived by the Federal Reserve and other bank regulators as a business with few risks. Other companies with securities-lending operations include MetLife Inc., State Street Corp. and Northern Trust Corp. While some invest their collateral only in Treasuries, others buy bonds backed by mortgages and credit-card receivables to get additional yield, said Josh Galper, a principal at Vodia Group LLC, a Concord, Massachusetts, financial-services research firm.

``The range of investments go from very conservative to very risky,'' Galper said.

$78 Billion

State regulatory filings show that AIG's securities-lending unit used almost two thirds of its $78 billion in cash collateral to buy mortgage-backed securities that plunged in value starting last July as subprime defaults climbed. Most of the securities were rated AAA or AA. The market value of the collateral pool, including cash and securities, fell to $64.3 billion as of March 31.

In addition to the $9 billion in unrealized losses, AIG and its 12 insurance and annuity units that participated in the securities-lending pool incurred $3.9 billion of realized losses, or declines the company no longer classifies as temporary. These losses reduced AIG's earnings, primarily in the fourth quarter of 2007 and the first quarter of 2008.

AIG has a third category of investment loss: those booked when an asset is sold below original cost. The insurance units are required to reimburse the securities-lending pool for their share of these losses. Though none of these losses have been recorded, AIG has agreed to cover up to $5 billion of them.

Maturity Mismatch

Subprime holdings in the securities-lending pool weren't the only issue cited by regulators. Some state officials said AIG invested more than half the collateral in debt securities that on average would pay off in three to 10 years. Because AIG loaned bonds for periods ranging from overnight to 60 days, the insurance units could be exposed to a cash crunch if borrowers suddenly returned securities and demanded their collateral back.

``We were surprised at the length of the paper,'' said Joseph Fritsch, director of insurance-accounting policy at the New York State Insurance Department in Manhattan. Still, Fritsch and Erin Klug, a spokeswoman for Arizona's insurance department in Phoenix, both said AIG had notified them about the losses in the securities-lending portfolio and voluntarily decided to backstop the insurance units involved.

``AIG did the right thing,'' Fritsch said. ``They have put the guarantees in, and they have put money into the companies.''

To contact the reporter on this story: Miles Weiss in Washington at mweiss@bloomberg.net

26 June 2008

The Bear Market of 1929 - 1933 and the Decline of June 1930


It was the first wave down in October 1929 that took out the speculators.

It was the third wave decline that decimated the nation and the professional traders such as Jesse Livermore and Arthur W. Cutten.

There were temporary bottoms and substantial rallies of hope off steep short term declines, all the way down to the bottom in 1933. The Republicans were swept out of office and a reform Democrat was elected, Franklin Delano Roosevelt.

The decline we have seen so far this June in the Dow Jones Industrial Average is the largest June drop since that short term market bottom in 1930.




A historical reminder for those who have a certain mindset about what happens when debt is wiped out, a serious deflation occurs, and a currency is devalued in response to it.



Dow Jones Industrial Average Nears its Worst June Decline Since 1930



Union Bank of Switzerland Formally Charged with Fraud by State of Massachusetts


AP
Mass. regulators file fraud charges against UBS
Thursday June 26, 1:50 pm ET
By Jay Lindsay, Associated Press Writer
Mass. regulators accuse UBS of fraud in sales of risky auction-rate securities

BOSTON (AP) -- Massachusetts regulators filed civil fraud charges Thursday against UBS Financial Services for allegedly selling investments it knew were extremely risky, but portrayed as safe.

The complaint by the Massachusetts Securities Division alleges that the financial services arm of the Swiss bank UBS AG knowingly let brokers present its auction-rate securities as virtually risk-free so it could reduce its own stake in the failing program.

The investments have their interest rates set at periodic auctions, depending on the submitted bids.

When the program ultimately failed, investors -- many of them retirees or small business owners -- were left with securities they can't sell, the complaint said.

"These customers have now discovered ... that they have been blindsided by the very people who were supposed to have their best interests at heart," the complaint said.

UBS spokeswoman Karina Byrne said the company was disappointed state regulators filed the complaint while the company was working to solve the problems caused by the auction rate market failure.

In a statement, she said the company supported the market longer than any other firm, and have offered loans at favorable rates to clients with holdings in it. "Contrary to the allegations, UBS is committed to serving the best interests of our clients," she said.

Auction rate securities were once considered safe, and were purchased by investors who wanted a place to park their money where it could be easily accessed.

But starting in February, weekly and monthly auctions at which investors normally purchase such the securities failed to yield buyers, as investors sought to avoid risk amid turmoil in credit markets.

The complaint alleges that even though executives were calling the program an "albatross" and knew it was near collapse early this year, it continued to sell the securities to individual investors. It presented them as a good value, in order to reduce its own inventory, the complaint says.

The complaint also alleges investors were never told the auctions weren't true auctions, and that UBS stepped in when buyers abandoned the program to underwrite the products and set the interest rate so the program wouldn't fail.

The state wants to force UBS to return all investor funds and pay a fine. The amount of money being sought was not disclosed in the complaint.

Last month, UBS agreed to buy back $37 million worth of these securities sold to 17 Massachusetts towns and cities and to the Massachusetts Turnpike Authority, under an agreement with Attorney General Martha Coakley.



Here Comes the Cavalry


Wall Street and the financial interests painted a picture of a 'bottom' and continued to hand off the losses and risk to the public and shareholders.

You were warned.

It is not over.


Goldman Cuts Banks, Strongly Advises Selling Citi
Thu Jun 26 11:32:32 2008 EDT
By Ed Welsch

NEW YORK (Dow Jones)- The business models of Wall Street investment banks and U.S.-based global banks continue to deteriorate and their recovery will take longer than anticipated, Goldman Sachs Group Inc. told clients Thursday.

The firm cut its recommendation of the sector to neutral from attractive and strongly recommended that investors sell shares of Citigroup Inc., saying it faced multiple problems, including more asset write-downs, higher loss provisions for consumer credit and the potential for more capital raises, dividend cuts or asset sales. (But they'd buy them for $2 and a backstop from Benny. - Jesse)

Financial stocks declined broadly, with shares of Citigroup recently falling 6.5% to $17.62 after earlier reaching a new 52-week low of $17.57. The previous low of $17.99 was reached March 17. A Citigroup spokeswoman said the company doesn't comment on analyst reports.

The move came as Goldman itself was downgraded to market perform by analysts at Wachovia "in light of renewed economic fears" and a poor outlook for investment banking business. Goldman is widely considered to be the strongest investment bank in the U.S. Goldman shares fell 3.2% to $177.84 in recent trading.

By adding Citigroup to its conviction sell list and expressing caution on other financial firms, Goldman reversed the positive stance it took on the financial sector following the near-collapse of Bear Stearns Cos. Wall Street had hoped that March 17 had marked the bottom for financial stocks and write-downs. Although write-downs have been slowing, more problems have cropped up for the banks as their boom-year businesses in structured financial products disappear and their assets tied to consumers deteriorate as the overall economy weakens.

Goldman cut its second-quarter and full-year estimate for several financial firms, both large and small. The most significant cuts were on Citigroup and Merrill Lynch & Co. (MER) -Goldman now sees both firms posting losses in the second quarter and full year; it put the second-quarter losses at 75 cents a share at Citigroup and $2 a share at Merrill. Goldman also cut its estimates for Piper Jaffray Cos. (PJC), Lazard Ltd. (LAZ), Evercore Partners Inc. (EVR)and Greenhill & Co. (GHL).

Shares of Merrill fell 4.9% to $33.73 in recent trading. A Merrill spokeswoman said the firm doesn't comment on analyst research.

Goldman expects Citigroup to take $9 billion in write-downs during the second quarter and Merrill to take $4.2 billion in write-downs in the quarter. Both firms are scheduled to report their second-quarter results in mid-July.

Bernstein Research also added to the gloomy chorus on investment banks Thursday, swinging its estimate of Merrill's second quarter to a loss. Bernstein expects Merrill to write down $3.5 billion during the quarter on its collateralized debt obligations, mortgage-related legacy exposures and its counterparty exposure to monoline insurers.

Bernstein said its projection of a second-quarter loss of 93 cents a share could prove to be too optimistic, "given the uncertainty of where CDO marks and monoline reserve levels will be this quarter."

Citigroup Chief Financial Officer Gary Crittenden said the bank would take "substantial additional marks on our subprime exposure" if current trends continue. He said the second quarter remained challenging but "was characterized in many respects by sequential improvement" over the first quarter, when Citigroup posted a loss of $5 billion on more than $10 billion in write-downs.

"However, the market continues to change rapidly, and volatility remains unprecedented," he said. "This could cause the remainder of the quarter to shape up very differently from what I've just discussed."

The analysts said the most troubled business units of the financial firms are investment banking, where merger and acquisition activity has slowed and where underwriting remains depressed compared to year-earlier levels, and the distressed areas of the fixed-income market made up of mortgage-backed securities.



25 June 2008

Gold Weekly Chart - 25 June 2008



Charts in the Babson Style for Midweek 25 June 2008


A lot of dominos lined up, but we are coming into the end of the second quarter and there is a lot of bonus money riding into this quarterly close on Monday. They have been selling the dogs the last few days, but that may end.

Don't jump in front of support. The SP futures need to climb back over 1322 and there is potential for a bounce off 1306 for a short term double bottom. Let's see if they can do it.











Beltway Ben Assumes a Neutral Stance, Complementing the Treasury Secretary's Wider Stance


"If every day a man takes orders in silence from an incompetent superior, if every day he solemnly performs ritual acts which he privately finds ridiculous, if he unhesitatingly gives answers to questionnaires which are contrary to his real opinions and is prepared to deny his own self in public, if he sees no difficulty in feigning sympathy or even affection where, in fact, he feels only indifference or aversion, it still does not mean that he has entirely lost the use of one of the basic human senses, namely, the sense of humiliation." Václav Havel in a Letter to Dr. Gustáv Husák 8 April 1975


Fed Keeps Rate at 2%, Cites `Upside' Inflation Risks
By Craig Torres

June 25 (Bloomberg) -- The Federal Reserve kept its benchmark rate at 2 percent and warned that faster inflation may accompany some strengthening of the economy.

``Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased,'' the Federal Open Market Committee said in a statement in Washington after a two-day meeting.

Fed Chairman Ben S. Bernanke and his colleagues ended the most aggressive monetary easing in two decades, refreshed their forecasts and reported some improvement in consumer spending. At the same time, crude oil prices have almost doubled in the past year and the cost of commodities from wheat to tin jumped to unprecedented levels.

``The Fed is more balanced now in their assessment,'' James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, said in a Bloomberg Television interview. ``A rate hike is now back on the table. If it goes weak again, it can ease.''

Stocks rose after the decision, pushing the Standard & Poor's 500 Stock Index up 0.6 percent to 1,321.97. The yield on the benchmark 10-year Treasury note rose about 1 basis point to 4.09 percent. The dollar weakened against the euro.

``The Committee expects inflation to moderate later this year and next year,'' the Fed said. ``However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.''

Next Meeting

``It is more or less a neutral statement, which is consistent with policy on hold pending more clarity,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. ``They are not tipping their hand for the next meeting.''

As policy makers convened, reports showed U.S. home prices fell the most on record, consumer confidence touched a 16-year low, and durable goods orders were unchanged in May. Households are also falling further behind on their debt, eroding profits at lenders. Banks and securities firms have taken almost $400 billion in asset writedowns and credit losses.

``Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters,'' the Fed said.

Continued Expansion

At the same time, the statement contained no mention of the contraction in gross domestic product that many officials judged possible at their April meeting. A government report tomorrow will probably show the economy grew at a 1 percent annual pace in the first quarter, up from an initial estimate of 0.9 percent, according to a Bloomberg News survey of economists.

Dallas Fed President Richard Fisher dissented from today's decision, preferring an increase. He dissented against the rate cut at the April meeting.

Oil prices touched a record $139.89 June 16, extending a rally that helped push the consumer price index up 4.2 percent in May compared with an average rate of 2.7 percent over the past decade. Energy costs are hurting profits and household incomes, and raising expectations for future inflation....

Dow, UPS

Dow Chemical Co. said yesterday that higher raw materials costs will cause the company to raise prices by as much as 25 percent in July, following an increase of as much as 20 percent. United Parcel Service Inc. lowered its second-quarter profit forecast on June 23 because of rising fuel costs and slowing U.S. growth.

American consumers foresee average annual inflation of 3.4 percent over the next five years, the highest expectation since 1995, according to the Reuters/University of Michigan survey.

Policy makers are ``going to remain about where they are until the data come in and make a strong case to move one way or the other,'' William Poole, former president of the St. Louis Fed, said in a Bloomberg Television interview.

Home prices in 20 U.S. cities fell in April by the most on record, signaling the housing recession is far from over. The S&P/Case-Shiller home-price index dropped 15.3 percent from a year earlier. The gauge has fallen every month since January 2007. Employers have reduced payrolls for five consecutive months, helping push the unemployment rate to 5.5 percent.

Crisis Response

Central bankers reduced the target rate for overnight loans between banks by 2.25 percentage points in 2008 with a series of aggressive rate actions, including two three-quarter-point cuts. In addition, the Fed invoked emergency authority in March to start lending directly to investment banks. The central bank also provided $29 billion of financing to secure JPMorgan Chase & Co.'s takeover of Bear Stearns Cos.

The FOMC at 10:45 a.m. today held a special meeting with supervisors to discuss investment banks and their borrowing of securities and cash from the Federal Reserve, according to a notice on the central bank's website. Fed officials have given themselves until September to decide on the future of the direct loan facility.

The financial system remains under stress. The Standard and Poor's Financials Index, which includes 90 bank, brokerage and insurance stocks, fell 21 percent from May 2 to June 24.

``Business conditions continue to weaken in the U.S. and so far this month we have seen credit indicators deteriorate beyond our expectations,'' American Express Co. Chief Executive Officer Kenneth Chenault said in a statement today.

Financing rates are also rising for consumers. The rate on a 30-year fixed-rate mortgage rose to 6.3 percent June 24 versus 5.79 percent at the start of the year, according to Bankrate.com.

New Projections

Fed officials discussed their new forecasts for 2008, 2009 and 2010 at the meeting. Bernanke will reveal the FOMC's new outlook for inflation, growth and employment in his semi-annual congressional testimony next month.

Wall Street analysts are divided on how higher energy costs may affect growth. The 38 percent rise in oil prices this year absorbs more consumer dollars, pulling spending away from other goods and services. If inflation is allowed to rise further, the purchasing power of incomes could fall. After tax incomes adjusted for inflation rose at a 1.8 percent rate for the 12 months ending April, versus 3.1 percent for the same period a year earlier.

The federal government has also injected $70.8 billion into the economy through tax rebates, which could lead to one or two quarters of stronger growth and add momentum to price increases.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net

Last Updated: June 25, 2008 16:33 EDT