Debt Rattle, July 1 2008: Trouble Bubble Double Rubble

Arthur Rothstein Hobo Jungle March 1936
A hobo jungle along the riverfront in St. Louis, Missouri

Ilargi: Some days I feel it’s a miracle there’s still any trade at all going in the City and on Wall Street. There’s just such a long list of brewing troubles, of an underground rumble that has started shaking the foundations so hard it is now distinctly audible.

The entire mortgage industry looks set for an additional set of hard knocks. Some will fail to get up this time. While that is nothing new, being dragged off to court and then to prison is. The Truth in Lending Act is about to be tested, and while I’m no lawyer, I can’t see how all lending practices can be considered truthful by all judges.

Florida is the third state, after Illinois and California, to file a lawsuit against Countrywide and its CEO, Bad-Tan Mozilo. The company will soon no longer be, after being swallowed by Bank of America, and it will be interesting to see who will pick up the tab for the fines that will be the result of those suits, and for the behemoth losses still to come out of their loan portfolio. If I were a betting man, I’d put my money on the Joe and Jill Six Pack family tab.

In banking, Lehman is bleeding profusively, down for the count, leaning on the ropes and struggling to get up one more time. With all others trailing in points, little help seems likely. Merrill Lynch is still standing, but you just know their defense is down. When a bank’s assets are worth more than its shares, the only thing that seems to make sense is to split it up.

Wachovia’s abrupt move away from Option ARMs sounds like a giant ship horn coming in through the mist. They won’t be the last lender (forced) to make that move. Wachovia is also forced into a buy-back, another field in which others will follow.

But UBS looks to be the bank that’s worst off. There have already been confessions about facilitating clients’ tax evasion, and the investigation is about to get serious. The UBS business model is built on wealthy customers, and anyone of them who can move their money elsewhere is doing so, or already gone. As the US probe widens, I’d think the Swiss authorities are bound to file their own inquiries.

A look at the 11.00 AM Dow tells me that monolines MBIA and Ambac are plummeting. What else is new? Is there any value left there? No, but there are hundreds of billions of swaps and derivatives that will go POOF in the night if they’re allowed to fail.

And: GM at a 54-year low?! It’s time to say goodbye to the walking dead in the US economy, pay our respects and allow them to go with what dignity they have left. I saw a headline this morning that says it all, in my view: $6 billion will buy GM.

And that's not all: we have three different views in the inflation or deflation or stagflation ongoing debate. You know, just to confuse you.


Mortgage ruling could shock U.S. banking industry

A lawsuit filed by a Wisconsin couple against their mortgage lender could have major implications for banks should a U.S. appeals court agree that borrowers can cancel their loans en masse when their lenders violate a federal lending disclosure law.

The case began like hundreds of others filed since the U.S. housing boom spawned a rise in sales of adjustable rate loans. Susan and Bryan Andrews of Cedarburg, Wisconsin, claimed that lender Chevy Chase Bank had hidden the true terms of what they believed was a good deal on a low-interest loan.

In their 2005 lawsuit, the couple said the loan's interest rate had more than doubled by their second monthly payment from the 1.95 percent rate they thought was locked in for five years. The interest rate rose well above the 5.75 percent fixed-rate loan they had refinanced to pay their children's college tuition.

The Andrews filed the case seeking class action status; and in early 2007, U.S. District Judge Lynn Adelman ruled that the bank had violated the Truth in Lending Act, or TILA, and that thousands of other Chevy Chase borrowers could join them as plaintiffs.

The judge transformed the case from a run-of-the-mill class action to a potential nightmare for the U.S. banking industry by also finding that the borrowers could force the bank to cancel, or rescind, their loans. That decision was stayed pending an appeal to the 7th U.S. Circuit Court of Appeals, which is expected to rule any day.

The idea of canceling tainted loans to stem a tide of foreclosures has caught hold in other quarters; a lawsuit filed last week by the Illinois attorney general asks a court to rescind or reform Countrywide Financial Corp mortgages originated under "unfair or deceptive practices."

The mortgage banking industry already faces pressure from state and federal regulators, who have accused banks of lowering underwriting standards and forcing some borrowers, through fraud, into costly adjustable loans that the banks later bundled and sold as high-interest investment vehicles.

The loans have caused serious instability in the financial sector, as mortgage interest rates adjusted upward and borrowers began defaulting at a significant rate starting in 2007, drawing lawsuits from investors and homeowners.

Federal appeals courts disagree over whether class-wide rescission under the Truth in Lending Act is available, said attorney Christine Scheuneman, whose firm represented Chevy Chase at the district court. "If class treatment is found to be available for rescission ..., given the current crisis not predicted in 2005, the result all over the country could be massive class suits," said Scheuneman, a partner at Pillsbury Winthrop Shaw Pittman LLP.

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GM touches near 54-year low

Shares of General Motors fell Monday, at one point trading at their lowest level since 1954, on the eve of what's expected to be a dismal report on June vehicle sales.

GM stock ended down 5 cents to $11.50 a share after hitting a low of $10.57 earlier in the session. That was the lowest level for the company's stock since Sept. 22, 1954, when it traded at $10.49 on a split-adjusted basis, according to data from the University of Chicago's Center for Research in Security Prices. So far this year, shares of the nation's largest automaker have lost half their value.

Last week, GM shares tumbled after Goldman Sachs analysts downgraded the company to "Sell" from "Neutral" and cut their six-month price target to $11 from $19. The automaker is set to announce its June sales numbers Tuesday and the outlook is grim. "People are expecting bad news," said David Healy, an auto industry analyst at Burnham Securities Inc. "For the industry as a whole, we're expecting the weakest month in years," he said.

Sales of full-size vehicles like trucks and SUVs, which were GM's most profitable products until recently, have declined dramatically as gas prices have soared. The national average price for a gallon of regular gas has reached an all-time high of $4.086, according to a daily survey by motorist group AAA released Monday.

In addition to falling demand for some of their flagship products, GM is also facing higher input costs as the price for raw materials like steel and other metals have risen. What's more, labor disputes earlier this year have caused significant delays in GM's production schedule. "People are beginning to realize the size of the losses they [GM] will take this year," Healy said.

But GM has plans to change its product line so that it can take advantage of rising demand for smaller, more fuel-efficient cars. Eighteen of the nineteen new vehicles GM is working on will be cars or crossover SUVs. And the company is developing a plug-in hybrid vehicle, the Chevrolet Volt, that can run about 40 miles without any use of gasoline. "They are adjusting their sales mix as quickly as the can, but in the meantime sales will be bad," Healy said

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Lehman Drops to Eight-Year Low on Sale Speculation

Lehman Brothers Holdings Inc. fell to an eight-year low on speculation the fourth-biggest U.S. securities firm may be sold for less than its market price, traders said. Lehman lost $2.44, or 11 percent, to $19.81 in New York, the lowest since May 2000. The company's value has tumbled 70 percent from a record $45.5 billion on Feb. 2, 2007, ending today at $13.8 billion, according to data compiled by Bloomberg.

"We're hearing that there may be a possibility of Lehman being taken over," said Michael Nasto, the senior trader at U.S. Global Investors Inc., which manages $6 billion in San Antonio. "There hasn't been any positive news on this firm for the last couple weeks and the value of the deal might not be in the best interest of Lehman shareholders."

An index of financial stocks in the Standard & Poor's 500 Index slid 2.1 percent to a five-year low, dragged down by Lehman's slide and losses in MGIC Investment Corp., the largest mortgage insurer. Richard Fuld, Lehman's chief executive officer, said June 16 that the company didn't need to be acquired.

"With this franchise, strength and power, we can go it alone," Fuld said. "But I have also said that we are a public company and if there is another model, or more importantly someone comes forward that we believe can create more shareholder value than our model can create, I clearly have the obligation to take that to the board."

Fuld told executives at Putnam Investments that his firm has enough money to remain independent and that the stock may be undervalued, Putnam's Kevin Cronin said after meeting with Fuld and Lehman President Herbert "Bart" McDade today in Boston. "They have a strong desire and intention to remain an independent firm," said Cronin, who helps oversee $180 billion as Putnam's head of investments.

"They're disappointed with the stock price and they think it's undervalued relative to their earnings and revenue potential." Cronin said his firm owns Lehman shares, bonds and convertible stock. Putnam held 4.58 million shares as of March 31, according to Bloomberg data. The stock added 59 cents to $20.40 in trading after the close of U.S. exchanges. Leman was rated "overweight" in new coverage by Morgan Stanley, which said the firm raised enough money "to absorb expected losses over the next two quarters."

Lehman plunged 70 percent this year after reporting the first quarterly loss in its history and selling $6 billion of stock to shore up its funding. The Securities and Exchange Commission investigated whether traders spread false rumors about Lehman's solvency to profit from a drop in the shares, two people familiar with the probe said in March.

"The rumors around are that there are some firms making discount offers for Lehman," said Clarence Woods Jr., chief equity trader with Baltimore-based MTB Investment Advisors, which manages $12 billion. The risk of Lehman defaulting on debt briefly rose. Credit default swaps gained as much as 15 basis points to 290 before falling back to 280, according to broker Phoenix Partners Group.

Options traders increased bets that Lehman will continue its retreat. Contracts conveying the right to sell the stock at $17.50 by July 18 more than doubled to $1.89. Trading of puts, which give the right to sell shares, exceeded calls, which convey the right to buy, by more than 6-to-1.

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Merrill shares look cheap, but there may be a reason

Merrill Lynch's shares trade well below the combined value of three of the company's most important assets, which to some investors signals the investment bank's shares are cheap. Others see it is a sign of future difficulties.

Merrill's wealth management business and its stakes in asset manager BlackRock Inc, and news and financial data provider Bloomberg, are worth more than $40 billion, analysts say, well above Merrill's current market value of about $32 billion. That disconnect implies a negative value for Merrill Lynch's other big asset, its investment bank. To some analysts, that idea does not make sense.

"At the end of the day the investment bank probably has some value," said James Ellman, president of hedge fund Seacliff Capital in San Francisco, which owns Merrill shares. As markets turn around, the bank could perform better, he added.
If so, then Merrill Lynch shares could have room to rise, said Anton Schutz, president of Mendon Capital Advisors, a mutual fund in Rochester, New York. "They're tempting from a long-term perspective," he added. The fund does not hold Merrill stock.

While Merrill Lynch trades at $27.91 on a book-value-per-share basis, Goldman Sachs is at $100.71 and JPMorgan is at $35.43. But other analysts are skeptical that Merrill Lynch should be better valued. Merrill Lynch is expected to write down billions of dollars in mortgage assets next month, after having already posted more than $30 billion of write-downs in the prior three quarters.

As a result, the No. 3 major Wall Street brokerage is widely expected to raise more capital, perhaps through selling its 49.8 percent stake in BlackRock, worth more than $10 billion at current market prices. Merrill Chief Executive John Thain said earlier this month the company would consider selling the stake if it needed to raise capital. But turning other businesses into dollars could be considerably more difficult.

"If you have to sell assets, and people know you need to do it, it could be very costly to sell them," said Blake Howells, director of equity research at Becker Capital Management in Portland, Oregon. Becker does not own Merrill shares. Merrill's 20 percent stake in financial news and data provider Bloomberg, which the bank said last month was worth $5 billion to $6 billion, could take a long time to sell, because the company is privately held. Any buyer for Merrill's stake must be approved by Bloomberg.

Several analysts estimate that Merrill's wealth management business, whose army of brokers comprise the traditional heart of the firm, could fetch more than $25 billion. Selling the brokerage, which has $1.6 trillion in total client assets and which Merrill CEO John Thain has praised as a steady source of revenue seems unlikely unless things get a lot worse.

So an investor hoping to benefit from Merrill Lynch's relatively low valuation had better be patient. Ben Wallace, a securities analyst at Grimes & Co, said the Westborough, Massachusetts investment advisory firm bought Merrill stock in the third quarter of last year. Merrill shares are down 55 percent from the end of September. "We have not been thrilled with how it's progressed," he said,

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UBS Falls as U.S. Seeks Summons for Clients' Names

UBS AG, the biggest wealth manager, fell to the lowest level in almost a decade in Swiss trading after U.S. prosecutors sought the authority to force the bank to reveal names of American clients with secret accounts. UBS dropped 1.47 Swiss francs, or 6.9 percent, to 19.97 francs by 12:41 p.m. in Zurich.

Prosecutors yesterday asked a Miami federal judge to let the Internal Revenue Service issue a summons to Zurich-based UBS for client information as part of an investigation into whether the Swiss bank helped affluent customers evade American taxes. The U.S. probe is intensifying at the same time the bank is reeling from record losses on subprime-infected assets.

The probe "has the potential to develop into a serious strategic headache for UBS in its most profitable business," Stefan-Michael Stalmann, an analyst at Dresdner Kleinwort, said in a note to clients. He said UBS may seek to settle the case, though "there is a clear risk that the damage will reach beyond whatever the direct cost of a settlement or fine will be."

The bank will probably post a loss for the second quarter after writedowns on real estate securities, analysts including Stalmann have forecast. The bank may report markdowns of about 5 billion francs ($4.9 billion) for the second quarter, according to the median estimate of six analysts, following more than $38 billion of writedowns in the previous three quarters.

UBS led a decline in financial shares across Europe, with asset managers among the worst hit. Julius Baer Holding AG, Switzerland's biggest independent wealth manager, dropped as much as 7.9 percent, while Schroders Plc sank as much as 7.3 percent in London trading. The 59-company Bloomberg Europe Banks and Financial Services Index declined 3.5 percent.

UBS Chairman Peter Kurer, who replaced Marcel Ospel in April, told shareholders at the annual meeting that month he will lead a strategic review of all of the bank's businesses to make them better complement the wealth management unit, which he called UBS's "core franchise." The bank said today that it plans to inform shareholders about results of the review at an extraordinary shareholders meeting on Oct. 2.

The meeting was called to elect four new board members, as Kurer seeks to increase the level of financial expertise on the board after criticism from shareholders including former UBS President Luqman Arnold. Arnold's Olivant Advisers Ltd. said in a statement today that it welcomed the changes in corporate governance at UBS. UBS shares sank 69 percent in the past year, cutting the bank's market value to 59.1 billion francs.

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UBS Account Records Sought by U.S. in Tax Inquiry

Prosecutors asked a Miami federal judge to require Swiss bank UBS AG to turn over information on its U.S. customers who may have used secret accounts to evade taxes. The unprecedented step comes as a Justice Department investigation into the bank is heating up.

Earlier this month, Bradley Birkenfeld, a former UBS private banker, pleaded guilty to conspiracy and said the bank helped wealthy U.S. citizens conceal $20 billion in assets and evade income tax laws. It is the first time the Justice Department has sought to serve a so-called "John Doe" summons on a foreign bank, said Justice Department spokesman Charles Miller.

John DiCicco, deputy assistant attorney general in the Justice Department's tax division, said in a statement that the U.S. has been "working cooperatively" with UBS and the Swiss government to obtain the account information. "However, we are prepared to seek enforcement if that process is not successful," DiCicco said. UBS spokeswoman Rohini Pragasam said the bank "takes this matter very seriously and is working diligently with both Swiss and U.S. government authorities."

A "John Doe summons" would be served on UBS by the Internal Revenue Service, which uses the tactic when it is investigating possible tax fraud by people whose identities are unknown. The summons would direct UBS to produce records identifying U.S. taxpayers who had accounts with the bank in Switzerland between 2002 and 2007, and who chose to have their accounts remain hidden from the IRS, the Justice Department said.

Birkenfeld said when he pleaded guilty on June 20 that he and his colleagues helped wealthy Americans hide money by telling them to put cash and jewelry in Swiss safety deposit boxes, buy artwork and jewels using offshore accounts and set up accounts in the names of others. In a court filing today, Internal Revenue Service agent Daniel Reeves said he interviewed Birkenfeld on Oct. 12, 2007, and that Birkenfeld said he was one of 40 to 50 UBS private bankers who made quarterly trips to the United States to manage customers.

Reeves said Birkenfeld told him that to avoid detection, the bankers were trained by UBS to lie on customs forms that they were visiting the U.S. for personal reasons rather than for business. They traveled with encrypted laptop computers that contained client portfolios, Reeves said.

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Wachovia Cries ‘UNCLE’ to the Pay Option ARM

This is huge, not only for Wachovia but for every bank or investor who owns Pay Option ARMs or securities derived from them. It was just reported that Wachovia will stop doing Pay Option ARMs immediately and waive all prepayment penalties associated with these loans.

The official release says:
-WB will no longer offer products that result in negative amortization.
-WB waiving all fees associated with Pick-A-Payment loans effective immediately.
-WB is waiving all prepayment penalties associated with its Pick-A-Payment mortgage to allow customers complete flexibility in their home financing decisions.

Just a month ago they were running TV commercials with families dancing around their kitchen promoting this loan programs and its ‘low payment options’. I said for months that this was an attempt to make the street think that their Pay Option ARMs were ‘different’ from everybody else’s. It was an obvious attempt at deception.

By virtue of them dumping this program and waiving the prepayment penalties, they are admitting what many including myself have said for years; that the Pay Option ARM is the most toxic loan program ever created. It is estimated they own nearly $200 bb in this product.

The ‘waiving prepayment penalty’ decision was interesting and perhaps forward thinking for a change. Very few people know this, but if a ARM reset forces a pre-payment penalty the pre-pay is not collectible. This is something most banks don’t even know.

What does this mean for other banks holding billions of these such as Countywide, IndyMac, WAMU, Downey Savings, First Fed, Lehman, Bear Stearns (the Fed), Deutsche Bank and many other banks and investment banks who originated and still own this paper? What does this mean for loans or securities they sold to investors who thought they were getting a prepayment penalty loan and paid a premium?

One of the big problems for banks with these loans on their books is that they are allowed to book as revenue the FULLY INDEXED payment amount of Index + Margin each month for each borrower. This can be as much or more as twice the minimum allowed payment. This is because in theory is they will get it back if they repo and sell the home or the borrower sells it or refi’s. But, now with the gross amount of negative equity out there, most borrowers can’t sell or refi and the banks are only recovering 50% though foreclosure.

In 80% of the cases, Pay Option ARM borrowers make the minimum monthly payment of 1% to 3.75% depending on the lender and program variation. The ‘deferred interest’ or negative amortization that the banks book as revenue must come back out. In the very near future, all pay option banks are likely to have to make a multi-year earnings restatement due to these programs.

This maybe why if you compare a stock chart of the banks I mentioned above, they are performing much worse than banks that never touched the Pay Option ARM. More on this story will follow, that’s for sure. Below is a chart of the predicted resets of Pay Option ARMs. This is a great visual of the pain they will cause the Real Estate market shortly.

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Wachovia shares slump on Prudential sale report

Wachovia Corp shares fell as much as 9 percent on Monday after the New York Post reported that Prudential Financial Inc could force the bank to buy its stake in a brokerage joint venture. The report was a latest blow to Wachovia, which was the biggest decliner among large banks, and is trading at a 16-1/2-year low.

The fourth-largest U.S. bank has already been throttled by concern that it might have to again cut its dividend and potentially raise more capital after raising $8.05 billion in April. Many of Wachovia's problems stem from losses on mortgages taken on through its October 2006, $24.2 billion buyout of Golden West Financial Corp.

Wachovia said on Monday it was putting an end to adjustable-rate mortgages that let borrowers pay less than the interest due, a type of so-called "option ARMs" that caused amounts owed on some mortgages to rise even as home prices fell. In addition, it would waive all prepayment fees associated with such mortgages. The New York Post said that Prudential, starting on Tuesday, could force Wachovia to buy the insurer's 23 percent stake in the Wachovia Securities partnership, which it said some analysts value at around $5 billion.

"Another headache the financials don't need today is a media report that Wachovia might be forced to purchase over 20 percent stake in a partnership from Prudential," said William Lefkowitz, options strategist at brokerage firm vFinance Investments in New York. "That report has led to selling in the Wachovia shares and the buying of Wachovia puts."

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Florida Files Countrywide Lawsuit

The Florida attorney general on Monday filed a civil lawsuit against Countrywide Financial Corp. and its chief executive, Angelo Mozilo, alleging the company engaged in deceptive and unfair trade practices.

The lawsuit, filed in state court in Broward County by Florida Attorney General Bill McCollum, alleges that Countrywide put borrowers into mortgages they couldn't afford or loans with rates and penalties that were misleading. It seeks civil penalties and damages.

Florida's action follows similar lawsuits filed last week by attorneys general in California and Illinois. Mr. McCollum said that his state has had a continuing investigation of Countrywide and "we thought it was important for us to do this right now."

A Countrywide spokesman declined to comment on the specifics of the suit but said the company is "fully cooperating" with the Florida attorney general's office and is "particularly focused" on working with customers who are having difficulty making payments.

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Deflationary Hurricanes to Hit U.S. and U.K.

Congratulations (of sorts) go to the UK as British household debt is highest in history.

British households are now more indebted than those of any other major country in recorded history, it has emerged.

Michael Saunders of Citigroup warned that - at 173pc of household incomes - the debt burden is higher even than Japan's when it peaked in 1990, before more than a decade of deflation. Philip Shaw of Investec said: "Although we take the view that the economy will avoid a recession, our confidence is ebbing."

Avoid A Recession? It will be hard for the US and UK to avoid a depression. What started as a tropical storm called "Subprime" has intensified in magnitude to engulf Alt-A, HELOCs, credit cards, commercial real estate, municipal bonds, corporate bonds, and the stock market, just as baby boomers are headed for retirement.

Most do not even understand the nature of the storm that is about to hit. Barclays is right at the top of the list. Please consider Barclays warns of a financial storm as Federal Reserve's credibility crumbles.

Barclays Capital has advised clients to batten down the hatches for a worldwide financial storm, warning that the US Federal Reserve has allowed the inflation genie out of the bottle and let its credibility fall "below zero".

"We're in a nasty environment," said Tim Bond, the bank's chief equity strategist. "There is an inflation shock underway. This is going to be very negative for financial assets. We are going into tortoise mood and are retreating into our shell. Investors will do well if they can preserve their wealth."

Barclays Capital said in its closely-watched Global Outlook that US headline inflation would hit 5.5pc by August and the Fed will have to raise interest rates six times by the end of next year to prevent a wage-spiral. If it hesitates, the bond markets will take matters into their own hands. "This is the first test for central banks in 30 years and they have fluffed it. They have zero credibility, and the Fed is negative if that's possible. It has lost all credibility," said Mr Bond.

Wage price spirals happen when corporations get into bidding wars over employees, not when they are shoving them out the door by the hundreds of thousands. Mr. Bond must be reporting from Bizarro World. The odds of a wage price spiral in the US are essentially zero as credit is drying up and overcapacity is everywhere you look. This is not Bizarro World, nor it is 1970.

If Barclays is betting on six interest rates hikes in the US with its own money it will likely get carted out in a coffin. Property values are crashing, unemployment is rising, wages are falling, global wage arbitrage is king, and most importantly Peak Credit Has Arrived.

It is impossible to get inflation out of that mix. Berananke could cut interest rates to zero tomorrow and it would not cause inflation, at least as properly defined: a net expansion of money and credit. Banks are strapped for cash. They cannot lend. Businesses do not want to borrow. There is overcapacity everywhere. The Shopping Center Economic Model Is History.

I struggle to see how anyone can get inflation out of that mix. Last Thursday when the stock markets were in a freefall, I asked Is The Inflation Scare Over Yet? Well, I guess it's not.

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Stoneleigh: I disagree with the premise of the following article and think Aaron Krowne is confusing both his terms and his concepts. I hate it when people start talking about inflation and then point to high oil prices as proof. The kind of parabolic rise we're seeing in oil is a typical run up to a commodity price top - a bubble thanks to huge capital flows overwhelming the scale of commodity indicies.

I think it's close to over in terms of time, although there may still be further to go in terms of price (my guess, perhaps $160). I don't think it defines the beginning of a new era or paradigm, in fact that sort of talk always precedes a reversal as even the diehards capitulate to the prevailing trend that seems unstoppable at the time.

The credit hyper-expansion as been the inflation-equivalent, but that trend has already ended IMO. Prices changes as a result of previous inflation are a lagging indicator. Deflation has already begun, but some prices continue to rise following the previous trend. IMO they are about to reverse as the pace of deflation increases. I don't think Krowne realizes just how much value is going to vapourize, and to what extent that will crash the money supply. A banking collapse, for one thing, is hugely deflationary, and is approaching rapidly IMO.

Debate Over: It's Hyperinflation (and US Economic Collapse)

A quick toy example illustrates the dynamic that is now in effect. Let's say there is $100 trillion of money, credit, derivatives, and all manner of exotic financial vehicles in the world (in fact the latest count of derivatives alone is over $1 quadrillion, per the BIS, just so you know). Now let's say we hit a credit crisis, and $50 trillion of that money/credit/derivatives simply vaporizes.

Some who label themselves "Austrian" would say "ah-ha, we've had 50% deflation"! Well, in a sense, maybe. In fact, as part in parcel of the same crisis, a not-negligible chunk of that financial money (for argument's sake, say $1 trillion) is likely to seek "safe haven" assets like government bonds, bidding down their yields. We have indeed seen that recently.

This is actually seen as a "good thing", because it "naturally" lowers interest rates (providing banking system "relief"), and makes it cheap for government to borrow, much to the delight of our ruling guns-and-butter enthusiasts. Indeed, you could call it "deflationary", both in cause and effect.

But there is more to this picture. Let's say $1 trillion of the $50 trillion remaining instead heads for commodities. Now we have some real fireworks, because commodities are a small and relatively tight market (after all, there is a limit to the amount of real stuff being produced). And virtually no one says this is a "good thing" (commodities investors have learned to be quiet about it).

And the reason this phenomenon might happen much more than it would otherwise would be a central bank setting the main interest rate obscenely low -- especially NEGATIVE -- such that scarce, essential real stuff is a "no-brainer" bet.

So here you have deflationary causes producing dramatically inflationary effects. Seems counter-intuitive, but this is really nothing new: it is historically called the "flight to real goods", and it happens in every hyperinflation, ALONG WITH financial market collapse.

I believe what we are seeing here in oil, and to a great extent in most other basic commodities, is the FIRST EVER GLOBAL HYPERINFLATION. This is happening historically now and in such a big way because the dollar is the de facto reserve currency -- and the first-ever fiat global reserve currency -- so the Fed's actions are magnified beyond anything that has ever been seen before.

They are also eclipsing the effect of the rest of the G7, which can't seem to decide if they will exercise restraint or provide cover for the Fed. They are basically puppets of the Fed (or have been -- there are signs of rebellion, especially from the ECB. I would say this rebellion is inevitable, and it will spread).

But interest rates in the West, if they do start going up by way of policy, probably will not go up fast enough to match the inflation they have already unleashed. And as long as the interest rates remain NEGATIVE in real terms (irrespective of manipulated CPI statistics), the problem will get worse. Hence the "hyper": continued negative real rates alongside collapsing paper money markets (along with supply and demand fundamentals) will keep the tailwinds on prices for essential commodities. Where else is the money going to go?

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Stagflation grips Eurozone as interest rates look set to rise

Eurozone inflation surged to an all-time high of 4pc in June despite worrying signs of a slump in manufacturing, confronting the European Central Bank with the toughest challenge since its creation a decade ago.

Soaring oil and food prices guarantee a quarter-point rise in interest rates to 4.25pc on Thursday, further widening the gulf in rates between Europe and America. The only question is whether the ECB opts for a "one-and-done" move or sets the course for yet more rises in the autumn.

Jean-Claude Trichet, the bank's president, has warned of an "acute risk" of a wage-price spiral unless inflation is wrung out of the system. But a growing chorus of critics fears that overkill could tip the eurozone into a severe downturn at this delicate juncture, and risk a dangerous chain of political events in southern Europe and Ireland - where voters have already thrown the EU into chaos by rejecting the Lisbon Treaty.

The Irish economy contracted at a rate of 1.5pc in the first quarter and is now facing the worst recession since the crash of the mid-1980s. Investment fell 19.1pc. House prices have now fallen for 15 months in a row. Spanish premier Jose Luis Zapatero was forced to reassure his nation's media this weekend that he was still on speaking terms with his finance minister Pedro Solbes, who has refused to endorse the government's economic crisis plan.

Both Mr Zapatero and Italy's Silvio Berlusconi have lashed out at the ECB in recent days, but even Germany's finance minister Peer Steinbrück has begun to question Frankfurt's hard-line policy. "An interest rate increase could have a pro-cyclical impact at a point when the economy is slowing down," he said. The comments come after five months of falling orders in Germany, the worst run since the early 1990s. Siemens, Volkswagen and other big industrial exporters have begun to cut jobs.

The ECB has held rates steady at 4pc since the credit crunch began last summer, even though Euribor lending rates have jumped 120 basis points. The euro has rocketed against the dollar, sterling, yen and yuan. The full effects of the monetary and currency squeeze will feed through the eurozone over the next year or so. There is a risk that the impact could hit just as the global economy slows sharply.

France's finance minister, Christine Lagarde, praised the apparent policy shift in Berlin. "For the first time my German colleague, who was resolutely determined to back the ECB whatever it does, is telling Mr Trichet, 'Be careful'. "There is more than one indicator. There is inflation, certainly, but there is also growth. Quite a few of us would like Mr Trichet to keep his eye on both barometers. Until now he has had only inflation on his radar," she said.

Her choice of words is significant. EU ministers have the ultimate power - under Maastricht Article 109 - to shape the eurozone exchange rate, giving them a backdoor means of forcing a change in the ECB's policy. The implicit threat to invoke this clause is a warning to ECB hawks that independence has limits.

The remarks by Paris and Berlin come as US Treasury Secretary Hank Paulson prepares to visit both Mr Trichet and Bundesbank chief Axel Weber today. The Bush administration is reportedly furious with the ECB for undercutting US efforts to stabilise the dollar and halt the oil spike in very dangerous circumstances.

The ECB is playing with fire, forcing the US to pursue a more restrictive monetary policy than it might think safe at a time when the financial system is already in dire trouble. The dispute has echoes of the Transatlantic rift before the stock market crash in October 1987. Oil jumped $16 a barrel in two days earlier this month on the back of a rising euro after Mr Trichet signalled an ECB rate rise.

The market response was a prize exhibit for those who argue that hedge funds have now run amok on the oil markets, using crude futures as a sort of "anti-dollar" currency - with multiple leverage. It also revealed that ECB tightening in this environment is counter-productive since it pushes inflation even higher. Critics say the bank is chasing its own tail, failing to adapt to the complexities of the modern global economy.

Stephen Lewis, chief strategist at Insinger de Beaufort, said the ECB is right to raise rates, despite the risks. "If they were to back off now after signalling a rise it would cause a catastrophic loss of credibility that would further harm global stability," he said. "The bank cannot formulate policy on the basis that this might be a short-term price spike. It would destroy consumer confidence and blast economic growth prospects if it lets inflation run ahead."

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U.K. Annual House Prices Declined by Most Since 1992

U.K. house prices fell in June by the most since the end of the last recession as banks starved the property market of loans, Nationwide Building Society said.

The price of an average home declined 6.3 percent from a year earlier to 172,415 pounds ($343,278), the biggest drop since November 1992, Britain's fourth-biggest mortgage lender said today in a statement. Prices dropped 0.9 percent from May. Real-estate stocks had their worst performance in more than 20 years in the second quarter and Bank of England Governor Mervyn King predicts "extremely weak activity" in the housing market.

Mortgage approvals fell to the lowest in at least nine years in May and consumer confidence deteriorated to the lowest level in 18 years last month, reports showed yesterday. "I can't see this price decline coming to an end any time soon," said George Buckley, an economist at Deutsche Bank AG in London who predicts values may fall at least 10 percent this year. "The biggest driver in prices tends to be approvals and yesterday's figure was quite shocking."

House prices fell for the eighth consecutive month, according to Nationwide. The pace of decline on the month was slower than the 2.5 percent drop in May, the most since Nationwide's index started in January 1991. Northern Ireland led declines on the year, while Scotland recorded the only annual gain, Nationwide said.

Property stocks extended their slide today. Shares of Taylor Wimpey Plc, the U.K.'s largest homebuilder, declined 4 percent and U.K. building materials distributor Travis Perkins Plc, which has lost almost three fifths of its value this year, fell 3.5 percent. Falling house prices risk pushing the U.K. economy into recession, as slowing growth and falling confidence curbs Britons' spending.

King said June 19 that "lower demand in the high street will go hand in hand with lower demand in the property market." Banks granted 42,000 loans for house purchase in May, compared with 57,000 in April, Bank of England data showed yesterday. An index of consumer confidence fell to minus 34 in June, the lowest since the London riots in 1990 before Margaret Thatcher's downfall as prime minister.

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UK mortgage approvals plunge 64% to new low

The number of new mortgage approvals during the 12 months to May plunged by 64 per cent to a record low, as the slump in the UK housing market shows no signs of abating. Monthly figures released by the Bank of England today revealed that 42,000 home loans were approved in May, signalling a 28 per cent fall on the previous month and the worst data since the Bank's record began in 1993.

At the same time, the value of mortgage approvals nearly halved from £4.59 billion in May last year to £2.34 billion last month. May's mortgage approvals also fell compared April when they reached, according tothe Building Societies Asssociation (BSA)
Last week, Mervyn King, the Bank of England Governor, warned that activity in the UK housing market would remain weak and reiterated his forecast that inflation, currently at 3.3 per cent, could rise above 4 per cent by the end of the year.

If inflation continues to rise the Bank of England could raise the interest rate - a move that was discussed during June's Monetary Policy Committee meeting - which could in turn cause more pain for mortgage borrowers hoping to secure a good deal. Adrian Coles, director general at the BSA, said: “It is important not to read too much into one month’s very low figures.

"However, the figures do reflect the considerable adjustment in housing market activity now being experienced. We expect activity to remain at low levels for some time.” The Bank of England data also showed a tumble in mortgage approvals for homeowners who were trying to remortgage, falling from 100,000 in April to 90,000 in May.

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UK house prices in grip of slump that experts expect to deepen

Britain is in the grip of a housing slump as bad as at any stage since the 1970s, property experts warned, as data suggested that first time buyers had all but disappeared from the market.

Figures due on Tuesday from the Nationwide, the country’s biggest building society, are likely to confirm that the housing down turn has turned into a full-blown slump, with prices falling nine months in a row and with the average property price having fallen £14,200 from its peak last summer.

Economists think that the property market is now in entering a prolonged downturn that will match the slumps experienced during the 1990s and 1970s – the two major corrections since the Second World War – after data from the Bank of England showed that the number of mortgages that banks and building societies had offered to home buyers had fallen to an all-time low.

Just 42,000 loans were handed out in May – down from 58,000 in April and a massive slump of 64pc compared to this time a year ago, when 116,000 mortgages were given to home buyers. This is the lowest level recorded in any month since the Bank of England started collecting data in 1993.

Property experts think it is worse than at any time since the 1970s, or possibly earlier. Separate data from the Bank showed a £556m jump in the amount of debt on credit cards during May, with some experts worried that this is proof that consumers are turning to plastic to meet the rising cost of living.

Economists called the mortgage figures “dire”, “disturbing” and “horrible”. With banks and building societies unable and unwilling to lend to people looking to buy a house – except at very high rates and with a large deposit – it is becoming nearly impossible for first time buyers to get on the housing ladder, despite the fall in house prices.

Melanie Bien, director at mortgage broker Savills Private Finance, said: “Unless they have got a substantial deposit – of at least 10pc of the value of the property – first time buyers can’t get a mortgage. “The only ones able to borrow money are those who have parents with lots of savings. And even when they are able to get a mortgage rates just keep on creeping up.”

The average two-year fixed rate mortgage that new customers were being offered yesterday was 7.05pc, according to MoneyFacts, the personal finance publisher. This has increased from 6.98pc in the space of just one week – adding £90 to the annual repayments on a typical sized £150,000 mortgage.

According to personal finance research house Defaqto, the average up front cost of getting on the housing ladder for the first time – including stamp duty, fees and a deposit – is £33,738, because mortgage companies are cracking down on all borrowers that do not have a long and unblemished credit history.

The sum required is 40pc higher than the national average annual salary of £23,800 and nearly 50pc higher than a year ago. Darren Cook, mortgage expert at MoneyFacts, said: “It’s nearly impossible for a standard first time buyer to get on the housing ladder. “And if they can get a mortgage, many are quite rightly nervous of buying a property that will fall in price over the next six months. Then they’ll be in negative equity.”

Estate agents have been shocked by the speed of the housing market slump and how quickly buyers have been forced off the ladder. John Caines, an estate agent in Wales, and member of Royal Institution of Chartered Surveyors, said: “It’s just as bad as the 70s or 90s if not worse. What is so alarming is how quickly it has gone from boom to bust. “In January we were celebrating our best year ever. In June I had to made 15pc of my staff redundant.”

Martin Seymour, an estate agent in East Sussex, and member of RICS, said: “It’s the worst I can remember it in 35 years. And in some ways it is far more worrying than the housing downturns of the 1970s and 1990s. Those were caused by high unemployment and high interest rates. This is more structural.” So far house prices have only started to dip by a relatively small amount, with figures out showing that the average property had lost 3.2pc of its value compared to a year ago.

However, economists predict that the collapse in the mortgage market will lead to a more severe correction in house prices as the year goes on. Howard Archer, at Global Insight, expects house prices to lose 24pc of their value compared with their August 2007 peak. This would knock nearly £50,000 off the average price, which hit £199,000 last summer, according to the Halifax.

“I am wondering if this is now a little conservative,” Mr Archer said. “If the economy starts to tank and unemployment rises sharply – and it has increased for the last four months – that would have a large knock-on effect onto the housing market, as a number of distressed sellers entering the market.” As well as the grim mortgage figures, the Bank of England data also showed that total debt on credit cards climbed from £16.4bn in April to £17bn in March.

Pat Boyden, debt expert at accountancy firm PriceWaterhouseCoopers, said: “My concern is that people – especially those coming off fixed-rate mortgages – are being squeezed, with fuel bills, food bills increasing.
“Credit cards have been used to fund people’s lifestyles. Are they now being used to fund their every day-to-day lives?”

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Ilargi: A few days ago, Fortis chairman Maurice Lippens said he expects 6000 US banks to fail. I think that is all you need to know to figure out how likely these savings guarantees are to succeed. They are set up for incidental bank failures, but useless in case of systemic failure.

UK Treasury to boost savings guarantee to £50,000

Depositors are to be guaranteed the first £50,000 of their savings if their bank fails, under a scheme to be announced by the Treasury today. The figure is understood to be the “lead option” proposed in a consultation paper on new banking reforms and will replace the existing guarantee of £35,000.

The figure would put Britain in line with the United States, which guarantees the first $100,000 of savers’ money in the event of a banking collapse. The new proposals, the biggest shake up to banking regulation in the UK for decades, are designed to avert another Northern Rock-style banking fiasco. The £50,000 figure is less than the £100,000 that was first mooted in the immediate aftermath of the Rock crash.

Under pressure from the banks, the Treasury has revised the number downwards. A similar system is also used in the US, where there is a $50 billion compensation pot, built up over many years, although that would be only a drop in the ocean if a bank failed and depositors started to demand their money back. In the case of Northern Rock, savers had £25 billion of deposits in the bank when it collapsed and they formed the now famous queues around branches to withdraw their cash.

The Treasury is also expected today to give itself the power to force banks to prefund the compensation scheme, although Alistair Darling, the Chancellor, is expected to say that he will not yet set a date for the introduction of prefunding.
The banks have made clear that they would prefer to pay compensation as and when it is needed. They have also said that they want a “sensible” limit on the level of savings guaranteed by the scheme.

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Ilargi: Barron’s interviews Peter Schiff. While I think Schiff has a lot of smart things to say, I don’t agree with him that "the rest" of the world will be fine. The financial system is truly international, built on the US economy and the US dollar, and Schiff underestimates to what extent the US decline will rip apart everything connected to the system.

Gloom and Doom? Nah; Just for the U.S.

You continue to be very bearish on the U.S. But haven't there been other times when there was lots of negative sentiment toward the U.S., only to see another era of prosperity emerge? Such as the late 1980s, when there was concern that Japan would take over the U.S. economy. Look at how that turned out.
Yes, but we haven't been through anything like what we are going through now. The United States has really been living in a fool's paradise, or a phony economy, probably for more than 20 years. But our economy has been growing and getting bigger and bigger. We have been able to convince the world to lend us money and to provide us with goods that we don't produce and that we can't afford to pay for with exports.

And it has gotten to the point now where the problem is so big, especially since the real-estate bubble. We've now borrowed so much money from abroad. Our trade deficits are now very big, and our industrial base and our infrastructure have been allowed to decay for so long, that we are now at a point that we can only survive as an economy thanks to the charity of the rest of the world. They have provided us with all the goods that we can no longer produce because we lack the industrial capacity. And they have to lend us the money because we don't have any savings anymore.

What's your take on oil prices?
As oil prices are going up in the U.S., they are not rising nearly as fast in other countries because their currencies are strengthening. Ultimately, when currencies like the renminbi that are pegged to the dollar are allowed to float, I see the Chinese currency rising five-fold against the dollar. That would make oil a lot cheaper in China relative to what it would cost in the U.S.

Speaking of China, how do you see things developing there and its impact on the U.S. economy?
The whole science of economics, as I see it, is how do you satisfy unlimited demand with limited resources? China has more than one billion people. It is not as if Americans are unique in wanting things. It's not as if the Chinese don't want dishwashers. The reason they don't have those possessions is because they don't have the purchasing power. But they do have that power; it's just that their government is taking it away from them and giving it to us.

But it is Americans who can't afford these goods, because we can't produce them. So if the renminbi is allowed to rise, then Chinese factory workers will be able to afford the products they are producing instead of shipping them over here. That's going to be a major, major boon for their economy.

So it sounds as if the U.S. will be relegated to second- or third-tier status.
The U.S. is in trouble. We are a post-industrial society, which is the same as a pre-industrial society; our manufacturing base has disintegrated. It's not nonexistent; we still make some things and we are still competitive in some areas. But on the whole, as a nation we are not competitive. We are mainly a nation of a service sector and consumers, and that's going to have to change. Nor do we have the savings that we need to fund the transition.

What could go wrong with your scenario?
Somehow, the U.S. could buy itself some additional time. We could convince the world -- Europe and Asia -- that they need us, and that while propping up the U.S. economy is going to hurt them with more inflation, letting the U.S. collapse is going to be even worse. Of course, none of that is true. The truth, in my view, is that the cost of propping us up far exceeds the cost of letting the U.S. economy collapse. But I think we are already in a pretty severe recession.

But isn't there an argument that once we clean up this housing mess -- along with the credit bubble, whenever that occurs -- the U.S. will be a lot closer to a bottom, where the outlook begins to improve?
I don't think that's true. The resolution to the housing problem is going to mean housing prices are going to be a lot lower than they are now, and most Americans are not going to have any home equity. It's going to mean that trillions of dollars will have been lost by the lenders. When the home equity is gone, Americans are broke, as they don't have any savings. All they had was their home equity. They were counting on their home equity, without which they will be unable to pay off their credit cards.

But don't U.S. companies that do business abroad benefit from all of the trends you have outlined?
Yes, they are going to benefit to the extent that they can generate higher sales abroad. But ultimately the shareholders are not necessarily benefiting just because a multinational company earns more dollars. If the dollars have less purchasing power, they are not necessarily better off. The way I see it, we are just putting our goods on sale to sell more of those goods. But if you want to look at U.S. corporate earnings in terms of euros, barrels of oil or gold bullion, these companies are not necessarily seeing a real increase in earnings.

Plenty of investors and financial advisers have decreased their allocations to U.S. stocks in recent years. Why not do that instead of completely writing off the world's largest economy?
Individuals can make their own decisions. I don't see a way for the U.S. economy to avoid a major retrenchment. There's no way that U.S. assets are not going to be marked down relative to foreign assets. Therefore, I would rather invest in the rest of the world. There are plenty of people who for the whole decade of the 1990s were investing everywhere but Japan, which is the second biggest economy in the world.

Why were they excluding Japan? It was obvious that it was in decline. I'm saying the same thing about the United States. I don't care if it is the biggest economy in the world; it is in decline. There are going to be a lot of losses in the United States, so why don't I avoid it? Worst-case scenario: I miss out on the U.S. market. But what are the odds that it is going to outperform all the other major markets that I am investing in? And I can't see how the dollar is going to be moving up over time.

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