How Long Will the Recession Be?

Martin Feldstein is professor of economics at Harvard University, and is the current chairman of the National Bureau of Economic Research which makes the formal declaration on economic recessions in the US. He was the leading contender for the Federal Reserve Chairman along with Ben Bernanke of Princeton.

U.S. May Be in `Very Long' Recession, Harvard's Feldstein Says
By Kathleen Hays and Timothy R. Homan
Bloomberg News

July 31 (Bloomberg) -- The U.S. may now be in a ``very long'' recession that will drive the unemployment rate higher, with little that the Federal Reserve can do to help, said Harvard University Professor Martin Feldstein.

``I don't see recovery'' on the horizon, Feldstein, who headed the National Bureau of Economic Research until June and serves on the group's recession-dating panel, said in an interview with Bloomberg Radio.

Feldstein said the Fed has already lowered interest rates as much as it can to help growth, and that exports offer the only bright spot, while they aren't strong enough to fuel a recovery. A former adviser to President Ronald Reagan, he also warned that policies proposed by Senator Barack Obama, the presumptive Democratic presidential candidate, would prolong the downturn.

The next president ``should not be raising taxes,'' Feldstein said. He said he was ``really surprised'' that Obama ``hasn't backed off his proposals for a major tax increase.''

Feldstein said today's gross domestic product figures reinforced his view that the economy entered a recession in December or January. GDP shrank at the end of 2007 and grew less than forecast in this year's second quarter, the Commerce Department reported today.

Fed officials have lowered their benchmark rate to 2 percent from 5.25 percent since September, bringing the reductions to a halt in June amid rising concern that inflation will accelerate. Feldstein indicated the central bank should refrain from lowering borrowing costs further.

Fed Role

``I don't think that there's much the Fed can do one way or the other at this point,'' he said.

While Treasury Secretary Henry Paulson today said that the fiscal stimulus package enacted in February will keep helping the economy in the second half, Feldstein wasn't so optimistic.

``The little boost that we got from the tax rebates we will give up in the third and fourth quarters,'' Feldstein said. ``We're in for higher levels of unemployment and job losses.''

A ``typical'' U.S. recession lasts about 12 months, while the past two were about eight months, Feldstein said. This time, the slump may be longer, he indicated.

``If we do end up dating the recession as beginning at the end of last year, it could be a very long recession,'' he said.

Both Feldstein and Robert Hall, the Stanford University economist who leads the NBER's Business Cycle Dating Committee that determines U.S. recessions, said it was too early to gather for a formal declaration....

How Much Farther Will the US Dollar Decline?

The short answer is that the dollar will continue to decline in relation to the currencies of its trading partners until it starts generating a trade surplus. As the dollar loses its status as the reserve currency of the world this process will accelerate.

This decline will not be uniform. The Euro may have already achieved much of its appreciation, with the Asian currencies and those of resource exporting countries lagging significantly.

The process will be slower to the extent that the world is willing to subsidize US consumption by treating the dollar as a reserve currency with inherent value greater than their own currencies. This is how the trade surplus was allowed to remain negative for so many years.

The price of imported natural resources such as oil will provide a significant lever in the dollar's decline.

Note that there is no discussion of domestic money supply growth or contraction per se, only the flow of currencies between and among countries. The issue of money supply becomes relevant through its effect on the interest rates, and the interest rate differentials.

This is not a metaphysical debate; this is math. Unless the rest of the world wishes to allow the US to be its sovereign lord and master, the dollar has a significant distance to travel on its long day's journey into night.


What is the Dollar’s Sustainable Value?
By Martin Feldstein
July 31, 2008

How much further will the dollar fall? Or has it already fallen so far that it will now start to move back to a higher level?

For travelers to the United States from Europe or Asia, US prices are dramatically lower than at home. A hotel room or dinner in New York seems a bargain when compared to prices in London, Paris, or Tokyo. And shoppers from abroad are loading up on a wide range of products before heading home.

But, despite this very tangible evidence, it would be wrong to conclude that US goods are now so cheap at the existing exchange rate that the dollar must rise from its current level. Although the goods and services that travelers buy may cost less in the US than abroad, the overall price of American products is still too high to erase the enormous trade imbalance between the US and the rest of the world.

To be sure, the falling dollar over the past few years has made American products more competitive and has caused the real value of US exports to rise sharply – by more than 25% over the past three years. But the trade deficit in 2007 nevertheless remained at more than $700 billion, or 5% of GDP.

The large trade deficit and equally large current account deficit (which includes net investment income) implies that foreign investors must add $700 billion of US securities to their portfolios. It is their unwillingness to do so at the existing exchange rate that causes the dollar to fall relative to other currencies. In falling, the dollar lowers the value of the dollar securities in foreign portfolios when valued in euros or other home currencies, shrinking the share of dollars in investors’ portfolios. The weaker dollar also reduces the risk of future dollar decline, because it means that the dollar has to fall less in the future to shift the trade balance to a sustainable level.

But what is that sustainable level of the trade balance and of the dollar? While experts try to work this out in terms of portfolio balances, a more fundamental starting point is the fact that a US trade deficit means that Americans receive more goods and services from the rest of the world than they send back – $700 billion more last year. The difference was financed by transferring stocks and bonds worth $700 billion. The interest and dividends on those securities will be paid by sending more “pieces of paper”. And when those securities mature, they will be refinanced with new stocks and bonds.

It is unthinkable that the global economic system will continue indefinitely to allow the US to import more goods and services than it exports. At some point, the US will need to start repaying the enormous amount that it has received from the rest of the world. To do so, the US will need a trade surplus.

So the key determinant of the dollar’s long-term value is that it must decline enough to shift the US trade balance from today’s deficit to a surplus. That won’t happen anytime soon, but it is the direction in which the trade balance must continue to move. And that means further depreciation of the dollar.

An important factor in this process will be the future price of oil and the extent of US dependence on oil imports. In each of the past four years, the US imported 3.6 billion barrels of oil. At the current price of more than $140 a barrel, that implies an import cost of more than $500 billion. The higher the cost of oil, the lower the dollar has to be to achieve any given reduction in the size of the trade deficit. So a rising oil price as measured in euros or yen implies a greater dollar fall, and therefore an even higher oil price when stated in dollars.

There is one further important consideration in thinking about the future value of the dollar: relative inflation rates in the US and abroad. The US trade deficit depends on the real value of the dollar – that is, the value of the dollar adjusted for differences in price levels in the US and abroad. If the US experiences higher inflation than our trading partners, the dollar’s nominal value must fall even further just to maintain the same real value.

The inflation differential between the dollar and the euro is now relatively small – only about one percentage point a year – but is greater relative to the yen and lower relative to the renminbi and other high-inflation currencies. Over the longer run, however, inflation differentials could be a more significant force in determining the dollar’s path.

Martin Feldstein, a professor of economics at Harvard, was formerly Chairman of President Ronald Reagan’s Council of Economic Advisors and President of the National Bureau for Economic Research.

Have Fed Policy Errors Pushed Us Into a Stagflationary Depression?

As we noted at the end of 2007, there is little doubt we entered a recession in 2007. The only question was how long and how well the Fed might conceal it, and mask its effects on the financial markets and banking system which is their first priority no matter what else they might say, for a variety of reasons.

Depending on how one wishes to define it, and how one wishes to measure our monetary inflation, we have probably been in a technical recession starting early in 2007 and perhaps late 2006.

The recession is growing stronger and deeper because of the Fed and Treasury policy errors, squandering valuable national capital on a financial sector that requires reform, not welfare support.

Their errors are so large and so misguided that they may have condemned the US to a stagflationary depression. The equally misguided efforts of several national central banks may drag a good part of the developed world down with us for several years.

This study is a significant focus of our inquiries at this time, our intellectual raison d'être now that the question of recession is settled. Its no longer a question of 'how long and how deep' but the evlving nature of this downturn, the actions of the Fed and Treasury in reaction and the manner in which they prolong and mutate it. We may be watching something truly exceptional, and are seeking to understand it.

It will probably be the employment numbers that eventually make the difference in definition, although as we have previously shown that the government is actively revising those numbers many years back on a regular basis.

The major stock markets deflated by an appropriate contra-dollar measure also are consistent with the view that we are entering the recessionary aftermath of a market crash that occurred in 2000-3. We have never legitimately recovered. The Fed has been engaged in a protracted monetary experiment. We await the outcome of their gamble with keen interest, as the stakes of the wage are severe.

A significant challenge is the lack of transparency and reliable government and private statistics, and the willing complacency of most economists.

This may be an historic event. It is entirely consistent with what occurred in 1929-31 that it is happening largely unnoticed by a complacent public until they are swept away by it, with revelation after revelation that they have been deceived and misled.

What about the theory that if we pretend there is no recession or inflation then we won't have one? If we pretend that reality doesn't matter we will simply and slowly go collectively insane. There is some precedent for countries that do this.

So what ought one to do? Get in there and short the financial markets? That is like running down on the beach to sell flotation devices for an incoming tsunami.

When the tsunami is coming, get off the beach. The 'beaches' in this case are dollar denominated financial assets and financial assets dependent on the US economy.

We hope that the vectors of our data analysis are not correct. May God have mercy if they are.


U.S. Recession May Have Begun in Last Quarter of 2007
By Timothy R. Homan

July 31 (Bloomberg) -- The U.S. economy may have slipped into a recession in the last three months of 2007 as consumer spending slowed more than previously estimated and the housing slump worsened, revised government figures indicated.

The world's largest economy contracted at a 0.2 percent annual pace in the fourth quarter of last year compared with a previously reported 0.6 percent gain, the Commerce Department said today in Washington. Growth for the period from 2005 through 2007 was also trimmed.

The revisions now reinforce measures such as employment and production that already signaled the economy was shrinking. The National Bureau of Economic Research, the Cambridge, Massachusetts-based arbiter of economic cycles, defines a recession as a ``significant'' decrease in activity over a sustained period of time. The declines would be visible in GDP, payrolls, production, sales and incomes.

``We're in a recession,'' Allen Sinai, chief economist at Decision Economics Inc. in New York, said in a Bloomberg Television interview. ``It's going to widen, it's going to deepen.''

The government also said incomes grew less than previously thought, raising the risk that consumer spending will again stumble after getting a temporary boost from the tax rebates last quarter....


Today's GDP Number Will Be Revised Lower - April 28

Why the US Has Really Gone Broke - April 28

Jobs Numbers Revised Back to 2003: Confirm Recession - April 4

The Potemkin Economy Just Fell Over - March 7

SP 500 Tops in Recessions

ISM Numbers As Indicators of Recession - February 6

Are We In A Recession? - February 4

Fed Policy Actions in Anticipation of a Recession - January 7

Recession, Straight Up with a Twist - December 8

Dow Jones Industrial Average Since 1999



Dow Jones Industrial Average Since 1999 Deflated by Gold



Shadow Government Statistics Estimates of Real GDP



Shadow Government Statistics Estimates of Consumer Inflation

Of Government Intervention and Other Questions of Balance

A brief treatise in which Jesse questions the reason for this blog among other things

Most people will read only the subject title of this essay and then immediately begin composing their own off-the-cuff thoughts which they will rush to either email to us or slap on some chatboard or blog somewhere. Or they might even scan it for a daytrade and then discard it. But one or two will read it and think about it, and become links in a chain, and the spirit of knowledge will grow, little by little.

The government is intervening in the various markets. There is little or no question about it, if you allow that actively changing, with intent, the rules, money supply, short term liquidity, interest rates, methods by which key statistics are tallied, spin and other information that might impolitely be called 'propaganda' is manipulating the markets. And it often is.

They admit it. The evidence is there. If you don't know about it you have not been keeping up with current events. So it becomes a question of when, where, and why.

On the other hand, there are those who think every market move is active government intervention. This just is not the case. In the short term markets are more like rugby scrums than chess or even a well-managed game of limit poker, and the bigger players spend a great deal of time putting up bluffs and bullying the smaller player using their better access to information and bigger stacks of chips, especially when government regulation is lax and inefficient, with society ruled by narcissism and greed, as it is today.

The action of the past two days in the US stock markets is a almost classic end-of-month paint job by the fund managers and other-people's-money crowd, who are able to influence the grade on their own reports cards by buying the market and driving certain prices up after selling their losers three days before the end of the month. Their motive is their bonus, and the lax regulation with light penalties, and their general lack of compunction against cheating which they have likely done in school, in sports, in relationships, in most of their lives.

It is very hard to look at a specific market at a specific time and say with certainty "Aha, this is explicit government intervention" as opposed to something else. Governments work through third parties and hide their tracks, except when it suits them to be blatant. Often big third parties are just flush with hot money from the Feds and looking to shove some market for the short term trade.

But they do it, both directly and indirectly. If you are a momentum player it doesn't really matter, and if you are an investor you will see it only in sustained efforts that last some time, and usually involve a multi-faceted approach. We call these 'reflations' and try to point them out as we think they are occurring.

Speculating about when, specific markets on specific days, and the why, their long term motivations, is fun because its like gossip. It also can have some value if it causes us to look at things more deeply and examine the evidence, which may be easily dismissed by the public. Spotting effort to suppress or inflate markets can be exceptionally rewarding, since they often fail and sometimes spectacularly so. And motive is a key companion to opportunity, means, and any other circumstantial evidence.

But more often in questioning long term motivations we are asking a question that cannot be answered objectively except after a very very long time, even if then. Its like arguing about whether or not God exists, or aliens are visiting us, or what is the best beer, or who all shot Kennedy, or which is the greatest football team. Sometimes these discussions are fruitful and scandals are uncovered. They do exist. But often they degenerate into recreational discussion and faux expertise.

What makes it fun is that you can just yell about it endlessly, and believe what you want, because what cannot be proved cannot be disproved.

It is a way to pass the time relatively effortlessly, like griping and bitching at work. It can be a trap because anytime you are wrong you can retreat into the rationale of external forces. How can you be responsible for your actions if 'they' are doing it to you. Sometimes it can be a crutch. But so many things are.

As a general rule an objective person doesn't take credit for being right unless they know why they were right and can explain it. Otherwise they might just have been lucky, and it not only does not add to our knowledge but may reduce it.

If the Fed is indeed making policy errors, then we will take one path versus another. Then one should do one thing versus another. Those things can be examined, can be dissected, can be studied, but they take work and effort, and one can be right or wrong. But they add to a body of knowledge. And often this work is dismissed by those doing the behind the scenes work as recreational gossip. They seek to raise the bar so high that no possible proof can be provided without subpoenas and wiretaps.

Speculation based on evidence is the heart on the scientific method. Yesterday's radical theory scoffed at and discouraged by the established view is tomorrow's generally accepted truth. The difference is free discussion and evidence, above all, strong comprehensible evidence.

The value we get from even pointless disagreements is that it causes us to think and define thoughts which otherwise are all too easily just parked in our minds, and never really given any vigor or life.

Besides the relentless impulse of humanism, this is a major reason for this blog. We used to look for valuable feedback and discussion on the specifics, but that's beyond hope.

Those who are in-the-know are in denial and hiding, trying to line their pockets and curry favor with whomever they think will be in power next.

Those who don't know are running around waving their hands, shouting slogans and hearing only their own voices, or just ignoring it all getting loaded on whatever happens to be handy.

All in all, a nice microcosm. Life imitates high school so often in our experience, and one's best recourse is essere umano, to be human throughout it, and perhaps give the bastards a swift kick just to let them know you're still out there.

In the meanwhile there are important and interesting questions to investigate as best one can. Its not clear yet exactly which way this thing goes, and the variables interact with one another, and are many more than can listed here:

A. Will our government become a better democratic Republic, Fascist, or Socialist, and the related broader question of the Individual vs. the State which tends to modify all the general types.

B. When and how the dollar will be further devalued and how fiat currencies can be sustained without being destroyed by inflation? (By the way in all history none have succeeded}.

C. How will the world's reserve currency evolve? Can a greater centralization of power and control be avoided gracefully? Can freedoms be maintained if it cannot?

D. How deep and protracted will the recession be and will it cross a threshold into a depression through Fed policy errors and how and when will we know it?

E. Will there be a 'moment of clarity' when the failure becomes evident and things move with alarming speed, or will this be a damp fizzling decline into an ignoble whimper.

We will continue to explore all these areas with what we hope is a bias to objective analysis and pertinent data, laced heavily with humour, satire, charts, and pictures.

Little by little, there is progress, and the body of knowledge grows, and life is renewed, and creation is made more orderly, and liberty and the spirit is restored.

The Future of Financials

Here is a video well worth watching.

The Future of Financials - Meredith Whitney

Meredith, in a polite and somewhat understated way, makes some excellent points as an independent analyst, but probably of necessity treads lightly around some serious issues and deeper economic problems.

The real economy must pay a significant 'tax' to support the financial sector as it is now, and an incredibly large tax to restore it to its former excesses. Don't forget this, especially when the government tries to argue that there is no money for human services, and health, and basic infrastructure.

It is a matter of our priorities. We can choose to pay that tax, and let our children pay it, or we can try to restrain the banks again and bring the economy back into balance. A healthy economy requires a finacial sector that functions as a capital accumulation and allocation system with price discovery in an open, honest and transparent system of transactions, with the minimum 'friction' of overhead and corruption.

We will have no sustained recovery overall until we move much further towards a balanced system as set forth in our Constitution, and establish rational, peaceful, and equitable policies for our nation.

So we must roll up our sleeves, let go of our fears, gather ourselves together, and move forward.

Just How Accurate is the ADP Payroll Report?

Not as accurate as we had thought it appears. Most assume that the monthly ADP employment report is based on actual data from the business sector on jobs additions, merely excluding the government sector, but a good "hard data" source indicative of the Non-Farm Payrolls Report.

We have this piece of information in an email from a capital asset fund manager:

"I just called an economist at MacroEconomic Advisors, the local St. Louis firm that compiles the monthly ADP (private) employment data which was reported today for the month of July. Please keep in mind that this firm has ties to former St. Louis Fed Governor Laurence Meyer. The statistic was a "shocking" +9000 JOB GAIN!!! This promptly pushed the equity futures market (and U.S. dollar) sharply higher at 8:15EDT. The DJIA after a half hour of trading is up 122 pts.

Now, are you sitting down? A component of this very suspicious report showed that Financial firms INCREASED employment by +4000 jobs. I promptly told this "economist" that there was no way in God's Green Earth that banks, brokerages, mortgage companies, and any other financial institutions had increased employment by 4000 jobs in July. He candidly told me that the firm had probably overestimated that sector for many months. Upon hearing that, I asked him why they don't change their methodology in compiling their data? He indicated that they were doing that but that it was a "monumental task!"

So, we have a sharp rally this morning in the equity market and U.S. dollar, based on data that even the reporting firm questions. I think we've seen it all!"

No we haven't seen it all yet. But we're on our way.

ADP Payroll Report or not, this stocks rally is frivolous.

The market was predisposed to rally however, otherwise it would not have. It was looking for an excuse, since the fund managers must have their fatter bonuses, and hot money must be consumed by mispriced beta.

To give the rally a little credit we'd allow that optimists are grasping at straws looking for a turn, a bottom. Some may be sincere in their hopes, like some of the financial media may be. Who wouldn't?

But we are watching people who are most likely about to lose real money, with real consequences, based on a system with too little in the way of transparency and integrity.

Until the banks are restrained and the proper regulation is restored there can be no recovery, no restoration of a sound economy based on sustainable values. We have no objective price discovery mechanism to determine the wheat from the chaff, the flawed from the viable, the foundation from the sand.

The Difference Between a Panic and a Crash

The definitions of terms in financial markets are evolving, to say the least.

The difference between a panic and a crash in the financial markets is an interesting study, and not particularly well defined. Here is our most recent effort.

As a rule of thumb, a correction is a decline in prices of less than 20 per cent. After the declines exceed 20 per cent for at least a two weekly prints on the charts we seem to be in the realm of the panic or a crash.

A panic might best be defined as a sharp decline in prices over a short period of time, usually less than a year, as assumptions and valuations are cast in doubt and corrected, often severly. A panic comes and goes, distorting perhaps the progress of the markets, adding certain safeguards to the regulatory process, but having otherwise relatively small lasting effects to the national economy.

A crash is a watershed event, generational in its scope, always accompanied by an economic slump of greater than a year, often called a depression rather than a recession. Its effects are measured in years. It is a furnace in which the national character is tested and tempered, hammered into something different from what had gone before.

From The Great Crash of 1929 by John Kenneth Galbraith:

"A common feature of all these earlier troubles [panics such as 1907 and 1914] was that having happened they were over. The worst was reasonably recognizable as such.

The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning.

Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune. The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost.

The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. (Not only were a recorded 12,894,650 shares sold on 24 October; precisely the same number were bought.) The bargains then suffered a ruinous fall.

Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or a fourth of the purchase price in the next twenty-four months.

The Coolidge bull market was a remarkable phenomenon. The ruthlessness of its liquidation was, in its own way, equally remarkable."

If the Great Depression had never happened, would the Great Crash of 1929 be remembered as vividly as "the great crash" or as a panic such of that of 1907 and 1987? (Give 1987 a little more historic distance, and it will be just a blip in the generational memory, if it is not one already).

The economic progressive believe that the Great Depression was a policy error by the new Central Bank, and are quite confident that it can never happen again, as we are now smarter and better. With the ascendancy of pure fiat currency and sophisticated financial engineering, are all Crashes extinct, merely the dinosaurs of an age of monetary barbarism?

Are financial markets now a science, freed of the emotions and bondage of human nature? Are we now Icarus, released from the bonds of the earth? There are those who believe that this is the case, and their wills and knowledge are being tested as we speak, if only the public can be kept malleable and docile and deluded enough to allow them time and latitude to work their financial alchemy. What if the Fed makes a different sort of policy error this time? Oops?

"There is no worse mistake in public leadership than to hold out false hopes soon to be swept away. The British people can face peril or misfortune with fortitude and buoyancy, but they bitterly resent being deceived or finding that those responsible for their affairs are themselves dwelling in a fool's paradise." Winston Churchill

Plus ça change, plus c'est la même chose

Fed Adds 84 Day TAF Loan and Extends Emergency Status until 30 January 2009

While the good times are rolling in the equity markets and the insiders are racking up those end of month bonuses, the Fed is quietly breaking out the emergency equipment and getting ready for more bail outs.

If there is nothing else we learn from this, it is that the banks must be restrained from speculation and regulated by incorruptible rules, for the good of the country.

Unless we put strong reforms in place we have done nothing to correct our problem.

Fed to Conduct Liquidity Operations Through January 2009, Introduces 84-Day TAF
07/30/08 08:58 am (EST)
By Erik Kevin Franco

(CEP News) - In addition to the $75 billion 28-day Term Auction Facility (TAF), the Fed will also be conducting a $25 billion 84-day TAF to address the ongoing "fragility" of the financial system.

The Fed also said it would be extending its extraordinary lending to late January 2009.

"In light of continued fragile circumstances in financial markets, the Board has extended the PDCF through January 30, 2009, and the Board and the Federal Open Market Committee (FOMC) have extended the TSLF through that same date," according to a statement from the Fed on Wednesday. "These facilities would be withdrawn should the Board determine that conditions in financial markets are no longer unusual and exigent."

Starting Aug. 11, the Fed will conduct bi-weekly TAF auctions alternating between 28-day and 84-day loans. The Fed currently holds a 28-day TAF every two weeks.

Dealers will also be allowed to access up to $50 billion in treasuries at the Term Securities Lending Facility (TSLF).

The Fed also announced that it was stepping up its international co-operation with the European Central Bank and Swiss National Bank. It will increase its swap line with the ECB to $55 billion from $50 billion while the SNB's line remains at $12 billion.

Both central banks will follow the Fed's TAF auction and offer U.S. dollar loans on their end.

The ECB said the move "is intended to continue the provision of USD liquidity for as long as the Governing Council considers it to be needed in view of the prevailing market conditions."

Corporate Bond Market Says A Tsunami of Debt Default is Coming

Wall Street is throwing an equity party and painting the tape for the end of month bonus calculations.

But the corporate bond markets are signalling serious economic trouble dead ahead, NOT behind us.

Brace for disillusion.


Crumbling bond market sounds distress alarm
Tue Jul 29, 2008 7:25am EDT
By Walden Siew and Dena Aubin

NEW YORK (Reuters) - Corporate bond investors are bracing for growing defaults and record company bankruptcies starting in 2009 as the volume of distressed debt climbs past $184 billion, an all-time high.

More corporate debt is now trading at distressed levels than in 2002, when there was $165 billion of distressed corporate debt following the last bankruptcy boom, according to Moody's Investors Service data.

Nearly one in three junk bonds trade at levels known as "distressed," suggesting a serious risk of default. Even higher-rated corporate bonds have sunk to distressed levels in near-record volumes.

Automakers General Motors Corp and Ford Motor Co lost their investment grade status in 2005 and their bonds have since plummeted to distressed credit levels.

Now bonds of financial firms such as CIT Group Inc, National City Corp, and bond insurers like MBIA Inc are trading as though investors expect them to follow that ignominious path.

"It's the fast deterioration of some of the higher-rated credits that is most alarming," said Jason Brady, a managing director at Thornburg Investment Management. "From a dollar standpoint, we're going to see a record wave of defaults and bankruptcies."

Spokespersons at CIT and National City didn't immediately return phone calls seeking comment about how their debt is trading. MBIA's spokeswoman cited the company's policy of not commenting on its bond market performance.

The total amount of high-yield debt trading at distressed levels is now $147 billion, while investment-grade distressed debt is about $37 billion, according to Moody's credit strategy group.

"The market is pricing in pretty ugly bankruptcy scenarios," said Brady from his Santa Fe, New Mexico, office, where the firm oversees $4 billion in fixed-income assets. "The dramatic bank deterioration is coinciding with the overall level of distress."

A slumping economy, high oil prices and tighter credit conditions are putting a greater squeeze on corporations and impacting their ability to manage and pay off their debt.

Credit crisis fears, especially in the financial sector, have pushed yields on several companies into distressed territory recently, though rating agencies still assign them low default risk.

High-grade companies trading at distressed levels in recent days include Washington Mutual Inc, CIT and Ambac Financial Group, according to MarketAxess.

Ambac's spokeswoman declined to comment, while Washington Mutual didn't immediately return a call.

In all, about 7.5 percent of high-yield and investment-grade debt combined is distressed, the same level seen during the credit downturn of 2000 to 2002, when bankruptcies soared, according to data from research firm Leverage World.

Public company bankruptcy filings climbed to 179 in 2000 and rose to a record 263 in 2001, according to bankruptcy court records.

"Investment-grade bond distress is a new feature of this cycle," according to analyst Christopher Garman, adding, "The largest corporate bankruptcies on record often follow this level of distress."

Some 27.2 percent of high-yield bonds by par value are distressed, or trade at yields of at least 1,000 basis points more than U.S. Treasuries, Garman wrote for Leverage World in a report titled "MegaDefault."

The 7.5 percent distress level points to nearly $97 billion of defaults through 2009, said Garman, a former head of high-yield strategy at Merrill Lynch.

For investment-grade bonds, the distressed level has climbed to 1.8 percent, shy of an all-time high of 2.4 percent. If all the high-grade distressed debt were downgraded, it would increase the volume of high-yield debt by 6 percent.

Both Standard & Poor's and Moody's Investors Service have noticed a sharp increase in junk bonds and credit default swap contracts trading at distressed levels as well.

The overall number of U.S. high-yield bonds trading at distressed levels has soared to about 27 percent, versus 17 percent in April and just 2 percent last year, according to Moody's research group.

More than 20 junk-rated borrowers have credit default swaps trading wider than 1,000 basis points, which implies a 58 percent chance of default over the next five years, according to Credit Derivatives Research.

Much of the distressed debt is in the auto sector, but high-yield opportunities may be growing in the financial sector, said Joe Robison, director of credit research at Allegiant Asset Management.

"As autos go, so does the high-yield market these days," Robison said. "Our area of emphasis is watching the financial companies. We're definitely going to see some financial names go from investment-grade to junk over the next years, and that's where we see opportunities."

There is No Doubt the US is in a Recession - SP 500 Operating Earnings

With the end of month rally in stocks, to provide fatter bonuses for fund managers, the happy-talk is flowing hot and heavy on the financial networks and the internet chatboards.

However, based on the facts there should be little doubt that the US is in an economic recession.

The only question is 'depth and duration?'

Expect the next phase to be the 'bottom-callers' predicting that stocks are starting to rally in expectation that the economy will recover in January 2009, roughly about six months out.

US Lawmakers Pressure FASB to Slow Down Disclosure Reforms

Yet another good reason to sweep the Congress clean in the fall elections.

FASB may delay off-balance sheet accounting change
By Emily Chasan

NEW YORK, July 28 (Reuters) - The Financial Accounting Standards Board, under pressure from lawmakers, will reconsider its timeline for a controversial rule change that may force banks to bring trillions of dollars in off-balance sheet assets onto their books at its Wednesday meeting.

FASB, which sets U.S. accounting rules, will reconsider the rule's effective date and transition provisions, according to a schedule posted on its website.

"Additionally, the Board will consider transitional disclosures and the timing of both projects," FASB said on its website.

FASB voted in April to revamp two accounting standards known as FAS 140 and FIN 46R, to eliminate a concept known as the "qualifying special-purpose entity," or QSPE, that banks use to keep assets like mortgage-backed securities and special investment vehicles off their balance sheets.

The board is expected to release its proposal by the end of August and leave it open for public comment for 60 days. It has suggested parts of the new rule could be applied as soon as next year for companies with fiscal years beginning after Nov. 15.

Troubles in those off-balance sheet assets have been blamed for helping trigger the credit crisis. FASB members have said they believe the current rules prevented investors from understanding the true risks banks faced. Analysts have estimated the rule change could force banks to bring $5 trillion in assets onto their books.

But concerns about the rule's effect on the capital requirements at financial institutions have triggered a firestorm on Wall Street and been partially blamed for the sharp decline in shares of mortgage lenders Fannie Mae and Freddie Mac over the past month.

Some have urged FASB to slow down the rule.

"Changes to securitization accounting could have a dramatic impact on the economy, the capital markets and consumers seeking credit," Republican Rep. Spencer Bachus of Alabama said in a letter to the chairmen of FASB and the U.S. Securities and Exchange Commission last week.

Industry groups such as the American Securitization Forum and the Securities Industry and Financial Markets Association have also written FASB to say "the risks of too much haste are high."

FASB spokesman Neal McGarity has said that other regulators, not FASB, are responsible for setting capital ratios for financial institutions. He was not immediately available for comment on the board's plans. (Editing by Leslie Gevirtz)

Traders Walking Like Egyptians Down "De Nile" on the Merrill Writedowns

First, and we cannot say this often enough, in light volume markets the short term action is more like a rugby scrum than a game of chess.

The funds are trying to 'paint the tape' into the end of month, and perhaps squeeze a few shorts along the way. Why? Because its fees and bonuses that drive Wall Street, the customers be damned, and don't ever forget it.

We are also in a period in which the cynicism and short term focus of professional traders is near all time highs thanks in large part to our government and regulatory environment. (See dollar chart below) This is the classic setup for a conflagration.

But in the short term, the market is what it is.

What Merrill shows is that the estimates of losses in the financials are substantially low, placing companies like Citigroup and Lehman and the other investment banks on the cliff edge of insolvency. Technical insolvency doesn't count, they are still a game until someone calls their hand, and Benny is trying to slip them a couple cards and some cash to help keep the game going.

Citigroup Markdowns May Rise $8 Billion, Analyst Says
By Adam Haigh

July 29 (Bloomberg) -- Citigroup Inc. will probably write down the value of collateralized debt obligations by $8 billion in the third quarter, Deutsche Bank AG analyst Mike Mayo said, after Merrill Lynch & Co. said it will sell the firm's CDO holdings for 22 cents on the dollar.

Citigroup values the securities, mortgage-related bonds at the heart of the credit crisis, at 53 cents, Mayo wrote in a report to clients today. Citigroup has $22.5 billion of CDOs and it may have another $7 billion in writedowns to come, Mayo said. That could force it to raise more money, as Merrill did today, he said.

''The decision about raising new capital may be closer than we previously thought,'' Mayo said in the report. He also expects the bank to write down an additional $1 billion because of its $2 billion in exposure to so-called monoline insurance companies.

The additional writedowns at Citigroup mean the bank probably will report a third-quarter loss of 59 cents a share and a full-year loss of 80 cents, said Mayo, who has a ''hold'' rating on the stock. He previously estimated the New York-based bank, the biggest in the U.S. by assets, would report a loss of 66 cents in 2008.

Citigroup fell 28 cents, or 1.6 percent, to $17.15 at 10:27 a.m. in New York Stock Exchange composite trading. They dropped 41 percent this year before today.

'Good News'

Merrill is taking a $4.4 billion loss on the sale of $11 billion of CDOs.

''The good news is that that the actual sales can give confidence that Merrill is finally selling assets rather than merely marking them to market,'' Mayo said. (Mayo is no Meredith by a long shot. Check out his revision just below on Merrill's full year losses. - Jesse)

Mayo estimates that Merrill, the third-largest U.S. securities firm, will report a full-year loss of $10.95 a share, compared with his earlier prediction of a $5.80 loss. Oppenheimer & Co. analyst Meredith Whitney estimates the company will report a loss of $10.50 in 2008.

UBS AG analyst Glenn Schorr estimates Merrill will report a full-year loss of $11.36 a share because of ''significant dilution'' from the plan to raise capital by selling about $8.5 billion of stock. Schorr has a ''neutral'' rating on Merrill.

''While we don't think Merrill's announcement necessarily implies a 40 percent writedown ($7.2 billion) for Citi, directionally we think investors should expect further incremental writedowns in coming quarters,'' Schorr wrote in a report to clients today.

Lehman Brothers Holdings Inc., the fourth-biggest U.S. securities firm, may have to sell ''significant assets'' to guard against further losses from its $65 billion of mortgage and real estate holdings, Schorr said.

Merrill Sells $30.6 Billion of "Super Senior" ABS Debt for 22 cents on the dollar and Provides the Financing for 75% of the Purchase Price

Until not too long ago this $30.6 B worth of super senior toxic crap was valued at over $11 B and is now in what can only be called a 'get us the hell out' distress sale with a government entity wealth fund. Said entity is also participating in a share offering, several billions of which is also coming from Merrill in penalties from prior offerings with resets based on share performance. Yikes!

As the IMF said today, this credit crisis is just not over yet at all, thereby taking down the US equities market and in particular the financial sector. Our cynical view is that there was knowledge of the coming Merrill announcement during the day in select trading circles as well.

There is no predicting how the Wall Street wiseguys will try to wrap this tomorrow. Is this finally the 'kitchen sink' mother of all writedowns for Merrill? Is this a sign of the bottom? We tend to think this shows what a farce the writedowns have been to date, and what accounting legerdemain underlies the valuations of several US financial companies. This does not bode well for a few of Merrill's Wall Street cousins. There may not be an indedependent investment bank standing by the time this is over, and north of fifty percent fewer hedge funds.

We are not sure about that. But we are reasonably confident that the credit crisis is going to come on with the relentless force and fury of a pyroclastic flow [1] and ignite a new bonfire of the vanities.

Get out of its way. Minimize your exposure to the financial system at your earliest convenience and seek the highest financial ground. The strategy now is the protection of wealth, the conservation of capital.

[1] A pyroclastic flow is a common and devastating result of some volcanic eruptions. The flows are fast-moving currents of hot gas and rock which travel away from the volcano at speeds generally greater than 80 km/h (50mph). The gas can reach temperatures of about 1,000 degrees Celsius (1,800 F). The flows normally hug the ground and travel downhill, destroying everything that they overtake.

Merrill to take $5.7 billion mortgage asset write-down
Mon Jul 28, 2008 6:31pm EDT
By Christian Plumb and Jeffrey Benkoe

NEW YORK (Reuters) - Merrill Lynch & Co Inc said it expects to take a $5.7 billion pretax write-down in the third quarter due to losses on the sale of mortgage assets and plans to raise at least $8.5 billion by selling new common shares.

Merrill said Singapore's Temasek Holdings Pte Ltd TEM.UL would buy $3.4 billion of the offering. Merrill has already taken billions of dollars in write-downs in past quarters and said it sold key holdings including a 20 percent stake in Bloomberg when it announced second-quarter earnings.

Merrill said on Monday it would pay $2.5 billion as required under a previous stock sale to state-run Temasek, along with $2.4 billion in required dividends to preferred shareholders. In previous deals to raise capital, Merrill had agreed that if it sold shares at too low a price in the future, it would reimburse investors.

The No. 3 Wall Street investment bank's shares were down 5 percent in after-hours trading after retreating 12 percent to $24.33 in the main trading session on the New York Stock Exchange.

Merrill also said it agreed to sell collateralized debt obligations with a face value of $30.6 billion for $6.7 billion to an affiliate of private equity fund Lone Star. (These are U.S. "super senior ABS collateralized-debt obligations" that are being sold for a little less than 22 cents on the dollar - Jesse)

Merrill Lynch Announces Substantial Sale of U.S. ABS CDOs, Exposure Reduction of $11.1 Billion
Monday July 28, 5:25 pm ET
Merrill Lynch Announces Initiatives to Further Enhance Capital Position
Original release from Merrill with Two Pro Forma Attachments

NEW YORK--(BUSINESS WIRE)--Merrill Lynch today announced a series of actions to significantly reduce the company’s risk exposures and further strengthen its capital position. These actions include:

-Announced substantial sale of U.S. super senior ABS CDO securities, resulting in an exposure reduction of $11.1 billion from June 27, 2008 (ABS CDOs are defined as collateralized debt obligations comprised of asset-backed securities).

-Agreement to terminate ABS CDO hedges with monoline guarantor XL Capital Assurance Inc. (“XL”) and settlement negotiations with other monoline counterparties

-Plans to issue new common shares with gross proceeds of approximately $8.5 billion through a public offering launched today (excluding a fifteen percent, or approximately $1.3 billion, option granted to the underwriter to purchase additional shares of common stock to cover over-allotments)

-Agreement that Temasek Holdings will purchase $3.4 billion of common stock in the public offering, a portion of which is subject to receipt of regulatory approvals

-Exchange of all of the outstanding mandatory convertible preferred securities for common stock or new preferred securities, which eliminates the reset features in the original securities

-Purchase of approximately 750 thousand shares of common stock in the public offering by executive management

“The sale of the substantial majority of our CDO positions represents a significant milestone in our risk reduction efforts,” said John A. Thain, Chairman and CEO of Merrill Lynch. “Our consistent focus has been to opportunistically reduce risk, and in order to take advantage of this sizeable sale on an accelerated basis, we have decided to further enhance our capital position by issuing common stock. The actions we announced both today and on July 17 will materially enhance the company’s capital position and financial flexibility going forward.”

As a result of the transactions announced today, the company expects to record a pre-tax write-down in the third quarter of 2008 of approximately $5.7 billion. This write-down is comprised of a $4.4 billion loss associated with the sale of CDOs, a $0.5 billion net loss on the termination of hedges with XL Capital Assurance and an approximately $0.8 billion maximum loss related to the potential settlement of other CDO hedges with certain monoline counterparties. In the third quarter, Merrill Lynch also expects to record an expense of $2.5 billion related to its reset payment to Temasek and $2.4 billion of additional dividends as a result of the exchange of certain existing mandatory convertible preferred stock for common stock as described under “Common Stock Offerings and Early Conversion of Mandatory Convertible Preferred.”

Pro forma for the transactions announced today, the sale of our interest in Bloomberg L.P. and the expected FDS transaction, Merrill Lynch’s Tier 1 capital ratio, total capital ratio and adjusted “if-converted” book value per share as of June 27, 2008 would have been 10.5%, 16.6% and $22.21. These figures do not include the impact of any exercise of the approximately $1.3 billion over-allotment option.

CDO Sale:

On July 28, 2008, Merrill Lynch agreed to sell $30.6 billion gross notional amount of U.S. super senior ABS CDOs to an affiliate of Lone Star Funds for a purchase price of $6.7 billion. At the end of the second quarter of 2008, these CDOs were carried at $11.1 billion, and in connection with this sale Merrill Lynch will record a write-down of $4.4 billion pre-tax in the third quarter of 2008.

On a pro forma basis, this sale will reduce Merrill Lynch’s aggregate U.S. super senior ABS CDO long exposures from $19.9 billion at June 27, 2008, to $8.8 billion, the majority of which comprises older vintage collateral – 2005 and earlier. The pro forma $8.8 billion super senior long exposure is hedged with an aggregate of $7.2 billion of short exposure, of which $6.0 billion are with highly-rated non-monoline counterparties, of which virtually all have strong collateral servicing agreements, and $1.1 billion are with MBIA. The remaining net exposure will be $1.6 billion. The sale will reduce Merrill Lynch’s risk-weighted assets by approximately $29 billion.

Merrill Lynch will provide financing to the purchaser for approximately 75% of the purchase price. The recourse on this loan will be limited to the assets of the purchaser. The purchaser will not own any assets other than those sold pursuant to this transaction. The transaction is expected to close within 60 days.

Termination of Monoline Hedges:

In addition to the CDO sale referenced above, Merrill Lynch also agreed to terminate all of its CDO-related hedges with XL and is in the process of negotiating settlements on certain contracts with other monoline counterparties. These short positions were the hedges on long CDO positions that are part of the announced sale.

Merrill Lynch executed an agreement to terminate all of its CDO-related hedges with XL. The transaction is expected to close in early August 2008. When the transaction closes, all of Merrill Lynch’s CDO-related hedges with XL will be terminated in exchange for an upfront cash payment to Merrill Lynch of $500 million. These hedges had a carrying value of approximately $1.0 billion at June 27, 2008. As a result of this transaction, Merrill Lynch will record a pre-tax loss of $528 million during the third quarter of 2008.

Merrill Lynch is also in the process of negotiating settlements on certain contracts relating to CDO hedges with MBIA and other lower-rated monolines. If Merrill Lynch were to receive no payments in connection with the settlement of these hedges, the maximum loss Merrill Lynch expects to record would be their current carrying value, $0.8 billion.

The hedges described above had a net notional value of $8.4 billion. To reflect the XL termination and the other potential settlements with other monolines, Merrill Lynch will reduce its U.S. super senior ABS CDO short exposures, or hedges, from $15.6 billion at June 27, 2008, to $7.2 billion on a pro forma basis.

Common Stock Offering and Early Conversion of Mandatory Convertible Preferred:

Merrill Lynch plans to raise $8.5 billion through the public offering of common stock announced today (excluding a fifteen percent, or approximately $1.3 billion option granted to the underwriter to purchase additional shares of common stock to cover over-allotments). Temasek Holdings, Merrill Lynch’s largest shareholder, has committed to purchase $3.4 billion of common stock in the offering, a portion of which is subject to regulatory approvals that are expected to be obtained after the closing of the offering. In addition, Merrill Lynch’s executive management team intends to purchase approximately 750 thousand shares of common stock in the offering.

In satisfaction of Merrill Lynch’s obligations under the reset provisions contained in the investment agreement with Temasek Holdings, Merrill Lynch has agreed to pay Temasek $2.5 billion, 100% of which Temasek has contractually agreed to invest in the offering at the public offering price without any future reset protection.(This reminds one of a company going to the vulture capitalists for last gasp financing. They are rolling penalties Merrill owes them from prior fundraising into this latest tranche. - Jesse)

In addition, $5.4 billion of the $6.6 billion of outstanding mandatory convertible preferred holders have agreed to exchange their outstanding preferred stock for approximately 195 million shares of common stock, plus accrued dividends payable in cash or stock at the option of the holder. A holder of $1.2 billion of outstanding mandatory convertible preferred has agreed to exchange their securities for new mandatory convertible preferred securities with a reference price of $33.00. The reset feature for all securities exchanged has been eliminated.

Toyota Suffers First Sales Declines in Seven Years

Toyota sees first output fall in 7 years, cuts '08 forecast
29 Jul, 2008, 0141 hrs IST,
The Economic Times

TOKYO: (Reuters) Toyota Motor on Monday cut its 2008 groupwide global sales forecast by 3,50,000 units to 9.5 million vehicles due to a pronounced downturn in the US market, in a rare setback for the world’s biggest automaker. The weaker sales outlook also means global production at the parent company would fall 1% from 2007 to 8.43 million vehicles, marking the first decline in seven years.

Toyota’s revision underscores an ever-toughening environment for global automakers faced with falling demand for cars, especially higher-margin, bigger vehicles amid rising gasoline pump prices. Profits are already under severe pressure as prices of steel and other raw materials continue to climb, while tightening environmental regulations raise the cost of research and development.

Analysts said the sales revision was expected after a weak performance in the year to date, particularly in the US, but one raised concerns about a possible profit warning when Toyota announces its April-June results on August 7.

“Toyota typically doesn’t alter its forecasts at the first quarter, but after a revision of this scope there’s always an off chance that they’ll lower their earnings outlook,” said Credit Suisse auto analyst Koji Endo.

Hit by a demand meltdown for pickup trucks and large sport utility vehicles in the United States, Toyota cut its parent-only sales forecast there to 2.44 million vehicles from the 2.64 million it announced in December. The new projection would represent a 7% fall from 2007. — Reuters

Toyota’s initial global sales plan called for sales at the group, which includes truck unit Hino Motors and minivehicle maker Daihatsu Motor, to grow 5% to 9.85 million vehicles this year. Overall sales forecasts did not change at Hino and fell only 10,000 units at Daihatsu. Toyota was responsible for the rest of the undershoot. Global sales are now expected to rise just 1%, likely keeping Toyota ahead of General Motors as the world’s biggest carmaker.

Industrywide US vehicle demand has taken a sharp turn for the worse in the second quarter of this year, prompting many automakers and forecasters to revise their 2008 sales outlook by around 1 million vehicles compared with even some of the more sober views at the beginning of the year....

US Stock Markets are in Important Support Areas Ahead of the End of July and the Jobs Report

We are heading into the end of July, and with settlements today was the last day for the funds to trade in this month.

We are on important support, and the stock bulls must rally tomorrow or risk some serious slipping all the way into the end of summer.

Volumes continue to be lackluster, but fear of financials are curbing the animal spirits. The big Jobs Report is coming out at the end of the week, so we may see a few more rally attempts until then and one might stick. But if they do not, the market can turn ugly, quickly.

Keep an eye on the financials. The market cannot sustain a rally without them. The low volume may be the bull's best friend, vis a vis a short squeeze attempt. But if serious selling starts, look out below.

Russian Central Bank Slashes Its Exposure to Fannie and Freddie

The opening move in The Prisoner's Dilemma tends to be the winning move.

Russia cuts exposure to US mortgage lenders
Mon Jul 28, 2008 9:19am EDT
Reuters

MOSCOW, July 28 (Reuters) - Russia has approximately halved to less than $50 billion its exposure to U.S. mortgage lenders Fannie Mae and Freddie Mac a senior central bank official told Reuters on Monday.

"It's now less than $50 billion," central bank first deputy chairman Alexei Ulyukayev said, when asked about Russia's investments in the agencies.

Russia held about $100 billion at the start of 2008.

Reporting by Yelena Fabrichnaya, writing by Robin Paxton

IMF Sees No End to the Credit Crisis - the possibility of hyperinflation

The outsized financial sector in the US has been slowly strangling the real economy for the past twenty years. The most telling symptom of this has been the stagnancy in the growth of median real wages, and the growing inequality in income and wealth distribution. This is not the hallmark of a healthy, growing economy.

As an aside, globalization is a policy that favors the large financial interests in the US as the primary wielders of the global reserve currency. If there is a price to pay for this by a large segment of the domestic population, then so be it. We will speak more about this some future day.

There will be no sustained, legitimate recovery in the US economy until this imbalance is corrected. If this is true all the Fed's and Treasury's efforts to support the status quo of the current financial sector are not only going to be futile, but are exactly the wrong thing to do. They are painting over rot.

Short of serious reform or an exogenous stimulus shock to demand (such as war or natural disasters) we see a deepening stagflation. But with the bailout of Freddie and Fannie and the blank check handed to the Treasury by the Congress we are now seeing the glimmers of a more serious inflation, and a potential hyperinflation in the dollar.

The conventional wisdom of the street is that hyperinflation is not possible, because there will be no one to "borrow the funds into existence." Technically a hyperinflation implies the destruction and reissuance under duress of the currency, as opposed to a devaluation by even some large number, such as fifty or even sixty to seventy percent. We do expect the dollar's fall to be about that, considering its downfall started when the DX was 120. (The DX index by the way is far from an optimal index with which to gauge the true downfall of the dollar from here).

There are no rules or magic formula per se in the creation of fiat currency. No one HAS to borrow anything. The Treasury and Fed are the printing machine. The rules regarding the creation of fiat are part of the illusion of substance that surrounds a currency that is backed by nothing.

Yes there are some niceties about the Fed not buying the Treasury debt directly, but these are not hard wired, and are likely to fall rather quickly when circumstances dictate. When you see this happen, you will know that the US is on the path to a hyperinflation.

People like to create these rules in their own minds because otherwise the current financial system would appear to be insane. Who was there to 'borrow' the money into existence in the Weimar Republic? There was no need for borrowing because the Republic owed a substantial debt in real assets to exogenous forces (the Allies). Does this sound familiar? Does the US owe significant debt IOUs in the form of Treasuries to foreign holders?

We still view hyperinflation and deflation as outliers to the strongest probability of a stagflationary recession that is likely to be deep and protracted.

But the possibilities of other outcomes are there, and it is important to know what to look for as the situation develops.

IMF sees no end in sight to credit crisis
By Krishna Guha in Washington
July 28 2008 15:45
The Financial Times

Global financial markets are “fragile” and indicators of systemic risk remain “elevated” almost a year into the credit crisis, the International Monetary Fund said on Monday.

The fund warned credit growth in the US could fall further as a result of ongoing financial system stress and warned that emerging markets would be tested as global financing conditions tighten and policymakers grapple with rising inflation.

The IMF also noted that house prices had softened in a number of European economies including the UK, raising the possibility of further problems in those markets.

The assessment came in the July update to the Global Financial Stability Report, led by former Bank of Spain governor Jaime Caruana.

The IMF said that while likely losses on US subprime mortgages have “largely been acknowledged” in the form of writedowns, financial institutions faced a second wave of losses on other loans.

Credit quality “across many loan classes has begun to deteriorate with declining house prices and slowing economic growth.”

The Fund said bank balance sheets were under “renewed stress” and that the decline in bank share prices had made it more difficult for them to raise new capital.

This “increased the likelihood of a negative interaction between banking system adjustment and the real economy.”

With mounting inflationary pressure, the Fund added: “Policy trade-offs between inflation, growth and financial stability are becoming increasingly important.”

The IMF reaffirmed its controversial earlier estimate that total losses in this cycle could total $945bn – a number that combines mark-to-market losses on subprime-related securities and estimates of likely losses on loans. (Its probably light by about a half a trillion or more - Jesse)

Relative to April, when the Fund published its last GFSR, it said “systemic strains in funding markets continue” and the “low level of risk appetite remains unchanged.”

Interbank lending rates “remain elevated” while “long term funding costs have risen” for financial institutions.

The IMF said financial institutions globally have written off about $400bn since the crisis began last August, and that while they had raised substantial amounts of capital, the losses “exceeded capital raised.”

Banks also faced problems maintaining their earnings, weakening stock prices, and making it more difficult to raise further capital.

The Fund said that policy interventions – mostly by the US Treasury and the Federal Reserve – had so far succeeded in containing systemic risk.

But it said the “nature of resolution strategies and the extent of support have come into sharper focus” in recent months – a polite way of saying that the authorities in the US in particular have had to intervene further to preserve financial stability.

It in effect endorsed the need for the US to shore up Fannie Mae and Freddie Mac in the short term – saying their failure would have systemic consequences – but said “the policy challenge now is to find a clear and permanent solution” for the troubled government-sponsored mortgage groups.

The US Treasury has tried to deal with the immediate threat to Fannie and Freddie, while postponing discussion of their long term futures to a later date.

Charts in the Babson Style for the Week Ending 25 July 2008

US Dollar Weekly Chart with Commitments of Traders as of 22 July 2008

US Dollar Weekly Chart with Moving Averages

Stiglitz on Fannie and Freddie, Free Lunches and Moral Hazard

Fannie’s and Freddie’s free lunch
By Joseph Stiglitz
July 24 2008 18:25
The Financial Times

Much has been made in recent years of private/public partnerships. The US government is about to embark on another example of such a partnership, in which the private sector takes the profits and the public sector bears the risk. The proposed bail-out of Fannie Mae and Freddie Mac entails the socialisation of risk – with all the long-term adverse implications for moral hazard – from an administration supposedly committed to free-market principles.

Defenders of the bail-out argue that these institutions are too big to be allowed to fail. If that is the case, the government had a responsibility to regulate them so that they would not fail. No insurance company would provide fire insurance without demanding adequate sprinklers; none would leave it to “self-regulation”. But that is what we have done with the financial system.

Even if they are too big to fail, they are not too big to be reorganised. In effect, the administration is indeed proposing a form of financial reorganisation, but one that does not meet the basic tenets of what should constitute such a publicly sponsored scheme.

First, it should be fully transparent, with taxpayers knowing the risks they have assumed and how much has been given to the shareholders and bondholders being bailed out.

Second, there should be full accountability. Those who are responsible for the mistakes – management, shareholders and bondholders – should all bear the consequences. Taxpayers should not be asked to pony up a penny while shareholders are being protected.

Finally, taxpayers should be com­pensated for the risks they face. The greater the risks, the greater the compensation.

All of these principles were violated in the Bear Stearns bail-out. Shareholders walked away with more than $1bn (€635m, £500m), while taxpayers still do not know the size of the risks they bear. From what can be seen, taxpayers are not receiving a cent for all this risk-bearing. Hidden in the Federal Reserve-collateralised loans to ­JPMorgan that enabled it to take over Bear Stearns were almost surely interest rate and credit options worth billions of dollars. It would have been easy to design a restructuring that was more transparent and protected taxpayers’ interests better, giving some compensation for their risk-bearing.

But the proposed bail-out of Fannie Mae and Freddie Mac makes that of Bear Stearns look like a model of good governance. It sets an example for other countries of what not to do. The same administration that failed to regulate, then seemed enthusiastic about the Bear Stearns bail-out, is now asking the American people to write a blank cheque. They say: “Trust us.” Yes, we can trust the administration – to give the taxpayers another raw deal.

Something has to be done; on that everyone is agreed. We should begin with the core of the problem, the fact that millions of Americans were made loans beyond their ability to pay. We need to help them stay in their homes, including by converting the home mortgage deduction into a cashable tax credit and creating a homeowners’ Chapter 11, an expedited way to restructure their liabilities. This will bring clarity to the capital markets – reducing uncertainty about the size of the hole in Fannie Mae’s and Freddie Mac’s balance sheets.

The government should set a limit to the size of the bail-out, at the same time making it clear that, while it will not allow Fannie Mae and Freddie Mac to fail, neither will it be extending a blank cheque. There may need to be a drastic reorganisation. There should be a charge for the “credit line” (any private firm would do as much) and, given the risk, it should be at a higher than normal rate.

The private sector knows how to protect its interests; the government should do no less. As long as the credit line is extended, no dividends should be paid. To ensure that the government is not simply bailing out creditors who failed in due diligence, at least, say, 25 per cent of any notes, loans or bonds coming due that are not lent again should be set aside in an escrow account, to be paid only after it is established that taxpayers are not at risk. Any government loans should be cumulative preferred debt: the taxpayers get paid before any other creditors receive a dime. To discourage moral hazard the interest rate should be at a penalty rate and, reflecting the rising risk, increase with the amount borrowed. Finally, the government should participate in the upside potential as well as the downside risk: for instance, by taking shares (which it might later sell) or, as it did in the Chrysler bail-out, warrants.

We should not be worried about shareholders losing their investments. In earlier years, they were amply rewarded. The management remuneration packages that they approved were designed to encourage excessive risk-taking. They got what they asked for. Nor should we be worried about creditors losing their money. Their lack of supervision fuelled the housing bubble and we are now all paying the price. We should worry about whether there is a supply of liquidity to the housing market, so that those who wish to buy a home can get a loan. This proposal provides the necessary liquidity.

A basic law of economics holds that there is no such thing as a free lunch. Those in the financial market have had a sumptuous feast and the administration is now asking the taxpayer to pick up a part of the tab. We should simply say No.

The writer, 2001 recipient of the Nobel Prize for economics, is university professor at Columbia University. He is co-author with Linda Bilmes of The Three Trillion ­Dollar War: the True Cost of the Iraq Conflict

Fitch Projects A Further 25% Decline in US Home Prices

Fitch Updates Ratings Model; Projects Steep Housing Price Declines
By: PAUL JACKSON
July 24, 2008
HousingWire.com

Fitch Updates US RMBS Model, Warns on More Downgrades

Fitch Ratings said Thursday that it had enhanced its U.S. residential mortgage loss model, called ResiLogic, a key component of the agency’s overall approach to assessing U.S. RMBS new-issue ratings. While the new-issue market has been essentially dead for all of 2008, Fitch’s revisions suggest that the agency is preparing for where the market might be headed next: seasoned mortgage issuance.

They also suggest a very bearish take on housing prices over the next five years: Fitch said in its report that it is expecting home prices to decline by an average of 25 percent in real terms at the national level over the next five years, starting from the second quarter of 2008. (If we get enough monetary inflation people may keep the illusion of price appreciation. Twenty-five percent inflation over five years is probably a lowball estimate. - Jesse)

And that’s the base case scenario....

For more information, visit http://www.fitchratings.com.

We interrupt regular programming to announce that America has defaulted …

As regular readers know, we have been fans of Satyajit Das for some years now. His knowledge of the derivatives market is outstanding, given his first-hand experience. He is the author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives. We have read it, and are trying to find the time to read it again in the light of what we have learned since it first appeared on the bookshelves.

The scenario he puts forward in this essay is feasible, although we expect the announcement to be less intrusive, more evolutionary, and accompanied by currency controls, selective default plans, and perhaps some geopolitical events. Domestically we will likely see the introduction of digital scrip to be used rather than dollars, as a form of rationing. Barter and black markets will flourish.

It also perhaps helps the reader to understand why the notion of a stronger dollar through debt default is a mistaken application of inappropriate examples at best, and a delusionary fantasy unto personal financial oblivion at worst.

A default on the dollar debt at this point seems inevitable. It is merely a matter of how they wrap and deliver it, and how far and wide the pain is spread.


EuroIntelligence
"We interrupt regular programming to announce that the United States of America has defaulted …"
by Satyajit Das

High levels of debt are sustainable provided the borrower can continue to service and finance it. The US has had no trouble attracting investors to date. Warren Buffett (in his 2006 annual letter to shareholders) noted that the US can fund its budget and trade deficits as it is still a wealthy country with lots of stock, bonds, real estate and companies to sell.

In recent years, the United States has absorbed around 85% of total global capital flows(about US$500 billion each year) from Asia, Europe, Russia and the Middle East. Risk adverse foreign investors preferred high quality debt – US Treasury and AAA rated bonds (including asset-backed securities ("ABS"), including mortgage-backed securities ("MBS")). A significant portion of the money flowing into the US was used to finance government spending and (sometimes speculative) property rather than more productive investments. (Allow us to print the world's reserve currency and we care not who makes the laws - Jesse)

The real reason that the US actually has not experienced a sovereign debt crisis is that it finances itself in it own currency. This means that the US can literally print dollars to service and repay it obligations.

The special status of the US derives, in part, from the fact that the dollar is the world’s major reserve and trade currency. The dollar’s status derives, in part, from the gold standard that once pegged the dollar to the value of gold. The peg and full exchangeability is long gone. The aura of stability and a safe store of value based on the strength of US economy and military power has continued to support the dollar. In 2003, Saddam Hussein, when captured, had US$750,000 with him – all in US$100 bills. The dollar's favoured position in trade and as a reserve currency is based on complex network effects.

Many global currencies are pegged to the dollar. The link is sometimes at an artificially low rate, like the Chinese renminbi, to maintain export competitiveness. This creates an outflow of dollars (via the trade deficit that in turn is driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers are forced to purchase US debt with dollars to mitigate upward pressure on their domestic currency. The recycled dollars flow back to the US to finance the spending. This merry-go-round is the single most significant source of liquidity creation in financial markets. Large, liquid markets in dollars and dollar investments are both a result and facilitator of the process and assist in maintaining the dollar’s status as a reserve currency. (Foreign countries must ironically liberalize their own internal policies to encourage consumption and write down their US dollar holdings significantly to break this cycle and maintain their sovereign freedom from the US financial interests. It will take the "too big to fail" debate to a new level. This is a classic prisoner's dilemma. The first country to do it will find it the easiest in the long term but potentially risky in the short term. - Jesse)

The dominance may be coming to an end. There is increasing discussion of re-denominating trade flows in currencies other than US$. Exporters are beginning to invoice in Euro or Yen. There are proposals to price commodities, such as oil and agricultural goods, in currencies other dollars. Some countries have abandoned or loosened the linkage of their domestic currency to the dollar. Others are considering such a move.

Foreign investors, including central banks, have reduced investment allocations to the dollar. The dollar’s share of reserves has fallen from a high of 72% to around 61%. Foreign investor demand for US Treasury bonds has weakened in recent times. Low nominal (negative real) rates on interest and dollar weakness are key factors.

Foreign investors may not continue to finance the US. At a minimum, the US will at some stage have to pay higher rates to finance its borrowing requirements. Ultimately, the US may be forced to finance itself in foreign currency. This would expose the US to currency risk but most importantly it would not be able to service its debt by printing money. The US, like all borrowers, would become subject to the discipline of creditors.

For the moment, the US$ is hanging on – just. This reflects structural weakness in the Euro and Yen based on deep-seated problems in the respective economies. The artificial nature of the Euro is also problematic. (Gold, perhaps along with silver, is the obvious alternative currency but the banking interests will fight it to the end - Jesse)

The dollar is also a beneficiary of the "too big to fail" syndrome. Foreign investors, especially central banks and sovereign investors in East and South Asia, Russia and the Gulf, have substantial dollar investments that would show catastrophic losses if the US were to default. The International Monetary Fund ("IMF") estimated that Gulf Cooperation Council (Saudi Arabia, the United Arab Emirates, Qatar and other Gulf States) may lose US$400 billion if they decide to stop pegging their currencies to the dollar.

Every lender knows Keynes’ famous observation: "If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours." In history’s largest Ponzi scheme, foreign creditors must keep supporting the US. As the old observation goes: "The only man who sticks closer to you in adversity than a friend is a creditor." (Don't quickly dismiss the scenario that the elites try to present the world with an offer they cannot refuse involving global governance and a New World Order - Jesse)

Does any of this matter? Walter Wriston, then chairman of Citigroup, opined that: "Countries don't go broke". In 1982, shortly after this statement, Mexico, Brazil and Argentina defaulted inflicting near mortal losses on Citibank.

Sovereign debt crisis, especially in emerging markets, are characterised by high levels of debt, especially foreign borrowings, poor fiscal policies, persistent trade deficits, a fragile financial system, over-investment in unproductive assets and a sclerotic political system. Arturo Porzecanski (in Sovereign Debt at the Crossroads (2006)) noted that: "Governments tend to default specifically when they must increase spending quickly (for instance, to prosecute a war), experience a sudden shortfall in revenues (because of a severe economic contraction), or face an abrupt curtailment of access to bond and loan financing (e.g. because of political instability). He further observed that: "governments with large exposures to currency mismatches and interest rate or maturity risks are, of course, particularly vulnerable."

Can the status quo continue? The US must ultimately pay the piper. So what must the US do to remedy the problem? In 1989, John Williamson described certain economic prescriptions - the Washington Consensus – that became a "standard" reform package promoted for crisis-wracked countries by the IMF. The controversial, much criticised package includes: fiscal policy discipline; redirection of public spending from subsidies; tax reform; market determined and positive real interest rates; competitive exchange rates; trade liberalization; liberalization of inward foreign direct investment; privatization of state enterprises; and deregulation. Resolution of the problems facing the US requires adopting many elements of the standard IMF economic reform package for emerging markets.

Some elements, such as fiscal and monetary discipline, are politically difficult if inevitable. Reform of farm subsidies must overcome deep-seated resistance.

Markets are restless for action and do not wait. The US dollar has weakened and is likely to fall further.. This helps exporters, tourism and will ultimately attract inwards foreign investment.

Foreign investment has been slow. Weak economic growth and concerns about the US financial system have offset the effects of a lower dollar. Despite this the "closing down sale" of US assets - real estate, companies and infrastructure assets - has begun. InBev, a Belgian based brewer has launched an unsolicited bid of US$46 billion for Anheuser-Busch, the brewer of Budweiser, the quintessential American beer. Abertis Infraestructuras, a Spanish infrastructure company teamed with Citigroup, submitted US$12.8 billion, the largest bid, for the right to lease the Pennsylvania Turnpike for the next 75 years.

Increasing foreign investment is politically sensitive in America. Surveys show that most American would prefer key businesses to remain in American hands. Public concern about investment by Sovereign Wealth Funds ("SWF") reflects this financial xenophobia.

The "adjustment" may be under way. The dry measured economic prose of the Washington Consensus does not capture its human elements. It will require reductions in US real wages and living standards on a scale that those who have not experienced it first hand cannot understand. Just ask the average citizen of many Asian countries (post the 1997/ 1998 monetary crisis), Argentina and any other country that has taken the IMF’s "cure". (We like the example of Russia in the 1990's since we were doing business there and saw it first hand. - Jesse)

In the twentieth century, the US and the dollar overtook Great Britain and the Pound Sterling as the pre-eminent global economic power and currency. A similar epochal tectonic shift in global economic order may be commencing.

The shift is not inevitable. There is much to admire about the US. It remains wealthier than other nations including the new titans - China and India. America remains a science and technology powerhouse. It accounts for 40% of total world spending on research and development, and outperforms Europe and Japan. For example, between 1993-2003 America’s growth rate in patents averaged 6.6% a year compared with 5.1% for the European Union and 4.1% for Japan. America's relatively fast-growing population, secure property rights and well-developed financial markets have been attractive to investors.

However as Warren Buffett in his 2006 annual letter to shareholders observed: "Foreigners now earn more on their U.S. investments than we do on our investments abroad … In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience ‘reverse compounding’ as we pay ever-increasing amounts of interest on interest. …. no matter how rich you are, borrowing on top of borrowing is not a great long-term financial plan. I believe that at some point in the future, U.S. workers and voters will find this annual 'tribute' (of interest payment on the debt) so onerous that there will be a severe political backlash … How that will play out in markets is impossible to predict – but to expect a 'soft landing' seems like wishful thinking."

The US faces a challenge to reestablish its economic credentials. Without drastic and radical action, America’s ability to continue to borrow from foreign investors to meet its financing requirement is likely to become increasingly difficult. (Meaning increasingly higher interest rates, asset sales, and then le deluge - Jesse)

The mass hysteria and panic that followed the broadcast of Orson Welles The War of the World played on fears about an attack by Germans. It is interesting to speculate whether a broadcast on a default by the US on its sovereign debt would play on the secret fears of global markets triggering a similar panic. "We interrupt regular programming to announce that the United States of America has defaulted on its debt!"

A good friend just sent us this excerpt of an essay from a long time favorite author of ours that seems pertinent to the above, and our current state of affairs.

National Madness
Gilbert Keith Chesterton

"This slow and awful self-hypnotism of error is a process that can occur not only with individuals, but also with whole societies. It is hard to pick out and prove; that is why it is hard to cure. But this mental degeneration may be brought to one test, which I truly believe to be a real test.

A nation is not going mad when it does extravagant things, so long as it does them in an extravagant spirit. But whenever we see things done wildly, but taken tamely, then the State is growing insane...

I should, in other words, think the world a little mad if the [wild] incident, were received in silence. Now things every bit as wild as this are being received in silence every day.... For madness is a passive as well as an active state: it is a paralysis, a refusal of the nerves to respond to the normal stimuli, as well as an unnatural stimulation. There are commonwealths, plainly to be distinguished here and there in history, which pass from prosperity to squalor or from glory to insignificance, or from freedom to slavery, not only in silence, but with serenity.

The face still smiles while the limbs, literally and loathsomely are dropping from the body. These are peoples that have lost the power of astonishment at their own actions. When they give birth to a fantastic fashion or a foolish law, they do not start or stare at the monster they have brought forth. They have grown used to their own unreason; chaos is their cosmos; and the whirlwind is the breath of their nostrils.

These nations are really in danger of going off their heads en masse; of becoming one vast vision of imbecility, with toppling cities and crazy country-sides, all dotted with industrious lunatics.... "

Unsecured Creditors Pulling Funds from Washington Mutual

The commentators on Bloomberg News were citing an analyst report that 'unsecured creditors were pulling funds from the bank.' Washington Mutual did not deny this, but responded that they are not reliant on the short term commercial paper markets as they can draw funds from their banking operations, so there.

Here we go again.

Reuters
WaMu shares fall as credit concerns grow
Thursday July 24, 3:39 pm ET
By Anastasija Johnson and Jonathan Stempel

NEW YORK (Reuters) - Washington Mutual Inc (WM - News) shares fell as much as 23.4 percent and the cost to insure its debt against default rose after an analyst said some creditors reduced their exposure to the largest U.S. savings and loan.

Citing the Seattle-based thrift's financial statements for the period ending June 30, Gimme Credit analyst Kathleen Shanley wrote that "many creditors have quietly been pulling funds" from the company.....

Housing Bill Stipulates All Credit Card Transaction Will Be Reported to the IRS

This analys is from Congressman Ron Paul's site. Ron Paul Campaign for Liberty

Finally, buried deep within the bill, and not mentioned in any MSM (main stream media) source that I am aware of, is the provision that every credit card transaction will now be reported to the IRS. How this fits in to the housing crisis is anyone’s guess.

Our own read of the legislation HR322118 indicates that there is a $10,000 threshold and/or a transaction limit threshold, so we do not think it is ALL payment card transactions. It is however, rather annoying and intrusive nonetheless. It appears to be targeted at merchants, a pre-emptive strike on any indiscreet selling of assets such as on eBay perhaps.

Use of an account number or other indicia associated with a payment card will be treated in the same manner as a payment card. A de minimis exception for transactions of $10,000 or less and 200 transactions or less applies to payments by third party settlement organizations. The proposal applies to returns for calendar years beginning after December 31,2010. Back-up withholding provisions apply to amounts paid after December 31, 2011. This proposal is estimated to raise $9.802 billion over ten years.

Ron Paul Housing Bill Commentary: All Credit Card Transactions To Be Reported to IRS

Yesterday Congress passed a housing bailout bill by a vote of 272 to 152. Here is a typical MSM story about the bill from the LA Times that lauds the importance of these “sweeping measures” that will “stave off foreclosure for 400,000 or more homeowners,” and allow the Treasury to “bolster confidence in Fannie and Freddie” by allowing the government to “temporarily increase its lending” and “buy their stock.” Couched in these terms, it probably sounds good to most Americans.

But there is much that the typical MSM dispatch does not mention (for example, where will the money come from?). For the rest of the story, take 7 minutes to watch Dr. Paul’s video commentary on the bill, which made the front page of Digg in a screaming three hours. Dr. Paul discusses what else is in the bill, including:

A provision to increase the national debt ceiling by $800 billion. This is something Congress has to do every few years, as spending is clearly out of control.

While this bill is often referred to in the news as a “$25 billion” plan, the final amount will likely be much, much higher. The Treasury’s previously limited $2.5 billion line of credit to Fannie Mae / Freddie Mac, which in 2001 Ron Paul proposed be abolished, has instead been increased to unlimited. The Treasury can now buy an unlimited amount of Fannie / Freddie housing securities and stock. While this may help “bolster confidence” in these companies, as the LA times mentions, don’t expect it to do much for the dollar! Once upon a time, our national currency was backed by gold. More recently, it has been backed by US Treasury securities. Now it will be backed - at least in part - by Fannie Mae / Freddie Mac housing securities - securities that are collapsing on the open market because no one else wants them.

In yet another example of persistent, big brother, big government, police state creep, anyone working in the mortgage industry will now be required to be fingerprinted.

Finally, buried deep within the bill, and not mentioned in any MSM source that I am aware of, is the provision that every credit card transaction will now be reported to the IRS. How this fits in to the housing crisis is anyone’s guess.

This is just the briefest of summaries of what is contained in the video. Watch it for the fascinating inside scoop that you won’t hear anywhere else, and pass it along to those you care about. As Dr. Paul notes, our economy is in deep trouble - addicted to easy money brought about by the inflationary programs of the Fed and deficit spending. If we quit these policies, there will be some short term pain, but if not, we’re likely to kill the patient - in this case, the US Dollar.

"What Happened Is... Wall Street Got Drunk"

He didn't know what hit him. Heh Heh.

Those Hemp Smoking Europeans Did It

Godless hopheads.

CFTC charges Optiver Holding with manipulation of futures
By Polya Lesova
Last update: 11:19 a.m. EDT
July 24, 2008

NEW YORK (MarketWatch) -- The U.S. Commodity Futures Trading Commission (CFTC) said Thursday that it has charged Optiver Holding BV, a Netherlands-based global proprietary trading fund, two of its subsidiaries, and three employees, with manipulation and attempted manipulation of New York Mercantile Exchange light sweet crude oil, New York Harbor heating oil, and New York Harbor gasoline futures contracts in March 2007. (Perhaps you haven't been keeping up with current events commissioners but energy did a moonshot in 2008 - Jesse)

The CFTC filed the civil enforcement action in the United States District Court for the Southern District of New York against Optiver Holding BV and the other defendants. The complaint alleges that defendants profited by approximately $1 million from their manipulative scheme.

Updated Gold Forecast for 2008-2009

Not a bad forecast so far considering how bleak things looked on May 3. They always seem to look bleak, don't they? And the forecast was almost right on the money until about 24 hours ago. :)

Let's see how things progress. IF we get a more profound correction to 880 area, then we think the next leg up may be quite 'brisk.'

UK Investors Buy Physical Gold in Record Numbers - Target Price for Next Leg Increases

Is the gold bull over given the past two days of serious price smackdown?

In a word - No. Not even close. The gold bull is still intact and healthy, and going through the same corrective pattern it has seen several times over the past five years.

Additionally, the high risk in the banking sector is driving more people to allocate a portion of their personal wealth into the safety of gold. This buying offtake of supply is likely to strengthen the bull market over time as demand builds.

Given the charts and the action we have seen, we are raising our target for the next leg of the gold bull market to 1250+ in US dollars if we break up and out of this symmetrical consolidation pattern.

Let's see what happens.

Investors buy gold bars in record numbers
By Paul Farrow
2:27pm BST 22/07/2008
UK Telegraph

Volatile stock markets and a lack of confidence in the UK banking system has boosted demand for gold bars and coins from private investors to levels not seen for 25 years.

Tens of thousands of investors have rushed to buy gold from bullion dealers over the past year, during which the gold price has broken through the $1,000 barrier on occasions.

Tony Baird of Baird & Co, one the UK's biggest gold bullion dealers, said business was getting busier and busier – with punters investing £1,500 to £150,000 in gold bars and coins. Baird, who has been in the gold business for 40 years, claimed that demand was on a par with the late 1970s.

He added: "We have had queues in here. People are nervous of the stock markets and they are nervous of the banks. Northern Rock was a trigger and now Fannie Mae and Freddie Mac have stirred things up again this week."

BullionVault.com – the online marketplace for gold bullion bars – said that number of private individuals investing in gold has more than doubled over the past year. It now holds 3.5 tonnes of gold on behalf of UK investors compared to less than 1.5 tonnes a year ago.

BullionVault founder Paul Tustain said: "Gold is always a popular choice of investment when the economy slows."

It is not just physical gold that investors are chasing. People are buying Exchange Traded Funds that track the gold price.

ETF Securities saw record inflows on Tuesday with inflows of $265m. Gold ETCs recorded $225 million of trading on the London Stock Exchange (LSE) on the same day the LSE issued a report showing that gold ETCs took two of the top four spots in terms of trading volumes in June 2008 on the LSE’s ETC/ETF trading platform.

According to db Research, the independent research arm of Deutsche Bank the top three traded ETFs last month were all gold: Lyxor Gold Bullion Securities, ETFS Physical Gold ETF Securities Ltd and ZKB Gold.

Nik Bienkowski, chief operating officer at EFT Securities, said: "We are not surprised that commodities and more specifically gold ETCs continue to shatter records for trading volumes and inflows."

Charts in the Babson Style for Midweek 23 July 2008

Bank of America To Buy Back 75 Million Shares

This news was released by Bloomberg simultaneously with an early release of the Fed's Beige Book which spoke about the "morose mood" of the public (morose: showing a brooding, gloomy, or sullen mood).

Doug Kass reports that "bank stocks just moved up on a story on the newswires that Bank of America (BAC) is going to buy back 75 miillion shares. Actually Bank of America is reducing its expiring 200-million-share buyback to 75 million shares (it had remaining authority of 190 million shares)."

Financial sector 'welfare queens' or just a simple case of market manipulation? Probably some of both.

It does not get much more "in-your-face" than this.


Bank of America to buy back up to 75 million shares
By Alistair Barr
1:52 p.m. EDT July 23, 2008

SAN FRANCISCO (MarketWatch) -- Bank of America said on Wednesday that it will buy back up to 75 million shares. The board authorized the giant bank to spend as much as $3.75 billion to repurchase stock during the next 12 to 18 months, it explained. The new program replaces an earlier 200 million-share buy-back plan that is expiring. Bank of America shares climbed 3.3% to $33.42 during afternoon trading on Wednesday.

AP
Bank of America declares dividend of 64 cents
Wednesday July 23, 1:55 pm ET
Bank of America declares dividend of 64 cents to be paid Sept. 26

CHARLOTTE, N.C. (AP) -- Bank of America Corp. on Wednesday declared a regular dividend of 64 cents.
The dividend will be paid Sept. 26 to shareholders of record on Sept. 5.

The board also declared a dividend of $1.75 for its 7 percent cumulative redeemable preferred stock, series B. That dividend will be paid Oct. 24 to shareholders of record on Oct. 8.

Congress Agrees to Bail out Fannie and Freddie

The dilution of the United States dollar to enable a de facto debt default has begun. The only way this will be feasible is if several of the other major currencies are inflated in sympathy with the dollar.

The dollar 'rally' and coordinated pressure on the metals and oil today that was ignored by the bond market makes a little more sense now with regard to timing.

Vote out all Republicans and the Democratic leadership this fall.

U.S. Lawmakers Reach Deal on Fannie, Freddie Bill
By Brian Faler

July 22 Bloomberg -- U.S. lawmakers reached agreement on a rescue plan for Fannie Mae and Freddie Mac that the House may vote on tomorrow, Representative Barney Frank said.

Under a modified version of proposals made by the Bush administration, the Treasury Department would gain authority to inject capital into the two largest U.S. mortgage finance companies, through loans and equity investments.

The agreement is the clearest indication yet that Congress will approve a backstop for the beleaguered companies, which Treasury Secretary Henry Paulson said today is essential for safeguarding U.S. financial market stability. Lawmakers added the provisions to legislation that would create a stronger regulator for Fannie Mae and Freddie Mac and expand federal efforts to stem mortgage foreclosures.

``The package we have got is fully acceptable'' to the Treasury and Senate lawmakers, Frank, a Massachusetts Democrat who chairs the House Financial Services Committee, told reporters in Washington today. ``Nobody is for everything that's in it or got everything in it he wanted, but we negotiated a lot.''

Treasury spokeswoman Brookly McLaughlin said in an e-mailed response to a question that the department is reviewing the language of the bill, which is 694 pages.

Crossing White House

Frank said lawmakers, defying a White House veto threat, decided to keep provisions for $3.9 billion to help local communities buy up foreclosed properties. The Bush administration opposed the idea because it said it would aid lenders who now owned the vacated properties, not struggling homeowners.

``It's clear that the Democrats chose to play politics with the legislation,'' White House spokesman Tony Fratto said in an e-mail, without mentioning any veto plans. He echoed McLaughlin that officials are reviewing the bill.

The Treasury would be barred from providing aid that would cause a breach in the federal debt ceiling under the agreement, a constraint aimed at limiting any taxpayer losses. The debt limit would be raised to $10.6 trillion from the current $9.815 trillion.

The plan would give Paulson power to restrict the companies' dividend payments and require regulatory approval of the salaries of top executives. (But we're not nationalizing them right? - Jesse)

Higher Cap

The legislation would also raise the limit on the size of the mortgages the companies may purchase. The new cap would be $625,000, or the median home price plus 15 percent, whichever is lower, Frank said.

Frank's counterpart in the Senate issued a statement indicating he backs the bill now progressing in the House.

``We have been engaged in extensive and largely fruitful discussions with our counterparts in the House'' and with Bush administration officials, Democratic Senator Christopher Dodd said in a joint statement with Republican Senator Richard Shelby distributed by e-mail. ``We remain optimistic about the prospects for this legislation.''

Dodd, of Connecticut, chairs the Senate Banking Committee and Shelby, of Alabama, is the panel's top Republican. (Dodd is the Senator who took the inexpensive mortgage from Countrywide - Jesse)

Paulson, who proposed a rescue program on July 13, reiterated today the plan is aimed at restoring investor confidence in the two companies.

Slide in Stocks

Fannie Mae has dropped about 45 percent in the past month, and Freddie Mac has tumbled about 60 percent, on concern the companies have insufficient capital to cover writedowns and losses amid the mortgage-market collapse.

Lawmakers wrapped the plan into a housing bill that would create a program aimed to help an estimated 400,000 Americans with subprime home loans refinance into 30-year, fixed-rate mortgages backed by the government.

The legislation includes tax breaks to help prop up the housing industry, including what would be the equivalent of an interest-free loan worth as much as $7,500 for first-time homebuyers.

The bill also would allow taxpayers who don't itemize their tax returns to temporarily claim a property-tax deduction, said Representative Richard Neal, a Democrat from Massachusetts and member of the Ways and Means Committee. States could offer an additional $11 billion of mortgage-revenue bonds to refinance subprime loans.

Final Approval

The Senate may vote on the legislation as early as July 24, said Jim Manley, a spokesman for Senate Majority Leader Harry Reid of Nevada. The bill would then go to President George W. Bush for final approval.

A Congressional Budget Office estimate released today put the cost of Paulson's plan at $25 billion, a figure below the total that some lawmakers had expressed concern about. (LOL, like the early estimates on the Iraq war. 25 billion. Is that why they lifted the debt limit by about 800 billion? And that's for openers. - Jesse)

``It's pretty good news -- a lot of people thought it would be much higher,'' Shelby said earlier today. (ROFLMAO - Don't worry it will be - Jesse)

Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac own or guarantee about half of the $12 trillion in outstanding home loans.

The companies, which buy mortgages from banks, face mounting losses stemming from the collapse of the subprime home loan market.

Lawmakers rejected a proposal to bar Fannie Mae and Freddie Mac from paying dividends while they are tapping the expanded line of credit with Treasury, Frank said. They decided instead to give Paulson the power to restrict such payments or to take preferred stock in the companies, he said.

``It's not a mandate,'' Frank said. ``He's got to have some flexibility.'' (And a wide stance - Jesse)

Paulson wanted Congress to grant the Treasury temporary authority to buy stock in the companies and offer an unlimited federal credit line.

Oil Trading Losses Take 12th Largest Non-Public US Company Into Bankruptcy

Their mistake was that they were not 'too big to fail' and were not protected by one of the Fed's banking syndicate.

Remember this when one or more of the metals shorts are brought to their knees, and they whine to the Treasury and CFTC to force a cash settlement on their predatory short positions.

Hank Paulson had an interesting quote about bailing out hedge funds today:

"We also need additional powers to manage the resolution, or wind-down, of large non-depository financial institutions, such as larger hedge funds, so as to limit the impact of a failure on the broader financial system."

Huge oil trading loss sinks energy trader SemGroup
By Robert Campbell
Tuesday July 22, 3:58 pm ET
Guardian UK

NEW YORK (Reuters) - SemGroup LP declared bankruptcy on Tuesday after $3.2 billion in oil-trading losses torpedoed what had been the 12th-largest private U.S. company.

The Tulsa, Oklahoma-based company racked up the massive losses as oil prices ran up record gains, undercutting short crude futures positions SemGroup bought to hedge against its 500,000 barrel-per-day trading business.

Officials said SemGroup, in order to meet obligations to creditors, plans to sell off oil and natural gas gathering, transportation, and storage assets purchased in a whirlwind of acquisitions since it was founded in 2000.

"We have determined that the best way to maximize value for our creditors is to undertake a sales process that will transition our valuable businesses to well-established companies," Terry Ronan, SemGroup's acting chief executive, said in a statement.

SemGroup was forced to take a $2.4 billion loss on July 16 after it transferred its NYMEX trading account to Barclays Plc. The firm had accounted for this position as "loss contingencies," according to its bankruptcy filing in Delaware federal court.

Included in the NYMEX losses is $290 million owed to SemGroup by a trading company owned by SemGroup's co-founder and former chief executive, Thomas Kivisto, who was placed on administrative leave on July 17.

SemGroup had engaged in regular hedging transactions with BOK Financial Corp, where Kivisto had been a board member since 2006 before resigning on July 16. As of the end of 2007, SemGroup had hedged 21 million barrels of crude oil with BOK, which had a fair value of negative $130 million.

At the end of March, this position was worth negative $88 million, said BOK spokesman Jesse Boudiette, who declined to comment on BOK's current exposure to SemGroup, saying the bank would not speak publicly about individual clients.

LOSSES

SemGroup, ranked the No. 12 private U.S. company by Forbes.com in 2007, incurred $850 million in losses on July 17 when its over-the-counter hedging program was marked to market.

SemGroup listed assets of $6.14 billion and liabilities of $7.53 billion in its bankruptcy filing. Liabilities included $3.1 billion of total debt, including $2 billion of secured debt and $594 million in unsecured notes.

SemGroup's financial difficulties were disclosed by its publicly traded affiliate SemGroup Energy Partners LP (NasdaqGM:SGLP) last week, when it warned that a liquidity crisis at its parent could lead to a bankruptcy filing. SemGroup Energy Partners and its general partner are not part of the bankruptcy filing.

Two hedge funds took control of SemGroup Energy Partners' general partner last week under the terms of a loan.

SemGroup Energy Partners management said it was confident the partnership could survive despite SemGroup's bankruptcy and would seek new business from third parties. The company's board has also authorized management to consider a sale or merger.

SemGroup Energy Partners also warned it was not ready to say if it would make a cash distribution to unitholders in the second quarter, though its management believes parent SemGroup will continue to use its fee-based assets to maintain operations while in bankruptcy.

One of the Remaing Bond Insurers Implodes As Hank Paints the Tape

And so we have a pathetically obvious intervention in the markets today to help to curb the declines in shares and bolster the dollar as banks declare more losses and one of the few remaining bond insurers implodes.

What would the penalty be for dynamiting bridges used by the public evacuating the shore areas from the approach of an incoming tsunami?

The market intervention 'for the good of the public' is being used to further line the pockets of the Wall Street wiseguys. Its a dirty business.


Assured Guaranty Plunges, Bond Risk Soars on Review
By Christine Richard and Shannon D. Harrington
July 22, 2008 11:11 EDT

July 22 Bloomberg -- Assured Guaranty Ltd., one of two bond insurers with a AAA ranking from the three major ratings companies, fell as much as 58 percent in New York trading after Moody's Investors Service said it may downgrade the firm.

The cost to protect against a default by Assured Guaranty soared to a record. Credit-default swaps on Financial Security Assurance Holdings Ltd., the unit of Europe's Dexia SA that was also placed under scrutiny by Moody's, also rose to a record.

Moody's review is a blow to Hamilton, Bermuda-based Assured Assured Guaranty and Financial Security of New York, the only two bond insurers to maintain their top ratings as losses in the industry crippled competitors. The companies are dominating new municipal bond insurance and seeking to fend off Warren Buffett, whose new bond insurer was awarded a Aaa rating. Without a Aaa stamp, former market leaders MBIA Inc. and Ambac Financial Group Inc., have seen their new business plunge.

``Potentially all the legacy companies are gone now,'' said Rob Haines, an analyst with CreditSights in New York. ``It has huge implications for the municipal bond market and for banks that may have to take another round of writedowns. It's just a mess.''

Assured Guaranty fell $9.45, or 50 percent, to $9.30 as of 10:45 a.m. in New York Stock Exchange composite trading after Moody's said late yesterday it's reviewing the financial strength ratings of the companies, which had avoided ratings reviews while five competitors lost their top rankings this year because of escalating losses on securities linked to U.S. home loans....

The Failure of the American Financial System

"Where are the leaders? Has our political process become so compromised by powerful interest groups and the threat of character assassination that even the best among us will not dare to speak honestly about the solutions that might bring us back to common sense and fundamental fairness?" Senator Jim Webb, A Time to Fight

One of the reasons we like Nouriel Roubini is that he is an economist willing to dig into all the pertinent details, to get involved in a meaningful way with current events, to take an intellectually honest stand and defend it, to tell it like it is, to borrow a phrase from another era.

This places him as a man apart from many of his peers, who lurk in obscure and irrelevant details, hiding behind rhetorical flourishes and courtly manners, lurking in the waiting rooms of universities and thinktanks, emerging every so often to speak for some vested interest with studies supporting pre-ordained conclusions. All of which of course is absolutely useless if not harmful to the real economy and the advancement of knowledge. But it does leave them open for research grants, and career appointments, honorariums, and self-advancement within a corrupt system that rewards those who propagate it with the motto, go along to get along.

There is a management style in which achievement is irrelevant, although there is often an intricate if not baroque system of measures, but mistakes are penalized, and heavily. As one manager of a large business said in an interview, "If you do 99 things right, and one thing wrong, all they will remember is what you have done wrong and use it against you, depending on who you are and who you know."

And the shame is, he was right. The firm for which he worked had ceased to be a meritocracy, and instead had become an oligopoly in which influence-peddling and personal connections mattered above all, even as the business results deteriorated. Its vision and preoccupations turned increasingly inward on itself, obsessively. It eventually went bankrupt, formally, long after it had become functionally bankrupt. We saw this phenomenon at any number of mature companies we visited in the course of our consultancy.

Yes, there is that element of oligarchy in all societies, in all companies, in every organization, especially after a long period of relative stability, and unfortunately fall under the control of a few powerful people whose number one priority is self-perpetuation and personal enrichment.

It is a matter of degree. When that modus operandi becomes predominant, pervasive, you have an organization that will surely soon be in trouble, headed towards a serious change of management, a major shakeup, a sometimes spectacular and precipitous failure, if it is subject to the external forces of the markets.

So too it is with countries. This is what happened to the former Soviet Union. And it is now happening to The United States with its financial-heavy economy. We have a bad case of the winner's curse. The dollar as the world's reserve currency fostered a deterioration of the American spirit that acted like slow poison on the vigor of the real economy.

The US is going to be passing through a prolonged purging of the system, and its 'management' for some time, measured in years but not decades, until it emerges renewed again and can move forward.

The Coming Systemic Bust of the U.S. Banking System: “Dead Stocks Rallying”
Nouriel Roubini
Jul 20, 2008
RGE Monitor

This past week started with concerns about another systemic meltdown of the U.S. financial system as the insolvency of Fannie and Freddie was revealed and as IndyMac went bust (this third largest bank collapse in U.S. history). But the week ended with a remarkable rally of financial stocks as better than expected results from Wells Fargo, JP Morgan and Citi soothed the fears that major financial institutions were in even more distress than already predicted by market analysts.

Unfortunately, this massive rally of financial stocks in the latter part of the week is just another temporary bear market rally that will fizzle away once the onslaught of bad financial and macro news builds up again.

The views I presented in a recent blog that we will experience a severe financial and banking crisis received the support of many well respected commentators. Alan Abelson – at Barron’s – is one of the most senior and well known commentators on financial issues and on Wall Street. In his latest Barron’s column – aptly titled “Dead Stocks Rallying” he wrote:

WHY WE'RE STILL BEARISH WAS SPELLED out starkly in a dispatch we received last week from Nouriel Roubini. Nouriel is a professor of economics at NYU Stern School of Business (but don't hold that against him) and runs an economic advisory firm called RGE Monitor that casts a knowing and clear eye on the global financial and economic scene. We think he's top-notch (which means we agree with him, a lot of the time).

The nub of his argument is that we're suffering the worst financial crisis since the Great Depression, and he proceeds to give chilling chapter and verse. He predicts that hundreds of small banks loaded with real estate will go bust and dozens of large regional and national banks will also find themselves in deep do-do.

He reckons that, in a few years, there'll be no major independent broker-dealers left: They'll either pack it in or merge, victims of excessive leverage and a badly flawed and discredited business model.

The Federal Deposit Insurance Corp., after it gets through picking up the pieces of IndyMac, will sooner or later have to get a capital transfusion, Nouriel asserts, because its insurance premiums won't cover the tab of rescuing all the troubled banks. He foresees credit losses ultimately reaching at least $1 trillion and anticipates a heap of woe for credit purveyors across the board.

The poor consumer, he contends, is shopped out and being hammered by falling home prices, falling equity prices, falling jobs and incomes, rising inflation. The recession he anticipates will last 12 to 18 months. And the rest of the world won't escape: He looks for hard landings for 12 major economies. As for the stock market, he hazards that there's plenty of room left on the downside. In fact, he feels the bear market won't end until equities are down a full 40% from their peaks.

We must say this vision is a mite too apocalyptic even for us. But Nouriel is not a
professional fear-monger out to make a splash with end-of-the-world prognostications He's a sound guy with a solid record and an impressive résumé. We obviously believe his views are worth pondering, even if they ruin your appetite.

That was a very nice summary by Abelson of my views and a kind endorsement of them.

But how to square the views that a large fraction of the US financial system is in trouble with the apparently better than expected earnings results and lower than expected writedowns presented by financial institutions such as Wells Fargo, JP Morgan and Citi that led to the financials’ stocks most recent rally? There are many reasons why those earnings results are misleading and cosmetically retouched upward while the true financial conditions of the financial system are more dire than otherwise presented.

Let us discuss next in some detail the various reasons why financial conditions of financial firms and banks are much worse than those headline figures and why we the US will experience a systemic financial crisis…

First of all, in a week when only a massive and open ended bailout rescued Fannie and Freddie, when IndyMac went bust and when Merrill presented much worse than expected results it is very hard to be optimistic about the health of the US financial institutions. Reports in the next few days will reveal whether reality is closer to Fannie/Freddie/IndyMac/Merrill or rather closer to the Citi/JPMorgan/Wells Fargo outlook.

Most financial institutions are putting increasing numbers of assets in the illiquid buckets of Level 2 and Level 3 assets. While FASB 157 should prevent manipulation of the valuation of such illiquid assets, forbearance by the SEC, the Fed and other regulators allows a massive amount of fudging.

An insider told me that in a major financial institution the approach is as follows now: top management decide in advance what the announced writedowns should be and folks dealing with the toxic/illiquid assets come up with totally ad hoc assumptions to make sure that such illiquid assets are valued consistently with the decided-in-advance amount of writedowns and losses.

This is not earnings smoothing; this is active manipulation and falsification of financial results aimed at creating even more obfuscation of the true state of financial institutions. This obfuscation is actively abetted by the SEC, the Fed and all other regulators that are now in forbearance crisis management stage where the objective is to avoid at any cost anything that may trigger a financial meltdown. Thus, most of these earnings reports are not worth the paper they are written off.

This earnings manipulation occurs in a variety of ways. First, ad hoc assumptions still used to value and write down level 2 and level 3 assets. Second, banks are leaving aside less reserves for loan losses that are much less than necessary; they do that by using ad hoc assumptions about future losses on mortgages, credit cards, auto loans, student loans, home equity loans and other commercial real estate loans and industrial and commercial loans. Reserves for loan losses have been sharply lagging actual and expected losses, thus padding earnings as decided by the financial institutions' managers. Third, there is disposal of illiquid and toxic assets in ways that misleadingly reduces the amount of actual writedowns. An example is as follows: suppose a bank wants to dump illiquid MBS or leveraged loans that are worth – mark to market – 70 cents on the dollar rather than 100 cents on the dollar. Then, instead of selling these at a price of 70 and showing a 30% writedown these are sold to hedge funds and other investors to a price closer to par – and thus showing in the balance sheet a smaller writedown – by providing a subsidy to the buyer of the security: so a hedge fund will buy such toxic securities at 80 or 90 cents and receive a loan to finance the transaction at an interest well below the borrowing costs for the funds. Thus, writedowns are then shown smaller than the true underlying loss on the asset and the bank finances that fudged transaction with earning less revenues than otherwise on its credit portfolio. This is an accounting scam- bordering on the criminal - that auditors and regulators are abetting on a regular basis.

The bailout plan of Fannie and Freddie implies a direct bailout of financial institutions and helps them to report better than expected earnings in two ways. First, since these financial institutions hold massive amounts of agency debt the government bailout of the holders of such unsecured debt props the market price of the agency debt (reduces its spread relative to Treasuries) and thus allows financial institutions and investors to report less mark to market losses on the values of such assets. Second, after the bust of subprime, near prime and prime mortgage markets the market for private label MBS is dead with absolutely no origination of new MBS. Thus, today – as senior mortgage market participant put it – Fannie and Freddie are “THE mortgage market” as the only institutions that securitize and guarantee mortgages are Fannie and Freddie. Without the government bailout plan that last channel for mortgage securitization and insurance would be frozen and the ability of banks to originate even prime and conforming mortgages would be serious hampered and its cost sharply increased. Thus, the Fannie and Freddie bailout is actually a bailout of the mortgage market and of every institution that holds agency debt or the MBS issued by the two GSES and of every institution that is in the mortgage origination business. On top of this Fannie and Freddie have also been used as tools of public policy in order to further grease the mortgage market and the banks originating mortgages: their portfolio limits were increased; their capital requirement reduced; and the limit for what a conforming loans – the only ones that Fannie and Freddie can securitize – increased from about $420K to over $720K.

The Fed has been actively beefing up the earnings and balance sheet of financial institutions in four major ways.

First, a 325bps reduction in the Fed Funds rate sharply reduced the cost of
borrowing for banks and allowed them to enjoy a nice intermediation margin (the
difference between longer terms interest rates at which they lend and the much
lower short term interest rates at which they borrow). This steepening of the
yield curve is a major subsidy to financial institutions.

Second, the Fed has created a range of new liquidity facilities – the TAF,
the TSLF, the PDCF – that allow banks and now non-bank primary dealers to swap
their illiquid toxic asset backed securities for liquid Treasuries and that
provide access for non-banks – and now also Fannie and Freddie - to the Fed’s
discount window liquidity.

Third, the bailout of Bear Stearns creditors – JP Morgan and many other
counterparties of Bear – not only avoided a systemic meltdown and a certain run
on the other broker dealers but it has led the Fed to take on a significant
credit risk by taking off the balance sheet of Bear Stearns over $29 billion of
toxic securities. So the Fed has directly and indirectly systemically subsidized
and propped up the financial system and the earnings of bank and non-bank
financial institutions.

Fourth, a variety of forbearance regulatory actions – starting with the
waiver of Regulation W for some major banks – have been used to beef up the
profits and earnings of financial institutions and reduce their reported
writedowns.

The entire Federal Home Loan Bank system – another GSE system that is another effective arm of the government - has been used to prop hundreds of mortgage lenders. The insolvent Countrywide alone received more than $51 billion of funds from this semi-public system. This is a system that has increased its lending in the last 18 months by hundreds of billions of dollars: Citigroup, Bank of America and most other US mortgage lenders have also been beneficiaries of this public subsidy to the tune of dozens of billions of dollars each.

In 1990-91 at the height of that recession and banking crisis many major banks – in addition to 1000 plus S&L's that went bust – were effectively insolvent, including, as it was well known at that time, Citibank. At that time the Fed and regulators used instruments similar to those used today – easy money and steepening of the intermediation yield curve, aggressive forbearance, creative – i.e. liar – accounting, etc. – to rescue these major financial institutions from formal bankruptcy. But at that time the housing bust and the ensuing decline in home prices was much smaller than today: during that recession home prices – as measured by the Case-Shiller/S&P index – fell less than 5% from their peak. This time around instead such an index has already fallen 18% from its peak and it will most likely fall by a cumulative 30% before it bottoms sometime in 2010. If a 5% fall in home prices was enough to make Citi effectively insolvent in 1991 what will a 30% fall in home prices – and massive defaults on many other forms of credit (commercial real estate loans, credit cards, auto loans, student loans, home equity loans, leveraged loans, muni bonds, industrial and commercial loans, corporate bonds, CDS) - do to these financial institutions? It challenges the credulity of even spin masters to argue that financial firms are not in worse shape today than they were in 1990-91 when a significant number of major banks were technically insolvent. So, not only hundreds of small banks and a significant fraction of regional banks but also some major money center banks will become effectively insolvent during this crisis.

In spite of the headline figures that showed better than expected earnings at some major financial institutions – Citi, JPM, Wells Fargo - the details were utterly ugly. For one thing, Merrill announced massive writedowns and losses that were much worse than expected. Second, even JPMorgan’s results details were worrisome: for example the recognition of a significant amount of rising losses on prime mortgages. In the case of Citi – a firm that has a presence in over 100 countries and whose revenues come, to a great extent, from foreign operations - there was a sharp increase in the losses on its consumer credit operations, including a large increase in delinquencies on credit cards both in the US and other markets (Brazil, Mexico). Thus, after having already shut down its money losing consumer credit operations in Japan, Citi is now experiencing a surge of delinquencies on unsecured consumer debt both at home and abroad. And the reserves set aside to take care of such expected loan losses are still woefully insufficient as they are based on very optimistic assumptions about the level at which such delinquencies will peak; this is another way to pad earnings and not recognize early on such losses. Systematic use of creative accounting is at work in all of these institutions and other banks and other financial institutions to hide the extent of the incoming losses on assets and loans.

With the excuse of wanting to crack down on “manipulators” the SEC has now imposed restrictions on short sales on the stocks of 19 major financial institutions including Fannie and Freddie. Let us be clear about this new rule: this is a clear and naked attempt by the SEC to manipulate upwards the price of equities of financial firms. The SEC should start investigation and legal action against itself for actively manipulating the stock market. And shame on the SEC for this most un-capitalist and manipulative action: when there is an upward bubble in stock prices and 95% of investors/speakers on CNBC are talking their books in that most public forum to manipulate upwards their portfolio the SEC does nothing and allows this charade to go on. But when short sellers are shorting the stocks of firms that are likely to be bust that is considered manipulation. That is a pretty pathetic action by the SEC that has artificially boosted the equity valuations of US financial firms – now up 20% plus in the last part of the past week after the introduction of this manipulative rule. And of course this manipulated increase in financials’ equity prices reduces the mark to market losses that banks and other financial firms holding such equities would have incurred, another additional way to pad upwards earnings.

The few and rare banks and mortgage/MBS analysts that were willing to provide a realistic assessment of the mortgage market and the financial conditions of US banks and brokers have been effectively muzzled by upper management. With the partial exception of Meredith Whitney who benefits from being at an independent research firm, many other analysts have gone into the spin mode that the Fed, the regulators and the senior management of these financial institutions have dictated to them. Sell-side research that was never independent – even after the additional Chinese walls that the corporate scandals of the early part of the decade led to – is even less independent today. So you have financial institutions manipulating at will their earnings and analysts falling for this supreme baloney.

The FDIC will for sure run out of money as hundreds of banks will go bust and their depositors will have to be made whole given deposit insurance. With funds of only $53 billion, already up to 15% of such funds will be used to rescue the depositors of IndyMac alone. Thus, the FDIC is already requesting to Congress that the deposit insurance premia should be raised to compensate for this shortfall of funding. Too bad that this increase in insurance premia – that should be high enough in advance (not ex-post) to ensure that deposit insurance is incentive-compatible and not leading to gambling for redemption via risky lending in banks – is now too little and too late and is requested when the damage is already done as the biggest credit bubble in U.S. history is now going bust. Also the FDIC has done a mediocre job at identifying which banks are at risk. So far there are only about 90 banks on its watch list; and IndyMac was not put on that list until last month! So if the FDIC did not even identify IndyMac as in trouble until it was too late, how many other IndyMacs are out there that that the FDIC has not identified yet? Certainly a few hundred but such honest analysis of banks at risk is nowhere to be found.

As I have argued in previous work all independent broker dealers are in deep trouble and may not survive – in a few years’ times – as independent firms. And some of them are already walking zombies. In a few years time there will be no major independent broker dealers as their business model (securitization, slice & dice and transfer of toxic credit risk and piling fees upon fees rather than earning income from holding credit risk) is bust and the risk of a bank-like run on their very short term liquid liabilities is a fundamental flaw in their structure. I.e. the four remaining U.S. big brokers dealers will either go bust or will have to be merged with traditional commercial banks. Indeed, firms that borrow liquid and short, highly leverage themselves and then lend in longer term and illiquid ways (i.e. most of the shadow banking system) cannot survive without formal deposit insurance and a formal permanent lender of last resort support from the central bank. (They did have quite a long run though - Jesse)

While a formal government bailout of most U.S. financial institutions has not occurred yet the U.S. government has avoided such bailout only by making sure that foreign government-owned institutions – the Sovereign Wealth Funds – did that job in lieu of the U.S. government. So instead of the U.S. government recapitalizing U.S. financial institutions we have seen foreign governments doing the job. Too bad that such SWFs have already lost 30% to 50% of their initial investments in such financial institutions. Thus, while U.S. financial firms will need hundreds of billions of additional capital injections to survive this crisis it is not obvious that foreign governments (SWFs) will not require conditions for such recapping (a percentage of equity that implies control, board membership, voting powers, common shares rather than preferred stock, etc.) that may not be politically acceptable in the U.S.

One could go on in more detail – as I have done in recent analyses – in discussing the severity of the current banking and financial crisis in the U.S. and how the official figures on earnings and balance sheets of financial institutions provide a misleading picture of the real financial state of such firms. As I argued before the $1 trillion of credit losses ($300-400 bn for mortgages and $600-700 bn for all the other non-mortgage credit) that I estimated last February are only a floor, not a ceiling, for such expected losses. Such losses are likely to end up being closer to my $2 trillion estimate. And such an estimate do not include the $200 to 300 billion that the rescue of Fannie and Freddie will entail. And such losses don’t even include scenarios where up to 50% of households who will end up underwater will walk away from their homes: that factor alone could entail mortgage losses of $1 trillion (average mortgage of $200k times the 50% loss that a foreclosure/walk away implies on that mortgage times 50% of the 21 million households that are underwater) rather than the $300-400 bn that I originally estimated.

So when you add it all up this will be the worst financial crisis since the Great Depression: not as severe as that episode but second only to it. And the real effects of this financial crisis will be severe and more severe if remedial policy action is not rapidly undertaken. Ditto for the US recession: this will be the worst of such U.S. recessions in decades.

Bank Credit and Money Supply Update

There is certainly a contraction in the growth of bank credit and the money supply.

Please note that these are reductions in growth, and from some recently lofty heights.

Before this is over, we ought to see some contraction in the overall supply of money. This is what we had seen in 2002 as the market approached bottom.

One question rarely considered by non-monetary economists is "What is the equilibrium rate of monetary growth, and is it always the same?"

If the economic population is not increasing, and the growth of real GDP is zero, should the money supply be increasing? If the economic population and real GDP are decreasing, would the correct level of monetary growth be a decrease to maintain stable prices? And then there is the matter of the velocity of money, and the notion of a virtual or derivative money supply. All good questions worthy of serious thought.

After Many a Summer Dies the Swan

The dollar decays, the dollar decays and falls,
The banks writedown their assets to the ground,
Bernanke comes and tills the field and lies beneath,
And after many a summer dies the swan.

with apologies to Alred Lord Tennyson, Tithonus

Here is an exposition of the view that we are heading into a Second Great Depression. Ambrose Evans-Pritchard lays out the facts well and makes some fine distinctions about the role of currencies, especially the dollar. This is critical in understanding events as they unfold.

We are not so certain that this is the correct path of events. Its aids us in making the case as to why a monetary deflation is a much less likely outcome for the US than it was for Japan. But this is certainly a scenario worth watching.

The global economy is at the point of maximum danger
Sunday, July 20, 2008
Ambrose Evans-Pritchard
UK Telegraph


It feels like the summer of 1931. The world's two biggest financial institutions have had a heart attack. The global currency system is breaking down. The policy doctrines that got us into this mess are bankrupt. No world leader seems able to discern the problem, let alone forge a solution. (They know what the problem is, and also the solution. They are afraid to be the first to reveal the truth for fear of backlash, pressure from The Interests, and the blame for causing the bust when the abyss opens - Jesse)

The International Monetary Fund has abdicated into schizophrenia. It has upgraded its 2008 world forecast from 3.7 percent to 4.1 percent growth, whilst warning of a "chance of a global recession." Plainly, the IMF cannot or will not offer any useful insights. (Will not. - Jesse)

Its "mean-reversion" model misses the entire point of this crisis, which is that central banks have pushed debt to fatal levels by holding interest too low for a generation, and now the chickens have come home to roost. True "mean-reversion" would imply debt deflation on such a scale that would, if abrupt, threaten democracy. (Its more a matter of imbalance than degree we think, which is the dirty little secret. The vested Interests would rather a deflation or inflation than a redistribution of their ill-gotten gains to something more equitable. Better the lord of hell than a servant in heaven and all that. - Jesse)

The risk is that these same central banks will commit a fresh error, this time overreacting to the oil spike. The European Central Bank has raised rates, warning of a 1970s wage-price spiral. Fixated on the rear-view mirror, it is not looking through the windscreen.

The eurozone is falling into recession before the US itself. Its level of credit stress is worse, if measured by Euribor or the iTraxx bond indexes. Core inflation has fallen over the last year from 1.9 to 1.8 percent.

The US may soon tip into a second leg of this crisis as the fiscal package runs out and Americans lose jobs in earnest. US bank credit has contracted for three months. Real US wages fell at almost 10 percent (annualised) over May and June. This is a ferocious squeeze for an economy already in the grip of the property and debt crunch.

No doubt the rescue of Fannie Mae and Freddie Mac -- $5.3 trillion pillars of America's mortgage market -- stinks of moral hazard. The Treasury is to buy shares: the Fed has opened its window yet wider. Risks have been socialised. Any rewards will go to capitalists.

Alas, no Scandinavian discipline for Wall Street. When Norway's banks fell below critical capital levels in the early 1990s, the Storting authorised seizure. Shareholders were stiffed. (This is closer to what ought to have been done in the US - Jesse)

But Nordic purism in the vast universe of US credit would court fate. The Californian lender IndyMac was indeed seized after depositors panicked on the streets of Encino. The police had to restore order. This was America's Northern Rock moment.

IndyMac will deplete a tenth of the $53 billion reserve of the Federal Deposit Insurance Corporation. The FDIC has some 90 "troubled" lenders on watch. IndyMac was not one of them.
The awful reality is that Washington has its back to the wall. Fed chief Ben Bernanke thought the US could always get out of trouble by monetary stimulus "a l'outrance," and letting the dollar slide. He has learned that the world is a more complicated place. (Ben is just playing for time, trying to get lucky and avoid sharp objects and the blame for this - Jesse)

Oil has queered the pitch. So has America's fatal reliance on foreign debt. The Fannie/Freddie rescue, incidentally, has just lifted the US national debt from German AAA levels to Italian AA- levels. (At the end of the day the US dollar as global reserve currency is a Ponzi scheme, along with everything that it underpins. No one wishes to face this. Its down to a jockeying for power into the next phase. - Jesse)

China, Russia, petro-powers, and other foreign states own $985 billion of US agency debt, besides holdings of US Treasuries. Purchases of Fannie/Freddie debt covered a third of the US current account deficit of $700 billion over the last year. Alex Patelis from Merrill Lynch says America faces the risk of a "financing crisis" within months. Foreigners have a veto over US policy.

Japan did not have this problem during its Lost Decade. As the world's supplier of credit, it could let the yen slide. It also had a savings rate of 15 percent. Albert Edwards from Societe Generale says this has fallen to 3 percent today. It has cushioned the slump. Americans are under water before they start. (And this is why a monetary deflation is not a viable policy option for the US. We wish more people would 'get' this, and the fact that with a fiat currency with no pegs it is just a choice of policy. - Jesse)

My view is that a dollar crash will be averted as it becomes clearer that contagion has spread worldwide. But we are now at the point of maximum danger. Britain, Japan, and the Antipodes are stalling. Denmark is in recession. Germany contracted in the second quarter. May industrial output fell 6 percent in Holland and 5.5 percent in Sweden. (This is the view that we all go down together, and that some are quicker to rise again than others. Think 1930's. - Jesse)

The coalitions in Belgium and Austria have just collapsed. Germany's left-right team is fraying. One German banker told me that the doctrines of "left Nazism" (Otto Strasser's group, purged by Hitler) had captured the rising Die Linke party. The Social Democrats are picking up its themes to protect their flank.

This is the healthy part of Europe. Further south, we are not far away from civic protest. BNP Paribas has just issued a hurricane alert for Spain.

Finance minister Pedro Solbes said Spain is facing the "most complex" economic crisis in its history. Actually, it is very simple. The country was lulled into a trap by giveaway interest rates of 2 percent under EMU, leading to a current account deficit of 10 percent of GDP.

A manic property bubble was funded by foreigners buying covered bonds and securities. This market has dried up. Monetary policy is now being tightened into the crunch by the ECB, hence the bankruptcy last week of Martinsa-Fadesa (E5.1 billion). With Franco-era labour markets (70 percent of wages are inflation-linked), the adjustment will occur through closure of the job marts.

China, India, east Europe, and emerging Asia have all stolen growth from the future by condoning credit excess. To varying degrees, they are now being forced to pay back their own "inter-temporal overdrafts."

If we are lucky, America will start to stabilise before Asia goes down. Should our leaders mismanage affairs, almost every part of the global system will go down together. Then we are in trouble. (This is 'The Second Great Depression" scenario. - Jesse)

The American Mainstream Media Says "Buy the Financials and Banks"

Good bottom call or siren song for a sucker's rally?

We think its the latter. Right now the banks, especially the investment banks, are obtaining a balance sheet smokescreen cover from the New York Fed.

In the short term we are going to lay off the short side on the financials and watch what happens, looking for a place to jump back on that trade. We won't fight the Fed, but we are not drinking the Kool-Aid either.

Why not buy the financials, just for a trade? It might work. We'd rather buy gold and play our gold-oil cross trade.

The next downdraft, when it comes, is likely to be breath-taking.

What to Bank On - Barron's

Hopes and Hints that Financial Stocks Have Finally Touched Bottom - New York Times

Jitters Ease as Citi, Rivals Show Signs of Bottoming Out - Wall Street Journal

Why No Outrage? Remember, Remember, the Fourth of November

Many, many years ago a much younger Jesse had a wise old Boss from whom he learned many things about managing people and a piece of a larger business.

One day The Boss remarked in passing that he did not care when his guys were complaining about small things. He considered it healthy. "Its when they get quiet for a long time that you need to worry. That's that's a sign that something is fundamentally wrong in the company. And when the right spark comes along, all hell is going to break loose."

One slight difference we might have with Mr. Grant is that he seems US-centric in his thoughts. Keep an eye on Europe, specifically Britain. They may show the way ahead.

The American elections will be Tuesday 4 November 2008. Vote.

Why No Outrage?
By JAMES GRANT
July 19, 2008
The Wall Street Journal

Through history, outrageous financial behavior has been met with outrage. But today Wall Street's damaging recklessness has been met with near-silence, from a too-tolerant populace, argues James Grant

"Raise less corn and more hell," Mary Elizabeth Lease harangued Kansas farmers during America's Populist era, but no such voice cries out today. America's 21st-century financial victims make no protest against the Federal Reserve's policy of showering dollars on the people who would seem to need them least.

Long ago and far away, a brilliant man of letters floated an idea. To stop a financial panic cold, he proposed, a central bank should lend freely, though at a high rate of interest. Nonsense, countered a certain hard-headed commercial banker. Such a policy would only instigate more crises by egging on lenders and borrowers to take more risks. The commercial banker wrote clumsily, the man of letters fluently. It was no contest. (Lend free, but at a HIGH rate of interest makes perfect sense, then and now. It prevent an artificial seizure of a credit crunch, but also avoids bubbles and other unintended consequences of excessively cheap credit that fosters distortions. This is the hallmark of the Greenspan Fed, and it is carrying over into the Bernanke Fed. - Jesse)

The doctrine of activist central banking owes much to its progenitor, the Victorian genius Walter Bagehot. But Bagehot might not recognize his own idea in practice today. Late in the spring of 2007, American banks paid an average of 4.35% on three-month certificates of deposit. Then came the mortgage mess, and the Fed's crash program of interest-rate therapy. Today, a three-month CD yields just 2.65%, or little more than half the measured rate of inflation. It wasn't the nation's small savers who brought down Bear Stearns, or tried to fob off subprime mortgages as "triple-A." Yet it's the savers who took a pay cut -- and the savers who, today, in the heat of a presidential election year, are holding their tongues.

Possibly, there aren't enough thrifty voters in the 50 states to constitute a respectable quorum. But what about the rest of us, the uncounted improvident? Have we, too, not suffered at the hands of what used to be called The Interests? Have the stewards of other people's money not made a hash of high finance? Did they not enrich themselves in boom times, only to pass the cup to us, the taxpayers, in the bust? Where is the people's wrath?

The American people are famously slow to anger, but they are outdoing themselves in long suffering today. In the wake of the "greatest failure of ratings and risk management ever," to quote the considered judgment of the mortgage-research department of UBS, Wall Street wears a political bullseye. Yet the politicians take no pot shots. (They are afraid. They have been co-opted. They need to go and find some honest work. - Jesse)

Barack Obama, the silver-tongued herald of change, forgettably told a crowd in Madison, Wis., some months back, that he will "listen to Main Street, not just to Wall Street." John McCain, the angrier of the two presumptive presidential contenders, has staked out a principled position against greed and obscene profits but has gone no further to call the errant bankers and brokers to account.

The most blistering attack on the ancient target of American populism was served up last October by the then president of the Federal Reserve Bank of St. Louis, William Poole. "We are going to take it out of the hides of Wall Street," muttered Mr. Poole into an open microphone, apparently much to his own chagrin. (The country is like an sullen mob, waiting for someone to make the first move - Jesse)

If by "we," Mr. Poole meant his employer, he was off the mark, for the Fed has burnished Wall Street's hide more than skinned it. The shareholders of Bear Stearns were ruined, it's true, but Wall Street called the loss a bargain in view of the risks that an insolvent Bear would have presented to the derivatives-laced financial system. To facilitate the rescue of that system, the Fed has sacrificed the quality of its own balance sheet. In June 2007, Treasury securities constituted 92% of the Fed's earning assets. Nowadays, they amount to just 54%. In their place are, among other things, loans to the nation's banks and brokerage firms, the very institutions whose share prices have been in a tailspin. Such lending has risen from no part of the Fed's assets on the eve of the crisis to 22% today. Once upon a time, economists taught that a currency draws its strength from the balance sheet of the central bank that issues it. I expect that this doctrine, which went out with the gold standard, will have its day again.

Wall Street is off the political agenda in 2008 for reasons we may only guess about. Possibly, in this time of widespread public participation in the stock market, "Wall Street" is really "Main Street." Or maybe Wall Street, its old self, owns both major political parties and their candidates. (and the mainstream media - Jesse) Or, possibly, the $4.50 gasoline price has absorbed every available erg of populist anger, or -- yet another possibility -- today's financial failures are too complex to stick in everyman's craw.

I have another theory, and that is that the old populists actually won. This is their financial system. They had demanded paper money, federally insured bank deposits and a heavy governmental hand in the distribution of credit, and now they have them. The Populist Party might have lost the elections in the hard times of the 1890s. But it won the future.

Before the Great Depression of the 1930s, there was the Great Depression of the 1880s and 1890s. Then the price level sagged and the value of the gold-backed dollar increased. Debts denominated in dollars likewise appreciated. Historians still debate the source of deflation of that era, but human progress seems the likeliest culprit. Advances in communication, transportation and productive technology had made the world a cornucopia. Abundance drove down prices, hurting some but helping many others.

The winners and losers conducted a spirited debate about the character of the dollar and the nature of the monetary system. "We want the abolition of the national banks, and we want the power to make loans direct from the government," Mary Lease -- "Mary Yellin" to her fans -- said. "We want the accursed foreclosure system wiped out.... We will stand by our homes and stay by our firesides by force if necessary, and we will not pay our debts to the loan-shark companies until the government pays its debts to us."

By and by, the lefties carried the day. They got their government-controlled money (the Federal Reserve opened for business in 1914), and their government-directed credit (Fannie Mae and the Federal Home Loan Banks were creatures of Great Depression No. 2; Freddie Mac came along in 1970). In 1971, they got their pure paper dollar. So today, the Fed can print all the dollars it deems expedient and the unwell federal mortgage giants, Fannie Mae and Freddie Mac, combine for $1.5 trillion in on-balance sheet mortgage assets and dominate the business of mortgage origination (in the fourth quarter of last year, private lenders garnered all of a 19% market share).

Thus, the Wall Street of the Morgans and the Astors and the bloated bondholders is today an institution of the mixed economy. It is hand-in-glove with the government, while the government is, of course -- in theory -- by and for the people. But that does not quite explain the lack of popular anger at the well-paid people who seem not to be very good at their jobs. ("The Interests" have a broader level of control thanks to the digital age and this hedonistic, dumbed-down generation than ever before. But their day to fall is coming. - Jesse)

Since the credit crisis burst out into the open in June 2007, inflation has risen and economic growth has faltered. The dollar exchange rate has weakened, the unemployment rate has increased and commodity prices have soared. The gold price, that running straw poll of the world's confidence in paper money, has jumped. House prices have dropped, mortgage foreclosures spiked and share prices of America's biggest financial institutions tumbled.

One might infer from the lack of popular anger that the credit crisis was God's fault rather than the doing of the bankers and the rating agencies and the government's snoozing watchdogs. And though greed and error bear much of the blame, so, once more, does human progress. At the turn of the 21st century, just as at the close of the 19th, the global supply curve prosperously shifted. Hundreds of millions of new hands and minds made the world a cornucopia again. And, once again, prices tended to weaken. This time around, however, the Fed intervened to prop them up. In 2002 and 2003, Ben S. Bernanke, then a Fed governor under Chairman Alan Greenspan, led a campaign to make dollars more plentiful. The object, he said, was to forestall any tendency toward what Wal-Mart shoppers call everyday low prices. Rather, the Fed would engineer a decent minimum of inflation.

In that vein, the central bank pushed the interest rate it controls, the so-called federal funds rate, all the way down to 1% and held it there for the 12 months ended June 2004. House prices levitated as mortgage underwriting standards collapsed. The credit markets went into speculative orbit, and an idea took hold. Risk, the bankers and brokers and professional investors decided, was yesteryear's problem.

Now began one of the wildest chapters in the history of lending and borrowing. In flush times, our financiers seemingly compete to do the craziest deal. They borrow to the eyes and pay themselves lordly bonuses. Naturally -- eventually -- they drive themselves, and the economy, into a crisis. And to the scene of this inevitable accident rush the government's first responders -- the Fed, the Treasury or the government-sponsored enterprises -- bearing the people's money. One might suppose that such a recurrent chain of blunders would gall a politically potent segment of the population. That it has evidently failed to do so in 2008 may be the only important unreported fact of this otherwise compulsively documented election season.

Mary Yellin would spit blood at the catalogue of the misdeeds of 21st-century Wall Street: the willful pretended ignorance over the triple-A ratings lavished on the flimsy contraptions of structured mortgage finance; the subsequent foreclosure blight; the refusal of Wall Street to honor its implied obligations to the holders of hundreds of billions of dollars worth of auction-rate securities, the auctions of which have stopped in their tracks; the government's attempt to prohibit short sales of the guilty institutions; and -- not least -- Wall Street's reckless love affair with heavy borrowing.

For every dollar of equity capital, a well-financed regional bank holds perhaps $10 in loans or securities. Wall Street's biggest broker-dealers could hardly bear to look themselves in the mirror if they didn't extend themselves three times further. At the end of 2007, Goldman Sachs had $26 of assets for every dollar of equity. Merrill Lynch had $32, Bear Stearns $34, Morgan Stanley $33 and Lehman Brothers $31. On average, then, about $3 in equity capital per $100 of assets. "Leverage," as the laying-on of debt is known in the trade, is the Hamburger Helper of finance. It makes a little capital go a long way, often much farther than it safely should. Managing balance sheets as highly leveraged as Wall Street's requires a keen eye and superb judgment. The rub is that human beings err.

Wall Street is usually described as an industry, but it shares precious few characteristics with the metal-fasteners business or the auto-parts trade. The big brokerage firms are not in business so much to make a product or even to earn a competitive return for their stockholders. Rather, they open their doors to pay their employees -- specifically, to maximize employee compensation in the short run. How best to do that? Why, to bear more risk by taking on more leverage.

"Wall Street is our bad example because it is so successful," charged the president of Notre Dame University, the Rev. John Cavanaugh, in the time of Mary Lease. He meant that young people, emulating J.P. Morgan or E.H. Harriman, would worship the wrong god. The more immediate risk today is that Wall Street, sweating to fill out this year's bonus pool, runs itself and the rest of the American financial system right over a cliff.

It's just happened, in fact, under the studiously averted gaze of the Street's risk managers. Today's bear market in financial assets is as nothing compared to the preceding crash in human judgment. Never was a disaster better advertised than the one now washing over us. House prices stopped going up in 2005, and cracks in mortgage credit started appearing in 2006. Yet the big, ostensibly sophisticated banks only pushed harder.

Bear Stearns is kaput and Lehman Brothers is reeling, but Morgan Stanley perhaps best illustrates the gluttonous ways of Wall Street. Having lost its competitive edge on account of an intramural political struggle, the firm, under Chief Executive John Mack, set out to catch up to the rest of the pack. In the spring of 2006, it unveiled a trillion-dollar balance sheet, Wall Street's first. It expanded in every faddish business line, not excluding, in August 2006, subprime-mortgage origination (the transaction, intoned a Morgan Stanley press release, "provides us with new origination capabilities in the non-prime market, which we can build upon to provide access to high-quality product flows across all market cycles"). Nor did it pull in its horns as the boom wore on but rather protruded them all the more, raising its ratio of assets to equity to the aforementioned 33 times at year-end 2007 from 26.5 times at the close of 2004. Naturally, it did not forget the help. Last year, Morgan Stanley paid out 59% of its revenues in employee compensation, up from 46% in 2004.

Huey Long, who rhetorically picked up where Lease left off, once compared John D. Rockefeller to the fat guy who ruins a good barbecue by taking too much. Wall Street habitually takes too much. It would not be so bad if the inevitable bout of indigestion were its alone to bear. The trouble is that, in a world so heavily leveraged as this one, we all get a stomach ache. Not that anyone seems to be complaining this election season.

James Grant is the editor of Grant's Interest Rate Observer.

The Long Gold - Short Oil Cross Trade

We've been playing the same trade that the noted Mr. Soros has picked up on.

25 June 2008 ...added quite a bit to our short oil/long gold cross trade.

June 23 - Gold / Oil Ratio Is at an Extreme

We are using DTO, DUG, GLD and CEF in the crosses, varying proportions and size. We refuse to provide any business to the US futures markets on a matter of principle. Their inclination to change the rules to suit their larger members inconvenienced us once too often.


The Croesus Chronicles
Gold And Oil For Soros; Illiquidity At Merrill
07.17.08, 8:53 AM ET
Robert Lenzner

...Undoubtedly, this spike in bank shares was due in large part to hedge funds, which began covering some of the massive short positions they've built up over the past 18 months. For example, billionaire George Soros--Croesus was told--has covered much of his shorts in financial stocks. Why chance another public policy move by regulators to shut off this automatic feeding trough?

Soros finally shorted oil at $137 a barrel and put on a long position in gold; he expects to see gold hold its ground even if oil continues to decline. In fact, the gold bug clique believes in a consistent 10-to-1 ratio for gold and oil. It holds that either gold will rise to 10 times a barrel of oil ($1,350 an ounce) or oil will fall to $96 a barrel--one-tenth the present market price of gold. Croesus was told Tuesday that statistics spanning many decades support, on average, this 10-to-1 ratio....

Charts in the Babson Style for Market Close 18 July 2008

US Dollar Long Term Chart with Commitments of Traders as of July 15 COB

Long Term Dollar with Moving Averages

The Whiners of Wall Street - Wall Street's Great Deflation

Wall Street's Great Deflation
by William Greider
07/14/2008 12:38pm
The Nation

Phil Gramm, the senator-banker who until recently advised John McCain's campaign, did get it right about a "nation of whiners," but he misidentified the faint-hearted. It's not the people or even the politicians. It is Wall Street--the financial titans and big-money bankers, the most important investors and worldwide creditors who are scared witless by events. These folks are in full-flight panic and screaming for mercy from Washington. Their cries were answered by the massive federal bailout of Fannie Mae and Freddy Mac, the endangered mortgage companies.

When the monied interests whined, they made themselves heard by dumping the stocks of these two quasi-public private corporations, threatening to collapse the two financial firms like the investor "run" that wiped out Bear Stearns in March. The real distress of the banks and brokerages and major investors is that they cannot unload the rotten mortgage securities packaged by Fannie Mae and banks sold worldwide. Wall Street's preferred solution: dump the bad paper on the rest of us, the unwitting American taxpayers.

The Bush crowd, always so reluctant to support federal aid for mere people, stepped up to the challenge and did as it was told. Treasury Secretary Paulson (ex-Goldman Sachs) and his sidekick, Federal Reserve Chairman Ben Bernanke, announced their bailout plan on Sunday to prevent another disastrous selloff on Monday when markets opened. Like the first-stage rescue of Wall Street's largest investment firms in March, this bold stroke was said to benefit all of us. The whole kingdom of American high finance would tumble down if government failed to act or made the financial guys pay for their own reckless delusions. Instead, dump the losses on the people.

Democrats who imagine they may find some partisan advantage in these events are deeply mistaken. The Democratic party was co-author of the disaster we are experiencing and its leaders fell in line swiftly. House banking chair, Rep. Barney Frank, announced he could have the bailout bill on President Bush's desk next week. No need to confuse citizens by dwelling on the details. Save Wall Street first. Maybe lowbrow citizens won't notice it's their money.

We are witnessing a momentous event--the great deflation of Wall Street--and it is far from over. The crash of IndyMac is just the beginning. More banks will fail, so will many more debtors. The crisis has the potential to transform American politics because, first it destroys a generation of ideological bromides about free markets, and, second, because it makes visible the ugly power realities of our deformed democracy. Democrats and Republicans are bipartisan in this crisis because they have colluded all along over thirty years in creating the unregulated financial system and mammoth mega-banks that produced the phony valuations and deceitful assurances. The federal government protects the most powerful interests from the consequences of their plundering. It prescribes "market justice" for everyone else.

Of course, the federal government has to step up to the crisis, but the crucial question is how government can respond in the broad public interest. Bernanke knows the history of the last great deflation in the 1930s--better known as the Great Depression--and so he is determined to intervene swiftly, as the Federal Reserve failed to do in that earlier crisis. By pumping generous loans and liquidity into the system, the Fed chairman hopes to calm the market fears and reverse the panic. So far, he has failed. I think he will continue to fail because he has not gone far enough.

If Washington wants real results, it has to abandon the wishful posture that is simply helping the private firms get over their fright. The government must instead act decisively to take charge in more convincing ways. That means acknowledging to the general public the depth of the national crisis and the need for more dramatic interventions.

Instead of propping up Fannie Mae or others, the threatened firm should be formally nationalized as a nonprofit federal agency performing valuable services for the housing market. That is the real consequence anyway if the taxpayers have to buy up $300 billion in stock. (We would prefer an orderly liquidation. The government has no business subsidizing the housing industry - Jesse)

The private shareholders "are walking dead men, muerto," Institutional Risk Analytics, a private banking monitor, observed. Make them eat their losses, the sooner the better.

The real national concern should be focused on the major creditors who lend to Fannie Mae and other US agencies as well as private financial firms. They include China, Japan and other foreign central banks. Foreign investors hold about 21 percent of the long-term debt paper issued by US government agencies--$376 billion in China, $229 billion in Japan.

It is not in our national interest to burn these nations with heavy losses. On the contrary, we need to sustain their good regard because they can help us recover by bailing out the US economy with more lending. If these foreign creditors turn away and stop their lending now, the US economy is toast and won't soon recover. (We would let them take their losses too. They purchased that Agency debt as part of a cycle of pegging their currencies at artificially low rates to the dollar for their own industrial export policy - Jesse)

Americans should forget about whining; it's too late for that. People need to get angry--really, really angry--and take it out on both parties. What the country needs right now is a few more politicians in Washington with the guts to stand up and tell us the hard truth about out situation. It will be painful to hear. They will be denounced as "whiners." But truth might be our only way out.

Stand up for the Constitution and send Washington a message. Vote out all Republicans and the Democratic leadership this fall.

US Banks with the Greatest Exposure to Home Equity

This chart is from Reggie Middleton's Boom Bust Blog

We've taken the liberty of turning it on its side to make it easier to read.

Reggie's site is worth reading. He tends to specialize in analyzing banks.

CitiFed's Results Boost Stocks into Option Expiration

And it only took a half trillion dollars of the taxpayer's money and an emergency SEC ruling that restricted trading in the big banks to create another important option expiration rally for the Wall Street trading houses.

Citi Posts Smaller-Than-Estimated Loss on Writedown
By Josh Fineman and Bradley Keoun

July 18 (Bloomberg) -- Citigroup Inc. reported a smaller- than-estimated loss by reducing mortgage-bond writedowns, eliminating jobs and borrowing money at lower rates. (Two of those three positives are courtesy of the Fed's balance sheet coverage for Citi - Jesse)

Citigroup, the biggest U.S. bank by assets, rose in New York trading after the company said its second-quarter net loss was $2.5 billion, or 54 cents a share, because of $12 billion in writedowns and increased bad-loan reserves. Analysts estimated the New York-based bank's loss at $3.67 billion.

Led by Chief Executive Officer Vikram Pandit, Citigroup is the third major U.S. bank to beat analysts' predictions this week, after JPMorgan Chase & Co. and Wells Fargo & Co. Merrill Lynch & Co.'s results yesterday fell short of Wall Street's estimates. Pandit, who took over in December, reduced assets by about $67 billion during the quarter, making progress on the $400 billion he has targeted.

``Conditions have eased a little bit and at the same time they have been able to grow their top line,'' William Fitzpatrick, an equity analyst at Optique Capital Management in Milwaukee, which manages $1.4 billion, said in a Bloomberg Television interview. ``They haven't had a lot of clients run out the door. They have been able to maintain relationships. Now it's just a matter of being more profitable.'' (Details, details - Jesse)

Writedowns for subprime-related assets and debt linked to bond insurers totaled $7.2 billion. The bank's credit costs increased $4.5 billion from the second quarter of 2007, mainly because of bad consumer loans in North America and the company's credit-card business.

Writedown Estimate

Credit Suisse Group analyst Susan Roth Katzke predicted in a June 24 note that the company would have as much as $10 billion of writedowns.

Shares of the company rose to $19.29 in New York trading, from $17.97 at the close on the New York Stock Exchange yesterday.

Second-quarter revenue dropped 29 percent to $18.7 billion, compared with the average estimate of $17.3 billion among analysts surveyed by Bloomberg. Earnings in the same quarter last year were $6.23 billion, or $1.24 a share.

The U.S. consumer unit, which includes retail banking and loans to individuals and small businesses, had revenue of $7.89 billion, virtually unchanged from a year earlier. The global cards business rose 3 percent to $5.47 billion.

Tier 1 Ratio

Citigroup's Tier 1 capital ratio, a measure regulators use to monitor a bank's ability to withstand loan losses, rose to 8.7 percent at the end of the quarter from 7.7 percent in the first quarter and 7.1 percent at the end of 2007. The minimum for a ``well-capitalized'' rating from U.S. regulators is 6 percent. Citigroup sets its own target at 7.5 percent, partly to assure its AA- rating from Standard & Poor's. (One way to increase that ratio is to take the 'bad stuff' off the balance sheet and let Benny carry it for you - Jesse)

Seven interest-rate cuts by the Federal Reserve in the past year have reduced the bank's borrowing costs and allowed it to trim the rates it pays depositors.

Revenue at Citigroup's corporate and investment bank plunged 71 percent to $2.94 billion. The wealth management division, which includes the Smith Barney brokerage, gained 4 percent to $3.32 billion.

Pandit, 51, put former Morgan Stanley colleague John Havens in charge of trading and investment banking, moved U.S. consumer head Steve Freiberg to oversee a new credit-card division and recruited former Wells Fargo executive Terri Dial to oversee consumer banking in the U.S....

How Bad Will It Get?

How bad is it? How bad will it become?

The straight answer is: worse than it is now, and it will last longer than you think. There is no easy way out. Bill Poole does not think it will be as bad as the Great Depression. But then again, we are in uncharted waters, and even he does not know.

There are some folks in Washington who think you cannot handle the truth, or at least handle it gracefully, without creating a fuss, maybe getting hysterical, and perhaps demanding a chunk of their hides. After all, your ignorance is their power.

Is it worth it? Ignorance? Is it worth making bad decision after bad decision, blissfully happy all the while, until you have doomed yourself and your family to a very painful and protracted period of near hopelessness and desperation?

Sometimes it gets so bad that an entire nation will surrender itself, willingly, to der Fuhrer or il Duce or the State, then to the madness, and finally, to the abyss.

The truth is not hidden. But it will not come to you unless you seek it, allow it in despite discomfort, and accept it, act on it.

"The secret of happiness is freedom. The secret of freedom is courage." Thucydides (c. 460 BC – c. 395 BC)

And the secret of courage is to care for something, someone, more than you care for yourself.

Seven Questions: How Bad Will It Get?
An Interview With William Poole
Foreign Policy

When William Poole warned in 2003 that Fannie Mae and Freddie Mac lacked the capital to weather a financial storm, his advice went unheeded. Five years later, the outspoken former president of the Federal Reserve Bank of St. Louis is far too polite to say “I told you so,” but he does have a message for the Fed: Wait too long to tackle inflation, and you’ll face an even worse recession in the years to come.

Foreign Policy: What’s your diagnosis of what happened to Fannie Mae and Freddie Mac?

William Poole: First of all, they had too little capital to withstand adverse circumstances. And the adverse circumstances were the severe downturn in housing, the decline in house prices, and the rising default rate on mortgages. I don’t know of anyone who early enough was saying that there would be a major national decline in house prices, so I can’t hold them to that standard, but I can hold them to a standard of holding adequate capital to be able to withstand unforeseen circumstances. That’s what capital is for.

FP: In 2003, you called for the government to eliminate its implied guarantee for Freddie Mac and Fannie Mae. Do you feel that Alan Greenspan, the Federal Reserve chairman at the time, didn’t listen to you?

WP: No. I never had any inkling that he disagreed with what I was saying. Greenspan was pretty much out in front also, saying we should try to scale back these companies and the implied guarantee—make them fully private companies so they’d be subject to market discipline. If Greenspan thought that I was way off base, he would have talked to me about it or had a staff member talk to me about it. That, I can attest, did not happen.

FP: Now, there has obviously been some turmoil in the banking sector. IndyMac, a regional California bank, collapsed last week. Analysts are wondering where the line is in terms of what banks are considered “too big to fail.” Where would you draw that line?

WP: I like the way that Greenspan used to put it and probably still does put it, that no firm should be too big to fail. Some might be too big to liquidate quickly and may require some support until they can be wound down, but there should be no firm too big to fail. We don’t know yet what the nature of the bailout of Fannie and Freddie is going to be, but I believe the plan would be to pay off at par all of the regular obligations. They are being turned into full faith and credit obligations of the United States government.

FP: So, what happens now?

WP: Here’s an analogy I like to use. In a formal bankruptcy, the court appoints a receiver. The receiver’s job is to, in some cases, reorganize a firm’s capital structure. Sometimes, the shareholders get wiped out and the bondholders become shareholders. Sometimes a company is liquidated and the creditors are paid according to certain legal rules. Depending on how particular credits are set up, a receiver’s job is to keep the company going long enough to obtain the maximum possible benefit for the creditors as a whole. In some cases, the company might be shut down quickly.

So that’s the analogy, and now the secretary of the Treasury is de facto in that position. But he’s operating under no established law. For the most part, everything that is now done to deal with Fannie Mae and Freddie Mac, to reorganize them financially or scale them back, is done now by negotiation between the secretary of the Treasury, Congress, and the companies. The companies have what you might call a “well-oiled political machine.” They have many members of Congress they talk to regularly who will represent their interests in this negotiation.

FP: NYU economist Nouriel Roubini, who has been sounding the alarm for quite a while, told Bloomberg News that we’re seeing the worst U.S. financial crisis since the Great Depression.

WP: I think that’s right, but let’s go back and revisit the Great Depression for a moment. In 1932, the economy was spiraling down and there were large numbers of bank failures. Eventually, in early 1933, various states started to declare banking holidays. They closed the banks and allowed them to continue to exist, but the depositors were not permitted to take any money out. They shut the doors.

When Franklin Roosevelt took office, he declared a national banking holiday. All the banks were closed, including the Federal Reserve banks. There was a total and complete collapse of the banking system, and the economy that had functioned on credit and deposits was suddenly left to function on hand-to-hand currency. We aren’t anywhere close to that and we won’t get close to that because of ample Federal Reserve resources and also intellectual understanding that would not permit that to happen. (What if the currency itself became nearly worthless? - Jesse)

FP: How bad will it get, then?

WP: We are going to have failures of large numbers of firms, financial firms in particular. A traditional important piece of business for community banks and regional banks are loans to real estate developers and builders. And now that some of those are going into default, it’s leading to failures of smaller commercial banks, and the ones that were the most heavily involved in real estate are the ones at the greatest risk. The longer these things go, the greater the depletion of capital. In time, the losses accumulate and exhaust capital and the firm fails, so the [Federal Deposit Insurance Corporation] shuts it down. It looks like there’s more of that to come, because there is no sign of a revival in home-building.

FP: Meanwhile, consumer prices are rising at their fastest rate in 17 years. Does that mean the Fed is running out of tools to keep growth going?

WP: All the financial turmoil that we’ve just been talking about—the tightening of credit, the fact that so many banks have impaired capital—that’s putting downward pressure on the economy, and the big increase in fuel prices is also putting downward pressure on real activity. You see that in transportation, the airlines, the auto industry—anything that has a big fuel cost. There is a growing amount of unemployment in those sectors, and the Federal Reserve is trying to support economic activity by holding the federal funds rate—the interest rate—at its current level. If the downturn in employment becomes much more severe, the Fed might even cut rates.
Now, to me, the inflation problem is actually part of what is depressing economic activity, because the generalized inflation that I think we have underway—although it’s not showing up in core inflation and wages just yet—is showing up in the depreciating dollar, and the depreciating dollar directly feeds through to increased energy prices and food prices. So, the depreciation itself is leading to depressed economic activity.

Moreover, if the inflation really starts to go into wages and into the core—the non-energy, non-food part—of the price indices, it will probably develop a fair amount of momentum and the Federal Reserve is not going to be able to reverse it even with a tighter monetary policy for probably a year or two, maybe even three. If the policy is too expansionary too long and we end up with a real inflation problem, all we’re doing is trading a bigger recession later for a smaller recession now. (Hell, we've been taking the easy way out of that trade off for twenty years or more. There must be a whopper of a recession just a waiting to get uncorked. - Jesse)

William Poole is the recently retired president of the Federal Reserve Bank of St. Louis.

Charts in the Babson Style Showing the Extent of the Bear Market Rally

We suggested on July 15 in our blog entry regarding bear markets and crashes that we were starting a counter-trend rally within the context of a bear market that is likely to be severe, and perhaps even provide enough decline to be called a crash.

No one can know for certain, but the rally will likely fade soon, if not already. Typically prices will run up to a major overhead resistance level and then fall back as the insiders continue to sell stocks to the 'greater fools' and raise more liquidity. Remember in a bear market its the three L's: liquidity, liquidity, liquidity.

Below are some updated charts to show the progress of the rally so far.

We also include the US dollar chart to show that despite some of the rah-rah cheerleading it is still quite weak, and has not nullified the short term H&S top that indicates a decline down to 68.30 if the neckline is broken. We are adding to our contra-dollar positions on weakness. Positions in gold and oil were sold today as part of the liquidity process we think by desperate banks and hedge funds, although we just had an option expiry for oil, and tomorrow is option expiration for stocks. The merry prankster games are in full swing even in hard times.

By the way, the accounting on some of the earnings results we saw on JPM and Wells Fargo was interesting to say the least. Citibank may provide the same balance sheet maneuvers tomorrow. Merrill was a disaster after hours today. This is not over, not even close, not even halfway, despite the smokescreen being generated by the Fed.

And the announcement by the SEC to ban naked short selling on the financials is a selective enforcement of market rules. Its is embarrassing that they provide this level of attention only after it affect a certain class of investors and stocks. It is a disgrace in an ongoing series of disgraceful lapses by the US market regulators.

Philly Fed Report Reveals an Unmistakable and Serious Stagflation

The outsized financial sector in the US continues to weaken the real economy by over-utilizing intellectual and capital resources, and twisting public policy to its own greedy benefit. Even worse, the efforts of the co-opted and corrupted central planning bureaucrats and politicians to support, rather than reform, the financial sector is triggering a nasty monetary inflation and just making our problems worse.

Things will not improve until fundamental reforms are made in the market processes which have become distorted over the past thirty years by the wealthy elite and Wall Street financial corporations.

The political process in the US needs new blood, new outlook, a new respect for the protection of the Constitution, and politicians less saddled down by special interests, favors, and past bad behaviour that allows others to control them. We can send Washington a message.

You have been played for a fool. Get over it, and do something. Send the pampered politicians packing. They have turned our trust into their personal trough. The first step will be to vote almost all Republicans and the Democratic leadership out of office in the fall elections.

The skeletons in their closets have become anchors on the Republic.

Manufacturing in Philadelphia Region Shrank in July
By Courtney Schlisserman

July 17 (Bloomberg) -- Manufacturing in the Philadelphia region shrank in July for an eighth straight month as orders and employment sank. (The Philly Fed report is an important bellwether for the national manufacturing report, and a key barometer of the real economy - Jesse)

The Federal Reserve Bank of Philadelphia's general economic index "improved" to minus 16.3 from minus 17.1 in June, the bank said today. Negative readings signal a decline. The measure averaged 5.1 last year. (The quotation marks on 'improved' are mine. That is not an improvement. It is a statistical flucuation in an undeniable and serious contraction in activity, but it was also 'worse than expected' which they forget to mention until later - Jesse)

The housing recession, now in its third year, has depressed demand for building equipment and materials and hurt consumer spending. Demand may keep slowing in coming months after the government finishes distributing tax rebate checks, indicating factories won't rebound.

''We're going to continue to see declines in manufacturing output,'' said Kevin Logan, senior market economist at Dresdner Kleinwort in New York, in an interview with Bloomberg Television. ''As manufacturers see the final demand for their products go down and inventories go up, they have to slow production and that means less employment.''

Economists forecast the gauge would improve to minus 15 this month, according to the median of 56 projections in a Bloomberg News survey. Estimates ranged from a minus 22 to minus 5.

Another report today showed builders began work in June on the fewest single-family homes in 17-years, signaling the real- estate recession continues to deepen. A change in the building code in New York led to a jump in construction of condos and apartments in the Northeast that unexpectedly propelled overall housing starts up 9.1 percent, the Commerce Department said.

More Claims

First-time claims for jobless benefits rose last week, the Labor Department also reported. Rising benefits reflect a weakening job market.

The Philadelphia Fed's measure of new orders was little changed at minus 12.1 from minus 12.4 last month. The shipments measure dropped to minus 8 from minus 6.7.

An index of prices paid climbed to 75.6, the highest level since 1980, from 69.3. A gauge of prices received decreased to 28.8 from 29.7, the Philadelphia Fed report showed.

''The pricing numbers are important too because it indicates that we're in a period of stagflation,'' said Dresdner's Logan. In the 1970's, the U.S. had 10 percent inflation and 10 percent unemployment, he said. Now, ''we're looking at 5 percent unemployment and 5 percent inflation. It's a sort of stagflation light.'' (Too bad the numbers are seriously dampened by government antics. Its more like 10 and 10 - Jesse)

Boosting Prices

U.S. Steel Corp., the second-largest U.S.-based metal producer, will boost prices for flat-rolled steel by $40 to $1,100 a ton, to pass on rising costs, two people familiar with the matter said July 11.

Fed Chairman Ben S. Bernanke told lawmakers in semiannual testimony earlier this week that inflation risks have ''intensified.'' At the same time, he dropped his June assessment that risks to the economic expansion had diminished, indicating policy makers aren't ready to raise interest rates to contain prices.

The Philadelphia Fed index measuring the manufacturing outlook for the next six months dropped to 18 from 21.3. (The outlook is negative - Jesse)
Today's report follows one by the New York Fed earlier this week that showed manufacturing in that state shrank less than forecast this month.

Exports

International demand has helped some factories keep running, preventing production from falling as much as in past economic downturns. The U.S. trade deficit narrowed in May as exports increased 0.9 percent, the Commerce Department said on July 11.

The Institute for Supply Management's factory index averaged 49.3 in the first six months of this year. During the 2001 recession, it averaged 43.5. Readings less than 50 signal contraction.

The Fed reported yesterday that industrial production rose 0.5 percent in June, more than forecast, helped by a jump in utility output and increased manufacturing of autos and computers.

Some manufacturing companies are prospering. Allegheny Technologies Inc., a metals maker that supplies Boeing Co., earlier this week boosted its profit forecast for the second quarter.

Allegheny is benefiting from ''our product, market, and geographic diversification,'' Chief Executive Officer Pat Hassey said in a statement.

Bear Market Rallies

"We wished to make this post on a day in which the markets started to rally, so as to give readers the latitude to exit their long positions gracefully should they choose to do so, and not leave them in a panic, which is not necessary nor productive." Jesse July 15

Bear market rallies, or 'relief rallies,' are sharp upward spikes in prices on the US equity markets.

They are fed by short covering. Those who are short, or have positions based on the assumption that the stock market is going lower, are forced to buy stocks either from fear of losses, or because they are undercapitalized and overleveraged. The leverage may be in terms of time (as in the case of stock options) or money (margin).

The bear market rally consists of a violent opening spike. That spike will be up to the nearest strong overhead resistance as the short sellers panic. Then the market will pull back, because there are no serious buyers yet to sustain the prices, and the early shorts have covered. Also, insiders will begin to feed their dog stocks into the public markets.

The prices will pull back to the nearest support. Once the bulls feel confident again, the buying will resume, this time more slowly as naive speculators begin to succumb to the 'good news.' The highwater mark of the opening price spike will be a definite target for this secondary move higher.

Often the initial effort to find support fails, and the bullish sentiment will pull back and try to find stronger support from which to resume the price advance.

Very infrequently there is a 'failure to rally' and a failure to find support at a near support level. Buyers (also known as 'the greater fool') are not to be found, and the dip buyers panic, and a freefall ensues. This also can be quite breath-taking, as the insiders are selling not buying, and the small speculators are exhausted and starting to panic. This is an uncommon event, but can be quite damaging if you are caught on the wrong side of it. This is how we came up with the term 'chasing nickels on the freeway' to describe it. Buying the dip in price in bull markets is easy money; buying the dip in bear markets is for gamblers.

The way we keep our orientation in these market events is to take a slightly longer time perspective. We like to watch the hourly futures chart, rather than the customary ten minute charts watched by daytraders. We also like to plot the support and resistance levels not only on the hourly charts, but also on the daily charts and keep a close eye on them. Why? Because this is how you know if you are still in a bear market or not. Are the longer term trends still in place?

The best way for most traders to play these markets is to stay out. The opportunity to be whipsawed is very high. Take a break. Go for a walk. The market will always be there. The greed of 'lost profits' pulls you back in, and then fear will take you out, on a stretcher if you are not careful.

Controlling one's emotions in volatile markets is the primary challenge for experienced traders.

Bear market rallies can be quite impressive. Wall Street insiders feed these rallies with stories and 'good news.' The financial reporters and many well-meaning people will go along with this because they wish to be optimistic, for any variety of reasons. Fundamentals can mean little in the short term in financial markets. Although in the longer term markets are 'efficient discounting mechanisms', in the short term a market is more like a tug-of-war, or a rugby scrum, dominated by the biggest players with the most money.

These are the trend corrections in which short term traders can make some very tidy profits, and insiders can unload more of their underperforming stocks on the unsuspecting public. The government and other officials are often complicit because they are seeking to calm the public and avoid a panic, so they will take whatever 'good news' they can get.

There is an ethical if not legal question involved. When does avoiding a panic become leading people into losses and bad decisions? If a major tsunami was approaching the eastern coast of the US, would the government be justified in hiding that fact, in telling people to stay in their homes near the coast, to 'avoid a panic?' We hope to see this tested in the courts in the next few years, in particular with regard to the financial news media and chief market strategists.

The way we are playing this market today, just as an example, is to add to some long positions in contra dollar plays on weakness (gold, Swiss franc and other instruments in bull markets), scalp profits from the primary trend of the equity markets, and to spend a little time with the kids, go for a walk, work outside, while we wait for this cycle of greed and fear to subside. (PS. We went into the close on the short side because we approached the end point of a classic short term rally. If we advance further tomorrow we will pull them back. - Jesse)

SEC Kicks Over Financial Stock Manipulation Rocks and Finds... Goldman Sachs

An earlier and related story from April: Secret of Bear Stearns demise revealed: Competitor Goldman Sachs started the run on the bank


Goldman Is Queried About Bear's Fall
By Kate Kelly and Susanne Craig
July 16, 2008
The Wall Street Journal

Goldman Sachs Group Inc. is the envy of Wall Street, navigating the credit crisis relatively deftly as many of its peers have been battered.

Now, the big securities firm has come under suspicion, at least from the chiefs of two rivals who have questioned in recent months whether Goldman, even indirectly, might have put pressure on their firms' stocks.

Alan Schwartz, who headed Bear Stearns Cos. when it collapsed in March, has pointedly asked Goldman Chief Executive Officer Lloyd Blankfein whether there was any truth to talk that in the days preceding Bear Stearns's fall, traders in Goldman's London office manipulated the struggling firm's stock, according to a person with knowledge of the conversation.

Lehman Brothers Holdings Inc. CEO Richard Fuld Jr., whose firm's shares also have been battered, also has contacted Mr. Blankfein. "You're not going to like this conversation," Mr. Fuld told Mr. Blankfein, according to people familiar with their talk, but he was hearing "a lot of noise" about Goldman traders who allegedly spread negative rumors about Lehman. In recent months, Mr. Fuld has contacted traders he felt may have been bad-mouthing his stock, according to someone familiar with the matter. Spreading rumors one knows to be false with the intention of manipulating a public company's price is illegal.

Mr. Blankfein was taken aback by the inquiry from Mr. Schwartz, according to a person with knowledge of the discussion, even though the former Bear Stearns CEO was quick to add that he didn't believe Mr. Blankfein would ever knowingly tolerate misconduct. Mr. Blankfein responded that he had no knowledge of any alleged manipulation, this person said, adding that he told Mr. Schwartz he would respond severely if he ever discovered such behavior by Goldman traders. Through a spokesman, the Goldman CEO says he doesn't recall the conversation with Mr. Schwartz.

Goldman strongly denies wrongdoing. "We went out of our way to be supportive of Bear and were rigorous about conducting business as usual," spokesman Lucas van Praag said. He said Goldman never altered its terms for doing business with Bear, even as lenders pulled their financing and some trading partners retreated during the troubled securities firm's struggles in early March.

The SEC investigation into Bear's collapse partly involves trading documents, which have been reviewed by The Wall Street Journal. The documents indicate that in the weeks before March 16, when Bear Stearns reached its initial agreement to sell itself to J.P. Morgan, Goldman Sachs International, which encompasses the firm's European trading units, was one of the most-active parties in trading securities known as credit default swaps that it had bought from or sold to Bear Stearns -- more than most other Bear trading partners.

Goldman Sachs Asset Management, the money-management division, exited a number of swaps on behalf of clients, the documents show. Mr. van Praag said it would be unwise "to make assumptions about this information without understanding the underlying transactions." He said Goldman's international unit handles trades "around the world, on behalf of clients" as well as for Goldman itself.

The documents show that a handful of other prominent firms cut their exposures to Bear Stearns, including Chicago hedge fund Citadel Investment Group and New York hedge fund Paulson & Co., which is run by a Bear Stearns alumnus.

Dozens of similar securities known as interest rate swaps, originally bought from or sold to Bear Stearns, were exited by Fairfax International Investments Ltd., a unit of Citadel, and transferred to another internal unit, Citadel Equity Fund Ltd., on March 3. An additional 40 or so credit default swaps were exited separately by Citadel Equity Fund; those contracts were taken on by a variety of other brokers. About 40 trades were exited by the hedge fund Paulson, primarily during the week of March 10, when Bear Stearns nearly ran out of cash.

In recent weeks, SEC investigators have questioned Citadel about its moves to unload complex securities contracts it had either bought or sold from Bear Stearns in early March, according to people familiar with the matter. Citadel executives have explained the moves as having been part of a long-planned restructuring in which certain holdings were transferred from Fairfax to another internal entity, these people say.

Senior people at Paulson & Co., run by former Bear Stearns executive John Paulson, have told associates that the swaps bought or sold from Bear during the March 10 week, most of which were transferred to Goldman, were part of the firm's overall effort to curb exposure to financial-services firms.

Comparison of the Market Declines of 2000-1 and 2007-8

This comparison is the number of days from the market high.

SEC Issues Emergency Rule on Short-Selling Financials

How thoughtful of the SEC to come to the aid of the primary dealers, the Wall Street banks, after virtually ignoring the naked short selling problem in the markets for the past eight years.

SEC to fight short selling of financials
By Joanna Chung in New York
July 15 2008 21:31
Financial Times

US regulators will take emergency action to stop abusive short-selling of stock in financial institutions such as mortgage financiers Fannie Mae and Freddie Mac and investment bank Lehman Brothers.

Christopher Cox, Securities and Exchange Commission chairman, told legislators on Tuesday that the agency would issue an emergency rule to stop so-called “naked” short-selling of shares in significant financial entities. The SEC will also consider new rules to extend those trading limits to the rest of the market.

Short sellers aim to profit from share declines – usually by borrowing a stock, selling it and buying it back in the market. But in a “naked” short the shares are sold without being borrowed first. The emergency rule, which would be in effect for up to 30 days, would require anyone making a short sale to borrow the security first.

It would apply to Fannie and Freddie – the government-sponsored entities that own or guarantee almost half of US mortgages – and all primary securities dealers including Lehman, whose shares have been battered by rumours the bank says are false.

The action comes amid intensifying efforts by authorities to crack down on rumour-mongering intended to manipulate securities prices. The SEC has been investigating whether false rumours and abusive short selling contributed to the collapse of Bear Stearns in March and the declines in Lehman’s shares.

It is now working with the Financial Industry Regulatory Authority and New York Stock Exchange Regulation to conduct industry-wide “sweep examinations” of market participants, including hedge fund advisors

“If we are successful in bringing future cases . . . I believe the penalties should be commensurate with the enormous amount of shareholder value that is destroyed by this kind of wantonness toward other people’s money,” Mr Cox said. The agency has used emergency rule-making powers in the past, for instance after the September 11 terrorist attacks, but this would be the first time it has issued an emergency rule on short selling.

Fannie Mae and Freddie Mac closed down 27.3 per cent and 26 per cent respectively.

US Treasuries Default Spreads "Surge to Record"

U.S. Treasuries' debt protection costs jump to record
Fri Jul 11, 2008 2:26pm EDT

NEW YORK (Reuters) - The cost to insure U.S. Treasury debt against default surged to a record on Friday on fears that the U.S. government may need to put capital into mortgage finance companies Fannie Mae and Freddie Mac, adding to government debt levels.

Investors are worried about increased Treasury debt supply after a report that the U.S. government may be considering a takeover of the country's two biggest mortgage finance companies.

The cost to insure Treasury debt with credit default swaps jumped to 16.5 basis points, or $16,500 per year for five years to insure $10 million in debt, from 8 basis points on Thursday, an analyst said.

Credit default swaps are used to buy protection against the likelihood of a borrower defaulting on its debt and to speculate on an issuer's credit quality. Protection costs rise when people become more concerned about an issuer's credit quality.

The 10-year Treasury note was trading 1-1/32 lower in price for a yield of 3.93 percent, up from 3.80 percent late on Thursday, while the 2-year note was 8/32 lower to yield 2.55 percent, up from 2.41 percent.

Debt protection costs on U.S. government debt are now higher than those for Germany, which trades at 9.5 basis points, and are trading at similar levels as Japan and the United Kingdom, which are around 16.5 basis points, the analyst said.
(Reporting by Karen Brettell; editing by Gary Crosse

The Stock Market Crash of 2008-10 is Well Underway Led by the Financial Sector

"The period of financial distress is a gradual decline after the peak of a speculative bubble that precedes the final and massive panic and crash, driven by the insiders having exited but the sucker outsiders hanging on hoping for a revivial, but finally giving up in the final collapse." Charles Kindleberger

We wished to make this post on a day in which the markets started to rally, so as to give readers the latitude to exit their long positions gracefully should they choose to do so, and not leave them in a panic, which is not necessary nor productive.

As a reminder, market 'crashes' are notoriously difficult to predict, and the fallibility of our judgement is acknowledged. There is not even a clear distinction between a crash and a severe correction, except that 'crashes' are thought to be short term, and are precipitants to bear markets. We think that the credit bubble has 'crashed' taking the financial sector and the housing sector with it. As it spreads, that will be the 'bear market.'

This is our opinion based on the facts at hand. If you read it through you will understand our reasoning, and may choose to agree or not.

It is not clear to us that once begun that 'crashes and bear markets' must inevitably play out to a pattern. There is a great deal of difference for example between the declines of 1987 and that of 1973-4, or 1929-33 and 2000-2. Sometimes they are over quickly, and sometimes they are protracted.

We suspect that the Treasury and Fed have more plans in their playbook, and we wish them well. Perhaps this event can be turned, or mitigated to a more graceful correction. But we are assuming a very defensive posture, and you may consider doing the same for yourself once you look at the charts.

Those of us that can remember such things will recall that in the tech bubble contraction of 2000-2 it was the big cap NASDAQ that led the way lower, well ahead of the other US equity markets, with a much deeper correction.



By almost any measure and definition, the US financial index has crashed as part of the credit bubble contraction.



The tech bubble was more isolated from the rest of the economy, whereas the credit bubble seems to permeate almost every aspect of the US economy. We expect this crash to be more pervasive and with a much more lasting impact on the real economy.

The financial markets seem to be leading the way for the credit bubble contraction and the Crash of 2008-10.



Please keep in mind that the deleveraging of a bubble is almost never a straightforward excercise, and even the worst decline, such as the Crash of 1929 and decline into the bottom of the Great Depression in 1933, was marked by sharp rebounds and bear market rallies.

We believe that our CrashTrak model has confirmed we are in a stock market crash. We expect the declines to at least rival those of the last Crash which we had in 2000-2, and perhaps that of 1929-33, barring some explosive growth in monetary inflation that will distort the statistics.

The stock market is of less importance we think than the real economy and employment levels. We expect the Fed and Treasury to push the Dollar to the limit in trying to prevent a destructive collapse in the real economy, and again, wish them well in this effort.

Blatant Market Manipulation Is a Distinct Moral Hazard

Our personal view is that one or two big trading desks just gave the futures markets a broad 'gut check' in commodities and stocks, selling oil and gold and silver, and buying equities.

Anyone who says that such things do not occur, often with an air of feigned sophistication and objectivity, is either naive or a poseur.

The 'game' is to dump a huge position into a particular market, driving down the price and running stop loss orders and small speculators and funds out, creating a short term drop in price and then buying back the positions at a cheaper price and pocketing the gain.

This scheme can be used over both short and long periods of time. Its is an old game, going back before even the great market 'pools' of the 1920's that set up the environment for the Crash of 1929 and the Great Depression.

The SEC remains blissfully asleep at the switch during the general looting of the country by the financial interests. The state of the silver market in the US under the guidance of the CFTC is a disgrace.

As traders we can live with it, but as citizens and parents we are appalled. It creates a general atmosphere of lawlessness and cynicism and amorality. It spawns larger and more sophisticated con games like Enron and collateralized debt, as the big financial houses become more greedy and emboldened. It is a source of corruption and decay in the politicial system. It corrupts regulators, politicians, and even the media.

It is one of the reasons why Glass-Steagall was enacted back in the 1930s, to prevent this predation by the large national banks using federally insured depositors funds and privileged access to cheap Federal Reserve funds as the instruments of their common cheats and frauds.

PBS: the RCA Stock Pool

The New York Times
Citigroup Regrets Bond Trades in Europe
By HEATHER TIMMONS
September 15, 2004

Citigroup told employees on Tuesday that it regretted executing a $13.5 billion bond trade that has raised the ire of rival traders in Europe and led to an investigation by regulators in Britain.

In an memorandum to all 40,000 employees of Citigroup's global corporate and investment bank, the chief executive for global capital markets, Thomas G. Maheras, said the trade was an "innovative transaction, that sought to access the liquidity in the European bond markets," but that it "did not meet our standards."

As a result, "we regret having executed this transaction," he said.

The bond sale, executed Aug. 2, caused widespread concern in Europe's markets. Citigroup sold 11 billion euros ($13.5 billion) of European government debt within minutes, mainly through electronic trades, then bought some of it back at lower prices less than an hour later, rival traders say.

Though the trades were not illegal, they angered other bond houses, which said the bank violated an unspoken agreement not to flood the market to drive down prices.

Citigroup "failed to fully consider its impact on our clients, other market participants and our regulators," Mr. Maheras said in the memo...

Citigroup Regrets Bond Trades in Europe

Net Asset Value of Certain Gold and Silver Funds and Trusts

IndyMac Second Largest Failure - 10,000 Depositors Uninsured for $1 Billion

"Some 10,000 depositors had funds in excess of the insured limit, for a total of $1 billion in potentially uninsured funds," the FDIC said.

Government shuts down mortgage lender IndyMac
By Alex Veiga
Associated Press

IndyMac Bank's assets were seized by federal regulators on Friday after the mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures.

The bank is the largest regulated thrift to fail and the second largest financial institution to close in U.S. history, regulators said.

The Office of Thrift Supervision said it transferred IndyMac's operations to the Federal Deposit Insurance Corporation because it did not think the lender could meet its depositors' demands.

IndyMac customers with funds in the bank were limited to taking out money via automated teller machines over the weekend, debit card transactions or checks, regulators said.

Other bank services, such as online banking and phone banking were scheduled to be made available on Monday.

"This institution failed today due to a liquidity crisis," OTS Director John Reich said.

The lender's failure came the same day that financial markets plunged when investors tried to gauge whether the government would have to save mortgage giants Fannie Mae and Freddie Mac.

Shares of Fannie and Freddie dropped to 17-year lows before the stocks recovered somewhat. Wall Street is growing more convinced that the government will have to bail out the country's biggest mortgage financiers, whose failure could deal a tremendous blow to the already staggering economy.

The FDIC estimated that its takeover of IndyMac would cost between $4 billion and $8 billion.

IndyMac's collapse is second only to that of Continental Illinois National Bank, which had nearly $40 billion in assets when it failed in 1984, according to the FDIC.

News of the takeover distressed Alan Sands, who showed up at the company's headquarters in Pasadena, Calif., to find out when he could withdraw his funds.

"Hopefully the FDIC insurance will take care of it," said Sands, of El Monte, Calif. "I'm also kind of kicking myself for not taking care of this sooner, sooner as in the last couple of days."

A couple of dozen customers could be seen outside the building, reading fliers handed out by FDIC staff. The agency set up a toll-free number for bank customers to call.

IndyMac Bancorp Inc., the holding company for IndyMac Bank, has been struggling to raise capital as the housing slump deepens.

IndyMac had $32.01 billion in assets as of March 31.

A spokesman for the lender referred media queries to the FDIC.

The banking regulator said it closed IndyMac after customers began a run on the lender following the June 26 release of a letter by Sen. Charles Schumer, D-N.Y., urging several bank regulatory agencies that they take steps to prevent IndyMac's collapse.

In the 11 days that followed the letter's release, depositors took out more than $1.3 billion, regulators said.

In a statement Friday, Schumer said IndyMac's failure was due to long-standing practices by the bank, not recent events.

"If OTS had done its job as regulator and not let IndyMac's poor and loose lending practices continue, we wouldn't be where we are today," Schumer said. "Instead of pointing false fingers of blame, OTS should start doing its job to prevent future IndyMacs."

The FDIC planned to reopen the bank on Monday as IndyMac Federal Bank, FSB.

Deposits are insured up to $100,000 per depositor.

As of March 31, IndyMac had total deposits of $19.06 billion.

Some 10,000 depositors had funds in excess of the insured limit, for a total of $1 billion in potentially uninsured funds, the FDIC said.

Customers with uninsured deposits could begin making appointments to file a claim with the FDIC on Monday. The agency said it would pay unsecured depositors an advance dividend equal to half of the uninsured amount.

During a conference call with reporters, FDIC Chairman Sheila C. Bair said the agency would cover all insured deposits and then try to recover its costs by selling IndyMac's assets.

"We anticipate trying to market the institution as a whole bank," Bair said. "How much money we derive from that will depend on who gets paid what."

Holders of unsecured IndyMac debt may not fully recover their investment, Bair said.

"Generally if a creditor is secured, they are at the top of the claims priority," she said. "If they are unsecured, they're pretty low on the claims priority and probably will take some type of haircut with this, but we have not had a chance to do a thorough analysis to know ... how extensive those losses will be."

IndyMac spent the last two weeks trying to reassure customers that it was not near default.

On Monday, IndyMac announced it had stopped accepting new loan submissions and planned to slash 3,800 jobs, or more than half of its work force - the largest employee cuts in company history.

In the letter to shareholders, IndyMac Chairman and Chief Executive Michael W. Perry said the drastic measures were made in conjunction with banking regulators to improve the company's financial footing and "meet our mutual goal of keeping Indymac safe and sound through this crisis period."

The plan was supposed to generate roughly $5 billion to $10 billion per year of new loans backed by government-sponsored mortgage companies, Perry said at the time.

But the run on its deposits ultimately short-circuited the strategy, prompting regulators to take action Friday.

Associated Press writer Raquel Maria Dillon in Pasadena contributed to this report.

Treasury Proposes 'Unlimited Stake' in Freddie and Fannie

Paulson Seeks Authority to Shore Up Fannie, Freddie
By Brendan Murray and Dawn Kopecki

July 13 (Bloomberg) -- Treasury Secretary Henry Paulson sought authority from Congress to buy unlimited stakes in and lend to Fannie Mae and Freddie Mac, aiming to stem the collapse of confidence in the largest sources of U.S. mortgage financing.

Paulson proposed that Congress enact legislation giving the Treasury temporary authority to buy equity ``if needed'' in the firms, and to increase their lines of credit with the department from $2.25 billion each. The Federal Reserve authorized the companies to borrow directly from the New York Fed, in a step that could provide funding before the bill is passed.

Today's announcement followed crisis talks between the firms, government officials, lawmakers and regulators, after Fannie Mae and Freddie Mac lost about half their value last week. Paulson and Fed Chairman Ben S. Bernanke are trying to prevent a collapse in the firms that would exacerbate the worst housing recession in 25 years and deepen the economic slowdown.

Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac own or guarantee almost half the $12 trillion in outstanding U.S. mortgages. As lenders retreated from the housing market, they have grown to account for more than 80 percent of the home loans packaged into securities.

Freddie Mac is scheduled to sell $3 billion in short-term notes tomorrow, and Paulson's comments indicate a growing concern that a crisis of confidence may take hold if investors balk. The companies issue debt to raise money for their purchases of mortgage securities.

Action This Week

Paulson spoke with congressional leaders and is confident that lawmakers will be able to add the measures in an existing housing bill and enact the package this week, a Treasury official told reporters on a conference call. The temporary authority granted to the Treasury may be for 18 months, the official said on condition of anonymity.

The plan would give Paulson power to buy an unspecified amount of stock in Fannie Mae and Freddie Mac, the official said. He also said he didn't recall any time in the past when the government has taken an equity stake in either company.

Paulson also proposed that the Fed get a ``consultative role'' overseeing the companies' capital requirements. The Fed said in a separate statement that the New York Fed was approved to make direct loans to Fannie Mae and Freddie Mac at the discount rate, currently 2.25 percent, charged to commercial banks.

Facing White House

The Treasury chief read his statement before cameras on the Bell Entrance of the department's building in Washington, facing the White House. The unusual step illustrated the significance of today's proposals.

Debt sold by Fannie Mae and Freddie Mac ``is held by financial institutions around the world,'' Paulson said in the statement. ``Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets.''

Freddie Mac shares tumbled 47 percent in New York Stock Exchange composite trading last week and Washington-based Fannie Mae lost 45 percent of its value, forcing Paulson two days ago to issue a statement of support for the companies in their ``current form.''

``Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer,'' Paulson said.

The government-chartered, publicly traded companies have already raised $20 billion to cover losses amid the highest delinquency rates in at least 29 years. Freddie Mac said earlier this month it planned to sell $5.5 billion of equity after it reports earnings next month.

To contact the reporter on this story: Brendan Murray at brmurray@bloomberg.netDawn Kopecki in Washington at dkopecki@bloomberg.net

Last Updated: July 13, 2008 18:29 EDT

Paulson Statement on Freddie and Fannie

US Treasury Plan to Inject $15 Billion Into Ailing Freddie and Fannie for Special Shares Class

Its liquidity, but its just not enough, so even if we do get a bounce on the news on Monday we will consider selling it.

The Sunday Times
US Treasury rescue for Fannie Mae and Freddie Mac
Treasury secretary looks at $15 billion cash injection for crisis-hit mortgage lenders
Iain Dey and Dominic Rushe
July 13, 2008

US TREASURY secretary Hank Paulson is working on plans to inject up to $15 billion (£7.5 billion) of capital into Fannie Mae and Freddie Mac to stem the crisis at America’s biggest mortgage firms.

The two companies lost almost half their market value last week as rumours of a government bail-out swept the stock markets, hammering share prices around the world.

Together, the two stockholder-owned, government-sponsored companies own or guarantee almost half of America’s $12 trillion home-loan market and are vital to the functioning of the housing market.

The capital-injection plan is said to be high on a list of options being considered by regulators as a means of restoring confidence in the lenders. The move would protect the American housing market, but punish shareholders in both companies.

Under the terms of the proposed move, the US government would receive a new class of shares in exchange for the capital, which would be hugely dilutive to shareholders.

The potential rescue comes as investors are braced for more bad news from the financial sector. Citigroup is expected to reveal further writedowns of at least $8 billion with its second-quarter results, and Merrill Lynch is forecast to reveal writedowns of some $4 billion.

Both banks are expected to post sizeable losses for the second quarter, and reveal plans to sell off billions of pounds worth of assets.

A number of US regulators and politicians have been attempting to restore confidence in the two mortgage agencies.

Paulson and President George Bush stepped in to give vocal support to the two firms on Friday. “Freddie Mac and Fannie Mae are very important institutions,” said Bush, adding that he had spoken with Paulson who had “assured me that he and Ben Bernanke [the Federal Reserve chairman] will be working this issue very hard”.

Paulson killed off speculation that the government would renationalise the two agencies, a move that would have pitched the US public accounts into a new state of crisis.

However, Paulson pledged to support the two companies “in their current form”. He is said to have been concerned about the prospect of a rescue plan benefiting shareholders.

The capital injection would also see both lenders granted permission to use the Federal Reserve’s discount window - a short-term emergency funding source.

Freddie Mac has a $3 billion short-term funding line that comes up for renewal tomorrow. The short-term debt is one of the hundreds of funding lines that the two agencies use.

The funding lines allow Freddie and Fannie to buy mortgages from America’s commercial banks, which it then sells on to bond investors through securitisations. A government guarantee on the company’s debts allows it to raise money cheaply, making mortgages cheaper to finance for US banks.

Some in Wall Street believe a rescue plan may be announced ahead of tomorrow’s US market opening to calm nerves and support the debt auction.

Howard Shapiro, a Wall Street analyst at Fox-Pitt Kelton, said: “I think it will happen over the weekend. There will be government action but it will be far short of the dire scenarios that people are envisioning.” He said there was “no question” that the two firms were fundamentally sound.

He added that Paulson would have to move in order to “change the psychology” of the market and put Fannie and Freddie back on a stable footing.

David Buik, partner at BGC Partners, said: “These agencies are the backbone of financial society in the US. They simply cannot be allowed to fail, and the government won’t allow them to fail. Whatever the solution is to this problem, I can’t imagine it will be good for shareholders.”

He added: “In London we may see a dead-cat bounce on Monday, especially if we get a rescue. But that’s all it will be - shares may pop up 50 points or so, but then they will head down again.”

In the UK markets, HBOS will this week complete its £4 billion rights issue in a move that could see underwriters Morgan Stanley and Dresdner Kleinwort lumbered with more than £1 billion of the bank’s stock.

More than 13% of the HBOS shares in issue have been sold short by hedge funds - a bet that the bank’s share price will fall.

Bradford & Bingley will also put its lifesaving £400m rights issue to a shareholder vote.

Robert Parkes, UK equity strategist at HSBC, said: “It’s a seller’s market - we’re generally advising clients to sit on the sidelines until all the current issues blow over.”

Periods of Financial Distress: the Swinging Dow

Periods of Financial Distress are also periods of significant swings in market price and sentiment, often intraday. Here is a list of the largest intraday swings in the Dow Jones Industrial Average by points and by percents.

We can vividly recall one day in July 2002 when the Dow was down over 600 points and a short term bottom was made, when the money honey herself Maria Bartiromo bared her milky neck and pursed her lips to say 'capitulation,' at which point the Dow turned right around and we had a buying panic rally that took us back into the green in the period of about an hour.

Here is a chart of that period, that significant market bottom.



Here is a view of the same market bottom showing the two month lead into it.



Here is the 2000-2002 bear market shown with an SP 500 chart, from the second high in September 2000 which the SP made after the initial 2000 decline



Here is the list of the biggest intraday swings in the DJIA which we received from Barry Ritholz.



For reference, here is the decline in the SP 500 from the recent market top in October 2007

Periods of Financial Distress

As regular readers will remember, we have a mathematical model of 'periods of financial distress' called CrashTrak. We bring it out in market moments in which we have had a long ramp up to a decided market peak, and then a decline that achieves at least 10 percent. We gave an initial nod to the developing crash scenario which we are now in back in January of this year.

Crash: the Rally that Fails as a Hallmark of Major Market Dislocations

Market 'crashes' are low probability events that are notoriously difficult to predict accurately. CrashTrak did predict the tech crash of 2000-2. Unfortunately we were not able to forecast the great stock market reflation of 2003-2007 which the Fed had engineered until it was well underway.

This points out the weakness of using technical analysis in forecasting markets priced in fiat currencies that can be used to mask the actual market dynamics of real values, especially if the deflators and actual rates of inflation have also been rendered opaque. Simple models that worked in the past may not work in this environment of economic obfuscation.

Nevertheless, it can be used successfully if one couples technical analysis with fundamental analysis. The movements on a stock chart are an abstraction that represents an underlying marketplace of individual transactions. There are other ways to assess these transactions to obtain enough data to forecast a 'crash,' again reminding the reader that forecasting a low probability event is notoriously difficult. The flow of money in the market is one of these tools which we use, and is listed on a number of the charts which we provide almost every day.

We will be publishing updates of CrashTrak now that we have reached a second threshold of probability with the dip of the major indices below the -20% decline from the top level again.

The underlying mechanics of crashes is interesting and informative. Here is one of the best descriptions of how a crash happens that we have found, quoted in a paper by Barkely Rosser. For those of you who are students of market dislocations, Charles Kindleberger is a 'must read.'

Falling from the Period of Financial Distress into the Panic and Crash

In 1972, Hyman Minsky described the "period of financial distress," in a paper in a journal that no longer exists (Reappraisal of the Federal Reserve Discount Mechanism, vol. 3, pp. 97-136), "Financial Instability: The Economics of Disaster."

Charles P. Kindleberger picked up on this and followed Minsky's analysis in his famous book, Manias, Panics, and Crashes: A History of Financial Crises... The period of financial distress is a gradual decline after the peak of a speculative bubble that precedes the final and massive panic and crash, driven by the insiders having exited but the sucker outsiders hanging on hoping for a revivial, but finally giving up in the final collapse.

According to Appendix B of Kindleberger's 2000 edition, 37 of the 47 great historical speculative bubbles exhibited such a period before the final crash...

Federal Regulators Take Over IndyMac After a Run on the Bank

Reuters
Regulators to run IndyMac until buyer found
By John Poirier and Rachelle Younglai
Friday July 11, 8:10 pm ET

WASHINGTON (Reuters) - Banking regulators on Friday swooped in to take over mortgage lender IndyMac Bancorp Inc, the second-largest bank failure in U.S. history and the fifth bank to close this year.

The Federal Deposit Insurance Corp estimated the cost of the California-based bank's failure to its $53-billion insurance fund at between $4 billion and $8 billion and will run the bank while it looks for a buyer.

The takeover of IndyMac capped a tumultuous day for U.S. financial markets that saw stocks slide on a surging oil price and renewed fears about the stability of the top two home financing providers, Fannie Mae and Freddie Mac.

IndyMac's primary regulator, the Office of Thrift Supervision, blamed comments by New York Democratic Sen. Charles Schumer for causing a run on the deposits at the largest independent publicly traded U.S. mortgage lender.

Schumer responded quickly on Friday, blaming the OTS for not doing its job and for letting IndyMac's loose lending practices continue.

The OTS said depositors have been withdrawing cash at an elevated pace since late June, when Schumer questioned IndyMac's ability to survive the housing crisis.

In the following 11 business days, depositors withdrew more than $1.3 billion from their accounts, the OTS said.

"This institution failed today due to a liquidity crisis," OTS Director John Reich said. "Although this institution was already in distress, I am troubled by any interference in the regulatory process," he said.

The successor bank run by the FDIC will open for business on Monday. Over the weekend, depositors will have access to their funds by ATM, other debit card transactions, or by writing checks. They will have no access via online banking and phone services until Monday.

Earlier in the week, IndyMac said it was unable to raise new capital, would slash staff by 60 percent and had stopped making home loans. Its stock slid precipitously in the past week and last traded at 28 cents on the New York Stock Exchange, down 95 percent from the beginning of the year.

The FDIC insures up to $100,000 per deposit and up to $250,000 per retirement account at insured banks.

At the time of closing, IndyMac had about $1 billion of potentially uninsured deposits held by about 10,000 depositors. The FDIC said it would pay those depositors an advance dividend equal to 50 percent of the uninsured amount.

OTS told a conference call with reporters that it did not expect significant market impact from IndyMac's closure as the firm is not a systemic institution and does not have numerous counterparties. Reich also said he did not expect a larger thrift to fail.

Former FDIC official Ann Graham said it was not unprecedented for the FDIC to start running a bank after it fails. "It happens when they need to move more swiftly with the closing than they can move with a potential sale," said Graham, a law professor at Texas Tech University.

"They don't have to sell the institution over the weekend," she said. "They have the time to shop around." (Put it on Craigslist - Jesse)

Graham said the FDIC has the authority to operate an institution for two years but expected the agency will dispose of it much sooner than that.

(Reporting by John Poirier, Karey Wutkowski, Rachelle Younglai; Editing by Toni Reinhold and Braden Reddall)

US Dollar Long Term Chart with Commitments of Traders as of July 8 Market Close

US Dollar Weekly Chart with Moving Averages



Ugly Selloff in the Long Bond - Continuation with concurrent Dollar and Stock declines Implies 'Capital Flight' from dollar financial assets

Charts in the Babson Style for Market Close 11 July 2008

The market action was technically volatile and ugly, with a strong downside bias. The Russell 2000 Chart shows a definite divergence to the upside and the best hope for the bullish case.

Today with the simultaneous declines in the major US stock indices, the Treasury long bonds, and the US dollar we had the first indication that capital flight might be occurring. We'll have to see that continue next week to start regarding it as a trend.

Fed Denies Talks with Fannie and Freddie about Discount Window

According to Bloomberg, the Fed just came out (after the close of trading of course) and denied that they had talks with Fannie and Freddie regarding opening the discount window for their use.

Reuters had a story in the afternoon to that effect, which sparked a sharp short-covering rally in Fannie and Freddie.

Personally we thought that they already had access to the Discount Window, considering who is bellying up to that bar already. If investment banks and Countrywide Financial, why not mortgage lenders?

But it just goes to show how these markets are. Today was some vicious trading, strictly a double black diamond slope. We loved it, but its really not a fruitful activity for the real economy.

Fannie and Freddie are Levered Up Like Hedge Funds (or any Wall Street Bank)

NOW he says something about it.

Snow Says Fannie Mae, Freddie Mac Followed `Hedge Fund' Model
By Brendan Murray

July 11 (Bloomberg) -- Former U.S. Treasury Secretary John Snow said that Fannie Mae and Freddie Mac have relied on leverage to fund their businesses in the same fashion as a hedge fund, and that the government should avoid taking them over. (Yep, so did the big banks too. It was a real party and Greenie was supplying the moonshine and goofballs - Jesse)

``Congress ought to be embarrassed'' for years of delays in passing legislation aimed at strengthening regulation of the two companies," Snow, now chairman of New York-based buyout fund Cerberus Capital Management LP, said in a telephone interview. He said he flagged when in office that ``the business model they were using was really the model of a hedge fund.'' (Then why didn't you do or say anything about it then you old fart-in-a-bucket? - Jesse)

The government-chartered companies, which grew to account for almost half of the $12 trillion in U.S. mortgages, were able to borrow at cheap rates because of an implicit federal guarantee, Snow said. His opposition to a full government takeover echoes the signal sent today by his successor, Treasury Secretary Henry Paulson. (They will point the finger of blame at everyone except the real ringleaders, the Wall Street banks - Jesse)

``The most important thing is that the systemic risks that those institutions present get dealt with,'' Snow said. ``They play such an important role in the secondary mortgage markets, but it's coming at such a high cost in terms of potential blowup of the whole financial system.''

Paulson has urged Congress to pass legislation setting up a new, strengthened regulator of Fannie Mae and Freddie Mac. Senator Christopher Dodd, the Connecticut Democrat who chairs the Senate Banking Committee, said in a press conference today that he expects legislation including the measure to be sent to President George W. Bush for signing next week. (

`Not Be an Option'

Paulson said in a statement today he wants the companies to remain in their ``current form.'' Snow agreed that ``nationalization should not be an option.''

Snow, who served at the Treasury from February 2003 to June 2006, said because Fannie Mae and Freddie Mac operated under federal charters, there's an implied guarantee of their debt that shouldn't exist. He said during his Treasury tenure he pointed out the two were ``arbitraging their lower borrowing costs that came about because of the implied status as government entity.''

Fannie Mae and Freddie Mac make money by borrowing in the bond market and reinvesting the proceeds in higher-yielding mortgages and securities backed by home loans.

Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default, implying the government will stand behind the companies' debt.

`Fundamental Problem'

``If I were in a public policy role, I'd be focusing attention on what has long been known to be the fundamental problem of risks to the balance sheet of the United States that are gigantic,'' Snow said.

In October 2003, Snow and Fannie Mae's then-Chief Executive Franklin Raines debated in a Senate hearing whether the Treasury should have the authority over new loan products. At the time, the government-sponsored enterprises were under scrutiny from the Treasury and other regulators to because of errors in accounting.

``Congress should not open the door for the regulator to prescribe, outside the necessities of safety and soundness oversight, how the enterprises conduct their business,'' Raines said. Snow said the new regulator was needed to ensure financial stability, adding that ``We don't face in my view any current crisis, but we never want to get close to the point where we would face that problem.''

Snow said today that ``even in the face of the scandals over compensation and accounting and the options and bonuses, we never could get Congress to cross the line.''

Fannie Mae and Freddie Mac ``have an enormous political organization, lots of reach into many congressional districts, and they had a storyline that at the time worked -- they were really promoting housing,'' he said.

To contact the reporter on this story: Brendan Murray at brmurray@bloomberg.net

In Times of Crisis Remember the "Three L's"

Liquidity, Liquidity, Liquidity.

Your size makes you more 'agile' than the big players who will urge you to stay invested, to hold your ground.
Your weakness is that information is not being given to everyone in the market at the same time.

No debt. Liquidity. But where to keep it?

That's the challenge.

We like hard currencies, short term Treasuries, cash, and gold and silver.
The time to buy equities will be coming, but not quite yet.

But that's just our opinion, and we could be wrong.

Housing Bubble Collapse Deals a Serious Blow to Middle Class Retirees

'At this festive season of the year, Mr Scrooge,' said the gentleman, taking up a pen, 'it is more than usually desirable that we should make some slight provision for the Poor and destitute, who suffer greatly at the present time. Many thousands are in want of common necessaries; hundreds of thousands are in want of common comforts, sir.'

'The Treadmill and the Poor Law are in full vigour, then?' said Scrooge.

'They are. Still,' returned the gentleman,' I wish I could say they were not.'

'Are there no prisons?"

'Plenty of prisons,' said the gentleman, laying down the pen again.

'And the Union workhouses.' demanded Scrooge. 'Are they still in operation?'

'Both very busy, sir.'

'Oh. I was afraid, from what you said at first, that something had occurred to stop them in their useful course,' said Scrooge. 'I'm very glad to hear it.'

Sorry, we needed your Social Security taxes to bail out Wall Street.

Whiners.


Housing Market Meltdown Will Cause Massive Losses in Household Wealth
Plummeting house prices will leave millions of homeowners dependent almost exclusively on Social Security in their retirement

Center for Economic and Policy Research
July 9, 2008

WASHINGTON, DC- As Senators McCain and Obama fine-tune their plans for Social Security in preparation for the 2008 presidential election, a new report from the Center for Economic and Policy Research (CEPR) shows that, due to the collapse of the housing bubble, the vast majority of Americans have accumulated little or no wealth. This means that they will be almost completely reliant on Social Security and Medicare to support them in their retirement years.

The study, “The Impact of the Housing Crash on Family Wealth,” analyzed the wealth holdings of families in all age cohorts in 2004 and projected the wealth of these families in 2009. The findings are presented by income quintile under three scenarios- real house prices remain at current levels, real house prices fall by an additional 10 percent, or real house prices fall by an additional 20 percent. In all three scenarios, the vast majority of these families will have little or no housing wealth in 2009.

“This extraordinary destruction of wealth will have tremendous implications for millions of families,” said report co-author Dean Baker. “Coupled with a very low personal savings rate, this means that many people, especially those near retirement will only have Social Security and Medicare to rely on once they leave the workforce.”

The report projects that if house prices stay the same through 2009, the median household headed by a person between the ages of 45 and 54, those in their prime earning years, will have 24.7 percent less wealth than did the median household in this age group in 2004. These households will have accumulated just $113,268 in net worth in 2009, barely $15,000 more than their counterparts in 1989, whose net worth totaled $97,600.

If real house prices fall 10 percent, the median household in the 45 to 54 cohort will see a 34.6 percent loss in wealth compared with the median in 2004 while families in the 18 to 34 cohort will lose of 67.6 percent. If prices fall by 20 percent, the most pessimistic scenario, families in the 55-64 cohort will experience a loss of 49.6 percent of their wealth compared to the same cohort in 2004.

This analysis should also prompt serious re-examination of policy proposals to cut Social Security and Medicare for near retirees. Baker commented, “policies that perhaps could have been justified at the peak of the housing bubble make much less sense now that tens of millions of near-retirees have just seen most of their wealth disappear.”

In analyzing wealth holdings for these families, the authors used data from the Federal Reserve Board’s 2004 Survey of Consumer Finance. The authors also used the S&P 500 and the Case-Shiller 20-City Composite Index to adjust for equity values and home price changes between 2004 and 2009.

Contact: Alan Barber, (202) 293-5380 x 115

There is No Recession, the US is just a " Nation of Whiners" - Phil Gramm

This is from Phil Gramm who has been an active participant in bringing us into our current financial crisis.

Stop whining you guys. Stop whining about high prices, corrupt politicians, and dying in foreign wars for the personal enrichment of a few crony capitalist insiders. Stop whining about lost jobs, government lies, and a financial system that has become nothing but a con game.

Time to get out the tar and feathers instead.

And vote every Republican and the Democratic 'do nothing' leadership out of office this fall.

That will be good for openers.

How Phil Gramm Helped to Destory the US Financial System

McCain Disagrees With 'Whiners' Remark
By LIZ SIDOTI,AP
2008-07-11 09:11:18
AOL News

FAIRFAX, Va. (July 10) -- Republican John McCain distanced himself from an economic adviser who dubbed the United States "a nation of whiners" in a "mental recession" as Democrat Barack Obama turned the remarks against his rival.

"I strongly disagree" with Phil Gramm's remarks, McCain told reporters in Belleville, Mich. "Phil Gramm does not speak for me. I speak for me." (Phil Gramm is McCain's chief economic advisor - Jesse)

The Republican presidential hopeful said a person who just lost a job "isn't suffering from a mental recession."

"America is in great difficulty. And we are experiencing enormous economic challenges as well as others," McCain said, seeking to stem the fallout of Gramm's comments.

Gramm, a former Texas senator who is a vice chairman of the Swiss bank UBS, made the remarks in an interview with The Washington Times. Gramm has a doctorate in economics.

In Virginia, Obama seized on the comments as he tried to paint McCain as out of touch: "America already has one Dr. Phil. We don't need another one when it comes to the economy."

He drew cheers and laughter with that comment referencing television psychologist "Dr. Phil" McGraw — and boos and hisses when he read Gramm's quotes to his audience. He contrasted them with rising gas and food prices, home foreclosures and job layoffs.

"It's not just a figment of your imagination," Obama said at a town-hall event focused on helping women advance economically. "Let's be clear. This economic downturn is not in your head."

"It isn't whining to ask government to step in and give families some relief," he said, drawing a standing ovation from the nearly 3,000 people in a high school gymnasium. "And I think it's time we had a president who doesn't deny our problems or blame the American people for them but takes responsibility and provides the leadership to solve them."

The economy is the top issue for voters, and, thus, has become the No. 1 issue in the presidential campaign. Each candidate is seeking to portray the other as out of touch with the country's struggles and himself as the leader able to pull the nation out of tenuous times.

Gramm's quotes in the Washington newspaper gave McCain heartburn and Obama an opportunity.

"You've heard of mental depression; this is a mental recession," Gramm told the Times. He noted that growth has held up at about 1 percent despite all the publicity over losing jobs to India, China, illegal immigration, housing and credit problems and record oil prices. "We may have a recession; we haven't had one yet."

"We have sort of become a nation of whiners," Gramm said. "You just hear this constant whining, complaining about a loss of competitiveness, America in decline" despite a major export boom that is the primary reason that growth continues in the economy, he said.

Associated Press writer Charles Babington in Michigan contributed to this report.

US Considers Nationalizing Fannie and Freddie

July 11, 2008
U.S. Weighs Takeover of Two Mortgage Giants
By STEPHEN LABATON and STEVEN R. WEISMAN
New York Times

WASHINGTON — Alarmed by the growing financial stress at the nation’s two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan said on Thursday.

The companies, Fannie Mae and Freddie Mac, have been hit hard by the mortgage foreclosure crisis. Their shares are plummeting and their borrowing costs are rising as investors worry that the companies will suffer losses far larger than the $11 billion they have already lost in recent months. Now, as housing prices decline further and foreclosures grow, the markets are worried that Fannie and Freddie themselves may default on their debt. (At one time we estimated the money market funds exposure to Fan and Fred at about 8%. It most surely is much lower now just because of their price collapse. But just how secure are those 1.00 NAVs? - Jesse)

Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers. (Social Services for banks are our highest priority - Jesse)

The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.

The officials also said that such a step would be ineffective because the markets already widely accept that the government stands behind the companies. (But not with an overly wide stance - Jesse)

The officials involved in the discussions stressed that no action by the administration was imminent, and that Fannie and Freddie are not considered to be in a crisis situation. (When will they be in a crisis, when their stocks go to zero? When the Republicans leave office in disgrace? - Jesse) But in recent days, enough concern has built among senior government officials over the health of the giant mortgage finance companies for them to hold a series of meetings and conference calls to discuss contingency plans.

A conservatorship or other rescue operation would be the second time in four months that the Bush administration has stepped in to engineer a rescue to prevent the financial system from collapsing. Last March, it forced the sale of Bear Stearns to JPMorgan Chase to avert a bankruptcy of that venerable investment house. (Maybe the banks could consider private savings plans instead of relying on the government? - Jesse)

Officials have also been concerned that the difficulties of the two companies, if not fixed, could damage economies worldwide. The securities of Fannie and Freddie are held by numerous overseas financial institutions, central banks and investors.

Under a 1992 law, Fannie or Freddie could be put into conservatorship if their top regulator found that either one is “critically undercapitalized.” A conservator would have sweeping powers to overhaul them, but would not have the authority to close them.

The markets showed fresh signs on Thursday of being nervous about the future of the companies. Their stock prices continued a weeklong slide, hitting their lowest level in 17 years. The debt markets, meanwhile, pushed up the two companies’ cost of borrowing — their lifeblood for buying mortgages.

The companies are by far the biggest providers of financing for domestic home loans. If they are unable to borrow, they will not be able to buy mortgages from commercial lenders. In turn, that would make it more expensive and difficult, if not impossible, for home buyers to obtain credit, freezing the United States housing market. Even healthy banks are reluctant to tie up scarce capital by offering mortgages to low-risk home buyers without Fannie and Freddie taking the loans off their books.

Together the two companies touch more than half of the nation’s $12 trillion in mortgages by either owning them or backing them. They hold more than $1.5 trillion of the mortgages as securities. Others are sold to investors in the form of mortgage-backed bonds.

In recent weeks, the companies have spiraled downward, undermined by declining confidence in their future and shaken by sharp declines in their assets as the housing markets have continued to slide and foreclosures have risen.

In the last week alone, Freddie has lost 45 percent of its value, and Fannie is off 30 percent. Expectations of default at the companies have also risen; it costs three times as much today to buy insurance on a two-year Fannie bond as it did three years ago.

Analysts expect the companies to announce a new round of write-downs and possibly be forced to raise capital by issuing additional shares, which would dilute their value for current shareholders.

Despite repeated assurances from regulators about the financial soundness of the two institutions, financial markets have concluded that by some measures they are deeply troubled.

Freddie, for instance, is technically insolvent under fair value accounting rules, in which the company puts a market value on assets as if it had to sell them now.

Although Treasury Secretary Henry M. Paulson Jr. and Ben S. Bernanke, the chairman of the Federal Reserve, passed up invitations by lawmakers on Thursday to seek legislation to deal with the crisis, officials said that the administration had been privately considering a government takeover should the markets continue to turn against the companies.

At a hearing of the House Financial Services Committee on Thursday, both Mr. Paulson and Mr. Bernanke were guarded, carefully trying not to say anything that could further erode confidence in Fannie and Freddie. They both said that the regulator of Fannie and Freddie had found that they were, in the words of Mr. Paulson, “adequately capitalized,” meaning that they had sufficient cash and other assets to withstand the turbulence in the markets.

“Fannie Mae and Freddie Mac are also working through this challenging period,” Mr. Paulson said.

Neither official would address a question posed by Representative Dennis Moore, Democrat of Kansas, who asked whether the failure of either institution would pose a risk to the financial system.

“In today’s world I don’t think it is helpful to speculate about any financial institution and systemic risk,” Mr. Paulson said. “I’m dealing with the here and now, and the important role that they’re playing and other financial institutions are playing.”

Mr. Bernanke said that Fannie and Freddie “are well-capitalized in the regulatory sense” but added that they, and other major financial institutions, needed to raise their capital levels further.

Despite repeated denials by officials in the Bush and prior administrations, financial markets have long assumed the government would stand behind Fannie Mae and Freddie Mac in times of difficulty, both because they are integral to the housing and financial markets and because the companies have a line of credit to the Treasury.

But Congress set that credit more than 38 years ago, long before the companies rose to such size and prominence, and its limit, $2.25 billion for each, has become a tiny fraction of the companies’ overall debt.

Some analysts have begun to propose that the Fed also permit the two companies to borrow from it, as Wall Street investment banks began doing after the rescue of Bear Stearns. But there is no indication that the Fed is contemplating such a move....

Charles Duhigg and Jenny Anderson contributed reporting from New York; Michael Cooper from Livonia, Mich.; and David M. Herszenhorn from Washington.

The Dow Transport Average Composition by Sector

They say one picture is worth a thousand words (and a big thanks to TheContraryInvestor for the chart. His weekly reports are invaluable.)

Here is why the slumping airlines do not affect the Dow Transports Index significantly.

We do not understand the rationale, but we were quite surprised to see how little they contribute to it.

Fannie and Freddie are 'Insolvent'

The Banks have always disliked Fannie and Freddie, in the way that rival criminal crews are sometimes in conflict, sometimes cooperating in an uneasy truce. Greenspan, as the voice of Banking, always sought to limit Fannie and Freddie even while he was urging wild abandon with just about every other form of credit and regulatory restraint, from hedge funds to credit derivatives to Glass-Steagall.

Allowing the Fed a greater role in regulation is a major policy mistake by almost any measure. They are private, they are opaque, they are controlled by special interests, they are not answerable to the people except on occasional visits to the relatively clueless Congress.

Fannie, Freddie `Insolvent' After Losses, Poole Says
By Dawn Kopecki
Bloomberg

July 10 (Bloomberg) -- Borrowing at Fannie Mae, the U.S. government-sponsored mortgage company, has never been so expensive and it may not get better any time soon.

Fannie Mae paid a record yield relative to Treasuries on the sale of $3 billion in two-year notes yesterday amid concern the biggest provider of financing for U.S. home loans won't have enough capital to weather the worst housing slump since the Great Depression. The company's credit-default swaps show traders are treating the AAA rated debt as if it were five steps lower. Fannie Mae shares tumbled 13 percent yesterday in New York to the lowest level in almost 14 years.

Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules, he said. The fair value of Fannie Mae's assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, Poole said.

``Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,'' Poole, 71, who left the Fed in March, said in the interview yesterday.

Fair value accounting measures a company's net worth if it had to liquidate all of its assets to repay liabilities. Fannie Mae and Freddie Mac, both of whom have the implicit backing of the government, make money by borrowing in the bond market and reinvesting the proceeds in higher-yielding mortgages and securities backed by home loans.

`Inflection' Point

Lawmakers in Washington may question Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson at a 10 a.m. hearing today about the financial health of the companies and whether they jeopardize the financial system. (This will be interesting to watch, to see how these jokers spin this - Jesse)

``At some point we're going to reach that inflection, where the government is going to have to either guarantee explicitly or Fannie and Freddie are going to have be left to fend for themselves,'' Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York, said in an interview with Bloomberg Television. ``We're getting to that point where a decision has to be made by Washington.''

The plunge in Fannie Mae and Freddie Mac yesterday in New York Stock Exchange trading led financial shares to their biggest decline in six years and sent the Standard & Poor's 500 Index into its first bear market since 2002. Fannie Mae, which dropped $2.31 yesterday, rose 41 cents to $15.72 in Frankfurt trading today. Freddie Mac, which declined $3.20 yesterday, rose 24 cents to $10.31 as of 9:25 a.m.

`Well-Capitalized'

The government is counting on Fannie Mae and Freddie Mac, which own or guarantee about half the $12 trillion in home loans outstanding, to help revive the housing market. Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger ``jumbo mortgages'' to spur demand for home loans as competitors fled the market.

Paulson said on July 8 he was pleased with Fannie Mae and Freddie Mac's efforts to raise capital. Bernanke said the same day the firms need to be ``strong, well-regulated, well- capitalized'' to provide credit ``without posing undue risks to the financial system or taxpayer.''

The Treasury has been discussing what to do if Fannie Mae and Freddie Mac fail for months as part of its contingency planning, the Wall Street Journal reported today, citing three people familiar with the matter. The government doesn't expect the companies to fail and it doesn't have a rescue plan in place, the Journal said.

`Long-Time Critic'

``We are managing our business and maintaining a capital position that will allow us to fulfill our congressionally chartered mission now and in the future,'' Brian Faith, a spokesman for Fannie Mae, said.

Poole is ``a long-time critic,'' said Sharon McHale, a spokeswoman for McLean, Virginia-based Freddie Mac.

``Freddie Mac is doing exactly what Congress intended when it chartered the company and, more recently, when it passed the Economic Stimulus Act,'' McHale said. ``We are well capitalized and positioned to continue to serve our vital housing mission.''

While leading the St. Louis Fed, Poole roiled markets in 2003 when he said the government should consider severing its implied backing of Fannie Mae and Freddie Mac and said the companies lack the capital to weather financial market disruptions. In 2006 and 2007 he called for lawmakers to strip Fannie Mae and Freddie Mac of their charters.

Government Ties

Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default.

The government will likely be forced to take over the companies because of the mortgage meltdown, Poole said. (The monetization of that debt should provide a nice kick to the inflation already underway - Jesse)

``We know in a crisis the Federal Reserve tap would be open,'' said Poole, now a senior fellow at the Cato Institute.

The bailout of Bear Stearns Cos. by JPMorgan Chase & Co., arranged by the Fed, demonstrates the government's unwillingness to allow ``large, systemically important'' financial institutions to fail, he said. Bear Stearns collapsed after customers fled amid speculation the company faced a cash shortage.

``I worry about those institutions,'' retired Richmond Fed President Alfred Broaddus said. ``They are huge. They dwarf the Bear Stearns issue. In the very worst case scenario, I don't know how you do it other than extend money and the public takes the loss.''

$20 Billion Raised

Fannie Mae and Freddie Mac have raised a combined $20 billion since December to cover losses of more than $11 billion generated since the credit crisis began last year. Freddie Mac has yet to raise a planned $5.5 billion, scheduled for mid-year.

The companies have access to the Fed's so-called Fedwire payments system allowing them to access funding if needed, said Vincent Reinhart, the Fed's chief monetary-policy strategist from 2001 until September 2007.

They can withstand the slump in part because most of their investments are mortgages made before 2006 when lending standards were tighter, making them less likely to default, said Eileen Fahey, a Chicago-based analyst at Fitch Ratings.

``We do not believe they are technically insolvent,'' Fahey said. ``People seem to lose sight of the fact that a majority of the mortgages that they are holding and are guaranteeing were originated pre-2006.''

Default Swaps

Comments by the companies' regulator this week that they are adequately capitalized also eased concern, said Lawrence Yun, chief economist of the National Association of Realtors in Washington. The companies have about $80 billion of regulatory capital supporting $5.2 trillion of mortgages.

``Just given the size of the two companies, surely the government would not stand aside'' and let them fail, Yun said.

Fannie Mae sold $3 billion of two-year notes yesterday to yield 74 basis points more than Treasuries. A basis point is 0.01 percentage point. That's the widest spread since Fannie Mae first sold two-year notes in 2000 and triple what it paid in June 2006.

The price of credit-default swaps, contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac, doubled in the past two months to more than 80 basis points for the senior debt, according to London-based CMA Datavision.

The median credit-default swap on debt rated Aaa by Moody's was 26 basis points as of July 8, data from the credit rating firm's strategy group show. It was 76 basis points for debt rated A2.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net; Shannon D. Harrington in New York at sharrington6@bloomberg.net.

Last Updated: July 10, 2008 04:15 EDT

Charts in the Babson Style for Midweek 9 July 2008

Another bounce back up to retest that neckline will not be surprising. If it fails again the bulls may be in real trouble.

Fitch Puts Merrill Lynch on Negative Credit Watch

Fitch says may cut Merrill Lynch debt rating
Wed Jul 9, 2008
12:22pm EDT

NEW YORK, July 9 (Reuters) - Fitch Ratings said on Wednesday it may cut Merrill Lynch & Co Inc's debt rating due to expected ongoing write-downs and diminished prospects for earnings.

Merrill's rating was the only one placed on review for downgrade as Fitch completed its evaluation of investment banks, affirming the ratings of Lehman Brothers, Goldman Sachs, and Morgan Stanley.

Fitch now rates Merrill "A-plus," the fifth-highest investment grade and the same as Lehman's rating, while Goldman Sachs and Morgan Stanley are rated one notch higher at "AA-minus."

Fitch said Merrill's exposure to mortgage-backed debt and downgraded bond insurers at the end of the first quarter was significant relative to its peers and expressed concerns about the level of the brokerage's long-term debt maturing over the next 12 months.

The rating firm said it expects the No. 3 Wall Street investment bank to report a fourth consecutive quarterly loss on July 17. It cited losses in fixed income, currency and commodities operations, which may "overwhelm" income from the better-performing retail brokerage, private client and equities businesses.

Just like its rivals, Merrill faces declining investment banking business opportunities due to the current negative credit environment, Fitch added.

"These reduced revenue opportunities, coupled with Merrill's ongoing negative mark-to-market adjustments, significantly constrain the company's earnings prospects," Fitch said in a statement.

The world's largest brokerage has recorded more than $30 billion of write-downs since the third quarter of last year and Wall Street analysts forecast up to $6 billion of additional charges in the second quarter.

To offset those write-downs, Merrill Chief Executive John Thain is widely expected to raise capital by selling assets, which could include the company's stakes in BlackRock Inc (BLK.N: Quote, Profile, Research, Stock Buzz) and Bloomberg LP. For details, click on [ID:nN09380419]

Fitch said monetizing these assets could generate "incremental capital," adding that current market conditions also limit attractive sales opportunities for other assets.

Although Merrill has over $80 billion in excess liquidity at the parent company level to cover unanticipated cash needs and has broad access to retail and institutional investors, Fitch expressed concerns about its funding profile. Merrill faces $73 billion of long-term debt maturing over the next 12 months, according to Fitch.

"Fitch believes the investor base may be becoming saturated and financial flexibility may be more limited in the future. Satisfying additional capital needs with more equity or unsecured term debt may prove costly," the rating firm said.

Fitch said the rating outlook on Lehman and Morgan Stanley is negative, while Goldman's is stable. The outlook indicates the likely direction of the rating in one to two years.

Reporting by Anastasija Johnson, Editing by Dan Grebler

Economics in Disrepute as the Economy Tumbles

The failure of the central bankers and economists to 'manage the economy' is nothing new. One only has to look at the mainstream economic 'forecasts' in 1929 and 1930 to realize that not only is economics not a precise science, but too often economists are nothing more than mouthpieces for vested interests, and dabbling in politics and public policy in the guise of science.

Yes, there are a few notable exceptions. We are speaking of the economics profession. Roger Babson was such an exception in 1929, being dismissed by his establishment peers as gloomy and a crank...until he was proven all too correct.

On September 5th, 1929, he gave a speech saying "Sooner or later a crash is coming, and it may be terrific". Later that day the stock market declined by about 3%. This became known as the "Babson Break". The Crash of 1929 and the Great Depression soon followed.

A new school of economics will likely rise out of the coming financial collapse of the US, as it did in the 1930s. Perhaps this one will be more scientific, less subservient to private business interests and political objectives. This may be a long process, as with the other sciences.

But until that time it is good to realize that much of the discussion of macro-economics is nothing more than public policy and personal philosophy, with a strong dose of financial bias. Economists can prove just about any hypothesis since the data is so abundantly malleable, the relationships so uncertain, the experiments virtually non-replicable in any practical timeframe, the consequences often unintended, and the methods so imprecise and subjective.

For the sake of our country, stop the Fed from increasing its opaque power to regulate and control our economy. They have made a botched job of it, and show no signs of improvement beyond serving the needs of their special interests and the wealthy elite. Our security is in checks and balances, review and transparency, fair discussion and disclosure. The would-be wizards and sorcerer's apprentices of the Fed are none of these.


When the going gets tough, economists go very quiet
They're happy to take the credit in the good times, but the disciples of this false science are hard to find as recession looms
Simon Jenkins
The Guardian
Wednesday July 9, 2008

So the Footsie has tumbled again. Forgive me for asking, but where are the economists? As the nation approaches recession, an entire profession seems to have vanished over the horizon, like conmen stuffed with cash, and thousands left destitute behind. They said recessions were over. They told politicians to leave things to them and all would be fine. Yet they failed to spot the sub-prime housing crash, and now look at the mess. (In the US they have the nerve to demand that the power of regulation be given to them in the person of the Fed - Jesse)

When I studied economics we were told we would be masters of the universe. Ours was not a dismal but a noble science. It had harnessed the verities of maths to those of human behaviour and would go on to conquer politics. Rampant recession would go the way of hyperinflation. Like leprosy and cholera, they were epidemics that modern medicine had rid from our shores.

It did not matter if the economists were welfare Keynesians such as Myrdal, Robinson and Galbraith or free-marketeers such as Marshall, Friedman and the Institute of Economic Affairs. All were "social scientists". They claimed to have cracked the DNA of economic exchange, to have turned the base metal of money into political gold.

We believed them. We believed the Keynesians until we slumped into stagflation. We believed light-regulation capitalists such as Margaret Thatcher and Gordon Brown, that they could convert boom-bust into an upward sloping plane of glory. We believed the Bank of England when it said that, in its hands, inflation was dead and prosperity eternal. Bliss was it in that dawn to be alive - and an economist.

If Britain were now in the grip of bubonic plague, there would be all hell to pay from some profession or other. An "influential" Commons committee would be summoning the chief medical officer and subjecting him to the third degree. Why no national rat strategy? Why no crash inoculation? Why so many planning delays on plague pits?

The espionage pundits were likewise castigated for wrongly leading the nation to war against Iraq, for giving dud professional assessments on fallacious intelligence. (Not here, we've given them a pass. Oops! - Jesse) The architectural profession has taken the rap (very occasionally) for the grotesque failures of public housing in the 1970s. Climate scientists may yet be damned for the costly lunacy of new energy sources, such as wind turbines and biofuels.

Yet economics is a Teflon profession. A quarter of a century ago 364 practitioners wrote a letter denouncing the policies of the then Thatcher government as having "no basis in economic theory". They were wrong in fact and wrong in judgment. Thatcher's policies laid the groundwork for a strategic shift in the underpinning of British prosperity. There was no inquiry, no hearing, no peep of retraction or remorse.

Since then economists have flooded into government; there were roughly a thousand at the last count. What do they all do? Despite reports of demoralisation in the Treasury, that department remains the home base for public sector management through financial aggregates. During the Blair/Brown era it has held government in thrall.

Economic managers have always claimed credit for the success of Brown's Treasury regime. They have espoused quantifiable outputs, targets and delivery indicators. They invented the celebrity consultant and the maxim that only what measures matters. Above all, the economics profession (and its house journal, the Economist) was ecstatic when Brown delegated monetary control to the Bank of England. This was supposed to isolate the economy from political pressure, subcontracting the regulation of interest rates and markets.

Today we are older and wiser. Controlling the agencies of credit has proved beyond the finest professional minds in the game. Where now are the effortless pundits of the Treasury and the Bank? Where now the gilded ones of Moody's and Standard & Poor's, credit raters to the mightiest in the land? They should have stuck to goose entrails.

Alan Greenspan, former chief of the US Federal Reserve Board and a Brown adviser, is unrepentant. He recently declared that "anticipating the next financial malfunction ... has not proved feasible". There is nothing so unseeing as a wronged economist. The Bank of England's apologias over Northern Rock have been protests that regulation is a mess and government indecisive.

When muck hits fan, economists always blame politicians. They would have some justice if they did not take credit when things go right. I was always uncomfortable at the overselling of economics as a science, when it is rather a branch of psychology, a study of the peculiarities of human nature. Its spurious objectivity, manifest in its ridiculous love affair with maths, induced a "Jupiter complex", a conviction that scientific certainty, applied with enough rigour to any problem, triumphs over all.

Economic management is and always will be about politics, about the clash of needs and demands resolved through the constitutional process. The delegation of interest rates to the Bank of England worked when it ran in parallel with politics, but not any more. Now that reflation seems urgent for recovery, the system is biased against common sense, yet no politician dare tell the Bank to cut rates and risk inflation.

The newest craze is "nudge" economics, from the Americans, Richard Thaler and Cass Sunstein. They put the subject firmly among the behavioural sciences - if not the arts. Human actions are too mysterious and unpredictable to be liable to quantification and modelling. They are responsive to what the academic Paul Ormerod called "butterfly economics". Nudge steers, but does not order or plan.

This requires knowledge of the working of markets, incentives, expectations and panics. But converting micro-economics into macro has always been a dangerous game. Much has been made of the success of Spain's dirigiste banking regulators in putting security before runaway profit. But this was a triumph of politics over economics. Greenspan may laconically remark that "we can never have a perfect model of risk", but we can have alertness to risk and we can have caution.

Economics has long traded on being a science when it is not. In this it is like war. For a third of a century since the 1976 IMF crisis it has enjoyed great influence over British policy. Now it has met its Waterloo and a little humility would be in order. Once again economics must be rescued by that true master of all things, politics.

simon.jenkins@guardian.co.uk

Ratings Delusions Part Deux: Fannie and Freddie Rated Aaa but Traded A2

In economics, cognitive dissonance is an uncomfortable feeling of stress caused by holding two contradictory credit ratings or financial assessments simultaneously: one from a corrupt official source and one from your own common sense and some basic math. (SEE also US trade deficit, Non-farm Payroll Report, Consumer Price Index, and Alan Greenspan)

Fannie, Freddie Downgraded by Derivatives Traders Over Capital
By Shannon D. Harrington and Dawn Kopecki

July 9 (Bloomberg) -- Fannie Mae and Freddie Mac, ranked Aaa by the world's largest credit-rating companies, are being treated by derivatives traders as if they are rated five levels lower.

Credit-default swaps tied to $1.45 trillion of debt sold by the two biggest U.S. mortgage finance companies are trading at levels that imply the bonds should be rated A2 by Moody's Investors Service, according to data compiled by the firm's credit strategy group. The price of contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac and to protect against a default doubled in the past two months.

Traders are overlooking the government's tacit guarantee of the debt as credit losses grow and concern rises that the companies don't have enough capital to weather the biggest housing slump since the Great Depression. (The COMPANIES don't have enough capital to cover it, hell, the FED doesn't have enough money to cover that 1.45 trillion debt - Jesse) Even an implied guarantee isn't enough to convince credit investors that there's little risk to owning Fannie Mae and Freddie Mac debt, said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.

''Investors are viewing even an implicit guarantee from the government as potentially troublesome,'' Backshall said. (Investors! What about the taxpayers? Greenie kept saying that there was NO guarantee. - Jesse)

Worries that Fannie Mae and Freddie Mac may need more capital were heightened this week after Lehman Brothers Holdings Inc. released a report saying a new accounting rule may require them to raise $75 billion. Freddie Mac dropped 18 percent June 7 in New York Stock Exchange composite trading and Fannie Mae dropped 16 percent.

The companies' congressional charters provide exemption from state and local corporate income taxes and give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default. Fannie Mae spokesman Brian Faith and Freddie Mac spokesman Michael Cosgrove declined to comment.

Gap Widens

Credit-default swaps tied to Washington-based Fannie Mae's senior debt climbed 39 basis points to 74 basis points since May 1, while contracts on McLean, Virginia-based Freddie Mac's senior debt increased 40 basis points to 75, according to London-based CMA Datavision. A basis point is 0.01 percentage point.

The cost to protect the companies' subordinated debt from default has risen at a faster rate amid concern the government may not honor the subordinated debt, Backshall said. The subordinated debt of both companies is rated Aa2 by Moody's because the owners would be paid after the senior bond investors.

Credit-default swaps tied to Fannie Mae's subordinated debt have jumped 108 basis points to 195 basis points since May 1. Contracts on Freddie Mac's subordinated debt have risen 105 basis points to 193 basis points.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They were conceived to protect bondholders against default and pay the buyer face value in exchange for the underlying securities or the cash equivalent should the company fail to adhere to its debt agreements.

A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

Combined Losses

Fannie Mae and Freddie Mac, which reported combined losses of more than $11 billion, have raised more than $20 billion since December. Merrill Lynch & Co. analyst Kenneth Bruce said in a report yesterday the ''highly levered financial institutions'' will have pretax credit-related losses of $45 billion.

''Fannie and Freddie are going to have to raise more capital and nobody thinks they're going to be able to raise capital when they need to,'' said Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia. ''It's going to be very expensive.'' (When you're a congressman all your problems look like taxpayers. - Jesse)

Recouping Losses

Fannie Mae rose 12 percent and Freddie Mac gained 13 percent yesterday, recouping some losses from a day earlier, after the companies' regulator said they were adequately capitalized and Treasury Secretary Henry Paulson said they can still be a ''constructive force,'' in the economy.

The companies own or guarantee about 46 percent of the $12 trillion U.S. mortgage market. (We are so fucked. - Jesse)

''It concerns me that people sort of extrapolate well beyond what the facts are,'' James Lockhart, the director of the Office of Federal Housing Enterprise Oversight, said in an interview with Bloomberg Television yesterday.

The government is leaning on the companies to help revive the mortgage market. Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger, so-called jumbo mortgages to spur demand for home loans as competitors fled the market. (What do they call that, the 'hair of the dog that bit you?' - Jesse)

Their share of new conforming mortgages, or loans of $417,000 or less, almost doubled to 81 percent in the first quarter, Ofheo said.

The bailout of Bear Stearns Cos. arranged by the Federal Reserve in March shows the government won't allow the companies to fail, Robert Millikan, who manages $5 billion as director of fixed income at BB&T Asset Management in Raleigh, North Carolina.

''We're looking at it from a standpoint of, if the Fed is not going to allow a problem with Bear Stearns, they're certainly not going to allow a problem with Fannie and Freddie,'' Millikan said. ''With all the exposure that banks have to Fannie and Freddie, the ripple effect through the whole financial system would be unbelievable if they were allowed to fail,'' he said. (Dude, the NY Fed couldn't stand up to a default by Fannie and Freddie - Jesse)

To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Dawn Kopecki in Washington at dkopecki@bloomberg.net.

Major US Stock Indices Deflated by Gold: the Cruel Deception

Our hypothesis is that after the tech bubble collapse of 2000-2002 and the economic shock of 911, the Fed began a concerted effort to inflate the currency through an unprecedented period of negative interest rates. The result of this has been a brief return to the 2000 highs in most stocks last year except of course the techs, and a substantial bubble in debt and credit derivatives that threatens to overturn the US banking system.

Here we present a few of the US stock indices as deflated by gold, showing their true performance in 'real value' terms discounting the Fed's monetary inflation. A number of commodities could have been used the same way as deflators of financial assets, among them some of the base metals, silver, and oil.

The Fed can create only paper. Inflation does not create value, it merely masks the rot of economic stagnation, but can do so for several years if the inflation can be concealed artfully. The US has been struggling through a particularly non-productive period for most Americans in terms of real wealth production especially as expressed in the growth of savings, which has been decidedly negative.

In their irresponsible foolishness and greed the Fed and the Bush Administration have managed to transfer more wealth from the many to the few, further impeding any sustained recovery since the health of the economic body has been concetrated in a few parts of questionable productive value.

This is how we coined the term "Potemkin Economy" many years ago. It is a cruel illusion of the Fed, the Treasury, and their associates in misdirection and deception. For that is what this has been, regardless of motives or intentions. It is a disgraceful espisode in our country's history, but this is what happens when one gives themselves over to the rule of fear and greed.


Here is the Dow Industrial Average, deflated by gold. It is also known as the "Dow-Gold Ratio." Long run the ratio tends to return to 2. It seems to be well on its way.



SP 500


Russell 2000

US Stocks Rally on a Decline in OIl Prices and the Fed's Extension of Credit Facilities

Crude Oil prices declined today and the US equity markets rallied hard in the final hours as the shorts were covering and the bulls took the opportunity to buy on a spark of optimism in these deeply short term oversold markets.

Alcoa reports after the bell that it beat Earning Per Share by a penny and also exceeded revenues on estimates that have been greatly lowered. Mohawk Industries warned and was spanked after hours. VMWare is weighing on the tech sector.

We'll have to see if this is just another short covering bounce or something more profound. Follow through to the upside tomorrow to take the SP back into the 1290's is required for a firmer indication of any trend change.



Follow through in the decline of oil prices is necessary. So far its just a correction in an obvious bull market.

IndyMac to Halt Most of Its Mortgage Business and Lay Off 53 Percent of Employees

IndyMac to stop most mortgage loans and cut 3,800 jobs
By Jonathan Stempel
Monday July 7, 5:47 pm ET

NEW YORK (Reuters) - IndyMac Bancorp Inc (NYSE:IMB), one of the largest U.S. mortgage lenders, said on Monday it will eliminate 3,800 jobs and stop making most home loans after regulators concluded it was no longer "well-capitalized."

In a letter to shareholders and employees, Chief Executive Michael Perry said Pasadena, California-based IndyMac will stop accepting most applications and locking rates on retail and wholesale mortgages. IndyMac plans to honor existing rate-locked loan commitments.

The job cuts will affect 53 percent of IndyMac's 7,200 person work force and be made in the next couple of months, reducing operating expenses by 60 percent, Perry said. They are in addition to about 2,700 cuts already made this year.

Perry said regulators have directed IndyMac to follow a new business plan designed to bolster capital, but the company does not expect to raise capital "until there is more stability and less uncertainty in the housing and mortgage markets."

IndyMac plans to focus on its mortgage servicing unit, its 33-branch southern California thrift with $18 billion of deposits and its Financial Freedom reverse mortgage unit.

The company made $77 billion of mortgage loans in 2007, ranking ninth nationwide, according to the Inside Mortgage Finance newsletter.

In addition, IndyMac expects its second-quarter loss to be larger than the $184.2 million, or $2.27 per share, it lost in the first quarter. Analysts on average expected a quarterly loss of 96 cents per share, according to Reuters Estimates. IndyMac lost $896 million in the nine months ending March 31.

"It shows the environment for mortgage lending remains extraordinarily challenged," said Keith Gumbinger, vice president of HSH Associates, a Pompton Plains, New Jersey mortgage information publisher. "IndyMac had been a well- regarded player in mortgages, but given how the market is, it may be easier to restart such a business in the future than maintain one now."

Perry also said he asked IndyMac's board to reduce his base salary by 50 percent. His annual salary is capped at $1 million, a regulatory filing shows. Perry was unavailable for comment, spokesman Grove Nichols said.

IndyMac is the largest independent, publicly-traded U.S. mortgage company, following last week's roughly $2.5 billion purchase of Countrywide Financial Corp by Bank of America Corp (NYSE:BAC - News). It joins more than 100 mortgage companies to curtail lending or go bankrupt since the start of 2007.

CAUGHT UP IN MORTGAGE BOOM

IndyMac long specialized in making "Alt-A" home loans, which fall between prime and subprime in quality and which typically go to borrowers who cannot verify income or assets.

While IndyMac typically sold many loans it made, it was hit hard as mounting delinquencies and defaults caused the market for most nontraditional home loans to disappear.

IndyMac in the second half of 2007 refocused on making smaller, safer loans that it could sell to government-sponsored enterprises Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE ).

The changes, however, came too late. IndyMac said its ratio of nonperforming assets to total assets increased sixfold to 6.51 percent in the year ending March 31, as its mortgage industry market share fell to 1.7 percent from 4.08 percent.

A June 30 report by the nonprofit Center for Responsible Lending said IndyMac, like many rivals, got caught up in "the overheated atmosphere of the mortgage boom" by making too many unsuitable loans in the quest for short-term profit.

On June 27 and 28, IndyMac said it suffered a mini bank run as customers withdrew about $100 million of deposits.

The withdrawals came after Sen. Charles Schumer, a New York Democrat who chairs the Joint Economic Committee, wrote to banking regulators that IndyMac could fail. IndyMac said on June 30 that Schumer's concerns created the "wrong impression."

Reverse mortgages let people, mainly 62 years and up, borrow against equity in their homes. Advances are not taxable, and loans typically need not be repaid during homeowners' lifetimes.

IndyMac Letter to Shareholders

Charts in the Babson Style for Market Close 7 July 2008

As a reminder, the first of the Dow Industrials, Alcoa Aluminum, will be reporting quarterly earnings after the close tomorrow.

The Decline from the Market High in October 2007



The VIX as an Indicator of Significant Market Bottoms



Charts in the Babson Style

Internal Report Urges Gulf States to Rethink Their Dollar Pegs

It makes perfect sense for high growth countries to de-peg from the US dollar, since the Fed does not have the latitude to raise rates to fight inflation, and a monetary inflation is gripping most of the world, sourced by the US dollar as the world's reserve currency and its negative interest rates.

The US dollar peg could transmit a troublesome easing of monetary policy to those who peg to its currency since the US is in recession, but inflation is more of a problem in the growth countries like the BRIC and the Middle East, and to a lesser extent in Europe.

The postential downside is that this provides an all too convenient for government and economic demagogues to denounce countries that drop the peg as causing the US' problems, shifting blame from themselves and the reckless and irresponsible US banking system, its regulators, the Fed, and the corporations that have sprung up around them.

Gulf states urged to rethink dollar pegs
By James Drummond in Abu Dhabi
Sunday Jul 6 2008 14:45
The Financial Times

Abu Dhabi has reignited speculation that the United Arab Emirates may break its fixed peg to the US dollar. The UAE is one of the world's main holders of dollar-denominated assets.

In a report published at the weekend, the Abu Dhabi department of planning and economy floated the idea of tracking a basket of currencies in advance of formation of a currency union in the six-member Gulf Co-operation Council.

The department is answerable to the emirate of Abu Dhabi and is not a federal policymaking body. However, it reflects official thinking in the most wealthy of the seven statelets that comprise the UAE.

Inflation in the UAE runs at 11 per cent and is higher elsewhere in the Gulf. The dollar peg means Gulf central bankers have to match the interest rate moves of the US Federal Reserve and thus have only limited tools with which to curb inflation.

"Although the UAE has officially made it clear that it would not de-peg its currency from the flagging US dollar, international financial institutions as well as experts and analysts have maintained that the UAE would do well [to float] its currency as a means [of] curbing inflation," the report said.

Qatar and the UAE are usually thought to be the most likely states to quit the dollar peg. Speculation mounted last year that the UAE was about to break with the dollar after ambiguous comments by Sultan Bin Nasser Al Suwaidi, central bank governor, but the authorities acted to deny it.

Of the GCC states, only Kuwait manages a currency basket dominated by the dollar but it can decide its own interest rate policy. Inflation in Kuwait is lower than in the other GCC states.

"GCC states need to peg against a basket of world currencies, taking into account the latest trading patterns, which tend to be bent toward the eurozone and Asia," the Abu Dhabi department said.

"That the Gulf states continued to have fixed-dollar exchange rates, even as the dollar continues to decline, causes greater harm to the Gulf countries," it said.

Analysts did not believe a change in the UAE's currency administration was imminent, although the report clearly reflected a strand of thinking. Simon Williams, economist at HSBC in Dubai, said the report showed a preference for joint action over unilateral action.

"The case for reform of the GCC currency regimes is strong but we don't anticipate change taking place in the near-term. The report may indicate that debate is ongoing but I don't take it as a sign that change is nigh," Mr Williams said.

The UAE yesterday said that it was forgiving up to $7bn (€4.5bn, £3.5bn) in principal and arrears of Iraqi debt to help Baghdad with reconstruction. The announcement coincided with a visit to Abu Dhabi by Nouri al-Maliki, Iraqi prime minister, and with confirmation that the UAE will send an ambassador to Baghdad two years after one of its diplomats was kidnapped there.

Currency Crisis in the Dollar May Be the Next Shock - BMO Nesbitt Burns

The Bottom Line: The Latest View on the Economy
Next Shock: Currency Crisis?
by Sherry Cooper
July 7, 2008
BMO Financial Group

The malaise of the U.S. economy is palpable. Not only have sky-high food and gas prices drained consumer discretionary income, but the weak dollar has dampened travel plans and the stock market declines have exacerbated the wealth destruction coming from the housing collapse. Businesses in many sectors continue to lay off workers as earnings collapse in the auto and airline industries, banks and brokerages, housing-related retail stores or just about anything discretionary.

Consumer finances are in perilous condition, a harbinger for further declines in consumer confidence. With growth running at about a 1% annual rate in the second quarter, most of which is in net exports, the Fed would have trouble doing anything but remaining on the sidelines, despite the mounting inflation pressure.

The ECB hiked rates last week for the first time in just over a year in a pre-emptive strike against inflation. The move had been so well telegraphed that the U.S. dollar actually rallied on the news, especially after Trichet indicated he had no bias on further moves.

A recession in the U.S. is apparent, but other G7 countries are now more vulnerable than ever to a punishing slowdown as well. After a decade and a half of continuous growth in Canada and Britain, a downturn comes as a painful shock. Ontario’s economic decline portends the spreading pain. Britain appears to be following the U.S. in a downturn in housing and retailing. As in the U.S., the bad news has weakened the prospects for the incumbent political parties.

Though many are calling for the government in both Britain and the U.S. to do something to spur the economy, the rising inflation pressure ties the hands of the central banks. Moreover, the governments cannot afford more crowd-pleasing giveaways, and there is a question just how effective the U.S. tax rebates were in the first place.

In the meantime, for decades, many emerging countries have fixed their currencies against the dollar to protect economies that were small, undiversified and dependent on the United States. But they are now the engines of global growth as the G7 struggles.

The BoE and the Fed have commented that inappropriately low interest rates in countries that peg their currencies to the dollar were helping to fuel commodity price inflation. Many of the countries in the Middle East and Asia are running double-digit or record-high inflation; but central banks cannot raise interest rates in response as long as they choose dollar pegs to keep their currencies undervalued.

The sustainability of the dollar pegs hinges on the U.S. interest rate outlook. If the Fed refrains from raising rates because of economic weakness, despite the rise in inflation, pegs will come under significant further pressure. This is a pressure cooker running over the boiling point.

The Bottom Line: The world may realize that it is no longer reasonable for the dollar to be the anchor currency. If several dollar-pegged currencies were revalued, we could expect to see some panic selling in the U.S. dollar, further destabilizing the global economy.

Dr. Sherry Cooper is the Executive Vice-President, Global Economic Strategist, BMO Financial Group, and Chief Economist, BMO Capital Markets & BMO Nesbitt Burns

Banking Crisis Will Be Much More Severe Than Expected Reaching $1.6 Trillion in Losses

This weekend a story appears in the Swiss Sunday newspaper SonntagsZeitung. It is based on a confidential report from Bridgewater Associates, one of the world's largest hedge funds.

Below is our translation from the German, and the original with a link. We find it amusing that stories of this magnitude from American sources are reaching us via Europe.

Based on these estimates we are about one-fourth of the way through this financial crisis.


SonntagsZeitung
Explosive Study: The banking crisis will be much worse

Westport (USA) - The expected losses from the financial crisis will be 1,600 billions of dollars. ($1.6 trillion). So far financial institutions have only declared 400 billion. This pessimistic forecast comes from a confidential study by Bridgewater Associates, the second largest hedge fund in the world.

"We are facing an avalanche of bad assets," says the study. The biggest losses have been in the U.S. banks. "We have significant doubts that the financial institutions will be able to raise new capital in order to cover the losses," says the report.

Bridgewater Associates enjoys a first-class reputation in financial circles, and several central banks are among its customers. "Bridgewater are on the pessimistic side," says George Magnus, Senior Economic Adviser at UBS in London, "but they have been absolutely right."


Original Story in German


Brisante Studie: Die Bankenkrise wird noch viel schlimmer

Westport (USA) - Die zu erwartenden Verluste aus der Finanzkrise werden sich auf 1600 Milliarden Dollar summieren. Davon haben die Finanzinstitute bisher erst 400 Milliarden bekannt gegeben. Die pessimistische Prognose stammt aus einer vertraulichen Studie von Bridgewater Associates, dem zweitgrössten Hedge- Fund der Welt.

«Wir stehen vor einer Lawine notleidender Vermögenswerte», heisst es in der Studie. Die grössten Verluste stünden den US-Kreditbanken bevor. «Wir haben grosse Zweifel, dass es den Finanzinstituten gelingen wird, genügend neues Eigenkapital aufzunehmen, um die Verluste zu decken», schreiben die Autoren.

Bridgewater Associates geniessen in Finanzkreisen einen erstklassigen Ruf, mehrere Notenbanken zählen zu ihren Kunden. «Bridgewater sind auf der pessimistischen Seite», sagt George Magnus, Senior Economic Adviser der UBS in London, «aber sie haben absolut Recht.»

Lessons from the Panic of 1907

We have just finished reading The Panic of 1907: Lessons Learned from the Market's Perfect Storm, written by Robert Bruner and Sean Carr in 2007. It is extraordinarily well documented step by step study of one of the worst bank panics and stock market crashes in modern times. (The broad stock market declined 37% from peak to trough in less than 15 months.)

Here is an extended quote from the author's closing remarks.

"Why do markets crash and bank panics occur? Any single case study, such as the one we have presented here, is subject to a range of interpretations, and we encourage the reader to draw one's own conclusions from the foregoing narrative.

Yet we think that the story of the panic and crash of 1907 inspires consideration that major financial crises can be the result of a convergence of certain unique forces - the forces of the market's perfect storm - that cause investors and depositors to act with alarm.

The recounting of the events of 1907 suggests that the storm gathers as follows.

It begins with a highly complex financial system, whose very complexity makes it difficult for anyone to know what might be going wrong; by definition, the multiple parts of the financial system are linked, which means that trouble in one institution, city, or region can travel easily and quickly to others.

Buoyant growth in the economy makes the financials system more fragile, in part due to the demand for capital and in part due to the tendency of some institutions to take on more risk than is prudent.

Leaders in government and the financials sector implement policies that advertently or inadvertently increase the exposure to risk of crisis.

An economic shock hits the financials system. The mood of the market swings from optimism to pessimism, create a self-reinforcing downward spiral. Collective action by leaders can arrest the spiral, though the speed and effectiveness which they act ultimately determines the length and severity of the crisis."

Our own reaction is similar to theirs, excepting for some different emphasis and a slightly different slant, based on our extensive readings of other panics and crashes, including a good first hand look at the Tech Wreck of 2000.

First, almost all panics and crashes are preceded by sustained periods of artificial growth, not based on improvements in productivity, but by a false expansion in the money system, aided and abetted by speculators and financiers. Although they do not act in overt cooperation, yet there is an unmistakable collusion of purpose that occurs. It suggest to us that the impulse to benefit in this way is present in a portion of the people at all times, as there are impulses to do