Debt Rattle, February 25 2008

Ilargi: Let's see, the Ambac deal cannot be done today or tomorrow, it will take at least another week. So, the banks call on S&P to please take Ambac off the CreditWatch list for the time being, since they have it hard enough. S&P obliges, for some obscure (green?) reason. Hey, they've messed up so badly, it can't get much worse, what's left to lose? The patient is too weak to be operated upon, so might as well roll her out of IC for now, and put some lipstick on.

And what do investors do? They sing Hosanna. Yeah, dive right in suckers. You're right, it's party time.


U.S. stocks buoyed by relief over bond insurers

U.S. stocks rallied into Monday's close, spurred by news that Standard & Poor's reaffirmed the credit ratings of two key bond insurers whose financial outlook has been at the center of investor anxiety in recent months. The late surge capped another volatile session that had the Dow Jones Industrial Average trading in a 240-point range, which included short detours into negative territory.

After managing only modest gains most of the day, the Dow shot up to its highs of the day late in the session after word hit that Standard & Poor's had affirmed the AAA rating of Ambac Financial Group Inc.'s bond insurance business and took the AAA rating of MBIA Inc.'s bond insurer unit off its CreditWatch.

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Any Ambac Deal Would Likely Be Next Week-Source

Any deal to rescue bond insurer Ambac Financial Group Inc would likely be signed early next week rather than today or tomorrow, a person briefed on the matter said.

Putting together a deal is enormously complicated and requires the agreement of a large number of parties, including banks, regulators and rating agencies, according to people familiar with the situation.
Ambac is looking to raise $3 billion of new capital after writing down more than $5 billion of assets in the fourth quarter, a person familiar with the matter said over the weekend.

The second-largest bond insurer is also looking at separating its municipal bond insurance business, which is unlikely to face big payouts, from its structured finance insurance business, which is likely to make big payouts in coming years. Splitting up the businesses may be the best way to ensure the municipal bond insurance operations can win new business, analysts said.

"New capital would be a plus, but it would be a Band-Aid," said Rob Haines of independent research firm CreditSights, "and it wouldn't address the fundamental concern here, that there could be more deterioration in the structured finance business."At least two bond insurers, industry leader MBIA Inc and FGIC Corp, have announced plans to divide their municipal bond insurance businesses from their other insurance operations.

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Ilargi: See here, the problem in a nutshell: the system can no longer save itself.

Insurers' Day of Reckoning

A hurricane comes through your town and levels your house. A few weeks later, you receive a letter from your insurance company telling you that unless you buy some of its stock, it won’t be able to pay your insurance claim. What do you do?

As far fetched as this question may feel, this is, in principle, what’s behind the bailout of the monoline insurance companies. Unless their biggest CDS counterparties step up with more capital, the insurance companies won’t be able to make good on their CDS and the banks will be forced to take write-downs. All that is happening is the further leveraging of an already leveraged and highly interdependent financial system.

Now there are those who suggest that creating a “good bank/bad bank” out of the insurance companies will create the opportunity for the incremental outside capital that I suggest is so much in need. And in general I would agree. Adding capital to the “good” municipal business would put that business on more solid footing. But what about the “bad” CDO business?

A review of history suggests that there was really no such thing as a good bank/bad bank strategy – only a good bank/dead bank strategy. For one to live, the other had to die. And to be clear, looking back in time, no matter how the good and bad eggs were unscrambled, the banks’ equity holders (and some holding company lenders) ultimately lost it all.

So until losses are taken, I continue to believe there is a day of reckoning to come for the monoline insurance companies. And I sense the same day of reckoning for those multinational banks who are stepping up to help. For rather than spreading risk beyond the financial system, every bailout effort seeks to concentrate it more and more onto the balance sheets of world’s largest banks. We continue to postpone the inevitable.

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Citigroup Losses and Writedowns

Citigroup Inc., the biggest U.S. bank by assets, may post its second-straight quarterly loss because of writedowns on home-equity loans and junk-grade corporate loans, Oppenheimer & Co.'s Meredith Whitney said. The bank may report a loss of $1.6 billion, or 28 cents a share, for the first quarter, compared with a profit of about $5 billion, or $1.01, a year earlier, Whitney wrote today in a note to clients. Her estimate compares with the 63-cent per share average gain expected by analysts surveyed by Bloomberg. Goldman Sachs Group Inc. analyst William Tanona said Citigroup may be forced to take a writedown of as much as $12 billion.

The rate of loan losses is "grossly underestimated by consensus estimates" at Citigroup and other U.S. banks, Whitney wrote. "Core fundamentals are rapidly deteriorating." She cut her per-share prediction for 2008 earnings by more than 70 percent to 75 cents. The New York-based company's shares could fall more than 36 percent to less than $16, she wrote. The shares have declined about 17 percent this year.

Whitney, 38, was among the first analysts to gauge the depth of Citigroup's losses, writing in a note last October that the bank may have to cut dividend payments to shareholders for the first time since the 1990s. In January, the bank slashed its dividend by 41 percent, reversing a pledge made by its executive-committee chairman, former U.S. Treasury Secretary Robert Rubin, to preserve the shareholder payout.

Citigroup may have additional writedowns this quarter on CDOs, along with losses on more than $43 billion of junk or "leveraged" loans, Whitney said. The bank may also face charges on more than $50 billion of residential mortgages granted to customers who borrowed in excess of 90 percent of the value of their homes, Whitney wrote. Credit-card loans also are prone to higher defaults. Citigroup may be forced to sell $100 billion of assets to free up capital, Whitney said. The lender will "likely be forced to sell what it can and not what it should," she wrote.

The bank may write down as much as $12 billion from the value of fixed-income assets in the first quarter, cutting earnings per share 63 percent to 15 cents from a prior estimate of 40 cents, Goldman analyst Tanona wrote in a report dated today. Tanona also reduced profit estimates for Merrill Lynch & Co., Lehman Brothers Holdings Inc., Morgan Stanley, Bear Stearns Cos., and JPMorgan Chase & Co., as bonds and loans they own lose value.

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Ilargi: Let's shift it a notch, shall we? Time to ask who lied, and who did what to whom, but no time to get caught on the wrong side of that line.

Time to blame the rich

We have, it seems, reached that point in the economic cycle when resentment is rising against the rich. In an economic upswing few mind that the rich are doing better than others. If you can buy a Mini then why worry that someone else is picking up a Maserati? But in the downswing it just seems plain unjust that the rich invariably avoid their share of the pain.

That sentiment has marked the US presidential election campaign as fears of recession grip the country. House prices are falling, over-stretched mortgage holders are losing their homes, banks have blown billions in the credit markets and yet disgraced financiers have walked away with millions in a perverse “heads-I-win, tails-you-lose” kind of capitalism.

German voters, already agitated by high pay-outs to imperious chief executives, have been further angered by the country’s biggest tax fraud, in which scores of rich executives are believed to have concealed their wealth in bank accounts in Liechtenstein. Jürgen Thumann, chairman of Germany’s BDI industry federation, told the Financial Times this week that the reputation of the business community had fallen so low that it feared “a public lynching”.

In the meantime, here is a suggestion for suasion rather than compulsion: send all rich taxpayers a copy of Andrew Carnegie’s Gospel of Wealth. The essay, first published in 1889, addressed what Carnegie saw as the problem of his (and our) age: the proper administration of wealth, vital so that “the ties of brotherhood may still bind together the rich and poor in harmonious relationship”. Great inequality was the price of progress. It was pointless to criticise the inevitable. “Much better this great irregularity than universal squalor,” he wrote.

Carnegie had no time for indiscriminate charity – arguing it only fed the vices it was intended to cure – and wrote that higher wages for the poor would mostly be wasted on the “indulgence of appetite”. But perhaps Carnegie’s most telling argument was that the rich had an immense responsibility to administer their money wisely during their lifetimes for the benefit of all.

Like him, they should give away the vast bulk of their wealth to provide “ladders upon which the aspiring can rise” – in his case an astonishing endowment of libraries and parks. While wealth creation and distribution should remain free, Carnegie supported high inheritance taxes. “Of all forms of taxes this seems the wisest,” he wrote. “By taxing estates heavily at death the state marks its condemnation of the selfish millionaire’s unworthy life.”

Carnegie’s conclusion still provokes thought and should inspire action: “The man who dies rich dies disgraced.”

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German Backlash Against the Rich

Germany’s crackdown on tax dodgers could fuel a growing backlash against international capital. When TV cameras captured Deutsche Post CEO Klaus Zumwinkel being escorted from his Cologne villa by authorities, the scene fed simmering resentment at managers whom average folks believe have gotten more than their share of Germany’s recent economic recovery.

It’s not completely true that only a narrow group has benefited from growth—more than 600,000 unemployed people have found work since last year. But the growth has come partly as a result of unpopular reforms including reduced jobless benefits and weaker job protections. Now it looks like internationally oriented managers such as Zumwinkel who pushed for austerity were, as the German saying goes, preaching water but drinking wine. Add in the big writeoffs by European banks that invested in subprime paper—and in at least one case required a taxpayer-financed bailout—and you’ve got the makings of a popular backlash.

One fruit of that backlash is a rise in the far left. The aptly named Left party, a coalition of East Germany’s post-Communist PDS and dissident Social Democrats, won enough votes in the states of Hessen and Lower Saxony to earn seats in the local parliaments. The Left party is a ragtag collection of traditional socialists and unreconstructed Communists. One Left Party representative-designate in Lower Saxony has already had to quit after she defended the Berlin Wall and the East German secret police in a TV interview.

But if it turns out Germany’s business elite did in fact, as alleged, hide assets in Liechtenstein banks, they’ll only have themselves to blame for the people carrying torches outside their villas.

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Ilargi: The Liechtenstein Files. Good name for a thriller.

Tax-evasion case spreads to U.K. from Germany

The tax scandal that began in Germany has spread to Britain, where an official said Sunday that the tax authorities had obtained information on Britons suspected of hiding funds in Liechtenstein banks. The tax office is "using the powers given to it by Parliament to protect the U.K. Exchequer from those who seek to hide behind secrecy laws to deprive the U.K. of tax revenues to which it is entitled," the British Revenue & Customs office said in an e-mailed statement.

The news was first reported in The Sunday Times in London. A spokesman for the Revenue & Customs office, Mike Burrell, confirmed that the authorities were looking into the matter, but he said that a formal investigation had yet to begin. According to the newspaper, the British tax authorities paid an informant £100,000, or $197,000, for the bank details of at least 100 wealthy Britons. It reported that the records were stolen from Liechtenstein. Burrell declined to comment on the specifics of the case.

British taxpayers seeking to hide revenue have traditionally sought to shelter funds in places like the British Virgin Islands, Dubai, Switzerland, Gibraltar and the Channel Islands. Britons found to have evaded taxes face fines of up to 100 percent of the money owed to the government and a possible jail term. LGT Group, the largest Liechtenstein bank, said Sunday that it believed that Heinrich Kieber, a former employee who was convicted in 2004 in connection with the theft of client data from its LGT Treuhand unit, was the source of both the German and the British revelations.

After the German authorities revealed that they had obtained confidential client data, the bank, which is owned by the Liechtenstein royal family, said that it would seek criminal charges against an unknown person. On Sunday, the bank said it was reregistering its complaint directly against Kieber. LGT Group said the data stolen in 2002 comprised approximately 1,400 client relationships of LGT Treuhand established before 2002, of which about 600 were in Germany.

Liechtenstein has been engaged in a battle of wills with Germany over the past few weeks amid revelations that German intelligence agents paid for stolen data from one of the principality's banks. The German authorities have since conducted numerous raids across the country to uncover tax evasion. The bank said reports that the German authorities had paid about €5 million, or $7.4 million, for data on tax evaders were "extremely offensive, particularly as it is apparently accepted that the person concerned could also misuse the confidential client data for other criminal purposes."

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Ilargi: Back to the order of the day. Yeah, so perhaps Ambac will triumphantly announce a rescue. But looking at the hollow-ringing details, how long will this one remain standing? The banks sure ain't willing to put in much of anything. Not that they have much to begin with, maybe that's the problem.

Monoline Death Watch: A "Bad Insurer/Worse Insurer" Split?

The market is wiling to treat thin gruel as nourishment. We saw an impressive 250 point rally in the Dow on Friday and an over 400 point gain in the Nikkei based on the improving odds of a rescue of troubled number two bond guarantor Ambac. But what is this salvage operation, exactly? The Wall Street Journal gives us some insight into the smoke and mirrors:

Ambac plans to raise $2.5 billion in a rights issue, in which shares are offered to existing shareholders at a discount to the market price, according to the people familiar with the matter. The bank group, which includes Citigroup Inc., UBS AG, Royal Bank of Scotland PLC and Wachovia Corp., would likely "backstop" the issue, meaning they would commit to buying up any unsold shares.

A rights offering with a mere backstop? The existing shares will be heavily diluted and the bank group hopefully puts up nothing, The fact that this group won't make an outright equity purchase is so inconsistent with their supposed downside exposure that it can say only one of two things. Either enough of them have taken deep enough writedowns that they don't think they have much at risk or they believe this rescue will be inadequate. In the latter case, they are better off keeping their powder dry rather than become the sugar daddies for the possibly insatible monolines.

That, needless to say, is a big vote of no confidence. Remember, the rescue program started January 23. Ambac has had over a month to persuade the banks that it has good business prospects. Obviously, that effort was less than a rousing success.Further proof of the "vote of no confidence" thesis:

Additionally, Ambac plans to sell $500 million of debt, probably in the form of a surplus note issued by the municipal side of the business, to further bolster its capital in order to satisfy requirements of the rating providers, who need to sign off on the plans, and maintain its triple-A credit rating.

Ooh, as of Friday, the rumor was the the banks would provide a $500 million line of credit. For a group this large, that's peanuts. But they aren't even willing to take that risk. They are instead making Ambac raise the dough itself, on what is sure to be very costly terms.

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German Bank Blames UBS for Subprime Hit

HSH Nordbank AG said Swiss bank UBS AG sold it $500 million in securities tied to U.S. subprime mortgages that have since soured, in the latest case of a midtier German lender to be singed by the slump in the U.S. mortgage market. HSH, which specializes in shipping finance, joins a growing number of investors around the world, including municipalities in the U.S. and Australia, that fault the banks that packaged and sold the investments.

HSH said yesterday in a statement that UBS had sold it investments tied to debt pools known as collateralized debt obligations and that those investments had incurred significant losses. HSH, based in Hamburg and Kiel, said in its statement that it was considering legal action. A UBS spokesman declined to comment.

UBS itself has struggled with massive losses, having written down $18 billion in investments tied to subprime securities and changed the top leadership of the company. UBS shareholders are scheduled to meet on Wednesday to vote on whether the bank, based in Zurich, can raise capital from Asian and Middle Eastern investors

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Numbers That Do Not Add Up

Anyway, the real reason for this report is the latest Qrtrly. Derivative Fact Sheet [Q2-07] – published by none other than the Office of the Comptroller of the Currency for the United States of America. The following is segment of a table on page 32 of the latest quarterly derivatives report which shows the size of J.P. Morgan’s and Citibank’s outstanding notional amounts in derivatives in general – and specifically – the enormity of their exposure to Credit Derivatives, which is the root source of most of the problems that ail the financial system:



(Source: Page 32 of Q2/07 OCC Quarterly Derivatives Report)

The chart above shows at Q2/07 [or Sept. 30 07] Citibank had outstanding notional Credit Derivatives of 3 Trillion. At this point in time, remember, the sub-prime melt down was only about two months old [having been widely acknowledged in early August 07].
The deleterious effects on Citibank’s financial performance stemming from this excess only began to be reported in Q4:

New York, NY, January 15, 2008 – Citigroup Inc. (NYSE:C) today reported a net loss for the 2007 fourth quarter of $9.83 billion, or $1.99 per share……
Management Comment 

"Our financial results this quarter are clearly unacceptable. Our poor performance was driven primarily by two factors – significant write-downs and losses on our sub-prime direct exposures in fixed income markets, and a large increase in credit costs in our U.S. consumer loan portfolio. Looking beyond these two factors, revenues and volumes continued to grow strongly in a number of our franchises and we generated record results in international consumer, transaction services, wealth management, and advisory," said Vikram Pandit, Chief Executive Officer of Citi.

Knowing that so much of what ails Citibank’s finances is effectively “fenced” by their 3 Trillion of notional Credit Derivatives – shouldn’t someone, somewhere be asking what’s really going on over at J.P. Morgan who has 7.8 Trillion in notional of the same stuff that is burying Citibank? The sub-prime meltdown is categorically and beyond a shadow of a doubt a credit derivatives induced / related event.

It behooves me that this institution manages to avoid any scrutiny in the mainstream financial press – unless perhaps one stops to consider this development [circa May, 2006] where Dawn Kopecki reported in BusinessWeek Online in a piece titled, Intelligence Czar Can Waive SEC Rules,

“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. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye.”

When one stops to consider this – suddenly all of the numbers, or lack thereof, make perfect sense!

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Was "Headed in the Other Direction" An Understatement?

Yesterday on this page I suggested that it's absurd to compare today's ailing economy to the economic woes of the 1970s. I asked the rhetorical question, Can you have "stagflation" -- or even a strong overall inflationary trend -- if home prices are headed in the other direction?
Unfortunately, what I've read today makes me wonder if "headed in the other direction" was an understatement. The source of my wonder was (yet again) a front-page story in The New York Times, which included this staggering quote:

"Not since the Depression has a larger share of Americans owed more on their homes than they are worth. With the collapse of the housing boom, nearly 8.8 million homeowners, or 10.3 percent of the total, are underwater. That is more than double the percentage just a year ago, according to a new estimate of the damage by Moody’s Economy.com."

That is not stagflation, dear reader. The correct word is "deflation." And I take no pleasure is saying that there's more:

"Bank of America, which is in the process of acquiring Countrywide Financial and has potentially huge exposure, has circulated a proposal to create a new federal agency that would buy vast quantities of delinquent mortgages at a deep discount and replace them with fixed-rate federally guaranteed loans. "The bank warned that tightening credit conditions were leading to 'escalating levels of delinquency and default among borrowers' and 'an unprecedented number' of homes that would enter foreclosure."

I went to the Moody's economy.com site, where it didn't take long to find a visual representation of exactly why Bank of America is sounding the alarm. The chart below clearly shows the disturbing rise in the trend, but note as well that the data only goes through the end of 2007.

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Brave New Economy

There is a delicious irony in the fact that U.S. banks have sought equity capital from the sovereign wealth funds of Asian and Middle Eastern countries to repair the balance-sheet damage inflicted by subprime mortgage securities. These same countries helped finance America's housing bubble and subprime debacle. Stung by the Asian financial crisis 10 years ago, central banks in developing countries began defensive actions to accumulate foreign-exchange reserves. Economies blessed with significant natural resources accumulated yet more dollars.

The problem is their overflowing coffers contributed to a major misallocation of capital in recent years that is likely to continue. During the past four years, the developing countries have run an aggregate current account surplus of nearly $2.5 trillion. In 2008 alone, the surplus will probably exceed $625 billion. These huge surpluses provided the global financial system with the excess liquidity that funded America's burgeoning current-account deficit and depressed bond yields four years ago.

The decline of long-term interest rates encouraged America's residential property boom and spawned the reckless lending for subprime mortgages. This process -- of surplus savings in developing countries influencing financial behavior in industrial countries -- has now made a complete circle with Abu Dhabi, Singapore and China rescuing Citibank, Merrill Lynch and Morgan Stanley. It is also a complete reversal of 20th-century history.

The current business cycle will go down in the history books as one which confirmed that leadership in the global economy is now shifting from the old industrial countries to the emerging market countries. During 2007, the developing countries produced over 52% of global growth, compared to 37% during the late 1990s. China alone produced 17.8% of global GDP growth last year, compared to 14.6% for the U.S. economy. The developing countries' share of total world output has risen to 29% this year from 18% in 1995.

As a result of their large current account surpluses, the developing countries also account for 75% of the world's $6 trillion of foreign exchange reserves. They also have sovereign wealth funds with assets of $2.5 trillion. Their market capitalization now exceeds $17.8 trillion, compared to $2.2 trillion in 2000. The capitalization of the U.S. stock market is $17.5 trillion.

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Commercial property values in for steep drop, says loan liquidator

Banks starting to unload distressed real estate loans; some sellers taking 50 cents on the dollar

In what may well be a sign of things to come, Mission Capital Advisors said it is accepting bids for a $131.2 million portfolio of non-performing loans secured by commercial mortgages foreclosed on by a Midwestern bank. David Tobin, a principal at Mission Capital, which manages the sale of troubled mortgage loan portfolios and real estate assets for lenders, said that “with the market conditions as they are, we expect a significant increase in similar offerings throughout the year.”

“The pace of offerings has picked up dramatically over the past year,” which has been one of his firm’s busiest, he added. “We did $5 billion of debt sales last year, all of it seasoned performing, underperforming, or non-performing [loans].” Mr. Tobin noted that “even the big investment banks are having trouble placing these [types of] loans, so we’re working twice as hard this year.”

More ominously, he predicted commercial property values are heading for a steep fall due to the rising tide of troubled portfolio sales by banks, as they move to get non-performing assets off their books. It’s tough for banks to determine mark-to-market prices because commercial-loan backed packages being resold right now have to go through a price discovery process, Mr. Tobin said. Packages whose chief underlying assets are residential mortgages are getting bids of about 50 cents to 60 cents on the dollar, down from about 90 cents in late 2006 and early 2007.

With bank lending drying up, commercial borrowers with older loans coming due are now also having trouble lining up refinancing. Some older loans are ending up being sold within the distressed packages. Eventually, Mr. Tobin believes the declines in the commercial real estate market could mimic those being registered in the residential market now.

“The delinquency trend is obviously increasing,” he said. “But when a loan out for 10 years can’t get refinanced, that tells you we’re giving back a lot of the gains of the past several years.”

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Week Ahead: Follow the Bond Insurers

Housing numbers, inflation data and lots of Fed speak loom large for markets but it may be the fate of bond insurers that really drive the direction of trading in the week ahead. Fed Chairman Ben Bernanke gives his monetary policy report to the House Financial Services committee Wednesday, starting at 10 a.m., then again on Thursday to the Senate Banking Committee.

There are also some big earnings on tap, including insurer AIG and Home Depot. There will be a lot of attention paid to the fate of the monoline insurers Ambac and MBIA. The two have been trying to work out ways to bolster capital levels to head off potential downgrades by ratings agencies.

I spoke to Merrill Lynch's Richard Bernstein a few days ago. He expects the stock market to stay choppy awhile, and says it could retest or even set new lows. I would say the volatility is telling you the leadership is changing," he said.[..] Bernstein made an interesting point in a report he issued this past week. First, he warned that energy stocks could be heading into a period where they will underperform. He says the sentiment toward the sector is extremely bullish even as fundamentals start to erode.

One point he made was that some investors see the Fed giving up its inflation fighting stance as it cuts rates deeply. But he says the credit contraction means that some of these inflation concerns are overdone. "Without credit extended to create excess money, the theory argues, it is impossible to abnormally stimulate demand for goods and get price increases," he wrote.

He also points out that credit is a leading indicator and some theorists see it as a leading indicator for inflation. Therefore, he notes, it may not be the right time to structure equity holdings by overweighting sectors with expectations of future inflation. "This probably explains why the Fed is being so aggressive despite the consensus that inflation is a significant problem. Simply put, they are easing in hope of offsetting a serious credit crunch, and believe that inflation is not an issue when credit is not being extended," he wrote.

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Spending Growth to Stall, Home Sales Down: U.S. Economy Preview

One source of concern for the Fed is the worst housing slump in a quarter century. The National Association of Realtors may report tomorrow that January sales of existing homes fell 1.8 percent to a 4.81 million annual rate, the Bloomberg survey median shows. Existing-home purchases account for 85 percent of the market.

New home sales, which account for the rest of the market, dropped 0.7 percent to an annual pace of 600,000 last month, the third consecutive drop, according to the Bloomberg survey median. The Commerce Department will report the figures Feb. 27. Sales of new homes are viewed as a leading indicator of the market because they are tabulated when a contract is signed. Existing-home sales reflect contract closings, which typically come a month or two later.

The glut of unsold properties is pushing prices lower. The S&P/Case-Shiller home-price index, scheduled for release Feb. 26, may show prices in 20 U.S. metropolitan areas fell 9.8 percent in December from a year earlier. The decrease, the 12th in a row, was the biggest since the group started keeping year- over-year records in 2001.

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Ilargi: Elaine Meinel Supkis writes a wonderful piece of history.

History of Gold/Silver Ratios

We all read many things about money and the economy but when I actually look at some relationships we often don't talk about, we see some interesting trends over the centuries. Generally speaking, from 1600 to 1873, the official price of the English Crown and then the new United States were not only one and the same but quite stable. The ratios between gold and silver were set in stone, it seemed. Indeed, the early revolutionaries, when debating the value of the new mint, believed that the ratios would be stable forever.


The US as well as England went through several bank collapses and bad times but the ratios moved against each only slowly. Gold very gradually increased its value against silver. Generally, it was between $14-16 an ounce of gold to $1 an ounce of silver in the distant past then---boom! The Civil War sends the ratio reeling.

After the panic of 1873, gold's ratio with silver is set at 16/1 which cannot hold. It never returns. Hereafter, the ratio between the two metals diverge for good. For 59 long years, the official price of gold sits at $20.67 an ounce. The 'street price' is identical. But look at the silver ratios! They rise to a 38/1 level at the time of the 1903 panic.

WWI brings the ratios back into classic levels but only momentarily. But in 1929, it takes off again. This signals a collapse of the currencies used by people. Most people do business with money based on silver, not gold. So the real inflation rate is often expressed in the deterioration of the value of silver. During the Great Depression, the ratio of silver to gold value sees its greatest ratio differentials in our history.

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Ilargi: More excellent Supkis

Looking Into The Derivative Beast's Cave

The nature of this Beast is clear: he is much, much, much bigger than all the world's wealth! He is bigger then the value of ALL reserves times ten! On this planet! In all our history! How on earth could this have been allowed to happen? This creature will stomp world banking into the dust beyond what anything has done in the past. The pain of this conversion of wealth to nothingness will hammer the US since we are the world's #1 debtor nation. But it will also hammer Japan, England, France and Germany. All the world will feel the lash of the whip here but the G7 nations will suddenly be dumped into the world's cellar faster than a blink of the eye! This is why the G7 are holding so many meetings. They are still yelling at the Chinese dragon who has snarled back, 'Raise your bleeping interest rates, you FOOLS!' only the opposite is happening as the G7 all fall down into the Japanese money pit.



This pair of graphs are so very interesting, aren't they? Through the roof! Derivatives changed from being a tool to being a BUBBLE! This is how all bubbles look. Look at how futures were neglected. No interest in piling funny money there! Options: ditto. A slight rise of value and activity. Looks normal, actually. Real business wasn't booming all that much during the housing boom but the business of taking money from the Bank of Japan and turning it into gold was a very busy business! So look at swaps! Wow. Just through the roof, straight upwards. Money poured into that sector like crazy. A classic bubble. And yes, derivatives can be a bubble, ANYTHING from tulip bulbs, baseball cards, stamps, rock collections, paintings, houses, gold, ANYTHING can be turned into an investment bubble. All we need is easy credit.

The second chart shows us the same thing: Interest rate tools shot up and up and up. Classic bubble and an elemental bubble in this case, the underlying cause of our banking collapse. Foreign exchange: nearly flat. Equities: barely an ant under the hoof of the giant interest rate Beast. Commodities, even with a host of gold bugs buzzing about rare metals, barely higher than a crack in the sidewalk compared to the wealth being 'made' in this interest Tower of Babble. Even credit derivatives makes barely a sneeze here.



Nearly $140 trillion in these interest rate derivative markets. All derivatives are nearly $200 trillion for the US. This is echoed in Europe which also played this exact same game. Globally, it is around $500 trillion so we can see the US has the lion's share. If the EU sees a collapse, this isn't nearly so bad as the US since they are individual nations while we get stuck with the entire $200 trillion and on a smaller tax and population base!

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Goldman's profit magic may be fading

At a recent investor meeting, Goldman Sachs Group Inc. Chief Executive Lloyd Blankfein made a wry apology for arriving late. "This is the wrong time to keep shareholders waiting," he said, according to people with knowledge of the matter. "Maybe I should offer to wash your car or something to make up for it." The joke spoke to a sobering reality check. After 10 quarters in a row of posting higher year-over-year earnings per share and avoiding many of the mortgage-related land mines that have blown up at rival securities firms, Goldman could post in mid-March its smallest quarterly profit in three years.

The problem: Many areas giving Goldman fits in the current quarter -- from leveraged-loan exposure to sluggish investment-banking activity -- aren't likely to recover anytime soon. As a result, its stock, still pricey compared with other Wall Street securities firms, could fall much further. In a sign many investors think the credit crunch has hit Goldman hard in its fiscal first quarter ending Feb. 29, the New York company's shares are down 14% since Feb. 1. Goldman shares Friday rose $2.54, or 1.5%, to $177.71 in New York Stock Exchange 4 p.m. composite trading. The stock peaked at $250 last October.

"The world knows this quarter stinks for Goldman, as well as the others," says Glenn Schorr, a securities analyst at UBS. David Trone, brokerage analyst at Fox-Pitt Kelton, believes Goldman could take roughly the same amount of write-downs in its fiscal second quarter as it does in its first quarter. Goldman should trade at just a 10% premium to rivals, he says, implying a price 19% below current levels.

One of the biggest worries is Goldman's large exposure to leveraged loans, which totaled $42 billion at the end of the firm's last quarter, according to analyst calculations. During the deal boom, Goldman was a huge player in financing private-equity buyouts. But investors started to avoid buyout loans last summer, causing the debt to pile up on balance sheets and their market values to drop.

Goldman also faces hefty losses on some of its large equity stakes. The most brutal could come from Industrial & Commercial Bank of China Ltd., whose shares have fallen 16% on the Hong Kong Stock Exchange since the end of November. That slide could translate into a financial hit for Goldman of roughly $400 million, based on figures provided in the firm's regulatory filings. Overall valuation losses on such large corporate investments could reach $1.4 billion,

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Citigroup to Bail Out Internal Hedge Fund

Citigroup earlier this week agreed to provide $500 million in credit to one of its troubled hedge funds, the bank disclosed in a regulatory filing late Friday. The Citi-managed fund, known as Falcon, was brought onto the bank's books, which will increase the bank's assets and liabilities by about $10 billion. The fund focuses on fixed income.

Citigroup recorded a $10 billion loss in the fourth quarter, and has been working to sell shares of itself and other assets to raise cash. The bank might continue having trouble returning to financial health, though. After home mortgages drained more than $150 billion from the world's banking industry last year, many experts say commercial real estate loans and bond insurers could be the next culprits.

In Citi's regulatory filing Friday, it detailed its exposure to these risky assets. The bank had $4 billion in investments, as of Dec. 31, that were directly exposed to bond insurers, which have been struggling to maintain their superior ratings and scrambling for cash. Citi is most exposed to the bond insurer Ambac Financial, which is in talks with regulators and a group of banks, including Citi, to come up with a way to raise its cash levels.

Citi's exposure to Ambac, through trading assets and debt instruments, was nearly $3 billion as Dec. 31. Meanwhile, Citi said it had approximately $20 billion in trading-related exposure to commercial real estate, and more than $20 billion in loans related to commercial real estate.

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Buffett's Berkshire Backs Over 100 Muni Bonds In Two Days

Warren Buffett's new bond insurance company has backed more than 100 municipal bonds [Feb 21 and 22], according to Reuters.  The wire service quotes a Moody's Investor Services spokesman as saying, "We have rated approximately 112 Berkshire Hathaway Assurance Corp-insured issues between yesterday and today."Reuters calls it a "development that shows just how fast the new unit is growing in a field where rivals are struggling."

Ambac and MBIA have been on the brink of losing their own AAA ratings from Moody's, Standard and Poor's and Fitch due to exposure to potentially big losses from risky investments like collaterialized debt obligations (CDOs).  In the last few minutes, however, CNBC's Charlie Gasparino reported that banks working on a bailout for Ambac could announce a deal Monday or Tuesday. Even though BHAC doesn't have its own AAA credit rating yet, the bonds it guarantees are getting the top rating from Moody's Investors Service.

In a news release, Moody's says BHAC's guarantees are backed by Berkshire-owned National Indemnity Co. (NICO), which does have its own AAA credit rating.  VP Bruce Ballentine, co-author of a new Moody's report on BHAC says in the release, "Moody's Aaa insurance financial strength rating on NICO reflects its superior capitalization, its unique ability to assume large and unusual risks, its expertise in managing long-tail portfolios, and the implicit support from Berkshire." 

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China to Stay With Tight Monetary Policy

China will stick with a tight monetary policy as controlling inflation remains a top priority, the vice governor of the People's Bank of China said. The central bank will "vigorously" soak up liquidity by raising the level of reserves that banks must keep on hand, Yi Gang said today at an economic forum in Beijing. The central bank will select an "optimal" package of currency, interest- rate and money-supply measures, he said.

Last month's 7.1 percent inflation rate was highest in more than 11 years. Snowstorms that started in mid-January in provinces such as Zhejiang, Guangxi and Jiangxi closed factories, paralyzed transportation and disrupted food and power supplies, pushing up prices that had begun to soar last year. "The central bank will stick with a tightened monetary policy this year despite uncertain factors domestically and externally," Yi said. "Inflation remains the biggest risk in the economy this year."

Chinese policymakers are preoccupied with inflation even as they face the prospect that an economic slowdown in the U.S. may curb demand for the country's exports. Overseas sales helped power 11.4 percent economic growth last year in China, the world's fourth-largest economy. "The inflation situation is serious and upward pressure will be further felt throughout the first quarter," Xing Ziqiang, an economist at China International Capital Corp., said today at the conference in Beijing. Xing predicted that the pace of consumer price increases may be higher than 7 percent in the first three months.

The central bank will make the yuan more flexible and use interest rate tools to curb inflation, it said in its monetary policy report issued on Feb. 22. The bank has kept borrowing costs steady this year after six increases in 2007 pushed the key one-year lending rate to 7.47 percent. Currency appreciation is the "most effective tool" to direct more resources to industries that will boost domestic consumption, Yi said. The Chinese currency gained 7 percent last year versus the dollar, twice as fast as in 2006, according to Bloomberg data.

"Because of the growing interest-rate differentials between China's yuan and the U.S. dollar, we believe currency adjustment will take on a larger role in tightening monetary conditions this year, compared with the past," Liang Hong, a senior economist at Goldman Sachs Group Inc. in Hong Kong, wrote in a recent note. Liang said the central bank may front-load currency appreciation over the next few months, with the full year's gains totaling 12 percent against the U.S. dollar.

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Japan wary of sluggish U.S.

Japan needs to monitor the impact that any U.S. economic slowdown might have on Chinese exports, many of which are assembled from semifinished products and raw materials from Japan and elsewhere in Asia, the country's economic minister said Friday.

“What shape the U.S. slowdown will take needs thorough monitoring,” Economy Minister Hiroko Ota said at a regular press conference. “Overall exports are still expanding, but that expansion is coming at a slower pace.”

She said Japanese exports to Asia including China are in good shape, while those to the European Union are flat.“As there is a time lag, we need to closely watch how the slowdown in the U.S. will affect the Chinese economy and how that will affect the exports of Japanese and emerging economies to China,” she said. About a fifth of China's exports go to the U.S., Ota said.

Separately, Bank of Japan Gov. Toshihiko Fukui said the country's domestic economy is slowing on lingering adjustments in the housing sector. “Moves in the Japanese economy are slowing down for now due to the weakness in housing investment,” he told a Lower House fiscal and financial panel.

However, he still maintained the view that Japan's economy is in a “favourable growth cycle of industrial production, income and expenditure.” Japan's housing starts fell 19.2 per cent on year in December, slightly worse than economists' average forecast of an 18.2 per cent drop, but much better than declines of 27 per cent to 44 per cent in the previous three months.

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Hedge Funds Feel New Heat

The past decade has been the era of the hedge fund, as investors snapped them up for their track record of beating the market with often highly complex trades. But now, as the credit crunch upends financial markets, that very complexity is coming back to bite some of them.

In the past year, shares of Fortress Investment Group LLC -- which became the symbol of hedge-fund success when it went public last February -- are down 50% as investors wring their hands about the value of its real-estate, debt and other holdings. A Fortress official declined to comment.

A pair of $2 billion funds run by AQR Capital Management Inc. are down about 15% this year. And yesterday Citigroup announced a bailout of an in-house hedge-fund group clobbered in part by bad bets on highly complex mortgage-related securities. Last month alone, so-called "quantitative" hedge funds (which make investments based on sophisticated mathematical formulas) fell 6% as a group, according to data-tracker Hedge Fund Research Inc.

Other funds have hit the scrap heap. D.B. Zwirn & Co. and Sailfish LLC have both seen investors rush for the exits, forcing each firm to close big funds. In recent weeks at Zwirn, clients have moved to withdraw some $2 billion from the firm's $5 billion in assets. That follows disclosures of improper accounting that delayed an outside audit of its returns. Zwirn will sell $4 billion of investments over the next few years from its two largest hedge fund

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Toll and Spend

The slow economy is hurting state tax revenues around the country. But look on the bright side: You could live in New Jersey, where decades of tax and spend politics is reaching its logical conclusion.
"We have a serious structural financial problem," the state's liberal Democratic Governor Jon Corzine told us on a recent visit. "You better address these problems or you will put yourself in a 1970s-style New York City situation, where you get a control board telling you what to do."

Mr. Corzine is promoting his own solution, but he's also tacitly admitting that the state's politicians have been sucking the place dry for decades. If you want to know where a state dominated by public-employee unions ends up, Trenton is it. Mr. Corzine spent 25 years at Goldman Sachs and is fluent with numbers, most of them harrowing if you're a New Jersey taxpayer.

In 1990 the state was $3 billion in debt. Borrowing has since grown at a compound annual rate of about 13%, and now the state is $32 billion in the red. Throw in unfunded pensions and health benefits for retirees, and that number swells to $113 billion, or $3,400 for every man, woman and child in the state. That's three times per capita higher than the national average, making New Jersey the nation's fourth-most indebted state.

Public workers and teachers can retire at age 55 after 25 years with a pension of 60% of salary -- indexed to inflation. Police and firefighters can retire at 65% of salary at any age after 25 years of service and 70% after 30 years. With such generous benefits, you might think funding pensions would be a priority. Ah, no. Last summer the state disclosed it had used accounting tricks to skip more than $7 billion in pension payments over 15 years. That money went to current spending to buy votes.

Mr. Corzine is like a new homeowner who finds rotting floorboards once he moves in. And he deserves credit for acknowledging the problem.

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'Closing of the Gap' Moment Approaching

On more than a few occasions prior to the collapse in share prices that began in October, I highlighted the disconnect between credit markets and the economy, on the one hand, and the stock market, on the other. I also anticipated that equity investors would eventually have their ignorance spelled out for all the world to see when -- not if -- stock prices played downside catch-up with a bearish reality.

In my view, we are nearing another one of those "closing of the gap" moments. Among other things, optimistic share traders have bet that: 1) the unraveling credit markets have it wrong, even though they have been the best leading indicator of what is to come from the very beginning; 2) we face a mild, garden variety downturn, even though evidence suggests a nasty, consumer-led recession is on the cards; and, 3) the Fed will save the day -- as it has done in the past -- even though the facts suggest the central bank is behind the curve, in panic mode, and lacking the tools to deal effectively with an insolvency crisis.

Aside from that is the almost surreal unwillingness by equity investors to accept that the profits companies made in recent years have been out-sized and unsustainable, especially in an environment where the consumer is scaling back hard and the notion of global "decoupling" has been dismissed as the psychotic rant of Wall Street economists who drank too much ivory-tower Kool-Aid or who had not given up the mind-altering "recreational" drugs of their younger years.

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Aaron Krowne comments on 'Closing of the Gap' Moment Approaching

The decoupling debate is interesting. Wall Street-aligned economists have embraced decoupling as a thesis for why the gravy train can keep right on rolling for equities, and the US financial economy as a whole. But we are certainly already past that point. The gravy train has derailed. And the world financial economy is already completely globalized, so whatever happens here happens everywhere (hence the subprime collapse ping-ponging around Europe).

Still, there is one valid point to consider for "decoupling": the real economies of surplus countries are unlikely to face the same impact the real economies of the US and other current account deficit countries are in store for. Surplus countries have to adjust to an abundance of wealth, not a lack of it. And the sooner they stop subsidizing the US and the rest of the anglosphere, the sooner they can spend their capital resources on realizing a real wealth increase at home.

E.g., to attempt to smooth over a collapse here in the US, we have to print or borrow money, a zero or negative-sum game. To boost ailing exporters in China, they could either use their surplus to subsidize them, or subsidize workers or natural resources generally. Thus I see financial turmoil for all, but far less real economy damage for the surplus countries.

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Credit Squeeze Is Still in 'Early Days,' Watsa Says

The credit squeeze that's led to $146 billion in writedowns for global banks won't end any time soon, said Prem Watsa, whose Canadian insurance company posted record earnings last year by betting against financial firms. "It's still early days," said Watsa, who heads Fairfax Financial Holdings Ltd. in Toronto. "This is a very extensive credit problem." "We're just rolling through mortgages right now, but we haven't gone through all the other areas yet," such as credit- card debt, commercial real estate loans and automobile lending, Watsa said.

Watsa said the company this year sold its credit-default swaps linked to bond insurers. Debt insurers including MBIA Inc. and Ambac Financial Group Inc. have been seeking capital since November when Fitch Ratings and Moody's Investors Service began reviewing the effect of rising defaults on subprime mortgage securities guaranteed by the insurers.

"We have sold most of our monoline insurers," Watsa said in an interview yesterday. "You figure out risk versus reward, and you might well decide to sell. We've done that with monolines, but the others we're continuing to review."

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The guys who had a gut feeling for risk

Fairfax this week disclosed an annual profit of $1.1-billion (U.S.) for 2007, nearly four times what the insurance and investment company had earned in its best year the year before. Much of that was the result of a single, contrarian bet the firm made that the world had got it wrong about risk.

Starting in 2003, and continuing through early 2007, Fairfax began to buy credit default swaps on U.S. companies. The buyer of such a derivative is essentially betting that the company's debt is overpriced – that the market has underestimated the odds of a financial failure. Some of Fairfax's swaps were against the debt of so-called monoline insurers, companies like MBIA Inc. and Ambac Financial Group Inc., that guaranteed U.S. municipal bonds but had massive exposure to subprime mortgages and other risky debt.

“All you had to do was take a prospectus or you take their 10-K and you open it up and you say, ‘Let me look at the risk factors,'” Mr. Watsa said. “It's all there. And what's amazing is that when you read it, you can't believe that these guys did what they did. “They never worried about risk.” The cause of their complacency, Mr. Watsa said, was the low volatility that prevailed between 2003 and 2006. “The only way that that could happen is we have to have a long period of stability – a long period where there wasn't any accidents. You'd never take that risk otherwise.”

It also happened because too many banks, insurers, hedge funds and rating agencies were given a false sense of security by statistical models that told them the probability of a financial “accident” was low. Where they used spreadsheets and algebra, aging investors like Mr. Watsa, 57, relied on their instincts and decades of experience to tell them something was amiss. And the grey-hairs won. “We were shocked at how low the risk premiums went,” Mr. Watsa said.

Until last summer, as the economy and credit markets boomed, investors were clamouring for risk, taking on more and more for less in return. Optimism ruled. The most tangible result was that market interest rates dove to record lows relative to government bonds, with even risky products such as junk bonds earning investors a scant premium to “risk-free” debt such as Treasury bills.

Fairfax won its bet when that trend reversed, starting last summer, as investors spooked by U.S. mortgage defaults once again demanded more compensation for taking chances. For winners like Fairfax and U.S. hedge fund manager Bill Ackman, the windfalls are tremendous, but for the losers, the costs are staggering.

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Populism 101

[..] I offer the following talking points to both campaigns, because I think either could benefit from talking about issues that normal, middle-class Americans could actually see making a direct and concrete change in their lives for the better. Which is what the entire concept of Populism is supposed to be all about. All of these issues revolve around the concept of fairness.

• Cap credit card interest rates
  
  To her credit, this is an issue that Hillary Clinton has raised recently. But I have to say, capping credit card interest rates at 30% isn't really all that bold a position. How about capping them at something less than loan-shark rates? I'm no economist, but personally anything over 15% sounds more like usury than it does a normal business transaction.
  
  
• Minimum wage COLA
  
  To his credit, Barack Obama has been using this subject on the campaign trail of late. Raising the minimum wage yearly with a cost-of-living adjustment ("COLA") means that Congress will never again be able to do nothing for a decade while the working poor fall farther and farther behind.
  
  
• All tuition tax deductible
  
  Both candidates have their own ideas on how to make college more affordable. But both are merely incremental steps, minor tweaking of the tax code. This is a fundamental issue, and should be attacked in a fundamental way. Just as any business is allowed to write off every dollar spent improving the company, private individuals should be able to write off every dollar spent on college tuition. Period.
   
  
• All charity tax-deductible
  
  This one is just as basic as the last one. Many people who donate to charity do not get to write off such charitable donations because they don't itemize their deductions. Make one easy fix to the tax forms, and put the line to deduct charity on the main form instead of on the form where you itemize, and everyone in America can deduct their charitable givings from their income.
  
  
• Remove cap on earnings for Social Security
  
  Barack Obama has talked about doing this, at least in an incremental way (he talks of "raising the cap" rather than "eliminating the cap," but it's at least a step in the right direction). Hillary Clinton has also expressed support for the idea, but I haven't heard her leaning on the issue lately. What is needed is to absolutely remove the cap entirely. By doing this, the rate itself could be cut slightly for everyone, resulting in a tax cut for 94% of working Americans. And the remaining six percent would just be paying exactly the same rate as everyone else instead of getting a massive tax break for the rich every single year. Making all working Americans pay exactly the same rate is going to sound pretty fair to the vast majority of voters.
  
  
• Tax all earnings the same
  
  I have to say, both campaigns have been cheating on this one. Call it the Warren Buffett shell game. Both candidates have used some form or another of the line (originally spoken by Buffett himself): "Billionaire Warren Buffett pays a lower percentage of his income in taxes than his secretary does."

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