Notes from Underground

This is a composite of chatter and 'gossip' and anecdotes picked up from multiple sources, some that could be considered reasonably informed, formally regarded as hearsay.

Treat it as rumour as none of it can be guaranteed authentic. More of it is coming from Europe than the US. There can be no verification in such opaque conditions without investigative staff and the power of subpoena.

Verify it for yourself; it is not a bad starting point to use as a skeleton upon which to hang events as we go forward. Sometimes you hear enough of the same thing from different sources, things that make sense and ring true, and the dots connected, even if in a rough way.

There was more of a struggle in deciding to allow the speculative portion of this out than you might imagine. The 'history' part seems consistent and valid, but probably a selective caricature. It could all be the overreaction of frightened people who merely do not see the next step yet. But since we started acting on it this week, not in terms of investments, but in bringing capital back to safer harbors, it did not seem right to ignore it.

The whole outlook could change next week, and for the better. Anything is possible, if one does not know what is true and what is not, even if it does not seem probable. And we never trade on rumours, only the charts which tell us things known only to the markets.

It seems as if the government is downplaying the seriousness of the situation a bit while they work to find a way forward. That is natural and expected. What might seem today like a radical solution may be adopted eventually but the people are not ready to hear it yet, and it is not clear that this will be required, so why do it?

No one wants to make the first moves ahead of an unfolding crisis, especially with the Republicans playing hardball politics and the blame game. The pressure is on from the moneyed interests, but there is a growing concern about the public mood.

In the meantime, people's favorite ideas for solutions are getting play because no one can agree on a comprehensive plan. Obama brought in an impressive array of experienced people who know where the levers are. The problem is that they are philosophically at odds with one another, and sometimes poles apart from the president and his inner circle. There are the natural start up problems, but there is a more serious lack of cohesion of vision that is going to be resolved. Obama seems capable of doing this.

There is an air of quiet desperation as the situation grows progressively worse, and there is intense debate on when and how to break it to the public. They are not even sure what exactly to break because the situation is so fluid. No one wishes to be the messenger and possibly be blamed for inciting a loss of confidence.

Wall Street and the banking system has been every bit as irresponsible and out of control as we thought in our worst moments, perhaps more. A group of twenty somethings with little or no adult supervision developed ideas for 'financial products' with the same care and planning that their counterparts perform extreme stunts on Youtube.

They did it because they could. They tested the system for boundaries and didn't find any.

You want leverage? Imagine a 20 billion dollar portfolio of mortgage backed securities with a capital base of $10k, literally 2 million-fold leverage. Imagine the shock of the inventor as he watches as his successors expand similar portfolios up to $900 billion.

After running out of gullible Japanese bankers these young cowboys began trolling for other pools of gullible buyers: hedge funds, pension funds, and University endowments sufficed. They even found some local suckers. Anything to make a sale and keep the money machine turning.

How did we go so far off the tracks?

The guys initially putting these packages together had some sense that they were crazy, that they made no sense, but nobody said stop, and they didn't care. It was a good time to make money and then move along.

Government regulators being paid $100k couldn't tell connected guys making $20 million what to do. They also had their marching orders from above. Don't get in the way of financial progress on Wall Street. The US has to be competitive. The senior managers loved the money flows.

A sea of cubicles were staffed with engineers, chemists, physicists, and mathematicians from the best colleges in the country with no knowledge of the history of financial markets, fat tails, and past human follies. But they knew how to turn the crank on financial engineering.

The average career age in the business is about 7 years. A twenty year veteran is a very old man. The creators of these innovative financial products understood the toxicity at some level. As they retired, however, the next generation of twenty somethings came in and had zero sense of risk. They were simply told which button to push and which lever to pull to make money. Nobody was really driving the bus.

The Street looked from one market to the next to find and angle and make money. Enron was only the tip of the iceberg. And when they found a market that was vulnerable they swarmed on it like a pack of wolves.

The money overwhelmed the system. The money pushed all regulations aside. It bought deregulation, politicians, and anything else necessary to keep the money machine growing. Nobody dared yell stop because so damned much money was being made.

Greenspan became a believer--he lost consciousness of what he was there to do. The reason he turned a blind eye and allowed the damage to accumulate remains unanswered.

So where are we now, and where are we heading?

Our financial system is infected by flesh eating bacteria. Every day looks more dire than the previous day. The solutions being proposed look feeble, and the Fed looks both powerless and confused.

TARP is throwing money down a rathole. That is why there is such a mood of abandon on the Street. They know this is just an exercise.

One of the so-called model banks is on a don't ask/don't tell policy; the Fed simply cannot handle another mega-catastrophe while they wrestle with the fully-insolvent among the top five. (Note: think derivatives). The word on the Street is to keep everything bad off the radar to buy time.

There are rumours swirling that there will be a bank holiday in the UK, and they will be particularly hard pressed because of the high percentage of their GDP that financial services represent. The pound is heading to parity with the dollar. The good news is that it will probably not be as bad as Iceland.

The problem with Germany, and by inference continental Europe, is that their regulators refuse to acknowledge their errors and deal with the problems. They are the polar opposite of the Fed which acts first and plans later. The problem is that the Germans cannot seem to get beyond the planning stage because they cannot believe that their regulations and safeguards failed so badly. It has shaken their confidence. Additionally, the failed German bond auction was deemed catastrophic in its implications and has them fearful of policy error.

There is no way out of this mess without serious pain. Despite a deflationary bias today, most insiders see inflation and spiking interest rates as the risk going forward, probably early 2010 or sooner depending on how fast things start moving.

Are We Ready to Try Market Capitalism?

'When I use a word,' Humpty Dumpty said, in rather a scornful tone, `it means just what I choose it to mean -- neither more nor less.'

`The question is,' said Alice, `whether you can make words mean so many different things.'

`The question is,' said Humpty Dumpty, `to be master -- that's all.'

The refrain from Wall Street these days is "I worked hard for that bonus."

Lots of people work hard. Most of the people we know, probably many of the readers of this blog, could give lessons in working hard to these Wall Street whizkids.

A waiter or waitress works hard, very hard. But they don't get huge tips when they dump hot soup in the customer's lap.

You don't get paid for how hard you work, you get paid for how much value you add for your customers and your shareholders. If you work on commission and bonus your pay is intended to vary with performance, not by how much you can grab off the table before the police arrive.

The pay structure on Wall Street looks less like a profit based enterprise and more like organized crime.

What starts as a valuable component, a method of efficiently allocating capital for a small fee, becomes an oversized drain on the process it is intended to serve.

There is nothing wrong with capitalism and competitive markets and a healthy meritocracy. It is probably the most efficient and effective means of creating wealth and managing businesses.

We should try that system now that the cult of pay for privilege, interconnected frauds, rule by empty suits, and crony capitalism has failed.

Economic Times
For CEOs, thirst for bonuses may be in their DNA31 Jan 2009, 1151 hrs IST

NEW YORK: Why do CEOs need extravagant perks even when they are firing staff and pleading for taxpayer bailouts? It may just be in their makeup, experts say.

It takes arrogance and narcissism to become leader of a Fortune 500 company. Those same traits, however, have become their undoing during the deepest recession in decades. (If their narcissism is particularly acute they might become a Senator instead - Jesse)

U.S. President Barack Obama has noticed, telling reporters on Thursday he was outraged by a New York State report that $18.4 billion in Wall Street bonuses were paid in 2008 as taxpayers rescued the crumbling financial system.

"That is the height of irresponsibility. It is shameful," Obama said. (And as recent denizen of Congress he has a refined palate for shameful irresponsibility, which has been the primary product from Washington DC in recent years. - Jesse)

New York State Attorney General Andrew Cuomo, who is investigating Wall Street bonuses, welcomed Obama's comments.

"While Wall Street melted down, top executives believed that, unlike the rest of the country, they still deserved huge bonuses," Cuomo said. (And Congress took increasing pay raises, and a private pension system, and superior healthcare, while the median wage stagnated and the middle class dwindled - Jesse)

For Bob Monks, a former executive who has written nine books on corporate governance, the reason is that the rich and powerful simply love their toys.

"It's a boy thing. Sort of, 'Mine's bigger than yours.' It's really childish," said Monks, a shareholder rights activist and the subject of a book called "A Traitor to His Class." (It is not childish, for that is a slander on children. It is pathological. It is an addiction, a compulsion, a sickness that transcends the occasional petulance of childhood - Jesse)
Monks related a story about flying on someone's corporate jet. The host was devastated when, upon landing, he saw that while he planned for a limo to be waiting at the airport another captain of industry had a helicopter take him to town.

"I thought my guy was going to die. ... It's entirely about people's self-image." (It is about a sense of personal worthlessness. Some people have a huge hole in the center of their being, and and a compulsion to fill it up with things and people, to try to make themselves feel whole, but it can never satisfies, and they are ravening - Jesse)
Longtime advocates of shareholder rights were handed a gift in November when Detroit auto executives flew to Washington on corporate jets to ask for billions of dollars in taxpayer money, sparking a public outrage.

More recently, it became known that former Merrill Lynch CEO John Thain spent $1.2 million remodeling his office last year, including $1,405 for a trash can. Merrill Lynch is owned by Bank of America, which consumed $45 billion of taxpayer money through bailouts.

Then on Tuesday, Citigroup canceled plans to buy a $50 million executive jet after a White House rebuke.

"People don't become head of Merrill Lynch without having a certain sense of self-importance. Once they arrive at that position, they have all kinds of toadies tell them what geniuses they are, then of course they begin to feel their lifelong feelings of self-importance have been confirmed," said Charles Goodstein, a psychoanalyst and professor at New York University School of Medicine.

Defenders of executive perks say generous compensation is needed to retain talent. (Generous, not extravagant. There is a direct proportion between the emptiness of the suit and the extravagance of the trappings. There are only a few Steve Jobs; most of the others are verbally adept, highly cunning, political animals. For the most part it is the myth of the "Great Man." A surprisingly large number of them are frauds. The problem is the system does not manage them, eliminate them. It pays for the office, not for the performance. - Jesse)
Sometimes it's jets but can also include home security systems, country club memberships, sports tickets and financial advice. The value of these benefits is considered income, so CEOs also sometimes get another perk: company help in paying their taxes. (Set the tax rates so bloody high that they might consider competing on something more useful, like the performance of their companies - Jesse)
"I was CEO of a bank once and it's not rocket science. You need the same skill set as somebody running a hardware store in a medium-sized town," Monks said. (For many corporate managers the most difficult of the job is protecting the business from overpaid corporate goons with nothing better to do than to subvert the good of the business to their own personal ends in some of the most imaginative ways possible. And in high tech startups, the most intractable problem is trying to keep the VCs from destroying the company with their clumsy attempts at stealing the business. - Jesse)

Steve Thel, a former lawyer with the Securities and Exchange Commission and now a professor at Fordham Law School, blames compliant board members who often come from the same privileged world and can get paid hundreds of thousands of dollars for attending a few meetings each year. (The Boards are bastions of the fraternity of empty suits and the brotherhood of professional courtesy -Jesse)

"It's endemic to the system. The last administration didn't think there was any structural flaw. Now across the political spectrum people feel that Wall Street executive compensation is out of control," Thel said. (The former president is the epitome of a thin veneer of privileged arrogance covering a deep well of incompetence. - Jesse)
He predicted Congress would pass legislation granting minority shareholders more say on pay and possibly introduce higher taxes on some parts of executive compensation.

"A year ago it was absolutely unthinkable that this would be heard in Congress," Thel said.

Three Banks Closed on Friday, One With No Willing Acquirer

Utah's MagnetBank closed without an acquirer

MarketWatch
FDIC shuts down three banks in one day amid ongoing credit crisis
By John Letzing

Federal regulators closed three banks in a single day Friday, as the ongoing credit crisis showed no signs of abating.

Utah's MagnetBank became the fourth bank failure of the year, and the Federal Deposit Insurance Corp. was forced to directly refund depositors after being unable to find another institution willing to take over its operations.

That marked the first time the FDIC has been unable to find an acquirer for a failed bank in nearly five years, according to FDIC spokesman David Barr. "This bank did not have an attractive franchise value, and not many retail deposits or core deposits," Barr said. The FDIC had conducted an extensive marketing process for the bank's assets, he said.

Salt Lake City-based MagnetBank had total assets of $292.9 million as of Dec. 2, and $282.8 million in total deposits. "It is estimated that the bank did not have any uninsured funds," the FDIC said in a statement.

The FDIC later said it has also closed Maryland-based Suburban Federal Savings Bank, and Florida's Ocala National Bank.

Suburban Federal had total assets of roughly $360 million as of Sep. 30, and total deposits of $302 million, the FDIC said in a statement. Tappahannock, Va.-based Bank of Essex agreed to assume all of the failed bank's deposits, the FDIC said.

Ocala National had $223.5 million in total assets as of Dec. 31, and $205.2 million in total deposits, the FDIC said. Winter Haven, Fla.-based CenterState Bank has agreed to assume all of the failed bank's deposits.

The closures mark the fourth, fifth and sixth bank failures of 2009, bringing the total to 31 since the start of the credit crisis.

US Dollar Long Term Chart with Commitments of Traders

The divergence of gold from traditional relationships with the euro, dollar and oil suggest that it is becoming an alternative reserve currency, primarily at the expense of the euro.

The last thing the real economy needs right now is a stronger Dollar. Other nations are already weakening their currenices competitively. It will be interesting to see how gold reacts in this type of environment with the fiat currencies being manipulated lower in sympathy with one another.

Oil will not recover in price while the House of Saud has our back. But at some point even they will concede to market forces, or some exogenous event, and then we will have the appearance of inflation. This may not occur until late 2009 or early 2010 when we expect the economy to begin to show signs of recoverery, at least relatively speaking. Until then the resurgence of gold is almost entirely a monetary phenomenon.

We believe that the stimulus is too backend loaded and unimaginative to affect anything sooner. Adding liquidity to the banks is as useful as filling the tank of a car wrapped around a telephone pole. Who are the banks going to lend to? And increased spending on health care, with the highest and least efficient per capita cost in the world, is like giving the driver of that car a bottle of vodka to ease their pain.

The consumer is insolvent, and until the median wage turns around will not be inclined to borrow for consumption again, as they should not. The nation must shake off the legacy of the Greenspan era and the economic cargo cult of the Chicago School.

It could be a long, hot summer.

SP Futures Hourly Chart at 3:30

Postscript After the Close:
The Dow Jones Industrial Average finished January down 8.84% on the month. Previously, the worst January for the Dow had been that of 1916, when it fell 8.64%. Friday, the Dow dropped 148.15 points to 8000.86 after briefly dipping below the 8000 mark. The Dow has fallen five straight months and in 12 of the last 15.

Today is the last trading day for January. If we go out near the current lows of the day, this will be the worst January for US equities in the last 92 years.

There will be no sustained recovery in the economy until the median wage improves. Allowing the banks to lend again to support consumption is a complete waste of capital. The purpose of not allowing bank failures, as in the 1930's, is not to save the banks, but to preserve the funds of private savers.

We should back the pensions and the savings of individuals one hundred percent. Government support should not be given to banks that are insolvent. They should be restructured first, and then recapitalized.

Are We Ready to Change the System?

"The general spread of the light of science has already laid open to every view the palpable truth, that the mass of mankind has not been born with saddles on their backs, nor a favored few, booted and spurred, ready to ride them..."
Thomas Jefferson

It is time to begin serious, and significant, systemic reforms in the financial system.

Maintaining the status quo will be fruitless because the system is broken. Trying to keep it from becoming 'more broken' is a nice short term fix, but we are beyond that now. This has been a long time in the works.

There has been a recent increase in noise from the Congress about changing a system which promotes excessive pay, and encourages the virtual looting of companies, by overpaid management and a corrupt financial system.

Rather than strike at the branches, and call a few individuals up before Congress for their ten minutes of tut-tutting, how about some serious change that cuts to the roots of the crisis?

One potential solution would be to institute a marginal income tax rate of, let's say, 80% at the 30 million dollar level of aggregate income in the AMT, with a significant raising of the minimum levels of income that trigger the AMT to about 4 million in aggregate income. It can graduate from 50% to 80% from the minimum to the maximum. The AMT was always intended to be a safeguard against loopholes for the highest income brackets. We can permit five year income averaging to allow the incredibly lucky to keep a bigger share. But rewarding luck encourages gambling and gaming the system, which is an open door to white collar crime and fraud.

And we have to ask, just how much is enough. Do you really think that having a 30 million dollar per year income is 'not enough?' Are we insane? Yes, allowing people to 'keep what they kill' is ingrained in our psyche by the last 100 years of a steady stream of propaganda, but its time to start thinking about social interaction and the protection of the innocent as well as the glorification of greed.

Yes, this will alarm the "Joe the Plumbers" out there who wish to fantasize about the looting of the system, or have pretensions of being the next American Idol, with a Pavlovian impulse to consider realistic expectations and a middle class life as socialism.

The top 1% of the wealthy Americans do not need additional incentive to take. They are, for the most part excepting the lucky and the idle heirs, psychologically driven to acquire beyond all rational need. What they need is restraint. And they will absolutely hate it.

But since most wannabe billionaires are delusional why let them drag us down under the bus with them? Let's stop legislating for the .1% probability, leaving the garden gate open for the pigs to come in.

We cannot continue to build and maintain this country if the most rewarding pursuits are gambling, gaming the system, fraud, and white collar crime. That game is over. We're done.

Reform the accounting rules for acquisitions and goodwill, inventory writedown with subsequent earnings effects. "Earnings management" is a tool of the price manipulation for stock option bonuses that is a source of market distortion.

Bring back Glass-Steagall. Let Goldman and Morgan get into the conventional banking business after passing through receivership. The point is to be solvent first BEFORE you get government support. And if you are not solvent we will help you become so through liquidation.

Back up the individuals, the savers and pensions, to the hilt, 100%, and put the financial institutions through the wringer, if not a meat-grinder. Stop beating this 'trickle down' approach in curing our problems by throwing money at the uber-wealthy and corporations. It does not work. It will not work. It is destroying our country.

Oh no, we cannot let honest people be limited in acquiring enormous wealth. Well, there probably aren't many completely honest people pulling down over 30 million per year in income. The criminal prosecution system is also horribly compromised, and we can fix it AFTER we stop the looting, and then the rules can be relaxed.

Direct the FBI and Justice Department to conduct a serious investigation of naked short selling and price manipulation. That aspect of the market is an open sore.

Institute aggregate position limits in commodities, and make them high enough so that they do not bother any legitimate speculators.

Refuse to admit any nation into the favored nation status unless their currency is open for trading on the world markets, free of pegs.

Stop the system of legalized bribery of the Congress and the Executive by lobbyists. That requires campaign funding reform, then let's do it now.

Stop selling this country short for the sake of 'competitiveness' and a perverted image of the "American Dream." If the Founding Fathers came back they would not be able to stop throwing up at what we now call 'freedom' and what we have done with their legacy for which they pledged their lives and sacred honor.

Europe needs to tell the Brits and the Yanks to piss off, fix the euro, take an enormous dose of humility, reform their financial system, and don't play the fool again so easily. Asia needs to take care of its own and grow a middle class, and stop treating its people as coolies. Australia needs to go walkabout with Europe. The Mideast is its own worst enemy. Africa is the shame of our world.

Too radical? Then you're not ready yet for the changes that are required to end this cycle of boom, loot and bust.

It is time to begin serious, and significant, systemic reforms in the financial system. It is preferable to the historically likely alternatives.

The Price of Gold and the Growth of the Money Supply

We have seen comparisons of the price of gold to the adjusted monetary base and to M1. Based on intense study and reasoning about the current trends in money supply we are convinced that this comparison of growth in MZM with a lag to the change in the price of gold is significantly much more valid than any other we have been able to produce, if one only considers the correlation of the graphs. And it makes logical sense.

MZM is the most valid measure of broad 'liquid' money in the system. We formerly used M3 but this has not been available, with any published certainty, since 2006.

It would make sense that in a free market, the growth trend of a broad measure of 'liquid money,' as opposed to credit or potential money, would be statistically valid with the price of an alternative currency, or wealth asset, like gold over the longer term.



Speaking wonkishly, our preferred comparison would be to be able to measure the difference in growth between real GDP and the growth in broad money supply, and then trend and compare that with the growth in the price of gold.

Since we have no honest measure of price inflation that task is difficult. Our second preference would be to make a similar comparison per capita the economically active rather than real GDP. Is there an accurate measure of job population growth fluctuations with the ebb and flow of the illegals? We are not sure, but are looking into it.

Goldman Sachs Says the Banks Now Need At Least $4 Trillion in Bailouts

Can we get an estimate that assumes we nationalize Goldman Sachs, Morgan Stanley, Citigroup, and J.P. Morgan, place them in receivership, selectively default on their derivatives, sell all their assets, and criminally prosecute their executive management from the year 2000 under the RICO statutes?

Reuters
Bank Bailout Could Cost Up to $4 Trillion: Economists
29 Jan 2009 04:35 PM

The cost of restoring confidence in U.S. financial firms may reach $4 trillion if President Barack Obama moves ahead with a "bad bank" that buys up souring assets.

The figure far exceeds even the most pessimistic estimates of how great the loan losses might be because there is so much uncertainty about default rates, which means the government may need to take on a bigger chunk of bank debt to ease concerns.

Goldman Sachs economists said ideally the public sector would step in to remove the hardest-to-value assets, which would alleviate nagging worries about future losses and hopefully help get lending going again.

"Unfortunately, with an unprecedented meltdown in mortgage credit and a deep recession in the broader economy, there is a great deal of uncertainty about the value of almost every asset," they wrote in a note to clients.

Obama and his economic advisers are expected to lay out their policy plan as early as next week. One idea that seems to be gaining traction is setting up an entity to buy troubled assets and hold them until they mature or resell them.

The hope is that once banks get rid of those bad loans, they can attract private investors, get back to the business of lending, and help revive the economy.

Vice President Joe Biden said Thursday that Treasury Secretary Timothy Geithner was considering all options to restart normal lending, but that no decisions had been made.

Goldman Sachs estimated that it would take on the order of $4 trillion to buy troubled mortgage and consumer debt. That number could shrink if the program were limited to only certain loans or banks, but it could also grow if other asset classes such as commercial real estate loans were included. (How much would it cost if we put Goldman and Morgan Stanley into receivership - Jesse)

New York Sen. Charles Schumer has said that a number of experts thought that up to $4 trillion may be needed to buy the bad assets, an estimate that a Senate aide said was based on informal conversations with people in the industry.

The Wall Street Journal said government officials had discussed spending $1 trillion to $2 trillion to help restore banks to health, citing people familiar with the matter.

At $4 trillion, that would be the equivalent of nearly 1/3 of U.S. gross domestic product. If the government had to fund that amount by issuing additional debt, it would intensify investor concerns about massive supply scaring off demand.

Depending on how the plan is structured, the government may not have to put up the full amount, and since the majority of people are still paying their mortgages and credit card bills, there is a reasonable expectation that taxpayers would recoup a substantial portion of the cost.

However, the potential loss is huge, and if more public money is needed to boost capital even after the bad assets are removed, the total would undoubtedly climb.

The International Monetary Fund said Wednesday that worldwide losses on U.S.-originated loans may hit $2.2 trillion, well above its October estimate of $1.4 trillion. It said banks in the United States, Europe and elsewhere probably needed to raise $500 billion to cover losses coming this year and next.

Cutting Out a Zero

For U.S. lawmakers who are already taking grief from voters over a $700 billion bailout approved last fall, passing another big spending measure carries significant political risk.

At the same time, Obama's team wants to take action that is bold enough to fix the problem once and for all, hoping to avoid the sort of ad hoc approach that has been criticized for adding to investor uncertainty.

Time is not on Obama's side. The more the economy weakens, the longer the list of potentially dodgy debt grows. That is why he faces enormous pressure from Wall Street to act fast.

The government would not necessarily have to spend the full $4 trillion to buy the assets. If it follows the model used in a Federal Reserve program to support consumer and small business loans, the government could potentially put up just 10 percent of the total.

Spending $400 billion would certainly be more palatable to Congress than $4 trillion. It may not even require that much additional funding. Economists estimate that perhaps $250 billion of what remains in the $700 billion bailout fund could be devoted to the "bad bank."

That money could buy bad assets, which would then be repackaged and sold to investors to raise more money which could then by recycled to buy more assets.

Stephen Stanley, chief economist at RBS Greenwich Capital, said although that sounds similar to the sort of financial engineering that spawned the credit crisis in the first place, it would be structured so that the central bank or whichever agency oversees the program is last in line to take losses.

"If things turn out so bad that the Fed ends up on the hook for $1 trillion in losses, then the financial sector, the economy, and everything else will be dead anyway," he said.

US 4Q '08 GDP Advance Number Out Tomorrow Morning

The US will release its Advanced Estimate of GDP for the fourth quarter of 2008 tomorrow morning at 8:30 AM.

The consensus of economists is for -5.4% which is a quarter number, non-annualized to put this into comparison with other countries which annualize their numbers.

A low end print of -6.0% is the whisper with the "Yikes!" number at -7.0%

It is thought by some that the Obama Administration release a conservative advance estimate to help shock the Senate into acting on their stimulus package. Who can tell about such things?

Keep an eye on the Chain Deflator which is estimated to come in at 0.6%.

In addition to GDP, the Chicago PMI and Revised Michigan Sentiment for January will also be released at 9:45 and 9:55 respectively.

When the Incoming Tide Turns to Tsunami

Not a matter of if, but when.

The Times
Gold price could treble if China divests dollars, warns mining boss
Jenny Booth
January 29, 2009

The gold price is likely to hit record highs in dollar terms as fears grow about the stability of the US currency, the chairman of Barrick Gold said today at the World Economic Forum (WEF) in Davos.

The founder of the world’s largest goldmining company said that there was even a possibility that central banks, including China’s, might start to switch from dollar holdings to gold, which could cause the price of the metal to treble.

“Gold is at record levels in every currency except dollars," Peter Munk told Reuters at the WEF meeting.

"Even within dollar terms it is within a few percentage points of an all-time high, at a time when all the other major commodities are falling.”

Mr Munk said: “Whether it’s the currency effect or a reaction to a feeling of uncertainty, gold, in my opinion, is more likely to go up than down.”

The gold price was up today, trading at about $890 at 1500GM. At present the record high is $1,030.80 an ounce, achieved in March last year.

Mr Munk emphasised that he was merely weighing the odds.

“It would be stupid to assume commodities prices can only go one way,” he said, adding that physical demand for gold jewellery was not high during the economic downturn.

Gold has been one of the best-performing assets of recent months, rising in value by nearly 17 per cent since late October even as the price of other commodities, such as oil and copper, has dropped sharply. (This is because gold is more monetary than commodity. Silver is a more even mix but it is still monetary as well as industrial. - Jesse)

Investors have bought heavily into physical bullion in the form of coins and bars, and physically backed assets, such as exchange-traded funds, as a safe store of value at a time of increased volatility in other asset prices.

Mr Munk said that downward pressure on the dollar, partly due to massive US spending and printing money to stimulate the economy, would increase gold’s attractions as an investment even further.

Gold usually moves in the opposite direction to the dollar, as it is often bought as a hedge against weakness in the US currency. (Gold has been moving with the dollar as foreigner flee out of other currencies and begin to treat gold as a safe haven alternative with, not in lieu of, the dollar - Jesse)

“My personal feeling is that with the rescue packages calling for trillions, not billions ... the value of the [US] currency has to go down,” Mr Munk said.

He said that there was a possibility that central banks, including that of China, a major dollar asset holder, might start buying gold. (Rumour is that the physical market is so tight they have been calling quietly around looking to lock in major sources of supply - Jesse)

“If they decide to diversify, we assume into gold, then we start to talk about a trebling or quadrupling of the gold price," he said. "It could be followed by Russia or Kuwait." (They could just be jawboning Tim Geithner back with a credible threat as well - Jesse)

“I don’t think it’s likely, but it’s more likely. I would not have said it two years ago — I’m not a gold bug — but it’s more likely than it was two years ago.”

He added that his company did not now hedge its output — meaning use derivatives to insure against a fall in price — and relied on the price climbing.

In the past its successful hedging allowed it to make key acquisitions.

“It would be dumb to hedge,” Mr Munk said. (Bill Murphy told you that when gold was at $300 per ounce, and he was right - Jesse)

SP Futures Hourly Chart Update at Noon

The SP futures failed at the resistance target and have rolled over to near support at 850.

We are still in the end of the month tape painting but earnings are deteriorating badly, causing some of the major players to start edging towards the exits, taking their profits from this double bottom rally off the table.

As an interesting change, there is a groundswell of interest among the wealthy to own physical gold bullion: not paper, not miners, not ETFs, but the actual gold. This was even referenced several times today on Bloomberg Television and in interviews from Davos. There are also fresh examples of delivery problems from Comex, and in particular with regard to 1000 oz. bars of silver which is something new. Previous shortages from commercial sources had been reported in the smaller unit bars only, with the Comex seen as a steady source of the big bars.

Part of this seems to be a swirl of talk coming out of London that there is going to be a bank holiday, and a major government action to shore up the financial system.

We do NOT have any particular insight into what is driving this and the specific short term timeframe. Rumours are easy to ignore since in the short term the technicals on the chart are most important to us, and specific news events. The macro events are on our 'radar screen' and are looking for any specific data or potential trigger events.

As a reminder, GDP for 4Q comes out tomorrow. Wall Street is bracing for the worst print since the Great Depression, on the order of -6%. Given the lags, and the monkey business that the Government plays with the numbers, we're not willing to bet on 4Q, although it does serve their purposes to come out badly, justifying the stimulus program.

"The wind blows where it will, and you hear the sound of it, but you do not know whence it comes or whither it goes"

SP Futures Hourly Chart Update for Market Close

There was a picture perfect breakout, at the intersection of our horizontal breakout resistance and the outer bound of the big downtrending diagonal channel.

So what next? While the futures remain in this tight channel a trader will not fight the tape, and no new shorts should be put on.

Now having said that we sold most of our straight up index longs into the close and did buy selective shorts into our hedge. Our bias is now short for a pullback potential off that touch on the big resistance at 875 which is now a very key level.

Trade this with care as the situation remains volatile. But as a rule of thumb when we see such a nice straight ramping pattern in the SP futures we assume that some big banking players are walking the index higher into a short squeeze. Its hard to miss as the will clearly signal their intention to the market.

Volatility remains high. The most important change is that this breakout has shifted the bias of the market from the bears to the bulls, and so now we are in rally mode until it fails. The failure points are obvious on the chart, at least for now.

The Fed Statement

Good News! The Fed stands ready to buy Treasuries, but not yet so don't worry about monetization. Will they or won't they?

Oh by the way:

The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant.

As you may recall, the foreign central banks have been dumping Agency debt en masse and using the proceeds to buy Treasuries, generally in the five to ten year duration of the curve.

So the Fed is buying those Agencies, but not buying Treasuries which would be monetization right? But somehow buying Agency debt is not monetization if it is the foreign central banks who are buying the Treasuries, right?

If the Fed uses its Balance Sheet to buy financial assets at above market prices, essentially providing a subsidy to the holders of those assets, this is not inflationary since that debt already existed, right? Oh, as long as it is at a loss, because as everyone can figure out buying them at 1000 times more than they are worth or marked on the holder's books would surely be inflationary, right? If the Fed buys my stamp collection at 1000 times it true value, that would be inflationary unless they sterilized the transaction. Is the Fed sterilizing all their transactions? Hah!

Will they or won't they indeed. They already are, indirectly. More misdirection from the transparent Fed.

From Tinker, to Evers, to Chance.


Press Release
Release Date: January 28, 2009

For immediate release

The Federal Open Market Committee decided today to keep its target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

Information received since the Committee met in December suggests that the economy has weakened further. Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending. Furthermore, global demand appears to be slowing significantly. Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight. The Committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant.

In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. The focus of the Committee's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level.

The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant.

The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.

The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Committee will continue to monitor carefully the size and composition of the Federal Reserve's balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Dennis P. Lockhart; Kevin M. Warsh; and Janet L. Yellen. Voting against was Jeffrey M. Lacker, who preferred to expand the monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs.

Inflationists vs. Deflationists: Economics as Bread and Circuses

In a purely fiat currency regime, a sustained inflation or deflation is a policy decision.

Since few systems in this world are pure, one has to account for exogenous factors and endogenous lags.

But it remains, deflation or inflation are the result of policy decisions in a fiat regime. If one does not understand that, then there is a fundamental misunderstanding of how things work in a modern monetary system which operates free from a hard external standard.

It is not an idle point, by the way, to understand that in a fiat regime there is a significantly greater latitude in policy decision than otherwise.

That is why central banks wish to maintain a fiat regime, and not to be encumbered by an external standard such as gold.

Once one realizes that it is a policy decision, one realizes that this 'inflation versus deflation" is not about some deterministic outcome based on market forces, but rather on a policy decision, what the governance thinks "should" be done.

Granted the Fed does not have perfect latitude. There are the restraints of law and the Congress, and the necessary cooperation of the Treasury and the banking system.

However, the most legitimate, the least endogenous limitation in a fiat system is the value of the bond and the dollar to external market actors. This is the tradeoff that the Fed and Treasury must make in weighing the outcome of their actions.

All this backslapping and scoring of points between the inflation and deflation 'camps' is particularly obtuse because this monetary chess match is most heatedly being argued about by people who think they are watching a game of ping pong.

Yes we will likely see a deflationary episode in the short term, certainly in prices as the aggregate demand contracts, as the Fed fights the credit collapse. We briefly saw deflation at the trough in 2002, depending on how one chooses to define deflation.

But, make no mistake, the Fed can print money and monetize Treasury debt until the cows come home. Bernanke was not lying when he put his cards on the table in his famous helicopter speech some years ago. He wasn't just trying to fool us as some would hypothesize.

They will monetize debt and 'print money' covertly and quietly because they do not wish to trash the Bond and Dollar, since this is the fuel of their machine.

Economic cargo cultists frequently resort to imaginary restrictions on the Fed, such as they can't do this or they can't do that. Growth in money supply must come from the lending of the private banking system. The Fed "only controls the monetary base" and "doesn't set interest rates."

That is all bollocks. It is playing with words, parsing the truth, Clintonesque.

First, there are some gray areas in the statutes that prohibit the Fed from DIRECTLY buying debt from the Treasury without subjecting it to the discipline of the marketplace, ie. taking through a public auction first. The law is soft on this point, but one might contend it is not necessary to change it if the Fed has one or two banks that are policy captives. We believe they do.

Second, growth in the money supply has to come from the lending of banks, the creation of new debt, only when you have run out of 'old debt' and prior obligations to spending.

Does ANYONE who has been following the fiscal discussions in the US believe that we will run out of debt in our lifetimes? The lending of the banks, the creation of new debt, is a measure of economic vitality in some dimensions yes. But growth by debt creation is NOT the only way for an economic system to function, and it may indeed may not be the best. But regardless, it is not necessary while there is debt that can be monetized, and certainly we have a surfeit of that.

The only limitation on the Fed and Treasury are the Congress and the acceptance of the dollar and the Bond in a fiat regime. Period.

Unless there is some greater conspiratorial policy reason, any net debtor that chooses deflation rather than inflation of the means of the repayment of their debt should have their head examined.

There are those who believe that the US "creditor class" will seek to encourage liquidationism and deflation to protect their private fortunes, created during the bubble period.

This is not actually a bad theory, except that the real creditor class lives in China, Japan, and Saudi Arabia. Since two of them are virtual client states of the US and the third is bound to its industrial policy the status quo seems to have some momentum, despite the best attempts of Zimbabwe Ben and His Merry Banksters to denigrate our currency and their customers' sovereign wealth.

One might suspect that the domestically wealthy (note the distinction between that and 'creditor class') would like to channel the bulk of the inflationary effort into their own pockets and benefits for the bulk of the effort before it stops short of hyperinflation, and then cut off the spending.

Hey, we're already doing that! Isn't it nice to see how things work?

People forget that in many ways this is a replay of the Great Depression, wherein a Republican minority in the Congress, and ultimately the Republican appointees on the Supreme Court, fought the New Deal tooth and nail, to the point of class warfare and a suspected plan to take the country into fascism in sympathy with the industrialists of Germany and Italy.

It was interesting to see the "Chicago School" A Dark Age of Economics making arguments against fiscal stimulus that would be worthy of freshmen economics students. One can make the case that these mighty brains are so highly specialized that they have forgotten the basics. An alternative reason might be a willingness to declare that 2+2=5 if it suits your ideological bias and those who must be obeyed. It was just a tiny bit satisfying to see Krugman and DeLong administer and intellectual beating to these luminaries.

So, as you may have noticed, Jesse is cranky today, and not merely because he was rousted from a warm bed to clear a snow-covered driveway. It is also because this country is in a dangerous, potentially fatal, situation and is suffering from an absolutely incredible, ongoing lack of adult supervision and serious discussion about the basic issues. Deception and spin is no longer an exception, but standard operating procedure.

Right now we are still in a 'credit crunch' which is a predictable (and we did predict it last year and even earlier than that) result of a collapsing bubble. In the very short term it was a liquidity problem, as the system seized, but as that was addressed the true problem is exposed as a solvency, not a liquidity, problem. And that problem exists because those that should take the hit for the writeoffs to resolve their insolvency want desperately to pass it on to someone else, eg. the public. There is still an enormous amount of accounting legerdemain (or would that be "ledgerdemain?")

There is not a shortage of liquidity; there is a scarcity of trustworthy market information in terms of value and risk that is causing a seizure in credit growth from fear. Why take 5% from someone who may already be bankrupt when you can accept a relatively no-risk 2% from the Fed? As the waters reced in this recession one would think the nakedness would be more apparent, except that the Treasury and Fed have been supplying portable cabanas to their favorite emperors, to spare their tender sensitivies and enormous bonuses.

We allow that a deflation can occur. If the Fed raised short term rates to 20% tomorrow and started draining, and raised reserve requirements to 50%, we would see a true monetary deflation in short order. But with regards to the here and now, as opposed to some alternate hypothetical universe, currently The Fed Is Monetizing Debt and Inflating the Money Supply.

We would like to see an intelligent examination of the series of policy errors that created the one decent example of a contemporaneous deflation in a fiat regime, that of modern Japan. Because it would then help people to get beyond it, and consider the other twenty or more examples of countries facing serious inflation or even hyperinflation since World War II. But let's just suffice to say that the problems in Japan were somewhat particular to their situation and it was a genuine policy choice which they made.

We might also make the same errors, or even repeat the errors of the Fed in the 1930 of withdrawing liquidity too precipitously because of a misplaced fear of inflation. But with a Democratic administration and a more knowledgable, almost complacent Fed in place this does not seem probable to us at all.

The country is still drunk on easy money and hubris and preoccupied with bread-and-circuses debate between political and financial strategists masquerading as policy experts, while insiders loot the country.

All this noise serves to do is to distract the nation from a identifying the causes of the current crisis and instituting meaningful reforms to keep us from throwing a quick fix at our latest disaster and setting up another cycle of bubble, boom and bust again.

There can be no sustained recovery in the economy until there is financial reform, and a revival of the individual consumer through an increase in the median wage. Right now consumers are attempting to repair their balance sheets by defaulting on debt. This is not productive in the longer term. And it is a bit of an ironic exercise as well, since the debt is being tacked right back on to the taxpayers through the public balance sheet in the government bailouts.

Why is every solution being addressed to and through the unreformed corporate sector? Is it because the best way to deal with a scandal which you caused is to put your own people in charge of investigating it, and setting the agenda for the discussion of potential reactions to maintain the status quo? Anyone who has been in a large corporation should be well familiar with such an obvious tactic. This is likely a reflection of our distorted economic and public policy infrastructure.

A proper examination of relative value and risk cannot be expected yet until we sober up. Let's hope that happens soon, and not as the result of critically damaging economic and social pain.

GE, GECC's Rating May Be Cut by Moody's

* Moody's places GE's long-term credit ratings on review

* GE sees no 'major operational impacts' if downgraded

* Shares fall 5 pct after the closing bell


Reuters
Moody's says could cut GE's triple-A credit rating
By Scott Malone
Tue Jan 27, 2009 5:45pm EST

BOSTON, Jan 27 (Reuters) - Moody's Investors Service said on Tuesday it was reviewing General Electric Co's (GE.N) triple-A credit ratings, which could lead to a downgrade, and its shares fell as much as 5 percent in extended trade.

The move raises the risk that GE, which has a hefty finance business, could lose the long-term triple-A rating that has been a cornerstone of its GE Capital finance business.

On Monday, Standard & Poor's -- which has already warned that it could cut GE's triple-A rating -- said its view would not be affected by disappointing fourth quarter results, but warned it believed it would be "increasingly challenging" for GE Capital to meet its earnings targets.

The U.S. conglomerate has been working to reduce its reliance on GE Capital, as the credit crunch has hurt that unit over the past year and weighed on its earnings.

"Moody's is concerned that deepening global economic weakness could further compromise (GE Capital's) asset quality, potentially jeopardizing its ability to meet earnings objectives while also maintaining high earnings quality," the rating agency said. [ID:nWNA4886]

Many on Wall Street believe the world's largest maker of jet engines and electric turbines may have to sacrifice either the triple-A rating or its $1.24 per share annual dividend as it copes with falling profit in a brutal economy....

A Fresh Breeze of Reform Blows Through Foggy Bottom

"The very word 'secrecy' is repugnant in a free and open society; and we are as a people inherently and historically opposed to secret societies, to secret oaths, and to secret proceedings... A nation that is afraid to let its people judge the truth and falsehood in an open market is a nation that is afraid of its people."
John F. Kennedy

This is a change for the better, a step in the right direction.

"The way to make government responsible is to hold it accountable. And the way
to make government accountable is to make it transparent so that the American
people can know exactly what decisions are being made, how they're being made,
and whether their interests are being well served.

The directives I am
giving my administration today on how to interpret the Freedom of Information
Act will do just that. For a long time now, there's been too much secrecy in
this city. The old rules said that if there was a defensible argument for not
disclosing something to the American people then, it should not be disclosed.

That era is now over. Starting today, every agency and department should
know that this administration stands on the side not of those who seek to
withhold information but those who seek to make it known."

President
Barack H. Obama

Weekly and Daily Gold Charts

Gold is in a potential breakout formation with a minimum upside measuring objective of 1200. A consolidation here that does not violate 800 to the downside is within the bounds of this formation and will be considered a right shoulder.

Such a correction is not necessary to the formation.





Gold is still in a bull market. There will be corrections, some of them quite challenging. This is the very nature of a bull market, to shake the resolve of the bulls, and continually entice and confound the bears, who struggle to hold their pessimism from one line in the sand to the next.

Some day the bull market in gold will end. But not yet.

SP Futures Hourly Chart at 3:30 PM

The theme for this week is Fed Watch for Wednesday afternoon, and an advance look at 4Q GDP on Friday, with earnings before and after the bell all week.

The bulls are working that bottom formation and it will run if they get the breakout. Notice the failure of a similar pattern about a week ago.

This can go either way. It may not give a clear signal until after the FOMC decision, unless 'something happens.'

Is Money Supply a Relative Absolute?

There has been discussion over the weekend regarding an intriguing blog entry from friend Cassandra Inflation v. Deflation with regard to the Fed's monetization of debt. The principle assertion seems to be that if the Fed is merely replacing existing credit dollar for dollar as it is written off, then the result is not inflationary.

If the original wholesale money market borrowing and lending was not inflationary, then why should its substitute be inflationary? Indeed, the real question is whether the expansion of the Fed's balance sheet is keeping pace with the contraction of money market credit more generally. If not, then the consequence may be deflationary.

Implicit in this of course are two conditions. The first, that the level of wholesale borrowing and lending had not been and would have continued not to be inflationary, and secondly, that the expansion of the Fed's balance sheet is equivalent dollar for dollar with the debt it is said to be replacing.

These distinctions will be lost on most, but they are quite important, and we urge to reader not to gloss over them in preparing a rebuttal to support their bias du jour.

Let's consider an hypothesis someone put to us some time ago. They claimed that the appropriate rate of growth for any money supply is zero, which they considered 'neutral.'

To this we put the question, "If one holds the money supply static for a long period of time in a country whose population is growing at 10% per annum, and GDP is growing at 10% as well, is this a neutral money supply growth rate?

The answer of course is no. Money supply that remains static in a growth situation, whether one measures it in a ratio to economic growth or per capita, is obviously on a deflationary trend because supply is not growing at a rate equivalent to the increase in demand.

Seems obvious in this perspective right? We are not saying it is good or bad, appropriate or not. It is what it is, a growth in money supply that is lagging the growth in demand for money.

Conversely, if money supply is kept static in a country where the population is decreasing, and economic growth contracting, is it neutral? No it is inflationary, since the growth rate of money supply (zero) is greater than the growth rate of the demand for money, which is in decline presumably.

Now, one can imagine all sorts of possible scenarios as exceptions because there are lags in all economic cause and effect. To complicate matters there is no instantaneously correct rate of money supply growth without a context since reality is inherently in a state of flux.

However, though, it is clear that a static money supply is not necessarily neutral compared to the state of the growth of the money supply in a different economic context.

Secondly, we will postulate something we are not quite ready to prove yet, and that is that credit is not the same as money supply. We offer a piece instead that was blogged some time ago in which the various components of money supply are discussed.

Money Supply: a Primer

Its something to consider, and has received too little attention in our opinion.

If you have one thousand dollars in cash, in your pocket, is it completely equivalent to one thousand dollars worth of honey which you have at home in your pantry, in terms of its affect on inflation or deflation?

Forgiving the pun, the honey is decidedly less liquid than the cash.

What if you have one thousand dollars in cash, and another thousand is owed to you by an acquaintance in a distant city who promised to pay it back on demand the last time you spoke to them a year ago. Are those equivalent dollars?

Does it matter who is holding the money? What if the bulk of the money being added to to the economy is being given to gamblers in Las Vegas, rather than lets say farmers in Pennsylvania. Is there a difference in that money's effect on inflation or deflation? Yes there are few differences in the very long run, but sometimes the run becomes so long that it is irrelevant to the policy questions at hand.

This essay does not seek to provide answer to these questions at this time, since this is basis for a new perspective in economics. And unfortunately the discussion is premature. It is rather like a room full of well seasoned drunks, after a week long binge, gathering to attend a lecture on sober thought. We have so utterly lost the conception and relationship of value and risk that we must sober up a bit before we can even think about it once again.

Rather, the purpose of this essay is to cast doubt on the certainty that what we call money is always and everywhere equivalent in force and power and influence as an economic actor no matter where and how it is held.

Having said all that, it is obvious that the Money Supply as measured by the means at our disposal is growing at a rate more significant than economic growth, and that difference is now even greater as the economy slows and contracts. As an engineer and an operational business unit manager we always tend to fall back on what can be measured, what is real and knowable, when theory fails and the bosses are lost in flights of fancy.

The Fed is Monetizing Debt and Inflating the Money Supply

As water is added to the ecosphere, it flows and pools in many places. Money as water in the econosphere is evaporating through debt retirement, but perhaps not through debt destruction, or at least not in the same way. Someone must lose if a debt is written off right? What if that loss is booked at the Fed, and they realize that loss by simply 'making it go away' at least as far as the real economy is concerned? Is there a contraction in the money supply anywhere?

There are all questions worth considering, and we will have much more data as the results of Mr. Bernanke's experiments produce additional data.

But one thing is certain in our minds, and that is certainty in this situation is an illusion. We do not think that even the Fed knows exactly what they are doing. Rather, they are feeling their way through uncharted waters, projecting perhaps a confidence, but this is primarily for effect, not as a genuine state of mind.

And based on first principles, deflation, while possible, is never a certainty in a fiat regime where there is a central monetary authority that holds the power to monetize debt. The only boundary on their power is the acceptability, or value, of the money they produce, and that is also known as inflation.

Obviously the Fed may do a poor job or an outstanding job of managing the nation's money supply and economy. We will not really know until after the fact given the lags in these sorts of machinations.

But what is different, what is dangerous, is that the Fed has grasped the reins of a highly complex system, that is now more global than at any time before, and is trying to pull it in a certain direction, without immediate feedback on what it is that is happening. The last five or six times in which the Fed has done this something 'unexpected' has occurred.

Another factor most do not consider which is of some importance is the potential for systemic reform in the economy that is the context for the actions of the money supply. Without serious financial reform we most likely will take spin on the wheel of boom and bust again, with a greater disparity of wealth and a greater loss of democratic freedoms.

Either state is possible, make no mistake, but the probability is highest that the loss of control will be an inflation, with the key metric being 'how bad' and 'how difficult to subdue once it is unleashed.' Why? Because inflation is the default condition of a fiat currency that becomes uncontrolled. Deflation requires a sustained effort for whatever reasons, generally policy error or a conflict in desired outcomes.

A softer, much more judgemental reason, is that those who are now telling us that inflation is not an issue are the very ones who have been acutely wrong, for whatever reason, since this crisis began, if not years before that. They speak their book, and shamelessly. But that is no determinant, merely a confirmation of sorts.

What concerns us most is that the Fed is quite confident, in their own words, that they know how to deal with inflation after Volcker. That reminds us too much of hubris, and the classical myth of Phaëton who confidently took the reins of the chariot of the Sun from the golden Apollo, and very nearly burned down the world in the process.

Bernanke's Gamble on the Dollar

There are several things of interest this week. The first and foremost is the Fed's FOMC two day meeting with their announcement on Wednesday at 2:15.

It is important despite the fact that rates are effectively at zero, and the Fed has declared for 'quantitative easing.'

How does the Fed intend to implement this quantitative easing? Another way to ask this is to say, "What is the next bubble?"

Quantitative easing implies market distortion, and traders will be keen to understand where and how that distortion will play, because they are still geared for supercharged returns in an environment where fewer and fewer opportunities exist.

The Treasuries seem like a safer place, because lower interest rates are to the economy's benefit. Foreign entities may not like the monetization aspect, but we wonder how many real 'investors' are left in the bonds? Most in there are domestic parties seeking safe havens with any sort of return, and foreign central banks supporting political and industrial agendas.

So the focus will be on the wording of the Fed's statement once again, looking for clues with regard to the Fed's easing implementation and potential distortions that provide market inefficiencies.


Bloomberg
Bernanke Risks "Very Unstable" Markets as He Weighs Buying Bonds
By Rich Miller
January 25, 2009 19:01 EST

Jan. 26 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke and his colleagues may try once again to cure the aftermath of a bubble in one kind of asset by overheating the market for another.

Fed policy makers meeting tomorrow and the day after are exploring the purchase of longer-dated Treasury securities in an effort to push up their price and bring down their yield. Behind the potential move: a desire to reduce long-term borrowing costs at a time when the Fed can’t lower short-term interest rates any further because they are effectively at zero.

The risk is that central bankers will end up distorting the Treasury market, triggering wild swings in prices -- and long-term interest rates -- as investors react to what they say and do. “It sets forth a speculative dynamic that is very unstable,” says William Poole, former president of the Federal Reserve Bank of St. Louis and now a senior fellow at the Cato Institute in Washington....

Inflated Prices

Recent history shows the economic danger of inflating asset prices. After a stock-market bubble burst in 2000, the Fed slashed interest rates to as low as 1 percent and in the process helped inflate the housing market. The collapse of that bubble is what eventually helped drive the U.S. into the current recession, the worst in a generation.

Faced with the danger of a deflationary decline in output, prices and wages, the Fed is considering steps to revive the moribund economy. On the table besides bond purchases: firming up a pledge to keep short-term interest rates low for an extended period and adopting some type of inflation target to underscore the Fed’s determination to avoid deflation.

The central bank has been buying long-term Treasury debt off and on for years as part of its day-to-day management of reserves in the banking system. Yet it has always gone out of its way to avoid influencing prices. What it’s discussing now, says former Fed Governor Laurence Meyer, is deliberately trying to push long rates below where they otherwise might be.

Fed Purchases

Bernanke raised this possibility in a speech on Dec. 1. While he didn’t specify what maturities the Fed might buy, in the past he has suggested that purchases might include securities with three- to six-year terms. (This is around the sweet spot for foreign Central Banks - Jesse)

Investors immediately took notice, with the yield on the 10-year note falling to 2.73 percent from 2.92 percent the day before. Yields fell further on Dec. 16, dropping to 2.26 percent from 2.51 percent the previous day, after the central bank’s policy-making Federal Open Market Committee said it was studying the issue....

Yields have since risen, with the 10-year note ending last week at 2.62 percent. Behind the reversal: expectations of massive fresh supplies of Treasuries as the government is forced to finance an $825 billion economic-stimulus package and a possible new bank-bailout plan. This week alone, the Treasury is scheduled to auction $135 billion worth of securities.

Jump in Yields

David Rosenberg, chief North American economist for Merrill Lynch in New York, says the jump in yields may prompt the Fed to go ahead with Treasury purchases.

This isn’t the first time Bernanke and the Fed have discussed buying longer-dated securities and ended up roiling the market. Bernanke touted the idea as a tool to fight deflation in speeches in November 2002 and May 2003.

Egged on by his comments -- and later remarks by then-Fed Chairman Alan Greenspan that the central bank needed to build a “firewall” against deflation -- many investors became convinced the central bank was poised to buy bonds. The yield on the 10-year Treasury note fell to 3.11 percent in June 2003 from 3.81 percent at the start of the year.

Traders quickly reversed course as it became clear the Fed had no such intentions, sending the 10-year Treasury yield soaring to 4.6 percent just three months later, on Sept. 2.

‘Miscommunication’

Poole, who was then at the St. Louis Fed, was critical at the time of what he called the central bank’s “miscommunication.” He now sees the Fed making the same mistake with its latest suggestions that it might buy longer- dated securities.

“If they do it, it’s going to be disruptive to the market,” says Poole, who is a contributor to Bloomberg News. “If they don’t do it, it will impair the Fed’s credibility and erode the confidence the market has in the statements that the Fed makes.”

Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers, says the Fed should, and probably will, go ahead with purchases as a way to lower borrowing costs. “The story is stop talking and start buying,” he says.

Still, he notes that not everyone at the Fed is enthusiastic about the idea. One concern: Foreign central banks and sovereign-wealth funds, which are big holders of Treasuries, might cool to buying many more if they believe prices are artificially high. (The buyers of our debt now are supporting their own industrial policy we would hope. Any other reason borders on mismanagement of funds while anyone in their country is hungry or unemployed - Jesse)

Undermine the Dollar

That may undermine the dollar. “There’s no guarantee that international investors would switch to other dollar- denominated debt if flushed from the Treasury market,” says Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. in New York, says foreign investors might also get spooked if they conclude that the Fed is monetizing the government’s debt -- in effect, printing money -- by buying Treasuries. (They already are, and they already are - Jesse)

Bernanke himself, in his 2003 speech, said monetization of the debt risked faster inflation -- something bond investors, foreign or domestic, wouldn’t like.

Some economists argue the Fed would help the economy more if it bought other types of debt. (Such as corporate bond - Jesse) Even after their recent rise, 10-year Treasury yields are still well below the 4.02 percent level at the start of last year....

Hawks at the Fed wouldn’t welcome such purchases. They are already uneasy that some of the central bank’s programs are effectively allocating credit to one part of the economy rather than others. Case in point: the Fed’s ongoing program to buy $500 billion of mortgage-backed securities, which Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, has called “credit policy” rather than monetary policy. (Its nice to see that someone else is noticing that the Fed has crossed the Rubicon from central bank to central economic planner in the worst sense of the description - Jesse)

US Treasury Department Official Allegedly Aided and Abetted Banking Fraud (Again)

Darrell Dochow earns $230,000 per year at Treasury in banking regulation. He reportedly gave Indymac some suggestions on cooking their books, and then allowed the exception to the rules to accomplish it. It appears to have been a blatant and obvious accounting fraud.

Mr. Dochow is also the official who presided over the Lincoln Savings and Loan scandal. Having looked into Charles Keating's eyes and seeing him a good man, he reportedly overrode the protests and findings of fraud from the banking experts. After his S&L debacle he was apparently demoted, but brought back into a position of importance under the Bush Administration. All the details on this have not yet been made public.

Mr. Dochow is unlikely to do any prison time, but may lose his job. That is because this is 'criminal with a small c' according to this news report.

When this sort of behaviour becomes criminal with a 'capital C' and when people like Dochow find themselves on the business end of FBI probes and Justice Department indictments at least as serious as the one mounted against Eliot Spitzer and his hooker, we might make some approach to honesty and reform in this country.

Ok, Obama Administration, the buck is on your desk now. Time to take meaningful action to back up the rhetoric.


ABC News, New York
Government regulators aided IndyMac coverup, maybe others
By Brian Ross, Justin Rood, and Joseph Rhee
Friday, January 16, 2009

A brewing fraud scandal at the Treasury Department may be worse than officials originally thought.

Investigators probing how Treasury regulators allowed a bank to falsify financial records hiding its ill health have found at least three other instances of similar apparent fraud, sources tell ABC News.

In at least one instance, investigators say, banking regulators actually approached the bank with the suggestion of falsifying deposit dates to satisfy banking rules -- even if it disguised the bank's health to the public.

Treasury Department Inspector General Eric Thorson announced in November his office would probe how a Savings and Loan overseer allowed the IndyMac bank to essentially cook its books, making it appear in government filings that the bank had more deposits than it really did. But Thorson's aides now say IndyMac wasn't the only institution to get such cozy assistance from the official who should have been the cop on the beat.

The federal government took over IndyMac in July, after the bank's stock price plummeted to just pennies a share when it was revealed the bank had financial troubles due to defaulted mortgages and subprime loans, costing taxpayers over $9 billion.

Darrel Dochow, the West Coast regional director at the Office of Thrift Supervision who allowed IndyMac to backdate its deposits, has been removed from his position but he remains on the government payroll while the Inspector General's Office investigates the allegations against him. Investigators say Dochow, who reportedly earns $230,000 a year, allowed IndyMac to register an $18 million capital injection it received in May in a report describing the bank's financial condition in the end of March.

"They [IndyMac] were able to maintain their well-capitalized threshold and continue to use broker deposits to make loans," said Marla Freedman, an assistant inspector general at Treasury. "Basically, while the institution was having financial difficulty, it kept the public from knowing earlier than it otherwise should have or would have."

In order to backdate the filings, IndyMac sought and received permission from Dochow, according to Freedman.

"That struck us as very unusual," said Freedman. "Typically transactions are to be recorded in the period in which they occur, not afterwards. So it was very unusual."

One former regulator says Dochow's actions illustrate the cozy relationship between banks and government regulators.

"He did nothing to protect taxpayers in losses," former federal bank regulator William Black told ABC News. "Instead of correcting it [Dochow] made it worse by increasing the accounting fraud."

Meanwhile, IndyMac customers who lost their savings are demanding answers and are further infuriated after learning Dochow was also the regulator in 1989 who oversaw the failed Lincoln Savings and Loan, a scandal that sent its CEO Charles Keating to prison.

"He's the person who claimed that he looked into Charles Keating's eyes and knew that Keating was a good guy and therefore ignored all of the professional staff that told him that Keating was a fraud, and he produced the worst failure of the Savings and Loan Crisis at $3.4 billion. Now he's managed more than triple that," said Black, now an economics professor at the University of Missouri in Kansas City, Missouri.

Following the Lincoln scandal, Dochow was demoted and placed into a relatively obscure office, but later, inexplicably was brought back into the Office of Thrift Supervision.

Dochow declined to answer questions from ABC News.

After Ronnie Lopez was killed in Iraq, his mother Elaine invested the life insurance proceeds at IndyMac. She lost $37,000 of it.

"I was hysterical," she told ABC News. "I literally thought I was going to kill myself that day, because I felt so bad that I had let him down. I remember going to his grave and telling him "don't worry, I'm going to get that money back,' and I feel like he was saying, 'Hey, Mom, don't let them take that. I did the ultimate for that.'"

A group of angry investors has started a website, demanding answers on the extent of Dochow's actions.

"It's just the strife and anger," said IndyMac customer Lisa Marshall. "That this Dochow person is still employed. It's unbelievable, it's shocking."

While Dochow could end up losing his job, neither he nor his colleagues are expected to go to prison.

"This is criminal with the small 'c,'" said Black. "No one within the regulatory ranks may go to jail, but they have done the worst possible disservice to the taxpayers of America."