Tuesday, June 3, 2008

Debt Rattle, June 3 2008: What goes up must come down harder

Dorothea Lange The Wayfarer February 1939
On U.S. 99 between Bakersfield and the Ridge, en route to San Diego.
Migrant man shaving by roadside.

Ilargi: Lehman is in serious trouble on Wall Street. But that’s nothing compared to Bradford & Bingley in the UK, which may be wiped out in a matter of days. As you can see below, they were very close a few days ago. A bank run has been avoided so far because of an alleged government guarantee for every first £35.000 in deposits. What that is truly worth remains to be seen if bank failuers come fast and furious in the UK.

That scenario is not that far out in left field; most large UK banks are caught up in rights issues. That over-supply means that to get any new capital, they’ll have to sell themselves dirt cheap. Which in turn will provoke enormous anger among shareholders. It could happen very soon. But yes, it’s still possible that Gordon Brown sells the future of his people to save the banking system.

Not that Lehman is looking good, mind you, they’re going "money intravenous” for the third time in a few months, and they lost over 50% of their values at the same time. If that trend doesn’t stop, there is no way out of failure or a fire-sale. And following tight on the Lehman heels, Wachovia is lined up for the emergency room, and perhaps the last rites. Or, you guessed it, a fire-sale.

People are often asking for "the" moment, and "the" writing on the wall. How about this: "Sales of [US] commercial properties were down 71 per cent in the first quarter compared with a year earlier.[..] Commercial property prices in the US in February saw their sharpest decline since records began nearly 15 years ago"

Any more for the 90 per cent club?
At the height of the dotcom bust, someone invented the term the "90 per cent club" to describe companies that had lost 90 per cent of their value. Membership of the club grew like topsy, until eventually the only way of maintaining exclusivity was to change it to the "99 per cent club".

Banks, it appears, are the new dotcoms, for already one of their ranks – Northern Rock – has qualified for the 99 per cent club, while Bradford & Bingley, once a member of the FTSE 100, yesterday joined the 90 per centers.

With other banks, the collapse in stock values hasn't been proportionately as extreme, but because they are much larger, the damage to shareholder value has been a great deal bigger. Since their peaks, Alliance & Leicester has lost 67 per cent of its value, Royal Bank of Scotland 64 per cent and HBOS 62 per cent.

Without the oil and mining sectors, the stock market would be in a state of profound collapse. Yet despite yesterday's evidence of bottom fishing among financials, with Texas Pacific coming into Bradford & Bingley as a 25 per cent shareholder, nobody is yet sure the sell-off is complete.

Just as the crisis in wholesale money markets begins to ease – albeit not yet convincingly – what we may now be seeing as the economy and housing market slow is a second wave in the banking crisis, with more conventional bad debt experience taking over from where mortgage-backed securities left off. Bank shares may already be oversold. But few will be buying while bad debts are rising.

We will foot the bill for banks' excesses
Financial turbulence does not always spill over into the real economy. Sometimes, central banks fend off further problems. Not this time, though.

Despite the billions poured into the markets since the sub-prime crisis blew up last summer, the continuing financial strain on banks and the weakness in the housing market are taking their toll. The rescue of Northern Rock, it turns out, was only the first act of the drama.

Mounting problems at Bradford & Bingley, the UK's largest buy-to-let mortgage lender, mark the start of the second act, where, traditionally, the plot thickens and sub-plots spin off in all directions. In the first phase, banks were hit on two fronts: they lost money in the fall-out from the sub-prime crisis; then they lost confidence and stopped lending to each other. It was the latter that did for Northern Rock.

B&B, on the other hand, has plenty of short-term financing. But it has run into other problems, such as rising arrears on its mortgages, which reflect a broader economic malaise. As a result, it warned yesterday of falling profits and brought in a new investor, the US private equity firm Texas Pacific Group.

News of its travails also knocked other UK bank stocks, especially HBOS and Royal Bank of Scotland, which, like B&B, are trying to raise fresh capital in increasingly grim conditions. Hadn't we been told that the worst is over? We had, but it isn't.

There are some grounds for hoping that the multi-billion pound losses by banks in the sub-prime crisis have been accounted for, but I'm not convinced that the write-offs have been big enough. More nasty surprises may still be lurking. Indeed, B&B popped out some fresh sub-prime losses among its other goodies yesterday.

But banks' woes are no longer limited to toxic sub-prime related assets. Just as they are struggling to regroup, they may have to start writing off bad debt on a new front: the UK housing market. According to the Nationwide Building Society, house prices fell 2.5 per cent in May and are 4.4 per cent lower than a year ago.

The Bank of England said yesterday that approvals for home loans hit a record low in April, pointing to further price falls in coming months. Most banks have said that they are expecting - and can cope with - falls in the region of 10 per cent in the next year or so. They should be so lucky.

"A 20 per cent fall from peak to trough would be a good result," argues George Magnus, senior economic adviser to UBS. He believes the housing market has dried up "for the foreseeable future", by which he means years rather than months.

The danger is that the falling housing market, coupled with pressure on consumers from rising food and energy costs, could create a steepening downward spiral, as homeowners fall behind on mortgage payments, and under-capitalised banks take further hits and rein in lending to new homebuyers and entrepreneurs.

Admittedly, B&B is particularly vulnerable as a result of its aggressive lending strategy. The bulk of its loans are in the riskiest parts of the mortgage market - buy-to-let and self-certified - but that probably means that it will feel the pain first, rather than alone.

Credit Hurricane To Make Landfall
We've heard so many stories about people that stubbornly refused to leave their homes and then got nailed by the hurricane. Many times it's a "better safe than sorry" move, and that seems to be the majority view on Wall Street these days, that the worst is behind us.

To be frank, I could not disagree more vehemently. I believe that the credit crisis is about to rear its ugly head again, potentially unannounced. It is possible that the storm will miss us and that the worst is behind us and if so, the worst thing that will happen is that we will make less money than the next guy, which is OK by me. I believe the next part of the crisis will be more widespread and have a larger impact on the real economy than many believe.

Delinquency rates in everything from credit cards, home equity loans, auto loans, utility bills and telephone bills are increasing. The one-two punch of dramatically higher oil and gasoline prices and a slowing economy, along with the high levels of indebtedness are taking its toll. Now back to the hurricane analogy.

If I'm correct, the next stage of the credit crisis, which I firmly believe is at our front door, could make the first stage feel like a walk in the park. This is when the hurricane makes landfall, and many that didn’t evacuate as they were instructed to (those taking credit risk at present no matter how disturbing the economic data has become will wish they had). Let’s say the storm comes and lasts six to nine months, and the newly elected president will likely blame past administrations and possibly wish they had never run for office, likely having a term of "one and done."

If you're lucky enough to make it past the front part of the hurricane, a seemingly calm period takes place (the eye) and once again, people feel relieved, see the sun and hope that the back end of the storm will break up as it hits shore. This could happen in 2009 at which point Stage 3 shows up, and the back end of a hurricane can be the most damaging and is the knockout punch. 

Virtually every data point that I am seeing these days gets worse by the day, yet the data is being greeted with complacency. Since the Fed has played the ultimate ‘Moral Hazard Card’ by back-stopping banks and brokers with their repo lines and term facilities, I suppose many feel that the Fed will be there to bail them out. I think they are sadly mistaken and that the Bear Stearns will be nothing close to an isolated instance.

The economy most certainly seems to be stalling with money still growing at rates near 20% annually. It is expected that the Bureau of Labor Statistics will release the fifth consecutive month decline in non-farm payrolls this coming Friday. Who would have thought that the economy would stall with excessive credit growth, bubbles in equities, real estate and commodities over the past ten years?

If the economy were on stable footing, surely the economy would be expanding at a rapid pace and the Fed would be forced to tighten monetary policy, not hand out cash to all its Wall Street buddies. But where is my bailout? When I make a bad decision in a portfolio, I don’t have a backstop. Rather, I have to pay for my mistakes, which is now happening at an even greater pace on Main Street. Homes are collapsing in value, equity markets around the world stagnate, credit spreads stay stubbornly wide and delinquencies accelerate.

The sole reason, in my opinion, is that much of the expansion and bubble creation were stoked by credit and derivative creation. Since the creation was unprecedented, we can only conclude that the unwind will be like something we have never seen before. The poster child of the unwind are the bank and brokerage stocks, the parties responsible for providing easy money and financial alchemy.

Ilargi: This will never fail to surprise me: Ben Bernanke talks out of his a$$. Look: "The Fed's commitment to price stability and maximum employment 'will be key factors ensuring that the dollar remains a strong and stable currency' ".
Bull. Nonsense. Foul Air. And LIES. The Fed has been busy weakening the dollar, intentionally and very actively. It’s lost 40% of its value in a few years. How is that a strong and stable currency?

But when confronted with these obvious lies, investors see signs of the Fed propping up the dollar. What is that all about? Hey, it ain’t my dough, but where have you guys been lately? He’s not going to do it, you know? He’s sucking you in, you suckers. he knows the numbers, he knows there won’t be any growth in the US economy, no matter what he says to make you think otherwise.

Bernanke Says Rates 'Well Positioned' for Growth, Stable Prices
Federal Reserve Chairman Ben S. Bernanke said that interest rates are "well positioned" to promote growth and stable prices, and that policy makers are "attentive" to the impact of the falling dollar.

The Fed is working with the Treasury to "carefully monitor developments in foreign exchange markets" and is aware of the effect of the dollar's decline on inflation and price expectations, Bernanke said today in his first speech on the economic outlook in two months.

The dollar climbed more than 1 cent against the euro and the price of gold dropped almost $14 after Bernanke's remarks reinforced speculation the Fed will refrain from lowering rates further. Policy makers lowered the benchmark rate 3.25 percentage points since September to 2 percent to alleviate the damage to the economy from the credit crisis and housing recession.

"I can't recall such a strong defense of the dollar from a Fed chairman," said Sophia Drossos, a currency strategist at Morgan Stanley in New York, who used to work at the New York Fed, where she helped manage the central bank's foreign-exchange holdings. "The Fed is putting its marker down in letting the market know that a weaker dollar would be detrimental."

Bernanke, 54, spoke via satellite to the International Monetary Conference in Barcelona, Spain. He is talking on a panel with European Central Bank President Jean-Claude Trichet, Bank of Japan Governor Masaaki Shirakawa and Bank of Spain Governor Miguel Fernandez Ordonez.

"For now, policy seems well positioned to promote moderate growth and price stability over time," Bernanke said. "We will, of course, be watching the evolving situation closely and are prepared to act as needed to meet our dual mandate." The dollar strengthened to $1.5505 against the euro from $1.5607 today after weakening by 16 percent in the past year.

Crude oil fell to $126.51 a barrel in New York at 9:19 a.m. from $127.98 in the minutes before Bernanke's comments were released at 9 a.m. "We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations," Bernanke said. The Fed's commitment to price stability and maximum employment "will be key factors ensuring that the dollar remains a strong and stable currency."

Paulson Finds Fed Won't Help With One-Year T-Bills
As if a slowing economy, a falling dollar, faster inflation and a credit crunch weren't enough headaches for U.S. Treasury Secretary Henry Paulson, he now has to worry that the Federal Reserve will undermine the return of the one-year bill.

For the first time since 2001, the government will sell 52- week debt tomorrow, expanding its source of funding as the budget deficit approaches a record. The Fed is selling Treasury bills at the fastest pace since it was founded in 1913 to support bank-lending programs meant to boost confidence in financial markets. The Fed owns $34.3 billion of the securities, down from $267 billion, or 27 percent of the market, in December.

"The Fed took a proportion of Treasury sales so regularly, so often, that we just took it for granted," said Stephen Van Order, a debt strategist in Bethesda, Maryland, at Calvert Asset Management, which oversees $10 billion in bonds. "You do have to find buyers for the Treasuries that the Fed would have taken in the past. Bills, of course, have been torched by this."

For every dollar the central bank adds to the banking system under the lending facilities, it withdraws a similar amount to maintain its target rate for overnight loans. The Fed bought bills at all but three of the 992 auctions from August 2001 to last December, according to the Treasury. By comparison, it didn't purchase bills at 30 of the 66 sales in the five months through April, and it won't buy any of those sold this week.

Interest rates on six-month Treasuries, the longest maturity bill before the revival of one-year securities, have climbed 95 basis points since mid-March, touching a three-month high of 2.04 percent on May 29. The 4.875 percent Treasury due May 2009, which was issued a year ago, yielded 2.25 percent as of 8:20 a.m. in New York.

The Treasury will sell $16 billion of 52-week securities tomorrow. The government began regular sales of the one-year bill in 1959 and eliminated it in 2001 after the U.S. posted three straight yearly budget surpluses. Now, President George W. Bush's administration forecasts the deficit will swell to $410 billion in the fiscal year ending Sept. 30, just shy of the record $413 billion set in 2004.

On top of that, the dollar has fallen 11 percent against a basket of six major currencies in the past year; inflation is rising at a 3.9 percent rate, almost double its pace in August; and U.S. financial firms have reported $162.5 billion in credit- market losses, Bloomberg data show.

"Not only is total issuance increasing, but the percentage of total issuance going to non-Fed investors is increasing as well," said Michael Pond, an interest-rate strategist in New York at Barclays Capital Inc., one of the 20 primary dealers that trade with the Fed and are required to participate in Treasury auctions. "And that's really a double whammy."

Soros Says Oil 'Bubble,' Market Signal Recession
Billionaire investor George Soros said an oil price "bubble" is working with fundamentals in the market that may lead to a recession in the world's largest economy. "The rise in oil prices aggravates the prospects for a recession," Soros said in testimony prepared for delivery today to the Senate Committee on Commerce, Science, and Transportation.

"The bubble is superimposed on an upward trend in oil prices that has a strong foundation in reality," he said. "To be sure, a crash in the oil market is not imminent." The committee is holding hearings on potential energy price manipulation.

Congressional leaders are pushing the Commodity Futures Trading Commission and other agencies to step up efforts at overseeing the markets for fuels such as gasoline as retail prices are forcing consumers to drive less. The hearings come as oil has retreated from a record $135.09 a barrel on May 22.

The average nationwide pump price for regular gasoline rose to a record $3.978 a gallon yesterday, AAA said. The price was above $4 in 12 states and the District of Columbia. Gasoline demand in America fell 5.5 percent from a year ago in the week ended May 23, according to MasterCard Inc.'s weekly SpendingPulse report. Sales have declined in 15 of the past 18 reports, when compared with a year earlier.

Soros said too much regulation of oil markets could drive trading into unregulated areas such as the over-the-counter market. He laid some of the blame on recent oil price rises on commodity index funds, which only buy oil contracts, helping to push prices higher.

Morgan Stanley, Merrill, Lehman Ratings Cut by S&P
Morgan Stanley, Merrill Lynch & Co. and Lehman Brothers Holdings Inc. declined in New York trading after Standard & Poor's lowered credit ratings for the investment banks, saying they may have to book more writedowns on devalued assets.

Morgan Stanley, the second-biggest U.S. securities firm by market value, was cut one level to A+ from AA-, S&P said today in a report. Merrill Lynch, the third-biggest, was also cut one level to A from A+, as was Lehman Brothers, the fourth-biggest. Goldman Sachs Group Inc., the largest of the group, was affirmed at AA-. The outlook on all four New York-based companies remains negative, S&P said.

The downgrades may make it harder for the banks to sell derivatives such as credit-default swaps that are tied to bonds or loans, said Brad Hintz, an analyst at Sanford C. Bernstein in New York. Single-A rated firms are less desirable as trading counterparties for fixed-income derivatives that extend longer than five years, he said.

"You'll see derivatives profitability drop off over a period of time," Hintz said of the three downgraded investment banks. "We estimate somewhere around 1 percent to 1.5 percent of fixed- income revenues are at risk." The firms are also likely to have to post more collateral on the trades they've already made with other parties, raising their costs, Hintz said.

In its last quarterly filing, Merrill said a one-notch downgrade of its credit rating would require it to post an additional $3.2 billion of collateral on over-the-counter derivative trades.

Morgan Stanley estimated in a regulatory filing that a single level downgrade would mean posting an extra $973 million. Lehman said a one level downgrade requires about $200 million of additional collateral.

Ilargi: Lehman lost 50% of its market value the past 5 months, and lost 8% yesterday alone. It has raised $6 billion since February, and now needs another $4 billion. That’s $10 billion in new capital, and dilution of what’s left of share value, or more than half of what the bank’s remaining market value is.

Lehman May Need to Raise Capital as Analysts See Loss
Lehman Brothers Holdings Inc. may report its first quarterly loss since going public in 1994, increasing pressure on the company to raise capital by selling stock.

The fourth-biggest U.S. securities firm probably will post a second-quarter loss of 50 cents to 75 cents a share, according to analysts at Oppenheimer & Co. and Bank of America Corp. New York-based Lehman holds "very large, illiquid" assets and "we can't rule out equity issuance" to replenish the balance sheet, analysts at Merrill Lynch & Co. said in a report yesterday.

Lehman may seek as much as $4 billion by selling common stock, the Wall Street Journal reported today, citing unidentified people with knowledge of the matter. The company has raised $6 billion since February amid asset writedowns and losses from the collapse of the U.S. subprime mortgage market.

Lehman dropped 48 percent in New York trading this year, the worst performance on the 11-company Amex Securities Broker/Dealer Index. "This is adding to the perception that there's a need for more write-offs and capital raisings," said Greg Bundy, executive chairman of merger advisory firm InterFinancial Ltd. in Sydney and a former head of Merrill's Australian unit.

Chief Executive Officer Richard Fuld said at the annual shareholders meeting in April that "the worst is behind us" in the credit-market contraction that has cost the world's biggest banks and brokerages more than $387 billion. Financial-services firms have been forced to raise $276 billion to cover the losses, according to Bloomberg data.

Citigroup Inc., the biggest U.S. bank, has raised the most, pulling in more than $44 billion with a combination of stock sales and private offerings to investment funds controlled by foreign governments including Abu Dhabi.

Lehman Chief Financial Officer Erin Callan said last month at an industry conference in New York that the firm's leverage-- the ratio of assets to equity -- declined to 27 to 1 from almost 32 to 1 at the end of the first quarter. The company needs more capital because of declines in the credit markets, David Einhorn, a hedge fund manager who's betting Lehman shares will fall, said in an interview last week.

Lehman to raise billions in fresh capital
Lehman Brothers Holdings Inc. may raise billions of dollars of fresh capital, suggesting the investment bank will post its first quarterly loss since going public, the Wall Street Journal said on Tuesday, citing sources familiar with the matter.

Analysts and Wall Street executives estimate it might total $3-billion to $4-billion(U.S.) , the newspaper said.
Lehman may issue common stock, diluting current shareholdings, and will probably reveal its capital plans when it reports quarterly results the week of June 16, the WSJ said.

Lehman's market value is about $18.7-billion, based on Monday's closing stock price of $33.83, Reuters data shows. The report sparked selling in the U.S. dollar and weighed on Asian stocks, while boosting demand for safe-haven government bonds such as U.S. Treasuries.

"The developments are a reminder to markets that the effects of the credit crisis continue to reverberate around markets," said Zurich-based UBS currency strategist Geoffrey Yu in a note to clients. According to recent analysts research notes, Lehman has been hurt by hedges used to offset losses in various securities.

Second-quarter losses from asset writedowns and ineffective hedges are likely to top $2-billion, the newspaper said. The bank will also realize losses tied to job cuts, the WSJ said, citing a person familiar with the matter. Lehman in May decided to cut around 1,300 jobs, or nearly 5 per cent of its work force, a person briefed on the matter said. It had laid off more than 5,000 people since the middle of 2007.

Lehman is the smallest of Wall Street's four major investment banks, following JPMorgan Chase & Co.'s purchase this weekend of Bear Stearns Cos. Several analysts expect Lehman to post a second-quarter loss, according to Reuters Estimates.

The next banking crisis?
Yesterday's announcements from Bradford & Bingley were not the first time the former building society had alarmed the market this year. On 13 February, B&B was the first British bank to announce full-year results, stunning investors with £228m of charges for wholesale assets and financial instruments hit by the credit crunch.

The writedowns and losses shook confidence in the banking sector, raising fears of massive losses at other lenders as results season unfolded. Though the numbers did not turn out as bad as feared at the time, the concerns were borne out later as Royal Bank of Scotland and HBOS revealed big writedowns last month and announced rights issues.

Now investors fear that B&B's latest warning is a harbinger of things to come. This time, the Yorkshire-based bank's main problem is not caused by losses on exotic credit products at its Treasury operation. Instead, the country's biggest buy-to-let lender has sounded the alarm over old-fashioned arrears and bad debts from its stock of mortgages.

Other banks' shares dropped yesterday as investors prepared for the next phase of the playing-out of the credit crunch as overstretched borrowers struggle to repay their debts. HBOS, the country's biggest mortgage lender and the second-largest player after B&B in buy-to-let, and Royal Bank of Scotland were forced to put out statements saying that they continued to trade in line with earlier guidance.

European banks such as UBS, which is preparing for its own rights issue, were also hit by negative sentiment spreading from B&B. Chris Willford, B&B's finance director, said: "It reminds those of us in the business and observers outside that this is a credit-risk business and there are cycles in that business. You have to go into this with your eyes open and you have to price for this in the cycle."

B&B's woes appear to be partly self-inflicted. The bank has concentrated on the high-margin but untested buy-to-let and self-certified mortgages that have mushroomed in recent years and has bought many billions of pounds of mortgages originated by GMAC, the US lender. Those loans performed worse than B&B's own assets despite the bank's protestations that underwriting standards at GMAC were the same as its own.

But analysts said B&B's troubles were an early sign of the inevitable rise in problem loans as heavily indebted households feel the pain of increased mortgage costs, higher household bills and the withdrawal of credit by banks. Northern Rock has already said it will more than double its number of debt managers over the next year as arrears increase.

"The trends at B&B are likely to be a feature of the industry more generally – it's a question of degree and what people already have in numbers," Credit Suisse analysts said yesterday. "Our forecasts assume a fairly sharp downturn and are consistent with a 15 per cent house price fall (from end 2007), a doubling in corporate charge-offs and a 50 per cent increase in unsecured charge-offs... We are not sure consensus factors this in though."

Wachovia shakeup: Analysts see JP Morgan as suitor
Wall Street analysts say the ouster of Ken Thompson as Wachovia Corp. chief executive could lead to a sale of the bank, with JP Morgan Chase & Co. identified as the most likely buyer. Even without such a sale, Charlotte, N.C.-based Wachovia is facing a period of significant change that some analysts view as a chance to improve the bank's earnings but others expect will mean more weakness and uncertainty.

"Under Ken Thompson's leadership, he took a defeated First Union franchise and transformed it into one of the premier retail banks in the country and significantly improved profitability," wrote Citigroup Global Markets Inc. analyst Keith Horowitz in a research note Monday. "Unfortunately, his legacy will more likely be defined by the ill-timed Golden West acquisition, which left Wachovia very exposed to the mortgage crisis."

Wachovia has been hit by a string of bad news in recent months, but the company's recent financial woes have revolved largely around the bank's massive exposure to the declining mortgage market, a byproduct of its 2006 acquisition of Golden West Financial Corp., a California thrift that specialized in nontraditional, option-adjustable-rate mortgage loans.

The deal put Wachovia in California and other Western states, but the bank bought the thrift at the peak of the mortgage market and has become swamped with defaulting mortgage loans. Thompson has since conceded the acquisition was poorly timed. The bank also recently cut its dividend to 37.5 cents per share from 64 cents per share while raising $8 billion in new common and preferred stock, which diluted the value of existing shareholders' stock.

Several analysts think a sale to JP Morgan may be likely. "JP Morgan would be regarded as the most likely buyer," wrote Edward Najarian, Merrill Lynch research analyst, in a research note Monday. He points out that JP Morgan's CEO, James Dimon, has said he would like to expand JP Morgan's branch network in the Southeast. "He would also likely find WB's over 14,000 retail brokers an attractive asset," he wrote.

Deutsche Bank analysts also say Wachovia offers what JP Morgan wants. "JP Morgan has indicated at times that it would be interested in franchises that include a combination of California, Texas, Florida and brokerage," analysts Mike Mayo and Chris Spahr wrote Monday, "and Wachovia contains all of these."

Bradford & Bingley underwriters were on the verge of pulling the plug
Underwriters to Bradford & Bingley's emergency rights issue were on the point of pulling the plug on the deal before private equity giant Texas Pacific Group bailed out the buy-to-let lender.

UBS and Citigroup believed B&B's massive profits warning, which caused the shares to tank 24pc to 67p yesterday, was sufficient to allow them to withdraw from underwriting the bank's initial £300m rights issue - an unprecedented move that would have left the troubled mortgage specialist in search of new capital sending shockwaves through Britain's fragile banking sector.

The two investment banks believed that material information on the group was omitted when they signed up to underwrite the rights issue two weeks ago. One source said: "When the full picture emerged, they went to B&B and said this is not how you described it to us. The choices were either to call in the lawyers or rearrange the issue."

Fears that they would abandon the lender were serious enough for the Financial Services Authority to intervene. The regulator contacted UBS and Citi over the weekend to discuss their intentions, although an insider insisted the intervention was "shepherding and encouraging" rather than "strong-arming".

Shareholders were livid that UBS and Citi were able to escape their underwriting commitments, for which they were paid £9m. One said: "In my memory this is without precedent, the underwriters getting off the hook. Shareholders will want an explanation." Since BP's troubled float in 1987, no underwriter in a major issue has been left to pick up the stock.

B&B 'bails out underwriters Citi, UBS at expense of shareholders'
Bradford & Bingley's chairman has owned up to a series of failings as he defended the slashing of the bank's rights issue price and a profits warning.

Rod Kent, who has taken over the job of chief executive after the sudden departure of Steven Crawshaw, admitted that the bank had made too many errors as analysts questioned him on the reasons for the bank's sudden change of guidance. He said B&B needed to overhaul its systems for transmitting financial information and communications.

The former building society slashed the price of its rights issue to 55p a share from 82p announced just over two weeks ago and blamed the worsening trading outlook and financial stock market valuations. The bank also announced the sale of a 23 per cent stake to TPG, the private equity firm, for £179m, priced at 55p a share.

Mr Kent said the rights issue would have been "under water" at the previous level because many of the bank's 950,000 small shareholders would not have taken up the rights. The capital raising was fully underwritten by UBS and Citi.

"It is not clear to me why you are bailing out the underwriters at the expense of shareholders," Tim Sykes, an analyst at Execution, told Mr Kent. James Eden, of Exane, said the change "beggars belief" and that the underwriters should have been forced to buy the shares at 82p and sell them at 55p.

The announcement was the latest instalment in the confused saga of the bank's capital plans. It denied reports last month that it was considering a capital raising and then announced a £300m cash call less than a month later. The bank is now raising £400m including the TPG investment. B&B said it had suffered a pre-tax loss in the first four months of the year as margins were squeezed and mortgage defaults rose.

B&B shares fell 24 per cent to an all-time low of 67p. The news hit other banks, with HBOS registering the biggest fall in the FTSE 100, dropping 10 per cent. HBOS and Royal Bank of Scotland, which have also announced capital raisings, issued statements saying they were trading in line with earlier guidance.

Bad debts for the first four months of the year jumped to £36m at B&B compared with £23m for the whole of 2007. Mortgage accounts three months in arrears rose to 2.16 per cent of the bank's book from 1.63 per cent at the end of last year. The bank was also hit by £15m of fraudulent mortgages.

Mr Kent admitted that the bank had been "over-optimistic and not realistic enough". The business had deteriorated in April but the board had only received the figures at the end of May, he added. "We are used to a less dynamic environment than we have seen in the past few months and days," said Mr Kent, promising a new "realism and a real sense of urgency".

Ilargi: And banking is not the only problem area in Britain. The entire economy is flat on the floor, and what claim to fame does it have left? What can possibly raise it up again?

New UK economy fears as manufacturing growth stalls
Manufacturing growth stalled last month, bringing a three-year run of recovery in the battered sector to an abrupt halt, a key survey showed yesterday. In findings that fuelled fears that the economy is on course for a severe downturn into next year, the latest CIPS purchasing managers' survey of industry showed that overall manufacturing activity stagnated during May.

In a worse-than-expected fall, the headline index of manufacturing activity from the Chartered Institute of Purchasing and Supply (CIPS) fell from 50.8 in April to 50.0 for last month, on a scale where any reading under this level indicates that the sector is shrinking. It marked the weakest result in the survey since July 2005.

Industrial businesses' orders fell for a fifth month in a row, with the CIPS survey's gauge of order books dropping sharply into negative territory to 48.3, also the worst level for three years. The drop in orders came despite the boost to the competitiveness of Britain's exports from the recent steep drop in the value of the pound. Export orders also slipped last month, although not as sharply as in April.

Manufacturers responded to declining orders by cutting back on production, with the survey's output gauge pointing to zero growth last month, for the first time since mid-2005.

The sector's companies also appeared to have begun to cut jobs in reaction to deteriorating prospects in both domestic and overseas markets. The CIPS measure of employment trends in industry also dropped into negative territory, sliding from 50.5 in April to a May reading of 49.2

Chinese monetary policy is driven primarily by RMB speculation
There is an article in this week’s Caijing that summarizes a survey by Deutsche Bank’s Jun Ma (here, for those who can read Chinese).  I haven’t managed to get it translated yet but blog participant Kar Kheng Giam summarized it for me as:
Key points:
For those with 'business' connections/enterprises: 52% opted to bring money in as 'FDI', and 11% as under-invoicing.  For those who bring money the old fashioned ways: 85% use either US$50,000 per person per year, using multiple relatives and friends, or the RMB80000 per day TT limit.  57% of respondents forecast RMB to rise to 5.50-6.00.

The survey seems to confirm what we had more or less guessed – there are an awful lot of ways to bring money into China and what is driving the speculative inflows are some pretty ambitious expectations of RMB appreciation.  The very large trade and investment accounts are a particular important channel for hot money and the family businesses with networks both inside and outside the mainland are likely to be particularly efficient at bringing money in (and are likely to be no less so at taking money out again one day). 
The survey also suggests that the “unexplained” portion of reserve accumulation – after backing out the trade surplus, FDI, interest income and revaluation gains – is biased downwards, since there may be substantial amount of hot money in the trade and FDI numbers.  Take this out and add it to the “unexplained” part and the most stable sources of reserve growth – FDI, the trade surplus, and so on – are becoming an increasingly small fraction of total net inflows.  Chinese monetary policy, in other words, is at this point almost entirely driven by hot money inflows.
This is a pretty disturbing conclusion and bears repeating: Chinese monetary policy is largely a function of massive and very volatile speculative inflows driven by RMB appreciation.  
Headline reserve growth for the first four months of this year was a breathtaking $228 billion.  We know that this number understates real inflows because of the redenomination of minimum reserve requirements and the transfer of assets to the CIC, and my best estimate is that adjusting for these reserves would have climbed by $340-370 billion.  Of this approximately $45-50 billion consists of interest income and valuation gains.  The trade surplus and FDI accounts for $94 billion, but almost certainly a large fraction of this consists of disguised hot money. 
Even ignoring the disguised hot money, that still leaves $200-230 billion unexplained.  Part of this unexplained amount will include such things as net tourism and some non-speculative financial transactions, but these aren’t likely to be large numbers, and I suspect that all of them together are probably less than the hot money inflows disguised in the trade and FDI accounts, or at least not a whole lot bigger.  A plausible guess, then, is that hot money inflows are greater than the headline reserve growth, or at least not a whole lot less.

$68,000 fill-ups herald 'grim' era for airlines
When Air Canada fills up a new Boeing 777 in Toronto with jet fuel for a one-way flight to London's Heathrow Airport, it now costs $68,948. While the airline is stronger than many rivals, that kind of sticker shock underscores why global carriers are finding it hard to avoid red ink, even with the introduction of hefty fuel surcharges.

Monday, the industry itself forecast at least $2.3-billion (U.S.) in combined losses this year. The International Air Transport Association's (IATA) dim projection is based on a conservative average oil price this year of $106.50 a barrel. The airline sector's 2008 losses would surge to $6.1-billion if oil prices average $122 a barrel – still lower than Monday's $128 but higher than the $105 average so far this year.

“With oil, each increment up makes it harder and harder on us,” said Air Canada chief executive officer Montie Brewer. “Oil was a problem at $80 and $100, and now it's crazy.” Montreal-based Air Canada introduced fuel surcharges last month on North American flights, and recently raised international fees. On the Toronto-London route, for instance, the one-way fuel surcharge has been boosted to $145 (Canadian) from $112.

Even with new fuel-efficient Boeing 777s, Air Canada's fuel surcharge on the Toronto-London route doesn't cover the one-way fuelling costs of $197.56 for each of the plane's 349 seats. Air Canada also uses smaller Boeing 767s on the transatlantic service, with the fill-up costing $47,658, or $225.87 for each of the aircraft's 211 seats.

“The situation is grim,” said IATA director-general Giovanni Bisignani, who compared the plight of airlines with “Sisyphus – a mythical character whose fate was to constantly carry heavy loads uphill.” In a statement from IATA's annual meeting in Istanbul, Mr. Bisignani said 24 airlines have suspended operations or gone out of business in the past six months, as prices for North Sea Brent crude soared 40 per cent.

In 2002, nearly $40-billion in fuel bills accounted for 13 per cent of the global airline sector's operating costs. This year, expenses for jet fuel will likely surpass $176-billion and gobble up 34 per cent of operating costs, IATA said. The forecast of a money-losing year marks the fourth time in the past 12 months that IATA has reduced its outlook for 2008. It had revised its profit prediction to $4.5-billion from the original $9.6-billion, before Monday's major revision into the loss column.

Dollar crisis looms, says Nobel laureate Mundell
A major dollar crisis could come within five years and China is discussing reforms to the global monetary system to protect its $1.6-trillion (U.S.) reserves pile, says Nobel Prize-winning economist Robert Mundell.

Mr. Mundell, who has regular contacts with Beijing officials, said they are considering proposing ways to fix major currencies including the dollar and the euro, in a system similar to the one which operated under the Bretton Woods agreement from the end of World War Two until the 1970s.

“There's no doubt about it that inside the Chinese government there's a lot of discussion going on. I'm not sure how they're doing it but I know they're going to get an input from me,” Mr. Mundell told Reuters in an interview. Without reform, the global monetary system is headed for a dollar crisis within years, Mr. Mundell believes.

However, he thinks the United States will avoid a technical recession during the current downturn and that the weak dollar will help it to make a recovery around autumn of this year. But its growing liabilities accumulated by its current account deficit means that it will eventually pay a high price if the current monetary set-up continues, he said. “I see the problem coming maybe in the next recession,” he said. “There could be a real dollar crisis in five years.”

China is worried about its pile of about $1.6-trillion in foreign reserves, built up during years of U.S. trade deficits, which loses value as the greenback depreciates. “What you need to have is an International Monetary Fund that's going to take some of these excess dollars, put them into a substitution account inside the IMF or some other institution and then use that and create what is a new international currency,” said Mr. Mundell.

“This kind of proposal would be very acceptable inside China. The Chinese are thinking in terms of this,” he said. Mr. Mundell, awarded the Nobel Prize for Economics in 1999 for his work on exchange rates and optimum currency areas, travels regularly to China, where he has advised senior government officials. For years, China has come under pressure from U.S. and European authorities to allow its currency, the yuan, to appreciate, in order to make Western goods more competitive. But Beijing has resisted.

“They don't have many pre-conceptions. They don't have a belief obviously that floating is a good idea, whereas the European Central Bank and the Americans think that floating is the best of all possible worlds,” Mr. Mundell said. Fixing exchange rates would favour the euro zone, which is now battling with a euro at around record highs against the dollar, said Mr. Mundell, who has often been referred to as one of the intellectual fathers of the single European currency.

“I think the risk now is that the high euro is going to build in pressure which is going to involve deflationary pressure in the asset markets, housing and so on, and that's going to cause a problem, a nagging problem, that's going to go on for a long time as long as the euro is as high as this,” he said.

“The swings in the dollar-euro exchange rate are big problems, and the problem is exacerbated by the fact that the Americans get the benefit of these swings and Europe gets the wrong end of the stick.” But Western policy makers, particularly in the United States which receives an economic stimulus from a weak dollar, would be reluctant to accept monetary change, Mr. Mundell said.

“The U.S. Bush administration isn't much interested in it, they're quite happy with the dollar the way it's working, and the Europeans are really behind the zone on this. Nobody in Europe is thinking about international monetary reform and Europe would be a major beneficiary of it.” “Bernanke and Trichet are very much behind the curve on this,” he said, referring to Federal Reserve chief Ben Bernanke and ECB head Jean-Claude Trichet.

Villains in the Mortgage Mess? Start at Wall Street. Keep Going.
Yes, the executives at Countrywide Financial Corp. planned a top-dollar shindig at a ski resort earlier this year, just after the bank's multibillion dollar losses on subprime mortgages required a shotgun marriage to Bank of America. (A Wall Street Journal story forced them to cancel the party.) And sure, Bear Stearns chief executive James E. Cayne was off playing golf last summer as two of his investment bank's hedge funds collapsed under gargantuan subprime losses. (He's been dumped.)

But so far, the current mortgage meltdown hasn't featured the crasser displays of the 1980s savings and loan fiasco, when executives partied hearty -- one banker famously dressed up as a king and served lion meat to his guests -- as they created a mortgage industry mess that cost taxpayers more than $500 billion.

As a reporter for this newspaper, I covered the savings and loan debacle in depth and later wrote a book about it. Watching the current crisis unfold, I see much of the same behavior that led to the "S&L Hell" of two decades ago. Indeed, some of the fixes for the last problem led directly to this one. Once again, too many people had access to other people's money with too little oversight.

Once again, the White House, Congress and federal bank regulators failed to police the financial services industry because they mistook deregulation for a system without any reasonable rules. And now as then, our saga is chock-a-block with people and institutions deserving special mention in the Suprime Hall of Slime.

But make no mistake: Today's crisis dwarfs the S&L fiasco. The eventual cost to taxpayers of this scandal is likely to make yesteryear's culprits look like pikers. The short version of how we got here: Lenders, fat with money made cheap by the federal government, aggressively coaxed millions of borrowers to take out unaffordable mortgages.

They lent this money without assessing whether borrowers could repay it. They assumed, in fact, that most wouldn't be able to and would have to refinance into new, equally unaffordable loans. This process would produce an endless cycle of fees for the lenders -- but only if home prices rose, fairy-tale-like, forever.

On what planet would that be an acceptable business plan?

GM to Close Four Plants, Shift Production to Cars, Cut Hummer
General Motors Corp., struggling to return to profit after three annual losses, said it will close four plants, introduce new small cars and review whether to shed its Hummer brand of large sport-utility vehicles.

Gasoline prices exceeding $4 a gallon represent "a structural change, not just a cyclical change," Chief Executive Rick Wagoner told reporters today before the Detroit automaker's annual shareholder's meeting in Wilmington, Delaware.
The four plant closings will save $1 billion and cut North American truck capacity by 700,000 vehicles, he said. At Hummer, "we're considering all options from a complete revamp to a partial or complete sale of the brand," Wagoner said.

Wagoner's priorities are shifting because gasoline has more than doubled since 2004, including this year's 31 percent climb to $4. As losses totaled $54 billion over 39 months, he focused on expanding Detroit-based GM's sales overseas while improving vehicles and cutting costs at home, including a wage-reducing accord with the United Auto Workers in 2007.

GM also approved the production version of the Chevrolet Volt electric car and adding third production shifts at some car plants. "It is significant, but this is a late reaction to changing market dynamics," said Dennis Virag, president of Automotive Consulting Group in Ann Arbor, Michigan. "The plans really should have been in place a number of years ago."

The gods of greed
They promised economic stability, order and prosperity. But instead the world's bankers have delivered chaos, debt and uncertainty - and then blamed the feeble governments that surrendered control of the global economy to them. In the first of three extracts from their new book, Larry Elliott and Dan Atkinson explain how the reckless speculation of a super-rich elite has left us all the poorer

March 2008 was no time to be a welfare scrounger in Gordon Brown's Britain. That month saw a much-trumpeted move, the latest of many since Labour came to power in 1997, to end the so-called "sick-note culture".

On March 17, Dame Carol Black, the government's national director for health and work, declared that absence and worklessness related to sickness were costing the country £100bn a year, and it was announced that ministers were to look at replacing the doctor's sick note with a "fit note", detailing what people can do rather than what they cannot when they are on leave for health reasons.

This was of a piece with the "tough love" approach of Brown and his predecessor to those on welfare benefits. It was all about reminding those who wanted to get their hands on public money that rights came with responsibilities.

Four days later, the chief executives of Britain's five largest banking institutions - Barclays, HBOS, HSBC, Lloyds TSB and Royal Bank of Scotland - met the Bank of England. In the jargon of the City, they wanted governor Mervyn King to widen the types of collateral against which the Bank would lend to the clearing banks. In plain English, they wanted him to lend taxpayers' money against much flakier assets than would normally be considered acceptable.

Why did they need this handout? Because banks themselves had stopped lending each other money. The collapse of the US housing market, and the complex financial instruments that had been spun off from it, had caused chaos in the money markets. The victims of last year's "subprime crisis" included two of the world's most respected banks, America's Bear Sterns and France's BNP, while the "credit crunch" that followed claimed Britain's Northern Rock.

Those banks that escaped unharmed were sure of only one thing: with so many of their peers exposed to incalculable risks, there was more bad news to come. That fear seems amply justified. Speculation has left the global economy more vulnerable to a financial collapse than at any time since 1929. According to the supposedly sophisticated models used by market practitioners, a stock-market crash such as the one in 1929 was likely once in 10,000 years.

They said the same, however, about the stock market crash of 1987, the collapse of the hedge fund Long Term Capital Management in 1998 and the subprime crisis. The obvious conclusion is that these models are flawed. The International Monetary Fund (IMF) recently described the crisis that erupted last August as "the largest financial shock since the Great Depression".

George Soros, the billionaire speculator who knows a thing or two about financial upsets, says the world is facing the "most serious crisis of our lifetime". Fortunately for the banks, in Brown's Britain they are seen as a cut above the average benefits scrounger. A month after they visited King, the governor announced a £50bn "special liquidity scheme" to provide emergency loans to struggling institutions.

It was a similar story across the Atlantic. Over the weekend of March 15 and 16, America's central bank, the Federal Reserve Board, launched a rescue for Bear Stearns, the country's fifth-largest investment bank. To smooth a takeover by JP Morgan Chase, the Fed assumed up to $30bn (£15bn) of Bear's more doubtful assets. Were this act of corporate welfare not sufficient, the Fed also announced that it was to provide emergency liquidity to the market. For good measure, it cut interest rates.

What was most extraordinary about all of this was not the bailing-out of City and Wall Street types who had spent decades, like surly teenagers, insisting that they wanted only to be free from the stuffy, paternal state institutions to which they now turned for help. Rather it was the failure of those same institutions to insist on any quid pro quo. In the real world, when a wild-child son or daughter comes home, tail between their legs, their "boring" parents usually require them to clean up their act in return for financial support and use of their old bedroom. Not so in the world of banking and finance. In remarks to the press in March, the British treasury actually ruled out tougher controls.

Economic depression in America: Evidence of a withering economy is everywhere
Look around. The evidence of a withering economy is everywhere. In "good times" consumers shun the canned meat aisle altogether, but no more. Today, Spam sales are soaring; grocery stores can't keep it on the shelves. Everyone is looking for cheaper ways to feed their families. The Labor Dept. assures us that core-inflation is only 4 per cent, but everybody knows it's load of malarkey.

Food prices are going through the roof. White bread is up 13 percent, bacon is up 7 percent and peanut butter is up 9 percent. Inflation is rampant and there's no end in sight. The dollar is closing in on the peso and working people are struggling just to get by. The bottom line is that more and more people in "the richest country on earth" are now surviving on processed pig-meat. That says it all.
In Santa Barbara parking lots are being converted into hostels so that families that lost their homes in the subprime fiasco can sleep in their cars and not be hassled by the cops. The same is true in LA where tent cities have sprung up around the railroad yards to accommodate the growing number of people who've lost their jobs or can't afford to rent a room on service-industry wages.

It's tragic. Everywhere people are feeling the pinch; that's why 9 out of 10 Americans now believe the country is now headed in the wrong direction and that's why consumer confidence is at its lowest ebb since the Great Depression. This is the great triumph of Reagan's free trade "trickle down" Voodoo economics; whole families living out of their cars waiting for the pawn shop to open.
The economy is on life-support. The rest of the world would be doing us all a favor if they decided to chuck the dollar and boycott US financial products altogether. That would put an end to Wall Street's chicanery once and for all. Foreign investors should be demanding restitution and impounding American assets to compensate for the trillions of dollars they lost in the subprime/securitization swindle.

Litigate, litigate, litigate; that's the only way to make the guilty parties pay for their crimes. Either that or set up a gallows on Wall Street and get down to business. The pundits on the business channel are telling us that the "worst is over"; that the Force 5 hurricane in the financial markets has weakened to a squall.

Don't believe it. The corporate bond market is still frozen, housing is in free fall, and the banking system is buckling from the overload of bad investments. The FDIC is even trying to lure former employees out of retirement to deal with the tsunami of bank failures set to touch down later in 2008. Corporate defaults are on the rise and and commercial real estate is crashing.
"Commercial property prices in the US in February saw their sharpest decline since records began nearly 15 years ago as sources of finance for deals has dried up, according to data from Standard & Poor’s out yesterday. Sales of commercial properties were down 71 per cent in the first quarter compared with a year earlier." (Financial Times).

Commercial real estate is following the same downward trajectory as residential housing. They're both headed for the bottom of the fish-tank. Any slump in CRE will send unemployment skyrocketing while adding to the solvency problems facing the banks.
We're not out of the woods by a long shot, and won't be for years to come. According to Bloomberg News, soaring raw material costs have caused a sharp rise in costs to producers that they won't be able to pass on to cash-strapped consumers. That means that corporate profits will fall and stock values will plunge.

We cannot go on eating like this
It is all very awkward. China and India are getting richer. And it appears their new middle classes want all the things we want: cars, washing machines, even meat. Here in the west, we have to restrain ourselves from saying: “Stop. You can’t live like us. The planet can’t stand it. And our wallets can’t stand it. Have you seen the price of petrol?”

Global equity is the awkward issue lying behind the world food crisis. In the long run, it will also prove fundamental to discussions on energy and global warming. But, for the moment, this difficult, abstract issue is largely obscured by the urgency of finding practical solutions to rising food prices.

Everywhere I have travelled over the past six months, the cost of food has dominated political discussion. In Pakistan I was told that, while foreigners might worry about terrorism or President Pervez Musharraf, ordinary Pakistanis were much more concerned by the soaring price of wheat. In the Middle East, the political impact of rising food prices is discussed with more urgency than Iran or the Palestinians.

But food-price inflation is an issue not just in poor countries. In France, aides to President Nicolas Sarkozy point to the rising cost of food and fuel as the key to his slump in the polls. In Britain and the US, unpopular governments tell a similar story.

The food summit that starts in Rome on Tuesday will search for ways of alleviating the crisis. Robert Zoellick, president of the World Bank, proposed some potential steps on these pages on Friday. They range from increasing emergency food aid to removing barriers to trade. There is a strong risk that rising food prices will lead to global political friction.

Look at the reaction in India to some fairly anodyne comments by President George W. Bush. He said that rising prosperity in the developing world led to people “demanding better nutrition and better food” and so “demand is higher and that causes prices to go up”. The reaction in India was furious. Commentators railed about how much more Americans eat than Indians – chucking in a few nasty asides about fat Yanks and liposuction.

On one level, this reaction was ridiculous. Most impartial analysts, including the World Bank, agree that rising prosperity in the developing world is an important underlying cause of rising food prices. But the emotional Indian reaction is also understandable. Any hint that the good life is available only to westerners is unacceptable.

Europeans and Americans do eat much more per head than the Chinese or Indians. While rising food prices strain household budgets in the west, they risk famines in Africa and Asia. The west is also making its own contribution to the food crisis – through subsidies for biofuels.

An American cartoon recently captured this unpleasant reality. It showed a fat man extracting a corncob from an African child’s food bowl, with the speech bubble: “Excuse me, I’m going to need this to run my car.” Alex Evans of New York University suggests that these global inequalities mean that it might be more useful to think about “food democracy” than about “food security”.

The moral dilemmas thrown up by calculating per capita consumption are not confined to food. They apply just as acutely to global warming. The US points out that China is now the world’s biggest source of carbon dioxide emissions. No global agreement on greenhouse gases will be worthwhile unless it includes China, India and other rising powers.

The Chinese respond by pointing out that the average American still has a far larger carbon footprint than the average Chinese. Like the Indians, they are angered by horrified western calculations about the environmental consequences of consumption by newly rich Asians.

Ilargi: I’ll repost something here that I wrote in yesterday’s Debt Rattle comments, reacting to a comparison of the tulip bubble and today's housing bust. I strongly feel people should think about these things, much more than they do now..

Houses and tulips
About the values of houses and tulips:

Unlike a tulip, a house has quite a lot of value, when calculated in numbers of construction hours, materials, hours mining and assembling the materials. Plus the less easily added worth of providing shelter, or even human emotional value, i.e. the happiness of raising a family in it. A tulip lacks most, if not all, of this. It’s just pretty- to some-.

However, what once distorted the "value" of the tulip can also distort the "value" of the home: speculative investment, mostly facilitated by an overkill in money supply, human greed and plain stupidity, in no particular order. And always, with no exception, what is added to the "value" on the upside will be subtracted on the downside. And then some. It works as any oscillation model does in physics.

Mortgages, as we know them these days, are the by far largest swindle of ordinary people. The "beauty" of the scheme, from the viewpoint of lenders and sellers, is that they have mananged to convince Jack&Jill6Pack that paying off a mortgage is a matter of pride and honor, of the American Dream.

Jack & Jill fall for this trap like mice for cheese (it helps when the president and Fed chairman push it incessantly in public), and end up paying, over the duration of the loan, 3 to 4 times the "value" of the property. In the end, they still haven’t clued in; quite the contrary: they’re proud of themselves for forking over, for having been swindled out of a huge sum of money over the 25-40 years it’s taken to pay for their loan. They are now, after all, the proud owners of something worth 25% of what they've paid for it.

Why does this happen, how did we get here?

Well, think back to Capra’s movie It’s a Wonderful Life. How do you think people in Bedford Falls, George Bailey (Jimmy Stewart)’s hometown, paid for a new home? George runs the Bailey Building & Loan Association, which provides home loans for the average man. "Buildings and Loans" belonged to the people of their communities. Those who had some money deposited it, which made it possible to lend out money for housing construction, and often, a modest interest rate was paid. It was all based on trust in one’s neighbors, on community spirit. Plus, the baker and the butcher knew the homes built with their money would provide new clients.

When, in the film, at about the time the Great Depression comes, people want their money out of their accounts, George tells them it’s all invested in the town. They can see it when they walk the streets, and it’s safe as long as the town is safe (NOTE: unlike tulips, homes keep communities alive), but they can’t all take it out at once.

George’s guardian angel, Clarence, then at one point shows him the town as it would have been without him, and without his B&L. The town’s now called Pottersville, where all loans go through the bank of Mr. Potter, who earlier in the film has already stated that he wants to end the "nonsense" of home loans for the poor.

The film is a perfect example with which to illustrate what is wrong with the "values" of homes, mortgages, and other loans in our days. Banks no longer belong to people in communities. Aa a result, there has been a huge concentration of wealth and power in the money business.

I think I have a good way to show it all (I have forgotten the origin). NB: forget about inflation for now, (or imagine how inflationary these mortgage schemes are).

Suppose the cost of a home, in construction wages and materials, is $100.000. Suppose also that it’s well-built and will stand for 100 years. Seems crazy now perhaps, but it’s not. This means that $1000 per year needs to be paid off, or $83.33 per month. If you want to pay it off in 25 years, it’s $333.33. And THEN IT”S PAID OFF!! No bank will ever have any say over it again.

You can give it to your kids, and they can live for free. You can sell it, and the buyer pays you and your kids. NOT THE BANK. No need, everyone can make $300 a month. Yeah, yeah, you may need repairs. $20.000 enough? Remember, it’s well-built. The bill then is $1200 per year, $100 per month, or $400 for 25 years.

See what happens? A developer these days, for a home that costs $100.000, charges $250.000. You need to pay that upfront, so you must get a loan from a bank (and George Bailey’s gone). When you’ve paid the loan in full, after 25-40 years, once interest and other charges are added, you’ve actually paid $1 million.

Then you sell it, say after 30 years. Now the whole thing starts all over again for the bank, with a new client and a new loan. The house, for which they’ve never paid a dime, will make them another $1 million over the next 30 years. And that is without a crazy market appreciation like the one we’ve just seen.

And don’t talk of competition between banks, or I’ll whoop you: Wall Street’s a closed system.

In the end, the $100.000 house may be paid for 20-30-50 times over in a hundred years. This is all money that is taken out of local communities, and concentrated in the hands of bankers and major shareholders, who live elsewhere. The community COULD have built bridges, schools, hospitals and roads, or taken care of its weaker members, or done a million other things to reinforce itself with that money.

That’s what It’s a Wonderful Life is about, and that’s what we see around us today. And yes, come to think of it, homes are very much like tulips.


Brian M. said...

You know Ilargi, I live pretty close to the Bailey scenario you describe, in a 100,000$ house that is over a century old and still in good shape, bought through a local Credit Union rather than a national bank.

And you are leaving some things out. First, property tax, I want there to be schools and fire departments in my town, right? Then housing insurance. Then even my credit union, or Bailey's Building and Loan needs some operating money, so they have to take some cut of the loan. This puts me up in the 800$ a month range (and in line with out last renting experience) rather than 400$ a month range, but hey, maybe we're being screwed and a good system could get the capital costs, banking overhead, property tax, and insurance down to 600$ a month, but 400$? only if you leave lots of the real costs out.

Anybody can make 600$ a month for 25 years, right? Wrong, no job works like that anymore. You might make 600$ in 90% of the months for the next 25 years, but what is the odds of health problem, or a job change somewhere in there? No town, or job, or career path is that stable anymore. You work a gig until it is gone, and then you have to move to a new location, or a new career path in the old location. And no one can trust their neighbors like in old Bailey's day, because the neighbors come and go all the time too. Here one year, gone the next. It isn't just that the non-local banks are taking all the slack in the system as personal profit, and taking it out of the little systems (that's true too). But that the whole damn thing is simply more fluid and precarious that in Bailey's day. No one, no one can make an honest 25 year commitment anymore, because no one knows where they are going to be, or what they are going to be doing for the next 25 years. And if we look at this particular set of 25 years 2008-2033, how many Americans do you think will be able to make 600$ a month to spend on housing every month, or heck 90% of the months over that particular time span? Yeah if I had money to loan to homebuyers, I want a pretty damn high risk premium on that bet too, even apart from worries about the underlying asset devaluing.

Ilargi said...


You either don't understand what I'm saying, or you pretend to. I'm talking about mortgages, not property taxes or insurance, and bringing them up just obfuscates the issue. You'd presumably pay those extra costs regardless.

Yes, times have changed since Bailey's S&L, but that has no bearing on the argument that over the course of 100 years, 30 times or more the cost of a house disappears from communities into the pockets of developers and faceless corporate shareholders.

That is arguably precisely the money that could pay for the schools and fire departments, and the roads and bridges too. Now you have to access additional funds to cover those costs. Moreover, since these funds now have to be borrowed from a bank, and paid over a long times, at interest, the same pervasive scheme plays there as well. Therefore, it's easy to see property taxes could be -much- lower if a large part of people's income would not be channeled away all the time.

Also, the 'paying off in 25 years' example means what it says, that is: no housing costs, none, going to a bank, for the next 75 years. It would be paid for.

Perhaps it's useful to consider the influence the Potter-like banking cabal has on communities breaking down. People often leave because homes are unaffordable, for one thing. We now know why they are.

Musashi said...

Houses that were built decades ago to last 100 years, represent(ed) the character, values and ethics of the people that built them.

Same with todays shit boxes that will be outlasted by the paper the notes are written on.

This is the root reason the US is doomed in it's present form.

The economy, politics and most everything else discussed (or not) are just the symphtom.

HappySurfer said...


I ask rhetorically as I am either not capable of understanding or I just can't believe...

Many times you, and other esteemed readers ( Stoneleigh, GZ and others) have pointed out that the times we live in are a "direct" manipulation by "interested parties” and they know and understand the final outcome for their personal greed.

I understand and believe that singular major events are staged and manipulated to achieve a “short term goal” say months – few years, but when it comes to a concerted effort over decades to achieve a manipulation I wonder if it can be truly so, or whether the people in power act on a collective lemming basis with poor moral judgement and “see” an opportunity which they pursue to their own benefits and damm the consequences, but planned to the “T” I am not sure.

If it is indeed so I have found in myself a new amazement to the lengths people will go.

In this short space I hope I have articulated well enough the question I ponder as I read your blog?



dark_matter said...

Jim Kunstler did a post once on Its a Wonderful Life titled Not So Wonderful. Google "Kunstler George Bailey" to find it. He points out that auto accessed suburbia is the unintended consequence of George's good intentions and that rather than a Potterville with bars and brothels lining main street, main street is today boarded up and people go to Walmart. Where did George go wrong? What better thing might he have done? The best thing to do with a system in equillibrium may be to keep it as is if you can. But a system like ours that is unstable ... who knows what ill will come from our best laid plans. We are like George not knowing the long term consequences of our actions. If I could invent a replacement for oil tomorrow I would probably do it but some future generation might curse me for it. Some dark film maker should do a sequel to Its a Wonderful Life showing that in the end maybe it would have been better if George never had been born.

Anonymous said...


I agree that a concerted 'conspiracy' is not happening.

Human beings it seems love to use hindsight to draw conclusions about the causation of past (and historic) events. While sometimes they are correct, the ensuing speculation about the motivation behind the causation is pure speculation.

One can see and is aware of the beneficiaries of such events precisely because they benefited. That does not mean they deliberately engineered them. What is unseen is the large number of others involved in causing the event who did not benefit, and hence did not gain fame and notoriety. They generally greatly outnumber the benefiters, and were oftentimes more powerful but history forgets them just the same.

Conspiracy theories seem to me to be a rationalization in response to fears that human systems are failing to prevent suffering. Therefore someone must be to blame, someone must be causing the suffering.

That logic assumes that suffering is completely avoidable. I would argue that it is the system itself that is failing, and actions of powerful individuals are symptoms of the system rather than the cause. To modify Hanlon's razor:

"Never attribute to malice that which can be adequately explained by stupidity" and greed.



Ilargi said...


No, I'm sorry, I can't really see a question, it feels to me like you're circling the wagons.


dark matter

I use the Bailey S&L metaphor for specific reasons, not to say that the film should be dissected. My point is to discuss money flows in loan industries, not architecture or town planning.

Blaming Bailey or thrifts in general for suburbia looks so far-fetched as to not be the smartest assertion.

Capra may have seen burbs as better than city slums, and there may have been a propaganda or advertising link like there was for cigarettes in the day, sure. But would anyone really want to argue that Pottersville is a happier place than Bedford Falls?

ric said...

It takes little analysis to see that Main Street works for Wall Street, which is criminal. Was the National Monetary Commission, and it's chairman, Nelson Aldrich, who wrote the Federal Reserve Act of 1913, unskilled in their design? Did the commission consist of fair-minded public servants trying to stabilize our money supply or were they titans concentrating power? Did the Federal Reserve Act succeed or fail? I suppose it depends upon whom you ask: the indebted middle class or those who are major equity holders of the US central banks.

Although discussing another context, Westexas at TOD puts it well today: "As in the movie "The Sixth Sense" (some ghosts don't know they are dead and they only see what they want to see), for most of us our old way of life is dead, but most of us see only what we want to see."

Greyzone said...

Happy Surfer,

May I suggest that you study the history of the formation of the Federal Reserve? It's instructive. The very people who deliberately caused the Panic of 1907 were the same ones who acted as the board to design the Federal Reserve.

May I also suggest that you review public organizations like the Council on Foreign Relations or The Trilateral Commission. These are not secret organizations and perhaps in that sense there is no conspiracy but please go read what their goals were in the first part of the 20th century then look at now and see how many of those goals were achieved. Then look at the goals they wished to achieve in the latter part of the 20th century and realize that we are going through processes right now intended to assist in achieving those goals.

Now if you actually study the history of the Federal Reserve as well as the CFR and TLC yet conclude that there is no concerted effort going on to direct our society down particular paths, I guess we will simply have to agree to disagree.

Anonymous said...

I agree with your conclusion that today's banks lack any sense of community responsibility, but your analysis is horribly flawed, completely worthless, and perhaps even (perhaps intentionally) misleading.

The value of those future dollars has to be discounted to reflect the loss of purchasing power. I keep reading that the dollar has lost 97+% of its value over the past ninety-five years (since the creation of the Federal Reserve). Do you really expect the next ninety-five (or call it a hundred to match your example) to be any different? That hypothetical one hundred thousand dollar house would cost four million dollars in a hundred years.

Most home buyers (even if they had the money to pay cash for a home) would be better off getting a big mortgage (especially with the tax deductability of mortgage interest and lower tax rates for capital gains) and investing their money elsewhere (yes, things look a little rocky now, but over any reasonably long term, most appropriate investments have a higher return than mortgage interest rates).

Anonymous said...


I don’t doubt that Main Street does work for Wall Street, nor that the creators of the Federal Reserve were skilled in their manipulation of power.

Perhaps I was unclear in my original comment, but I was primarily responding to HappySurfer’s statement that “they know and understand the final outcome for their personal greed” and apply “concerted effort over decades” to reach these outcomes. Such a feat would require a clairvoyant insight into the future.

I concur with HappySurfer that there is no deliberate long term strategy (the “conspiracy”). Rather, the appearance of a concerted long term effort is simply the result of a continuation of actions fueled by short term greed, that generate events that are in reality beyond anyone’s grasp at the time. We only see it as a continuation because of hindsight, and the limited viewpoint that it provides conveniently ignores all the actions that failed for they are then largely invisible.

I think this is particularly evident in what is happening currently. Everyone is hurriedly pushing each other around a circle of musical chairs in time to music that stopped playing sometime ago. The crux is that it is only those who get seats in the final stampede who will be remembered, for they get to set the rules for the next round.

Now, if you were also a winner in a previous round, then you might think this was all quite fun (and profitable), and decided the rules only need minor tweaking. And of course the bigger you are the more you can bully your way to a chair or steal one outright, so many times it is the same people winning.


Ilargi said...

...your analysis is horribly flawed, completely worthless, and perhaps even (perhaps intentionally) misleading.

No, you are not a very good reader, that’s all. If people think I am not bright enough to understand the issues (or that I am, and intend to mislead for some reason), by all means, have your fun.

But I do know, and very well, that it’s possible to bring up property taxes, insurance and even inflation in a piece such as this. However, I have to have faith in my readers’ intelligence, or I can’t write this sort of thing without spending most of my time addressing things that might pop up if people react before thinking.

It’s very obvious when you write things like the ones I do every day, that what people read is what reflects in their respective minds. Not necessarily the whole of what you write, but bits and pieces of it that set off thought processes, which in turn hinder proper reading.

Moreover: I did address inflation specifically:

"..forget about inflation for now, (or imagine how inflationary these mortgage schemes are)."

See? There I pose the question of what inflation would look like without present banking systems. Inflation is a deliberate policy, not some force of nature. When loans for a house suck up 30 times the actual value of that house, it should be very clear that that is inflationary.

The money supply in the economy needs to be increased by the same amounts, or people will not be able to pay for the loan. Which, by the way, is yet another proof that today, inflation is not possible in the rich world: people can’t pay up anymore.

Therefore, assuming that, in the Bailey example I sketch, inflation would remain at levels such as they were over the 20th century, is far too shaky and riddled with question marks. That’s why I left it out.

But even with inflation, there would be no necessary difference. After all, inflation simply means that a brick that was once sold for $1, can be sold 100 years later for $1000, without anything basic having changed. As long as wages and prices rise by the same amounts and percentages, nothing elemental changes. It all goes astray when for instance loans for a house suck up 30 times the actual value of that house. That is where the problem lies.

Brian M. said...

You are right of course that what we respond to in our comments, is the bits of what you wrote that spark some thoughts in our own head. That's how reading and commenting is. Sometimes what interests us isn't the same as the main point you were trying to make. I'm sorry if I frustrate you by falling for distractions from the main issue you were trying to talk about.

Even if a mortgage DOES suck up 30 times the value of the home over its lifetime, we buy them because we can't come up with a better way to pay for housing. If we were rich enough to pay for the house construction ourselves we would do it. If we could trust neighbors long term enough to pool our resourses and pay for the houses, we would (and occasionally do, that's pretty much what a credit union is right?). Where renting is competitive, it is tempting, but even then it is too easy to get kicked out. So to you it looks like the problem lies in sending much of the value out of the community. That looks like symptom of the lack of better options as much as the problem to me. Rather it looks to me like uneven distribution of wealth, or lack of trust are at least as central as exporting value.

The poor schmucks who use the payday loan places wind up sending lots of money to faceless outsiders. Why? Well sometimes they don't know any better, but often they understand what they are doing, and don't feel they have any other options. The faceless outsiders are the ones with the access to money on demand, if we don't have such access and need it, we just have to pay their damn price. Mortgages and payday loans are just middle class and lower class versions of the same double-bind. But maybe I'm misunderstanding again, or you simply disagree...

HappySurfer said...

Thank you for your comments, I have thought about what you have said and I will heed what you say.

A few more thoughts, I am not a US citizen and live in Africa, maybe I feel the actions of the FED etc are not directly affecting me but as I am interested I read blogs such as this. Yes we are secondarily affected by the course of the USA due to its far reaching power/ effects.
Do I feel the FED are taking my tax money? - hmmm No, Do I feel the actions of the US directly affect me ? - hmmm No, Do I think we have the same actions in our country with big business and government? - hmmm Yes but not to the same extent.

I looked up the sites you linked to and I will look them up in more detail to do your comment more justice, but to date I skimmed through them. Bearing in mind your comments, I had in mind the feeling, I think it comes from "Confessions of an Economic Hitman", when he talks of websites which had subtle comments - which spoke volumes to those in the know. I am not in the know. :-(


you said more eloquently what I was trying to say


Anonymous said...

"Moreover: I did address inflation specifically:

'..forget about inflation for now, (or imagine how inflationary these mortgage schemes are).'"

I did see that, but that (in my opinion) is what makes your analysis so dishonest. Over the past generations, on average more than half of interest income on "safe" investments has gotten lost to inflation (then throw in taxes on the ENTIRE amount - not just the real return, and even the greedy banks actually have to work for their money).

You simply can't ignore inflation when the value of the currency has fallen 97%+ over the last ninety-five years. It makes the analysis meaningless.

"Inflation is a deliberate policy, not some force of nature."

I agree with that. :)

"When loans for a house suck up 30 times the actual value of that house, it should be very clear that that is inflationary."

You could probably not find a single house that ever sucked up that much. If a loan gets paid off in five years (a rather typical scenario), the bank has earned maybe 25%-30% of the value of the house (before inflation, taxes, and expenses). Even if a bank did that twenty times in a hundred years, they don't even come close to a double digit figure times the value of a house.

"It all goes astray when for instance loans for a house suck up 30 times the actual value of that house. That is where the problem lies."

It isn't thirty times (or even close) because the value of the house has gone up due to inflation. Loans get paid off with cheaper dollars.

I agree that inflation encourages (too much) borrowing, but I still believe you have given a poor example to back up your assertion.

Ilargi said...

"...the value of the house has gone up due to inflation"

That little sentence shows both why you are wrong, and why inflation should be left out of these discussions.

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