Washington's Blog: October 2008

Friday, October 31, 2008

Big Investors Betting on Deflation

Mark Hulbert says that investors in U.S. treasury bonds are betting on deflation:

"The Treasury market [is huge] and its collective judgment cannot be dismissed lightly.
***
The bond market is betting that the [consumer price index] will average less than 1 percent annually over the next decade....Economists at the Cleveland Fed have devised an econometric model that estimates [how much treasury bonds are] skewed downward by . . . liquidity considerations. That model recently calculated this bias to be around 0.5 percentage point, suggesting that the true message of the bond market right now is that inflation would average around 1.4% year over the next decade.
***
The bond market is betting on deflation.
This puts into perspective the federal government's efforts in recent months to pour huge amounts of money into the financial arena. That would otherwise be quite inflationary.

But not if the forces of deflation are as large as the bond market is evidently assuming them to be.

And judging by the recent performance of both the bond and gold markets, it would appear as though deflation still has the upper hand."

There are good arguments for stagflation - instead of deflation.

But if the big boys are betting on deflation with their own money, that's important information.

Thursday, October 30, 2008

Law Professor: "We're Going To Have Casinos In Las Vegas Reconstituting Themselves As Bank Holding Companies and Applying for Government Loans"

An article by McClatchy includes two must-read quotes on the bailout:

"I could say I told you so," said Rep. Joe Barton, R-Texas, who helped lead a revolt against GOP leaders and sunk the $700 billion plan on its first pass. "It was so open-ended and we put so little accountability into it, they can basically do whatever they want to with the money."

***
John Coffee, a law professor at Columbia University in New York and adviser to Wall Street regulators, said the government missed an opportunity by taking equity stakes in banks without attaching requirements that they use the bailout funds for new loans to spur the economy.

"If we could do this all over again . . . you could have conditioned the loan (plan) on how the proceeds could be used," he said. "Some banks are still hoarding the money . . . and others simply are not interested in lending in areas where they classically lent, like construction lending, because they see a major recession coming. . . .

"Before this is over that we're going to have casinos in Las Vegas reconstituting themselves as bank holding companies" and applying for government loans, Coffee warned.

Wednesday, October 29, 2008

Credit-Default Swaps on US Treasuries Have Risen Nearly 40 Percent Since Bailout Law Signed; Now About the Same as on Mexican and Thai Government Debt

Bloomberg writes the following bombshell:

"Credit-default swaps on [U.S.] Treasuries have risen nearly 40 percent since TARP was signed into law Oct. 3, and are now about the same as Mexican and Thai government debt before the credit markets began to seize up in June 2007."

The article also states:

"Trading of credit-default swaps on government debt has increased since countries from the U.S. to Germany began pumping cash into their banks to prevent more failures, said Puneet Sharma, head of investment-grade credit strategy at Barclays Capital in London. The expenditures mean the 'probability of downgrade has increased,'' he said.

Investors are buying protection on countries to speculate on a deterioration of their credit quality and ratings as governments take on risky assets, even if they don't think there is a chance of default."

What do "probability of a downgrade" and "deterioration of ... credit quality and ratings" mean?

Well, credit rating agencies, such as Standard & Poor's and Moody's, assign credit ratings to countries, as well as companies.

A September 18 article in Bloomberg raised the possibility of a credit downgrade for the U.S.:

America's credit "profile is now weaker because contingent risks have become actual risks to the U.S. government,'' said John Chambers, managing director of sovereign ratings at Standard & Poor's in New York.

In fact, Standard & Poor's raised a possible downgrade of U.S. credit back in April. An article in Marketwatch explained:

The performance of government-sponsored enterprises like Fannie Mae could have a direct impact on the national economy and more importantly, the credit standing of the U.S., Standard & Poor's said Monday.

Fannie and Freddie, which enjoy implicit government guarantees, could cause the U.S. to lose its sterling triple-A rating if the government were forced to come to their rescue, the ratings agency said in a report.

"Even though...credit damage from GSEs is unlikely, the greater risk to the U.S. lies with them than with broker-dealers," S&P noted.

The demise of Bear Stearns Cos. - and the Federal Reserve's extraordinary efforts to alleviate strains at broker dealers - has captured the attention of market participants who feared that the financial system would seize up last month.

S&P, however, noted that while this credit crunch has caused financial markets to swoon, it hasn't threatened the standing of the nation's credit quality upon which U.S. Treasurys and the debt priced off this government debt depend.

But should a protracted recession cause Fannie and Freddie to buckle, S&P said, the U.S. rating would be in danger.

Of course, Fannie and Freddie did buckle and - in many ways - the health of the U.S. economy is much worse than it was in April, and the U.S. is spending literally trillions of dollars it doesn't have on corporate bailouts.

A 2005 article in Lew Rockwell called "Should the US Government’s Sovereign Credit Rating be Downgraded to Junk?" provides some details of how credit rating agencies assign credit ratings to countries:

When examined objectively, one could make the case that Uncle Sam’s sovereign credit rating should be downgraded – perhaps even to "junk." So where are the credit rating agencies? Are they going to miss this one just like Enron?

***

Both Moody’s Investors and Standard and Poor’s have granted the U.S. the highest sovereign credit rating possible (Aaa and AAA respectively). Most other countries are less fortunate and have lower credit ratings – which can affect such a country’s interest rates and access to the credit markets. The lower the credit rating, it is believed, the higher the chances are for a country to default on its sovereign debt obligations. Be aware S&P downgraded Japan’s sovereign credit rating to AA– on April 15, 2002 . . .

The article then analyzes the U.S. economy using 8 traditional credit-rating factors, and concludes that the U.S. has performed abyssmally in all 8:

Having gone through all eight variables, it should be obvious that both Moody’s and Standard & Poor’s have grossly overrated America’s sovereign debt – it doesn’t merit the top grade of AAA. In variables such as default history, inflation, external balance, external debt, and economic development, the U.S. should rate significantly lower than does Japan – and should rate worse in many variables as compared to a developing country such as Botswana.

So why hasn't America's credit rating been downgraded?

Well, a report by Moody's in September states:

"In superficially similar circumstances, the ratings of Japan and some Scandinavian countries were downgraded in the 1990s.
***
For reasons that take their roots into the large size and wealth of the economy and, ultimately, the US military power, the US government faces very little liquidity risk — its debt remains a safe heaven. There is a large market for even a significant increase in debt issuance."

So Japan and Scandinavia have wimpy militaries, so they got downgraded. But the U.S. has lots of bombs, so we don't?

In any event, as a quote from the Marketwatch article cited above hints, foreign governments themselves will likely demand a higher interest rate when loaning money to the U.S. because of its precarious situation:

"The federal government assumes that it can borrow whatever it wants from foreign lenders at low interest rates for as long as it wants,'' said David Walker, former comptroller of the U.S. Government Accountability Office who's now head of the Peter G. Peterson Foundation in New York. "That's an imprudent assumption."

Indeed, the International Monetary Fund - which oversees third-world economies - is so concerned about the solvency of the U.S. economy that it is conducting a complete audit of the whole US financial system. The results of that audit might be more honest than credit ratings by American companies, and may result in a reduced opinion of America's creditworthiness.

One way or the other, America's credit rating will be downgraded, which will only add to America's financial problems.

Tuesday, October 28, 2008

Government Saying One Thing on Bailout, Doing Another

In an act of superficial political theater today, Bush told banks to "stop hoarding money".

However, Bush's Treasury Department is encouraging banks to use the bailout money to buy their competitors, and has pushed through an amendment to the tax laws which rewards mergers in the banking industry.

Moreover, Bush's government bucked tradition and insisted that it only take non-voting shares in banks it bails out, ensuring that it has no power to require them to lend out money.

The government is saying one thing, while doing the exact opposite.

The Government's Actions Are Making the Financial Crisis Worse

The government's previous actions lead to the current financial crisis. See this.

Moreover, the government's current actions are actually making things worse:

The "Central Banks' Central Bank" says that all of the "central bank intermediation may in some cases weaken banks’ incentives to resume their intermediation function".

The bailouts are causing HIGHER mortgage rates for consumers

The government's commercial paper buying spree is INCREASING the cost of borrowing

Arbitrary interventions by the government (AIG rescued, Lehman left to fail) create chaos in the markets. Other than some brief exceptions, the stock market has steadily plunged since the bailout bill was signed. Indeed, every time Paulson, Bernanke or Bush speak, the stock market tanks.

They also undermine consumer confidence. For example, consumer confidence is now at an "all-time low", due partly to "increasing uncertainty about the government’s rescue plan".

The bailouts are drastically increasing America's debt and causing other problems

The bailouts may actually being INCREASING libor (and see this)

The bailouts may cause unintended problems for money markets

PhD economist Marc Faber says that the government action may ensure that this crisis is worse than the Great Depression

Ill-advised government actions regarding the economy are not a trivial matter. For example, economists at UCLA have concluded that some of FDR's policies extended the length of the Great Depression by 7 years.

The government's attempt to stop the inevitable deleveraging process will also backfire.

In Trying to Stop the Inevitable Deleveraging Process, the Government is Only Making It Worse

The financial system is undergoing a period of deleveraging that cannot be stopped. For example:

Barrons is running an editorial entitled "The Crash Must Come: Intervention can't stop the business cycle".

The Economist writes, "Once started, the process [of deleveraging] is hard to stop."

The Financial Times quotes the Bank of Tokyo-Mitsubishi in saying, "There seems little what the authorities can do to reverse the process of deleveraging that is taking place with financial institutions all contracting their balance sheets at the same time".

Satyajit Das writes:

Ultimately, “all the king’s horses and king’s men” cannot prevent the de-leveraging of the financial system under way.

***

Like a giant forest fire the de-leveraging process cannot be extinguished. Thoughtful actions can create firebreaks that limit preventable damage to the economy and the international financial system until the fire burns itself out.

The process of deleveraging cannot be stopped, but the government is trying to stop it anyway. Instead of allowing an orderly deleveraging process, the government is actually trying to prop up the leverage.

For example, instead of requiring banks to deleverage, the government is reducing their cash reserve requirements so they can increase their leverage to loan money they don't have through fractional reserve banking. See also this.

And - even after Greenspan confessed that derivatives were dangerous (and see this) - the government refuses to rescind them or take any other real actions to contain the nuclear fallout from such "weapons of mass destruction". Instead, the government is trying to prop up the derivatives market by various means.

By trying to put out the raging deleveraging forest fire, the government is actually fanning its flames and making it more dangerous. And even in those areas where the government appeared to put out the fire, there are hot coals just beneath the surface that are already erupting back into flame (as just one example, inter-bank lending rates are back up).

Instead of clearing out the flammable debris which could ignite next, the government is letting it accumulate . . . a recipe for another financial crisis.

As with other aspects of the government's actions, the attempt to stop the inevitable deleveraging process is only making matters worse.

Monday, October 27, 2008

The IMF Can Print Money Like a Central Bank

In an article entitled "IMF may need to 'print money' as crisis spreads", the Telegraph reveals that the IMF has the power to create money just like the Federal Reserve:

"The nuclear option is to print money by issuing Special Drawing Rights, in effect acting as if it were the world's central bank. This was done briefly after the fall of the Soviet Union but has never been used as systematic tool of policy to head off a global financial crisis.

'The IMF can in theory create liquidity like a central bank,' said an informed source. 'There are a lot of ideas kicking around.'"

Inflation, Deflation or New Nation?

Smart people like PhD economist Krassimir Petrov argue that we will have stagflation - inflation plus stagnant growth.

Other smart people like PhD economist Nouriel Roubini argue that we will have deflation (and see this).

But the debate about whether we will have inflation or deflation may be overshadowed by the question of whether the whole playing field is going to shift.

Specifically, inflation and deflation are both things which occur relative to a certain currency. For Americans, this means asking whether dollars will buy more or less.*

But the G-20 meeting in mid-November could totally change things. The biggest creditor nations might demand that a new world reserve currency replace the dollar (they've hinted at this). Or they could demand that the U.S. dollar go back to the pre-Nixon gold peg agreed to under Bretton Woods (they've hinted at this, too).

If a new nation takes over the role - which the U.S. has held for 64 years - as issuer of the world reserve currency, this will fundamentally change the landscape on which the inflation versus deflation debate occurs. The dollar would fundamentally be changed and - with it - the risks of inflation or deflation.

Confidently forecasting inflation or deflationary before the G-20 meeting is like trying to use the team roster to forecast who will win the second half of a football game when a major earthquake has just tilted and uplifted part of the gridiron and ripped deep canyons in another part.

* The Austrian school of economics points out that inflation and deflation are really about the size of the money supply, and not prices. If a new currency replaces the dollar as reserve currency, that would still shift the debate onto entirely new territory.

Of course, the U.S. is, or may soon become, insolvent. This would also dramatically shift the debate.

Saturday, October 25, 2008

Senator Warns of Revolution

Senators don't normally use the word "Revolution".

As a central part of the government, Senators do not normally wish to stir up any images of major challenges to power or of guillotines.

So it is dramatic that Senator Dodd mentioned the "R" word with a New York Times reporter:

I caught up with Senator Dodd, and asked him what he was going to do if the loan situation didn’t improve. “All I can tell you is that we are going to have the bankers up here, probably in another couple of weeks and we are going to have a very blunt conversation,” he replied.

He continued: “If it turns out that they are hoarding, you’ll have a revolution on your hands. People will be so livid and furious that their tax money is going to line their pockets instead of doing the right thing. There will be hell to pay.”

That statement is especially interesting because the banks have admitted that they will continue hoarding cash for quite a while.

Even the New York Times Calls Paulson a Liar

Even the New York Times is calling Paulson a liar:

“First [Paulson’s Department of Treasury] says it has to have $700 billion to buy back toxic mortgage-backed securities. Then, as Mr. Paulson divulged to The Times this week, it turns out that even before the bill passed the House, he told his staff to start drawing up a plan for capital injections. Fearing Congress’s reaction, he didn’t tell the Hill about his change of heart.

Now, he’s shifted gears again, and is directing Treasury to use the money to force bank acquisitions. Sneaking in the tax break isn’t exactly confidence-inspiring, either.”

What tax breaks is the Times talking about? The article explains:

A new tax break [pushed by Treasury], worth billions to the banking industry, that has only one purpose: to encourage bank mergers. As a tax expert, Robert Willens, put it: “It couldn’t be clearer if they had taken out an ad.”

The "Magic" of Compound Interest

As long as I can remember, whenever someone talked about "the magic of compound interest", I have been skeptical.

It always seemed to me to be some kind of pyramid scheme.

Ellen Brown sums up the evidence that this is true:

All the king’s men cannot put the private banking system together again, for the simple reason that it is a Ponzi scheme that has reached its mathematical limits.

A Ponzi scheme is a form of pyramid scheme in which new investors must continually be sucked in at the bottom to support the investors at the top. In this case, new borrowers must continually be sucked in to support the creditors at the top. The Wall Street Ponzi scheme is built on "fractional reserve" lending, which allows banks to create "credit" (or "debt") with accounting entries. Banks are now allowed to lend from 10 to 30 times their "reserves," essentially counterfeiting the money they lend.

Over 97 percent of the U.S. money supply (M3) has been created by banks in this way. The problem is that banks create only the principal and not the interest necessary to pay back their loans.

Since bank lending is essentially the only source of new money in the system, someone somewhere must continually be taking out new loans just to create enough "money" (or "credit") to service the old loans composing the money supply.

This spiraling interest problem and the need to find new debtors has gone on for over 300 years -- ever since the founding of the Bank of England in 1694 – until the whole world has now become mired in debt to the bankers’ private money monopoly.

The parasite has finally run out of its food source. But the crisis is not in the economy itself, which is fundamentally sound – or would be with a proper credit system to oil the wheels of production. The crisis is in the banking system, which can no longer cover up the shell game it has played for three centuries with other people’s money.

The "magic" of compound interest - unfortunately - is not real. It is the Disney kind of magic . . . fun while it lasts, but gone as soon as you get back to the real world.

Note: I edited Brown's quote slightly for readability.

The Stunning Irony of the Financial Crisis

The financial crisis is full of irony.

For example, the loudmouth cheerleaders for free-market deregulation, such as Goldman Sachs CEO Henry Paulson, are now implementing socialism in America.

And the U.S. - which has long lectured third-world countries about the benefits of American-style neoliberal capitalism, is now a bankrupt debtor nation begging for loans from its creditors (including the countries we previously lectured).

But the biggest irony of all may involve America's depiction of Muslims and the "clash of civilizations" against the Middle East.

It turns out that the Muslims that the American neocons painted as barbarian, devil-worshippers who hated us because of our successful capitalist freedoms, may weather the financial storm a lot better than us, because they have avoided the most of the derivatives and other scams and - in some ways - practiced capitalism more faithfully than we have.

As an expert on Saudi-American relations writes:

Ironically, least affected by the crisis are Islamic banks.

They have largely been immune to the collapse because Islamic banking . . . forbids the buying and selling of a debt as well as usury. Additionally, [Islamic] banking laws forbid investing in any company with debts that exceed thirty percent.

"Islamic banking institutions have not failed per se as they deal in tangible assets and assume the risk" said Dr. Mohammed Ramady, Professor of Economics at King Fahd University of Petroleum & Minerals. "Although the Islamic banking sector is also part of the global economy, the impact of direct exposure to sub-prime asset investments has been low" he continued. ... Instead, said Dr. Ramady, oil surplus Arab nations are "reconsidering overseas investments in financial assets" and speeding up their own domestic projects.

Eight years ago, in May 2000, Saudi Islamic banker . . . Dr. Nayef bin Fawaaz ibn Sha'alan publicly gave a series of economic lectures in Gulf states.
***

He warned then that it was a certainty that the US economic system was on the verge of collapse because of its cumulative debts, ever-increasing deficit and the interest on that debt. "When the debts and deficits come due, they just issue new Treasury bonds to cover the old bonds due, with their interest and the new deficit too." The cycle cannot be stopped or the debt cancelled because the US would no longer be able to borrow. The consequence of relieving this cycle would be a total collapse of their economic system as opposed to the partial, albeit massive, crash of 2008.

"Islamic banking", said Dr. Al-Sha'alan, . . . has the best of capitalism - filtering out its negatives . . . ."
***

The whole exercise in democracy by force against Arab Muslim nations has almost bankrupted the US. The Cold War is over and the US has nothing to offer: no exports, no production, few natural resources, and no service sector economy.

The very markets that resisted US economic policies the most, having curbed foreign direct investments into America, are those who will fare best and come out ahead.

In other words, the Islamic barbarians may weather the storm much better than us because - in some ways - they practiced a form of true capitalism, buying and selling real things, while we abandoned Adam Smith's vision and turned America's economy into a rigged casino which collapsed under its own weight of manipulaton and greed.

Note: I know virtually nothing about Islamic banking, and am not promoting or endorsing it.

I am not a Muslim, and I despise fundamentalist Muslims as much as fundamentalists of any religion.

Finally, I do not support or criticize the leaders of any country in a vacuum based on religion or race. Instead, I look to their historical actions to see if they benefit or oppress people.

Friday, October 24, 2008

Disinfo Boys Strike Again?

A friend asked me to post this (click the title to go to link). For background, see this, this and this.

Paulson's Parallel Universe

In the real world, strong banks that made good decisions should thrive and weak banks which made dumb investments and lending decision should fail.

But in the parallel universe inhabited by Sec Treasury Paulson, the wealthiest banks as well as poor banks should all get bucket loads of money so consumers won't know which are weak and which are strong, but will keep on banking with the weak banks. As CNBC writes:

"Nine of the largest U.S. banks were essentially arm-twisted last week into signing on for the first $125 billion in capital infusions in an attempt to remove the stigma that participating banks need the funds to survive."

In the real world, banks aren't lending, and they've admitted that - no matter how much the government throws at them - they won't lend in the foreseeable future.

But in Paulson's parallel universe, the banks will be cheerfully handing out loans loans left and right to every mom and pop who politely ask:

"Our purpose is to increase confidence in our banks and increase the confidence of our banks, so that they will deploy, not hoard, their capital. And we expect them to do so, as increased confidence will lead to increased lending," Paulson said on Monday.

In Paulson's reality, everything is working out just fine. But in the real world where the rest of us live, the real problems aren't being addressed, and the bailouts are only making problems worse.

Bretton Woods II Could Mark Shift Away From American Dominance

You know that upcoming meeting of the G-7, dubbed "Bretton Woods II"?

Well, it turns out it will actually involve some 20 countries and regions, including those with emerging markets. As US News and World Report puts it:

"President Bush will meet not just with the traditional Group of Seven (G-7) cluster of industrialized countries but rather with the Group of 20. That larger forum brings in the major emerging-market nations. They include such rising powers and emerging economies as Brazil, India, China, Russia, South Africa, Mexico, and Turkey, among others."

Specifically, the G-20 includes:

1. Argentina

2. Australia

3. Brazil

4. Canada

5. China

6. France

7. Germany

8. India

9. Indonesia

10. Italy

11. Japan

12. Mexico

13. Russia

14. Saudi Arabia

15. South Africa

16. South Korea

17. Turkey

18. United Kingdom

19. United States

20. European Union

The G-7 is made up solely of Western countries and Japan (one of America's closest allies). On the other hand, the G-20 includes China, India, Russia and Brazil - countries that are not so closely aligned with America - as well as Saudi Arabia, one of America's largest creditors.

China and others have been making noises for a while about the need to shift away from a U.S. and dollar-centered financial system. For example, one of China's largest newspapers wrote today that the US has plundered global wealth by exploiting the dollar's dominance, and the world urgently needs other currencies to take its place.

Something might really happen at the G-20 meeting, scheduled to occur around November 15th. Especially since many of America's largest creditors will attend, it may truly mark a shift away from not only America's economic dominance but also its spendthrift behavior.

Giant Companies are Using YOUR Money to Buy Competitors

Giant companies are using YOUR money to buy their competitors.

For example, Bloomberg writes today:

PNC Financial Services Group Inc., Pennsylvania's biggest bank, plans to buy National City Corp. for about $5.2 billion in stock after receiving U.S. Treasury funds.
***
The $7.7 billion of Treasury funding, part of the government's $250 billion plan to recapitalize banks, "put this transaction on a very solid footing,'' PNC said.

Remember that the $250 billion is part of the $700 bailout which taxpayers are paying for.

This confirms CNBC's report that the feds were using the bailout to push bank mergers.

Update: Bloomberg posted a second article entitled "PNC's $5.2 Billion National City Purchase Is Takeover Template for Paulson" after I wrote this essay, which says:

PNC Financial Services Group Inc.'s taxpayer-backed $5.2 billion purchase of National City Corp. is a blueprint for regional bank takeovers pressed for by U.S. Treasury Secretary Henry Paulson, investors said.

Update 2: See also this New York Times article.

Hedge Fund Losses May Lead to New Derivatives Meltdown

Hedge funds are getting hammered. And the co-chief executive of Europe’s biggest hedge fund is warning that thousands of hedge funds are on the brink of failure.

This could lead to a derivatives nightmare.

Remember that the economic crisis was bad when home values dropped and the "subprime" loans started being defaulted on, but it really got bad when the collateralized debt obligations (CDOs) - which repackaged those loans - started plummeting in value. (CDOs were highly-leveraged, so a small drop in home prices resulted in large declines in the value of the CDOs; then, as the companies which held huge sums of CDOs started bleeding out, credit default swaps started being heavily bet against them, which drove up their price of doing business, which caused them to fail).

As Nouriel Roubini pointed out on October 15th:

Rating agencies [are] start[ing] to downgrade collateralized fund obligations (C.F.O.) which are the hedge fund equivalent of mortgage-backed securities: securities backed by hedge funds. Some have a 7-year lock-up period. While few in number, C.F.O.’s represent a broad swath of the $2 trillion industry.

CFOs are a "CDO-type vehicle that invests in hedge funds or private equity investments". Basically, if the value of the hedge fund increases, then the CFOs go up, and if they go down, they go down. Like CDOs, they are highly-leveraged derivatives, so that a small fall in the value of the hedge fund can lead to large losses in the CFO.

Because hedge funds are getting clobbered and many will go out of business, that creates a huge CFO derivatives exposure.

In addition, remember that hedge funds have a lot of derivatives exposure concerning other types as derivatives as well. As Roubini points out:

Hedge funds are among the net sellers of credit protection in the $54 trillion credit derivatives environment and might be called to perform on their obligations wrt Lehman, WaMu, Kaupthing, etc.

Therefore, if hedge funds go belly up, someone else will end up with their derivatives' liability.

See also this.

The Return of the Ice Age: Temporary Thaw in Inter-Bank Lending is Over

The one, much-trumpeted bright spot in the world economy was that inter-bank lending rates started to fall slightly.

Of course, banks lending to each other is not the same thing as banks lending to real people and the real businesses. They're not doing that, and won't any time soon. And the inter-bank lending rates may have been manipulated, so its hard to know whether the situation really eased or not.

However, manipulated or not, even the inter-bank lending rate is now rising again.

Any way you look at it, the much-hyped "thaw" in bank lending is over, and everything is freezing back up. Despite governments spending trillions upon trillions of dollars, we remain in an ice age of frozen lending.

Thursday, October 23, 2008

Gold May Do Well During the Later Stages of Deflation

Most people agree that gold does well during periods of inflation.

But what about during periods of deflation?

Leading economist Dr. Marc Faber wrote in October 2007 that gold will do well even in a deflation:

How would gold perform in a deflationary global recession? Initially gold could come under some pressure as well but once the realization sinks in how messy deflation would be for over-indebted countries and households, its price would likely soar.

Therefore, under both scenarios - stagflation or deflationary recession - gold, gold equities and other precious metals should continue to perform better than financial assets.

Faber's argument is supported by the following charts showing gold's performance as compared to the yen during Japan's "lost decade" of deflation:

Japan's deflation didn't definitively end until 2007 or 2008.

This provides some evidence that gold may tend to hold or increase its value at least in the later part of the deflationary period as compared with the relevant national currency.

Moreover, about half the time, gold has risen during recessions in the United States:

(The grey vertical bars show periods of recession; if your browser is cutting off the right edge of the chart, click here for full image; the chart gives gold prices in monthly averages).

Close examination shows that gold often falls during the beginning stages of a recession, then rises in the later stages of the recession.

Remember that gold is supposed to be a save haven investment during times of uncertainty and instability. Plain vanilla recessions are not really times of uncertainty or instability, so the tendency of gold to rise in deflations should hold more true than during recessions.

Greenspan Admits Credit Default Swaps Have "Serious Problems"

Alan Greenspan praised credit default swaps in 2002. But today he admitted to Congress that there were “serious problems” with CDS.

Greenspan told Congress:

"Credit-default swaps, I think, have serious problems associated with them.
***
Excluding credit default swaps, derivatives markets are working well."

Derivatives are working well, other than the credit default swap market - which is bigger than the entire worldwide economy - and which was a major cause of the collapse of Bear Stearns, AIG, Lehman and the others?

That’s like saying “other than not being strong enough to handle ice bergs, the Titanic was a good ship”.

Or asking President Lincoln’s wife after he was assassinated while watching a play: “other than that, how did you like the play, Mrs. Lincoln?”

Forecast: 2 Years of Deflation, Followed by Raging Inflation

I'm calling 1 1/2 to 2 years of deflation, followed by raging inflation.

Deflation Now

Richard Berner of Morgan Stanley, said: “A global recession is now under way, and risks are still pointed to the downside for commodity prices and earnings.”

Nouriel Roubini writes: "There is a glut and excess capacity of goods while aggregate demand is falling soon enough we will start to worry about deflation, debt deflation, liquidity traps . . . ."

And an oxford professor of economics and expert on U.S. inflation thinks deflation is probably on the way.

As Dan Denning writes:

So far, it looks like the deleveraging of the global financial system is destroying wealth faster than central banks can create new credit to replace it. [My comment: it wasn't real money, only "cotton candy".]

***

[The trillions being spent on bailouts worldwide] small compared to the amount of value already destroyed in the residential real estate market and in the stock market. Twenty trillion has already been wiped off global shares. Property markets in the UK and the US are imploding.

So what we may have underestimated is how quickly this deleveraging and value destruction would spread to the commodity markets, which we thought would provide relative safety with the backing of tangible value. Resource stocks did not hold up for long at all. Why not?

On the one hand, it now looks like a lot of investors were buying commodities – and staying "long" of the trend – with borrowed money. Those investments have now been sold to raise cash and pay back loans.

Secondly, when it's a bear market in stocks, there aren't too many stocks that do well, full stop. Not even Gold Miners against the backdrop of gold bullion holding up well...or at least, not collapsing alongside everything else.

According to Bloomberg, people are not buying even though things are being sold at "Armageddon" prices.

Big investors are also hoarding cash. A report by JP Morgan shows:

"Markets are reflecting extreme levels of caution among investors. Institutional cash positions are close to their all-time highs."

Banks will keep on hoarding cash.

The Deutsche analysts don't see a bottom occurring until 2010. A recovery won’t occur until further beyond that: “unlikely in the foreseeable future”.

Inflation Later

But eventually, inflation will kick in. You've heard successful investors like Warren Buffet and Jim Rogers warn of inflation.

Well, the smart analysts I have been listening to are forecasting 1 1/2 to 2 years of deflation, followed by raging inflation.

Denning gives a possible scenario for how it is likely to play out:

If governments borrow to finance these various programs, they'll issue new bonds. Bonds soak up the available pool of global savings. To that extent, this new borrowing crowds out other ventures, which might otherwise have put the savings to a productive use. But financing the scheme with bonds is not, at least, right away, inflationary. Not in itself.

However, if governments can't find takers for the bonds they issue to finance these schemes, they will have to either raise taxes (not likely in a recession) or simply print the money.

And here's a hint. That's what they always do, from Argentina to Zimbabwe.

That is why we maintain the preferred response to huge debt levels is outright money-printing. Besides, simply making credit more available by lowering interest rates stops working after awhile (like when you can't lower rates any further...and become zero bound). How do you get available credit out of bank computers and into consumer wallets? It's not easy. Bankers are suddenly quite shy where they were once promiscuous.

***

Right now, all this government cash is simply shoring up bank balance sheets with more capital. But to really "get things going again" and "fight the recession", the money will have to get back into the real economy. And this is where we see the inflation coming. Not in asset prices for houses or shares. But in real goods. Why?

If the government engages in massive public works projects as a way of stimulating demand in the economy and keeping up growth, it's going to be resource intensive. In a way, this is just another kind of phony boom, but with the free-market varnish stripped off to reveal it as an über-lending program by some kind of pan-governmental agreement worldwide.

***

Western governments are already suggesting a system where the world's top thirty banks will operate under the supervision of a government panel of some sort. You'll see more "super banks" and greater control of the levers of global banking too, plus a concerted program to flood the world with new fiat currency.

Of course, the deflationary phase could be shorter or longer, depending on what the government does.

And remember that we might very well get simultaneous inflation in some asset classes and deflation in others.

Caveat: I am not an investment advisor and this should not be taken as investment advice.

Greenspan and Cox Confess

Former Fed chair Alan Greenspan and SEC head Christopher Cox confessed their mistakes to Congress today.

By way of background, Greenspan was a one of the main supporters of derivatives since at least 1999 (and see this). He was one of the main cheerleaders for subprime loans. And of course, he pushed "easy credit" with low interest rates.

The SEC has advocated no government oversight and "voluntarily regulation" by the companies themselves.

But today, they confessed. As an article in Market Watch says:

Three current and former financial regulators told Congress Thursday that they made fateful mistakes that helped drive the global financial system to the brink of disaster, and urged Congress to fill the regulatory gaps.

"We have learned that voluntary regulation does not work," said Christopher Cox, chairman of the Securities and Exchange Commission, in testimony on Thursday at the House Oversight and Government Reform Committee. "It was a fateful mistake" that no one was given the authority "to regulate investment bank holding companies other than on a voluntary basis."

Former Federal Reserve Chairman Alan Greenspan . . . said, he and others are in "a state of shocked disbelief" that "counterparty surveillance" failed. He said he still doesn't fully understand what went wrong.

***
Greenspan said he favored strengthening the regulatory structure.

Bloomberg writes that Greenspan conceded to a "flaw" in his market ideology, and confessed his mistakes regarding derivatives:

Greenspan said he was "partially'' wrong in opposing regulation of derivatives and acknowledged that financial institutions didn't protect shareholders and investments as well as he expected.

Greenspan's admission might not sound very dramatic at first glance. But for a guy who is known for his cryptic mumblings and for rationalizating his own actions, this is his way of saying "we broke it, now someone's got to fix it".

Wednesday, October 22, 2008

The Fed’s Response to the Financial Crisis: More of the Hair of the Dog That Bit Ya

John Riley nails in a single paragraph what the government is doing wrong in responding to the economic crisis:

The Fed’s response to the financial crisis has been more of the hair of the dog that bit ya. Virtually everything the Fed is doing is increasing debt, not decreasing it. It seems that the Fed’s theory is to keep the drunk drinking to avoid the inevitable hangover. As we have said many times, the longer you put it off, the worse the hangover will be. And we are due for a whopper, thanks to the bartender, I mean the Fed’s irresponsible actions.

Riley has summarized in a few words what the Austrian school of economics, Ron Paul, and everyone else with a good head on their shoulders has been saying for a long time. The problem is that too much credit, artificially low interest rates and cheerleading for the binge by Greenspan and company led to massive malinvestments. The only way to get through the financial crisis is to tough it out until the hangover is really over.

Other people have used the image of heroin to make their point. For example, Financial analyst Puru Saxena compared the bailouts with "shots of heroin to fix the problem of an addict".

In the "Horse is Already Out of the Barn" Department

According to CNBC:

A group of Democratic senators asked the U.S. Treasury Department on Wednesday to set guidelines saying that banks receiving government capital injections should use the funds to restore their lending activities to levels prior to the credit crunch.

The senators said in a letter that Treasury officials should also issue guidelines or best practices that specify the type of lending allowed, encourage loan modifications, and provide more oversight of executive compensation.

"Although we are supportive of your efforts to restore stability to the financial system through direct capital injections into financial institutions, we are concerned that if the program is not implemented correctly, its effectiveness will be limited," the letter said.

***

"This plan will only be effective if these funds are used to increase lending by banks, and it is Treasury's obligation to ensure that," said Schumer, who chairs the Joint Economic Committee. "The last thing these banks should be doing is stuffing this money under the proverbial mattress."

Um, guys . . . you already approved the trillion dollar bailout, without insisting on giving the government any power to force the banks to lend, they aren't lending, and they won't lend until the financial crisis is over (see this).

We know that Treasury will not force the banks to loan money, and we can see through your political posturing.

The horse is already out of the barn. In fact, YOU opened the door and helped escort him out. Despite the fact that most Americans didn't want the bailout, and despite the millions of phone calls and letters we sent Congress saying "no".

We Are Giving Them Our Real Money to Make Up for Losses of Pseudo Money that Never Really Existed

In response to an essay about the government bailouts, I received the following comment:

"I posed a question to a few ‘experts’ asking where all this lost money had gone, or if it ever existed, but got no reply.

A couple of days later I heard the same question asked to a BBC radio business program. They went across the road from the BBC studio, to the London school of Economics to ask 2 of their senior lecturers this question.

Their answer? No, the lost money never really existed!

So now we are giving them OUR money to make up for the losses that only really existed as 1s and 0s in their computers. Unbelievable."

Is he right?

Yes.

As derivatives expert Satayjit Das puts it:

[A leading financial writer] coined the phrase "candy floss money" ["candy floss" is the British expression for "cotton candy"].

Financial technology spun available "real" money into an exaggerated bubble that, like its fairground equivalent, collapses ultimately. . . . The perceived abundance of liquidity was, in reality, merely an illusion created by high levels of debt and leverage as well as the structure of global capital flows.

The "lost" bank money which taxpayers are being forced to "replace" had no more substance than cotton candy.

Ratings Agencies "Sold Their Soul" . . . Joining Wall Street and the Government

A Congressional committee is holding a hearing today on the credit rating agencies and their role in the financial crisis.

Specifically, the big 3 ratings agencies - S&P, Moody's and Fitch - kept companies' credit ratings high for years after they should have been slashed due to inadequate capital, overstated assets, over-exposure to derivatives and other risky investments, and other chronic problems.

Indeed, emails show that the rating service employees knew they were acting fraudulently

Employees at Moody's Investors Service told executives that issuing dubious creditworthy ratings to mortgage-backed securities made it appear they were incompetent or "sold our soul to the devil for revenue,'' according to e-mails obtained by U.S. House investigators.
***

The Securities and Exchange Commission in a July report found the credit-rating companies improperly managed conflicts of interest and violated internal procedures in granting top rankings to mortgage bonds.

An e-mail that a S&P employee wrote to a co-worker in 2006, obtained by committee investigators, said, "Let's hope we are all wealthy and retired by the time this house of cards falters.''

As CNBC points out:

This instant message exchange between two unidentified Standard & Poor's officials about a mortgage-backed security deal ... :

Official #1: Btw (by the way) that deal is ridiculous.

Official #2: I know right...model def (definitely) does not capture half the risk.

Official #1: We should not be rating it.

Official #2: We rate every deal. It could be structured by cows and we would rate it.

A former executive of Moody's says conflicts of interest got in the way of rating agencies properly valuing mortgage backed securities.

Former Managing Director Jerome Fons, who worked at Moody's until August of 2007, says Moody's was focused on "maxmizing revenues," leading it to make the firm more "issuer friendly."

The credit rating agencies deserve the heat they are taking.

However, those agencies shouldn't be set up as the sole "fall guy".

Remember, the government de-regulated derivatives and many other important areas of finance (and see this), and failed to exercise any oversight.

And don't forget that:

"President George W. Bush has bestowed on his intelligence czar ... broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations."

(Business Week, May 23, 2006). Why isn't anyone investigating these questions:

How many times did [the] next intelligence czar nod and wink in this way? Which companies did they give a pass to? What "national security" crisis prompted them to exercise these extraordinary powers? And who in the White House and Congress ordered, signed off on, or who knew of, their actions?

CDS Report: Europe, Junk Bonds and Synthetic CDOs Getting Hammered

Central banks apparently watch credit default swaps as the single most important economic indicator. So I'll keep watching them also as a window into the real state of the economy.

Indicators for credit default swaps shows that several Europen countries, junk bonds, and synthetic CDOs are all getting hammered.

Europe

Several European countries are getting battered by CDS. Today's update from Markit shows that Ukraine, Hungary, Serbia and Turkey are in big trouble.

Junk Bonds

Low-grade investment bonds are also hammered (see this article from Bloomberg, and this from Alphaville).

There will be a lot of defaults on these bonds in the coming year, and many people who bought junk bonds (and some companies which issued CDS protection on them) are going to lose money.

Synthetic CDOs

Bloomberg has a very good article today on synthetic CDOs and credit default swaps. I'll quote it at some length, as it gives insight into the relation between CDS and synthetic CDOs:

Defaults and so-called "credit events,'' which can include government takeovers, force payment of the credit-default swaps packaged in the debt. This causes losses for investors or erodes capital.

"The same kind of shudders that went through the asset- backed CDO market will probably go through the corporate CDO market,'' said Sillis. "We'll see a pickup in default rates.''

Barclays Capital estimates that 70 percent of synthetic CDOs sold swaps on Lehman. Swaps on Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Banki hf were included in 376 CDOs rated by S&P. The company ranks almost 3,000.

About 1,500 also sold protection on Washington Mutual, the bankrupt holding company of the biggest U.S. bank to fail, according to S&P. More than 1,200 made bets on both Fannie Mae and Freddie Mac, the New York-based rating company said.

The collapse of Lehman, WaMu and the Icelandic banks, as well as the U.S. government's seizure of the mortgage agencies, will have a "substantial'' impact on corporate CDO ratings, S&P said in a report Oct. 16.

The government in Reykjavik seized Kaupthing Bank, the country's largest lender, earlier this month. Assets and liabilities from Landsbanki Islands and Glitnir Banki were transferred to state-owned entities, triggering default swaps.

***

Investors may sell the CDOs back to the banks that structured them, which will unwind protection they wrote to hedge swap transactions, Barclays said. The chain of events will push up the price of default protection and company borrowing, according to Barclays.

Banks unwinding hedges helped double the cost since April of default insurance on the lowest-ranking equity portion of the benchmark Markit CDX North America Investment Grade Index, to 75 percent upfront and 5 percent a year. That equates to $7.5 million in advance plus $500,000 annually on $10 million of debt for five years.

***

Forecasts for ratings downgrades are "going to force a lot of activity'' in unwinding CDOs, said Rohan Douglas, former director of global credit derivatives research at Citigroup. '

Tuesday, October 21, 2008

International Swaps and Derivatives Association Says Lehman Payout Only $6-8 Billion Dollars

Its hard to believe, but I hope - for the sake of the economy - that it is true.

The Government Has Given Banks YOUR MONEY, and You Won't Get Anything For It

The government has given banks handfuls of YOUR MONEY and you won't get anything for it.

Don't believe me?

Let's recap:

The fed and treasury said they had to spend trillions of dollars to "restore liquidity" (that is, free up loans by banks)

However, according to top experts, the problem was never a lack of liquidity

And the government did not insist that the banks use the money to extend loan credit

So the banks are not using the bailout money to extend loans, and they admit they won't do so anytime soon

So why has the government authorized trillions on our dime?

Well, the original version of the bailout would have helped mainly Paulson's old company, Goldman Sachs.

And according to one of the leading experts on monetary policy and economics, the government isn't "trying to save the banking system [but just] trying to save banks." Paulson trying to help out his buddies at Goldman Sachs and elsewhere?

Moreover, as the headline from a CNBC report reads today, "Feds Using Bailout to Push Bank Mergers". Hmmm. That would benefit Paulson's buddies, also, letting them use federal bailout money to take over their competitors.

I'm not saying for sure that all of the bailouts are solely for the purpose of helping out Paulson's buddies. What I am saying is that they won't help YOU.

Banks ADMIT They'll Keep on Hoarding Cash

Many people (including me) have been warning that the banks will keep hoarding cash no matter how much money the feds give them.

Now, even the banks themselves are admitting it.

As the New York Times writes in an article entitled "Banks Are Likely to Hold Tight to Bailout Money":

"Will lenders deploy their new-found capital quickly, as the Treasury hopes, and unlock the flow of credit through the economy? Or will they hoard the money to protect themselves?
John A. Thain, the chief executive of Merrill Lynch, said on Thursday that banks were unlikely to act swiftly. Executives at other banks privately expressed a similar view.
'We will have the opportunity to redeploy that,' Mr. Thain said of the new capital on a telephone call with analysts. 'But at least for the next quarter, it’s just going to be a cushion.'
***
Lenders have been pulling back on credit lines for businesses, mortgages, home equity loans and credit card offers, and analysts said that trend was unlikely to be reversed by the government’s money.
Roger Freeman, an analyst at Barclays Capital, which acquired parts of the now-bankrupt Lehman Brothers last month [said] 'My expectation is it’s quarters off, not months off, before you see that capital being put to work.' ”

And another Times article includes the following quote:

“It doesn’t matter how much Hank Paulson gives us,” said an influential senior official at a big bank that received money from the government, “no one is going to lend a nickel until the economy turns.” The official added: “Who are we going to lend money to?” before repeating an old saw about banking: “Only people who don’t need it.”

The banks are going to sit on the cash, not loan it out. So can everyone please stop saying that the bailouts were necessary to increase liquidity?

Monday, October 20, 2008

The Problem Was Never Liquidity, But Insolvency ... And We Should Let Insolvent Banks Fail

The problem was never really liquidity.

Says who?

Says Anna Schwartz, co-author of the leading book on the Great Depression, and someone who actually lived through it.

The Wall Street Journal ran an interview with Schwartz last weekend:

Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old [but still sharp as a tack], is one of the exceptions. She's not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, "A Monetary History of the United States" (1963). It's the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.

***

Federal Reserve Chairman Ben Bernanke has called the 888-page "Monetary History" "the leading and most persuasive explanation of the worst economic disaster in American history." Ms. Schwartz thinks that our central bankers and our Treasury Department are getting it wrong again.

To understand why, one first has to understand the nature of the current "credit market disturbance," as Ms. Schwartz delicately calls it. We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads -- the difference between what it costs the government to borrow and what private-sector borrowers must pay -- are at historic highs.

This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. "The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."

So even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue."

In the 1930s, as Ms. Schwartz and Mr. Friedman argued in "A Monetary History," the country and the Federal Reserve were faced with a liquidity crisis in the banking sector. As banks failed, depositors became alarmed that they'd lose their money if their bank, too, failed. So bank runs began, and these became self-reinforcing: "If the borrowers hadn't withdrawn cash, they [the banks] would have been in good shape. But the Fed just sat by and did nothing, so bank after bank failed. And that only motivated depositors to withdraw funds from banks that were not in distress," deepening the crisis and causing still more failures.

But "that's not what's going on in the market now," Ms. Schwartz says. Today, the banks have a problem on the asset side of their ledgers -- "all these exotic securities that the market does not know how to value."

"Why are they 'toxic'?" Ms. Schwartz asks. "They're toxic because you cannot sell them, you don't know what they're worth, your balance sheet is not credible and the whole market freezes up. We don't know whom to lend to because we don't know who is sound. So if you could get rid of them, that would be an improvement."

What are the "exotic", "toxic" instruments Schwartz is talking about?

Derivatives.

As former Secretary of Labor Robert Reich says:

Despite all the money going directly to the big banks, despite all the government guarantees and loans and special tax breaks, despite the shot-gun weddings and bank mergers, despite the willingness of the Treasury and the Fed to do almost whatever the banks have asked, the reality is that credit is not flowing.
Why? Because the underlying problem isn't a liquidity problem. As I've noted elsewhere, the problem is that lenders and investors don't trust they'll get their money back because no one trusts that the numbers that purport to value securities are anything but wishful thinking. The trouble, in a nutshell, is that the financial entrepreneurship of recent years -- the derivatives, credit default swaps, collateralized debt instruments, and so on -- has undermined all notion of true value.
Many of these fancy instruments became popular over recent years precisely because they circumvented financial regulations, especially rules on banks' capital adequacy. Big banks created all these off-balance-sheet vehicles because they allowed the big banks to carry less capital.

Banks and financial houses have indeed hidden their derivatives exposure off the balance sheets.

And remember, mortgages were repackaged into derivatives called collateralized debt obligations (or "CDO's") and sold to both big and regional banks and investment companies worldwide. The CDO's were highly-leveraged -- many times the amount of the actual loans. When the subprime loan crisis hit, the high leverage magnified the fallout, and huge sums of CDO derivatives became essentially worthless.

And remember, almost no one really understood derivatives:

"Not only [world's richest man] Warren Buffett, but Bond King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary Henry Paulson and the rest of America's leaders can't 'figure out" the derivatives market.

According to Paul Volker, the former chairman of the Federal Reserve, the entire modern financial system is based upon derivatives, and the financial system today is entirely different from the traditional American or global financial system because derivatives - a relatively new concept - now underly the entire fabric of the financial system.

No one knows what their own derivatives assets and liabilities are, let alone anybody else's (which is why Lehman's credit default swaps have caused so much anxiety, as just one example). Every bank knows that - because of its derivatives exposure and their poor business practices - its derivatives exposure may be many times bigger than its assets. And every bank fears that the other guy's ledger might be even worse.

As one of the leading experts on derivatives puts it:

Uncertainty about the impact of financial distress of one entity [from derivatives] on all other market participants causes trading in the inter-bank market to freeze up further increasing volatility and potentially risk of failure of weaker firms.

So its not a liquidity problem. As Schwartz says, it is an insolvency problem. Or more accurately, a lack of trust that the other guy not going to go belly up because of his derivatives liabilities.

Note: Schwartz believes that the fed should let insolvent companies which made bad decisions fail, instead of artificially propping them up. She thinks that propping them up will only prolong the crisis.

The government is not only fighting the last war, and not only failed to help solve the derivatives mess, it has made it worse. The government de-regulated derivatives (and see this) and failed to exercise any oversight in this area. In addition, the government may have allowed normal accounting principles to be totally suspended under the guise of "national security".

Is LIBOR Still Being Manipulated?

The London interbank offered rate ("LIBOR") is the rate at which banks offer to loan money to one another in London. As such, it is a key indicator of liquidity in the financial system. (LIBOR is also to determine rates on $360 trillion of financial products worldwide, from mortgages to company loans and derivatives).

The governments of the U.S. and Europe have been pumping trillion dollars into the system to increase liquidity. LIBOR has, in fact, been falling, which is a very good sign.

However, the question is whether LIBOR is being manipulated, or is falling on its own.

Of course, the fact that governments have been giving banks staggering sums of cash encourages the banks to loan some of that money to each other. That's not manipulation - its socialism. But that's not what this essay is about.

What I'm focusing on is actual fudging of the numbers.

As Bloomberg notes today:

The Bank for International Settlements said in March some lenders may have "manipulated'' rates to keep from appearing like they were in financial straits.

The Bank for International Settlements is called the "central bankers' central banker", and so its opinion carries great weight.

Bloomberg carried the following quotes in May:

"The Libor numbers that banks reported to the BBA [the British Bankers Association] were a lie,'' said Tim Bond, head of global asset allocation at Barclays Capital in London. "They had been all along. The BBA has been trying to investigate them . . . ."
***
"Since the credit crunch, it's something that appears to have been manipulated,'' said Hahn, a former managing director at Citigroup.

Indeed, the central banks are now watching credit default swaps more than LIBOR as an economic indicator of the health of the economy. Is this partially because they know LIBOR isn't reliable?

As the Wall Street Journal explained in April:

In a development that has implications for borrowers everywhere, from Russian oil producers to homeowners in Detroit, bankers and traders are expressing concerns that the London inter-bank offered rate, known as Libor, is becoming unreliable...

Some banks don't want to report the high rates they're paying for short-term loans because they don't want to tip off the market that they're desperate for cash. The Libor system depends on banks to tell the truth about their borrowing rates....

No specific evidence has emerged that banks have provided false information about borrowing rates, and it's possible that declines in lending volumes are making some Libor averages less reliable. But bankers and other market participants have quietly expressed concerns to the British Bankers' Association....

Questions about Libor were raised as far back as November... In a recent report, two economists at the Bank for International Settlements, a sort of central bank for central bankers, also expressed concerns that banks might report inaccurate rate quotes.....

In a recent research report on potential problems with Libor, Scott Peng, an interest-rate strategist at Citigroup Inc. in New York, wrote that "the long-term psychological and economic impacts this could have on the financial market are incalculable." Mr. Peng estimates that if banks provided accurate data about their borrowing costs, three-month Libor would be higher by as much as 0.3 percentage points....

***
In one sign of increasing concern about Libor, traders and banks are considering using other benchmarks to calculate interest rates, according to several traders. Among the candidates: rates set by central banks for loans, and rates on so-called repurchase agreements, under which borrowers provide banks with securities as collateral for short-term loans.

In a report published in March by the Bank for International Settlements, economists Jacob Gyntelberg and Philip Wooldridge raised concerns that banks might report incorrect rate information. The report said that banks might have an incentive to provide false rates to profit from derivatives transactions. The report said that although the practice of throwing out the lowest and highest groups of quotes is likely to curb manipulation, Libor rates can still "be manipulated if contributor banks collude or if a sufficient number change their behaviour."

If banks manipulated LIBOR earlier to downplay how much trouble they were in, could they be manipulating LIBOR now to try to pretend that things are getting better and the the global economy is recovering?

If consumers thought the economy was recovering, they might buy more and borrow more, which means more profits for the banks. Therefore, the banks may have a very strong motivation for manipulating LIBOR.

I hope that the fall in LIBOR is real, but given the history of manipulating, we can't passively accept it without question.

Sunday, October 19, 2008

Bubbles Are Bursting Worldwide

CNN writes:

"The credit market crisis, combined with the recent stock market declines and the plunge in home values over the past two years, is setting off the deflationary alarm bells for economists.

Paul Kasriel, chief economist with Northern Trust in Chicago, said most bouts of deflation have started with sharp declines in assets such as stocks or homes. That has tended to lead to a loss of value of collateral for loans and ultimately, large losses by lenders and very tight credit"

Remember that a housing bubble has burst not only in the U.S., but in France, Spain, Ireland and the United Kingdom, Eastern Europe, and many other regions. China is slowing down as well.

And stocks are down worldwide.

This may point towards global deflation.

The Economist writes:

"A global recession is almost certainly on the way . . . With commodity prices falling sharply ... and economies suffering, inflation risks are evaporating in the rich world. .... Deflation is an increasing risk."

The Telegraph provides impressions of the slow down spreading all around the world:

The commodity and emerging market booms are breaking in unison, leaving no more bubbles left to burst. Almost every corner of the world is now being drawn into the vortex of debt deflation.

The freight rates for Capesize vessels used to ship grains, coal, and iron ore have fallen 95pc to $11,600 since May, hence the bankruptcy of Odessa’s Industrial Carriers last week with a fleet of 52 vessels. Cargo deliveries dropped 15.2pc at the US Port of Long Beach last month, but that is a lagging indicator.

From what I have been able to find out, shipping is slowing as fast as it did in the grim months of late 1931. “The crisis is now in full swing across the entire world,” said Giulio Tremonti, Italy’s finance minister. “It is hitting the real economy, the productive forces of industry. It’s global, it’s total, and it’s everywhere,” he said.

Italy’s industrial output has fallen 11pc in the last year. Foreign orders have dropped 13pc. But we are all in much the same boat. Europe’s car sales fell 9pc in September (32pc in Spain). US housing starts fell to a 45-year low in September.

Last week, the International Monetary Fund had to rescue Hungary and Ukraine as contagion swept Eastern Europe ....

Russia’s foreign reserves have fallen by $67bn since August. Ural crude prices fell to $65 a barrel last week, below the budget solvency threshold of the now extravagant Russian state.

The new capitalists have to repay $47bn in foreign loans over the next two months. In Russia, oligarch fiefdoms built on leverage - Mikhail Fridman (Alfa), Oleg Deripaska (Basic Element), and Vladimir Lisin (Novolipetsk) - are lining up for state bail-outs from a $50bn rescue fund.

Brazil is free-fall as well. Sao Paolo’s Bovespa index is down a third in dollar terms in a month. Hopes that the BRIC quartet (Brazil, Russia, India, and China) would take over as the engine of world growth have proved yet another bubble delusion.

China says 53pc of the country’s 3,600 toy factories have gone bust this year. Economist Andy Xie says China is at imminent risk of its own crisis after allowing over-investment to run rampant, like Japan in the 1980s. “The end is near. They’ve been keeping this house of cards going for a long time with bank support,” he said.

Indeed, China's GDP has slowed from 12 percent to 9 percent, and the Financial Times writes that "Indicators hint China [is] on verge of slowdown", and may be in for a hard landing.

Saturday, October 18, 2008

Pumping Dollars Into an Airplane with a Hole in the Side

Banks and other lenders have lost trillions of dollars recently (see this).

And, as we all know, they have severely reduced their extension of credit. As just one example, credit card lines will be reduced by some $2 trillion dollars in the next year or so .

Credit contraction is deflationary. Indeed, one of the two basic definitions of deflation is "A contraction in the volume of money and credit relative to available goods."

If the amount of money in circulation and available credit drops, then prices will eventually drop also.

In addition, banks are hoarding cash like never before. When cash is hoarded, it decreases the "velocity of money" - that is how quickly money changes hands. This also tends to lead to deflation and eventual prices drops.

If the economy is an airplane flying through the air, then deflation could be thought of as a decrease in cabin pressure.

The current economic crisis - with trillions of dollars in losses (an evaporation of available money), trillions of dollars less available credit, and hoarding of cash - is like a big gash in the side of the plane. For more evidence of deflation, see this.

The government's actions of lowering interst rates, sending people rebate checks, and throwing trillions of dollars at Wall Street is like someone trying to stabilize the cabin pressure in an airplane with a gash in the side by blowing air into the cabin.

If that person had a nuclear-powered blower, he might be able to re-inflate the cabin pressure in most parts of the cabin.

Are the government's actions powerful enough to stabilize the pressure? Will the government prevent deflation and push us into inflation?

Models Not Very Good at Predicting Behavior During Tipping Points

Many people are sure we're headed into deflation. Others are just as sure we're headed into inflation.

But an expert says that its hard to predict which way it will go during periods of rapid change. Specifically, Oxford Economics professor John N. Muellbauer, an expert on U.S. inflation, said on October 10th:

The world is on the cusp of an inflation “turning point”, so the standard models are likely to go badly wrong.

***

Forecasting inflation is notoriously difficult. . . . the speed of price changes tends to increase with big shocks. Most forecasting models used by central banks therefore put a large weight on recent inflation. This tracks inflation quite well except at turning points because the models miss key underlying influences.

***
We are now on the cusp of the most significant tuning point for inflation in the last 20 years so that the many of the standard models are likely to go badly wrong.

Too Much Here, Not Enough There

Leading economist Dr. Marc Faber acknowledges that if the government takes enough action to fight inflation, it will cause some price increases. But, he points out that it is impossible for anyone - even the government - to predict which prices will increase.

For example, he notes that the government would like house and stock prices to increase, as that would help reinflate the economy (or at least give the middle class some sense of well-being in the short-run).

However, he said that it is possible that - instead - commodity or interest rate prices will increase, which will harm the consumer by causing higher food and energy prices and the cost of other essentials. As CNN writes: "Stock prices have plunged in recent weeks. So have oil prices. Most Americans probably see the former as terrible news and the latter as a ray of sunshine at a dark time." And as CNBC writes: "Home prices, much like stock prices, fundamentally affect people's sense of wealth".

When the government shoots its high-powered hose inside an airplane with a huge hole in its side, it will cause too much pressure in some parts of the cabin (unintentionally pushing some people out of the airplane) and not enough pressure in other parts.

We're in for a bumpy ride . . .

Friday, October 17, 2008

Inflation Or Deflation? BOTH

I have previously discussed the debate between inflation and deflation. There are good arguments on both sides.

But there are strong arguments that we will experience both inflation and deflation.

How is that possible?

Inflation Lags Money Supply

Inflation does not occur simultaneously with the money supply is increased. There is always a lag time between printing more money and inflation.

So a lot of people believe we will get hit first with deflation, and then - after some lag time - inflation. Even Mike Shedlock - one of the leading forecasters of deflation - thinks there might be inflation coming down the road after a period of deflation.

Some Prices Will Go UP, Others DOWN

Some people think that some prices will go up at the same time that others go down.

For example, Dominic Frisby writes:

Are we going to see rising prices or falling prices? Of course, it depends on the asset class – and in what currency you are measuring.
***
Falling prices in assets associated with debt - houses and financial stocks – and rising prices in things which you buy with cash – food, energy and some imported goods.

Adam Hamilton of Zeal LLC agrees:

Anything typically financed by debt is likely to see its prices plunge dramatically, like houses and cars, as the ongoing Great Bear bust continues to destroy the gross excesses of debt via higher long rates. Conversely, anything not typically ‘paid for’ with debt, including groceries and general living expenses, is almost certain to rise in the coming years. We are staring down a brutal environment of widespread inflation marked by various sectors witnessing falling prices as debt leverage implodes.

So we may very well experience both inflation and deflation.

Which Emerging Economies Are In Danger of Collapse?

Bloomberg has an interesting graph (courtesy of Danske Bank) showing the credit default swap risk of emerging economies:

(Click for sharper image).

On October 15th, Danske explained:

"The global credit crisis is now spreading to the most leveraged economies in the world. Iceland was the first economy to fall victim to the global credit crisis. However, it is not only Iceland that seems to be in need of a helping hand ....

***

Over the past month credit default swaps spiked in a number of Emerging Markets indicating a significant increase in worries over funding problems on the back of the intensified credit crisis. . . . In the graph [above] we show the 20 countries that have seen the strongest rise in CDS spreads over the past month.

***

It is striking that most of the countries in the “top 20” are countries that are either running large current account deficits . . . and/or countries that in recent years have had very strong credit growth."

See also this.

Nouriel Roubini agrees that the countries with the most CDS bets being made against them - particularly those with large current account deficits - are in desperate shape, and may need emergency loans from the IMF to stay afloat.

See also this.

Central Bankers Think Credit Default Swaps are the Most Important Economic Indicator

Many of us talk alot about derivatives (see this) . You might think that we are too obsessed about the role of derivatives, including credit default swaps, in the economic crisis.

But even the mainstream press is now acknowledging that credit default swaps were largely responsible for bringing down AIG, Bear Stearns, WaMu and other mammoth corporations.

Moreover, according to Markit analyst Paul Davies:

"Most people might assume that central bankers would be watching libor rates, or spreads between libors and overnight interest rates as the main indicator as to the health of the system - they are not. These guys have recently become big devotees to the movements of the CDS markets."

In other words, credit default swaps - not the interest that banks charge each other for inter-bank loans or other indicators - are the most important indicator that the world's central banks are now watching.

Snake Oil Derivatives Salesmen Bankrupting Schools

Do you think derivatives are some abstract thing which don't effect real people? Or that derivatives salesmen are just good folks who innocently sold bad products?

Well, as an article in Bloomberg points out, neither assumption is true:

"The U.S. Securities and Exchange Commission is investigating a Pennsylvania school district's derivative trades with JPMorgan Chase & Co. and Morgan Stanley that paid at least $8 million in fees to the banks and advisers.
***
The SEC inquiry follows a Feb. 1 article by Bloomberg News showing that ... school districts across Pennsylvania were charged excessive fees by banks and financial advisers that sold them interest-rate swaps. The schools were routinely unaware of the fees they paid for the contracts, some of which have backfired amid the credit crisis.

***

The derivatives sold to school districts are known as interest-rate swaps, in which two parties agree to exchange periodic payments whose amounts are based on an underlying bond issue. The contracts are usually paired with municipal bonds whose interest rates are reset sometimes daily. The derivatives are designed to protect customers against the risk of higher interest rates, though they also can be used to speculate on movements in global lending rates.

***

The fees banks earn on the derivative transactions are rarely, if ever, disclosed, even by advisers school districts hire to render an opinion on whether the amounts are fair, the story found.

The contracts are typically awarded without competitive bidding and have left school districts exposed to soaring interest rates as the financial crisis causes banks and investors to hoard cash. Jefferson County, Alabama, has been pushed close to bankruptcy by its swap and bond deals, while elsewhere local governments have been slammed by high interest costs or fees to break derivative deals.

The Butler, Pennsylvania, school district, about 40 miles north of Pittsburgh, in August paid JPMorgan $5.2 million to escape from a derivative transaction that would have forced it to sell the type of debt being shunned by investors. Last month, the district sued JPMorgan and financial adviser Investment Management Advisory Group Inc. for allegedly conspiring to hide the fees the bank earned on that transaction and requested that the SEC investigate. The Erie, Pennsylvania, school district filed a similar suit.

***

At least five former JPMorgan municipal derivatives-unit employees are targets of that investigation, which centers on whether banks and advisers conspired to overcharge local governments, public records show. Some two dozen securities firms and advisers have also been subpoenaed in that investigation. No charges have been filed.

***

In the last week of September, the rate on $55 million of floating-rate bonds issued by [one Pennsylvania] school district in 2007 jumped to 8.5 percent compared with 1.9 percent at the beginning of the month. Two swaps with JPMorgan on the bonds added another 6.51 percent, making the district's total rate on the debt 15 percent. The overall rate has since declined to 9 percent.
***
"The people who sold these came to us, not to assist us, but because they saw a way, with our money, to make money for themselves and we fell for it,'' said Stephen Antalics, 79. "Who's going to pick up the expense? It's going to come out of taxpayers' pockets. The people who created this will walk away Scot free.''

Thursday, October 16, 2008

Another Ticking Time Bomb: $71.2 Trillion Dollars in "Unallocated" Derivatives

According to the CIA Fact Book, the world economy was $54.62 (at official exchange rates) in 2007.

You've probably heard that the amount of credit default swaps (CDS) is greater than the world economy. This is confirmed by the Bank for International Settlements - the official organization which tracks derivatives - there were $57.9 trillion dollars worth of CDS as of December 2007 (Table 19).

But did you know that the amount of unallocated derivatives as of December 2007 was an additional $71.2 trillion dollars (Table 19)?

I'm not sure if anyone except the financial players themselves know what these unallocated derivatives are. But one thing is for sure: CDS and the unallocated derivatives have to be canceled or valued at a penny each, and regulated quickly.

Credit Default Vultures Turn Focus on Main Street

Wall Street firms have been getting clobbered for months by credit default swaps - bets that the companies will fail. Indeed, that is a large part of why Bear Stearns, AIG, Lehman and other giant companies failed.

Now, the CDS vultures are turning their focus on Main Street.

As Markit analyst Paul Davies wrote yesterday:

"Credit derivative markets turned their attention away from financial armageddon towards plain old recession on Wednesday morning, pushing up the costs of protection on the main indices for the first time this week."

(Markit is the leading analyst of European derivatives).

And Markit analyst Gavan Nolan wrote today:

"A recessionary mood is setting in, with the number of widening credits [i.e. increasing bets that companies will fail] in the Markit iTraxx Europe index outnumbering tightening names by 5 to 1 . . . Supermarket chains - often thought of as defensive names - were among the worst performers. The move was indicative of the negative sentiment affecting the market. More illustrious companies, such as luxury goods firm LVMH, also widened sharply."

In other words, the bet-makers think that the economic crisis has trickled down from Wall Street to Main Street, and are starting to wager real money that supermarkets and other Main Street businesses will fail. This, in turn, will make it more expensive for Main Street to do business, increasing the damage done by the financial crisis.

October 21st is Pay Day

October 10th was "D-Day", where D stands for "derivatives". That was the day that an auction for Lehman's $400 billion dollars worth of credit default swaps determined that sellers of swaps would have to pay out 91.375 cents on the dollar.

October 21st is "Pay Day", when those liabilities actually have to be paid by the counterparties to Lehman's CDS.

The Depository Trust and Clearing Corporation- one of the main companies which handles processing and payments of CDS - has estimated the total Lehman CDS payout at only $6 billion dollars.

However, a finance & banking analyst at RGE Monitor says that the real payout would, in fact, be much closer to $360 billion dollars, and certainly more than $200 billion dollars.

As leading economist and RGE Monitor writer Nouriel Roubini says:

"After AIG, monolines and hedge funds are likely to scramble to raise cash for Lehman settlement on October 21, while banks enjoy access to Fed liquidity. The notional payout is likely to amount to $360bn (91% of $400bn). AIG received $85bn + $37bn already to respond to immediate CDS margin calls after Lehman's default, 10 dealer banks opened a $70bn liquidity pool to accomodate novations of contracts with new counterparties--> hedge funds and monolines, insurers, SPV are likely to owe the remaining $50bn or so by October 21."

Bailouts Have Failed: Banks Are Still Hoarding Cash

Despite spending trillions of dollars on the bailout plans, banks are still hoarding cash.

Why?

Because:

Credit card defaults are skyrocketing, "forcing banks to hoard cash to protect against future losses"

They have huge derivatives liability (especially on credit default swaps), and they are trying to build up enough of a nest egg to be able to pay off their derivatives debts

They're stashing cash to try to ride out the financial crisis in general

Some are even using the money to buy up rivals

The feds handed out all of the dough without keeping any control whatsoever to make sure the banks used the money to lend out to Main Street.

The feds' hope that the banks would use the money to lend out to Main Street is about as smart as handing over your wallet to a robber based upon the hope that he'll pay your bills with it.

Wednesday, October 15, 2008

Is China Shielded From Derivatives?

Conventional wisdom is that China is shielded from the derivatives hurricane battering the rest of the world. For example, an article in the Financial Times says (partly tongue-in-cheek):

Asia . . . shunned the easy profits promised by the peddlers of toxic derivative products and fancy collateralised debt obligations. Its banks eked out a respectable living through the sensible business of lending money, its manufacturers through the old-fashioned practice of making things.

Is this true?

Well, China has in fact allowed currency derivatives, gold futures, and other types of plain vanilla derivatives trades.

And China apparently has had problems with a unique type of derivative called an "accumulator", betting against an inverted Euro curve. Indeed, when the Euro curve inverted, people demanded that the Chinese banks pay out on the derivatives, and they have simply refused to do so. See this and this.

Chinese banks have also purchased credit default swaps in Lehman and other American companies. As China Stakes reported on September 20th:

"China’s banking authorities have been rocked by Wall Street's financial crisis and are worried about the risks facing Chinese banks and financial institutions. Analysts repeat that the crisis has perhaps only begun and may worsen.

***

According to Caijing Magazine, Chinese-funded banks hold assets worth dozens of billions of dollars related to Lehman . . . . These assets include direct-held bonds, loans to Lehman, and bond-related derivatives with Lehman . . . ."

So China is clearly not totally insulated from foreign derivatives.

However, China did largely avoid the repackaged mortgage derivatives known as CDOs.

Moreover, China passed derivatives regulations in 2004 which aim to "specify qualifications, standardize trading behaviour, contain trading risk and ensure financial safety". It is not clear whether or not such regulations were effective (or even enforced). But given that the U.S. has not regulated derivatives at all, this is better than nothing.

So the bottom line is that China does have some derivatives exposure, but probably less than Western countries. As one blogger puts it "state owned Chinese Banks . . . have far less exposure to derivatives" than Western banks.

Hedge Funds' Derivatives Exposure and Margin Calls Driving Stock Market Crash

Leading economist Nouriel Roubini explains in bullet-point form how hedge funds are driving the stock market collapse. Take careful note of how credit default swaps are a key factor in the stock market sell-off, and how another type of derivative - "collateralized fund obligations" - may be the next shoe to drop:

Moreover, hedge funds are among the net sellers of credit protection in the $54 trillion credit derivatives environment and might be called to perform on their obligations wrt Lehman, WaMu, Kaupthing, etc.

Oct 1: There are dozens of hedge funds whose Lehman prime-brokerage accounts were frozen when the company filed for protection from creditors on Sept. 15. "One executive who used Lehman as a prime broker -- and who asked not to be named because his firm is private -- estimates that hedge funds had between $50 billion and $70 billion in Lehman prime-brokerage accounts." Moreover, hedge funds had pledged equity securities as collateral that Lehman then loaned to other investors under a practice known as rehypothecation - PWC says in that case "clients may cease to have any proprietary interest in them."

***

Perfect Storm for Hedge Funds: Short-selling rules were altered in a flash, the implosion of brokerages reduces the possibility for borrowing money, they’re stuck with delevering, and to top it off, many are getting hit with redemptions as September comes to a close, marking the end of the year for many funds. (MarketBeat) Redemptions could lead to fire sales and vicious circle.

FT Alphaville: Because so many firms hold similar positions, forced selling by one in response to redemptions can have ripple effects, forcing other funds to sell. More nimble hedge funds have sought to profit from the dynamic by taking short positions in securities known to be widely held by rivals --> HF adopt strategies to take advantage of competitors' unwinding positions

***

NYT: In the month of July, hedge funds experienced nearly $12 billion in outflows. September 30 is the deadline when many funds are scheduled to accept withdrawal requests for the end of the year. To pay back investors, some funds may be forced to dump investments at a time when the markets are already shaky thus fuelling a vicious circle--> some hedge funds are reported to block withdrawals.

Attari/Ruckes: Redemption feature causes fundamental maturity mismatch with borrowing short term and lending/investing long-term and illiquid e.g. in leveraged loans--> when redemptions increase, hedge funds have no other choice than liquidate assets thus fuelling a negative spiral. Evidence from leveraged loan market shows that this is unravelling is underway.

cont.: Rating agencies start to downgrade collateralized fund obligations (C.F.O.) which are the hedge fund equivalent of mortgage-backed securities: securities backed by hedge funds. Some have a 7-year lock-up period. While few in number, C.F.O.’s represent a broad swath of the $2 trillion industry.

***

About 350 were liquidated in the first half of the year and if the trend continues, the number of closures would be up 24 percent this year from 2007.

Seides (InvestorsInsight): Hedge funds are sellers of 32% of all CDS, insuring exposure of $14.5 trillion. Recent estimates indicate that the entire hedge fund market is approximately $2.5 trillion in net assets under management. Thus, hedge funds are bearing risk in excess of their ability to pay the piper if anything goes wrong--> risk might well land again with former investment banks and broker dealers.

Roubini: “one cannot rule out that some systemically important hedge fund may get into trouble with systemic consequences.”

For more on how hedge fund margin calls may be leading to the run on the stock market, see this.

Fire or Ice: Are We Headed Towards Hyperinflation or Deflation?

The most important debate among economists, high-level investment advisors and financial experts is whether the U.S. economy will heat up or cool down - that is, whether it will go into runaway inflation or deflation.

"Hyperinflation" is runaway inflation. This is what Germany experienced in the 1920s's, where people had to literally pay barrels full of German marks to buy a loaf of bread.

Deflation is what the U.S. experienced in the Great Depression, where most people had no one had money to spend, hire employees, or do much of anything else.

If we're going into hyperinflation, then investments like gold - which tend to hold their value in inflation - are best. In this case, the government should stop printing money like its Monopoly money.

If instead, we're going into deflation, then cash or treasury bills hold their value the best. Because prices go down in a depression, each dollar is worth much more, and is a good thing to hold onto for investing purposes. In this case, the government should spend more to get things going.

The Argument for Hyperinflation

Whenever governments inject a lot of money into the system, it tends to cause inflation.

Why?

Because there are more dollars chasing the same amount of goods and services, which increases demand while keeping supply the same, which encourages sellers to raise prices.

The government has been injecting trillions of dollars into the system with its series of bailouts and "loans". Indeed, a Bloomberg analyst says that the supposed $700 billion bailout alone could balloon to $5 trillion dollars. And there are many trillion dollars in numerous other bailouts, federal guarantees of Fannie and Freddie's liabilities, and "loans" to financial institutions through the Fed's Open Market operations.

Indeed, according to the Wall Street Journal:

"The U.S. central bank said Monday it would provide unlimited dollars to the European Central Bank, Bank of England and Swiss National Bank, allowing them to relieve pressure on commercial banks across their regions. "

Do dollars given abroad cause inflation inside the U.S.? Yes - because some proportion of those dollars will be spent by Europeans to buy stocks, commodities, goods and services within the U.S.

No wonder billionaire investor Jim Rogers says we are facing an "inflationary holocaust".

Thomas Wagner argues that the U.S. will experience massive inflation when China finally decides to dump the U.S. as a prized customer, and spends all of its stashed dollars buying U.S. commodities.

Steve Randy Waldman argues that inflation will win out, because Americans will not put up with deflation.

Even Warren Buffet says:

The policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

And Peter Schiff, the manager of 1 billion in funds, argues in his bestselling book Crash Proof that Americans should get all of their investments outside the U.S. (and into Europe and Asia), because America will suffer hyperinflation.

The Argument for Deflation

On the other hand, a new report shows that US retail sales are plummeting more than expected.

A second report shows that producer prices are falling.

A third report shows industrial production is plummeting (and see this).

A fourth report from the Federal Reserve also points to a slowdown. As summarized by MarketWatch:

A broad slowdown in economic activity was under way by the end of September, according to the latest report on economic activity released Wednesday by the Federal Reserve.

Consumer spending was down in most regions. Factory activity was also slow.

Even more worrisome was the downturn in "nonfinancial services," which has been the backbone of economic activity.

Residential real-estate and construction activity weakened or remained low, according to the report, known as the Beige Book. Most districts also reported slower commercial real-estate activity.

***

Labor-market conditions also deteriorated and wage pressures remained muted.

State and local governments are also facing huge budget shortfalls:

At least 29 states are facing huge budget shortfalls, and many are begging the federal government for bailouts of loans. For example, California - one of the world's largest economies - is begging the feds for billions

Local governments are also in trouble. For example, facing a huge hole in Chicago's current and upcoming budgets, Mayor Richard Daley announced on Tuesday a plan to partially shut down city government for six days

The federal government has liabilities exceeding $56 trillion dollars, according to the former Comptroller General of the United States, and so is hard-pressed to borrow much more from its foreign creditors, at least at cheap lending rates.

International trade and shipping is declining (for example, see this).

Banks are hoarding cash (instead of lending it out) to try to weather the financial crisis. Indeed, surging foreclosures may wipe out any reassurance to the banks caused by the Treasury's bailouts.

And Americans are spending much less and borrowing much less because of the economic crisis.

Agricultural commodities are falling off a cliff. And energy costs are declining.

Top officials from the Fed are warning of a deepening recession, leading economist Nouriel Roubini is calling a severe recession in the U.S., and the International Monetary Fund is forecasting U.S. and global recession. Indeed, even China is not immune.

All of this points to deflation and potentially depression, as most people have less available money, which means fewer dollars chasing the same goods and services, which means falling prices.

Indeed, as CNN notes:

"The credit market crisis, combined with the recent stock market declines and the plunge in home values over the past two years, is setting off the deflationary alarm bells for economists.
Paul Kasriel, chief economist with Northern Trust in Chicago, said most bouts of deflation have started with sharp declines in assets such as stocks or homes. That has tended to lead to a loss of value of collateral for loans and ultimately, large losses by lenders and very tight credit.
***
This week, San Francisco Federal Reserve Bank President Janet Yellen broke a taboo among Fed officials when she said in a speech that the economy "appears to be in a recession."

But in the same speech, she was reluctant to use the word deflation, even though she danced around the concept. She said falling commodity prices, job losses and weak demand for products were likely to "push inflation down to, and possibly even below, rates ... consistent with price stability."

MoneyWatch's Dominic Frisby thinks the depressed mood indicates we'll experience deflation - at least for a while - even though governments are trying to inflate their way out of deflation.

Richard Russell, who has published Dow Theory Letters since 1958, believes that we are on the eve of world deflation:

“From what I see, the markets are telling us to prepare for hard times, and a global spate of the worst deflation to be seen in generations. This is why gold has been sinking, this is why stocks have been falling - big money, sophisticated money, is cashing out, raising cash, preparing for world deflation.”

URALSIB writes:

"Under normal circumstances, an increase in dollars would hike inflationary risks but these are not normal circumstances. The crisis on the world’s credit markets is rapidly slowing the circulation of dollars which will offset the effects of an increase in global money supply. At the same time, the looming recession in the developed world is pushing down prices for raw materials, goods and services and creating deflationary rather than inflationary pressures."

Karl Deninger argues that deflation will win out because bankers profit more during deflationary environments. He thinks that Bernanke's talk about throwing money from a helicopter is just that - talk.

Oxford Economics professor John N. Muellbauer - an expert on U.S. inflation - wrote on October 10th:

The world is on the cusp of an inflation “turning point”, so the standard models are likely to go badly wrong. Recent research with better models suggests that the US inflation rate could become negative within the next 18 months.

No wonder people like Mike Shedlock of the popular website Global Economic Analysis, and investment advisor at Sitka Pacific Capital Management, argues that we are headed for deflation (Shedlock follows the Austrian school's definition of inflation and deflation; see this article by a former employee of the Federal Reserve Board of Governors and the Securities and Exchange Commission explaining the Austrian view of inflation and deflation).

The Argument for Stagflation

Some people argue that we will get severe stagflation. In other words, high inflation and economic stagnation occuring simultaneously and remaining unchecked for a period of time.
Some believe we might experience conditions that makes America's bout with stagflation in the 1970's look like a walk in the park.

Indeed, some argue that we may experience a hyperinflationary depression, where the economy experiences both hyperinflation and depression. For example, economist and leading inflation expert John Williams argues:

"By the time hyperinflation kicks in, the economy already should be in depression, and the hyperinflation quickly should pull the economy into a great depression. Uncontained inflation is likely to bring normal commercial activity to a halt."

Williams argues that - at least for a while - the entire monetary system will break down when this happens. Williams argues that, in the absence of a monetary system, people will turn to barter.

He makes the following specific recommendations:

With standard currency and electronic payment systems non-functional, commerce quickly would devolve into black markets for goods and services and a barter system.
Unlike Zimbabwe, the United States does not have widely available, for circulation, a back-up reserve currency for use in place of a highly-inflated domestic currency. The alternative here is in the traditional monetary precious metals. Gold and silver both are likely to retain real value and would be exchangeable for goods and services. Silver would help provide smaller change for less costly transactions.
Other items that would be highly barterable would include bottles of a good scotch or wine, or canned goods, for example. Similar items that have a long shelf life can be stocked in advance of the problem, and otherwise would be consumable if the terrible inflation never came. Separately, individuals, such as doctors and carpenters, who provide broadly useable services, would have a service to barter.

A note of caution was raised once by one of my old economics professors, who had spent part of his childhood living in a barter economy. He told a story of how his father had traded a shirt for a can of sardines. The father decided to open the can and eat the sardines, but he found the sardines had gone bad. Nonetheless, the canned sardines had taken on a monetary value.

Reserves of the Necessities of Life. Howard J. Ruff, who has been writing about these problems and issues since Nixon closed the Gold window, rightly argues that it will take some time for a barter system to be established, and suggests that individuals should build up a six-month store of goods to cover themselves and their families in the difficult times. Mr. Ruff covers this and many other excellent fundamentals in his new book How to Prosper During the Coming Bad Years in the 21st Century (see recommended further reading at the end of this report).

Financial Hedges. During these times, safety and liquidity remain key concerns for investments, as investors look to preserve their assets and wealth through what are going to be close to the most difficult of times.

In such a circumstance, gold and silver would be primary hedging tools that would retain real value and also be portable in the event of possible civil turmoil. Also, at some point, the failure of the world’s primary reserve currency will lead to the structuring of a new global currency system. I would not be surprised to find gold as part of the new system, structured in there in an effort to sell the system to the public.

Real estate also would provide a basic hedge, but it lacks the portability and liquidity of gold. Having some funds invested offshore — outside of the U.S. dollar — would be a plus in circumstances where the government might impose currency or capital controls.

While equities do provide something of an inflation hedge — revenues and profits get expressed in current dollars — they also reflect underlying economic and political fundamentals. I still look for U.S. stocks to take an ultimate 90% hit, peak-to-trough, net of inflation, during this period [Williams wrote this in April 2008]. Where all stocks are tied to a certain extent to the broad market — to the way investors are valuing equities — such a large hit on the broad market will tend to have a dampening effect on nearly all equity prices, irrespective of the quality of a given company or a given industry."

Williams wrote the above in April, but on October 16th he wrote: "Inflationary Recession Remains Intact and Intensifies", so he does not think that the bailouts and other government actions are helping to prevent an inflationary recession.

Personally, I hope and pray that Williams is wrong, but I have the gut feeling that he is right.

Of course, if the money system does collapse, we can use that as a window of opportunity to build a better world.

Listen to the following 2 debates between leading some leading proponents of inflation and deflation here and here.

Tuesday, October 14, 2008

Feds Give Hundreds of Billions to Banks, But Get Only NON-VOTING Shares in Return

Paulson's original bailout plan was so ill-conceived, and the markets reacted so poorly, that he had to copy the European model of buying shares in banks in return for injections of capital. As Kenneth S. Rogoff, a professor of economics at Harvard, said, “The Europeans not only provided a blueprint, but forced our hand”.

But the European governments get voting shares in return for bailing out their banks. With voting shares, the governments could force the banks to operate in the best interests of the country, make sure they loan to consumers and small business, and take other action necessary to get their economies back on their feet.

With voting rights, the European governments can also insist that the banks stop buying and selling risky derivatives, which are one of the root causes of the economic crisis.

In contrast, America's bank buy-out gives the government non-voting shares. In other words, the feds can say pretty please, but they have no voting power.

This flies in the face of U.S. history as well. As the Wall Street Journal notes:

"During the Depression, the Reconstruction Finance Corp. bought billions of dollars of preferred stock that came with voting rights. The government then barred banks from paying dividends until they had bought out the government's stakes. This time, the government stakes are nonvoting and the dividend restrictions are less onerous."

Without voting rights, the banks can keep on doing the same things that got them (and our economy) into trouble in the first place.

Update: As an article in Bloomberg entitled "Paulson Lacks Leverage to Compel Banks to Put New Cash to Work" puts it:

"The equity stakes the government is purchasing ... come with no guarantee that the investments will spur lending and unfreeze credit markets. Nor do they give the government board seats or any other leverage to demand that that the firms actually use the money to help the economy.
``The truth of the matter is, they can't put a gun to their head and say you have to lend this money,'' said Charles Horn, a former official at the Office of the Comptroller of the Currency, part of the Treasury Department, and now a partner at the Mayer Brown law firm in Washington.

Treasury officials acknowledge they can't force banks to get the taxpayer money into the hands of their customers. Instead, officials are betting that the government's investment will create conditions where banks have a greater incentive to earn profits from lending than to hoard money to shore up their balance sheets.
***
Subtle government pressure on banks may not make much difference . . . the U.S. won't take a major share of the banks they invest in. Also, the Treasury has said it won't seek voting rights when it buys stakes."

NSA Tapped 9/11 Hijackers' Phone Calls for 2 Years - Inside the U.S.

I've previously pointed out that the U.S. government heard the 9/11 plans from the hijackers' own mouth. Most of what I wrote about involved the NSA and other intelligence services tapping top Al Qaeda operatives' phone calls outside the U.S.

However, it turns out that the NSA was also tapping the hijackers' phone calls inside the U.S.

Specifically, hijackers Khalid al-Mihdhar and Nawaf al-Hazmi lived in San Diego, California, for 2 years before 9/11. Numerous phone calls between al-Mihdhar and Nawaf al-Hazmi in San Diego and a high-level Al Qaeda operations base in Yemen were made in those 2 years.

The NSA had been tapping and eavesdropping on all calls made from that Yemen phone for years. So NSA recorded all of these phone calls.

Indeed, the CIA knew as far back as 1999 that al-Mihdhar was coming to the U.S. Specifically, in 1999, CIA operatives tailing al-Mihdha in Kuala Lumpur, Malaysia, obtained a copy of his passport. It contained visas for both Malaysia and the U.S., so they knew it was likely he would go from Kuala Lumpur to America.

The above information comes from James Bamford, the Washington Investigative Producer for ABC's World News Tonight with Peter Jennings for almost a decade - where he won a number of journalism awards for his coverage national security issues - whose articles have appeared in dozens of publications, including cover stories for the New York Times Magazine, Washington Post Magazine, and the Los Angeles Times Magazine, and is the only author to write any books (he wrote 3) on the NSA.

Israel Companies Handle Sensitive U.S. Spying Data

You might take comfort in the assumption that - if the U.S. government is spying on Americans - at least patriotic Americans are handling our sensitive information.

However, at least two foreign companies play key roles in processing the information.

Specifically, an Israeli company called Narus processes all of the information tapped by AT &T (AT & T taps, and gives to the NSA, copies of all phone calls it processes), and an Israeli company called Verint processes information tapped by Verizon (Verizon also taps, and gives to the NSA, all of its calls).

Even worse, two top Verint executives have already pled guilty of fraud and various felonies. And the founder and CEO of Verint is on the run. He's literally a fugitive from justice hiding out in Namibia.

The above information comes from James Bamford, the Washington Investigative Producer for ABC's World News Tonight with Peter Jennings for almost a decade - where he won a number of journalism awards for his coverage national security issues - whose articles have appeared in dozens of publications, including cover stories for the New York Times Magazine, Washington Post Magazine, and the Los Angeles Times Magazine, and is the only author to write any books (he wrote 3) on the NSA.

Kids Decide Who Lives or Dies in Iraq

You probably assume that high-level military and intelligence officers decide who gets thrown into the Abu Ghraib prison to get tortured, and whose house gets bombed in Iraq.

That's not how it works.

It turns out that kids fresh out of high school decide. Specifically, young people with only sixty-three weeks of training in in standard Arabic at Monterey, California make these life-or-death calls. They have usually have no training in Iraqi dialects, and don't have any real-world experience.

After their stint at Monterey, they are transferred to Fort Gordon, Georgia, where they work for the NSA. In that capacity, they listen into phone calls between Iraqis, and decide who lives, who gets tortured, who dies:

"it’s these people here that are sitting in this windowless room in the state of Georgia, near Augusta, Georgia, that are listening to these conversations in Iraq, in Baghdad, and they’re making instantaneous decisions on whether somebody is telling the truth or not. So they’re writing out these—they’re doing these transcripts, and then they’re writing these little comments saying this person here, Ali, is saying he’s going to deliver a load of melons to his cousin Mohammed tomorrow. And then you have somebody making a decision: is he telling the truth, or isn’t he? Are these melons, or possibly could they be IEDs? And if a person says, 'You know, I don’t think he’s telling the truth,' there’s a good chance that that house could be blown up or that person could be put in Abu Ghraib, or whatever."

Monday, October 13, 2008

Helicopter Gordon, Helicopter Nicolas and Helicopter Angela

Fed chairman Ben Bernanke is nicknamed "Helicopter Ben" because he said years ago he would drop money out of a helicopter to fight deflation. And the U.S. has spent trillions in the last couple of months to try to artificially stop deflation.

Now, the European Union is now spending $2.5 trillion dollars on their bailout as well, including hundreds of billions each by British prime minister Gordon Brown, German chancellor Angela Merkel, and French president Nicolas Sarkozy.

Helicopter Gordon, Helicopter Angela and Helicopter Nicolas have now joined Helicopter Ben in throwing money at the problem, instead of fixing the real problems with the world's economy, like derivatives.

The Economy: Good News and Bad News

The stock market has reacted favorably to the European and American emergency economic plans launched over the weekend, with its biggest 1-day rise ever.

But as everyone knows, the stock market doesn't give the real picture . . . it only provides a superficial snapshot of investor mood (and - perhaps - a shove from the PPT).

So what is really going on underneath the surface?

Good News

BNP Paribas reports that the weekend efforts have lowered the inter-bank lending rate (LIBOR), the main indicator of a "liquidity crisis". As summarized by economist Nouriel Roubini:

Credit spreads start to ease:
- O/N USD LIBOR: 246bp down from 463bp (17bp pre-crisis);
- TED spread (3m LIBOR-T-bill spread) slightly down to 456 from record 463 earlier on Oct 13 after Fed announces unlimited USD liquidity (17bp pre-crisis);
- 3M USD LIBOR-OIS slightly down to 359 from 364 (10bp pre-crisis);
- 3M EUR LIBOR-OIS narrows to 182bp from 207 (10bp pre-crisis)

Moreover, the cost of credit default swap protection dropped for many European banks:

"Royal Bank of Scotland and Halifax-Bank of Scotland were two of the biggest improvers in credit derivatives markets Monday morning even as shares in both tanked after the finalisation of the UK government plan to inject both groups with fresh capital.

The falling cost of protection for most leading banks and insurers in Europe helped the iTraxx investment grade index to rally sharply, taking 6.3 basis points of the spread to 131.8bp, according to data from markit Group. This mimicked the wave of relief that swept stock markets broadly in Europe, although the dilutive effect of the measures on RBS and HBoS shareholders saw their stocks pummelled.

However, RBS led the way in credit default swap markets with its cost of protection dropping about 44.5bp to about 144.2bp, according to Markit, which means it costs €144,200 annually to insure €10m worth of debt over five years. UBS was next, 31.3bp lower at 185bp, while HBoS followed 31.2bp tighter at 155.8bp."

This shows that the bet-makers are somewhat reassured by the weekend moves, and believe that the risk of failure of these banks has lessened somewhat (it is not clear how much the nationalization of the Royal Bank of Scotland and other institutions affected the credit default swap rates).

Bad News

On the other hand, nothing has fundamentally changed concerning America's underlying economic problems.

This week, reports on retail sales figures, industrial production and housing starts will be released, and they will all be bad.

America is already deeply in debt and the various bailout schemes will increase our debt by two or more times.

America is losing its status as the world's reserve currency.

We have no real manufacturing base, haven't saved anything, haven't fixed the derivatives nightmare, and haven't decided to bite the bullet and go back to sound policy or sound money.

And forget the housing meltdown, there could be wholly-unrelated additional meltdowns on the horizon (see this for example).

Forecast

Because the fundamentals are getting worse, rather than better, my guess is that today's stock market rally is a several week long bear market bounce, and that there are more crashes ahead.

Investor euphoria over the flooding of money into the system by central banks will eventually give rise to disillusionment as the fact that you cannot patch a busted dam with water becomes clear.

Sunday, October 12, 2008

Europe to United States: You're On Your Own!

Bush begged the G-7 to help fix America's economic meltdown. Like a drowning man trying to hang onto the back of a good swimmer, he pleadingly said "We're all in this together."

But nothing concrete came out of the G-7 meeting, as the European countries weren't willing to slit their own throats to help the U.S. Instead, right after the G-7 broke up, the European countries met in Paris and agreed to concrete proposals to protect Europe from the economic crisis.

In response, Paulson begged for a joint response:

"Appealing for global unity in a time of crisis, Treasury Secretary Henry Paulson said Sunday that isolationism and protectionism do not offer a way to contain the spreading damage."

Will Europe be able to save itself? Stay tuned for updates . . .

Saturday, October 11, 2008

The Next Derivatives Bloodbath: Insurance and Auto Makers

This essay is about future derivatives problems. But before we look to the future, let's recap what happened yesterday, to gain some perspective.

Post-Game Analysis on Lehman

As the Washington Post writes today about yesterday's auction of some $400 billion dollars in credit default swaps for Lehman:

'If we see defaults from the standpoint that protection sellers don't pay up, then we're going to have a huge problem in the market,' Telpner said. 'But we don't have any explicit evidence indicating that sellers ultimately are not going to be able to pay the amounts owed to buyers.'

And the Sunday Times writes today:

"The valuation leaves the insurers of the debt a bill of about $365 billion. It is not clear whether the insurers, which are required to settle the bill in the next two weeks, will be able to pay – a development that could further undermine increasingly stressed capital markets."

Will the "insurers" of Lehman's CDS be able to pay up? The big bank insurers to the Lehman swaps have been hoarding cash, and so can presumably pay.

The bigger question is whether the hedge funds - such as Citadel - will be able to pay up or will go belly up. The next couple of weeks will tell.

But even if no companies are wiped out by their Lehman CDS obligations, it is clear that yesterday was, indeed, a traumatic day for the world economy. As today's Sunday Times article put it:

"Lehman’s corporate debt default promises to increase the stress across global credit markets. Sean Egan, of the Egan-Jones ratings agency, said: 'This is a killer. Lehman said a month ago that it was in terrific shape and now you can’t even get ten cents on the dollar for its debt.
'It underscores the deep structural flaws in our financial system, knocks confidence in the financial markets and raises the cost of capital. It also demonstrates that we are experiencing not only a crisis of confidence, but a crisis.'"

Next Up: Automakers

The next phase of the derivatives wipeout will hit insurance companies and auto makers.

Initially, Standard and Poor's is saying that GM and Ford may very well go bankrupt.

As of 2004, "GM was among the five companies most frequently included in credit-derivatives contracts in 2004, along with Ford Motor Co., France Telecom SA, DaimlerChrysler AG and Deutsche Telekom AG, Fitch said."

Indeed, according to Fitch's, as of 2004 and 2005, there were perhaps billions of dollars in GM credit default swaps traded per day. Fitch's noted that "GM CDS are the second most included named in synthetic collateralized debt obligations (CDOs), behind Ford, as disclosed in several Fitch analyses of the CDS market."

On October 3rd, Bloomberg wrote:

General Motors Corp. saw its credit default swaps rise to a record after the automaker said Sept. 19 it was going to draw down the remainder of a $4.5 billion revolving credit line to preserve cash because of the instability in the financial markets. Detroit-based GM, the largest U.S. carmaker, has lost almost $70 billion since 2004.

As of June of this year, "The cost to insure GM's debt with credit default swaps rose to 33.5 percent upfront . . . plus annual payments of 500 basis points" and "Ford saw its credit default swap spread increased to 30.5 percent upfront, plus 500 basis points annually".

According to financial advisor Mike "Mish" Shedlock, there are appromixately one trillion dollars of credit default swaps for GM.

If GM goes bust, there would be huge credit default swap liability. While I have seen no estimates of the current amount of Ford CDS, it is probably also quite high, given that it was one of the most common CDS issued in 2004.

Insurance

The insurance companies are also getting hit hard by CDS.

The October 3rd Bloomberg article states:

"The cost to protect against default by Hartford, Prudential Financial Inc. and MetLife Inc. soared to records and shares fell yesterday on speculation that turmoil in financial markets may be spreading to insurance companies."

As an article at Naked Capitalism explains:

First it was banks and securities firms, and now the focus of worry has widened to include insurance companies. Reader John referred us to a Reuters article that MetLife credit default swaps are now trading on an upfront basis, which means buyers of protection against the default of MetLife bonds must make an upfront payment as well as agreeing to periodic fees. Only companies seen as being in serious risk of failure trade on an upfront basis. Another story shows similar pricing of XL Capital CDS.

Concerns about MetLife became serious when the company announced it was writing down its investment portfolio and withdrew its 2008 earnings forecast.

From Reuters:
Metlife Inc's credit default swaps on began trading on an upfront basis on Thursday, indicating perceptions that its credit quality is considered distressed.

The cost to insure Metlife's debt rose to around 10.5 percent the sum insured as an upfront sum, or $1.05 million to insure $10 million in debt for five years, in addition to annual premiums of 5 percent, according to Markit Intraday.

The swaps had closed on Wednesday at a spread of around 717 basis points, or $717,00 per year for five years to insure $10 million in debt, according to Markit.
The second Reuters story:
Credit default swaps on XL Capital Ltd [an insurance copmany] began trading on an upfront basis on Thursday, and its stock price plunged more than 37 percent.

The cost to insure XL's debt rose to around 12.5 percent the sum insured as an upfront sum, or $1.25 million to insure $10 million in debt for five years, in addition to annual premiums of 5 percent, according to Phoenix Partners Group....

The swaps had opened at a spread of around 750 basis points, or $750,00 per year for five years to insure $10 million in debt, according to Phoenix.

Instead of being the end of the derivatives bloodbath, Lehman was probably just the beginning.

Friday, October 10, 2008

Who Got Nailed on Lehman's Credit Default Swaps?

We know that issuers of Lehman's credit default swaps will have to pay out hundreds of billions of dollars. But who will actually have to pay that out?

The Times of London writes today:

"About 350 banks and investors are thought to have insured an estimated $400 billion of Lehman’s debt through complex derivatives, known as credit default swaps. These include Pacific Investment Management, the manager of the world’s largest bond fund, Citadel, the US hedge fund, and American International Group, the insurer that the US Government recently bailed out with two loans totalling about $123 billion."

In addition, JP Morgan gave the following chart of European banks' counterparty risk on Lehman a couple of weeks ago:

Those banks apparently also got nailed.

The Royal Bank of Scotland probably also got creamed. An article in the Guardian states:

"[An analyst] singled out Barclays and Royal Bank of Scotland as being most exposed among the UK banks to the credit derivatives market. Both have bought and sold, in roughly equal measure, £2.4 trillion of such contracts. [He] believes Barclays and RBS are highly likely to be prominent among those required to pay out on Lehman CDSs."

Hedge funds also got creamed.

And probably some of the big American banks and investment houses (like JP Morgan, Citi and Bank of America) and insurers with CDS exposure listed here also got nailed.

Some sovereign wealth funds may have also taken a hit.

Derivatives Bloodbath

The auction of Lehman's credit default swap derivatives (CDS) occurred today. The final price bid for Lehman's CDS was 8.625.

That means that holders of Lehman CDS will have to pay 100 minus 8.625, or 91.375 cents on the dollars.

That equals around $365 billion dollars (since there are around $400 billion in CDS for Lehman).

This is even worse than expected.

As an article on CNBC puts it:

"News that the settlement price might be lower than the 13 cents Lehman bonds have been trading at may have rattled the financial markets today. The theory being that if the sellers of insurance of Lehman bonds had to make a larger payment to protection buyers than previously thought, this might force the protection sellers to liquidate assets (of all kinds and in all asset classes) to raise money for the final settlement."

In related news, Bloomberg writes today:

"Credit-default swap indexes around the world soared today on concern the deepening credit crisis will trigger company and bank failures."

If the government is going to stick its nose in the free market, it should deal with derivatives - the 800 pound gorilla.

And see this regarding who will be most hurt by the CDS.

When the Liars Open Their Mouths, The Market Tanks

I've previously argued that the economy won't improve until the liars who got us into this mess are gone.

Seems like even mainstream news sources are starting to agree:

CNBC is running a clip called The 'Paulson' Effect—Markets Slide When He Speaks

The Washington Post's Dan Froomkin writes:
"When it comes to the current financial crisis, it's become pretty clear that an appearance by President Bush doesn't calm nerves. It rubs them raw.

***

The president seems checked out. His approval ratings are in the toilet. His credibility is shot. He's arguably responsible for this mess in the first place. And his presence and his words have led to more fear and panic, not less."

CNN is running an article with the following quote:
"Analyst Anne Mathias with the Stanford Group said for Bush, trying to reassure Americans and the markets is problematic on several levels.
'The first part is that he's really not very popular right now. ... The second part is that he is not very fluent in discussing these kinds of issues,' Mathias said, adding, 'it's a really dicey question because the markets are so reactive that if you say the wrong thing it's easy to make the problem much worse.'
Mathias says the third difficulty for Bush is credibility. 'There are many who oppose him or are upset with the White House who put the blame for us being in this position at his feet,' she said. 'It's difficult to be a credible part of the solution when many people think you are part of the problem.'

ABC news noted that during Bush's speech today trying to convey reassurance about the economy, the Dow went down 107 points

Bloomberg ran an article noting:
"Comments by Bush and members of his administration haven't calmed markets since the Senate cleared the legislation on Oct. 1. Since then, Bush has spoken publicly or issued statements about the rescue plan seven times, and the Dow Jones Industrial Average declined by 20.8 percent. Stocks sank again this morning, capping the worst week ever for the Standard & Poor's 500 Index"

Bush, Cheney, Paulson, Bernanke, Pelosi, Frank and the whole rest of them are the problem.

Thursday, October 9, 2008

Banks Hoarding Cash to Pay Derivatives Liabilities

Tomorrow, the auction for Lehman's credit default swaps will be held, and the final result will probably be that that holders of credit default swaps will have to pay around $360 billion dollars (see below). That's for Lehman alone. Derivatives exposure due to other failed businesses is even higher.

This is why Wall Street firms and banks have been hoarding cash. As the Financial Times wrote on October 7th:

Banks are hoarding cash in expectation of pay-outs on up to $400bn (£230bn) of defaulted credit derivatives linked to Lehman Brothers and other institutions, according to analysts and -dealers.

***

Michael Hampden-Turner, a credit strategist at Citi, estimates that there could be $400bn of credit derivatives referenced to Lehman.

These contracts will be settled on Friday [October 10th], and with the recovery value on Lehman bonds currently estimated at about 10 cents on the dollar, the pay-out by banks and other sellers of credit protection on Lehman could reach a gross $360bn.

As Fox News puts it:

Massive positions are just starting to be unwound in the credit default swaps market as tens of billions of dollars worth of these contracts are now getting settled in the aftermath of several high-profile flops.

Banks are hoarding cash in expectation of expected payouts on anywhere from $200bn to $1 tn–no one knows the amount, adding to volatility–for defaulted credit derivatives linked to the collapse of Lehman Brothers, the government’s seizure of mortgage giants Fannie Mae and Freddie Mac, the government’s rescue of American International Group, and the failure of Washington Mutual.

And as leading economist Nouriel Roubini wrote today in an article entitled "What Is Really Bothering Markets: Lehman's CDS Settlement on October 10 With A $360bn Expected Payout" (after quoting the above-described Financial Times articles):

Lehman was one of the top ten counterparties in the unregulated $62 trillion OTC credit default swap (CDS) market. As Lehman defaults, tens of billions worth of hedges become worthless and can only by renewed with a new counterparty at much higher premiums (i.e. CDS spreads). Moreover, Lehman bondholders will only receive about 10 cents on the dollar in exchange for defaulted Lehman bonds and protection buyers will have a claim on 90 cents on the dollar in the hope that protection sellers will be able to perform.

Systemic event: S&P acknowledges that Lehman's default was key to AIG's demise with spillover to Europe, as well as to money market funds breaking the buck with spillover to the commercial paper market. Hedge funds's brokerage accounts have been frozen and they might also be exposed to derivatives trades.

Does Buying Into Banks Mean Buying into their Huge Derivatives Exposures?

The federal government is considering buying ownership interests in a bunch of U.S. banks, including both "healthy" and unhealthy banks.

Citibank and Bank of America are considered two of the "healthiest" banks in the U.S.

But Citibank owns $37 trillion dollars in derivatives, including $1.5 trillion in toxic credit default swaps. And Bank of America holds $39 trillion dollars in derivatives, including $1.3 trillion in credit default swaps. (See this).

If the government bought into them, it could put taxpayers on the line for trillions of dollars in derivatives exposure.

Therefore, I am wholly opposed to any purchase of stakes in banks which does not expressly shield U.S. taxpayers from the banks' derivatives exposures.

I know that that the above figures are "notional value", and that the "actual" figures might be more like tens or hundreds of billions. But remember that these turkeys have been off the books in the "shadow banking system". And remember that even the derivatives traders themselves can't keep track of all of the trades which have been made. So, in reality, no one knows the true exposure from derivatives.

I also know that some people will claim that the U.S. government will buy equity interests, and not incur liabilities. However, the whole purpose of the bailout is for taxpayers to incur liabilities and take them off the backs of the banks. Moreover, even equity owners can be held liable when the "corporate veil is pierced" due to inadequate capitalization.

Wednesday, October 8, 2008

Please Spread This Video Virally

Please spread this half-hour interview with Naomi Wolf virally:

Did John Negroponte Help Create the Economic Crisis?

John McCain said that head of the SEC should be fired for his bungling of oversight of corporate securities. Indeed, the head of the SEC himself admitted that oversight flaws fueled the economic collapse.

However, trying to blame the lack of oversight solely on a "rogue" SEC is like trying to blame the White House torture policy on "a couple of bad apples".

Why?

Obviously, this administration has exerted tremendous control over all of its agencies.

More importantly, as Business Week wrote on May 23, 2006:

"President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations."

Negroponte was a key figure in the illegal Iran-Contra scheme. Yet he and his successors - in the name of "national security" - could tell companies such as AIG, Lehman, Bear Stearns, Washington Mutual, Wachovia, etc. that they could use phony accounting and keep the SEC in the dark.

How many times did Mr. Negroponte and the next intelligence czar nod and wink in this way? Which companies did they give a pass to? What "national security" crisis prompted them to exercise these extraordinary powers? And who in the White House and Congress ordered, signed off on, or who knew of, their actions?

Who's Got the Biggest Derivatives Exposure?

For years, I've heard rumors about which banks and Wall Street investment firms hold what amount of derivatives. Well, I've found the official numbers.

Specifically, the following table shows the top 25 American commercial bank and trust company holders by notional value of all derivatives:

(click for larger image).

The following table shows the top 25 American commercial bank and trust company holders by notional value of credit derivatives, including credit default swaps:

(click for larger image).

This information comes from the official Comptroller of the Currency Administrator of National Banks' Quarterly Report on Bank Trading and Derivatives Activities for the Second Quarter of 2008. Past reports can be found here.

The British Bankers Association also reports on the largest types of buyers of credit default swaps:

(click for larger image).

And the BBA reports on the largest types of sellers of credit default swaps:

(click for larger image).

Moreover, in 2006, Fitch reported by name the biggest counterparties in credit default swap contracts.

(click for larger image).

This information comes from a 2007 report from the International Swaps and Derivatives Association.

Unofficial sources fill in some of the missing details. For example, economist Nouriel Roubini shows that hedge funds have large exposure in both credit default swap and collateralized fund obligations type derivatives .

And an article in the Guardian quotes an analyst as saying that "Barclays and Royal Bank of Scotland [are] most exposed among the UK banks to the credit derivatives market. Both have bought and sold, in roughly equal measure, £2.4 trillion of such contracts."

Sovereign wealth funds also hold alot of derivatives. For example, this chart shows that sovereign wealth funds have more than one trillion dollars in single-name CDS instruments.

See also this for foreign banks that were large counterparties for Lehman CDS.

How To Solve the Financial Crisis: Get Rid of the Liars

After 7 years of lies from Bush, Cheney, Pelosi and the gang, people have stopped believing them.

As Ralph Waldo Emerson said:

"Who you are speaks so loudly I can't hear what you're saying."

Its like a thief who has been arrested 5 times for burglary. Even though he says all the right things to the judge at sentencing, the judge is still going to throw the book at him.

If the thief is appointed to head a government commission on corruption, do you think people will have confidence in the commission or its proposed actions? (Paulson was the head of Goldman Sachs when they sold huge sums of mortgage-backed securities called collateralized debt obligations, which are part of what caused the financial meltdown).

Paulson, Bernanke, Busy, Pelosi and the gang may be saying nice things about fixing the economy, shoring up the financial system and helping American citizens, but people don't believe them anymore. They've been proven liars one too many times.

While the Bush administration is doing everything in their power to prop up the stock market until they are out of office (or at least until after the election), the problem is them: Americans and people everywhere distrust Bush and congress so much that they see through every superficial magician's trick that might have worked when people had a less jaundiced eye.

People have woken up to the scam. Americans are no longer quite so gullible about how "good" their government is. They hate Bushco and they hate Pelosico.

Who they are speaks so loudly that we can't hear what they're saying.

The only thing that can restore confidence in the economy and the financial system is to replace the whole lot of them (tar and feather them) with honest leaders who will do what's best for the people.

Forget the "toxic debt" that the talking heads keep referring to. The only way to restore confidence is to get rid of the "toxic leaders" who caused the mess.

And while we're at it, we need to replace the systems which are rotten to the core with transparent and honest systems which the people have control over. See also this.

Tuesday, October 7, 2008

You've Bin Conned

A lot of us said that Bin Laden was being used as a prop in the propaganda effort to promote the "war on terror".

We said that Bin Laden might very well be dead, with the U.S. covering it up so Americans remain scared. If he wasn't dead, we said that the U.S. is intentionally letting him run free in order to keep their "boogeyman", in order to sustain fear among Americans (so they'll support the "war on terror").

Well, CBS interviewed one of the top special ops commandos who confirms that special forces had Bin Laden in their sites and could have taken him out, but the political "higher ups" gave a thumbs down.

And a highly-regarded former CIA officer says “Of Course Bin Laden is Dead”.

Ladies and gentlemen, you've Bin conned.

Bailout Has Already Been Proven Worthless (Can We Cancel It Now?)

As many people warned (including me - here and here), the bailout and the "loaning" of trillions of dollars through the Fed's Open Market Program will not free up liquidity because the banks are hoarding cash.

Bloomberg confirmed this today in an article entitled "Money-Market Rates Climb as Banks Hoard Cash, Crisis Deepens", which starts with these words:

Money-market rates climbed worldwide as banks hoarded cash on speculation the seizure in credit markets is deepening and may prompt more financial institutions to collapse.

As I also warned, the bailout would not reassure companies or investors. Just look at the stock market in the U.S. (or any other country) and you'll see it hasn't reassured anybody, except a couple of Paulson's closest buddies who stand to make billions from it.

Can we cancel the bailout now? It has already been proven to be totally worthless in solving our economic problems.

Congress can enact a new law rescinding the bailout.

If you think its not politically realistic to cancel the bailout now that it has been passed, let me ask you this . . . is it politically realistic to increase the chances that we will be hit with a great depression? Or that the county be bankrupted? Because that's what top economists and government officials are warning the bailout could do.

Monday, October 6, 2008

Friday is D-Day

Forget the stock market gyrations. Forget Bernanke and Paulson's ineffective, unconstitutional schemes.

Friday's auction for Lehman's credit default swaps (CDS) is much more important.

Why?

Well, if banks are reassured by the CDS auction, it could do more to free up frozen capital than all of the Fed and Treasury's ill-conceived plans put together.

As Bill Gross, head of $721 billion dollar fund Pimco, says:

Credit markets are based on trust and when there is no trust, markets can freeze up . . . . Imagine yourself at the drive-thru ordering a Big Mac. At one window you order and pay, at the other – 20 feet ahead – you pick up your lunch. What if you thought that after paying at the first window, your 1000 calorie sandwich might not be waiting for you a few seconds later. You might not pay; business as usual might not take place. That is what is happening in the credit markets. They are frozen in “McFear.” After the failure of Lehman Brothers – an investment bank which took orders at one window, and promised to pay at another for trillions of dollars of those CDS, swaps, and other derivative “sandwiches” – institutional investors said that they’d prefer to stay at home and have peanut butter instead of risking their money ordering a Big Mac. And so their money goes into that figurative mattress instead of the register at McDonald’s, people are laid off, profits go down, bank loans become less available, our economic center cannot hold.

An auction occurred today to determine the value of Freddie and Fannie's CDS. While there were approximately $500 billion in CDS written against Freddie and Fannie, those who issued CDS will be repaid between 91.5 percent and 99.9 percent of protection they sold. In other words, the issuers of such CDS will only have to pay out between .1 and 8.5 cents on the dollar.

For a rough, back-of-the-envelope calculation, let's split it down the middle and call it 95% of $500 billion, which means that the issuers of Freddie and Fannie CDS will only have to pay out about 5 cents on the dollars, or about $25 billion total. That's a lot of money, but not catastrophic.

On the other hand, "investors who wrote protection on a Lehman default will have to pay out between 81 and 85 cents on the dollar."

No one has disclosed how many billions of dollars in Lehman CDSs are out there. And no one knows the exact payout amount which will be determined at Friday's auction.

But it is known that "Lehman was one of the 10 largest parties participating in credit default swaps, the New York Times reports. The company’s most recent quarterly filing said it bought and sold $729 billion in derivatives with a fair net value of $16.6 billion." And a lot of people bought CDS betting on Lehman's failure in September.

D-Day

So Friday is D-Day, where "D" is for "derivatives".

If there are a lot of Lehman CDS out there, and if the auction price comes in high, it could greatly exacerbate the global economic crisis no matter what Bernanke and Paulson do. On the other hand, if there aren't that many CDS out there, or if the price comes in lower than people expect, it would be a huge sign of stability in the CDS market that could reassure financial institutions and investors worldwide, which could "free up liquidity" and help avert a depression (no matter what Bernanke and Paulson do).

Washington Mutual's CDS auction is October 23rd, and we might not have a final answer on how big the CDS crisis is until then.

Friday, October 3, 2008

There's No Difference Between Martial Law and the Threat of Martial Law

If a bully threatens to beat up a skinny kid if he doesn't give him his lunch money, and the bully doesn't have to follow through because the kid does fork it over, does that mean that the aggressive kid isn't a bully?

Of course not. He's a bully because he threatened to beat up the skinny kid and used coercion to get his way.

Well, Congressman Sherman said that congress was threatened with martial law this week. Specifically, he says that Congress was told martial law would be imposed if they didn't pass the Paulson bailout proposal.

Martial law means that the separation of powers which the Founding Fathers enshrined in the Constitution are destroyed, and an all-powerful executive branch calls the shots.

Is the threat of imposing martial law any different than actually imposing it?

No. Congress is just like the skinny kid.

Just because it forked over $700 billion or more in our lunch money based upon coercion by the thugs in the executive branch doesn't mean that the thugs are still following the separation of powers or anything else in the Constitution.

Remember that, for years, Congress has operated under "martial law" provisions which force Congress members to vote on legislation without having time to adequately read and review it.

Remember also that the U.S. has been in a declared state of national emergency for 7 years, and normal constitutional provisions were probably long ago superseded.

As University of California Berkeley Professor Emeritus Peter Dale Scott has warned:

"The systems of checks and balances established by the U.S. Constitution would seem to be failing.

To put it another way, if the White House is successful in frustrating [Congress' requests], then [the declared state of emergency] has arguably already superseded the Constitution as a higher authority."

And remember that U.S. troops are being stationed inside the U.S. to suppress "civil unrest".

Whether or not there is martial law in name, there is martial law in fact.

Thursday, October 2, 2008

Former Head of Fed's Open Market Operations Says Bailout Might Make Things Worse

Another key insider has said that the Paulson plan might make things worse. Specifically, the former head of the Fed's open market operation - the key Fed agency which has been loaning hundreds of billions of dollars to Wall Street companies and banks - was quoted in Bloomberg:

"Every time you tinker with this delicate system even small changes can create big ripples,'' said Dino Kos, former head of the New York Fed's open-market operations . . . "This is the impossible situation they are in. The risks are that the government's $700 billion purchase of assets disturbs markets even more.''

In other words, it might do more harm than good.

Mr. Kos joins a long list of other leading experts who question the bailout, including:

The Dallas Federal Reserve Bank President (Richard Fisher) said the proposed bailout would plunge the U.S. government deeper into a fiscal abyss

The former Secretary of the Treasury (Paul O'Neill) questions the bailout

The director of the nonpartisan Congressional Budget Office (Peter R. Orszag) said the bailout could deepen the crisis

The former Chairman of the FDIC (William Isaac) doubts the bailout will work in its current form

Hundreds of leading economists, including numerous nobel prize winners, question the bailout

Former White House economist (Steve Hanke) adamantly opposes the bailout

Nobel prize economist and former chief economist of the World Bank (Joseph Stiglitz) opposes the bailout

A prominent economist (Nouriel Roubini) says "The Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown."

A highly-regarded economist (Michael Hudson) says that the bailout is a giveaway that will cause hyperinflation and dollar collapse

Many other leading economists question the bailout

The "Do SOMETHING to Calm People Down" Argument Just Failed

One of the biggest - if unspoken - reasons for proposing the bailout is that quickly doing something big will reassure investors and the public.

That argument has just failed (even with the PPT's best efforts).

Today, the stock market, Nasdaq, S&P, oil and gold all got hammered. Everything being down at the same time means that investors are panicking, and pulling money out of the markets.

This is on the heels of the Senate passing the Paulson bailout plan (with a little added lipstick), and widespread reports in the mainstream media that the bill will likely pass in the House on the second round.

In other words, the real economic crises are swamping any false hope from the phony bailout remedy.

As an article on Bloomberg puts it, "U.S. Stocks Decline on Concern Bank Rescue Won't Stop Slowdown".

Since the bailout won't calm investors or the public's fears, let's just save the trillions in taxpayer money and start addressing the real problems facing America. Or - if the government is going to do something - it should address the real problems with real solutions.

First, Do No Harm

The most basic principle in medicine is summarized by the 2,000-year old saying coined by Hippocrates, the father of medicine: First, Do No Harm.

When a patient is wheeled into the hospital, the doctor has to make sure that any treatment doesn't make the patient worse. You want to make the patient better, if possible. But it doesn't really matter how wondrous the treatment sounds if it ends up killing the patient. In deciding between possible treatments, the fundamental first priniciple is that you don't want to do anything which will make the patient worse.

The "First, Do No Harm" principle applies at all times, even in the most urgent, life-and-death ER situations (ask any ER doctor).

The treament proposed by doctors Paulson, Bernanke and company will not work to make the patient - the U.S. economy - better. (See this).

More importantly, it violates the most basic prinicipal of First, Do No Harm. For example:

The director of the nonpartisan Congressional Budget Office (Peter R. Orszag) said the bailout could deepen the crisis

The former head of the Fed's open market operation - the key Fed agency which has been loaning hundreds of billions of dollars to Wall Street companies and banks - was quoted in Bloomberg:
"Every time you tinker with this delicate system even small changes can create big ripples,'' said Dino Kos, former head of the New York Fed's open-market operations . . . "This is the impossible situation they are in. The risks are that the government's $700 billion purchase of assets disturbs markets even more.''

The Dallas Federal Reserve Bank President (Richard Fisher) said the proposed bailout would plunge the U.S. government deeper into a fiscal abyss

A highly-regarded economist (Michael Hudson) says that the bailout is a giveaway that will cause hyperinflation and dollar collapse

Billionaire investor Jim Rogers says the bailout would prolong the financial crisis

Congressman Ron Paul said that the bailout will probably make things worse

And many other people have said the same thing.

Call and fax congress TODAY and read them the above-list of experts who have said that the bailout will do more harm than good.

Wednesday, October 1, 2008

Rum, Wooden Arrows, and the Pork Barrel Bailout

The shock-doctrine peddlers are saying the world will end if the bailout isn't passed. So you'd think that Congress would focus a little on fixing the financial crisis.

Instead, the Senate bailout bill includes issues of vital national importance such as :

Extension of economic development credit to American Samoa (p. 279)

Rum excise tax to Puerto Rico and the Virgin Islands (p. 279)

Motorsports racing track facility (p. 290)

Wool modifications (p. 295)

Children and wooden arrows (p. 300)

The list goes on and on . . .

It also includes plenty of unfunded mandates.

Indeed, it seems like pork barrel politics as usual in Washington.

The Elephant in the Room: Credit Default Swaps

Studies show that people often fear the wrong things. We are terrified of things which probably won't hurt us, but blissfully unconcerned with things that might really kill us (see this, this and this). So we put a tremendous amount of energy into solving non-problems, and get blindsided by things that we don't know about or which we are too afraid to even think about.

The same applies to the economic crisis.

For example, the market for credit default swaps is larger than the entire world economy.

Credit default swaps - which were largely responsible for bringing down Bear Stearns, AIG (and see this), WaMu and other mammoth corporations - are now being taken out against the U.S. government.

So you'd think that politicians trying to prop up the teetering U.S. economy would want to cancel credit default swaps, or at least declare their value is somewhere near zero.

Nope . . . not even on their discussion list, even though it is the real economic crisis.

Instead, they are proposing things which most experts say will actually harm the economy.

Call congress and tell them to stop their political posturing, stop ignoring the derivatives elephant in the room, and either do something useful or nothing at all.

The Entire Premise of the Bailout Plan is False

Today, Congressman Defazio said that the Paulson bailout plan won't create liquidity. He also referred to reports that banks are reducing their loans to consumers and to each other in anticipation of the bailout bill passing.

What's he talking about?

A professor of economics and an expert in liquidity explained:

"I suspect that part of what we're seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,'' said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory.

As a prominent economist says:

"No one is lending to counter-parties as no one trusts any counter-party (even the safest ones), and everyone is hoarding the liquidity that is injected by central banks."

And some savvy financial writers are saying that Wall Street is borrowing billions of dollars through the Feds Open Market program and the parking it in commercial money market funds and CDs.

This is a repeat of the 1990's Japanese financial crisis. Specifically, when the Japanese government threw cash at their big banks in the 90's, the banks just horded the money instead of using it to restore "liquidity".

The entire premise of the bailout plan - that it will unfreeze frozen credit markets - is false.

Friday, October 31, 2008

Thursday, October 30, 2008

Wednesday, October 29, 2008

Tuesday, October 28, 2008

Monday, October 27, 2008

Saturday, October 25, 2008

Friday, October 24, 2008

Thursday, October 23, 2008

Wednesday, October 22, 2008

Tuesday, October 21, 2008

Monday, October 20, 2008

Sunday, October 19, 2008

Saturday, October 18, 2008

Friday, October 17, 2008

Thursday, October 16, 2008

Wednesday, October 15, 2008

Tuesday, October 14, 2008

Monday, October 13, 2008

Sunday, October 12, 2008

Saturday, October 11, 2008

Friday, October 10, 2008

Thursday, October 9, 2008

Wednesday, October 8, 2008

Tuesday, October 7, 2008

Monday, October 6, 2008

Friday, October 3, 2008

Thursday, October 2, 2008

Wednesday, October 1, 2008

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