Gold Is Rallying Because....

Gold is a superior store of value.

It resists the attempts by the monetary authorities to debase it, because except for concerted attempts to suppress its price through non-profitseeking selling at key market points by central banks, and naked short selling by the global commercial banks in the paper markets, gold cannot be created and controlled by financial engineers like Ben Bernanke.

It provides a refuge, a store of wealth for private citizens during a period of general currency risk.

A simple chart should suffice.



As part of the quantitative easing regime, the Fed has so debased the financial system that dollar debt is paying negative interest rates once again as it did in the 1970's.

In other words, it is costing money to hold dollar financial assets because of the mispricing of risk being engineering by the G7 central banks.

So, people and some central banks are seeking refuge in a stable store of wealth that is beyond the control of the financial engineers.

"With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people." Fredrich August von Hayek

"The gold standard has one tremendous virtue: the quantity of the money supply, under the gold standard, is independent of the policies of governments and political parties. This is its advantage. It is a form of protection against spendthrift governments." Ludwig von Mises

Alan Greenspan himself states the case most eloquently in his famous essay from 1966 Gold and Economic Freedom.

"This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."

When the currencies of the US and Europe are debased by the financial engineers for the sake of the banks, when spendthrift governments run enormous deficits to fill the pockets of their special interests, informed wealth seeks a refuge in places where it cannot be so easily consumed for the exclusive benefit of the political elite.

This is sadly the case today, especially within the Anglo-American sphere of influence, from which the dollar had become the new opium trade, viciously addictive and debilitating. And so we have seen an historic flight to safety that began in the developing world, but is gaining momentum as the global dollar regime falters.

If you hold dollars, the Fed and the Treasury can confiscate your wealth, virtually at will. That is real power.

When the Fed lifts interest rates to again provide a positive return against inflation, then gold may stop rallying and reach a stable equilibrium price. This will be more difficult to do than it was to debase, as it is always easier to destroy than to create.

And it may be difficult to determine when that time comes, because the US bureaucrats have so thoroughly altered the Consumer Price Index over the past ten years that it is no longer a fair measure of inflation. Therefore it is a challenge to determine what is real and what is not, what is priced fairly and what is not. This is the hallmark of the modern western bankers and their accountants, and their demimonde in politics and the media.

Still, the message of the market is quite clear, to anyone who will listen.

A pleasant Thanksgiving holiday to my American friends, and a reminder to the rest of the world that you must muddle through without the direction of Wall Street for the next few days. How fitting that Thanksgiving was declared a national holiday by Lincoln in the depths of the Civil War, and made official by the Congress in 1941, at the end of the Great Depression, on the cusp of a terrible world war.

And Lloyd, I would not join the many and be happy at all if you took your own life as you have recently confessed that you feared they would. But there might be a cause for celebration if a master of the universe such as yourself would simply take this timeless message into you heart, and make it the light of the rest of your life. That is the right pricing of risk, the proper valuation of all that you are.

"Come, let us sing to the Lord; let us make a joyful noise to the rock of our salvation. Let us come before His presence with thanksgiving; let us make a joyful noise to Him with songs of praise. For the Lord is a great God, and a great King above all. In His hand are the deep places of the earth, the heights and strength of the hills. The sea is His, for He made it, and His hands formed the dry land. Come, let us worship respectfully, let us kneel before the Lord our Maker. For He is our God and we are the people of His pasture and the sheep of His hand. Now, if you will but hear His voice." Psalm 95

No time for despair, now is the time to be surprised by joy.

"I do not think of all the misery, but of the glory that remains. Go outside into the fields, nature and the sun, go out and seek happiness in yourself and in God. Think of the beauty that again and again discharges itself within and without you, and be happy." Anne Frank

What Is a Tobin Tax?

The purpose of a Tobin Tax is to place a financial penalty on short term transactions to curb speculation. It was originally proposed by James Tobin in the 1970's as a means of discouraging international currency speculation after Nixon closed the gold window and rendered the Bretton Woods agreement moot, at least until the ascendancy of the current dollar reserve currency system.

The tax is generally discussed as being 0.1% of the total transaction, or 1.00 per 1,000. It certainly would have a discouraging impact on the daytraders, and some could argue, as I would, that a percentage of the transaction at .1% might be considered regressive, and a huge penalty on institutional trading.

The tax might be better targeted at 'frequency' of trading, rather than nominal size of the transaction, in order to target speculation, under some reasonable transaction limit.

So for example, a flat tax of .50 per transaction would be negligible for the average investor, but would seriously impinge high frequency trading that is de rigeur amongst professional speculation these days.

What is also of concern is the discussion of a Tobin Tax as a international source of revenue, let's say for the IMF. A system of direct taxes on US citizens for the funding purposes of an international entity like the IMF must surely be unconstitutional.

And it goes without saying that there are sure to be 'exemptions' for certain types of trading in this tax, if the lobbyists have anything to say about it.

There will be another bailout of the banks. There will be discussion about punitive and ameliorative legislation to deal with them, in addition to the general lack of discussion about existing antitrust and bankruptcy laws, and the Glass-Steagall law which stood the test of time for sixty years.

American Banking News
Is a Tobin Tax in Store for Large Banks?
By Christopher
November 24th, 2009

The phrase “too big to fail” may get retired in 2010, but for banks such as Goldman Sachs, Citigroup Inc., and Bank of America, they may face a new round of punitive legislation to deal with the political fallout.

According to a special report in Money Morning, heavy government intervention in the banking sector combined with low interest rates and ongoing stimulus has made 2009 a profitable year for many banks.

In fact, according to a special report in Money Morning, so-called “bad” banks including Goldman Sachs, Citigroup Inc., and Bank of America have turned out to be a better investment than good banks.

But as they look to 2010, these same factors may signal trouble.

To begin with, if the Federal Reserve raises interest rates as is widely expected, it would reduce trading profits, reduce the profitability of borrowing short-term and lending long-term, and reduce the prices of assets such as houses and commercial real estate – putting even more strain on loan portfolios.

But an increase in interest rates is only the first of three areas of concerns for investors.

The length and the level of U.S. unemployment have economists wading through unchartered waters. If unemployment rises above its current 10.5% level and tests a postwar period high of 10.8% set back in 1982, it could signal huge losses as the U.S. consumer-credit system is not “stress-tested” for such high unemployment rates over a prolonged period of time.

And if the losses start piling up, the Fed might very well intercede again with a second bailout. This would be yet another strike against bank stocks since politicians would try to penalize investors for needing taxpayer money twice in two years.

All of this, plus the recent news of record bonuses at Goldman Sachs is creating momentum for punitive legislation against the banks that goes beyond the premiums banks pay to the Federal Deposit Insurance Corp. (FDIC).

One idea being considered is a “Tobin tax”. Originally proposed by economist James Tobin after the Nixon administration effectively ended the Bretton-Woods system of tying the U.S. dollar to the gold standard.

The idea behind such legislation, which would fall most heavily on very big conventional banks and trading-oriented investment banks, would be to tax transactions in bonds, stock commodity and foreign exchange markets.

Opinions are divided between those who discern a Tobin tax could protect countries from spillovers of financial crises, and those who claim the tax would constrain the effectiveness of the global economic system and dry up world liquidity.

Massive Deflation Sighting in the US As Noted in the Asia Times

David Goldman says in the Asia Times that "It’s Still the Worst Deflation in US History." He shows a chart (below) of US commercial lending to prove his point.

Asia Times
It’s Still the Worst Deflation in US History
November 18th, 2009
By David Goldman

This morning’s news that housing starts “unexpectedly” dropped by 11 percent month on month is consistent with my grim view of the American economy. The crystal-meth monetary policy at the Fed makes everyone feel better, until they don’t.

The nonstop rise in the price of dollar hedges tells us that it can’t last forever. Large balance sheets attached to the Fed’s money pump can show profits, and the price of spread assets (as PIMCO’s Bill Gross keeps emphasizing) is stupid rich. But at the capillary level, through, the economy is dying and gangrene is setting in.

Here’s year on year growth in commercial and industrial loans from weekly reporting banks in the US:



A 20% decline year on year does not look like a recovery. In fact, it looks like nothing we have seen since the Great Depression. C&I loan growth lags the end of recessions, to be sure, but this extreme level of credit reduction suggests profound trouble....

Yes commercial lending is slack and gone negative. And yes, it does signal severe economic distress in the productive economy. But is that deflation?

No, it is a sign of a very slow GDP growth and deleveraging in the aftermath of a credit bubble, with a GDP that I think is still negative in real terms. The US economy is still very bad, and David is probably less gloomy about that than Le Proprietaire.

One could assume that by 'deflation' David means 'a recession/depression' or 'a lousy economy.' But that is not deflation, as the economists learned in the economic stagflation of the 1970's. Words count, and this is an important distinction, because one reacts to situations as diverse as inflation or deflation, hyperinflation or stagflation, differently.

Is this a deflation which we see now in the US, even if it is not the 'worst in history?' Is there a steadily strengthening US dollar ,and low money supply growth relative to demand, or GDP relative to money suppy as indicated by an abnormally high velocity of money?

Only in the mind and imagination of someone who already believes in a deflationary outcome with all their mind and heart.

Can deflation happen? Yes. That is inherent in a fiat currency.

If the Fed raised the overnight interest rates to 20% tomorrow, we would have a deflation 'lickity split' because that would be an extreme policy action which relative to the underlying demand for money and economic conditions, is purposeful and dramatic towards a specific end. And this is the Fed's 'hole card,' the means by which they think they can control inflation in the future once the US economy has recovered (if it does sustainably I would add, and not just another asset bubble).

Inherent in David's conclusion is that money supply can only grow through bank lending. This is economic illiteracy. The Weimar inflation, for example, was not caused by excessive lending by German commercial banks in a vibrant economy. It was caused by the monetization of existing debts, the war reparations debt, without a corresponding growth in productive GDP.



So, absent a conscious policy decision by the Fed to strangle the US economy premature to recovery, deflation becomes a likely outcome if the Federal Reserve runs out of debt obligations, both public and private, which it is willing and able to monetize. That is the only 'hard stop' in the game on that side of the equation, and good luck with that.



Deflation would hurt those who owe debts in dollars, and be a boon to those who are the creditors. The American people are the debtors, and they control the growth of their money supply, at least for now.



The obvious pivot point, one key vector, in all this is one simple question: "Can the US economy become self-sustaining again, productive in its own right without having to export inflation by printing currency and living on credit?"

A second, but important question is can China and the rest of the mercantilist world adjust gracefully to a rebalancing in the distribution of demand, while maintaining sustainable growth of their own, despite their fears of a rising middle class?

We say yes, but only with a serious effort at fiscal and economic rebalancing. Cutting spending alone is not enough. That is the route to self-destruction, economic anorexia, if nothing else changes. Liquidationism alone is inherent in the neo-Calvinist roots in the US that emphasize the justice of non-redemptive suffering. They have sinned, so they must suffer, and the more the better.

There are three things the US must do: reform, reform, reform. Everything else is a palliative, to buy time at best while you seek to make the necessary systemic changes.

What does it matter, the details of the outcome, as long as the economy is in a slump?

If you want to suffer, go into a serious and protracted stagflation in the US holding dollars as the bulk of your wealth, and that will give you a taste of hell.

What is the most likely outcome? Would you care to buy a vowel? I would suggest that you buy an "I" and then see if there is an "S."

Deflation and straight inflation are relatively easy to hedge. Stagflation is the most difficult outcome to manage from an investment perspective. We'll talk more about this later if that appears to be the case.

Stagflation will be the unintended consequence that will catch the most people unprepared. This is the outcome most feared by the Fed, because it renders their monetary policies ineffective. The Fed can create money until the dollar goes to zero, but it cannot manage fiscal and industrial policy, and confer productive vitality which is essential to a sustainable recovery.

You cannot say that Bernanke did not warn you about what he will do. Deflation: Making Sure "It" Doesn't Happen Here

But we cannot stress enough that the outcomes are not predetermined, except in the minds of true believers. Therefore flexibility and clear-headed watchfulness are important now, more than ever.

The Last Bubble

The purpose of monetary and fiscal stimulus in economics is similar to the use of anesthesia and antiseptics during an important surgical procedure to correct some systemic difficulty, some disease, some serious problem in a patient. They enable the procedure, help the patient get through it without excessive pain and death from infection or systemic shock.

To apply stimulus and the other monetization programs which the Treasury and the Fed and the Congress and the system of global trade settlements are now doing without enacting sigificant and serious systemic reform to correct the underlying problems, the disease itself, is like taking a patient with a life threatening condition, applying large amounts of anesthetic and antibiotics and antiseptics to keep them stable and quiet, but then refusing to perform the operation to correct the life threatening condition.

Because in this case the disease that is infecting the patient and consuming their life has bribed the physicians and hospital administrators and nurses to leave it alone. It wants to maintain the status quo as long as is possible.

The pulse of patient, their blood flow, is the dollar. And the dollar is laboring under serious difficulties. The disease is consuming it, and the Fed is adding clear plasma to replace it, but is unable to add vitality, the white and red blood cells. They cannot create life, only sustain its appearance.

The liquidationists, by the way, would simply take the patient off all medications, and see how well he can fight the disease while running on a treadmill, hoping his body can cure and correct itself on its own. If the patient is not too sick, this has worked in the past. But if the problem is systemic, if the disease is advanced, then the patient is likely to go critical and sustain a stroke, and a major loss of functionality, even death. Benign neglect might work, it might not. Sometimes the cure is worse than the disease when applied without a perceptive diagnosis.

The Obama Administration (the doctors) and the Congress of both parties (the hospital administrators) and banks (the hospital owners) and the mercantilist trade system most notably China and Japan (the medical suppliers) are failing to deal with the problems of the US economy at hand, merely applying the anesthetic and antiseptics, for which they are being paid handsomely as the hospital bills run higher and higher.

This may be the last bubble, the one that takes the patient to a hospice for long term care in a zombie like condition, or worse, to the morgue. It is the last bubble, malpractice of the highest order, the mother of all policy errors. Nothing is inevitable here except selective default most likely through inflation.

The banks must be restrained, and the financial system reformed, and balance restored to the economy before there can be any sustained recovery.

Associated Press
Third-Quarter U.S. Growth Revised Lower
November 24, 2009

WASHINGTON (AP) — The economy grew at a 2.8 percent pace last quarter, as the recovery got off to a slower start than first thought.

The government’s new reading on gross domestic product was not as energetic as the 3.5 percent growth rate for the July-September period estimated just a month ago.

The main factors behind the downgrade: consumers did not spend as much, commercial construction was weaker and the nation’s trade deficit was more of a drag on growth. Businesses also trimmed more of their stockpiles, another restraining factor.

The new reading on G.D.P., which measures the value of all goods and services produced in the United States — from machinery to manicures — was slightly weaker than the 2.9 percent growth rate economists surveyed by Thomson Reuters had expected.

Still, the good news is that the economy finally started to grow again, after a record four losing quarters. The bad news is that the rebound, now and in the months ahead, probably will be lethargic.

The worst recession since the 1930s is very likely over, but the economy’s return to good health will take time, Fed officials and economists say...

The US Dollar Is In a Secular Bear Market and Will Remain in One Until...

Contrarians might take some cheer from dollar bearishness, but one needs to be aware that not everything that is fundamental and recognizable is overdone and wrong.

Markets do overrun their trends, especially on the short term and by amateur speculators, setting up very nice opportunities for the professional market makers. The attractiveness of being a 'contrarian' is that when you are right you can set yourself up as superior to those who were wrong, distinguishing yourself from the mere mortals, and feel the euphoria of God's favored hand.

But being a contrarian requires a superior sense of what is real, and what is out of synch with reality. In general few amateurs possess this level of judgement and perspective, and end up just looking silly and eccentric after a few correct calls, taking the opposite position because it is the opposite, proclaiming night to be day, and the moon to be cheese.

Oh they deny it, and keep changing their forecasts, and burying their mistakes, fooling no one really but themselves, constructing ever more intricate theories about why they are right and will be ultimately vindicated in their 'beliefs.' But on the whole they lose money and take a terrific financial beating for being obstinately. Every seasoned trader learns this lesson, at least once, and bears its scars. They become superior traders when they are able to take a position again and hold it, despite the market head fakes, because they are right and they know it.

Markets do fluctuate. This is why it is so important to determine whether a move in a market is a purely 'technical move,' ie a bounce or dip to skin the overleveraged speculators who have piled on to a momentum move, and a genuine and sustainable change in direction underpinned by some fundamental reason.

And this news piece provides an important clue as to when a change in the dollar bear market may begin to occur.

“History tells us the dollar shouldn’t start rising on a sustained basis until 12 months after the Fed starts to lift rates.”

The rise in rates will be relative to other currencies and commodities in valuation, but the forecast here is substantially correct. The dollar is in a bear market and will remain there for the foreseeable future. Again, with bounces and dips to tempt the punters in to be fleeced and skinned.


Dollar Slump Persisting as Top Analysts See No Bottom
By Bo Nielsen

Nov. 23 (Bloomberg) -- The most accurate dollar forecasters predict the world’s reserve currency will continue sliding even when the Federal Reserve begins to raise interest rates, which policy makers say is an “extended period” away.

Standard Chartered Plc, Aletti Gestielle SGR, HSBC Holdings Plc and Scotia Capital Inc. say the dollar will depreciate as much as 6.4 percent versus the euro. About $12 trillion of fiscal and monetary stimulus, the world’s lowest borrowing costs and a record $4 trillion of government bond sales between 2009 and 2010 will weigh on the currency, they said. So will the nation’s 10.2 percent unemployment rate and signs that the economic recovery may falter, they said.

“History tells us the dollar shouldn’t start rising on a sustained basis until 12 months after the Fed starts to lift rates,” said Callum Henderson, the Singapore-based global head of foreign-exchange strategy for Standard Chartered.

The best forecaster of the dollar against the euro in the six quarters ended June 30 in Bloomberg’s ranking of 46 firms last month predicts the greenback will weaken 5.3 percent to $1.58 per euro in 2010, from $1.4970 today.

“It’ll take time to drain the oversupply of dollars from the market,” Henderson said. “The dollar will remain weak until the Fed’s rates rise above the competitors’....”

Has the American Model of Capitalism Failed?

This video is well worth watching to provoke thought and provide a perspective which you may not obtain from the mainstream media, particularly in the States

Naomi Klein, Howard DeSoto, and Joe Stiglitz on Economic Power and the Financial Crisis in the US

Has the American system failed? What is the American system of markets?

Is the US becoming a 'banana republic' and if so how has this happened?

What are the roots of the financial crisis?

Howard DeSoto is interesting, but takes a decent macro concept and then flogs it to death without taking it to the next step towards relevancy. Naomi Klein is more of a popularizer but makes some interesting points and explains them exceptionally well. Stiglitz is his usual brilliant self, and one must only regret that he and Volcker have no voice or real place in the Obama Administration.

But at the end of the day, one still suspects that all this talks around the basis for this financial crisis, which is a determined, if loosely organized campaign to undermine of the rule of law and to 'fix the game' in a way that has numerous historical examples.

It is best epitomized by the well-funded campaign led by Sandy Weill to capture the regulatory and political process in the US, and to overturn Glass-Steagall and the restraints on markets and leverage and oversight for the Wall Street banks. It was more sophisticated in its own way than Bernie Madoff's ponzi scheme and certainly on a grander scale than Enron, but is of the same general species of financial fraud.

As the book title says, It Takes a Pillage...

Dimon Touted as Replacement for Geithner

This news story is what is known in American parlance as a 'trial balloon.' It is a little leak to the press to assess the public and media reaction to a proposed change.

The game plan appears to be one of creating change you can believe in by replacing Bernanke and Geithner with Larry Summers, currently Obama's chief economic advisor and financial Rasputin, and Jamie Dimon, the CEO of J. P. Morgan bank. Lloyd Blankfein apparently is not available for the job, having found his vocation in doing God's work.

At least that is the plan that is being put 'on the table' by an influential group of financiers, or so we have been informed. Senator Chris Dodd, often the message bearer for Wall Street, mentioned last week that Mr. Bernanke's confirmation as Fed chief was not a certainty.

Jamie Dimon learned the business from Sandy Weil, one of the chief architects of the efforts of the Wall Street banks' campaign to overturn Glass-Steagall. He is also very smooth and politique, as opposed to Mr. Geithner who is in quite a bit of political trouble and not handling it with the gravitas mixed with detached joie de vivre expected in elite circles.

As Treasury Secretary perhaps Jamie can help out his old firm with their 130 million ounce naked short in silver. Oops, the US Treasury is out of silver too.

We are discounting rumours that President Obama is considering an executive pardon for Bernie Madoff, with the condition that he agree to serve as Treasury Secretary. "Take those T bills and put them where the mooncakes don't shine, Hu Jintao."

Reuters
Dimon seen as successor to Geithner
By Ajay Kamalakaran in Bangalore
On 4:52 am EST, Monday November 23, 2009

(Reuters) - Several U.S. policy makers consider J P Morgan Chase & Company Chief Executive Jamie Dimon as a potential successor to U.S. Treasury Secretary Timothy Geithner, the New York Post said, citing sources.

Dimon "would love to serve his country," the paper quoted people familiar with his thinking as saying.

JPMorgan could not be immediately reached for comment by Reuters outside regular U.S. business hours.

Geithner endured a grilling last week before the U.S. Congress over his role in the rescue of American International Group Inc in 2008, when he was president of the New York Federal Reserve Bank.

US Commercial Banks: the Turkeys Are Stuffed

The increase in the monetary base created by the Fed's monetization of debt is striking, not seen since the early stages of the Great Depression.



Banks are not lending despite the massive quantitative easing. They are fat with reserves, paying huge bonuses again, and obviously doing something with their money other than providing funds for the commercial activity of the nation.



Excess Reserves are an accounting function. The banks themselves do not reduce their reserves significantly through lending in the aggregate, but seek to minimize the opportunity cost of reserves. But it is symptomatic in the sense that the lack of reserves is most definitely NOT an issue with lending.

No one can deny with any credibility that if the Federal Reserve reduced their payment on reserves to zero, or even a negative, that lending activity would not increase. And yet they do not. Why?

Because the first priority of the Fed is the health of the banking system itself, and not the national economy and the availability of credit to non-banking institutions. They are seeking to drive commercial entities out of secure savings to risk investment again, but providing a safe harbor for the banks while they are doing it, while attempting to maintain the appearance of financial system solvency.

The critical, unspoken factor is that the US banking system is not yet healthy, is not sound, is not well capitalized despite the record expansion in the monetary base and its specific direction to the banks themselves. They have simply not taken the writedown necessary to make themselves financially sound, because they do not wish to take the hit to earnings, salaries, stock options and bonuses.



Ben Bernanke's gambit is as much financial fraud as it is a monetarist exerperiment in cynicism with regard to the management of a nation's money.

Gold and the SP 500 Charts

The SP is looking a little 'heavy' going into a holiday short weekend in the States. This is where the bulls need to hold the trend.



Here is where we find out if the Fed and Treasury effort to reflate the financial asset sector will 'stick' or not. Their approach to the bailouts was a political policy error of the first order, almost shockingly naive to see from an Administration headed by skilled politicians. One has to think that Timmy will be a fall guy at some point, with Larry Summers tossing him under a bus.



Watch the lower trend line because if it gets broken and confirmed we could go down for a 50% retracement of this rally, and perhaps further to set a new low. As it is, a 5% corrective in a short holiday week looks likely.



Gold is performing an 'in your face' breakout and holding its gains into an option expiry next week which is wildly bullish. The target on the weekly is 1240ish, and one has to wonder if there will be enough of a pullback to allow the bears to cover their shorts before they are taken out on stretchers. It will take a severe correction in stocks to do it I suspect. But let's see.

Short Term T Bills Go Negative

Too many dollars chasing too few opportunities because of mispriced risk, so they are piling into short Term Treasuries again.

Grab something solid and hold on tight. Could be rough seas ahead.

Three Month T Bill Rates Go Negative On Concern Risk Rally Overdone
By Cordell Eddings

Nov. 19 (Bloomberg) -- Treasury three-month bill rates turned negative for the first time since financial markets froze last year on concern that the rally in higher-yielding assets has outpaced the prospects for economic growth.

Investors were willing to pay the government to hold their money as stocks slid amid speculation the eight-month, 68 percent rally that drove the valuation of the MSCI World Index to the most expensive level in seven years already reflects forecasts for a 25 percent rebound in corporate earnings next year. Federal Reserve Bank of St. Louis President James Bullard yesterday said experience indicates policy makers may not start to increase interest rates until early 2012.

“As long as the economy is stuck in a rut and there are not viable fixed-income alternatives, they will buy Treasuries,” said George Goncalves, chief fixed-income rates strategist at Cantor Fitzgerald LP, one of 18 primary dealers that trade directly with the Fed.

Rates turned negative on some bills maturing in January, according to Sarah Sobeck, a Treasury trader at primary dealer Jefferies & Co. The three-month bill rate was at 0.0051 percent, the least this year. Six-month bill rates dropped to the lowest since 1958. Treasury bills turned negative last December for the first time since the government began selling them in 1929 as investors scrambled to preserve principal and were willing to sacrifice returns in the months following the collapse of Lehman Brothers Holdings Inc.

The two-year note yield fell five basis points to 0.70 percent at 4:24 p.m. in New York, according to BGCantor Market Data. The 1 percent security due October 2011 rose 3/32, or 94 cents per $1,000 face amount, to 100 18/32. The yield touched 0.6759, the lowest since Dec. 19. It fell to an all-time low of 0.6044 percent on Dec. 17.

Don’t Dismiss

“Investors are preparing early for year-end and trying to ensure liquidity,” said Sobeck. “The move in the two-year resulted from the bid for collateral.”

Banks typically buy the safest maturities at the end of the year to improve the quality of assets on their balance-sheets.

Two-year yields rose yesterday following the comments from Bullard, who will be a voting member of the Federal Open Market Committee next year.

“The fact that he introduced the idea should not be dismissed as the ranting of a madman,” according to a report by senior economist Tom Porcelli and interest-rate strategist Christian Cooper at primary dealer RBC Capital Markets in New York. “Even the most bearish analysts weren’t talking about 2012 as a possibility. But the idea has just received credibility.”

Bullard’s comments followed a Nov. 16 speech by Fed Chairman Ben S. Bernanke in which he indicated that the central bank’s extended period of low borrowing costs may be even longer amid economic “headwinds.”

New Asset Bubbles

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said the “systemic risk” of new asset bubbles is rising with the Fed keeping interest rates at record lows.

“The Fed is trying to reflate the U.S. economy,” Gross wrote in his December investment outlook posted on the Newport Beach, California-based company’s Web site today. “The process of reflation involves lowering short-term rates to such a painful level that investors are forced or enticed to term out their short-term cash into higher-risk bonds or stocks.”

The central bank lowered its target rate to a range of zero to 0.25 percent in December and purchased $300 billion of Treasuries this year as part of its effort to lower consumer borrowing costs and support the housing market, the collapse of which triggered the worst slump since the Great Depression....

GAZ and UNG: A Classical Gas

An intriguing divergence for two funds that are purported to have a .99 correlation and are tracking essentially the same thing.

Right now, for example, UNG is down .67% for the day and GAZ is up .61%.

UNG is considerably more 'liquid' as they say on the Street. Does that make it a more efficient price discovery mechanism?

Or more amenable for gaming the retail markets?

The Partnership Between Wall Street and the Government Will Continue Until the System Collapses?

“Hindsight is a wonderful thing,” said Timothy W. Long, the chief bank
examiner for the Office of the Comptroller of the Currency. “At the height of
the economic boom, to take an aggressive supervisory approach and tell people to
stop lending is hard to do.” Post Mortems Reveal Obvious Risks at Banks, NY Times

Well, the boom is over, so what about now?

The current notional value of derivatives on US commercial banks’ balance sheets is $203 trillion. 97% of these ($196 trillion) sit on FIVE banks’ balance sheets, according to a recent report from that very same Office of the Comptroller of the Currency.

It is obvious from this report that Goldman Sachs is by no means a bank, and deserves no consideration as such. It is a hedge fund. In general, Wall Street is out of control.



Today's testimony by Timmy Geithner in front of the US Congress is interesting to watch. It serves to reinforce my opinion that the Administration is incompetent, caught in old solutions and the status quo, and that the Republican alternative is morally and intellectually bankrupt, given to demagoguery, and owned by a similar but slightly different set of special interests.

Most of the congress are indifferent to the interests of the American people as a whole, whether through self interest or mere cravenness, despite their occasional histrionics for the cameras. It is remarkable how they can act as outraged bystanders, when they have long been at the heart of the corruption and decline. It is their job to manage the government. They have classic American CEO amnesia and 'incredible denial.'

The key to a general reform has been and still is campaign finance reform and a reduction of lobbying payments and campaign contributions as soft bribes to Congress. As the banks cannot regulate and reform themselves, at least according to John Mack's recent advice to the American people, so the Congress and the federal government seem incapable of reforming and managing themselves. If one does it, takes liberties with the law, then they all want to do it to a greater or lesser degree; and in some ways they must if they are to be competitive, if the administration of justice creates the opportunity for selective exceptions, the weakening of regulation.

And too many in the States are yearning for a strong leader, someone who will tell them what to do. A great man, who will exercise authority with a directness and little or no discussion. Someone who will 'put things right.' The primary question seems to be less policy than fashion, whether to wear brown shirts or black, and whether torchlight is too 'retro.'

On a brighter note, the Noveau beaujolais for 2009 is rather nice, dry almost to a fault, but not too tannic. A little more 'fruitiness' would have been a highlight.

SP 500 Daily Chart: Pete and Repeat Were on a Boat...

Just another day doing God's work on earth...

"Hello Lloyd? Yeah, Larry and I were talking, and we would like to see the market go up, not too fast, but on a nice gentle slope, within a range.
Whatever gains you make doing this are yours to keep. Ben will supply the liquidity. We need to make it look like the Administration's policies are working.
And most Americans will think they are if the stock market is up."

Alternative View: Housing Prices Have Fallen Significantly Towards the Trend

Here is the graph associated with a view of the deflating housing bubble that shows we have appreciably fallen, further than the 25% in the blog entry from yesterday.



For the details on this view read here.

It appears that both sets of numbers, the ones above and the ones from yesterday, have been adjusted somewhat.

The numbers from yesterday are Indexed to 1980 = 100, and are therefore a percentage of increase.

The numbers above are nominal prices, and then adjusted for inflation using some governmental measure presumably.

One appears to be based on median prices, and the other on total transactions.

I have not yet reconciled the two views, as I am rather tired and 'under the weather,' compliments of the children's propensity to bring home their sniffles and sneezes at this time of year, the head colds that seem to linger endlessly, despite the repeated application of vitamins, chicken soup, sudafed, ibuprofen, and the occasional sip of Beaujolais Noveau. But for today at least I am, like Mr. Buffett is to the economic recovery, 'all in.'

And yes, I did finally break down and listen to the spouse, obtaining a swine flu vaccination. Perhaps it will help me think like a Fed banker and figure out their gameplan. lol.

Have Home Prices Only Fallen 1/4 of the Way to Trend?

Interesting chart to say the least.

Ben is pumping the money buttons so hard that the trend may be realized a bit higher in nominal terms once inflation kicks in.

But it may not yet be the best time to buy that new home, unless it is done for a primary residence, and with great care.

As forecast here several times earlier this year, commercial real estate will be a train wreck in 2010. That should help housing find another leg down.

New Observations.net
Values Have Fallen Only 25% of the Fall Needed to Reach Trend
By Michael White
November 11, 2009

PRICE TRENDS / WAR OF THE WORLDS (Part 4): Property owners nationwide have lost only one dollar for every four dollars they can ultimately expect to lose on their home...



Read the rest here.

NAVs of Certain Precious Metal Funds and ETFs

Buiter Still Obsessing Fitfully on Gold: What Time is the Next Currency Crisis?

Mr. Buiter, advisor to central banks and to Goldman Sachs, is at it again, comparing gold to Yap Island stone money, ranting against those who would trade valuable bank paper for something that he does not like, (but has endured as a store of wealth nonetheless for thousands of years).

Once is a phenomenon, but twice is a trend. What can be dismissed as a crank rant must now be seen as a symptom of a man talking his book, and none too gracefully.

We give more credence now to the rumours that the Bank of England has miscalculated badly and the LBMA et al. are 'on the hook' for more gold than they can provide, precipitating a crisis for their advisors, especially those on the wrong side of the trading advice. And further, that gold held offshore by some prominent members of the European Union are having difficulty getting their collateral back from some of the bullion banks in a deliverable condition.

Quite a few options are coming due on the US Comex next week, and the bankers may be once more 'staring into an abyss.' Or setting up for a big push lower to 'save the banks.' That would be traditional central banking stewardship of late days.

"We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake..." Eddie George, Governor Bank of England, in a conversation with CEO of Lonmin, September 1999

"W. Buiter, CBE, Member Monetary Policy Committee of the Bank of England (1997-2000)" Shoulder to shoulder with Sir Eddie on the brink, eh? That must have been rather intense. Oh, bravo.

People can remain rational and place their trust in the timeless longer than central bankers and politicos can feed them arbitrary illusions and promissories for wealth on the bankers' terms. At least while they retain free market choice.

Welcome to the unintended downside of quantitatively easing your way to wealth, ie. a loss of credibility.

Welcome to the world of bubble-nomics with negative returns on savings.

Financial Times
Yapping away at gold: lessons from the last days of the Rai

By Willem Buiter

November 16, 2009

Far be it from me to assert that a fate similar to that suffered by the Yapese Rai will befall gold - another intrinsically worthless fiat commodity. But the demise of the Rai as a store of value and means of payment, when taken together with the historical experience of pre-columbian native American tribes and nations that attached very little value to the shiny metal, should give the gold bugs some sleepless nights. More importantly, it ought to discourage investors who are not rich enough to survive a speculative disaster from putting too much of their savings into this frivolous store of value.

(Pre-columbian native American tribes that atttached very little value to the shiny metal Oops1 and Oops2 not to mention the Aztecs and the Mayans, who were rumoured to have existed prior to the arrival of the Europeans. Fact check please, other than watching American 'cowboy movies.'

Oh, perhaps your understanding of early American economic history pivots on the sale of Manhattan island to the Dutch by a tribe of Indians for some beads? A bit selective perhaps, and a narrow experience for a pivotal historical thesis. It may be like basing a general history of European Banking on Wall Street's recent selling worthless CDO "wampum" to the continent's commercial banks. - Jesse)

Comment 5 to this article from some fellow named 'Jesse'

"Perhaps if I phrase it this way it might be more clear.

In one philosophic sense, gold is indeed a fiat valuation, if all valuations are fiat,

nothing being essential but air to breathe, food to eat, shelter and clothing in

roughly that order. All else is discretion.

Gold, however, may be less fiat, less arbitrary a a money, a medium of exchange

and a store of value, rather than the essential itself, in an other than barter economy. Just as the Aussie dollar or the euro may be less ephemeral than the US dollar,

This is what is happening. The Bank of England made an error in selling its nation's

gold 'at the bottom' and will pay a price for this; live with it.

Oh, and try to move on please, else you may begin to resemble King Canute, sitting

on his throne at ocean's edge, ordering the incoming tide to stop its inundation.

Thank you. Mr. Buiter Apparently Does Not Like Gold

Mr. Willem Buiter’s CV Summary

Previous academic appointments in economics at Princeton University, the LSE, the University of Bristol, Yale University and Cambridge University.

Former external member of the Monetary Policy Committee of the Bank of England (1997-2000)

Former Chief Economist and Special Counsellor to the President, European Bank for Reconstruction and Development (2000 - 2005)

Advisor/consultant for the International Monetary Fund, the World Bank, the Inter-Americal Development Bank, the OECD, the European Bank for Reconstruction and Development, the European Commission, many national governments and central banks.

Advisor to Goldman Sachs International (2005 - present)

P.S. If Goldman Sachs is holding gold short on your advice and getting face-ripped by it (sweet) I'll let you be my Facebook BFF for life.

What is a "Nominal" Stock Market Chart Versus a "Deflated" View?

Lots of interesting questions in the email bag over the weekend.

A reader asks 'What exactly is a nominal or artificial stock market rally as you use the terms?'

Nominal is used to mean "being such in name only; so-called; putative." This is an example of a nominal, or artificial stock market rally that someone had posted over at Alphaville earlier this year. (Hat tip to Rasputin of WSB for reminding me of where I had seen these charts.)

The Zimbabwe Industrial Index



I would have preferred a logarithmic chart for this extreme view of a hyperinflation in action, because the final moonshot tends to crush the detail of the prior action by skewing the scale so high. Still on the surface that looks pretty good right? Enough to get Jimmy C. to pound some teak on the table on Mad Money?

Another way to show the detail is to deflate the nominal chart.

The 'deflated' view is when you take the index and show what its value would be in terms of some other value, in this case the US dollar.

The Zimbabwe Industrial Index Deflated by the US$



Here is an example of the SP 500 viewed from two perspectives.



"Oh this is all very well and good Jesse, but when I go to the grocery store or to the gas station or the convenience store to buy my instant Lotto tickets I pay in dollars and not gold or euros."

Yes, but when your suppliers go to buy their goods that are imported, they pay in dollars that are depreciating. You know that some prices are moving higher despite slack demand overall. This is what we call 'selective inflation.' This is how it starts.

The trick of course is to get off Bernanke's monetary hamster wheel. If you are not in the US, reducing exposure to the dollar is more straightforward. If you are a Yank, then generally you would look to add exposure to contra dollar hedges to lessen your currency risk. You might also wish to begin to secure some essentials for your future.

Having said all this, as you may recall we are dubious on the hyperinflationary and severe deflationary scenarios for the US. It seems that a severe 'stagflation' is most likely based on current policies. Obama and crew are inflating the currency, but it is selectively being applied to the FIRE and Health sectors, resulting in a very slack stimulus to overall employment and the median wage.

The worst of both worlds: Inflation and Unemployment.

This is the policy mistake made by Japan in trying to reflate a status quo that was broken beyond all sustainable repair. But what can you expect when you reappoint the same team of Timmy and Larry to key economic positions, the crew that started the mess in the 1990's under Robert Rubin?

Continuity of error you can believe in, it appears.

Long Term Gold Chart Updated (And An Addendum Showing Detail)

The character of this move of the breakout will tell us how far gold will correct when it hits an intermediate top and consolidates or corrects.

Gold is in a bull market. One never gives up all their position in a bull market. Rather, you hold it while the bull is running. If you are an aggressive 'trader' you can buy on support and sell at resistance around a stable position to improve your cost basis, taking some of your own money 'off the table' but letting your profits run.

Otherwise it is better to just hang on and enjoy the ride.



As always, in a general market crash the liquidation will also hit gold and silver, and may set up an exceptional buying opportunity. But do not count on it. Never give up your seat completely on a bull market train while it is running, because it may take an extraordinary act of will to get it back again.

Last Update November 4, 2009

Sept. 16 Addendum: Someone asked for a 'picture of Scenario 1.' Here is what it might look like. With regard to timing, I am expecting gold and the SP 500 to make some sort of a short term top together, and for SP 500 DEC futures to peak out about 1117 before they correct back down to trend support. So you can see my dilemma in trying to synchronize these two views and charts. I think a market 'crash' is off the table unless there is an event, but who can predict something like that reliably?

Money Supply and Demand, and the Monetization of Debt

The growth of the broad short term money supply remains strong for a slack economy, although not quite as robust as when there was a flight to quality out of equities and Ben did his moonshot with the Fed's balance sheet.



Demand for money? What demand? This is something new in the post World War II era.



Relative to the growth of bank credit, the growth of broad short term money as measured in MZM is outsized as the Fed intends it to be.



The limit of the Fed's ability to monetize various debt instruments already in existence is the value of the dollar relative to the purchasing power of the other major fiat currencies.



Do people realize that a monetization of the dollar is occurring? Some do.



As one might expect the velocity of money, which is the ratio of money supply to the aggregate demand for money (GNP), is very low. This is helping the Fed to keep inflation selectively low, because although there is a lot of money relative to bank credit demand, that increased money is not doing much chasing of goods. It seems to be flowing once again into financial assets, which is probably an artifact of where the money has been allocated. How many cars and meals can a wealthy person or corporation consume? They do not create consumption out of their excess, they increase their speculation and the acquisition of the means of future production.

As the velocity of money starts increasing then the Fed will have to change its stance on quantitative easing, which is really nothing more than the monetization of existing debt.

SP 500 Volumes and Cash Flows Fading

They got the Dollar General IPO out the door and a few more deals were done so its "Mission Accomplished" for Wall Street. The SP 500 looks to be completing a hand off to the retail crowd of overpriced paper in this cycle of the price pump. Time to dump the bids and let it drop, with maybe one more push higher at most to suck in a little more money from the productive economy, or at least what is left of it.

Be aware. This rally is a ponzi scheme thinly disguised even by US Wall Street standards. But do not try and get in front of it, to short it prematurely.

The Obama administration is as asleep at the switch and coopted by its masters in New York as was the prior administration's regulators under Chris Cox, and that is a real accomplishment in a failure to reform.

People forget what the markets were like in the late 1970's when the pits were dead and the average person wanted nothing to do with the US equity markets. The creation of 401k's and more gambling tables like the options exchanges helped to perk things up. This latest generation of jokers will not stop until they have trashed the markets once again.

Expect more token reforms like position limits out of this crew in key commodities, with loopholes big enough for a vampire squid to slip through without inconvenience like the other 'reforms' being crafted by Barney, Tim, Larry, and Chris.

America, what are you becoming?

"How are the mighty fallen, and their devices of empire perished..."

Sachs: Obama Has Lost His Way On Jobs

Obama has not lost his way. His team led by Summers and Geithner are making the same mistakes that they did in the formation of the first tech bubble in response to the Asican currency crisis and the Russian debt default. The Obama Administration is serving its employers and contributors on Wall Street.

The banks must be restrained, the financial system reformed, and balance restored to the economy before there can be a sustained recovery.

Here is a perspective from Jeff Sachs of Columbia University.

Speaking of Garish Bling, the US Long Bond Is On Sale Today

Some US institutions are being compelled by new government regulations to buy long bonds to 'match duration' of their obligations per a ruling of a few years ago.

Other than that, anyone buying the 30 year bond, other than for the Fed carry trade, in an time of quantitative easing and free spending government, should be institutionalized.

The Fed bond carry trade is when the primary dealers buy Timmy's bond with Ben's money, and then sell it back to the people's short term debt in dollars via the Fed. It keeps yields on the long end down, and maintains the appearance of stability. The dealers get to front run the buys and short the sells.

It is a pyramid scheme to accomplish a short term objective.

MarketWatch
Treasurys edge up before long bond auction
By Deborah Levine
Nov. 12, 2009, 11:11 a.m. EST

NEW YORK (MarketWatch) -- Treasury prices edged up Thursday as investors anticipated the government would garner sufficient demand for a record amount of 30-year bonds sold during the session.

The $16 billion bond sale follows two major note auctions earlier in the week that were met with plenty of demand from investors.

Traders also pointed to a significant amount of maturing debt and coupon payments when the auctions settles that create a natural bid, as investors may roll that cash into the new securities.

"After the success of the first two offerings, this one is also expected to garner good support too," said analysts at Action Economics. "There remains a lot of cash to invest."

NAVs of Certain Precious Metal ETFs and Funds

Secondary offering in the equity of the CEF fund is pending, although this tends to be a wash less transaction fees because the proceeds are used to expand the base of metals held.

The premiums expand and contract in the funds depending on sentiment on the future course of gold and silver bullion prices. The premiums on the ETFs are relatively stable, representing 1/10 ounce of the metal with a discount to the spot price for management fees. There is no NAV presented because the volume of any metal that might be underlying the price fluctuations varies greatly, and can lag.

Fraud on the Street in the Purchase of 3COM

The fraud is becoming more blatant on all fronts.

Mary Shapiro and the SEC should immediately subpoena the records of options purchases in 3COM and Hewlett-Packard for this week, and look for unusually large purchases. But chances are that they will do nothing, because there is a soft partnership between the government and Wall Street.

Make no mistake. Front running and monetary bubbles are not victimless crimes, anymore than robbing a grocery store at gunpoint is a victimless crime. They take from the many to give to the few.

There are some smokey allusions to 'calendar spreads' being put forward, but this is disinformation, and does not speak to the surge in stock buying and the pattern of insider trading. It was fraud, pure and simple.

And this is just the tip of the iceberg. The basis of the SP rally on high frequency trading and a liquidity bubble is a fraud, and will be exposed as such when the bottom falls out of the market. And the people know who the primary actors are in this.

The Obama Administration is a disgrace.

Bloomberg
3Com Option Trades May Have Been More Than ‘Luck’ Before Buyout
By Jeff Kearns

Nov. 12 (Bloomberg) -- Analysts say good timing alone doesn’t account for trading in bullish 3Com Corp. options yesterday.

Volume in contracts to buy shares of the Marlborough, Massachusetts-based company surged to the highest level since September 2007 before Hewlett-Packard Co. said it would buy the maker of computer-networking equipment for $2.7 billion.

“I don’t believe in that much luck,” said Steve Claussen, chief investment strategist at OptionsHouse LLC, the Chicago- based online brokerage unit of options trading firm PEAK6 Investments LP, and a former market maker at the Chicago Board Options Exchange. “If you’re on the other side of someone buying calls and a takeover is announced, it’s like someone held you up at gunpoint. It’s like you’ve been robbed and you feel violated.”

Call options that convey the right to acquire stock for a given price by a certain date usually offer higher returns to traders speculating on takeovers. The U.S. Securities and Exchange Commission polices the options market to ensure investors aren’t engaging in insider trading.

More than 8,000 3Com calls changed hands yesterday, 17 times the four-week average. The most active were contracts conveying the right to purchase 3Com for $5 through Nov. 20, followed by December $5 calls. The shares rose 5.2 percent, the most since Sept. 28, to $5.68 in Nasdaq Stock Market composite trading prior to the announcement.

Almost 4,000 of the November $5 calls and 3,300 December $5 calls traded, with almost all of the transactions occurring at noon. That compares with a total of six puts giving the right to sell 3Com shares. Hewlett-Packard, the world’s largest personal- computer maker, agreed to pay $7.90 a share in cash for 3Com, a 39 percent premium to yesterday’s closing price.

More than 22 million shares of 3Com changed hands in the stock market yesterday, compared with this year’s daily average of 4.85 million and the most since March 2008. Trading was heaviest in the hour after 11 a.m. in New York, data compiled by Bloomberg show.

“Somebody knew something was coming,” said Stefen Choy, founder of Livevol Inc., a San Francisco-based provider of options market data and analytics. “It looks like very unusual call buying. I see this very frequently when there’s a takeover...”

Goldman Sachs Group Inc. advised 3Com on the transaction, while Morgan Stanley helped Hewlett-Packard, according to data compiled by Bloomberg. Both banks are based in New York. 3Com has its headquarters in Marlborough, Massachusetts, and Hewlett- Packard is based in Palo Alto, California...

Guest Post: Ralph Cioffi's Acquittal for Fraud - Janet Tavakoli

By Janet Tavakoli of Tavakoli Structured Finance

Ralph Cioffi and Matthew Tannin, former hedge fund managers and co-heads of Bear Stearns Asset Management, were acquitted yesterday (November 10) of all six counts in their fraud trial” U.S. v. Cioffi, 08-CR-00415, U.S. District Court for the Eastern District of New York (Brooklyn).

"I worked at Bear Stearns in the late 1980s and remembered amiable newcomer Ralph Cioffi to be Bear Stearns’ most talented and successful salesman of mortgage-backed securities. He was usually even tempered, always hard working, and thoughtful. I headed marketing for the quantitative group run by both Stanley Diller, one of the original Wall Street “quants,” and Ed Rappa (now CEO of R.W. Pressprich & Co, Inc.), a managing partner. Ralph was a popular salesman with my colleagues and a heavy user of our quantitative research. In gratitude for analytical work that helped him make sales, Ralph presented our group with an $800 portable bond calculator purchased out of his own pocket. When I was lured away from Bear Stearns by Goldman Sachs, Ralph Cioffi tried to persuade me to stay, matching the offer. Around 20 years had passed and since then we occasionally stayed in touch, but we were not close friends.

Among other hedge funds, Bear Stearns Asset Management (BSAM) managed the Bear Stearns High Grade Structured Credit Strategies fund. By August 2006, the fund had a couple of years of double-digit returns. BSAM launched the Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage fund taking advantage of the first fund’s “success.”

Both funds managed by BSAM included CDO and CDO-squared tranches backed in part by subprime loans and other securitizations (collateralized loan obligations) backed by corporate loans and leveraged corporate loans. In August 2006 when BSAM was setting up the Enhanced Leverage fund, other hedge fund managers (like John Paulson), shorted subprime-backed investments.

Investors in the two funds managed by BSAM had been getting double digit annualized returns on high-grade debt at a time when treasuries were yielding less than 5 percent. In fixed income investments, that usually means investors are taking risk.

Ralph seemed to have similar views to mine on CPDOs, the leveraged product that I had said did not deserve a AAA rating. Ralph told me he thought the AAA rating could “lull the unsophisticated investor to sleep,” and that for the purposes of his hedge funds, if he liked an investment-grade-rated trade he could have the same trade without paying fees and: “easily lever up … fifteen times.” To paraphrase Warren Buffett, if the price of your investments drops, leverage will compound your misery.

On May 9, 2007, Matt Goldstein called and asked me if I had a chance to look at the registration statement for a new initial public stock offering (IPO) called Everquest Financial, Ltd (Everquest). Everquest is a private company formed in September 2006, and the registration statement was a required filing in preparation for its going public. The shares were held by private equity investors, but the IPO would make shares available to the general public.

Everquest was jointly managed by Bear Stearns Asset Management Inc, and Stone Tower Debt Advisors LLC, an affiliate of Stone Tower Capital LLC. I was curious, but I was swamped. I told him no, I was very busy and had not even had a chance to glance at it. He called again asking if I had seen it, and again I said no, “Go away.” The next morning I ignored Matt’s voice mails, but finally took his call the afternoon of Thursday May 10 telling him that I still had not looked at the registration statement and had no plans to do so that day. My first call on the morning of Friday, May 11, 2007, was again from Matt Goldstein. He thought the IPO might be important.

I went to the SEC’s website, and as I scanned the document I thought to myself: Has Bear Stearns Asset Management completely lost its mind? There is a difference between being clever and being intelligent. As I printed out the document to read it more thoroughly, I put aside the rest of my work and said: “Matt, you are right; this is important.” I was surprised to read that funds managed by BSAM invested in the unrated first loss risk (equity) of CDOs. In my view, the underlying assets were neither suitable nor appropriate investments for the retail market.

I did not have time for a thorough review, so I picked a CDO investment underwritten by Citigroup in March 2007 bearing in mind that if the Everquest IPO came to market, some of the proceeds would pay down Citigroup’s $200 million credit line. Everquest held the “first loss” risk, usually the riskiest of all of the CDO tranches (unless you do a “constellation” type deal with CDO hawala), and it was obvious to me that even the investors in the supposedly safe AAA tranches were in trouble. Time proved my concerns warranted, since the CDO triggered an event of default in February 2008, at which time Standard & Poor’s downgraded even the original safest AAA tranche to junk.

The equity is the investment with the most leverage, the highest nominal return, and is the most difficult to accurately price. The CDO equity investments were from CDOs underwritten by UBS, Citigroup, Merrill, and other investment banks.

Based on what I read, Everquest’s original assets had significant exposure to subprime mortgage loans, and the document disclosed it, “a substantial majority of the [asset-backed] CDOs in which we hold equity have invested primarily in [residential mortgage-backed securities] backed by collateral pools of subprime residential mortgages.” Based on my rough estimates, it was as high as 40 percent to 50 percent.

I explained my concerns to Matt in a general way. Among other concerns: (1) money from the IPO would pay down Everquest’s $200 million line of credit to Citigroup; (2) the loan helped Everquest buy some of its assets including CDOs and a CDO-squared from two hedge funds managed by BSAM, namely the Bear Stearns High-Grade Structured Credit Strategies Fund that had been founded in 2003 and the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund (“Enhanced Leverage Fund”) launched in August 2006; and (3) the assets appeared to include substantial subprime exposure.

Matt Goldstein posted his story on Business Week’s site later that day. Initially it was called: The Everquest IPO: Buyer Beware, but after protests from Bear Stearns Asset Management, Business Week changed the title to Bear Stearns’ Subprime IPO. I hardly think that pleased Bear Stearns more.

Ralph Cioffi contacted me about the Business Week article. He said that dozens of IPOs like Everquest had been done—mostly offshore so as not to deal with the SEC. According to Ralph, BSAM’s hedge funds and Stone Tower’s private equity funds would own about 70 percent of Everquest stock shares (equity), and they had no plans to sell “a single share at the IPO date.” They planned to use the IPO proceeds to pay down the Citigroup credit line and possibly buy out unaffiliated private equity investors.

I responded that verbal assurances that there are no plans to sell a share at the IPO date are meaningless. Publicly traded shares can be sold anytime. But even if the funds kept their controlling shares, it was not good news. Retail investors would have only a minority interest which would be a disadvantage if they had a dispute with the managers.

Ralph claimed that subprime was “actually a very small percent of Everquest’s assets.” He reasoned that on a market value basis the exposure to subprime was actually negative because Everquest hedged its risk. Technically, Ralph might have been correct—but the registration statement for the Everquest IPO itself suggested otherwise: “The hedges will not cover all of our exposure to [securitizations] backed primarily by subprime mortgage loans.”

It is fine to talk about net exposure (left over after you protect yourself with a hedge), but one usually also discusses the gross exposure (of the assets you originally bought). Hedges cost money, so they can reduce returns.

Ralph Cioffi said CDO equity is “freely traded and easily managed.” I countered that CDO equity may be easy for Ralph to value, but investment banks and forensic departments of accounting firms told me they have trouble doing it.

I told him that if this were a CDO private placement, it would have to be sold to sophisticated investors and meet suitability requirements, but since it is in a corporation, it can be issued as an initial public offering (IPO) to the general public. It seemed to be a way around SEC regulations for fixed income securities, and it was not suitable for retail investors in my view.

Ralph said he would talk to his lawyers about changing the IPO’s registration statement to add a line about third party valuations. We seemed to be talking at cross purposes, since the registration statement already said that third party valuation would occur at the time of underwriting. The problem with that was that the assumptions for pricing would be provided by a conflicted manager, and assumptions are critical in determining value. Moreover, on an ongoing basis, one had to rely on a conflicted management’s assumptions for pricing.

Ralph did not seem to want to end the discussion, so I asked him if there was something he wanted me to do. He said it would be great if I issued a comment saying I was quoted “out of context,” that my being quoted in Business Week lent credibility to the article and was not helping me, and that I would be “better served” writing my own commentary. I ignored what I perceived to be a thinly veiled threat. I told him that if he wanted me to write a commentary, I would do a thorough job of raising all of the objections I had just raised with him. Ralph seemed unhappy but my thinking he was a hedge fund manager from Night of the Living Dead was the least of his problems."

Excerpted with permission from the publisher, John Wiley & Sons, from Dear Mr. Buffett, What an Investor Learns 1,269 Miles from Wall Street , by Janet Tavakoli. © 2009 by Janet Tavakoli.

SP Futures Daily Chart

An obvious reflationary effort that, without serious financial reform and economic rebalancing, will degenerate into another phase of the financial crisis and the ongoing banking fraud in a corrupt partnership with government.

"There is a mysterious cycle in human events. To some generations much is given. Of other generations much is expected.
This generation of Americans has a rendezvous with destiny." Franklin D. Roosevelt

Same chart as above, but fitted with curved rather than linear trendlines.