Debt Rattle, May 17 2008: Harvest Time in Spring

Ben Shahn: Harvest Time - 1937
Salvaging coal from the slag heap at Nanty Glo, Pennsylvania. Coal pickers get 10 cents for each hundred-pound sack or two dollars a ton. One man can make from 10 to 20 sacks a day

---

Please read also: Vietnam is the new China is the new America

---

Meredith Whitney: Losses will be far worse than currently expected

A prominent U.S. banking analyst, Meredith Whitney, offered a gloomy outlook for the financial services sector, saying growing struggles of consumers to pay their debts will increase losses for lenders.

"We remain cautious on financials as credit-turns this early in the credit cycle signal to us that ultimate loss experience will be far worse than current expectations," wrote the Oppenheimer & Co analyst, who in October had accurately predicted that Citigroup Inc would cut its dividend and go on a capital-raising spree.

While struggles in the mortgage market are already well known, Whitney identified growing signs of stress in credit cards, as payment rates fall and losses rise.

The average credit card payment was 19 percent in April, down 0.66 of a percentage point from a year ago, and marked the sixth consecutive month of negative year-over-year payment rates, Whitney wrote in her "May U.S. Consumer Monthly" report.

While Whitney said cash levels on consumers' balance sheets remained "relatively high," she said consumers are nevertheless "building card balances and making lower payments." On Friday, the Reuters/University of Michigan Surveys of Consumers showed that U.S. consumer confidence tumbled to its lowest level in 28 years this month.

---

Housing Starts Plunge 30.6%

Does this look like a bottom to you ?



The Commerce Department released the Housing Starts data. It was not pretty

Construction of single-family houses in April dropped to the lowest level in 17 years. Builders broke ground on 692,000 single units at an annual rate, the fewest since January 1991. Multiifamily units -- Condos, townhouses, and apartments -- rebounded for the month. Total housing starts were up 8.2% since last month, but plummeted 30.6% below the level of construction in April 2007.

WSJ:

Builders have been reluctant to build because demand for new homes has plunged and the supply of unsold property remained high. The latest data show new-home sales, for March, were down 36.6% from a year earlier. On Thursday, the National Association of Home Builders reported its index for sales of new, single-family homes slipped to 19 in May from 20. The gauge is based on a survey of builders asked about prospects for sales.

---

Ilargi: HOLD IT RIGHT THERE! Wait a minute!

Bernanke wants to pay interest on the reserves commercial banks have with the Fed. That much is clear.

But isn’t there something wrong here, something missing? Is it just me? Let’s go back for a moment to the non-borrowed reserves issue we talked about before. Here’s a graph with April ‘08 data. It depicts non-borrowed reserves (which as we know are deeply negative) vs borrowed reserves (which are shooting up, vertically skyward).


So what are these reserves that Bernanke wants to pay interest over? The Fed is going to pay the banks interest over the reserves they borrow (and pay interest over) from the Fed? Would he pay them more than they pay him? I think that may be the plan. The bill for the difference between the two rates could then be conveniently sent to the Treasury.

Bernanke Requests Power to Pay Interest on Reserves

Federal Reserve Chairman Ben S. Bernanke asked Congress to give the Fed immediate authority to pay interest on reserves deposited by commercial banks, seeking to streamline efforts aimed at alleviating credit strains.

The payments would help officials push money into the banking system without influencing the main policy rate, by giving lenders an incentive to leave funds with the Fed. Congress already passed a law giving the central bank the authority, starting in October 2011.

"We recommend that the date be changed to make the legislation effective immediately," Bernanke wrote in a May 13 letter to House Speaker Nancy Pelosi, a California Democrat. "Congress recognized that payment of interest on reserves would contribute to the efficiency of the financial system." Pelosi, after speaking to Bernanke, is reviewing "the feasibility" of meeting his request, said Nadeam Elshami, a spokesman for Pelosi.

The benchmark federal funds rate, the overnight lending rate between banks, has at times diverged from policy makers' target in recent months as banks attempted to manage their reserves amid the credit crunch. The fluctuations also came as officials stepped up provision of liquidity to the banking system.

Bernanke, 54, and his colleagues have started twice monthly auctions of cash to banks and opened lending to securities dealers to revive credit markets. Officials have also accepted mortgage debt and other asset-backed securities as collateral for loans.

Interest payments on reserves may give policy makers the ability "to inject potentially vast sums of money into the system without having an impact on the federal funds rate" said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. It would also "put a floor under" the rate, he said.

Congress would need to approve the accelerated timetable for the payments, which would then require the president's signature. Banks are required to hold a proportion of their customers' deposits in an account at the Fed. If the Fed paid interest on surplus reserves, banks would be less inclined to dump the funds into the money markets, pushing the federal funds rate lower.

The New York Fed's Open Market Desk is charged with buying and selling Treasuries with 20 Wall Street securities firms to keep the federal funds rate close to the target set by the Federal Open Market Committee. The desk has struggled to keep it stable as banks raised and lowered their reserves, removing or injecting funds into cash markets.

On May 14, for example, the benchmark rate fluctuated between 1.75 percent and 7 percent. On April 23, the range was 1 percent to 10 percent. Under the current statute, the Fed may pay interest "at a rate or rates not to exceed the general level of short-term interest rates" starting in October 2011.

The U.S. central bank cut the federal funds rate target to 2 percent April 30 and indicated it may hold off on further reductions. The Fed's Board of Governors discussed paying interest on reserves in a closed session the same day. Central bank staff began discussions this month with Congress on bringing forward the date that interest can be paid. Fed officials are considering how the program would work, including the rate the Fed would pay.

---

Investment Banks Doing Better, But Profits An Issue Long-Term

Big U.S. investments banks have gotten a crash course in damage control over the past several months, telling investors and analysts alike to dial down their expectations until the credit crisis runs out of steam. But what happens when it does recede, and banks need to dial those expectations back up again?

Most experts figure it'll be a tough sell. And they can trot out a number of reasons why.

The decline in mortgage markets has drastically reduced the number of structured investment vehicles and securitized bonds that had been a key source of income before the crisis hit. Meanwhile, subprime-related losses have wreaked havoc on banks' balance sheets, making it much harder to secure loans by leveraging their assets. And there's a lack of capital to fund M&A deals.

These and other woes won't go away anytime soon, watchers say. "The outlook is not positive because the core businesses which drove earnings over the last few years are no longer in effect," said Dick Bove, analyst at Punk Ziegel. Over the short-term, investment banks will have enough on their plates just navigating through a volatile market.

Three of the four top brokerages — Goldman Sachs, Morgan Stanley and Lehman Bros. — are expected to post earnings declines over the next couple of quarters. Merrill Lynch should post big bottom-line gains in the latter half of the year — mainly because it lost so much money in 2007 it has no place to go but up.

Easy year-over-year comparisons should let all four brokerages enjoy double-digit profit growth in 2009. But in 2010, all but Morgan Stanley are expected to post single-digit gains. That's a far cry from the way things were as recently as a year ago, when investment banks piled up the profits and routinely shattered quarterly estimates.

"It's impossible to say what 'normalized' earnings are for these guys right now," said Peter Boockvar, equity strategist at Miller Tabak & Co. "There's just so much weakness in so many areas." That weakness led Oppenheimer analyst Meredith Whitney to cut her estimates for all four big brokerages. In a May 13 note to clients, she said that "with less than three weeks until the end of the fiscal second quarter, the global capital markets activity for the quarter shows continued weakness."

Whitney also noted that many banks haven't fully digested the temporary gains they earned in the first quarter, when prices for credit-default swaps rose. Those gains have been reversed in the second quarter, when prices fell. Beyond the risks of doing business in such a murky environment, investment banks face the prospect of more government oversight regarding how they recognize and disclose assets.

---

Scandinavians unite to end Iceland's financial chaos

The central banks of Norway, Sweden and Denmark have joined forces in a stunning move to rescue Iceland, offering a credit line of €1.5bn (£1.2bn) to beat back speculators and shore up the battered krona.
 
The solidarity gesture is a powerful signal to hedge funds betting on Iceland's downfall that they are up against the international system. The swap accord doubles the foreign reserve cover of the Icelandic government at a stroke. Iceland's central bank said the deal was a "precautionary measure" to stabilise the currency, which has crashed 25pc this year.

Stefan Ingves, head of Sweden's Riksbank, said the accord aimed to restore stability after months of mayhem. The Icelandic krona surged 3.7pc on the news. Björn Gudmundsson, an economist at Landsbanki, said the Bank of England might need to join the Nordic front to stop the crisis spreading.

Icelanders have become big investors in Britain. They have borrowed heavily on the sterling market to launch bids for a clutch of high street names. There are concerns that the Icelandic system as a whole could turn into an "offshore Northern Rock".

Lars Christensen, an economist at Danske Bank, said the swap deal would make it harder for speculators to short the krona but would not stop Iceland plunging into a deep recession. "Economically, this changes nothing. Iceland is one of the most indebted countries in the world," he said.

Paul Rawkins, of Fitch Ratings, said the country's external debt had reached $97bn, five times the size of the economy. " The markets had begun to doubt whether the government had the resources to rescue the banks," he said.

Iceland has evolved into a sovereign hedge fund.

With a home economy the size of Bristol, its banks have borrowed massively on the global capital markets to launch raids on companies across Europe. The high-wire act has now come to grief. The central bank has lifted interest rates to 15.5pc to stop double-digit inflation spiralling out of control. The government expects the country's economy to contract by 4pc over the next two years.

Chris Whalen, head of Institutional Risk Analytics, said Iceland was the emblem of our times. "The country is like a big pension fund that has taken a punt with leverage," he said.

---

Carlyle and the Washington Factor

Carlyle Group, the private equity behemoth, has for years been trying to shed its image as the ultimate Washington insider, profiting from its ties to the power brokers in government, business and the military. But its $2.5 billion acquisition Friday of a majority stake in the government consulting arm of Booz Allen Hamilton, an influential Washington-area firm, is bound to dredge up some of those old associations.

At one time, Carlyle was known for employing former politicians and government apparatchiks, making it an easy target for accusations — fair or not — that it was a crony capitalist machine buying favors, as opposed to a private equity firm with a knack for buying and selling companies at the right time. In the past few years, Carlyle has taken steps to put this issue to rest.

It has in large measure stopped placing high-ranking politicians on the boards of its portfolio companies and further diversified its holdings and investments across a wide range of industries. It asked members of the bin Laden family to divest from the firm and took former President George Bush Senior and former British Prime Minister John Major off its payroll.

Carlyle has reduced its holdings in the aerospace and defense industries, from a peak of about 20 percent of its overall portfolio in the 1990s to about 6 percent today, according to the firm. In an interview Friday with DealBook, a Carlyle spokesman said this drop had more to do with the lack of attractive investment opportunities in these sectors than any attempt to alter its image.

Carlyle currently holds interests in six defense and aerospace companies, many of which supply parts and material to the United States military. It has employed a regiment of former military personnel who assist in making investment decisions along side top-tier M.B.A. types. Of course, Carlyle also owns many companies that are totally unrelated to defense and aerospace, such as its recent acquisition of nursing home company Manor Care.

In its Booz Allen deal, Carlyle may be getting the Rolls-Royce of government-consulting contractors. Booz Allen has a hand in sensitive projects that run the gamut from helping NASA build the International Space Station to helping the US Air Force upgrade the tracking systems for their military satellites. (Carlyle is only acquiring the Booz Allen unit that deals with United States government-related contracts; the firm’s commercial consulting unit will become a stand-alone company.)

Why would Carlyle move deeper into the government arena, after reducing its ties to Washington in recent years? Well, the seized-up credit markets have made it much harder for private equity firms to arrange leveraged buyouts, or at least forced them to use less leverage. Going back to what it knows could be part of Carlyle’s strategy to gain an upper hand over its competitors in a grim deal environment — even if it could raise a few eyebrows.

---

Ilargi: Long predicted here, and now coming to fruition, the property taxes bloodbath that will decimate municipal budgets across America, taking hundreds of thousands of city jobs with it. It is hard to overestimate the pain that will come from this. Services will deteriorate to levels few can imagine today.

Road maintenance will be the first visible casualty, but water and sewage treatment are certain to be far more hurtful. Brace yourself, try to make sure your community is aware of this, so it can stay ahead of developments. Don't give your councils the option to hush-hush it, because the price you pay for that will be steep.

Home sellers turn to new ally, tax grievance assessors

:Barbara Thorton blames her $8,281 property tax bill. Her four-bedroom home seems priced right at $400,000, but it's been sitting on the market for almost a year. "That's a hunk of change," the Medford homeowner said of the tax bill. "That's a lot of money for a young couple."

For the first time in 25 years, she's going to file a tax grievance, hoping it's the lemonade in a souring real estate market soggy with inventory. Nowadays, when just touting the Jacuzzi, crown molding and new roof won't do, many home sellers have resorted to challenging their property assessments. They're contacting assessors in droves. Some pay hundreds of dollars for appraisers' reports. Others promise to forfeit half the first year's tax savings to firms that win reductions.

Some listings even reserve special punctuation for taxes: One reads "Village Tax Grievance Filed and Approved" while another says "Taxes in Process of Grieving!!!!!" "It is a new clause that I've never seen before -- 'Taxes being grieved. May result in a reduction of X number of dollars,'" said Greg Hild, who's been Smithtown's assessor for 24 years. "They have a good chance."

Hild said the residential assessment formula will be changed across the board next year to reflect the down market, resulting in lower property values and -- assuming tax rates don't change -- lower taxes. Unlike the boom years, when houses flew off the market, the contrast between high property values and high taxes didn't look so out of kilter.

Homes sold so fast that few needed the lure of tax grievances. Soaring prices made it hard for sellers to argue that their property values had dropped and owners were due tax reductions.

But now, many buyers expect to see taxes in line with declining property values, especially when it can break a loan in a tighter credit market. "Apples to apples, my house will get sold, even if my house isn't as good, if it has lower taxes," said Lisa Sherman, a Commack-based agent for Coldwell Banker Residential. "Almost 90 to 95 percent of all the houses of my customers are over-assessed based on what they could sell their houses for today."

A tax grievance victory helped Sherman score a closing in March with buyer Steven Caplan, after he had walked away from a four-bedroom, Dix Hills ranch because the owner would not lower the price and the $15,640 tax bill was $4,000 higher than Caplan had budgeted. The house had been put up for sale in April 2007 in an area with about 200 listings.

Caplan had given up on the house in September but Sherman called him in November when Huntington Town lowered the taxes by $3,644. "I assumed that nothing was going to happen and if it was going to happen, it was going to be way down the line," said Caplan, a senior financial analyst.

Several assessors expect a banner year in filings. In Nassau, whose filing deadline was in March, filings grew about 18,000 to 140,197 for the 2008-09 tax year and already has more than 134,000 cases for 2009-10. In Suffolk, the deadline is Tuesday and each town rules over its cases; Brookhaven, the biggest town, peaked at 19,000 annual filings in the mid-1990s and expects up to 27,000 cases this year.

At the Mark Lewis Tax Grievance Service in Centereach, Lewis last year began dedicating an employee to checking new listings and mailing pitches to sellers and agents. Seller clients get letters with estimated tax reductions, so they can attach them to fliers and show them to house hunters. What Lewis has seen is a contradiction: houses assessed as much as hundreds of thousands of dollars above what buyers will pay nowadays.

"When you're in a recessionary market, people need money," said Lewis, who expects filings to double to 15,000 compared to last year, with a quarter of them from sellers. "There is no question that this is the time [to file]. With the down market that we have, you may not get another opportunity like this in 10 years."

---

Barclays scents victory against credit crisis

Barclays Wealth has advised clients to jump back into stock markets across the world, believing the danger of a severe downturn has receded after the dramatic rescue moves by central banks.

"We remain confident that the world's financial authorities will win the war against the credit crunch," said Michael Dicks, the group's research chief. "The recovery is now gathering steam. Ultimate victory should benefit risky asset classes."

Barclays' closely-watched Signpost report says the US is at last beginning to claw its way out of trouble, while investors no longer seem spooked by every piece of bad news. "Many financial firms have announced further write-offs. But the surprise is that equity markets have viewed the moves favourably," it says.

Barclays Wealth, which manages $132bn (£68bn) for Barclays clients, has boosted its overweight position in equities to 7pc, focusing on the rebound story in the US. It says the forward price-earnings ratio for US stocks is now 14, cheap by historical standards. It is also nibbling British stocks and lifting holdings in emerging markets.

The bonds of blue chip companies are coming back into favour. The report says top-notch issues have been grossly "oversold" in the indiscriminate flight from credit. The coming wave of defaults will be concentrated in the junk bond family, not the posh high-grades. Barclays admits it was caught off guard by the bloodbath which began last August, and says central banks have had to invent new weapons to unlock the credit system across the globe.

"The authorities have had to fight more battles than we expected, with the financial crisis morphing from one market to another in a way that we did not anticipate. The war has become a world war, not a localised one." The group warns that the most of the global economy is still "heading south", while inflation looms as a threat. But stock markets move to their own rhythm.

Not all banks share the tentative optimism at Barclays. Morgan Stanley's equity team has advised investors to sell stocks, arguing that we are now near the top of a classic "bear rally". Teun Draaisma, Morgan Stanley's equity guru, says profits will slide relentlessly as the credit crisis inflicts its slow damage on the broader economy. He dismisses belief in government magic as a typical illusion at this stage of a downturn.

---

"Deep Distress": Confidence Slumps, Single-Family Home Starts Fall

U.S. consumer confidence was the weakest this month since Jimmy Carter was president, and single- family home construction fell to a 17-year low in April.

The Reuters/University of Michigan preliminary index of consumer sentiment dropped to 59.5, compared with an average reading of 85.6 in 2007. Builders broke ground on 692,000 single-family homes at an annual rate, the Commerce Department said today in Washington. Total housing starts unexpectedly rose because of an increase in condominium construction.

The figures show that consumers see more pain ahead, even as Wall Street executives proclaim that the worst of the credit crisis is over. The rout in housing is depressing home values, a threat to the consumer spending that accounts for more than two- thirds of gross domestic product.

"We are in the neighborhood of zero" growth, Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York, said in a Bloomberg Television interview. Consumer sentiment is also being hurt by the increase in energy costs, which "will weigh on consumer spending," he said. Total housing starts jumped 8.2 percent to 1.032 million as construction of multifamily units rose 36 percent following a 35 percent drop in March, the Commerce figures showed.

"There may be signs that we are getting close to a bottom but we don't think we're there yet," said Adam York, an economist at Wachovia Corp. in Charlotte, North Carolina. "The housing market still has a ways to go towards working off its problems."

Lower prices and other incentives have yet to revive demand for houses, indicating builders will need to come up with even more discounts to attract buyers. Stricter lending rules, job losses and growing pessimism about the economy signal sales will not rebound quickly. Building permits, a sign of future construction, rose 4.9 percent to a 978,000 pace, reflecting gains in both single- and multifamily units.

Economists had forecast starts would fall to an annual pace of 939,000, according to the median of 73 projections in a Bloomberg News survey. Building permits were projected to fall to a 915,000 annual rate. The confidence index was forecast to fall to 62, according to the median of 65 forecasts. The index of consumer expectations for six months from now, which more closely projects the direction of consumer spending, dropped to 51.7 from 53.3.

"These are terrible readings," Richard Dekaser, chief economist at National City Corp. in Cleveland, said in a Bloomberg Television interview. "The popular sentiment right now is that the economy is in deep distress and it's looking towards dim prospects going forward."

A gauge of current conditions, which reflects Americans' perceptions of their financial situation and whether it is a good time to buy big-ticket items like cars, decreased to 71.7, the lowest level since December 1980, from 77.

Consumers said they expect an inflation rate of 5.2 percent over the next 12 months, compared with 4.8 percent in the April survey. Longer-term, Americans projected prices would increase 3.3 percent, up from a 3.2 percent estimate last month. Builders' confidence continues to flag. The National Association of Home Builders/Wells Fargo sentiment index fell one point to 19 this month, the group said yesterday.

"The trends are horrific," said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York, who had the closest housing-starts estimate in Bloomberg's survey. "There's just no reason things are getting any better. Why would you buy a house? Why would you spend money to buy a depreciating asset?"

---

Fed's Lockhart says world will feel U.S. slowdown

U.S. exports have been helped by a weaker dollar and this is providing a boost to an otherwise weak economy, Federal Reserve Bank of Atlanta President Dennis Lockhart said on Saturday. "The U.S. dollar has depreciated against the euro and on a trade-weighted basis. The export sector of the U.S. economy has benefited and remains quite strong.

Export growth has diluted - but not offset - the negative trend of the U.S. economy," he said in prepared remarks. A copy of his speech, to the Southern Center for International Studies Young Professionals in Atlanta, was released to media in Washington prior to delivery.

The dollar has slipped to record lows against the euro and other major currencies this year as the Fed slashed interest rates to offset the fallout from a housing crisis that has chilled growth. Its benchmark overnight funds rate has been lowered since September to 2 percent from 5.25 percent.

"The U.S. economy is in the midst of a pronounced slowdown, with very little growth recorded for two consecutive quarters. The weakness was initially centered in the housing sector but has become more widespread," Lockhart said. He also described inflation as "elevated" due in part to higher energy and commodity prices. But he did not dwell on how he saw price pressures evolving in the speech, and mainly focused on the prospects for emerging economies.

"Global economic integration has progressed in recent years to the point that a slowdown in the United States will unquestionably be felt, but not as severely as imagined by some," Lockhart said.

"Domestic growth momentum in many emerging economies will attenuate the influence of U.S. weakness. And the accumulation of foreign currency reserves by these countries - the result of trade surpluses - provides an accessible resource to stimulate their own domestic growth to offset weaker exports, should that weakness materialize," he said.

---

Government's rosy data doesn't reflect real life

The relentless rise in energy over the past few years has had an impact, certainly in what we pay for gasoline but also in what we pay for food.

Food prices rose last year by the largest amount since 1990 and have continued surging this year in large part because of higher energy costs, which means that fertilizer is more expensive. Transporting the produce from the farm to the processor to the grocery shelves costs more, too.

But outside of increases in food prices — partly blamed on an energy-related impact that more cropland has been diverted from growing corn for food to growing corn for ethanol — there has been little sign that higher energy prices have become embedded in higher overall inflation.

The weak economy has played a major role in that by helping to restrain labor costs, which account for two-thirds of the cost of most goods. With layoffs rising for four straight months and the economy flirting with a recession, there has not been a lot of pressure to raise wages. Indeed, the government reported Wednesday that inflation-adjusted wages for nonsupervisory workers fell by 1 percent in April compared to a year ago, the seventh consecutive decline.

A severe bout of energy-driven inflation in the 1970s did lead to a wage-price spiral as workers began demanding more pay to keep up with soaring prices. That's not expected this time thanks to the inflation-fighting credibility gained by the Federal Reserve.

After aggressively cutting interest rates since September, the Fed signaled with its seventh rate cut last month that it was pausing to make sure it didn't generate inflation pressures that would be hard to contain. Many economists believe the Fed's next move will be to start raising rates, but probably not for another year after unemployment has peaked and started coming back down.

While recessions and near-recessions have a remarkable ability to chase away the inflation dragon, energy remains the big wild card. Forecasters believe crude oil prices, which briefly touched a new record this week close to $127 per barrel, will eventually start coming down.

Rebecca Braeu, an economist at John Hancock Financial in Boston, said she believed oil prices will fall to around $100 per barrel by the end of this year. She believes this will help restrain overall inflation in 2008 to an increase of around 3.5 percent, down from last year's 4.1 percent rise, which had been the highest in 17 years.

"A deceleration in energy prices coupled with lower wage pressures coming from a slowing economy bodes well for lower inflation," she said.

---

Ilargi: More economists posing as scientists trying to convince themselves and others that economic bubbles are somehow natural phenomena beyond anyone’s control. Are so many of these drips so stupid? I know who creates these bubbles, and they don’t?

Bernanke's Bubble Laboratory

Bubbles don't spring from nowhere. They're usually tied to a development with far-reaching effects: electricity and autos in the 1920s, the Internet in the 1990s, the growth of China and India. At the outset, a surge in the values of related businesses and goods is often justified. But then it detaches from reality.

Mr. Hong, growing up in Sunnyvale, Calif., and teaching at Stanford, had a front-row seat to the technology boom. Recognizing a mania, he resisted investing in tech stocks himself -- until they were about to crest. He recalls his thought process: "My sister's getting rich. My friends are getting rich....I think this is all crazy, but I feel so horrible about missing out, about being left out of the party."

In 2000, "I finally caved in," he says. "I put in some money just as a hedge against other people getting richer than me and feeling better than me." But 2000, of course, was the year the bubble burst. Mr. Hong, who came to Princeton two years later, and now is 37, argues that big innovations lead to big differences of opinion between bullish and bearish investors. But the deck is stacked in favor of the optimists.

One who believes a stock is too high can short it, borrowing shares and selling them in hopes of replacing them when they're cheaper. But this can be costly, both in the fees and in the risk of huge losses if the stock keeps rising. Many big investors rarely short stocks. When differences between bullish investors and bearish ones are extreme, many of the bears simply move to the sidelines. Then, with only optimists playing, prices go higher and higher.

In housing and the credit markets, the innovation was slicing and dicing loans in novel ways. As investors bought the resulting mortgage securities, they provided abundant capital for home buyers; buoyed by this and falling interest rates, house prices surged.

Betting against house prices is hard; only a few sophisticated investors found roundabout ways to do it, in derivatives markets. Most skeptics about the housing boom just sat it out; the optimists were unchecked.

At some point in a bubble, optimists' enthusiasm runs its course. Prices turn down. There's an expectation that at this point, investors who were skeptical may see prices as more reasonable and start buying. If they don't, that's a signal that prices had gotten way too high -- and then they tumble.

The insights of bearish investors "are more likely to be flushed out through the trading process when the market is falling, as opposed to when it's rising," Mr. Hong and Harvard's Jeremy Stein write. They say this explains why prices fall more rapidly than they go up. Over 60 years, nine of the 10 biggest one-day percentage moves in the S&P 500 were down.

When a lot of borrowed money is involved -- as it often is in a bubble -- once prices peak, the speed of their fall is intensified as investors sell urgently to pay down debt. That pattern offers a strong argument, in Mr. Hong's view, for government to restrain bubbles and the borrowing that fuels them.

---

A Gamble That Went Bust

ANB's Collapse From Real-Estate Bet Is Ominous for Small, Midsize Lenders

In the Quail Ridge subdivision, for-sale signs have popped up like the overgrown grass choking lawns of four-bedroom and five-bedroom homes, costing as much as $450,000, that never should have been built. "If you had a tool belt and a pickup truck, you could get a construction loan," says Robert W. Abercrombie, owner of Betty's Homes Inc., which built some of the houses in Quail Ridge but filed for bankruptcy protection in 2006 after sales stalled.

Mr. Abercrombie's company defaulted on more than $2.5 million in loans from ANB Financial, a local bank known for its enthusiastic lending. So did another Quail Ridge home builder that borrowed from ANB. By Friday, an epidemic of bad real-estate loans had overwhelmed the bank, which was seized by federal regulators in the second-biggest federally insured bank failure since 2001.

On Monday morning, nine ANB offices reopened as branches of Pulaski Bank & Trust Co., which took over some of the closed bank's assets and deposits. The bust is reverberating as a sign of turmoil at many small and medium-size banks throughout the U.S. that pinned huge hopes, and capital, on the housing boom.

Delinquencies and charge-offs are rising at lenders that barreled into real-estate loans but now are feeling a double whammy of the housing slump and credit crunch. Regulators are bracing for more failures. Even banks in no danger of collapse will need years to slog through their lending mistakes.

---

Economic woes bedevil Kentucky

Kenny Ramage has been cooking up pork butts and ribs, chickens, hams, beef brisket and even mutton up to 18 hours a day for the past 18 years, but the business of feeding the fires and serving up hickory pit-smoked meats with a side of deep-fried corn on the cob is bittersweet these days.

The reason is located on the other side of Shepherdsville Road. From the window of Ramage's Ole Hickory Pit Bar-B-Cue you can see the historic, sprawling manufacturing complex known as General Electric's Appliance Park, a place that for more than half a century has churned out GE washers, dryers, dishwashers, refrigerators and stoves.

That churn has turned to a trickle and Appliance Park, which in 1954 installed a 30-ton room-sized UNIVAC to become the first commercial operation to use a computer, has seen operations curtailed and divisions lopped over the years. And the 5,000 people who work there—about half white collar and half union manufacturing—could soon be out of a job because of news Friday that GE will sell or spin off its consumer appliance business.

"I really won't know until they're gone how much it will affect me," Ramage, 61, said as he looked across the street at the sprawling complex. "I'd say it's about 30 percent of my business. Maybe more." Not far from Ramage's restaurant, a frustrated William T. "Tommy" Spires is fielding phone calls.

Prior to the announcement on Friday, the president of Local 761 of the International Union of Electrical, Radio and Machine Workers, part of the Communications Workers of America, was taking questions he couldn't answer. "I don't know any more than what you've read and what you've seen," Spires said. "I've checked with local management here. We've called to no avail. They're making no comment on 'speculative' press reports. That's an easy way out I guess."

The situation at Appliance Park is a symbol for what will greet the prolonged Democratic presidential contest that winds its way to Kentucky for balloting on Tuesday. The unsettled economic climate has created a sense of personal apprehension in a state attempting to portray a progressive development policy while already trying to counter above-the-national-average unemployment, an aging, overwhelmingly white population, a decline in manufacturing and a large rural citizenry with lower educational attainment.

---

NAFTA: Dead end for free trade

Peter Durant is getting edgy. The 41-year-old Ontario trucker should be on his way to Toledo, Ohio, to pick up a load of Oreo cookies for Kraft Canada. Instead, he's stuck at a truck stop outside Windsor, Ont. The U.S. Customs computer system that handles freight has crashed and can't read his electronic manifest.

By the time the all-clear sign comes from his dispatcher an hour later, about 100 trucks are lined up on the U.S. side of the Ambassador Bridge. It will take him another 11/2 hours to navigate the 13-kilometre drive through Windsor and clear customs on the U.S. side. It's another day at the busiest trade gateway on the planet – not a bad day; not a particularly good day. Just thick.

Dense layers of security, designed to shield Americans from a world full of threats, have conspired to make life enduringly less predictable for everyone else. “I can't see this is an efficient way to move things across the border,” observed Mr. Durant, who has hauled cargo across the border once or twice a week for the past 14 years. “This isn't it,” he said as he guided his rig through winding, rutted lanes beneath the bridge.

Call it thick, sticky or whatever you like. For the people and companies who ply the border trade, the new reality is an increasingly complex, time-consuming and costly experience. And we're all paying the price. The long-ago promise of the Canada-U.S. free-trade deal was about dismantling barriers – tariff and otherwise – along the world's longest undefended border. But those benefits are being slowly eroded as companies absorb ever greater costs – anything and everything to keep trade moving.

Just-in-time inventory management has evolved into just-in-case.

Companies are stockpiling inventory in both countries to cope with the increasingly unpredictable border, wiping out many of the efficiencies of integrated supply chains, according to recent studies by the Conference Board of Canada as well as the Canadian and U.S. Chambers of Commerce.

Stockpiling isn't the only coping mechanism seeping into everyday business. Disturbingly, businesses are reverting to behaviour that was common before free trade, a trend that is eroding the benefits of Canada's open access to the U.S. market, the Conference Board concluded. Companies now routinely preship orders, cross at night or on weekends, send empty trucks to make pick-ups or ship duplicate orders – anything to make sure a delivery arrives on time. All at a cost.

---

Judge puts off ABCP ruling

The judge overseeing the $32-billion restructuring of Canada's frozen asset-backed commercial paper market said that he can't give approval for the plan yet because he's not satisfied that the legal immunity provisions that would protect some parties from lawsuits are fair or legal.

Ontario Superior Court Justice Colin Campbell had promised this week after two days of hearings to rule as soon as possible, but said in an endorsement issued Friday afternoon that he is not prepared to make a decision without further information.
The sticking point is the so-called legal release in the plan that would give parties in the ABCP market broad protection against lawsuits, including immunity from potential claims of fraud.

Challengers of the plan have argued that it's not legal to give immunity to fraud claims under the Companies' Creditors Arrangement Act under which the restructuring is now taking place.

“I am not satisfied that the release proposed as part of the plan, which is broad enough to encompass release from fraud, is in the circumstances of this case at this time properly authorized by the CCAA, or is necessarily fair and reasonable,” he wrote. “I simply do not have sufficient facts at this time on which to reach a conclusion one way or another.”

The delay puts at risk the nine-month-long restructuring process, because banks that are backing the plan to swap the frozen notes for new bonds have said they will walk away without the releases. But the judge said that if he lets the plan go ahead with the releases there's a chance it will fall apart later because it may not “stand up to the scrutiny of being within the jurisdiction of the court within the CCAA.”

Because of that, he wants the parties to come up with a solution for the fraud issue by May 30. “In my view, within the spirit of the CCAA there is an urgent need for, and there can be a solution by which, the plan can be approved,” he wrote.

---

Alaska's capital goes green after avalanche cuts power lines

Juneau, the capital of Alaska and a popular cruise-ship stop, has had little to celebrate since an avalanche wiped out the lines supplying it with hydroelectricity. But four weeks later it has become a model for energy conservation, with its citizens doing everything from unplugging tumble-driers to regulating airport runway lights.

It is a crisis no American metropolis would wish for itself. On 16 April, a roaring snow-slide in the Coastal Range made matchsticks of pylons linking the city to the hydroelectric dam about 40 miles to the south that supplied 80 per cent of its power.

The good news was that the local provider had back-up diesel generators waiting to be cranked up in just such a situation. Less good is the expense. Residents, who already have to contend with a cost of living higher than almost anywhere in the US because of Juneau's remoteness, were told to expect their power bills to quintuple during the three or four months that it would take to repair the lines.

Most homeowners will get their first glimpse of those new bills this week. But the pain may not be quite so bad as anticipated, thanks to an effort by citizens to cut back on energy consumption. It has been an unlikely go-green campaign that is already being seen as a lesson to the rest of America at a time when conservation, in times of rising oil prices, is touted for all.

Everyone has been doing their bit, including the city authorities, which took steps that included closing the municipal sauna, mothballing one of the two lifts in the main library and turning off the airport's runway lights when planes are not landing or taking off. The hope is that some of the initiatives will endure after the avalanche damage is repaired, which may not be until early July.

Businesses have responded too. Televisions in display windows have gone dark. Department stores, hotels and offices have replaced some bulbs with energy-saving models and simply removed others. At the convention centre, the thermostats have been notched down eight degrees to a not-so-toasty 60F.

"Turn off, turn down, unplug," Sarah Lewis, chairwoman of the Juneau Commission on Sustainability, said recently. "That's what everyone is doing and being vigilant about and commenting when others are not." In all, the city, unreachable by road and with a population of 30,000, has managed to cut consumption by 30 per cent in less than a month, a margin some experts had thought impossible.

But the greatest contribution may have come from homeowners themselves, who have done everything from lighting paraffin lamps to rigging up clotheslines – tumble-driers being one of the greediest of household appliances – and forgetting the ironing. It seems that even in energy-guzzling America people can change their ways when the incentive is there.

"We sold all of our clothes pins the first day," said Doug White, general manager at Don Abel Building Supplies. "I don't think kids even knew what they were for, but they're learning now." It is a phenomenon that was seen before in Brazil, when a drought starved the power grid of hydro-electric power in 2001. On that occasion, consumers were ordered to cut their use of power by 20 per cent or face fines.

It worked. "In two months, the whole country cut their demand by 20 per cent, and they never really returned to the same level of consumption after that," said Alan Meier, of the Lawrence Berkeley National Laboratory in California.

---

The Last Bite

Is the world’s food system collapsing?


In his “Essay on the Principle of Population,” of 1798, the English parson Thomas Malthus insisted that human populations would always be “checked” (a polite word for mass starvation) by the failure of food supplies to keep pace with population growth. For a long time, it looked as if what Malthus called the “dark tints” of his argument were unduly, even absurdly, pessimistic.

As Paul Roberts writes in “The End of Food”, “Until late in the twentieth century, the modern food system was celebrated as a monument to humanity’s greatest triumph. We were producing more food—more grain, more meat, more fruits and vegetables—than ever before, more cheaply than ever before, and with a degree of variety, safety, quality and convenience that preceding generations would have found bewildering.” The world seemed to have been liberated from a Malthusian “long night of hunger and drudgery.”

Now the “dark tints” have returned. The World Bank recently announced that thirty-three countries are confronting food crises, as the prices of various staples have soared. From January to April of this year, the cost of rice on the international market went up a hundred and forty-one per cent.

Pakistan has reintroduced ration cards. In Egypt, the Army has started baking bread for the general population. The Haitian Prime Minister was ousted after hunger riots. The current crisis could push another hundred million people deeper into poverty. Is the world’s population about to be “checked” by its failure to produce enough food?

Paul Roberts is the second author in the past couple of years to publish a book entitled “The End of Food”—the first, by Thomas F. Pawlick, appeared in 2006. Pawlick, an investigative journalist from Ontario, was concerned with such predicaments as the end of the tasty tomato and its replacement by “red tennis balls” lacking in both flavor and nutrients. (The modern tomato, he reported, contains far less calcium and Vitamin A than its 1963 counterpart.)

These worries seem rather tame compared with Roberts’s; his book grapples with the possible termination of food itself, and its replacement by—what? Cormac McCarthy’s novel “The Road” contains a vision of a future in which just about the only food left is canned, from happier times; when the cans run out, the humans eat one another. Roberts lacks McCarthy’s Biblical cadences, but his narrative is intended to be no less terrifying.

Roberts’s work is part of a second wave of food-politics books, which has taken the genre to a new level of apocalyptic foreboding. The first wave was led by Eric Schlosser’s “Fast Food Nation” (2001), and focussed on the perils of junk food. “Fast Food Nation” painted an alarming picture—one learned about the additives in a strawberry milkshake, the traces of excrement in hamburger meat—but it also left some readers with a feeling of mild complacency, as they closed the book and turned to a wholesome supper of spinach and ricotta tortellini.

There is no such reassurance to be had from the new wave, in which Roberts’s book is joined by “Stuffed and Starved: The Hidden Battle for the World Food System,” by Raj Patel; “Bottomfeeder: How to Eat Ethically in a World of Vanishing Seafood,” by Taras Grescoe; and “In Defense of Food: An Eater’s Manifesto,” by Michael Pollan, the poet of the group.

All of these authors agree that the entire system of Western food production is in need of radical change, right down to the spinach. Roberts opens with a description of E.-coli-infected spinach from California, which killed three people in 2006 and sickened two hundred others. The E. coli was traced to the guts of a wild boar that may have tracked the bug in from a nearby cattle ranch.

Industrial farming means that even those on a vegan diet may reap the nastier effects of intensive meat production. It is no longer enough for individuals to switch to “healthier” choices in the supermarket. Schlosser asked his readers to consider the chain of consequences they set in motion every time they sit down to eat in a fast-food outlet.

Roberts wants us to consider the “chain of transactions and reactions” represented by each of our food purchases—“by each ripe melon or freshly baked bagel, by each box of cereal or tray of boneless skinless chicken breasts.” This time, we are all implicated.

---