The Insolvency of Lehman and the Artifice of the Deal

"It is the aim of good government to stimulate production, of bad government to encourage consumption." - Jean Baptiste Say

Here is an english translation of a story about the KDB - Lehman discussions from a Korean news agency. It provides some fascinating insights into the deal. And a follow up story that shows that the deal is not dead, but downsized.

Here is a Korea, anxious to make its mark on the global financial stage after it rebounded from the Asian currency crisis of the 1990's. The former Lehman regional manager of the Seoul office is now chairman of the KDB and is anxious to buy it for the home team. At the end of the day, the Korean government nixes the deal after they get a closer look at the books and realize that KDB is probably going to get saddled with far more debt default expense than they realized.

A senior [Korean] government official said, "After a review of its account book, we found that its [Lehman's] insolvency was serious. Then if insolvency becomes more serious, we would have to pour additional funds. But we concluded that it was too risky for the KDB to take the deal."

The fellow at KDB was no doubt disappointed that the Korean government simply said 'no' to the deal, with the best interests of their people in mind.

The Korean bankers might start working on the strategy of regulatory capture, the co-option and corruption of the legislative and regulatory functions by the industry that they oversee, in order to fully enter into the spirit of the global financial industry.

In the meantime scaling the deal down to a more 'manageable amount' is de rigeur in deal-making circles. And so the saga continues, as shown in the second story down about renewed discussions between KDB and Lehman for a presumably smaller $6 Billion investment, without it appears informing the Dr. No's in the Korean government.

KDB 'Gives Up' on Buying Lehman
Aug.22,2008 06:44 KST
The Chosun Ilbo

Negotiations for Korea Development Bank to buy a stake in Lehman Brothers, the fourth largest U.S. investment bank, have collapsed. Rumors about the impending bankruptcy of the investment bank have been circulating on Wall Street in the wake of the U.S. subprime mortgage meltdown.

KDB and Lehman executives reportedly held secret negotiations until early August but hit a snag at the last stage. KDB has now given up on buying a stake in Lehman, but there is still the chance that a civilian Korean bank will take it over.

The president of one Korean bank said it was “marvelous” that Korean firms have even negotiated to buy America's fourth largest investment bank. “This is a sea change, compared with the financial crisis 10 years ago when we begged the U.S. for help,” he added.

Lehman Brothers began trying to sound out Korean firms in June. A few Lehman executives informally visited the Korea Investment Corporation, which had earlier invested $2 billion in Merrill Lynch. After feasibility studies and a review of investment opportunities, KIC judged that the American bank was not an attractive investment target.

But Lehman approached KDB about the time KIC said no to its offer. KDB chairman Min Euoo-sung, who had been chief of Lehman's Seoul branch for three years until right before he became KDB chief in June, pushed for the takeover deal. KDB continued negotiations with a plan to take over Lehman in cooperation with several other Korean banks.

A bank executive who participated in the negotiations, said, "We believed that if we buy a world-renowned financial firm for W7-8 trillion (US$1=W1,055), it will provide important momentum for Korea's financial industry to go global.”

The two sides had reportedly agreed that even after the takeover deal, the current American management system would be maintained.

According to international news reports, the takeover price proposed in the negotiations was 50 percent higher than Lehman's book value, and talks failed because KDB felt it was too high. (In fact this was probably not the case except on the most generous of descriptions, and the fact that on one level deals are always about price.' - Jesse)

A senior government official said, "After a review of its account book, we found that its insolvency was serious. Then if insolvency becomes more serious, we would have to pour additional funds. But we concluded that it was too risky for the KDB to take the deal."

KDB kept mum on details of negotiations on grounds that talks are not completely finished and it is also considering investing in two to three other American financial firms.

Min said it was “normal that several negotiations and ruptures occur before a takeover deal is successfully completed. In the current circumstances, we can't put all our cards on the table."

South Korea watchdog not told of Lehman talks-source
1 Sep, 2008, 0830 hrs IST,
The Economic Times

SEOUL: (Reuters) South Korea's financial watchdog has not been officially informed of renewed talks between Lehman Brothers and Korea Development Bank and has no plans to take any position before pricing is known, a senior regulator source said on Monday.

The comment came after Britain's Sunday Telegraph newspaper reported that Lehman was trying to raise as much as $6 billion in a share sale to KDB that could be concluded this week.

"We haven't received any official report about the deal's specifics, including the price," said the source, who declined to be identified.

The Unbearable Lightness of Being an Investment Bank

The substance of even the largest financial constructs and empires remains exceptionally ephemeral.

"Ubi sunt qui ante nos fuerunt?"

Merrill losses wipe away longtime profits
By Francesco Guerrera in New York
August 28 2008 23:32
The Financial Times

Merrill Lynch’s losses in the past 18 months amount to about a quarter of the profits it has made in its 36 years as a listed company, according to Financial Times research that highlights the extent of the global banking crisis.

Since the onset of the credit crunch last year, Merrill has suffered after-tax losses of more than $14bn as its balance sheet has been savaged by almost $52bn in writedowns and credit-related losses.

The $14bn in losses for 2007 and the first two quarters of 2008 equal half of Merrill’s profits since the beginning of the ­decade.

Merrill had the highest ratio of credit crunch losses to historical profits among 10 US and European financial groups analysed by the FT, which included Citigroup, JPMorgan Chase, Bank of America, Morgan Stanley, Goldman Sachs, Lehman Brothers, Bank of America, Credit Suisse and UBS.

UBS, which has lost more than $15bn during the crisis, had the second-highest ratio.

UBS and Merrill – a Wall Street pioneer that revolutionised finance with its “thundering herd” of retail brokers – declined to comment.

Since taking over from Stan O’Neal in November, John Thain, Merrill’s chief executive, has sought to shed toxic assets and replenish its balance sheet by raising almost $30bn of capital.

The size of the losses at Merrill and other Wall Street firms underlines the risks of an investment banking model that relied on complex securities and cheap leverage to drive profit growth. (This sounds like a general description of the US industrial policy since Reagan - Jesse)

Analysts have questioned whether standalone investment banks such as Merrill, Lehman, Morgan Stanley and Goldman will ever top the profit levels reached during the boom in securitisation, leveraged loans and mortgage-backed products.

“The mammoth writedowns suffered by investment banks across the globe show that their business model needs to change,” said Robert Gach, head of the global capital markets practice at Accenture, the consultancy.

Merrill’s historical profits were adjusted for inflation by using a methodology from www.measuringworth.com, an academic website.

The Oil Complex Buttons Down while the NYMEX Opens Early

Most U.S. Gulf oil output shut as Gustav threatens
Sun Aug 31, 2008 9:55am EDT
Reuters

U.S. crude oil fell from a record high $147.27 a barrel in July to close at $115.46 on Friday.

The New York Mercantile Exchange on Saturday moved up Sunday's start time for electronic trading of energy contracts to 2:30 p.m. EDT from 6 p.m. EDT. (To facilitate the evacuation of the oil shorts? Or to enable the spin that its no big deal and the Strategic Petroleum Reserve will provide emergency aid? Stay tuned. - Jesse)

Katrina and Hurricane Rita that followed on its heels destroyed 124 offshore platforms, temporarily shuttered about 30 percent of U.S. refining capacity and left nearly a quarter of offshore Gulf oil production shut up to nine months later.

The Gulf provides a quarter of U.S. oil output and 15 percent of natural gas production.

Shell, the region's largest producer at 370,000 barrels of oil equivalent per day, was shutting all offshore oil and natural gas production on Saturday.

BP said it was also shutting its Gulf production on Saturday, while Exxon Mobil Corp said 5,000 barrels of oil output and 50 million cubic feet per day in natural gas production was shut by Saturday morning.

PRODUCTION CUTS

Six Louisiana refineries that process 1,305,000 barrels per day of crude oil -- 7.4 percent of U.S. refining capacity -- were closing down for the storm, while a total of 12.4 percent of U.S. refining capacity had been affected in someway.

Mississippi River traffic south of New Orleans closed at 6 p.m. CDT. Ship channels into Lake Charles in west Louisiana and Beaumont and Port Arthur in east Texas planned to shut by Sunday night, cutting off crude oil shipments to refineries.

The Louisiana Offshore Oil Port, the only U.S. deepwater port capable of offloading giant oil tankers, stopped taking crude from ships on Saturday, a spokeswoman said, but continued to supply refiners from onshore crude oil tanks.

Gustav Intensifies to Category 4 Hurricane, May Turn More Deadly

FEMA says Gustav soon to be rated Category 5 storm
Aug 30 03:34 PM US/Eastern
By JENNIFER LOVEN
Associated Press Writer

WASHINGTON (AP) - The government's disaster relief chief says Hurricane Gustav is growing into a monster Category 5 storm. The storm that hit Cuba Saturday could reach landfall along the Gulf Coast by early Tuesday.

Federal Emergency Management Agency chief David Paulison told reporters several times at a briefing Saturday that the storm was strengthening into a Category 5 hurricane.

FEMA officials said Bill Read, the director of the National Hurricane Center, interrupted an afternoon teleconference involving the agency, Gulf Coast states and the National Weather Service to say he is going to issue a special advisory statement raising Gustav to Category 5. That means winds greater than 155 mph and a storm surge greater than 18 feet above normal.

Word about the Category 5 development reached FEMA shortly before Paulison briefed reporters.

THIS IS A BREAKING NEWS UPDATE.

Courtesy of Joe Bastardi, chief hurricane forecaster for AccuWeather – www.AccuWeather.com – here is the map every investor needs to keep at his or her fingertips. It shows the hurricane path that Bastardi says would cause the greatest damage to offshore and onshore energy facilities in the U.S. Gulf of Mexico. In an interview with EnergyTechStocks.com, Bastardi called it the path of the “Ultimate Storm.”

Energy experts say the ultimate storm would send spot oil and gas prices up sharply and keep them there for an extended period unless, by some miracle, the damage inflicted was only minor. (It would probably be several days before oil company personnel could conduct a full assessment.)

GDP Second Quarter Was More Likely Negative, Perhaps Remarkably So

This excerpt is from this week's Up and Down Wall Street commentary by Alan Abelson in Barron's. It echoes what we said in this blog immediately after the GDP revision for the second quarter came out.

We subscribe to Barron's and read it every week. We recommend it as a good weekly source of market news and commentary.

People do not like to accept that the government is misleading us with the economic numbers. It shakes their faith in their leaders and the system, and it creates the problem of having to think for themselves.

However, there are times when the case is so clear you just have to say what David Rosenberg of Merrill Lynch says at the end of Alan Abelson's column.

GDP, IN COMMON PARLANCE, stands for gross domestic product, or the aggregate value of all the goods and services produced on these blessed shores. Or, at least, that's what it used to mean in those long-gone days of yore, when life was simpler and government statistics credible. These days, alas, those initials more typically signify "gross deceptive pap."

The insidious change has not gone unremarked, both in this magazine and by more than one skeptical scanner of the turgid flow of numbers flowing out of Washington. Yet purportedly professional seers, who draw handsome paychecks for sifting through the unending streams of digits and making sense of them for hoi polloi like us, deferentially pass along the official numbers unsullied by even a modicum of analysis, as if they were holy writ, especially when they're upbeat.

A case very much in point was last Thursday's revised report on second-quarter GDP, which helped spark a nice, if something less than enduring, leap forward by the stock market. The initial version released in July posited that the venerable economic barometer had risen by 1.9% -- up from the first quarter's meager 0.9% gain, but obviously no great shakes.

Comes now the so-called preliminary estimate that claims second-quarter GDP grew by a much more robust 3.3%. That was hailed by the incorrigibly constructive contingent in the Street as evidence of the resiliency (favorite word) of the economy and prompted the thinned-out ranks of investors to put their worries and their plans for an extra-long weekend on hold and pile into stocks. Hooray! Hooray!

But even a cursory look at what they're drooling over reveals pretty thin gruel. Nothing, for sure, that would cause any sentient being to start humming "Happy Days Are Here Again." For the ostensibly better GDP showing is a mirage, conjured up by the usual suspects out of smoke and mirrors.

The key here is the GDP deflator, which purports to adjust GDP for the impact of inflation; it's a curious calculation in that, contrary to its moniker, it seems designed to do the exact opposite of deflating GDP.

Thus, according to this accommodating measure (accommodating, that is, if you're determined to put a good face on a dreary report), inflation grew at an improbably restrained 1.33% in April-June. And maybe it did -- but not in the good old U.S. of A. However, obviously more important than accuracy to those doing the calculating is this simple equation: The lower the deflator, the greater the growth of GDP.

John Williams of Shadow Government Statistics, whose incisive description of the decades of willful distortion of inflation by Washington we cited a few weeks ago, points out that the supposed 1.33% increase in the second quarter would represent the lowest inflation rate in five years. Must be that plain folks stubbornly refuse to recognize the dramatic drop in inflation, because, as Phil Gramm said, we're such a bunch of whiners.

Of course, even by the government's not entirely extravagant figuring, the consumer-price index was up a hefty 8% in the latest quarter. Perhaps the computer that tallies the CPI doesn't talk to the computer that measures the deflator.

By John's reckoning, "a second-quarter year-to-year contraction of 2.9% would have been more in line with underlying fundamentals, past methodologies and the ongoing recession."

He suggests that a more telling picture of the economy's progress or lack of it is the alternative to GDP, known as gross domestic income, or GDI. It's a rough equivalent of GDP but measures the nation's income instead of production.

According to John, after adjusting for inflation, GDI in the June quarter weighed in at an anemic 0.5%, atop negative growth in the preceding two quarters -- which, as it happens, meets the popular definition of a recession.

Friday's disclosure that personal income in July suffered its biggest decline in three years doesn't exactly portend a rebound in the third quarter, and certainly didn't come as a big surprise to John, who sees the outlook for the economy remaining glum, with no early end to the banks' solvency crisis, as he terms it, nor the inflationary recession.

THE ASTUTE ECONOMY-WATCHER for Merrill Lynch, David Rosenberg, also strongly advises digesting the suspect GDP report with a "very large grain of salt." Among other things, he casts a skeptical eye on how the report treats the decline in corporate profits. (We won't keep you in suspense: The answer is: "gingerly.")

More specifically, he notes, "national-account corporate profits declined at a 9.2% rate in the second quarter." For domestic industries, he goes on, profits are down 14.4% year over year.

But according to the GDP report, domestic nonfinancial profits fell at a much sharper 22% annual rate. The reason the drop in total corporate earnings was limited to 9.2% was that, David relates, profits in the financial sector, so claims the report, surged -- get this -- at a 27% annual rate.

His wonderfully eloquent comment:

"Are you kidding me?"

Charts in the Babson Style for the Week Ending 29 August 2008

US Dollar Weekly Charts

Bank Consolidation in Germany

Expect to see this continue as the credit crises continues to batter the financial industry. The actions of the Fed and Treasury have slowed the process a bit in the US by providing individual bailout services especially for the investment banks.

The 'wild card' will be the regional banks, and the potential loss of diversity and competition in the financial services sector.

Fewer corporations are holding more of the power in the media, communications and finance. We are probably nearing the end of this long term move of centralization.


Commerzbank set to buy Allianz's Dresdner
29 Aug, 2008, 1431 hrs IST
The Economic Times

FRANKFURT (Reuters) Allianz has agreed in principle to sell its Dresdner Bank unit to Commerzbank, a source familiar with the situation said on Friday, a deal that will fuse Germany's second- and third-biggest banks.

Commerzbank plans to take an initial 51 percent stake in Dresdner, then buy the remaining 49 per cent at a later stage, the source said.

Commerzbank had no comment. Allianz was not immediately available.

Lower Prices Send Sales of Physical Gold 'Skyrocketing' in India

Although it is tempting to view charts as abstractions with their own sets of rules, we need to remind ourselves occasionally that they are merely representations of the interactions of price with supply and demand in real markets as part of the price discovery process.

The lower price of gold in New York and London has caused sales of physical bullion to 'skyrocket' in India, a significant market.

These sales will tend to underpin the futures markets as more dealers take delivery. And so the physical market will react and possibly provide some discipline to the metal bears of Wall Street.

And this is why any attempt by Central Banks to permanently suppress the price of gold are doomed to eventual failure as long as markets remain open and buyers are allowed to take physical delivery.


Gold Makes Glittering Comeback
29 Aug, 2008, 0606 hrs IST,
Amrita Nair-Ghaswalla
Times of India

MUMBAI: Gold is enjoying a modern-day renaissance in the country. From retail sales of 300-400 kgs of gold bar per day at the start of 2008, demand has surged to 3,000 to 4,000 kgs per day. Barring the slight rise in price at the start of this week, most counters registered an unprecedented sale.

Gold's dip below Rs 12,000 per 10 grams early this month has sparked off widespread buying. From a high of Rs 13,900 for 10 grams around a month and half ago, the price of the yellow metal slipped to Rs 11,850 on Wednesday, ensuring droves of customers.

The demand for the metal has skyrocketed to such an extent that imports for the month of August alone are set to cross 100 tonne. Last August, the country imported 69 tonne of gold.

'' Ten days ago, the price was Rs 11,300 and retail outlets recorded consumer demand many times higher than that witnessed during 'Dhanteras' , the first day of Diwali, or 'Akshaya Tritiya' , when buying gold is considered auspicious,'' said Suresh Hundia of the Bombay Bullion Association.

India, the world's biggest buyer of bullion, is also set to increase its gold imports for the first time in nearly 12 months, analysts told TOI. Given that the first half of 2008 saw volatile gold prices driving down demand, the last few weeks have witnessed a sudden rush of imports....

World's Largest Refiner Runs Out of Krugerrands
By Claudia Carpenter
Bloomberg

Aug. 28 (Bloomberg) -- Rand Refinery Ltd., the world's largest gold refinery, ran out of South African Krugerrands after an ``unusually large'' order from a buyer in Switzerland.

The order was for 5,000 ounces and it will take until Sept. 3 for inventories to be replenished, said Johan Botha, a spokesman for Rand Refinery in Germiston, east of Johannesburg. He declined to identify the buyer.

Coins and bars of precious metals are attracting investors as a haven against a sliding dollar and conflict between Russia and its neighbor Georgia. The U.S. Mint suspended sales of one- ounce ``American Eagle'' gold coins, Johnson Matthey Plc stopped taking orders for 100-ounce silver bars at its Salt Lake City refinery and Heraeus Holding GmbH has a delivery waiting list of as long as two weeks for orders of gold bars in Europe...

Broad Money Supply Growth in the US Remains Robust and Inflationary

Considering the slowing GDP, the growth of the broad money supply figures, MZM and M2, remains exceptionally strong. We would expect the growth of the broad money supply to be a little closer to a steady growth in GDP. From the charts it appears obvious that the Fed stimulates money supply when the economy slows.

The money supply growth has been achieved in spite of the declining growth of commercial bank credit thanks in large part to the Fed, the Treasury and several of the foreign Central Banks. Money supply expands from many sources other than commercial bank lending.

G7 Plans to Support the US Dollar In Case of a Major Financial Failure

Report of US currency rescue plan
By Krishna Guha in Washington
August 28 2008 03:00
Financial Times

The US, Europe and Japan discussed the possibility of co-ordinated currency intervention to support the dollar during the Bear Stearns crisis in March, according to Japan's Nikkei online.

The US Treasury declined to comment on the report, which claimed the G7 had considered issuing an emergency communiqué during the weekend of March 15-16.

The Financial Times was unable independently to verify the Nikkei report. A G7 official said he understood there were some preparations for possible currency intervention during that period, but did not comment on any international talks.

As reported earlier in the FT, US and European policymakers have been concerned at various stages of the credit crisis about the possibility that, in an environment of persistent dollar weakness, a crisis at an individual financial institution could trigger a disorderly plunge in the US currency.

Such a disorderly decline would aggravate existing stress in other financial markets and could lead to foreign investors demanding a currency risk premium on all dollar assets, pushing up long-term US interest rates.

It would also increase the stain on economies such as the eurozone that have floating exchange rates, pushing up their own currencies to unsustainable levels.

This concern was acute at the time of the Bear Stearns crisis. G7 policymakers were in contact then and discussed potential spillovers in international markets.

However, in the event there was no emergency G7 statement. The G7 waited until their scheduled meeting on April 11 when they expressed concern about "sharp fluctuations in major currencies" and "their possible implications for economic and financial stability". They added: "We continue to monitor exchange markets closely, and co-operate as appropriate."

This statement marked a shift in international currency policy. Hank Paulson, US Treasury secretary, remained generally sceptical about currency intervention, but was careful not to rule it out in all circumstances.

Prior to March, US and European officials were at odds over currencies, with eurozone officials concerned about the decline of the dollar against the euro, but US officials broadly welcoming this as a prop to growth.

However, following the April 11 G7 meeting, US and European officials told the FT they were united in their support for a stronger dollar. Ben Bernanke, Federal Reserve chairman, joined Mr Paulson in talking in public about the US currency.

Policymakers believe a crisis at a financial institution is less likely to trigger a run on the dollar in an environment of general dollar strength. A stronger dollar also helps to curb oil and inflation, and support confidence in US assets.

Without another Bear Stearns-style crisis, currency intervention is unlikely, but if a similar crisis were to occur again and the dollar were to weaken precipitously, co-ordinated intervention is possible.

You Can Believe the GDP Revision for the Second Quarter...

You can believe today's GDP revision upwards to 3.3% growth for the second quarter to the extent that you accept that inflation is running at an annual rate of 1.2%, which is what was used for the deflator to calculate the GDP revision.

There is a profound mathematical relationship between higher GDP and the assumption of a lower rate of inflation.

In addition to the GDP figures, there are GDP deflators, which measure the change in prices in total GDP and for each component. Though the consumer price index is a more closely watched inflation indicator, the GDP deflator is another key inflation measure. Unlike CPI, it has the advantage of not being a fixed basket of goods and services, so that changes in consumption patterns or the introduction of new goods and services will be reflected in the deflator.

In short, the government economists have a SIGNIFICANT amount of latitude to make the GDP deflator appear to be what they wish it to be, and thereby to make real GDP growth achieve whatever growth objectives that they feel people will need to see to believe that the government is doing a good job, and that all is well.

And oh by the way...

Bank of England Sees Significant Downside Risk in the Credit Crisis

There are parallels between what we are experiencing now and what occurred in the 1930's and the 1970's as referenced in the attached. One must hope for the best but prepare for the likely eventualities, noting both the similaries and the differences. Stagflation appears to be the most likely outcome for now.

It would be in character for the Banks to offer us a solution that they think we cannot refuse. Recall that it was a credit crisis, the Panic of 1907 that ushered in the Big Fix, the Federal Reserve, in 1913.


Slowdown echoes Great Depression, says Bank's deputy chief
26 August 2008
By Gerri Peev
The Scotsman

THE severity of the current economic downturn has been likened to the Great Depression of the 1930s by the new deputy governor of the Bank of England.

The slowdown, which has threatened to plunge the world's major economies into recession, was likely to drag on for "some time", according to Charles Bean, Britain's second most senior banker.

And he raised the spectre cited by other economists that the combination of market upheavals and soaring oil prices could trigger conditions similar to the depression that started in the late 1920s and dragged on for a decade.

His warning came amid reports that the International Monetary Fund (IMF) has scaled back forecasts for global growth made just a month ago.

The IMF is predicting world growth of 3.9 per cent in 2008, compared to the 4.1 per cent estimated in its July World Economic Outlook. It also forecasts growth next year of 3.7 per cent instead of 3.9 per cent.

"It's fair to say that if you look at the shocks impinging on us this is at least as challenging a time as back in the 1970s," Mr Bean said at the annual conference of the world's top central bankers in Jackson Hole, Wyoming.

"Some people have said it's as big a financial shock as the Great Depression and as far as the oil shock goes the rise in oil prices is in the same order of magnitude that we had to deal with in the 1970s."

"Last year this was a financial crisis that we thought with a bit of luck would be over by the time of Christmas, but it has dragged on for a year and looks like it will drag on for some considerable time further yet," he said.

He and his colleagues are facing the biggest financial challenge of the last 40 years, with the threat of a slowing market and rampant inflation conspiring against the Bank to immediately cut interest rates.

Inflation is running at 4.4 per cent – more than double official targets – and is set to peak above 5 per cent driven by surging food, fuel and energy costs.

Even when the markets looked like they were improving, another "grenade explodes" bringing fear of sustainability to financial institutions, Mr Bean said.

"We have our fingers crossed but there is the recognition there is still quite a long way to go yet."
Mr Bean added that he hoped that the economy would grow next year, despite official figures last week signalling the end of a 16 year boom.

Inflation "should drop back" into next year, he said, in remarks that will fuel hopes for borrowers of interest rate cuts.

His warning was echoed by Sir Peter Burt, the former governor of the Bank of Scotland.

But Sir Peter appeared to take a swipe at new accounting rules imposed on banks and called for the government to ensure that no other financial institution would go bust.

"I hope the Bank of England are doing more than just crossing their collective fingers." he said.

Tough new rules made it more difficult for banks to lend and these rules had been like "pouring petrol onto a bonfire".

"The Bank of England must be prepared to act as lender of last resort. We cannot afford to let a major bank collapse," he told BBC Radio 4.

A bank closure would "lead to the dominoes falling like crazy" with knock-on effects for all parts of the economy.

The government's insistence that the newly nationalised Northern Rock pay off £25 billion in 12 months was taking that amount out of the mortgage market, he said.

David Kern, an economic adviser to the British Chambers of Commerce, said: "We certainly believe that the impact of the credit crunch is going to take some time to sort out and it may be prolonged.

"But if the right measures can be taken by the government and the monetary policy committee, they can avoid a major recession."

Vince Cable, the Treasury spokesman for the Liberal Democrats said Mr Bean's comments showed that the government and Bank of England were powerless to do much about the British economy which was "to a large extent in freefall".

Devastating outcome of collapse in confidence

IT STARTED with a stock market crash in the United States in October 1929, but soon no major industrialised nation was left untouched by what became known as the Great Depression.

The decade-long economic collapse was a time of runs on banks, falling prices and rising unemployment of a magnitude that has not been replicated since.

Thousands of investors lost their livelihoods when the New York Stock Exchange prices collapsed on Black Tuesday in October 1929. Within three years, shares had plunged to just one fifth of their 1929 values.

Nearly a third of US banks had failed by 1933, dramatically ending the speculative boom that had underpinned the 1920s.

This in turn knocked the confidence out of other parts of the economy, triggering a huge drop in production as the US imposed tariffs in the belief that this would protect it.

The impact soon spread to the United States' greatest dependents in the post First World War era.

The most affected was Germany, where the poor economic conditions had profound political consequences, with the rise of Adolf Hitler.

Britain's export sector was also hit and unemployment more than doubled from one million to 2.5 million in one year.

In industrialised cities such as Glasgow, a third of the working-age population was unemployed.

The Great Depression – a term coined by Lionel Robbins, a British economist who taught at the London School of Economics – was only ended by the militarisation in the run up to the Second World War.

Workers were needed to fulfil the generous armaments contracts .

Gold and Oil Long Term Weekly Charts

We view charts not as predictive, but as indicative of probabilities, and as a means of assessing and interpreting events as they unfold. The number of variables and the opportunity for exogenous events make this obvious. Life is indeed a school of probability.

Tropical Storm Gustav Heads into the Gulf Oil and Natural Gas Complex

The warm waters of the Gulf will intensify the storm to full hurricane status.

Goldman Sachs: the Dreadnought Shudders

Among investment banks, Goldman Sachs has been the Dreadnought, ploughing forward through troubled financial seas, stopping only to take a prize here and there, and deposit executives in key political postions throughout federal and state governments.

Can even the mighty Goldman shake and tremble in the face of troubled markets? We will have to wait and see when they report earnings. We are not betting against or for them. We'll prefer to watch for additional developments, including the NY Attorney General's probe noted below.

Goldman Profit Estimate Cut 45% by Morgan Stanley
By Poppy Trowbridge and Christine Harper

Aug. 27 (Bloomberg) -- Goldman Sachs Group Inc. had its third-quarter earnings estimate cut almost in half by Morgan Stanley analyst Patrick Pinschmidt, who said stock market declines will force the bank to revalue investments.

Pinschmidt said Goldman's third-quarter earnings will probably be $1.65 a share, down from his earlier prediction of $3. The New York-based bank may record a loss of $525 million on so-called principal investments, compared with a gain of $211 million a year earlier, he said in a note to clients today.

Goldman, the biggest and most-profitable U.S. securities firm, had its estimates reduced an average of $1.33 per share by 13 analysts this month because of decreased trading volume and a drop in stock prices. Pinschmidt's estimate is the second-lowest of 19 compiled by Bloomberg behind Atlantic Equities analyst Richard Staite, who lowered his per-share estimate today to $1.60 from $3. The average is $2.44.

``Goldman Sachs is not immune to difficult market conditions,'' Pinschmidt wrote. ``Significant declines in equity markets will take a toll on principal investment marks and principal trading strategies.''

Goldman has declined 28 percent in New York Stock Exchange composite trading this year. The shares fell $1.46, or 0.9 percent, to $153.73 at 9:53 a.m.

Principal investments at Goldman include private equity and real estate holdings, as well as stock in the Industrial and Commercial Bank of China Ltd., the nation's biggest lender. ICBC's shares have declined 18 percent since the end of May in Shanghai trading.

Record Decline

Pinschmidt's estimate for Goldman's third quarter, which ends Aug. 29, would represent a 73 percent drop in earnings per share compared with the firm's income of $6.13 a year earlier. That would be the steepest year-over-year earnings decline since Goldman went public in 1999. Pinschmidt rates Goldman stock ``over-weight.''

Lower values for residential and commercial mortgages are likely to require Goldman to take a $1 billion writedown, Pinschmidt said...

NY AG confirms probe into Goldman, Fidelity
Wednesday August 27, 1:10 pm ET
By Joe Bel Bruno

NEW YORK (AP) -- The New York attorney general's office said Wednesday it is investigating whether Fidelity Investments was given incentives by Goldman Sachs Group Inc. to sell auction-rate securities to investors.

Investigators are examining if Fidelity pitched auction-rate securities that were underwritten by Goldman Sachs because it received other services from the investment bank. A spokesman for New York Attorney General Andrew Cuomo confirmed the investigation, but declined to provide further details.

Higher Levels of 'Troubled Banks' as Financial Earnings Plummet

The worst is yet to come despite the soothing words coming from public officials. The US financial system is on a knife's edge, and the Treasury and Fed are on watch to intervene in the event that a domino-like collapse is ignited by a failed institution. We are entering the moment of maximum stress, wherein any significant external shock might ignite a string of failures and set off a plunge that will test the circuit breakers on the NYSE. Let's see what happens and hope for the best and a bit of luck.

Credit crisis: 117 troubled banks in US, highest level since 2003
27 Aug, 2008, 0330 hrs IST
The Economic Times of India

WASHINGTON: The number of troubled US banks leaped to the highest level in about five years and bank profits plunged by 86 percent in the second quarter, as slumps in the housing and credit markets continued.

Federal Deposit Insurance Corp data released on Tuesday show 117 banks and thrifts were considered to be in trouble in the second quarter, up from 90 in the prior quarter and the biggest tally since mid-2003.

The FDIC also said that federally-insured banks and savings institutions earned $5 billion in the April-June period, down from $36.8 billion a year earlier. The roughly 8,500 banks and thrifts also set aside a record $50.2 billion to cover losses from soured mortgages and other loans in the second quarter.

"Quite frankly, the results were pretty dismal," FDIC Chairman Sheila Bair said at a news conference, but they were not surprising given the housing slump, a worsening economy, and disruptions in financial and credit markets.

The majority of US banks "will be able to weather" the economic and housing storms, with 98 percent of them still holding adequate capital by the regulators' standards, Bair said.

Total assets of troubled banks jumped from $26 billion to $78 billion in the second quarter, the FDIC said, with $32 billion of the increase coming from IndyMac Bank, which failed in July - the biggest regulated thrift to fail in the United States.

"More banks will come on the (troubled) list as credit problems worsen," Bair said. "Assets of problem institutions also will continue to rise."

Nine FDIC-insured banks have failed so far this year, compared with three in all of 2007. More banks are in danger of collapsing this year, Bair and other FDIC officials said, and they expect turbulence in the banking industry to continue well into next year.

IndyMac's failure and others in the quarter reduced the federal deposit insurance fund from $53 billion to $45 billion. Bair said the agency will raise insurance premiums paid by banks and thrifts to replenish its reserve fund and bolster depositors' confidence.

The $50.2 billion set aside to cover loan losses in the April-June period was four times the $11.4 billion the banking industry salted away a year earlier. Nearly a third of the industry's net operating revenue went into building up reserves against losses in the latest quarter, according to the FDIC.

Except for the fourth quarter of 2007, the earnings reported Tuesday were the lowest for the banking industry since the final quarter of 1991, the agency said.

Concern has been growing over the solvency of some banks amid the housing slump and the steep slide in the mortgage market. The pressures of tighter credit, tumbling home prices and rising foreclosures have been battering banks of all sizes nationwide.

The FDIC has been keeping an especially close eye on banks and thrifts with high levels of exposure to the riskiest borrowers and markets, agency officials say, including subprime mortgages and construction loans in overbuilt areas.

Another area of potential concern: banks' holdings of preferred stock of troubled mortgage giants Fannie Mae and Freddie Mac. A government rescue of the companies, whose share prices have rebounded a bit this week after plummeting recently as they struggle with billions of dollars in losses from bad mortgages, could be costly for scores of banks that hold billions in their preferred shares.

"We're closely monitoring that situation," Bair said.

The FDIC said troubled assets - loans that are 90 or more days past due - continued to rise in the second quarter, jumping by $26.7 billion, or 19.6 percent, over the first quarter. It was the first time since 1993 that the percentage of total loans that were troubled broke 2 percent, at 2.04 percent.

The agency doesn't disclose the names of institutions on its internal list of troubled banks. On average, 13 percent of banks that make the list fail.

Pasadena, Calif.-based IndyMac was taken over by the FDIC on July 11 with about $32 billion in assets and deposits of $19 billion. It was the second-largest financial institution to close in US history, after Continental Illinois National Bank in 1984.

SP Hourly Futures Chart

Citigroup Settles Charges of Widespread Theft of Customer Funds

We can imagine how a large company might rationalize the actions that led to these charges. Customers have positive credit balances on their cards for a variety of reasons. Why not just "sweep" the cash into your own bank account, and use it as part of your leveraged reserves? The customer does not really need the money, right? Especially if they are "poor or recently deceased." You are merely 'borrowing it' with no harm done. Right? Clever. We're the Master's of the Universe, the smartest boys in the room.

We hate to use this example of Citigroup's bad behaviour when there are much better ones. Not all that long ago Citi was caught consciously manipulating the european bonds markets. They would come into a quiet market, sell a remarkably large amount of government bonds all at once to drive the prices down and run the stops of other traders, and then cover their shorts reaping a tidy little profit. Citigroup Embroiled in Bond Selling Scandal Sounds like standard operating procedure for the US futures and commodity markets to us.

But Citi is not an outlier. Anyone who thinks the brokerage and investment industry can be self-regulated, relying upon mature and enlightened self-interest, is either naive, corrupt, disingenuous, or misinformed. Wall Street has proven time and again that the lure of quick profits will cause them to subvert any and all oversight and prudent business principles. And there are many scams and frauds in the markets from a variety of smaller players as we all know. But it is the systemic frauds, the price manipulation and naked shorting, that is particularly insidious and destructive of free markets.

Strong independent regulators capable of investigating potentially criminal activity are needed and not a bunch of propeller heads or captive regulators. The Fed is utterly unequipped and incompetent to rein in these sharks as principle regulator. It would be like sending in the Schoolyard Safety Patrol to maintain order at a pedophiles convention.


AP
Citi pays $18M for questioned credit card practice
Tuesday August 26, 3:05 pm ET
By Madlen Read

NEW YORK (AP) -- Citigroup Inc. will pay nearly $18 million in refunds and settlement charges for taking $14 million from customers' credit card accounts, California's attorney general said Tuesday....

"The company knowingly stole from its customers, mostly poor people and the recently deceased, when it designed and implemented the sweeps," said Brown in a statement. "When a whistleblower uncovered the scam and brought it to his superiors, they buried the information and continued the illegal practice."

Citigroup, however, said in a statement that it voluntarily stopped the computerized "sweeping" practice in 2003, and that it also voluntarily began refunding customers before the settlement.

"We take issue with the state's characterization of our conduct and the parties' voluntary settlement," Citigroup said in a statement. "This agreement affirms our actions, and we are continuing to make full refunds to all affected customers," Citigroup said.

Citigroup shares rose 2 cents to $17.63 in afternoon trading.


Citigroup settles with California over credit card skimming
By Wallace Witkowski
MarketWatch
12:22 p.m. EDT Aug. 26, 2008

SAN FRANCISCO (MarketWatch) -- Citigroup Inc. settled charges that it stole from its customers using a computer program that skimmed positive credit card balances into the bank's general fund, according to the California Attorney General's office Tuesday. Under the settlement, Citigroup will return more than $14 million to customers with 10% interest, and pay California $3.5 million in damages and civil penalties.

Abu Dhabi Bank Sues Morgan Stanley, Bank of NY and Ratings Agencies for Fraud

Abu Dhabi bank sues in U.S. over risky investments
Mon Aug 25, 2008 6:36pm EDT

NEW YORK, Aug 25 (Reuters) - A United Arab Emirates bank sued Morgan Stanley, the Bank of New York Mellon Corp and ratings agencies Moody's and S&P on Monday, accusing them of fraud in operating a fund that collapsed in the U.S. credit crisis.

The lawsuit filed by Abu Dhabi Commercial Bank in U.S. district court in Manhattan said a complex deal known as the Cheyne Structured Investment Vehicle (SIV) was marketed by the defendants as highly rated and reliable, but they had hidden the risks.

"Instead of protecting the SIV and its investors as promised, defendants exposed the SIV to significant undisclosed risks," the lawsuit said. "Defendants knew the assets purchased and held by the SIV were risky and of poor quality. They further knew the models used to generate the high rates were flawed."

SIVs, which once held some $350 billion in assets, have played a major role in the U.S. credit crisis, after proving unable to refinance their short-term debts.

A series of SIVs are now selling off bank debt and assets such as asset-backed securities to try to pay back investors, a move that many see as further pressuring credit markets.

A deal was announced last month to restructure Cheyne, which at receivership was a $7 billion fund. Many investors who elected to stay in the restructured fund now have assets worth less than one-half of their former value, and the Abu Dhabi Commercial Bank's investment is worth zero now, the complaint said.

A spokeswoman for Morgan Stanley and a spokesman for Bank of New York Mellon declined to comment.

A spokesman for S&P parent McGraw-Hill Cos Inc declined comment, saying the company had not yet been served with the complaint.

A spokesman for Moody's Corp was not immediately available for comment.

SIVs used short-term funding, such as asset-backed commercial paper, to buy longer-term assets such as bank debt and asset-backed securities.

The bank brought the action on behalf of all investors who bought investment grade Mezzanine Capital Notes issued by Cheyne Finance PLC and its wholly owned subsidiary Cheyne Finance Capital Notes from October 2004 to October 2007.

"The ratings agencies intentionally, recklessly or negligently misled investors in Cheyne," according to the suit. "But for the ratings agencies violations of law, the capital notes never would have been issued."

Just a Pause for the Commodity Bull Market in the Collapse of Bretton Woods and the Pax Americana

The author of this thoughtful piece rests his argument for a resurgence in commodity prices on three pillars: oil is the heart of the commodity price bull market, oil is peaking in production, and overall demand for all commodities will continue to stress against supply levels even with reduced demand for the short term. Commodities trends and production increases are long cycle phenomena.

We have come to a similar conclusion but from a different path. The eye of the commodities storm has not been oil, and peak oil, but rather a collapsing international trade system based on the US dollar.

The heart of the problem is that trading increasingly worthless dollars for hard goods has been a nice protection racket with an amazingly long run under the Pax Americana. The non-G7 countries will stop accepting this arrangement, and the world will adjust.

The markets are searching for a replacement for the Bretton Woods II arrangement of dollars for oil and military protection. Increased demand and peaks in supply will merely accelerate and intensify the storm.

We think that this is already well underway, thanks in great part to the Clinton-Bush Administrations and their careless disregard for the stewardship which the US accepted with the world's reserve currency. The heightened sense of risk and volatility is because the world's markets do not yet see a viable, sustainable solution.

A new equilibrium that will underpin international trade will be discovered. But given the length and breadth of the status quo the seismic shocks of the adjustment may be quite convulsive, taking down more than a few major institutions. The epicenter for this global earthquake is somewhere between New York and Washington DC.


Commodity Bull's Not Dead, Just Resting
Vijay L Bhambwani
Daily News & Analysis - India
August 23, 2008 03:57 IST

Once the deliberate downward pressure on these assets eases, there will be a resurgence in prices

Recent days have seen an intense debate within the analyst community on the hot topic of the year — commodity prices. Many have started writing obituaries for the commodity bull and pronounced an end to the ascent in commodity prices. The impact on the corporate sector was advocated to be salutary and it was widely expected to signal an end to the woes of the equity investors....

I expect the post-US election year to be particularly tough on the global energy front as the supply-side constraints choke the optimists. Once the deliberate downward pressure on these hard assets is eased, there will be a resurgence in prices.

I am afraid the following rally may just surpass the recent one. In my humble opinion, the commodity bull is just taking a breather, forget his obituary for now. The future shock will lie not in rising commodity prices, but in not preparing for it.

A Perfect Storm of a Global Recession - Roubini

Roubini's analysis has been better than most. A worldwide recession is highly probable.

At some point we will most likely see competitive devaluations of currencies as countries vie for exports. We will see a de facto trade war, not explictly until much later in the cycle perhaps, but implicitly through policies and barriers more subtle than overt tariffs. The industrial policies of Japan and China are just a taste of things to come.

A currency devaluation is a very effective means of erecting trade barriers and encouraging exports. But without a global reference point the situation can quickly deteriorate into a relative competition with commodities assuming the more narrow prior position of gold, which would rise with the general tide of commodities. This will break the Central Bank's scheme to maintain Bretton Woods II.

This may be the fuel for the continuing stagflation despite flagging demand in the G7. The BRIC's will slow, but still maintain a positive growth. As currencies devalue the commodities may ironically become more expensive. We may see a repeat of the 1970's but on a global scale. That might be something for the economics professors to puzzle on for a few years as their models get marked to the markets.

The Perfect Storm of a Global Recession
by Nouriel Roubini
Project Syndicate

NEW YORK – The probability is growing that the global economy – not just the United States – will experience a serious recession. Recent developments suggest that all G7 economies are already in recession or close to tipping into one. Other advanced economies or emerging markets (the rest of the euro zone; New Zealand, Iceland, Estonia, Latvia, and some Southeast European economies) are also nearing a recessionary hard landing. When they reach it, there will be a sharp slowdown in the BRICs (Brazil, Russia, India, and China) and other emerging markets.

This looming global recession is being fed by several factors: the collapse of housing bubbles in the US, United Kingdom, Spain, Ireland and other euro-zone members; punctured credit bubbles where money and credit was too easy for too long; the severe credit and liquidity crunch following the US mortgage crisis; the negative wealth and investment effects of falling stock markets (already down by more than 20% globally); the global effects via trade links of the recession in the US (which still counts for about 30% of global GDP); the US dollar’s weakness, which reduces American trading partners’ competitiveness; and the stagflationary effects of high oil and commodity prices, which are forcing central banks to increase interest rates to fight inflation at a time when there are severe downside risks to growth and financial stability.

Official data suggest that the US economy entered into a recession in the first quarter of this year. The economy rebounded – in a double-dip, W-shaped recession – in the second quarter, boosted by the temporary effects on consumption of $100 billion in tax rebates. But those effects will fade by late summer.

The UK, Spain, and Ireland are experiencing similar developments, with housing bubbles deflating and excessive consumer debt undercutting retail sales, thus leading to recession. Even in Italy, France, Greece, Portugal, Iceland, and the Baltic states, frothy housing markets are starting to slacken. Small wonder, then, that production, sales, and consumer and business confidence are falling throughout the euro zone.

Elsewhere, Japan is contracting, too. Japan used to grow modestly for two reasons: strong exports to the US and a weak yen. Now, exports to the US are falling while the yen has strengthened. Moreover, high oil prices in a country that imports all of its oil needs, together with falling business profitability and confidence, are pushing Japan into a recession.

The last of the G7 economies, Canada, should have benefited from high energy and commodity prices, but its GDP shrank in the first quarter, owing to the contracting US economy. Indeed, three quarters of Canada’s exports go to the US, while foreign demand accounts for a quarter of its GDP. (This is why the loon will track US performance more closely than other commodity currencies as we have noted before - Jesse)

So every G7 economy is now headed toward recession. Other smaller economies (mostly the new members of the EU, which all have large current-account deficits) risk a sudden reversal of capital inflows; this may already be occurring in Latvia and Estonia, as well as in Iceland and New Zealand.

This G7 recession will lead to a sharp growth slowdown in emerging markets and likely tip the overall global economy into a recession. Those economies that are dependent on exports to the US and Europe and that have large current-account surpluses (China, most of Asia, and most other emerging markets) will suffer from the G7 recession. Those with large current-account deficits (India, South Africa, and more than 20 economies in East Europe from the Baltics to Turkey) may suffer from the global credit crunch. Commodity exporters (Russia, Brazil, and others in the Middle East, Asia, Africa, and Latin America) will suffer as the G7 recession and global slowdown drive down energy and other commodity prices by as much as 30%. Countries that allowed their currencies to appreciate relative to the dollar will experience a sharp slowdown in export growth. Those experiencing rising and now double-digit inflation will have to raise interest rates, while other high-inflation countries will lose export competitiveness.

Falling oil and commodity prices – already down 15% from their peaks – will somewhat reduce stagflationary forces in the global economy, yet inflation is becoming more entrenched via a vicious circle of rising prices, wages, and costs. This will constrain the ability of central banks to respond to the downside risks to growth. In advanced economies, however, inflation will become less of a problem for central banks by the end of this year, as slack in product markets reduces firms’ pricing power and higher unemployment constrains wage growth.

To be sure, all G7 central banks are worried about the temporary rise in headline inflation, and all are threatening to hike interest rates. Nevertheless, the risk of a severe recession – and of a serious banking and financial crisis – will ultimately force all G7 central banks to cut rates. The problem is that, especially outside the US, this monetary loosening will occur only when the G7 and global recession become entrenched. Thus, the policy response will be too little, and will come too late, to prevent it.

Regional US Banks are Heavily Invested in Fannie and Freddie Preferreds

This may help to understand the Treasury's next moves.

The banksters really do not want Fannie and Freddie to be bailed out and maintained in anything such as their current form. They want Fannie and Freddie's business, more precisely the fees from same. They also want the debt to be made whole.

The big banks do not care so much about the preferred stock. In fact, they might even be in favor of a haircut there, to set up some bargains for the coming wave of bank consolidations. But the Fed doesn't like it, because they see the domino risk to the system.

Again, this might help to explain the solutions that comes out of Washington and New York. There is significant maneuvering behind the scenes by the vested interests. Of course then there are the Democrats. Hank has a window of opportunity to settle the GSE's hash before he loses his grip on power. Let's see what happens.

Fannie and Freddie threat to banks
By Saskia Scholtes in New York and James Politi
The Financial Times
August 23 2008 03:00

Small regional US banks could face substantial writedowns if the government has to rescue Fannie Mae and Freddie Mac, the two giant US mortgage financiers.

Regional banks, together with US insurers, hold the majority of Fannie and Freddie's $36bn of outstanding preferred stock, which could be wiped out in the event of a government rescue.

Few banks have taken any writedowns on the preferred shares, which have lost more than half of their value since June 30. This could exacerbate the impact of losses on the preferred shares at a time when many banks are experiencing losses on residential construction loans and home equity portfolios.

Tom Priore, chief executive of Institutional Credit Partners, a boutique investment bank, said: "If the government takes a senior preferred stake, it will crystallise existing losses for the banks and add to them in a way that damages local lenders at a time when they can least afford it."

Fannie and Freddie's preferred stock ratings were cut by Moody's yesterday from A to Baa3. Moody's said the cut reflected the uncertainty surrounding how these securities would be treated if the US Treasury provided Fannie or Freddie with support and the reduced financial flexibility the two companies would have in the event of a Treasury intervention.

The rating agency said it saw the odds of such an intervention as increasingly likely, pushing Fannie and Freddie's stock prices down by a further 14.5 per cent and 8.25 per cent, respectively. Both stocks have lost more than 40 per cent of their market value this week on fears that government intervention is imminent.

"Given the GSEs more limited ability to raise capital and grow their portfolio to accomplish their public policy role in a time of mortgage market turmoil, we believe that there's an increased probability of actual support coming from the US Treasury," said Brian Harris, analyst at Moody's.

The Treasury was granted powers last month to extend its credit lines to Fannie and Freddie and invest in their debt and equity, but it has not given any further clarity on the structure a rescue for the companies might take.

Many analysts believe the most likely option is for the government to get preferred shares as part of any rescue, eliminating the value of common shares, and ranking higher than existing preferred shareholders, who will probably see their dividends cut.

Philadelphia-based Sovereign bank said this week it holds more than $600m in preferred stock issued by Fannie Mae and Freddie Mac, representing 0.78 per cent of its total assets.

Analysts at CreditSights said a full write-off of Sovereign's preferred stock in Fannie and Freddie could represent as much as four quarters of earnings. Sovereign executives warned there was a possibility they could take a significant writedown in the third quarter.

The Fed's Fatal Attraction with Wall Street Is a Source of Policy Error

Link to Buiter's Complete Paper Presented at Jackson Hole

Fed Attention to Wall Street `Dangerous,' Buiter Says
By John Fraher and Scott Lanman
Bloomberg News

Aug. 23 (Bloomberg) -- The Federal Reserve pays a ``dangerous'' amount of attention to the concerns of Wall Street, constraining its ability to influence the economy, former Bank of England policy maker Willem Buiter said.

``The Fed listens to Wall Street and believes what it hears,'' Buiter said today in a paper presented to the U.S. central bank's annual symposium in Jackson Hole, Wyoming. ``This distortion into a partial and often highly distorted perception of reality is unhealthy and dangerous.''

The central bank has drawn criticism from some officials in the U.S. and Europe by trying to end the yearlong credit crisis through an expansion of lending. The steepest interest-rate cuts in two decades risk stoking inflation, while the Fed has been too generous in aiding banks, Buiter said.

In addition to rescuing Bear Stearns Cos. from bankruptcy, the Fed created a program to swap Treasuries for mortgage bonds, opened up lending to Wall Street firms and reduced the premium for direct loans to commercial banks.

Buiter, a founding member of the Bank of England's independent rate-setting board in 1997, said the Fed's behavior over the past year represents an example of ``regulatory capture.'' In such a relationship, policy makers take on ``as if by osmosis, the objectives, interests and perception of reality of the vested interest they are meant to regulate and supervise in the public interest,'' he said.

Heated Debate

Buiter's paper sparked the most heated debate of any item on the two-day conference agenda. Bank of Israel Governor Stanley Fischer opened the question-and-answer session by holding up a fire extinguisher and saying, ``I asked the organizers for some technical assistance in dealing with this discussion.''

Former Fed Vice Chairman Alan Blinder said that the central bank's performance, while not flawless, has been ``pretty good under the circumstances.''

Fed Governor Frederic Mishkin, one the strongest advocates of the ``risk management'' approach to financial crises, said after Buiter's presentation ``there are a lot of unguided missiles that have been shot off.''

Under Bernanke and his predecessor, Alan Greenspan, the Fed has cut rates in response to falling stock prices more than is justified to safeguard economic growth, Buiter said. On Jan. 22, as global stock markets tumbled, the Fed slashed its overnight lending rate by 75 basis points.

Safeguard Economy

Bernanke has argued that policy makers' actions were necessary to safeguard the economy from the impact of the credit crisis. Greenspan engineered rate cuts in 2001 through 2003 at a time when joblessness climbed in the aftermath of the recession seven years ago. The Fed by law is mandated to achieve stable prices and maximize employment.

Buiter also criticized the Fed and other central banks around the world for not providing more information about the valuation of collateral they accept from banks.

Such information would allay concerns financial institutions will use public funds to subsidize financial institutions, he said. This is ``most acute'' in the case of some of the Fed's emergency lending programs created in the past year.

Two economists echoed Buiter's concern in another paper presented today, saying the Fed's program allowing institutions to swap Treasuries for mortgage bonds and other debt enables firms to ``window dress'' their balance sheets.

`Deception Easier'

``Financial institutions can hold low-quality securities for the period where no reporting is required,'' wrote Franklin Allen of the University of Pennsylvania and the University of Frankfurt's Elena Carletti. ``Temporarily increasing the supply of Treasuries makes this kind of deception easier. It helps remove market and regulator discipline.''

The financial crisis is also forcing the European Central Bank to rethink aspects of its money market operations, which provide a flexibility that has been favorably compared with programs at the Fed and the Bank of England.

The ECB plans to tighten collateral rules to head off the risk of abuse by some financial institutions, ECB council member Yves Mersch said in an interview today.

Buiter won some praise for openly confronting the Fed's record at its summer retreat in the Teton Mountains.

``Willem's papers don't pull punches, they have attitude,'' Blinder said. ``You have to give credit to a guy with the nerve to come here with black bears on the outside and the FOMC on the inside and be this critical of the Federal Reserve.''

China Expects Adequate Compensation for the Failure of Freddie and Fannie .... Or Else

A very crystal clear 'suggestion' indeed. Back your markers or its game over.

Freddie, Fannie Failure Could Be World `Catastrophe,' Yu Says
By Kevin Hamlin

Aug. 22 (Bloomberg) -- A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank.

``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. ``If it is not the end of the world, it is the end of the current international financial system.''

Freddie and Fannie shares touched 20-year lows yesterday on speculation that a government bailout will leave the stocks worthless. Treasury Secretary Henry Paulson won approval from the U.S. Congress last month to pump unlimited amounts of capital into the companies in an emergency.

China's $376 billion of long-term U.S. agency debt is mostly in Fannie and Freddie assets, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd. in Hong Kong. The Chinese government probably holds the bulk of that amount, according to McCormack.

Industrial & Commercial Bank of China yesterday reported a $2.7 billion holding. Bank of China Ltd. may have $20 billion, according to CLSA Ltd., the Hong Kong-based investment banking arm of France's Credit Agricole SA. CLSA puts the exposure of the six biggest Chinese banks at $30 billion.

`Beyond Imagination'

``The seriousness of such failures could be beyond the stretch of people's imagination,'' said Yu, a professor at the Institute of World Economics & Politics at the Chinese Academy of Social Sciences in Beijing. He didn't explain why he held that view.

China's government hasn't commented on Fannie and Freddie.

Yu is ``influential'' among government officials and investors and has discussed economic issues with Premier Wen Jiabao this year, said Shen Minggao, a former Citigroup Inc. economist in Beijing, now an economist at business magazine Caijing.

Investor confidence in Fannie and Freddie has dwindled on speculation that government intervention is inevitable. Washington-based Fannie has fallen 88 percent this year, while Freddie of McLean, Virginia, has slumped 91 percent.

Paulson got the power to make purchases of the two companies' debt or equity in legislation enacted July 30 that was aimed at shoring up confidence in the businesses. He has said the Treasury doesn't expect to use that authority.

The two companies combined account for more than half of the $12 trillion U.S. mortgage market.

US Dollar Weekly Charts With COT as of 19 August 2008

Weekly Dollar Chart with Commitments of Traders



Weekly US Dollar Chart with Moving Averages

Charts in the Babson Style for the Week Ending 22 August 2008

Stocks caught a bid at week's end as hopes of a purchase of Lehman Brothers by the Korean Development Bank had the financials leading a rally higher. No price or terms are specified.

Korean DB is said to be attracted to Lehman's books. "They are soft and smelly like a well aged kimchee," said one anonymous connoisseur of investment fare.

Bernanke's Strategy: Painting the Roses Red.

Bernanke's strategy is obvious. It is obvious because he has few choices left. He must paint the roses red, and hope that this will hold off the destructive rage of the Mad Queen.

The Fed will continue to prop up the US financial system while encouraging the economy to muddle through this recession with negative real interest rates.

Inflation doesn't matter to the Fed while they think they can control the public perception of our true financial situation, and especially the consequences.

The Fed feels confident that they know how to fight even a seriously strong inflation so they will let it pass for now. This is a fatal policy error. Volcker was a smart and determined Fed chairman, but he was also lucky.

That means no rate increases until next year at the earliest. The Fed is hoping that nothing unexpected happens to upset their plans. A big bank failure might cause a panic, so Ben and Hank will be working overtime to keep the lid on the problem, and try workouts behind the scenes.

The challenge is to define what a big bank failure really is. Was Bear Stearns a 'big bank failure' or a successful bailout? This is of immediate concern regarding Lehman Brothers which is in an obvious death spiral. Korea DB will not buy them for the 20 percent premium that Dick Fuld demands. So, a hostile takeover by a Fed friendly bank, similar to JPM - Bear, is most likely.

This will give us a look at who the other captive bank of the Fed might be if there is one. If you wish to know what a Captive Bank does besides serving as a wastebasket for other broken banks, read the blog entry just below about the manipulation of the markets.

There may be a role for well-connected predator banks as free lance mercenaries for the Fed's and Treasury's policy decisions. You keep what you kill. This appears to be the ongoing strategy of Hank's alma mater, Goldman Sachs.

A sign that the strategy is at work will be the creation of yet another bubble. Where it will be we cannot know yet. It may be in equities again. Or bonds. The Fed and Treasury are using asset bubbles as instruments of policy to act as a channel of liquidity and to provide the appearance of financial health to an increasingly moribund economy.

Each time the Fed intervenes in the monetary system we get a bubble somewhere, in some 'real world' asset or liability. As we continue forward the interventions and double-talk may become increasingly bold and obviously untrue, especially to outside observers. These are intelligent men, but increasingly desperate and frightened, serving an administration best described as an odd collection of mediocrities and eccentrics. What behaviour they may rationalize together will probably exceed all rational expectations.

The last bubble (or anti-bubble if you prefer) will be an economic depression, and end in a re-issuance of the Dollar, unless the Fed gets very lucky in their friends. By re-issuance we mean that the dollar will be revalued and replaced by something else, whether the amero or a freedom dollar. The precise timing is unknown.

But we have reached the point where at least a de facto default on our debt obligations is the only option. The continuing devaluation of the dollar is running out of steam.

Although there may be a short term liquidity crunch in the unwinding of leverage, the notion that the spectacular dollar debts of 50+ trillions will be paid for with an increasingly valuable dollar through a sustained monetary deflation is a fantasy. No debtor nation that is democratic would choose that course unless it was dominated by foreign powers.

The endgame is default.

The strategy for the rest of the world varies depending on who you are in relation to ground zero for the financial collapse. The most obvious strategy for all will be to limit exposure to the US and its debt deflation.

At the point when the dollar and the debt decouple all hell will break loose, and the system will be tested to its maximum. What replaces the US dollar as the world's reserve currency is more than incidental: it is pivotal. Whomever prints the gold makes the rules.

The empire will be given up in due course. The trick for the bigger players will be to stay out of its way as it happens, and above all to avoid falling into a conflict with the US where the strengths, though diminished, are still formidable.

Ben and Hank are going to try and bluff their way out of this, avoid major failures, and play for time until leverage unwinds and liquidation occurs in an orderly manner, and the economy begins to grow. Some of the other central banks will actively cooperate with the Fed, and some may go down in failure with the US as a result. There will be civil wars and popular revolutions in some countries because of this. Others will merely stand aside and bide their time. The US financial system remains highly precarious.

If you keep this model in mind the next few months and years might make more sense.


Bernanke expects inflation to ‘moderate’
By Krishna Guha in Jackson Hole, Wyoming
August 22 2008 15:14

The decline in the price of oil and the recent strength in the dollar is “encouraging” Ben Bernanke said on Friday at the start of the Federal Reserve’s annual retreat in Jackson Hole Wyoming.

The Federal Reserve chairman said the US central bank had based its strategy of running low interest rates on the assumption that commodity prices would ultimately stabilise, in part due to “slowing global growth.”

Mr Bernanke remarks on oil are the strongest to date and suggest the US central bank – which was initially very wary of reading too much into its decline – is starting to put more weight on the notion that oil may now have stabilised.

But Mr Bernanke said the inflation outlook “remains highly uncertain” not least because of the possibility that oil could rebound.

He said the Fed would “monitor inflation and inflation expectations closely” and would “act as necessary” to secure medium term price stability.

The Fed chief said the “financial storm” that broke a year ago “has not yet subsided” and said its effects on the broader economy were “becoming apparent” in the form of “softening growth and rising unemployment.”

His language suggests that the impact of the credit squeeze on the real economy is still unfolding and it is not likely that the economy will pull out of this soon.

Taken together, his comments underscore that the US central bank has no intention of raising interest rates in the near term, and could stay on hold through the end of the year if growth risks remain high and inflation and inflation expectations ease as expected.

This represents a softening of the Fed’s stance since the May to July period, when policymakers turned hawkish amid growing inflation fears and hopes that the markets and the economy were turning the corner.

However, Mr Bernanke did not suggest that the Fed thinks the inflation problem is over simply because oil has moderated. He said the “jump in inflation” was “in part” the product of a global commodity boom – suggesting other factors could be at work as well.

The Fed continues to retain an underlying orientation towards inflation risk, in large part because policymakers feel they have already addressed growth risks through big pre-emptive rate cuts, but are not protected against any revival in inflation danger.

Policymakers view core inflation (excluding food and energy) and inflation expectations as too high, and will seek to ensure that they decline in the months ahead as the economy weakens.

The Fed chairman told the assembled central bankers from 43 nations that reforms were needed to strengthen the financial system, reduce systemic risk and thereby minimise the “moral hazard” that firms could operate irresponsibly in the belief that they would not be allowed to fail.

He called for a “migration of derivatives trading toward more standardised instruments and the use of well-managed central counterparties.” Mr Bernanke said the Fed was working on ways to strengthen the resilience of the triparty repo market.

Mr Bernanke said Congress should consider giving the US central bank explicit authority to oversee payment systems, while granting Treasury authority to manage a special bankruptcy regime for non-commercial banks.

He said a shift towards a more “macroprudential” approach to regulation – that would consider the systemic implications of market behaviour – was “inevitable and desireable” but said it was necessary to be “realistic” as to how this would work

A Few Large Financial Firms Have Been Manipulating the Price of Commodities

A few large financial firms were able to influence the rules on the exchanges to allow the manipulation of commodities prices, including oil and other energy products.

Enron was an early example of this new found power. The havoc this one company was able to inflict on the State of California is a microcosm of what is happening to the world today.

This report from The Washington Post shows what opened the door for this latest round of market manipulation. Goldman Sachs figures prominently in this story.

The Commodity Futures Modernization Act, along with the repeal of the Glass-Steagall Act, set in motion the events that are battering the financial system today.
How Phil Gramm and the Wall Street Investment Banks Helped to Destroy the US Financial System

The worst is yet to come. The actions of the Fed and the Treasury are only serving to make the final outcome worse. We are heading inexorably towards an abyss.

Until reforms are put back into place, and markets and governance are once again efficient and relatively free of corruption, and price discovery and asset allocation is restored to normal functioning, the economy will lurch from crisis to crisis until we are exhausted and collapse.

The best an individual can do is to try and make themselves, their wealth, their family, and their ongoing welfare as independent as possible from the US financial system. And to vote against every Republican and the old Democratic leadership this fall.

We may be sacrificing a generation of Americans to the altar of greed.

A Few Speculators Dominate the Vast Market for Oil Trading
By David Cho
Washington Post
Thursday, August 21, 2008;

Regulators had long classified a private Swiss energy conglomerate called Vitol as a trader that primarily helped industrial firms that needed oil to run their businesses.

But when the Commodity Futures Trading Commission examined Vitol's books last month, it found that the firm was in fact more of a speculator, holding oil contracts as a profit-making investment rather than a means of lining up the actual delivery of fuel. Even more surprising to the commodities markets was the massive size of Vitol's portfolio -- at one point in July, the firm held 11 percent of all the oil contracts on the regulated New York Mercantile Exchange.

The discovery revealed how an individual financial player had gained enormous sway over the oil market without the knowledge of regulators. Other CFTC data showed that a significant amount of trading activity was concentrated in the hands of just a few speculators.

The CFTC, which learned about the nature of Vitol's activities only after making an unusual request for data from the firm, now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency. That figure may rise in coming weeks as the CFTC checks the status of other big traders.

Some lawmakers have blamed these firms for the volatility of oil prices, including the tremendous run-up that peaked earlier in the summer.

"It is now evident that speculators in the energy futures markets play a much larger role than previously thought, and it is now even harder to accept the agency's laughable assertion that excessive speculation has not contributed to rising energy prices," said Rep. John D. Dingell (D-Mich.). He added that it was "difficult to comprehend how the CFTC would allow a trader" to acquire such a large oil inventory "and not scrutinize this position any sooner."

The CFTC, which refrains from naming specific traders in its reports, did not publicly identify Vitol.

The agency's report showed only the size of the holdings of an unnamed trader. Vitol's identity as that trader was confirmed by two industry sources with direct knowledge of the matter...

The documents do not say how much Vitol put down to acquire this position, but under NYMEX rules, the down payment could have been as little as $1 billion, with the company borrowing the rest.

The documents do not say how much Vitol put down to acquire this position, but under NYMEX rules, the down payment could have been as little as $1 billion, with the company borrowing the rest.

The biggest players on the commodity exchanges often operate as "swap dealers" who primarily invest on behalf of hedge funds, wealthy individuals and pension funds, allowing these investors to enjoy returns without having to buy an actual contract for oil or other goods. Some dealers also manage commodity trading for commercial firms.

To build up the vast holdings this practice entails, some swap dealers have maneuvered behind the scenes, exploiting their political influence and gaps in oversight to gain exemptions from regulatory limits and permission to set up new, unregulated markets. Many big traders are active not only on NYMEX but also on private and overseas markets beyond the CFTC's purview. These openings have given the firms nearly unfettered access to the trading of vital goods, including oil, cotton and corn. (and the metals - Jesse)

Using swap dealers as middlemen, investment funds have poured into the commodity markets, raising their holdings to $260 billion this year from $13 billion in 2003. During that same period, the price of crude oil rose unabated every year.

CFTC data show that at the end of July, just four swap dealers held one-third of all NYMEX oil contracts that bet prices would increase. Dealers make trades that forecast prices will either rise or fall. Energy analysts say these data are evidence of the concentration of power in the markets...

The first major change to this regulatory framework occurred in 1991, when Goldman Sachs, through a subsidiary called J. Aron, argued that it should be granted the same exemption given to commercial traders because its business of buying commodities on behalf of investors was similar to the middlemen who broker commodity transactions for commercial firms.

The CFTC granted this request. More exemptions soon followed, including one to the Houston-based energy trader Enron.

"When the CFTC granted the 1991 hedging exemption to J. Aron (a division of Goldman Sachs), it signaled a major shift that has since allowed investors to accumulate enormous positions for purely speculative purposes," said Rep. Bart Stupak (D-Mich.) Now, he added, "legitimate businesses that hedge and take physical delivery of oil are being trampled by the speculators who are in the market purely to make profit."

A second turning point came when Congress passed the Commodity Futures Modernization Act of 2000. The law formally allowed investors to trade energy commodities on private electronic platforms outside the purview of regulators. Critics have called this piece of legislation the "Enron loophole," saying Enron played a role in crafting it.

In the months after the act was passed, private electronic trading platforms sprang up across the country, challenging the dominance of NYMEX.

"Investment banks had been frustrated with the established exchange because they really were never able to get control of it," said Michael Greenberger, a law professor at the University of Maryland and a former staff member at the CFTC.

The most successful of the private platforms was InterContinental Exchange, or ICE, founded by Goldman Sachs, Morgan Stanley and a few other big brokerages in 2000. ICE soon opened a trading platform in London, allowing its founders to trade vast quantities of U.S. oil overseas without being subject to regulation.

The exemptions for swap dealers and the development of overseas markets allowed big brokerages to open the door for more hedge funds, pensions and big investors to move into commodities.

In the coming years, commodity investments by funds could grow to $1 trillion, veteran hedge fund manager Michael Masters said in testimony before the Senate earlier this year. In an interview, he said this trend could raise commodity prices for everyone in the coming years and "have catastrophic economic effects on millions of already stressed U.S. consumers."

Meanwhile, commodities have been good business for big Wall Street brokerages. Its commodity trades helped keep Goldman Sachs profitable during the credit crisis, said Richard Bove, a banking analyst at Ladenburg Thalmann.

"Business is lousy right now," Bowie said about Goldman Sachs. "Commodities and currencies are clearly the strongest business they have right now."

In the coming months, swap dealers expect to have yet another venue for oil speculation. The CFTC has stated it would not stand in the way of trading in U.S. oil contracts overseas in Dubai. Goldman Sachs and Vitol are among the major investors in this new exchange.

Cuomo's Probing Eye Turns To BofA, Deutsche Bank, Goldman Sachs and the Retail Brokers

They will have to wade through a lot of small fry, red herrings, patsies and stooges before they crack one of the big banking houses, if ever. That was the experience in the investigations following the Crash of 1929 and the first years of the Depression. Get your documentation in order gentlemen, and remember, he who cuts the earliest deal makes the best terms.


Cuomo’s probe looks into three banks By Aline van Duyn in New York
August 21 2008 01:59
The Financial Times

Bank of America, Deutsche Bank and Goldman Sachs are being investigated by Andrew Cuomo, the New York attorney-general, as part of his investigation into the selling of auction-rate securities.

Already, Wall Street firms have agreed to buy back nearly $50bn of the securities sold to retail investors, in one of the biggest examples of a bail-out of small investors by large financing groups.

Citigroup, JPMorgan, Merrill Lynch, Morgan Stanley and UBS have agreed to buy back securities at their full face value, even though much of this debt is now trading at a discount.

Most institutional investors are not covered by the agreements.

As well as underwriters of auction-rate debt, which collapsed in February after Wall Street dealers withdrew their support for the debt sales, Mr Cuomo said he was still investigating the role of brokerages that sold the securities, such as Fidelity, Charles Schwab, TD Ameritrade, E*Trade Financial and Oppenheimer.

A spokesman said the investigation’s attention had also turned to Bank of America, Deutsche and Goldman Sachs....

Mr Cuomo’s office replied on Monday in a letter that his investigation “has already begun to uncover some disturbing facts that seem to belie the innocent picture of downstream brokerages you paint”.

“If downstream brokerages deliberately stuck their heads in the sand but continued to actively market these products to unknowing investors, that will certainly be relevant to our calculus of the firms’ culpability,” the letter said...

Bush Remains Adamant and Defiant on Georgia

Hello? The Republic of Georgia launched an unprovoked military assault on South Ossetian civilians under the cover of the opening of the summer Olympic games.

No matter. Bring it on! And we dare you to stop buying our increasingly worthless Treasury and Agency debt.

Is this some kind of Kafka moment? Fool me once, shame on you. Fool me twice, shame on me. Fool me three times and I must be a faithful viewer of Fox News.



Bush: World must stand with Georgia
20 August 2008

ORLANDO, Florida (AFP) — US President George W. Bush said Wednesday that Russia must withdraw its forces from Georgia and that "the world must stand for freedom" in the former Soviet republic.

In a speech to a major US military veterans group, Bush underlined that Georgia had contributed troops to US-led wars in Afghanistan and Iraq "to help others realize the blessings of liberty."

"Georgia stood for freedom around the world. And now the world must stand for freedom in Georgia," he told the Veterans of Foreign Wars (VFW).

Bush hailed Georgia's democratic shift since its 2003 "Rose Revolution" as "one of the most inspiring chapters of history" and warned that the West could not sit idle while fragile reforms came "under siege" by Moscow.

"The world has come together to condemn this assault," he said, noting NATO criticism of Russia and repeated warnings from the West that it cannot do "business as usual" with Moscow in light of the offensive.

NATO "agreed that Russia must honor its commitment to withdraw its troops from Georgia and to return to the status quo before the hostilities began on August the 6th," said Bush.

"The United States of America will continue to support Georgia's democracy. Our military will continue to provide needed humanitarian aid to the Georgian people," said the US president.

"South Ossetia and Abkhazia are part of Georgia. And the United States will work with our allies to ensure Georgia's independence and territorial integrity," he said.

Jim Rogers Exclusive Interview

Jim is certainly the gloomy side these days.

Unfortunately we can not rule out anything he says.

Jim Rogers Predicts Bigger Financial Shocks Loom, Fueling a Malaise That May Last for Years
Keith Fitz-Gerald
Investment Director
19 August 2008

VANCOUVER, B.C. – The U.S. financial crisis has cut so deep – and the government has taken on so much debt in misguided attempts to bail out such companies as Fannie Mae (FNM) and Freddie Mac (FRE) – that even larger financial shocks are still to come, global investing guru Jim Rogers said in an exclusive interview with Money Morning.

Indeed, the U.S. financial debacle is now so ingrained – and a so-called “Super Crash” so likely – that most Americans alive today won’t be around by the time the last of this credit-market mess is finally cleared away – if it ever is, Rogers said.

The end of this crisis “is a long way away,” Rogers said. “In fact, it may not be in our lifetimes.”

During a 40-minute interview during a wealth-management conference in this West Coast Canadian city last month, Rogers also said that:

U.S. Federal Reserve Chairman Ben S. Bernanke should “resign” for the bailout deals he’s handed out as he’s tried to battle this credit crisis.

That the U.S. national debt – the roughly $5 trillion held by the public– essentially doubled in the course of a single weekend because of the Fed-led credit crisis bailout deals.

That U.S. consumers and investors can expect much-higher interest rates – noting that if the Fed doesn’t raise borrowing costs, market forces will make that happen.
And that the average American has no idea just how bad this financial crisis is going to get.

“The next shock is going to be bigger and bigger, still,” Rogers said. “The shocks keep getting bigger because we keep propping things up … [and] bailing everyone out.”

Click on this link for the interview and the rest of the story: Money Morning/The Money Map Report

A Warning from Richard Russell of the Dow Theory Letter

A dire forecast from Richard Russell indeed. Its within the bounds of our own probability as we have said.

We believe it will play out in slower motion until an event triggers the actual slide. This makes timing very difficult. What makes it even more difficult is that the dynamics are progressive with time.

The magnitude of the trigger event necessary to precipitate the collapse decreases with time until it reaches the point of near triviality. At the same time the forces built up behind the crash potential dissipate with time, resulting less force behind the decline. This is the equation that determines the different profiles of a 1929 and a grinding slide of a 1973-74.

Time to button down and get into hard assets, and let's see what happens. We see 1255on the SP 500 as an important support level but not the showstopper. We have underestimated the manipulative tricks of the Merry Pranksters at the Fed and Treasury before.

August 19, 2008
Richard Russell's Dow Theory Letter

My PTI was down 6 today to 5910. Moving average was 5931. PTI remains bearish by a large 20 points!

What do we do? Where do we go? Put your money in T-bills and await the coming next great buying opportunity with good stocks scraping the bottom. The stock market is now in full crash mode, and where it ends nobody knows.

In the meantime, the US balance-of-payments continues in negative shape. As I've written so many times, we're a global empire living on borrowed money. Our goofy president insults our biggest creditors -- Russia and China -- and seems totally oblivious of the situation. No empire can continue afloat while borrowing money to do so. At some point, nobody will lend the US money, at which point the empire starts to unravel. The dollar plunges, the US becomes a paper tiger. The all-important reserve status disappears.

I'd like subscribers to get rid of all non-bullion gold items and build cash. Sell GDX, SLV, XAU, HUI, and get flush with cash for the bargains that lie ahead as this market moves towards its inevitable final low.

The Rally is Weakening and Highly Vulnerable to Event Risk

The counter trend rallies in stocks and the dollar are nearly done. We may have to wait for market volumes to pick up from the vacation doldrums to see the results.

Quite a bit of the recent market action has been technical trade in light summer volumes, as the wiseguys bat prices around while the Bosses are at the Beach.

Until we see some confirmation, the rally is the rally and the charts are the charts.

Credit spreads point to end of equity rally, Merrill says
By Deborah Levine
MarketWatch
3:21 p.m. EDT Aug. 19, 2008

NEW YORK (MarketWatch) - Credit spreads, which represent the gap between corporate debt and Treasury yields, have been a pretty good predictor of how stocks perform - and they're not looking good.

When credit spreads widen, it signals investors are attaching more risk to lending money to companies. And wider spreads tend to foreshadow the stock markets' next move, according to Merrill Lynch chief North American economist David Rosenberg.

When credit spreads rise, as they are doing now, the equity market goes the other way 88% of the time, he said.

"Credits spreads, especially in the financial sphere, may remain vulnerable to upside pressure and this will only reinforce the vulnerability of this bear market rally in equities," Rosenberg wrote in a note.

For example, in mid-June, the spread between 10-year Baa-rated bonds -- the lowest investment grade rating -- and U.S. 10 Year Treasurys narrowed to 290 basis points, or 2.90 percentage points. That came exactly a month before the S&P 500 index recovered, Rosenberg said.

Now, the spread has again widened to 326 basis points, nearly as wide as in mid-March when the near-bankruptcy of Bear Stearns sent investors fleeing corporate debt and prompted a massive government intervention, including the firm's purchase by J.P. Morgan.

Although spreads have been widening over the past month, the S&P 500 has managed to rally 7% -- as of Monday -- after hitting a intermediate low in mid-July. The shares of financial firms were leading the rally, even though their corporate bonds have continued to lag behind other debt.

"So, we feel that investors should be put on notice that the divergence we have seen take place in the past month is unlikely to be sustained, in our view," Rosenberg said.

Goldman Cuts Estimates on LEH, MER, JPM, MS

AP
Goldman cuts projections for Lehman and others
Tuesday August 19, 5:56 pm ET

NEW YORK (AP) -- Lehman Brothers Holdings Inc. received more bad news on Tuesday after another analyst projected that the investment bank will unveil a big third-quarter loss.

William Tanona, an analyst at Goldman Sachs, said after the market closed he believes Lehman will post a $2.5 billion-to-$3.5 billion loss during the quarter. He also believes that any recovery for the troubled industry is still a few quarters away, and that many Wall Street banks will focus on purging their books of risky mortgage securities.

He also lowered third quarter and full-year estimates for Merrill Lynch & Co., JPMorgan Chase & Co., and Morgan Stanley. Major investment banks have written down more than $300 billion since the credit crisis began last year, with several posting the first losses in their company's history.

Those Lazy, Hazy, Crazy Days of Summer

The market has been in a "back and forth" pattern in this light volume August market. Many senior traders and managers are taking their last vacations for the summer.

The trading programs like to churn the market back and forth, taking down the undercapitalized speculators, probing for signs of weakness among the funds.

As we are on key support we'll see if they can bounce it tomorrow. If they cannot then things may get interesting quickly, probably next week. We'll assume that something big is boiling over behind the scenes and the calls are coming in from the watering holes in the Hamptons.

Will Wall Street Devour AIG?

Just the largest US insurance company, and not a bank. Ben will not feel compelled to save them unless they represent significant counterparty risk to banks.

In a discussion today on Bloomberg, Fed head Jeff Lacker of Richmond indicated that while the common equity holders of Fannie and Freddie may take a hit, the preferred shares are another matter since "they are heavily owned by the banks, and we cannot have the banks being hurt by taking losses."

If that happens, if the banks are bailed out as a part of the nationalization of Fannie and Freddie, then free markets and risk-based capitalism are a thing of the past. The Fed and Wall Street will attempt to do whatever it takes short of burning down the rest of the country to save the few big banks.

AIG Falls as Goldman Says a Capital Raise Is `Likely'
By Hugh Son

Aug. 19 (Bloomberg) -- American International Group Inc., the biggest U.S. insurer by assets, led the decliners in the Dow Jones Industrial Average after Goldman Sachs Group Inc. said it's ``increasingly likely'' the firm will have to raise more capital.

AIG may have to pay $20 billion on credit-default swaps that the company sold to protect fixed-income investors against losses, resulting in rating-firm downgrades and a ``large scale'' capital raise, analyst Thomas Cholnoky said in a note today. The company dropped $1.67, or 7.7 percent, to $19.93 at 12:06 p.m. in New York Stock Exchange composite trading.

Chief Executive Officer Robert Willumstad, 62, hasn't ruled out raising more capital after three straight quarterly losses driven by about $25 billion in writedowns tied to valuation declines on the swaps. AIG may eventually have to pay as much as $8.5 billion on the contracts, three times more than the firm previously estimated, the New York-based insurer said Aug. 7.

``Investor confidence in AIG is damaged,'' Cholnoky wrote. ``The stock may continue to drift downward as investors remain wary of the possibility of a dilutive capital raise.'' Cholnoky cut his 12-month price target to $23 from $30.

AIG has declined 66 percent this year in New York Stock Exchange composite trading, the worst performance in the Dow Jones Industrial Average. The company raised $20.3 billion in May by selling debt and equity.

The insurer hadn't made any payments on the swaps as of Aug. 7 and posted $16.5 billion of collateral through July 31 demanded by investors who purchased protection through the contracts. The swaps guaranteed $441 billion of assets at the end of June, including $57.8 billion in securities tied to subprime mortgages.

`Troubling' Risks

AIG's losses put the company at risk of losing employees and may convince potential customers to take their business elsewhere, said Cholnoky, who rates AIG ``neutral.'' Investors who believe AIG's writedowns will eventually reverse, must consider ``the important and troubling near-term risks,'' he said.

Cholnoky correctly predicted that AIG would post a loss in the fourth quarter of 2007, while the average estimate of 18 analysts surveyed by Bloomberg was for profit of 73 cents a share.

The insurer may raise $20 billion in a worst-case scenario to cushion writedowns, Sanford Bernstein analyst Todd Bault said Aug. 13 in a note. The capital would be required if Willumstad decided to stem future losses tied to the housing market by selling subprime-related holdings at a loss and buying the securities tied to credit-default swaps, Bault said.

Rating Downgrade

Willumstad, also chairman of AIG, was named CEO in June. He has promised to complete a review of AIG by Sept. 25 to help return the insurer to profitability.

Nine analysts recommend investors accumulate AIG shares, 9 say to ``hold'' and one says ``sell,'' according to Bloomberg data.

Standard & Poor's cut AIG's credit rating by one level to AA-, the fourth-highest investment grade, in May after the company posted a record $7.81 billion first-quarter loss.

Another downgrade is likely ``if earnings do not stabilize by the third quarter,'' S&P said Aug. 7.

Investors may demand $13.3 billion more in collateral if the insurer's credit rating is downgraded again, AIG said Aug. 6 in a regulatory filing. Ratings reductions ``could have a material adverse effect on AIG's liquidity,'' the insurer said.

The Spiral - Downfall of an Investment Bank

Thanks to Going Private for producing this satire

The Spiral - Part I - Those Vultures

The Spiral - Part II - Managing Directors Everywhere

The Spiral - Part III - On Stage

The Spiral - Part IV - Liquidation

The Worst Is Yet To Come in the US Financial Crisis

Large U.S. Banks May Fail Amid Recession, Rogoff Says
By Shamim Adam

Aug. 19 (Bloomberg) -- Credit market turmoil has driven the U.S. into a recession and may topple some of the nation's biggest banks, said Kenneth Rogoff, former chief economist at the International Monetary Fund.

``The worst is yet to come in the U.S.,'' Rogoff said in an interview in Singapore today. ``The financial sector needs to shrink; I don't think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job.''

The U.S. housing slump has triggered more than $500 billion of credit market losses for banks globally and led to the collapse and sale of Bear Stearns Cos., the fifth-largest U.S. securities firm. Rogoff said the government should nationalize Fannie Mae and Freddie Mac, the nation's biggest mortgage-finance companies, which have lost more than 80 percent of market value this year.

Freddie Mac and Fannie Mae ``should have been closed down 10 years ago,'' he said. ``They need to be nationalized, the equity holders should lose all their money. Probably we need to guarantee the bonds, simply because the U.S. has led everyone into believing they would guarantee the bonds.''

...``The only way to put discipline into the system is to allow some companies to go bust,'' Rogoff said. ``You can't just have an industry where they make giant profits or they get bailed out.''

The world's largest economy is already in a recession, and the housing market will continue to deteriorate, Rogoff said. The U.S. slowdown will last into the second half of next year, he said, predicting a faster recovery in Europe and Asia.

The Federal Reserve, which has left its key interest rate at 2 percent after the most aggressive series of rate reductions in two decades, risks raising inflationary pressures, he said.

``Rates are too low,'' Rogoff said. ``They must realize we're going to get inflation if things stay where they are. They need to raise rates but I don't think they are going to because they're way too nervous.''

To contact the reporter on this story: Shamim Adam in Singapore at sadam2@bloomberg.net.

Bravo Roubini!

Nouriel Roubini is an original thinker, a forward thinking economist, and importantly is not swayed by a policy bias or political loyalies as so many other popular economists seem to be. Roubini pursues the outcome of his data, which is broadly based and insightfully examined.

The scandal is that so many other economists seemingly missed such an obvious set of conclusions by such a huge margin. Sometimes market action and peer pressure can be overwhelming.

Anyone can be mistaken. But we saw too many instances of 'financial leaders' who were willfully wrong, dismissive, censorious, and driven by things other than a stewardship of knowledge it appears.

Bravo Roubini! Ringraziamo il Dottore per il coraggio del suo lavoro.


Nouriel Roubini Gets a Medal
Brad Setser
Sunday, August 17th, 2008

A well-deserved one too. Nouriel stuck to his core views — housing was massively over-valued, the financial system was heavily exposed to a fall in home prices and the fall out from a fall in US home prices wouldn’t be contained either nationally or globally – when those views were decidedly unpopular.

Back in early 2007, there was a great deal of complacency among America’s financial leadership. Many thought macroeconomic volatility had been vanquished, and as a result financial volatility was justly low. High levels of leverage consequently made sense — and a range of asset market prices reflected this. In the language of the time: credit markets weren’t over-valued, equity markets were under-valued. Recessions - or at least severe recessions and financial crises – were things that happened to other countries, not the US. The US had survived the .com bubble with only a shallow downturn. The 2003-2006 rise oil prices hadn’t put a big dent in the US economy. The large US current account deficit reflected high savings abroad and the attractiveness of the US financial assets; the US, after all, had a comparative advantage in financial-engineering. The IMF wrote that “innovative US fixed income markets [provided] many assets which simply aren’t available elsewhere” (see p. 12). There wasn’t much too worry about.

Read Michael Lewis’ argument that Davos man spent too much time worrying. He wrote in 2007:

Oil prices double, the U.S. housing market tanks — no matter what happens, financial markets adjust quickly and without hysteria. There are obviously a few things to worry about just now in the world, but the inability of traders to find a sensible price for the spread between European junk and European Treasuries isn’t one of them. So why do these people waste so much of their breath and, presumably, thought, with their elaborate expressions of concern?

Even the IMF – which is paid to worry – was tired of worrying. In late January of 2007, Chris Giles of the FT ran an article, based on an interview with the IMF’s Deputy Managing Director, that was titled “Big risks to global economy receding.” I thought that captured the mood of those times well.

Nouriel didn’t waver then. Others (myself included) did. Standing apart from the herd can be hard.

Over time, the focus of Nouriel’s concerns has shifted over time from the United States’ external deficit to the housing market and the financial system. But there has been a core consistency to his views: he never thought that it was healthy for the US to borrow heavily from the rest of the world to finance large fiscal deficits, high levels of consumption and lots of investment in suburban housing. And he thought this borrowing binge would end badly. Very badly.

...Yale’s Shiller notes that Nouriel’s greatest strength his capacity to synthesize an enormous amount of information: “Nouriel has a different way of seeing things than most economists: he gets into everything.” I wrote Bailouts and Bail-ins with Nouriel and I then worked for Nouriel at RGEMonitor – and I fully agree. The breadth of Nouriel’s interests — and his ability to synthesize information from multiple sources — is extraordinary.

I wouldn’t mind if Dr. Roubini was proved to be a bit too pessimistic, and not all the near-term risks he sees come to pass. But I also think it would be a mistake to base policy on the assumption that the worst of the credit crisis is over.

Once Again to the Brink for Lehman?

Lehman Faces Another Loss, Adding Salt To Its Wounds
By RANDALL SMITH and SUSANNE CRAIG
August 18, 2008;
The Wall Street Journal

Lehman Brothers Holdings Inc. has been taking its time as it wrestles with how to escape the problems haunting the investment bank. It probably can't wait much longer.

With the end of the New York company's fiscal third quarter less than two weeks away, some analysts are girding for a loss of $1.8 billion or more, instead of the modest profit they previously expected. If the dour projections come true, Lehman's losses since the start of March would total at least $4.5 billion -- or more than the firm churned out in profit during fiscal 2007.

The likelihood of back-to-back quarterly losses, fueled by widely anticipated write-downs in a portfolio saddled with more than $50 billion in risky real-estate and mortgage assets, puts even more pressure on Lehman Chairman and Chief Executive Richard S. Fuld Jr. to show that the losses won't keep piling up. If they do, Lehman could need to raise additional capital beyond the $6 billion it got in June.

In the past few months, Lehman officials have examined an array of options to bolster the company's financial position, ranging from selling troubled real-estate assets at a discount to divesting a piece of profitable asset-management unit Neuberger Berman, according to people familiar with the matter.

Another stock offering would be hard to pull off without angering existing shareholders, largely because the tidal wave of common shares floated in June has since plunged in value by 42%....

The Case for the Gold Bull Market

We are experiencing a correction in the gold bull market that is within the bounds of our past experience. In 2006 gold had a correction of -22+% in a breathtakingly short period of time, and then consolidated and retested and starting moving higher to the new highs in 2007.

The correction in 2008 while uncomfortable is still very much in line with this bull market. We seem to have violent corrections every few years with major bottoms reached after capitulation lows. More often we experience lesser corrections of 10%.

One possible concern is that this correction will be a sustained central bank intervention, with all the stops out as a move in desperation. Even it is is, it will fail.

This is a possible caution for short term trading, make no mistake. Nothing is certain. But it is just another point along the way for serious long term investors looking for a hedge for their wealth, buying physical metal without significant leverage.

For aggressive traders, we need to be aware of a major opportunity in buying more short term positions in the miners and funds, although this is for the experienced with deep pockets and strong stomachs. A market decline may sink many boats. Deleveraging is still the major market trend.

We can expect violent price swings including moves of even $100 up in less than a few days as the collapse of the dollar hegemony causes a seismic shift as major political constituents migrate to different standards of global valuation.

Here is an essay from Seeking Alpha that contains some interesting charts and data that is useful to review.

The Bedrock Case for the Return of the Gold Bull

More Pain to Come in the Financial Crisis

The real wild card here is continued 'co-operation' amongst the world's central banks, geopolitical events, and of course the length and depth of the recession.

Morgan Stanley sees more finance crisis pain
Sun Aug 17, 2008 9:23am EDT

FRANKFURT (Reuters) - The financial crisis will probably not end until next year or even 2010, Germany's Handelsblatt newspaper quoted Morgan Stanley co-President Walid Chammah as saying in a preview of its Monday edition.

Chammah also expected more banks to fall victim to the crisis, the paper said.

"We will likely see more insolvencies among small U.S. regional banks that have focused on mortgage business," the paper quoted him as saying.

Chammah also said return-on-equity rates of 25 percent were a thing of the past for the investment banking industry, the paper reported.

"I estimate returns in the industry will be more like 15 to 20 percent as a rule," the paper quoted him as saying.

US Dollar Weekly Charts

With the Commitments of Traders as of Tuesday 12 August 2008



With the Moving Averages

Charts in the Babson Style for the Week Ending 15 August 2008

Four Scenarios for the US Dollar and Equity Rallies

As you may have noticed we have been experiencing a powerful counter-trend rally in the US dollar and financials assets including stocks, especially the financials and the broader indices like the Russell, and the US Bonds. Certain commodities like oil, gold and silver have gotten beaten like a rented mule. Why has this occurred with such sudden power?

Here are several scenarios worth considering.

1. Short Squeeze and Forced Liquidation: The "sell dollar and buy energy and metals" trade had become vastly overdone, the big players noticed this, and are using their Wall Street ways to force out the funds and specs that were holding this trade. We consider this a high probability because of the sharpness and violence of the move which has all the hallmarks of a forced liquidation and short covering. Considering that this move has been progressing on low summer volumes during the Olympics in China lends credibility to a calculated trading gambit.
   
   There may also be some government intervention involved over the short term as a 'spark.' There is a disinformation effort tied to specific objectives, such as option expiration and unloading 'dog stocks' along with the usual mindless optimism of the prompter readers. The banks may be intentionally crowding out the hedge funds from short term liquidity for a trade, since they don't have many other sources of income and they require the capital anyway. 'Betraying your customer when the chips are down' is a time honored tradition on the Street, face-ripping-wise. And most importantly so far the moves are well within the parameters of corrective rallies on most of the charts, especially the dollar, stocks and gold.



2. Government Sponsored Reflation: In contrast to a simpler government intervention, a government sponsored reflation is a longer term effort to lift the markets against the tide through the judicious application of liquidity in repetitive tranches of less than three months overlapping. On our long term Dow chart we have identified a couple periods after the 2000-2002 tech bust that we consider reflationary attempts by the US Treasury and the Fed that inflated bubbles in various markets including stocks and housing. This is a medium probability.
   
   It will increase in probability if the market continues to rally with liquidity efforts and new asset bubbles begin to appear. The rallies coincidence with the operation in Georgia which had the marks of a Bushco calculated event lends some credibility to this as well as the first scenario.



3. Goldilocks is back in town: The US economy is ahead of the rest of the world in getting past its credit crisis and restoring soundness to its financial system. The recession will be mild and short lived. The markets are anticipating the US advantage of grossly distorting its economic statistics versus Europe's relative honest reporting. This is a low probability.
   
   The data just does not support an improving economy in the forseeable future. Ben and Hank will botch the rescue effort required for this scenario and activate scenario 2, handing the next president a serious problem. If its McCain we'll just go to war to take our minds off our problems. If its Obama, we'll have a lot of fireside chats to keep us warm in the winter winds that blow through our ruined economy.



4. Prelude to a Crash: It is a little premature to discuss this scenario further with charts and examples unless the stock market reverses hard in a 'rally that fails.' We're keeping a close eye on it. The probability may move very quickly from low to high if we see the 'right moves.' It has a nice cynical irony of betrayal of the public trust once again by the financial sector as well. But it is unlikely as of now. But we wanted to make you aware of it, because the elements for this to form are all there, despite the oncoming Presidential election.
   

We'll have to see what happens to assess the situation further. But it is apparent that the US financial system is badly in need of reform and responsible adult supervision. Truth, accountability, and vigilant justice are among the commodities in the shortest supply.

Who Holds the Most US Dollars?

The People's Bank of China now holds the most dollars on the asset side of its balance sheet, more than even the US Federal Reserve Bank.

Now THAT's a global imbalance.

The full essay from Brad Setser is available at this link which is a bit slow in responding at times. It is a discussion of how a monetary authority can influence policy by acquiring certain types of debt rather than others.

Its a bit of a moot point, since China holds US debt in aggregate, excepting any Fannie and Fred agencies of course. Since the Treasury and Fed are busily monetizing nearly everything, China may only have a single lever to pull: to buy or not to buy.

But it does strike us as a nice example of the imbalances in the world's financial structure, and yet another reason why a true monetary deflation in the US dollar is most likely a fantasy.

"The Capitalists will sell us the rope with which we will hang them." V.I. Lenin


Follow The Money
Quaint
Brad Setser

...The PBoC now has a larger dollar balance sheet (on the asset size) than the Fed. It holds around a trillion dollars of Treasuries and Agencies (over $950b can be identified using the TIC data, and the TIC data understates China’s holdings … ). The Fed has around $900 billion in assets — $940 billion, to be precise....

Most US Companies Pay No Federal Income Tax

We like to read the non-US newspapers to get a better idea of what is happening in North America.

It does appear that change might be in the wind. But we're not optimistic.

Most people are still thinking in slogans, headlines, and cartoons of reality, shaped by what is given by the media, the professional story-tellers, and character assassins. One has to only look at the chain emails they receive, uncritically passed around from person to person, to see how pathetically misinformed the majority seem to be.

So many Americans say "Good!" when they hear that many corporations and the abundantly wealthy few are paying less taxes, without realizing that they and their children are paying for this instead, since government spending is increasing dramatically. They are paying for the billions being created by the Treasury and Fed to subsidize the reckless banks and the huge war profits of the corporations.

We are no better nor different than any other people that have been deluded and misled by propaganda, no matter how ridiculous it might have sounded to others. We asked, "How could they have believed that nonsense, right up to the point of their own destruction?" Now we know.

Its not that we are any less intelligent than others. We are more complacent, self-absorbed, conceited and naive, with our senses dulled by excess. And before you smile too smugly about the Americans, it is a high probability that your own country and central bank have deeply involved you in this financial scheme. Its just that their propaganda has a different tone and flavor.

"It also gives us a special, secret pleasure to see how unaware the people are around us of what is really happening to them." Adolf Hitler


Most Companies in US avoid Federal income taxes
12 Aug, 2008, 0955 hrs IST
The Economic Times (India)

WASHINGTON: Unlike the typical American citizen, most U.S. corporations and foreign companies doing business in the United States pay no federal income tax, according to a new report from Congress.

The study by the Government Accountability Office, expected to be released Tuesday, said two-thirds of U.S. corporations paid no federal income taxes between 1998 and 2005, and about 68 percent of foreign companies doing business in the U.S. avoided corporate taxes over the same period.

Collectively, the companies reported trillions of dollars in sales, according to GAO's estimate.

``It's shameful that so many corporations make big profits and pay nothing to support our country,'' said Sen. Byron Dorgan, who asked for the GAO study with fellow Democratic Sen. Carl Levin.

An outside tax expert, Chris Edwards of the libertarian Cato Institute in Washington, said increasing numbers of limited liability corporations and so-called ``S'' corporations pay taxes under individual tax codes.

``Half of all business income in the United States now ends up going through the individual tax code,'' Edwards said.

The GAO study did not investigate why corporations were not paying federal income taxes or corporate taxes and it did not identify any corporations by name. It said companies may escape paying such taxes due to operating losses or because of tax credits.

More than 38,000 foreign corporations had no tax liability in 2005 and 1.2 million U.S. companies paid no income tax, the GAO said. Combined, the companies had $2.5 trillion in sales. About 25 percent of the U.S. corporations not paying corporate taxes were considered large corporations, meaning they had at least $250 million in assets or $50 million in receipts.

The GAO said it analyzed data from the Internal Revenue Service, examining samples of corporate returns for the years 1998 through 2005. For 2005, for example, it reviewed 110,003 tax returns from among more than 1.2 million corporations doing business in the U.S.

Dorgan and Levin have complained about companies abusing transfer prices _ amounts charged on transactions between companies in a group, such as a parent and subsidiary. In some cases, multinational companies can manipulate transfer prices to shift income from higher to lower tax jurisdictions, cutting their tax liabilities. The GAO did not suggest which companies might be doing this.

``It's time for the big corporations to pay their fair share,'' Dorgan said.

Consumer Inflation Comes in Smoking Hot

Tomorrow is the August stock options expiry and the Wall Street wiseguys are gaming the system aggressively to skin the public, so don't let the short term market reactions to any news we get influence your own thoughts. Think for yourself.

August 15, 2008
Inflation Hits Annual Pace Not Seen Since 1991
By MICHAEL M. GRYNBAUM
NY Times

Inflation reached a 17-year high last month, fueled by high gasoline and food prices, all but assuring that the Federal Reserve will keep interest rates on hold for the time being.

Consumer prices were 5.6 percent higher last month than they were in July 2007, a brisker pace than economists had expected, the Labor Department said on Thursday.

That was the sharpest annual increase since January 1991, as Americans paid more for clothing, food, transportation and recreational products.

The news was distressing for investors and the stock markets initially fell on the report. The major exchanges recovered, however, and the Dow Jones industrials up more than 100 points in early afternoon trading.

Investors returned to buying financial stocks, taking advantage of a sector that has fared poorly in recent sessions. The broader S.&P. 500-stock index was up 0.61 percent. Wal-Mart also reported a better-than-expected rise in quarterly profits, but the discount retail giant also issued a gloomy sales forecast for the rest of the year. In addition, crude oil prices continued to fall, dropping below $113 a barrel.

The overall Consumer Price Index, considered the benchmark gauge of domestic inflation, rose 0.8 percent in July. Economists had forecast a rise of half that rate. In June, prices rose 1.1 percent, the second highest monthly pace in 26 years.

The C.P.I. surveys prices of a basket of common consumer goods, measuring everything from toothpaste and prescription drugs to airline fares and restaurant menus.

Because food and energy prices can be highly volatile from month to month, the Labor Department also calculates a so-called “core” price index, which strips out those costs. In July, core C.P.I. rose 0.3 percent, reaching a 2.5 percent annual rate.

That is higher than the Federal Reserve and other economic policy makers would prefer. Central bankers use core C.P.I. to see whether price increases are becoming entrenched in the broader economy; Fed officials are said to prefer a ceiling of 2 percent annual increases.

The Fed has signaled repeatedly that it has no plans to lower interest rates, given the threat inflation poses to the economy. Lowering rates could stimulate more economic activity, but such a move would risk inflating prices further. Thursday’s C.P.I. report cements that view, and suggests that a rate increase could come sooner rather than later. (They will only raise rates under extreme duress - Jesse)

Still, central bankers face a difficult set of possibilities. The American economy continues to deteriorate: consumer spending is bad and likely to get worse; home prices continue to fall; and Wall Street has been unable to shake a credit crisis that keeps hurting big institutions. Stock prices are down too, further eroding household wealth.

The C.P.I. provided further evidence about the price pressures facing Americans this summer. Energy prices were up 4 percent in July; transportation costs increased 1.7 percent on a sharp rise in airline fares; and the price of clothing soared 1.2 percent after falling or staying steady for most of the year.

Food and beverages also cost more, with prices rising 0.9 percent last month. Since July 2007, food prices have risen 5.8 percent.

Bank Seizures of US Homes Rise 184 Percent

Note the origin of the cartoon (China Daily, Beijing).

"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs." Thomas Jefferson

U.S. Foreclosures Increase 55%, Bank Seizures Rise to Record
By Dan Levy

Aug. 14 (Bloomberg) -- Bank repossessions almost tripled in July and U.S. foreclosure filings increased 55 percent from a year earlier as falling prices cut homeowner equity, accelerating the housing decline, RealtyTrac Inc. said.

Bank seizures rose 184 percent, the most since reporting began in January 2005, the Irvine, California-based seller of foreclosure data said today in a statement. More than 272,000 properties, or one in 464 U.S. households, got a default notice, was warned of a pending auction or were foreclosed on. Nevada, California and Florida had the highest rates.

``It's getting worse,'' Rick Sharga, RealtyTrac's executive vice president for marketing, said in an interview. ``The number of properties that have been foreclosed on by the banks and still haven't sold is the highest we've ever seen.''

Total filings rose 8 percent from the previous month to 272,171, just shy of the record 273,001 set in May, said RealtyTrac, which has a database of more than 1.5 million properties. Through July, 775,244 properties were owned by banks, compared with about 445,000 for all of 2007 and about 224,000 in 2006, Sharga said.

Foreclosures are depressing home prices, contributing to job losses and weakening consumption as fewer people borrow against the value of their home, New York-based analysts at Lehman Brothers Holdings Inc. said Aug. 7.

U.S. home prices fell 15.8 percent in May, the most since at least 2001, according to the S&P/Case-Shiller home-price index. One-third of home sellers in the second quarter lost money, Zillow.com, a Seattle-based provider of home valuations, reported this week....

Price Manipulation Always and Everywhere Creates Artificial Gluts and Shortages.

Silver & Gold Shortage Announcement


Due to the recent price fluctuations, APMEX is experiencing a temporary shortage on certain popular products.

We are actively scouring our sources to locate additional inventory to satisfy the needs of our valued customers.

The Decline of the G7, of Bretton Woods II, and Monetary Neo-Colonialism

Perhaps this policy discussion may cast some light on the efforts of the paper-producing nations to dampen global commodity prices and control certain geographic areas of essential resources.

At some point the Rest of the World may realize that having any nation's fiat money as the international reserve currency is nothing more a thinly veiled form of colonialism.

Policy is a matter for The World, not just a Rich Club
By Jean Pisani-Ferry
The Financial Times
August 12 2008 19:40

As the collapse of the trade talks in Geneva in July made clear, there is no longer any   meaningful  trade negotiation without the main nations from the emerging world. The year 2008 may go down in history as the one in which rich countries discovered that this applies to macroeconomic policies, too.

In January it looked as if the opposite lessons could be drawn from events. For a while, Ben Bernanke at the US Federal Reserve and Jean-Claude Trichet at the European Central Bank seemed to be the only relevant policymakers in the world – and they were, as far as liquidity strains were concerned, if only because the US and Europe account for about two-thirds of the global supply of financial assets.

But as months went by, it became clear that countries affected by the shock represented merely a half of world gross domestic product, two-fifths of global energy demand and not even a third of world cereal consumption. Furthermore, rich countries have significantly less weight at the margin: their contribution to world growth is about half their share of world GDP, so one-quarter of the total, and the same rule of thumb applies even more to the demand for oil and foodstuffs. So in the market for scarce commodities, the effects of the slowdown in the US and Europe were offset by domestic booms in the emerging world.

By the end of spring, policymakers in the Group of Seven leading nations had awoken to an uncomfortable reality that focusing on a regional financial shock had led them to ignore a global commodity shock. Worse, thanks to the fact that most emerging and developing countries in Asia and the Gulf were part of a de facto dollar zone, actions taken by the Fed to address financial stress in fact compounded runaway domestic demand in those countries and fuelled global hunger for commodities. In spite of rising inflation, real interest rates in the main emerging countries are still inappropriately low or even negative.

Stagflation is not here to stay. East Asia is unlikely to remain immune from current near-zero growth in Europe (to where it exports about 5 per cent of its GDP) or, even more, from forthcoming deterioration in the US (to where it exports almost 7 per cent of its GDP). Commodity prices have started to decline. However, the underlying issue will not go away, for two reasons.

First, lingering scarcity of fossil energy and agricultural commodities is likely to remain and to change the macroeconomic scene significantly. For about two decades, since the start of the current wave of globalisation, it seemed that there were no real speed limits to global growth. Disinflationary forces coming from the increase in the global labour force and the weakening of organised labour were powerful enough to ensure an environment of low prices worldwide. This Goldilocks era has ended and the world economy is likely, over and again, to test the speed limit stemming from constraints on the supply of commodities.

Second, in the same way German unification revealed the fault lines in the European monetary arrangements of the 1980s, the current episode has exposed the fault lines in the so-called “Bretton Woods 2” arrangement, whereby a large part of the emerging world pegs to the US dollar. But for the direction of the shock (a boom then, a slump now), what is happening now is in many way a repetition of what happened then to the European exchange rate mechanism: here, a shock to the anchor country that desynchronises it from its monetary bedfellows.

So the question is: what do we need to manage interdependence better? A straightforward solution would be for the main countries or groupings to target domestic inflation independently in the context of flexible exchange rates. The proviso is that for such a solution to work participants would have to target total, not core, inflation (this may seem obvious but it has apparently escaped some policymakers, who claim that there is nothing they can do about inflation because it is not home-made). This is more or less the arrangement industrialised countries came to a decade or so after the collapse of Bretton Woods. It involves minimal co-ordination and can accommodate differences in preferences. In the European case, it has proved compatible with tighter regional agreements – including a single currency.

The problem is that a large part of the emerging world, starting with China, is not ready for independent floating. There are genuine obstacles to it, such as incomplete financial liberalisation and resistance stemming from the fear of uncontrolled appreciation. However, there is no reason why a preference for managing exchange rates should imply the status quo remains. Ad­justments are needed and the current de facto dollar pegs are often at odds with the countries’ foreign trade. From basket pegs involving currencies other than the dollar, especially the euro, to innovative solutions such as the commodity peg advocated by Jeffrey Frankel of Harvard, there is a large menu of options to choose from for reformers looking to strengthen domestic and world stability.

But with managed exchange rates comes closer policy interdependence. If they are to remain prevalent in one form or another, there will need to be more co-operation in setting reference rates and monitoring aggregate demand. This implies multilateral discussions on exchange rate arrangements as well as on domestic demand policies and domestic subsidies to oil and food consumption. From an institutional standpoint, this also implies going beyond the existing loose arrangements or mere lunch invitations such as the last G8 summit in Hokkaido. The G7/G8 is not the appropriate forum for macro-financial matters any more. A frank policy dialogue between emerging and developed countries requires an appropriate venue.

The one option that is not advisable is to ignore the lessons from this year. For some time now, globalisation has been increasingly difficult to sustain politically, in spite of having brought income gains and low prices to the citizens of the advanced economies. It will already be much harder to convince the same sceptical citizens that they must accept it despite the fact that it brings higher commodity prices and lower incomes. It would simply be impossible to make the case for it if, in addition, it were to be perceived as a source of enduring instability.

Exchange rate arrangements and their implications for global macro­economic management should thus be a priority topic for the international community and especially the International Monetary Fund. The Fund is looking for a renewed purpose; here is one that belongs to its core mission and where it has no substitute. Success, however, will only be possible if the G7 countries admit that the days when they were running the show are over.

The writer is director of Bruegel, the European think-tank

The Next Six Months May Be the Heart of the Financial Storm

The Administration and the Fed are fully deploying their bag of tricks to patch up, prop up, and disguise what is really happening in the credit markets and the economy. The intervention has increased considerably in the last week.

They *may* be successful, which will only defer the reckoning with past malinvestment and the destruction of productive capital into the future where it will fester and grow. When the bankers intervene they often can only create the appearance of health and vigor temporarily as in the Crash of 1929. After this the decline is worse since it impacts so many who are late entries and poorly equipped to absorb the losses, capitulating in a panic.

Time will tell. We may be seeing the end of a long phase of central bank influence in the world as they spend the last chips of their credibility. If this is for the benefit of the financial insiders who are exiting their own positions then no punishment will be too severe for such a disgraceful betrayal of the public trust.

The next six months may be the heart of the storm, but the reconstruction and repair may take the heart out of an entire generation of Americans. Equitable punishment will serve as a deterrent and as an act of justice which may restore lost credibility in corrupt governance not only in the US but in Europe and Japan.

August 12, 2008, 11:07 am
The Wall Street Journal
Who’s on the Other Side of That Trade, Anyway?
Donna Kardos reports:

A growing proportion of U.S. firms are seeing credit-default-swap counterparty risk as a serious threat to global markets, and think another major financial company will go under due amid the global-markets crisis, according to a study by research firm Greenwich Associates.

The study’s results, which say the proportion seeing CDS counterparty risk as a serious threat is approaching 85%, highlight the perceived concern of another financial firm going down. Only 27% of the institutions surveyed think there won’t be another casualty along the lines of Bear Stearns, Greenwich consultant Frank Feenstra said in a statement.

The research firm said of the 146 U.S. and European banks, hedge funds and investors it surveyed, most “believe another major financial-services firm will fail as a result of the ongoing crisis in global markets — and they expect it to happen sooner rather than later.”

Almost 60% of the respondents expect another big financial firm will collapse within the next six months, while another 15% see it happening in six to 12 months.

“If you are looking for a silver lining in these findings, it seems that most institutions think we are currently in the most dangerous period for global financial-services firms,” Feenstra said. “Perhaps if the markets can make it through the next six months, the level of pessimism may begin to subside.”

Greenwich said nearly 80% of the firms in the study say their banks have tightened margin or collateral requirements since the outbreak of the global credit crunch. More than a quarter of those companies said the new requirements have caused them to reduce their trading activity.

Concerns about counterparty risk have caused institutions to cut back on their CDS use. Among fixed-income survey participants that employ such swaps, 62% said higher counterparty risk has caused them to limit their use.

Meanwhile, nearly two-thirds of the firms in the survey said they try to limit their concentration of exposure to a single counterparty, while three-quarters said the establishment of a centralized clearing entity would be effective in mitigating credit-default swap counterparty risk.
In Europe, institutions are “at least slightly more sanguine,” Greenwich said compared with U.S. firms surveyed. It said just more than 55% of the European companies surveyed see CDS counterparty risk as a significant danger.


AP
JPMorgan shares tumble on widening 3Q losses
Tuesday August 12, 11:44 am ET

JPMorgan shares fall after bank reports widening losses related to mortgage debt in 3rd qtr

NEW YORK (AP) -- Shares of JPMorgan Chase & Co. tumbled Tuesday after the bank said it has heaped more losses in its mortgage investments so far in the third quarter than it did in the previous three-month period.

In a filing with the Securities and Exchange Commission late Monday, the bank said turbulence in the credit markets has caused it to lose about $1.5 billion, after hedges, in its mortgage-backed securities and loans to date in the July-to-September quarter.

That's more than the $1.1 billion in losses JPMorgan incurred in its investment bank's portfolio during the second quarter.

The news set off fresh concerns about the scope of the troubles in the credit markets and the overall health of the financial sector.

Meanwhile, New York Attorney General Andrew Cuomo said Monday he is expanding his investigation into the collapse of the auction-rate securities market to include JPMorgan, Morgan Stanley and Wachovia Corp.

In its quarterly regulatory filing, JPMorgan said it is cooperating with the investigations.

Long Term Gold and US Dollar Charts

Our working hypothesis is that there has been a coordinated intervention by several central banks to support the dollar, perhaps tied to an overall message to Russia from the Bush Administration. Foreign central banks, most notably Japan, have been supplying significant capital to the Fed via the custodial accounts as noted in the last chart.

One or more of the big multinationals became aware of this and have taken the opportunity to trigger a forced liquidation among the hedge funds as they unwind cross trades, such as short financials - long oil. The funds are also strangled for short term liquidity as the banks suck up the available capital.

We may see several hedge funds and commodity brokers fail because of the steepness of the decline. We think the predators will emerge and become known. They may even be the same ones who helped to trigger the run on Bear Stearns.

We doubt this is a major trend change simply because the fundamentals for the dollar and the economy are so negative, and world growth has not gone on permanent hold. The demand-supply figures are compelling.

The mantra now is "Yes the US is bad but Europe is worse." Perhaps, but the jury is still out and it does sound a little too Orwellian.

The dollar is at serious resistance, and gold has strong support at 790. Let's see what happens.

Corporate Defaults 'Could Hit 10%' as the Credit Crisis Worsens

Nothing has changed. The fundamentals continue to deteriorate in the US financial system and economy. What this headline implies is that ten percent of US businesses could become bankrupt in the next year or so. Think about that.

So why is the dollar strengthening and the stock market rising? For two reasons.

First, as the fog of war descends on the Caucasus, so too the fog of government meddling if not outright intervention has been descending on the financial markets. It would take a leap of faux faith to believe that Georgia launched their assault, timed with the opening of the Olympics, without informing the US which is supplying logistical support and military advisors. Cheney has shown rare personal involvement as well. At the least we are sure that there is more to this than meets the eye.

Secondly, a significant amount of liquidity has been arriving at the NY Fed's custodial accounts, coming from Japan and other foreign central banks, which explains much of the short term financial markets action during the thinly traded late summer months.

Nothing has changed. Things continue to worsen in the real economy. We will look for the markets to reflect the underlying trends again soon enough.


Corporate debt default ‘could hit 10%’
By Nicole Bullock
The Financial Times
August 8 2008 01:28

Defaults on corporate debt are ratcheting up as economic weakness takes it toll on the financial health of companies.

The global default rate is expected to climb to 6.3 per cent over the next 12 months and it could reach 10 per cent should the US sink into a protracted recession, Moody’s Investors Service said on Thursday.

“The storm is gathering for default rates moving up,” said Kenneth Emery, Moody’s director of corporate default research.

Fellow rating agency Standard & Poor’s also warns that credit conditions are deteriorating. “We have long been proponents of the view that the credit euphoria of the prior boom years beginning with 2003 would necessitate a shake-out and purge,” S&P said in a recent report.

“This would result in substantially higher downgrades and defaults, concentrated in the US, but not without repercussions in other parts of the world.”

A year into the credit crunch, defaults have begun to move higher, but they still remain well below the levels reached in other economic downturns. Moody’s default rate hit 10.4 per cent in 2002 and the all-time peak was 11.9 per cent in 1991.

In July, the speculative-grade default rate rose to 2.5 per cent from a revised level of 2.1 per cent in June, marking the largest monthly increase since the default rate bottomed at 0.9 per cent in November 2007, Moody’s said. A year ago, the global speculative-grade default rate stood at 1.5 per cent.

“Certainly, this year the lack of issuers with debt coming due and the prevalence of covenant-lite deals have helped to keep a lid on defaults,” Mr Emery said. “As we move through this year and 2009 that lid will be removed.”

In the past few years of easy lending, issuers refinanced debt and obtained so-called covenant-lite deals, which do not include traditional default triggers that safeguard lenders.

In the US, the consumer transportation companies, primarily airlines, will have the highest defaults, Moody’s expects, while in Europe durable consumer goods companies will be the most troubled.

The Fog of War Descends on the Oil Rich Caucasus

"Give me the money that has been spent in war and I will clothe every man, woman, and child in an attire of which kings and queens will be proud. I will build a schoolhouse in every valley over the whole earth. I will crown every hillside with a place of worship consecrated to peace." Charles Sumner

The spark for the start of the first World War was the assassination of Archduke Ferdinand in Serbia, although the friction amongst the great colonial empires provided the fuel. One of the precursors to the second World War was the Spanish Civil war in which the fascists and the republicans engaged in some preliminary exercises, although it was the German incursion into Poland that unleashed the dogs of war.

In all these instances the large multinational bankers were actively supporting both sides. It is a shocking fact that both British and American banks continued to do business with the Nazis even after the War was well underway. Banking with Hitler - BBC War can be surprisingly good for business, especially if natural resources are on the table, and big money often knows no sides. From an economic point of view, war is just another means of impoverishing the many in order to enrich the few.

The Russians contend that Georgia has provoked this conflict. Georgia is an ally of the United States, and has been seeking NATO membership, although that has been deferred by a Europe not seeking to provoke Russia. It is the largest contributor of troops to Iraq after Britain. Israel is said by Debka.com to be supporting the Georgians with military advisers.

This incursion was interestingly timed with the start of the Olympics. This appears to be a tactical strike designed by someone to change the profile and balance of the oil resources and pipelines in the region. It would be incredible to assume that Georgia had not informed the US of its intentions beforehand, considering we have troops based there, although anything is possible with regard to who fired first. This may be 'blowback' from a Russia that has been increasingly pressured by the US. On the other hand it may be a last provocation from the neo-cons and Bushco. The 'fog of war' is descending rapidly.

Watch this one closely for signs of escalation and spillover, and any impact on the oil markets. We cannot illuminate the good from the bad, the provacateurs from the responders. But we can see trouble, and this on has heavy implications for oil.Sometimes tactical actions can get out of hand and gain momentum.

Timeline of the Georgian - Ossetian - Russian Tensions

"In war the first casualty is the truth." Aeschylus

"When the rich wage war it is the poor who die." Jean-Paul Sartre

"War hath no fury like a noncombatant." Charles Montague

"Every gun that is made, every warship launched, every rocket fired signifies in the final sense, a theft from those who hunger and are not fed, those who are cold and are not clothed. This world in arms is not spending money alone. It is spending the sweat of its laborers, the genius of its scientists, the hopes of its children. This is not a way of life at all in any true sense. Under the clouds of war, it is humanity hanging on a cross of iron." General Dwight Eisenhower

"Battle not with monsters lest ye become one; for when you look into the Abyss, the Abyss looks into you." Friedrich Nietzsche

"Throughout history, it has been the inaction of those who could have acted; the indifference of those who should have known better; the silence of the voice of justice when it mattered most; that has made it possible for evil to triumph." Haile Selasssie

How fortunate for leaders that men do not think. Adolf Hitler

Your Weekend Read on a New School of Economic Thought

Since its August and she-who-must-be-accommodated is on holiday leaving us to fend for ourselves, we don't mind accomplishing the task of illuminating the flaws in the financial system for this weekend not by our own hand but by recommending an excellent essay from The London Banker.

As we have said many times before, (before you started nodding off, or thinking about the Olympics, or most likely just kicks, bangs, and thrills of the bellybutton and below), a new school of economic thought is scheduled to arise from the ashes of the economic conflagration in which are we are presently engaged, three hundred point up days in stock markets to cheer the mob notwithstanding.

The London Banker sets the scope for this new school of economic thought in his essay.

An appetizer and then the link to the repast. Enjoy.

It should be obvious that the financial sector, as intermediaries between savers and productive ventures requiring capital, should never rise to the point where it alone represents over thirty percent of economic activity. Nonetheless, markets all over the world carelessly followed the path of under-production, dis-savings and over-consumption as the path to prosperity rather than a betrayal of capital into hopelessly unproductive works...

Regulatory policies promoting misallocation of capital included elimination of restrictions on bank dealing and brokerage of securities and derivatives, self-determined models-based capital adequacy calculation, ratings-based weightings of capital assets, accounting reforms that permitted off-balance sheet financings and acceptance of ill-transparent corporate structures....

If the core problem leading to the current seizure of the credit markets is the misallocation of credit into unproductive works during the boom years, then no amount of new credit will solve the problem unless the distortions promoting misallocation are redressed through fiscal and regulatory policy changes. Bailouts and recapitalisation of failed policies of the past are only digging a deeper hole, betraying more capital of younger generations into the unproductive works financed by the current generation.

Snake Oil and Deflation by The London Banker

Crazy Eights - Charts in the Babson Style for Week Ending 8.8.08

US Dollar Weekly Charts with Commitments of Traders as of 5 August 2008

Weekly US Dollar with Moving Averages

UBS Will Buy Back Auction Rate Securities for $19.4 Billion

UBS Will Buy Back Bonds for 19.4 Billion
By Beth Healy
August 8, 2008
Boston Globe

State and federal regulators have reached a $19.4 billion agreement with UBS Financial Services Inc. to settle charges that the firm misled investors into buying bonds that were far riskier than advertised, according to people briefed on the talks.

The deal would require the Swiss bank to buy back the investments, called auction-rate securities, which were widely sold on Wall Street as safe and cash-like until the $330 billion market collapsed in February. The firm also agreed to pay $150 million in fines, split between Massachusetts and New York.

The settlement is scheduled to be disclosed this morning by state regulators and the US Securities and Exchange Commission.

The UBS deal is the largest so far in the nationwide investigation of these investments, which have trapped thousands of investors and caused havoc among student lenders and nonprofits. The firm was facing fraud charges brought by Massachusetts Secretary of State William F. Galvin, who led the UBS investigation, and by New York Attorney General Andrew M. Cuomo. Galvin alleged that top UBS executives knew the auction-rate market was failing but did not inform many customers.

The firm has also paid about $40 million to settle findings by Massachusetts Attorney General Martha Coakley that it illegally sold auction-rate bonds to 21 towns and cities and the Massachusetts Turnpike Authority.

UBS declined to discuss the settlement talks but said in a statement, "We are consistently working with regulators toward a comprehensive solution for all auction-rate investors."

Pictures at an Exhibition of a Housing Slump

Merrill Agrees to Buy Back 10 Billion in Illiquid Auction Rate Securities (Starting in 2009)

So who is picking up this tab on behalf of the taxpayers, Ben or Hank?

Merrill Lynch To Buy Auction Rate Securities Positions From Its Retail Clients

NEW YORK, August 7, 2008 - Merrill Lynch today announced that effective January 15, 2009 and through January 15, 2010 it will offer to buy at par auction rate securities sold by it to its retail clients.

"Our clients have been caught in an unprecedented liquidity crisis," said John A. Thain, chairman and chief executive officer. "We are solving it by giving them the option of selling their positions to us."

"We have made tremendous strides in working with issuers during the last five months; over 40% of our clients' auction rate holdings have been liquidated," said president of Global Wealth Management Robert J. McCann. "But we are not satisfied with this pace, even though the marketplace continues to move forward and we expect issuer redemptions to accelerate with time. With this offer, we continue to put the interests of our clients first."

Merrill Lynch acknowledges the important role being played by the SEC, New York State Attorney General Cuomo, the Massachusetts Securities Division and the North American Securities Administrators Association on these issues. Merrill Lynch also will continue to work closely with and encourage auction rate securities issuers in their restructuring efforts to resolve the outstanding liquidity issues for all of Merrill Lynch's retail and institutional clients.

Merrill Lynch's action creates liquidity for more than 30,000 clients who hold municipal, closed-end funds and student loan auction rate securities. Merrill Lynch retail clients currently hold an estimated $12 billion in auction rate securities, which Merrill Lynch expects to be reduced to under $10 billion by January 2009 as a result of announced and anticipated issuer redemptions. In addition to its offer to buy auction rate securities, Merrill Lynch will continue to actively provide clients with attractive loan arrangements to give them needed liquidity.

Under the plan announced today, retail clients of Merrill Lynch would have a year, beginning on January 15, 2009 and ending January 15, 2010, in which to sell Merrill Lynch their auction rate securities, if they so wish. Retail clients include individuals, charitable institutions and many family-owned and small businesses. Auction rate securities that are the subject of pending issuer redemptions or successful auctions will not be eligible for purchase by Merrill Lynch.

The auction rate securities that are owned by Merrill Lynch's clients are predominantly rated AAA and are not credit-impaired. Merrill Lynch does not expect its purchase of auction rate securities in 2009 through 2010 to have a materially adverse impact on its capital ratios, liquidity, or consolidated financial performance.

CITI Agrees to Pay Fines and Buy Back 7 Billion in Illiquid Misrepresented Securities

The AP headline below makes Citi sound like Saint Nicholas or Robin Hood doesn't it? Citi was caught with their hands in the cookie jar making consciously false claims for securites which they wished to unload on the public, and then attempting to obstruct justice by destroying evidence. They made their plea bargain to avoid the discovery process and criminal prosecution.

Look for all the other big banks involved to plead out as well. This was once again driven by the States attorney-generals. We wonder if Bernanke will be exchanging these auction rate securites for US Treasuries at par for Citi at the special customers window?

The wristslaps will continue until the victims wake up and do something or are bankrupt, whichever comes first.

AP
Citigroup returning billions to investors
Thursday August 7, 12:05 pm ET

Citigroup returning billions to investors, paying fine in deals over auction securities

WASHINGTON (AP) -- Citigroup Inc. will buy back more than $7 billion in auction-rate securities and pay $100 million in fines as part of settlements with federal and state regulators announced Thursday.

Citigroup will buy back the securities from tens of thousands of investors nationwide under separate accords with the Securities and Exchange Commission, New York Attorney General Andrew Cuomo and other state regulators. The buybacks will have to be completed by November.

The nation's largest financial institution also will pay a $50 million civil penalty to New York state and a separate $50 million civil penalty to the North American Securities Administrators Association, which represents securities regulators in the 50 states and the District of Columbia.

The SEC also will consider levying a fine on Citigroup, the agency's enforcement director Linda Thomsen, said at a news conference. (Smaller than a wristslap and perhaps not bigger than a parking ticket. Financial crime pays at the Federal level. - Jesse)

New York-based Citigroup neither admitted nor denied wrongdoing under the settlements.

Cuomo had threatened to charge Citigroup with fraudulent sales of auction-rate securities and with the destruction of key documents. (Citi once again avoids discovery - Jesse)

The $330 billion auction-rate securities market involves investors buying and selling securities backed by municipal bonds, student loans and other debt. The market collapsed in February amid turmoil in the credit markets.

"More than 50 percent of our retail clients' holdings in (auction-rate securities) have been redeemed or auctioned at par since the crisis began," Citigroup said in a statement. "We remain committed to continuing our work on initiatives that will secure the best and fastest route to providing liquidity to our clients."

The federal and state regulators have been investigating marketing of the securities by a number of big banks.

Cuomo's office sued the Swiss bank UBS AG last month over billions of dollars in sales in auction-rate securities, and states including Massachusetts and Texas have filed similar complaints. Massachusetts last week accused Merrill Lynch of fraud in promoting the sale of auction-rate securities.

Interest rates on the securities are set at periodic auctions, on the basis of bids submitted.

Charts in the Babson Style for MIdweek 6 August 2008

Reserves? We Don't Need No Stinking Reserves!

The credit crisis was caused by a long period of negative short term interest rates, excessive money supply growth, reckless credit expansion, insufficient reserves and over leverage. The regulatory process became hopelessly ineffective and co-opted. Key safeguards that had been in place since the 1930's were brought down through conscious and well-funded lobbying.

The banks think that they have established the principle that if they overborrow enough, if they are reckless enough, if they expand enough, they become "too big to fail" and their losses will be borne by the taxpayers and all holders of the currency, while they keep their personal profits and bonuses.

The Fed would like to introduce some 'turbo-charging' to that money-printing machine, cry 'Fiat!' and unleash the dogs of leveraged credit expansion and monetary inflation. The final link will be a directly funding capability between the Treasury and the Fed, which although not legal is not yet technically sanctioned by the US Uniform Code of Law. But if the Treasury can monetize debt directly such as in the Paulson plan for Fannie and Freddie purchases that point may be moot for quite some time. This is going to be interesting.


Divorcing Money from Monetary Policy
Authors: Todd Keister, Antoine Martin,and James McAndrews
New York Federal Reserve

Many central banks implement monetary policy in a way that maintains a tight link between the stock of money and the short-term interest rate. These procedures require the central bank to set the supply of reserve balances precisely in order to implement the target interest rate.

Because reserves play other important roles in the economy, the link can create tensions with other objectives of central banks. For example:

The imbalance between the intraday need for reserves for payment purposes and the overnight demand leads central banks to provide low-cost intraday loans of reserves to participants in their payments systems, exposing central banks to credit risk and potential moral hazard problems. (This is like worrying about having dirty dishes in the sink while hauling toxic sludge into the house by the truckload, if one considers the dodgy debt the Fed is bringing in from the investment banks through Special Facilities. As for their concerns about moral hazard, these financial swingers have the moral sensibilities of a billy goat. - Jesse)

The link between money and monetary policy prevents central banks from increasing the supply of reserves to promote market liquidity in times of financial stress without compromising their monetary policy objectives. (This is the issue, the punchline. The bank wants to be able to flood the market with liquidity at will without it showing up in the short term interest rates and money supply figures. Since they have eliminated M3 that takes care of the top end. They basically would like to free themselves from even nominal restraints on printing money. - Jesse)

The link also relies on banks facing an opportunity cost of holding excess reserves, which leads them to expend effort to avoid holding these reserves and thereby makes the monetary system less efficient. (Yes we have seen the high efficiency that has been gained recently by insufficiently low reserves and high gearing of leverage. Let's increase it now that we think the worst has past to see if we can get lucky again - Jesse)

Keister, Martin, and McAndrews consider an alternative approach to monetary policy implementation—a “floor system”—that can eliminate these tensions by “divorcing” the central bank’s quantity of reserves from its interest rate target.

By paying interest on reserve balances at its target interest rate, a central bank can increase the supply of reserves without driving market interest rates below the target.

The authors explain that a floor system allows a central bank to set the supply of reserve balances according to the payment or liquidity needs of financial markets. By removing the opportunity cost of holding reserves, the system also encourages the efficient allocation of resources in the economy.

A version of the floor system was recently adopted by the Reserve Bank of New Zealand; this option for monetary policy implementation will be available to the Federal Reserve beginning in 2011.

Divorcing Money from Monetary Policy - NY Fed - pdf download

The Next Shoe to Drop - Pay Option ARM Defaults

Pay Option ARMs - Up to 48% Default Rate! First Federal Featured
August 5th, 2008
Mr. Mortgage

I have been preaching that the ‘Pay Option Implosion’ will make the ‘Subprime Implosion’ look like a hiccup in states in which this loan program was widely used such as CA. This is because this loan program knows no socio-economic boundaries and was very heavy used in more affluent areas because of its ultimate affordability feature, negative amortization.

The Pay Option ARM (POA) is the most toxic of all loan programs with up to 80% of borrowers making the minimum monthly payment and acruing negative. Combine that with a house price crash of 32% in the past 13 months in CA and most of these borrowers owe more than their home is worth and are at an exponentially greater risk of loan default. Remember, these were once PRIME borrowers in many cases.

Part of my day job is analyzing banks and mortgage lenders using proprietary data and tracking mortgage loan defaults and REO by bank. I can see near real-time what is happening on a bank level and it is not pretty. About four months ago I noticed the subprime defaults waning, which I have been telling all of you about ever since. Over the past four months subprime defaults in CA are down about 25% but total Notice of Defaults have remained near historic highs of 43k per month. This is because Alt-A defaults have filled the gap.

The Alt-A universe is much larger in unit count and dollar volume than subprime so even though we are just at the beginning of the ‘Alt-A Implosion’, they have already filled in the subprime default void. Scarier yet, roughly 65% of all Alt-A defaults are POA’s. (Pay Option ARMS) The ‘POA Implosion’ is upon us.

As a matter of fact, just last week S&P, Moody’s and Fitch all hit Alt-A hard with an emphasis on Pay Option ARMs....

Morgan Stanley Cuts Home Equity Lines of Credit

Morgan Stanley Said to Freeze Home-Equity Credit Withdrawals
By Christine Harper

Aug. 6 (Bloomberg) -- Morgan Stanley, the second-biggest U.S. securities firm, told thousands of clients this week that they won't be allowed to withdraw money on their home-equity credit lines, said a person familiar with the situation.

Most of the clients had properties that have lost value, according to the person, who declined to be identified because the information isn't public. The New York-based investment bank will review home-equity lines of credit, or HELOCs, monthly from now on, the person said yesterday.

Wall Street firms including Morgan Stanley are ratcheting back on risks after the collapse of the subprime mortgage market and ensuing credit contraction saddled banks and brokerages with almost $500 billion of writedowns and losses. Consumers fell behind on home-equity credit lines at the fastest pace in two decades in the first quarter, the American Bankers Association reported last month.

``Morgan Stanley periodically reassesses client property values and risk profiles,'' said Christine Pollak, a Morgan Stanley spokeswoman in Purchase, New York. ``A segment of clients was recently notified of a change in the status of their home- equity line of credit, or HELOC, due to a change in the value of their property and/or their credit profile.''

Pollak declined to specify the dollar amount of the frozen credit lines. The firm's global wealth management division, which doesn't disclose how many clients it serves, had 8,350 advisers managing $739 billion of customer assets at the end of May, according to its second-quarter earnings report.

No Recovery Seen

``It's evidence that they don't think the economy is going to recover quickly,'' said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York who rates Morgan Stanley shares ``outperform'' and who owns some of the stock. ``The fact that they're trying to get ahead of the problem is very good.''

Morgan Stanley has already taken about $14.4 billion of losses related to leveraged loans and collateralized debt obligations. The clampdown on home-equity loans mirrors similar efforts by commercial banks, said David Hendler, an analyst at Credit Sights Inc. in New York.

``All consumer lenders and home-equity lenders are reassessing the environment given the pressure on housing and the economy,'' Hendler said....

Here Come the Waves of Credit Defaults, Deleveraging, and Recession

Its called an economic contraction. The US is in a serious recession, much more serious than the headlines will allow because of the significant understatement of inflation in the chain deflator, worse even than the CPI. The government and financial sector is acting with reckless disregard for the welfare of the country by silencing all the alarms one used to be able to rely upon to protect themselves and make sound personal and business decisions.

Credit Card ABS Locking Up: Report
By: PAUL JACKSON
August 5, 2008
HousingWire.com

Here it comes: the spillover from subprime mortgages that many secondary market participants had hoped not to see looks increasingly as if it may finally be coming home to roost. A published report Tuesday morning noted that the credit card ABS market is locking up, as investors pull back from the sector and more borrowers begin to default on their consumer credit debt.

The Wall Street Journal, citing data from JP Morgan Securities, said that issuance of credit card ABS fell to $4.4 billion during July, off from $5.26 billion in June and less than half of the $10.1 billion issued in March. A report by JP Morgan structured finance analysts said that deal flow has “slowed considerably” — and, adding insult to injury in the latest xBS market to falter, those deals that are coming to market are taking longer to do so.

Adding to investor fears in the credit card sector was an August 1 report by Citigroup Inc. with the Securities and Exchange Commission that saw the fourth-largest credit card issuer post a $176 million loss in credit card securitization activity during the second quarter.

Overall U.S. ABS issuance slowed to a crawl, totaling just $8.6 billion in July according to industry trade publication Asset Backed Alert; so far this year, ABS issuance has totaled just $123.5 billion.

Last year at this time, total U.S. ABS issuance was $465.8 billion. Forty-two percent of U.S. ABS issuance this year has been in the form of credit card debt, the largest percentage of ABS (which also includes auto financing, student loans, and the like).

July’s abysmal ABS issuance total was the worst since December 2007, and the second worst in more than 9 years; and it’s led more than a few market participants to wonder what’s next in a capital market that has been reeling from the effects of the mortgage crisis for more than a year now.

“One has to wonder if the subprime thing wasn’t just an underwater event out in the ocean and now the tsunami waves are rolling in, one after another,” said one of HW’s sources, an MBS/ABS analyst, via email on Tuesday morning.

When the Going Gets Weird, the Weird Turn Pro

We just don't have the words.

Morgan Stanley to Advise U.S. Department of the Treasury Regarding Fannie Mae and Freddie Mac


NEW YORK -- (Business Wire) --

Morgan Stanley (NYSE: MS) confirmed today that it has been

retained by the United States Department of the Treasury to provide

capital markets advice to support the Treasury's responsibilities

associated with its new authorities regarding Fannie Mae and Freddie

Mac. As part of that assignment, Morgan Stanley will support the

Treasury's work to promote market stability and the availability of

mortgage credit.


Morgan Stanley Chairman and Chief Executive Officer John J. Mack

said, "Morgan Stanley is honored to have been asked to serve as

financial advisor to the U.S. Treasury as it evaluates various

alternatives for Fannie Mae and Freddie Mac. We are pleased to be able

to offer our services to the government and look forward to working

with Secretary Paulson and his team as they work to restore stability

to the global capital markets and confidence in the U.S. housing

market." Morgan Stanley will accept no fees for this assignment and will

receive only $95,000 from the Government toward its expenses.

($95,000 for expenses? That's a lot of Taittinger at The Palm and VIP lapdances at Camelot. Or are we talking something a little more Spitzeresque? We'll take that job in a Manhattan minute for free. It would put a certain 'edge' to our blog. Think about it Hank. - Jesse)

The Message of the Markets

Today's market action looked like a major Wall Street insiders push to break the traders/funds who were playing the long oil-long metals - short dollar-short financials cross trades. They were leaning awfully hard on them.

Just as an update we took down our short oil - long gold cross trade the past couple days. We wanted to be in a stronger cash position to be a able to move quickly in case some things unfold as we expect they might.

The volumes are just not there so far to justify this run up in the stock indices. The Fed did not do anything today to justify a 300+ point rally. The spin on financial television is running hard from the 'chief strategists.' Wall Street wants to get the market up and offload more shares to mom and pop to further damage the economy for their own benefit. That's what they do. This is why our economy is sick. It is being run by shills and gamblers for the benefit of 'the house.'

We will be very surprised if the market does not sell off tomorrow, but we have an open mind and will start considering the notion of government intervention which could sustain a prolonged 'reflation rally.' If the Fed and Treasury can get behind this in a meaningful way then all bets are off.

But for now this just looks like the Wall Street wiseguys peeking at the other players cards from their seating vantage points as insiders and limit raising the bets against the prevailing trades on the trend fundamentals. If this is the case, the prior trends should reassert themselves within the week. If not, then we might be in a new ballgame.

We will WAIT for a sign that this is the case, although we did put on a few Sept. Index shorts into the close. There is no point jumping in front of this in case it is something more profound than just the usual Wall Street shenanigans.

More on Fisher and the Theory of the Great Depression

In 2006 a Mr. Alex Grey had posted an insightful comment on one of the financial blogs which we have kept in mind. Here it is in its entirety.

There was definitely a hole in Keynes' theory of the Great Depression. This has thankfully been filled by the article "Fisher, Keynes and the Corridor of Stability" by Robert Dimand (American Journal of Economics and Sociology, Vol. 64, No. 1 (January, 2005), pp. 185-199).

This article is I think the missing link that established that the Keynesian Liquidity Trap that characterised the Great Depression was a result of debt deflation as described by Fisher. This establishes that Friedman and Schwartz's view of the great Depression has the causality reversed - the economic contraction led to the contraction in monetary aggregates, notably M3. The Fed or its the equivalent could do little to avert this.

I think averting the process of debt deflation cannot be accomplished through monetary policy (Bernanke following Friedman believes the opposite). This again points to the contrast between Keynes and Friedman.

Evidence in support of the incorrectness of Friedman's view is seen in the experience of Japan in the 1990s where the government succeeded only in increasing M1 while M3 continued to shrink (see paper by Krugman (1997 on this) and asset prices, notably housing, continued to fall. The reason why monetary policy cannot avert debt deflation is that asset prices are bid up to unrealistically high levels during booms based on the same "animal spirits" that govern investment. When markets turn then so do expectations which cannot easily be reversed and certainly not by monetary policy.

Financial innovation as described by Minsky leads to greater increases in asset prices during booms as it permits greater amounts of borrowed funds to flow into asset markets making asset prices more sensitive to the business cycle. As a result the risks of debt deflation during cyclical downturns increases over time. The reasoning behind this is simple - the ultimate effect of all financial innovation is to increase the level of debt relative to income. At the macro level this entails an increase in the debt to GDP ratio.

Therefore the Great Depression can be viewed as the natural course of the business cycle in economies subject to financial innovation. The full downswing portion of the business cycle can be forestalled by Keynesian counter-cyclical policy however this has to be accompanied by financial regulation. If not, financial innovation risks creating pro-cyclical swings in asset prices that will ultimately swamp Keynesian counter-cyclical policy.

Since 1980 we have witnessed the elimination or substantial reduction in almost all legislation governing the financial sector. This combined with disinflation and financial innovation set in motion a period of sustained increase in private credit relative to GDP. The foregoing suggests that an imminent recession could morph into an economic depression if it triggers debt deflation.

There does seems to be little doubt that Bernanke et al. believe that they can mitigate the process of credit contraction through monetary policy. There is an interesting question about the possible inflationary effects.

It is to be expected that Bernanke et al. have all thought about this, and would seek to mask the short term inflationary effects and the indicators of this very phenomenon described by Alex Grey of a sluggish broader money supply as compared to the narrow measures which are more amenable to monetary policy.

There is it seems a significant wild card which few seem to account for explicitly in the relative values of currencies and their impact on the import prices of economically important commodities.

We will be speaking more about this in the future. One of the slants on this that seems worth considering is the difference between the Japanese economic experience, which so many cite, and the Russian experience, which is qualitatively different and perhaps illuminating of important elements and differences therein.

LEH in Talks to Sell Asssets and New Equity to Raise Capital

Lehman may have to raise capital if sells assets
Mon Aug 4, 2008 12:48pm EDT
By Dan Wilchins

NEW YORK (Reuters) - Lehman Brothers Holdings Inc is expected to follow in Merrill Lynch & Co Inc's footsteps and sell a lot of risky assets at a loss. But shedding the assets may create another headache for Lehman -- the need to raise large amounts of new capital, including common equity.

Any capital raise would be painful for Lehman and its shareholders, given that the company just raised $6 billion in June and trades at a significant discount to its book value, or the net accounting value of its assets.

But Lehman, the fourth-largest U.S. investment bank, may have little choice as it wrestles with roughly $65 billion in mortgage-related assets, particularly after Merrill Lynch agreed to shed $30.6 billion in toxic assets at a fire-sale price of 22 cents in the dollar, analysts said.

"Lehman's caught between a rock and a hard place. They're getting more and more pressure from regulators and investors to add reserves or mark these things down," said David Hendler, an analyst at independent research firm CreditSights in New York.

"In normal times, they could wait it out, but the market wants it done now," Hendler added.

The New York Post reported on Friday that Lehman was talking to potential buyers about selling $30 billion in assets. CNBC television reported Friday that Lehman was in talks with BlackRock Inc to sell mortgage securities and other assets. Both Lehman and BlackRock declined to comment.

Lehman's chief financial officer told Merrill analyst Guy Moszkowski recently that the investment bank was willing to sell assets at a loss if the deal materially reduced risk, the analyst said in a report.

Lehman had roughly $65 billion in mortgage and real estate-related assets on its balance sheet as of May 31.

Selling at a loss seems increasingly likely after the Merrill deal last week. Lehman's assets may be of much higher quality, but Merrill's low sale price for mortgage-linked securities implies that many banks' assets connected to mortgages may be marked down further.

Lehman wouldn't have to sell assets at much of a loss before it had to raise capital.

Brad Hintz, an analyst at Sanford C. Bernstein, wrote in a note on Monday that any loss much greater than $1.5 billion -- which translates to selling $30 billion at a discount of at least a 5 percent to their current value on Lehman's books -- would likely force Lehman to issue at least some common equity.

Selling assets at enough of a loss would force Lehman to record a quarterly charge -- eating into capital for an investment bank that many investors already believe is undercapitalized. Any big reduction in Lehman's capital could bring pressure from regulators and rating agencies to raise capital.

Depending on the price that the assets are sold for, Lehman might have to raise $4.5 billion to $7 billion in capital to offset losses, CreditSights' Hendler said. Given that Lehman's market capitalization, or value in the stock market, is currently about $13 billion, such a capital raise could leave existing shareholders owning a much smaller portion of the company.

NEUBERGER UP FOR SALE?

If Lehman needs to raise more capital, it may consider selling all or a portion of its asset management business, analysts said -- a move mentioned in media reports as a possibility for weeks.

Investment banks have increasingly been looking to sell assets instead of issuing shares since shedding businesses that provide a relatively low amount of revenue may be less painful for shareholders than dramatically boosting outstanding shares.

Merrill sold back its 20 percent stake in Bloomberg LP, the news and financial data company, to Bloomberg Inc for $4.4 billion in July. It also said last month it was in advanced talks to sell a controlling stake in its Financial Data Services Inc unit, in a deal that could value the business at more than $3.5 billion.

Lehman's asset management unit, which includes the Neuberger Berman business that Lehman bought in 2003, generated about $1.88 billion in net revenue in 2007. Analysts estimate the unit could sell for about $8 billion.

Selling a business to raise capital may be better than issuing shares, but it is generally not pleasant, in part because getting a good price in a sale is tough now. Few buyers have the capital to make big acquisitions, and any potential acquirers know the sellers are anxious to sell assets.

Merrill Chief Executive John Thain told investors in June that he saw the Bloomberg business as worth between $5 billion and $6 billion, but the investment bank ended up selling it for less than that.

The Neuberger business is a steady generator of earnings for Lehman, which has helped stabilize Lehman's overall profits....

Citi Takes a Serious Hit on Credit Card Losses - Sees Defaults Rising

Citigroup Posts Loss on Credit-Card Securitizations
By Bradley Keoun

Aug. 4 (Bloomberg) -- Citigroup Inc. reported its first loss since at least 2005 on credit-card securitizations, signaling that risks may be growing in a business that generated $3.5 billion of revenue in the past three years.

The biggest U.S. credit-card lender lost $176 million in the second quarter packaging card loans into securities, the company said in an Aug. 1 regulatory filing. The New York-based bank completed fewer deals and was forced to mark down its own $9 billion stockpile of the debt instruments and other stakes the company amassed while selling them to investors.

Led by Chief Executive Officer Vikram Pandit, 51, Citigroup manages about $202 billion of credit-card loans worldwide, about $111 billion of which have been turned into securities and sold, according to the filing. Delinquencies on the securitized portion have jumped by 16 percent since the end of last year to $2.16 billion as of June 30, Citigroup said. The firm's results may portend similar losses for rivals.

Banks and other card issuers ``are predicting higher net charge-off rates across the credit-card industry,'' said Meghan Crowe, a Fitch Ratings analyst who tracks credit-card issuers including American Express Co., Capital One Financial Corp. and Advanta Corp. ``Things have been worse than anticipated.''

Citigroup spokeswoman Shannon Bell declined to comment. The company's shares fell 73 cents, or 3.9 percent, to $18.14 at 10:30 a.m. in New York Stock Exchange composite trading.

Jobs Cuts Spreading Throughout Much of the Economy

So much for the credibility of the ADP Jobs Report. Just How Accurate is the ADP Payrolls Report?

U.S. July Job Cuts Double Year-Earlier Level, Challenger Says
By Timothy R. Homan

Aug. 4 (Bloomberg) -- Job cuts announced by U.S. employers soared last month, led by reductions at airlines and financial firms, according to a report by a private placement firm.

Firing announcements increased to 103,312 last month, up 141 percent from 42,897 in July 2007, Chicago-based Challenger, Gray & Christmas Inc. said in a statement today. That's the biggest year- over-year percentage increase since November 2001, at the end of the last official recession.

Companies are trimming payrolls as fuel prices increase and the housing slump drags on. The Labor Department last week said that the U.S. economy lost jobs for a seventh straight month in July and the unemployment rate reached the highest in more than four years.

``We have seen job cuts increase in the majority of industries that we track,'' John A. Challenger, chief executive officer of the placement company, said in a statement. ``The downturn, which was isolated to the housing and financial sectors just a few months ago, has spread throughout much of the economy.''

Companies have announced a total of 579,260 cuts so far this year, up 33 percent from the first seven months of 2007, according to the report.

The number of planned job cuts rose 26 percent last month from 81,755 in June, the report said. The figures aren't adjusted for seasonal effects, so economists prefer to focus on year-over- year changes instead of monthly figures.

Transportation companies led industries in announced reductions in July, with 17,051. Financial firms followed with plans to eliminate 15,517 positions, and retail stores, which announced 12,160 cuts.

Incoming: Another Significant Wave of Mortgage Defaults

The Fed and Treasury face wave after wave of defaults from the unwinding of the credit bubble. They have lowered interest rates to try and stem the incoming tide of collapse, and in doing so they will trigger inflation and perhaps yet another bubble elsewhere if they can. What will it be? It may be a bubble in certain commodities, and indeed even be an anti-bubble in the dollar and the imposition of draconian domestic measures.

August 4, 2008
Housing Lenders Fear Bigger Wave of Loan Defaults
By VIKAS BAJAJ

The first wave of Americans to default on their home mortgages appears to be cresting, but a second, far larger one is quickly building.

Homeowners with good credit are falling behind on their payments in growing numbers, even as the problems with mortgages made to people with weak, or subprime, credit are showing their first, tentative signs of leveling off after two years of spiraling defaults.

The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A mortgages, quadrupled to 12 percent in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7 percent in that time.

The mortgage troubles have been exacerbated by an economy that is still struggling. Reports last week showed another drop in home prices, slower-than-expected economic growth and a huge loss at General Motors. On Friday, the Labor Department reported that the unemployment rate in July climbed to a four-year high.

While it is difficult to draw precise parallels among various segments of the mortgage market, the arc of the crisis in subprime loans suggests that the problems in the broader market may not peak for another year or two, analysts said.

Defaults are likely to accelerate because many homeowners’ monthly payments are rising rapidly. The higher bills come as home prices continue to decline and banks tighten their lending standards, making it harder for people to refinance loans or sell their homes. Of particular concern are “alt-A” loans, many of which were made to people with good credit scores without proof of their income or assets.

“Subprime was the tip of the iceberg,” said Thomas H. Atteberry, president of First Pacific Advisors, a investment firm in Los Angeles that trades mortgage securities. “Prime will be far bigger in its impact.”

In a conference call with analysts last month, James Dimon, the chairman and chief executive of JPMorgan Chase, said he expected losses on prime loans at his bank to triple in the coming months and described the outlook for them as “terrible.”

Delinquencies on mortgages tend to peak three to five years after loans are made, said Mark Fleming, the chief economist at First American CoreLogic, a research firm. Not surprisingly, subprime loans from 2005 appear closer to the end of defaults than those made in 2007, for which default rates continue to rise steeply.

“We will hit those points in a few years, and that will help in many ways,” Mr. Fleming said, referring to the loans made later in the housing boom. “We just have to survive through this part of the cycle.”

Data on securities backed by subprime mortgages show that 8.41 percent of loans from 2005 were delinquent by 90 days or more or in foreclosure in June, up from 8.35 percent in May, according to CreditSights, a research firm with offices in New York and London. By contrast, 16.6 percent of 2007 loans were troubled in June, up from 15.8 percent.

Some of that reflects basic math. Over the years, some loans will be paid off as homeowners sell or refinance, and some homes will be foreclosed upon and sold. That reduces the number of loans from those earlier years that could default. Also, since the credit market seized up last year, lenders have become much more conservative and have stopped making most subprime loans and cut back on many other popular mortgages.

The resetting of rates on adjustable mortgages, which was a big fear of many analysts in 2006 and 2007, has become less problematic because the short-term interest rates to which many of those loans are tied have fallen significantly as the Federal Reserve has lowered rates. The recent federal tax rebates and efforts to modify more loans have also helped somewhat, analysts say.

What will sting borrowers more than rising interest rates, analysts say, is having to pay interest and principal every month after spending several years paying only interest or sometimes even less than that. Such loan terms were popular during the boom with alt-A and prime borrowers and appeared appealing while home prices were rising and interest rates were low.

But now, some borrowers could see their payments jump 50 percent or more, and they may not be able to sell their properties for as much as they owe.

Prime and alt-A borrowers typically had a five- or seven-year grace period before payments toward principal were required. By contrast, subprime loans had a two-to-three-year introductory period. That difference partly explains the lag in delinquencies between the two types of loans, said David Watts, an analyst with CreditSights.

“More delinquencies look like they are on the horizon because so few of them have reset,” Mr. Watts said about alt-A mortgages.

The wave of foreclosures is still rising in states like California, where many homeowners turned to creative mortgages during the boom. From April to June, mortgage companies filed 121,000 notices of default in California, up nearly 7 percent from the first quarter and more than twice as many as in the second quarter of 2007, according to DataQuick, a real estate data firm based in La Jolla, Calif. The firm said the median age of the loans increased to 26 months from 16 months a year earlier.

The mortgage giants Freddie Mac and Fannie Mae, which own or guarantee nearly half of all mortgages, are trying to stem that tide. Last week, they said they would pay more to the mortgage servicing companies that they hire to modify delinquent loans and avoid foreclosures.

Delinquencies in prime and alt-A loans are particularly challenging for banks because they hold more such loans on their books than they do subprime mortgages. Downey Financial, which owns a savings bank that operates in California and Arizona, recently reported that 11.2 percent of its loans were delinquent at the end of June, a big increase from the 6.1 percent that were past due at the end of last year.

The bank’s troubles stem from its $6.2 billion portfolio of so-called option adjustable-rate mortgages, which allow borrowers to pay less than the interest owed on their mortgage in the early years. The unpaid interest is added to the principal due on the loan, so over time borrowers can owe more than the initial loan amount. Eventually, when loans grow by 10 percent or 15 percent, the borrowers are required to start paying both the interest and principal due.

Many borrowers who got these loans during the boom had good credit scores, but many of them owe more than their homes are worth. Analysts believe that many will not be able to or want to make higher payments.

“The wave on the prime side has lagged the wave on the subprime side,” said Rod Dubitsky, head of asset-backed research at Credit Suisse. “The reset of option ARM loans is a big event that will drive the timing of delinquencies.”

US Credit Crisis: There Will Be No Resolution Until There Is Reform

Its good to be aware that we are not the only ones saying things like this. It is a general theme being repeated throughout the international media, if not in the domestic media in the States. There will be no resolution of the credit crisis until there is meaningful systemic reform.

Jul 31, 2008
The Asia Times
Paulson still doesn't get it
By Peter Morici

Once again, we have good news and bad from Wall Street.

US Treasury Secretary Henry Paulson has announced that Citigroup and three other banks will begin issuing covered bonds in an effort to rejuvenate commercial bank mortgage lending and the housing market.

Concurrently, Merrill Lynch announced it is taking yet another big write down on its subprime securities, selling paper with a face value of US$30.6 billion to private equity firm Lone Star for $6.7 billion. It will dilute its common stock 38% through the sale of additional shares to make up the losses.

Paulson's covered bonds would be backed by specific mortgages held by the banks. In essence, these would be large certificates of deposit. Though not necessarily insured, the bonds would be backed by specific assets on the banks books, and the banks would to take steps to ensure these mortgages were good - not the junk Merrill Lynch, Citigroup and others have been hoisting on investors.

Whether the bond market accepts these securities - essentially whether insurance companies, pension funds and other fixed-income investors take the plunge - comes down to trust in the banks. Recent events at Merrill Lynch, Citigroup and others indicate that such trust will require a bold leap of faith.

The basic problem at the big banks is compensation schemes that encourage bank executives to make risky bets that allow them to profit when things go well and to push the losses on bond and stockholders when things go sour. Upon taking over Merrill Lynch, John Thain increased executive bonuses but established a risk management scheme. That hasn't worked.

At Citigroup, chief executive Vikram Pandit is selling off assets to cover losses, but he has not given back the $165 million he took from shareholders in his sale of the Old Lane hedge fund to his employer. The bank subsequently took more than $200 million in losses, yet the Citigroup bonus machine continues to payout to its executives.

USB is under investigation for fraud in the sale of auction rate securities.

It seems hard to find a major bank without some a record of sharp practices.

Paulson is trying to sell trust in the banks with his new covered bonds. It's tough to sell trust in a Wall Street bank these days because there is not much to trust.

An insurance company that buys Paulson's covered bonds will likely be all right, but it is taking an imprudent risk. That should tell you something about the competence of its management, and it would be signal to dump its stock.

Paulson's scheme to reopen the bond market to banks for mortgage lending will only work, if the commercial banks clean up the management practices that caused the subprime crisis, and massive losses imposed on shareholders and bond customers. (and taxpayers, and all holders of US dollars - Jesse)

The federal government is imposing new a regulator on Fannie Mae and Freddie Mac, which will have authority to regulate executive compensation. The Federal Reserve has loaned hundreds of billions to Wall Street banks and securities companies without any real commitments for management reform. The asymmetry is puzzling.

Paulson will only get the mortgage market, housing crisis and economy turned around when he resolves the confidence gap on Wall Street. That requires systemic reform in the business practices and compensation structures. What's good for Fannie and Freddie would be good for Citigroup, Merrill Lynch and the others.

Peter Morici is a professor at the University of Maryland School of Business and former chief economist at the US International Trade Commission.

The Mortgage Crisis Is a Replay of the TechBubble, Enron, the S&L Crisis...

When will we stop allowing the organized looting of our country by a relatively small number of greedy and unscrupulous men?

S&P emails slammed mortgage debt products
Sat Aug 2, 12:36 PM ET
by Jim Marshall

CHICAGO (Reuters) - Analysts at Standard & Poor's Rating Services warned against mortgage-related debt products in internal e-mails that, in one case, called the complex financial deals "ridiculous," the Wall Street Journal reported in its weekend edition.

The Journal cited a draft revision of a U.S. Securities and Exchange Commission report on bond-rating firms that was first released on July 8.

In one email message, an S&P analyst called a mortgage or structured finance deal "ridiculous" and wrote "we should not be rating it."

In another email, an S&P manager said ratings agencies were helping to create an "even bigger monster -- the CDO (collateralized debt obligation) market. Let's hope we are all wealthy and retired by the time this house of card falters."

Rating agencies struggled with the growth of asset-backed securities and saw breaches in their conflict-of-interest policies, according to the report released early last month on an industry blamed for helping contribute to the subprime mortgage crisis.

An SEC examination "uncovered serious shortcomings," SEC Chairman Christopher Cox said when the report was released, adding that the problems are being fixed.

The SEC spent 10 months looking at the biggest ratings firms: Moody's, Standard & Poor's and Fimalac SA's Fitch Ratings.

A spokesman for Standard & Poor's, a unit of McGraw-Hill Companies Inc (MHP.N), was not immediately available to comment on the Journal report.

A Review of the Gold Bull - 2 August 2008

Here is a long term view of this gold bull market back to the major upturn. Note the periodic corrections and consolidations.

Things happen for a reason. The reason there are corrections and consolidations in these long term trends is that there are contrary opinions among traders which engage the push and pull of the market. Also, and importantly, different traders have different positions operating on different timeframes and different agendas.

Within a long term trend there are opportunities to squeeze the shorts and shake out the weak hands on the long side. With 8000 desperate hedge funds out there, and ten or more outsized banks flush with hot money and a shrinking pool of opportunities, we can expect more short term volatility as traders try to set up gambits, squeezes and traps. There is also a bias among the central banks against gold, which is the antithesis of an arbitrary power to determine the value of money. This is at the root of their greatest policy error. For all the reason noted, the bigger players will shove against the price trend when they can, but as is obvious from the chart they cannot resist the pressure of a valid trend indefinitely at least while markets function.



Here is a closer look with a simpler line. Again note the corrections. Charts are not modern art. They are symbolic representations of reality. Of course at some point the long bull trend will end, but until then it will often correct and consolidate. It is our task to try and set some reasonable criteria to see what is happening as closely to when it happens. As the progress of the trend proceeds we buy weakness and sell strength as best we can, managing leverage and our emotions above all.



Here is a look at the same closeup but on a percentage basis. Note the wavering, the push and pull of the bulls and bears, the big trading desks and the small speculators and funds. We have friends and acquaintances who abhor gold, because they think that they have missed the bull trend and wish to see it fail, so that they might be proven 'correct.' The only correct thing to do in trading and investing is to make a profit fairly, with justice.



Here is a closeup view, the daily chart which we post every day. Although we cannot be sure, it does look as though we are closer to the end of this correction than the beginning, and that we are testing some strong support. The dollar is also at a key juncture in its countertrend rally. The FOMC will make their August policy statement next Tuesday 5 August. This will probably be a decisive moment. Gold has strong support at 875 and 860. The dollar has strong support at 68.

We will not be surprised to see gold test the psychological barrier of 900 severely. That does not matter. It does not change the trend. When the market realizes that the test is over and the trend is in control again the move higher may be impressive. This is the same for all bull markets, whether they be gold, oil, swiss francs, euros, silver, whatever. Bear markets have a slightly different character, although the bear market in the dollar is being managed artificially so as to even its decline. Bear markets are normally more violent than bull markets.

Let's see what happens.

US Dollar With Commitments of Traders as of 29 July 2008

US Dollar Weekly Chart with Commitments of Traders



US Dollar Weekly Chart with the Moving Averages

Charts in the Babson Style for the Week Ending 1 August 2008

Next week may be important for the stocks and dollar rally as the FOMC will meet on Tuesday 5 August.

Net Asset Values of Several Gold and Silver Funds and Trusts

A Theory of Great Depressions and a Confession from a London Banker

The London Banker has an interesting blog, and for some weekend reading we offer his latest piece on Irving Fisher's Theory of Economic Depressions, excerpt and link.

Mr. Fisher is a bit neglected these days, having made himself look the fool on the occasion of the Crash of 1929 and several times thereafter with optimistic pronouncements that in retrospect are incredibly embarrassing, severely tarnishing his reputation, perhaps deservedly so. but overshadowing some finer work in other periods of his career.

Is this perhaps why so many economists not in the employ of large trading houses and the government are so silent on the things that matter these days, with a few notable exceptions which will certainly be remembered favorably?

Nevertheless, the London Banker's views on this are worth reading, carefully and thoughtfully. It is a little disappointing in that he does not spend more time bringing Fisher's theory up to date. In particular, it is important to remember that Fisher was still thinking in terms of a currency constrained by an external standard for money, even though the dollar was substantially devalued in 1933.

We are seeing a replay of the elements which created the Crash and Great Depression complete with Fed policy errors and a complacent public, but played out under a purely fiat monetary regime. Exogenousl restraints may not limit the expansion of the dollar, providing new possibilities and variations on a theme. A brave New World indeed.

Those who are thinking of the scenario in which the US dollar gains in value during a debt deflation are imagining the dollar as a commodity rather than a currency.

As a commodity in short supply, they believe that the dollar will become more valuable because of some imagined constraint in its production by the Fed, tied to the creation of new credit. The average mind rebels at what a fiat currency actually represents.

They place too much emphasis on a fiat currency as a store of value, rather than its primary function as a medium of exchange. As a store of value the dollar is, and has been, and will be a wretched performer over all but the short term in special situations.

Another British economist Peter Warburton published in 1999 a more expansive view of this in a book that has become a cult classic, Debt and Delusion: Central Bank Follies that Threaten Economic Disaster.

In his April 2001 essay, The Debasement of World Currency: It Is Inflation, But Not As We Know It Warburton noted:

"What we see at present is a battle between the central banks and the collapse of the financial system fought on two fronts. On one front, the central banks preside over the creation of additional liquidity for the financial system in order to hold back the tide of debt defaults that would otherwise occur. On the other, they incite investment banks and other willing parties to bet against a rise in the prices of gold, oil, base metals, soft commodities, or anything else that might be deemed an indicator of inherent value. Their objective is to deprive the independent observer of any reliable benchmark against which to measure the eroding value, not only of the U.S. dollar, but of all fiat currencies. Equally, their actions seek to deny the investor the opportunity to hedge against the fragility of the financial system by switching into a freely traded market for non-financial assets."

Lastly, before the serving of the main course, a chillingly relevant quotation from Francisco d'Anconia's discourse on money in Atlas Shrugged:

Watch money. Money is the barometer of a society's virtue. When you see that trading is done, not by consent, but by compulsion - when you see that in order to produce, you need to obtain permission from men who produce nothing - when you see that money is flowing to those who deal, not in goods, but in favours - when you see that men get richer by graft and pull than by work, and your laws don't protect you against them, but protect them against you - when you see corruption rewarded and honesty becoming a self-sacrifice - you know that your society is doomed...

Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values. Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked: "Account overdrawn.

Thursday, 31 July 2008
Fisher's Debt-Deflation Theory of Great Depressions and a possible revision
The London Banker

“Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works”. John Stuart Mill

I have been both a central banker and a market regulator. I now find myself questioning whether my early career, largely devoted to liberalising and deregulating banking and financial markets, was misguided.

In short, I wonder whether I contributed - along with a countless others in regulation, banking, academia and politics - to a great misallocation of capital, distortion of markets and the impairment of the real economy.

We permitted the banks to betray capital into “hopelessly unproductive works”, promoting their efforts with monetary laxity, regulatory forbearance and government tax incentives that marginalised investment in “productive works”.

We permitted markets to become so fragmented by off-exchange trading and derivatives that they no longer perform the economically critical functions of capital/resource allocation and price discovery efficiently or transparently.

The results have been serial bubbles - debt-financed speculative frenzy in real estate, investments and commodities....

Fisher's Debt-Deflation Theory of Great Depressions and a Possible Revision - The London Banker