Saturday, August 9, 2008

Debt Rattle, August 9 2008: Not if you've done it

End of the Road June 27, 1964
"Great Falls, Montana. Return after 3 weeks vacation."

Ilargi: As I was thinking about the best way to explain the reality behind the surge in the American dollar, I thought of an age-old wisdom:

The truth will set you free!

Well, not if you've done it........

I think that about says it all. A stronger dollar is a very mixed blessing for the US, at best. It's nice if your currency gets stronger... But not if you're neck deep in debt.

There has been no change in the toxic paper that still lies in Wall Street vaults, and resides with pension funds and all levels of US government. It'll all have to come out one day, and a stronger dollar just makes that more expensive.

And it's nice if your currency gets stronger... But not if the only thing that keeps you going is your export products getting cheaper for foreigners.

What could be positive is that it will take the misdirected attention away from high gas prices, instead of the much more damaging plummeting real estate values, away from commodities bubbles, away from the silly notion of inflation.

Those are not the real issues, they're just the things that media and politics would like you to focus on.

While the average American home has lost $30.000 in a year (try spend that on extra gasoline costs!), and $800 billion more in taxpayers' money is about to be spent on Wall Street bail-outs.

Yeah, the truth will set you free.... Well, not if you're deep in debt.

Dollar surges as markets put their money on US
The dollar charged higher yesterday, extending its biggest 24-hour rally against the euro since 1999, as currency markets scrambled to rethink competing economic prospects in the United States and the eurozone.

Dramatic gains by the dollar that took it to its highest for five months against a broad range of currencies sparked predictions from economists that it is embarked on a long-term recovery, after a five-year run of unrelenting weakness. The rally in the dollar in yesterday’s frenetic trading triggered the steepest one-day losses for the euro for four years, sent US blue-chip shares soaring and fuelled sharp falls in oil prices of more than $4 a barrel.

On Wall Street, the Dow Jones industrial average leapt 302.90 points to close at 11,734.30. Earlier, the newly vulnerable euro tumbled by more than 1.8 per cent to five-month lows just above $1.50 – leaving it almost 10 cents below its record high of $1.6028 struck less than a month ago. It lost nearly 5 cents during the past 24 hours alone.

The pound also tumbled against the resurgent greenback, plunging more than 2.8 cents to 17-month lows below $1.92, to close in London at $1.9159. Economists said that the dollar’s surge came after a barrage of bleak news over the eurozone’s economic outlook combined with more upbeat developments in the United States to lead global markets into a drastic reassessment.

While, until now, official eurozone interest rates that are more than double those in the US have kept the euro high by sucking in flows of “hot money” to Europe in search of stronger returns, analysts said that fast-fading eurozone prospects meant that this was no longer enough to bolster it.

“The dollar is, in my view, in a genuine recovery. This trend could run much further than many think,” Stephen Jen, of Morgan Stanley, said. Markets’ fears over the threat of a severe eurozone downturn were fuelled this week when Jean-Claude Trichet, the President of the European Central Bank (ECB), admitted that the pace of decline in the economic fortunes of the 15-nation bloc had taken it by surprise.

Anxieties were reinforced yesterday after it emerged that the Italian economy shrank by 0.3 per cent in the second quarter, suggesting that Italy is in, or is very close to, recession. At the same time, a key ECB survey showed that eurozone banks further tightened lending conditions in the second quarter, adding to economic woes.

“This is a major reassessment. In a very short period of time, the sentiment turned 180 degrees,” Ulrich Leuchtmann, of Commerzbank, said. “The market now believes that the US economy once again will be able to leave a crisis behind very quickly . . . That’s why we see the dollar rising like a phoenix.”

Renewed market optimism that US growth will revive and inflation pressures ease was boosted by a further plunge in oil prices yesterday, adding to the dollar’s upward momentum. Benchmark US light crude fell almost $4.82 in early afternoon trading, at $115.20 a barrel, its lowest since early May and more than $30 below July’s record.

In turn, the dollar’s gains helped to stoke downward pressure on the price of oil, as well as the price of other commodities. Gold prices sank by $18.85 an ounce, or more than 2 per cent, to $853.60.

US Productivity Masks A Threat
Americans are working hard, productivity data released on Friday showed, but the data might well be a leading indicator of economic distress. Nonfarm productivity increased at an annual rate of 2.2% in the second quarter, which is less than the 2.7% gain expected by economists polled by Thomson Financial, but still a strong showing.

"They're generally pretty good numbers," said David Wyss, chief economist at Standard and Poor's, "just a little softer than expectations, but we like to look at these on a four-quarter basis, it for that it was darnn good." The 2.2% increase reflected a 1.7% jump in output and a 0.5% decline in hours worked. That is the twist.

"Remember," said Joe LaVorgna, chief economist at Deutsche Bank, "productivity is calculated by dividing output by the aggregate of hours worked in a specific period. As such, if employers are quick to lay off workers when activity slows, productivity can still look solid even though the economy is sputtering."

Wyss more or less noted the same thing. "While these numbers are good, they're also fairly typical for the early stages of a recession," he said. U.S. employment has indeed been weak in recent months, with July showing special pressure on younger workers.

Unit labor costs rose 1.3% as expected, down from the 2.5% increase in unit labor costs in the prior quarter. Wyss was pleased to see that there was not a lot of evidence of any pressure on labor costs. Over the last four quarters productivity is up 2.8%, and unit labor costs are up 1.5%. That means the cost to employers of their workers trails that of consumer price inflation signifcantly. The Consumer Price Index for June was up 5.0% from the level the previous year.

But in the manufacturing sector, productivity fell at a 1.4% annual pace in the second quarter, as output dropped faster than hours worked. Unit labor costs for manufacturers rose 6.1% in the quarter, the largest increase seen since the fourth quarter of 2006.

Financial markets did not show much direct reaction to the data. The yield on the 10-year government bond edged up to 3.95% from 3.93% late on Friday. More interesting was the dollar, which has been surging in recent weeks, though that may be more a reflection of expected slack in Europe's economy than enthusiasm about America's.

US dollar rallies as extent of worldwide recession becomes clearer
The psychology of global markets has shifted hugely over recent days as it becomes clear that Europe, Australasia and parts of Asia are sliding into recession.

The US dollar has launched its best rally in half a decade, reflecting a recognition that half the world is in even worse shape than the US. In fact, America is the only G7 country to eke out modest growth this summer.

The US dollar index - currencies watched closely by traders - smashed through resistance yesterday in the biggest one-day move since the long dollar slide began seven years ago. "This was highly significant. Perceptions have changed," said Ian Stannard, currency strategist at BNP Paribas.

The greenback gained three cents to $1.5050 against the euro, with big moves against other currencies. Commodities tumbled as hedge funds and financial investors struggled to untangle themselves from crowded positions on the futures markets.

Brent crude fell $4 to under $114 a barrel, down over 20pc since peaking in early July. The Baltic Dry Index has now fallen every day for over three weeks, dropping 30pc on fears that ship demand is fizzling out. Copper fell to a six-month low on reports of rising inventories in China and Europe. Lead, nickel and tin all dived in frantic trading on the London Metal Exchange.

"We see a deep global recession," said Albert Edwards, chief strategist at Société Générale. "Growth prospects in the Eurozone, Japan and the UK have deteriorated. Most now accept that recession has already begun in all three," he said. Mr Edwards predicted a "collapse" in emerging markets next. "You ain't seen nothing yet," he said.

The commodity slide boosts the dollar as petro-payments are recycled into euros, not the greenback.
A Bundesbank study found that for every $1 sent to the Middle East or Russia for oil, the eurozone gets 40 cents back. Europe is the chief supplier of cars and industrial good to the petro-economies. The US receives just 10 cents.

This bias is now going into reverse. Moreover, Danske Bank says there has been a $70bn net outflow of investment from the eurozone over the last year. It appears that foreign governments are sated on European bonds.

The drip-drip of bad news in America is now being trumped daily by the icy douche splashing over Europe. The markets were stunned by leaks from Berlin last week that Germany's economy had shrunk by 1pc in the second quarter. Yesterday Italy revealed a 0.3pc contraction.

The last straw was an admission this week by European Central Bank president Jean-Claude Trichet that "downside risks had materialised" and there was no clear end in sight. The comments were followed by the ECB's lending survey yesterday, confirming that banks have cut back sharply on mortgages and household credit.

BNP Paribas said it was now clear that the ECB had misjudged the severity of downturn. The monetary squeeze of the last year has raised mortgage costs by 150 basis points in Spain, Italy, Ireland and other states that rely heavily on floating-rate contracts. House prices are dropping in several regions at rates that match the US slide.

Bernard Connolly, global strategist at AIG, said the falling euro would come too late to prevent a severe economic crunch across southern Europe. "We think the EMU credit bubble is about to burst," he said.

Current account deficits have already reached 10pc of GDP in Spain and Portugal, and 14pc in Greece. The region depends on foreign capital flows to keep its economies afloat. This is now under threat as investors become alert to the solvency risks of debt deflation, causing a blizzard of warnings from rating agencies on the health of the banks in these countries.

Over the last few months the US dollar appears to have hit the bottom of its cycle, suggesting its relentless slide since 2001 may finally be over. Arguably, the US is now super-competitive. Airbus and Volkswagen are shifting production plant across the Atlantic. US furniture and textile companies have stopped outsourcing to China, and are coming home.

The International Monetary Fund says the dollar has fallen 25pc to 30pc on a global basis, just as it did in the late 1980s. There was no shortage of dollar doomsters at that time, warning that America was finished - left behind by Japan and Germany. Events played out otherwise. America was on the cusp of a recovery.

Will this be repeated? The US current account deficit has fallen from 7pc of GDP to under 5pc early this year, or nearer 4pc after adjusting for the oil spike. As the Habsburgs used to say, "the situation is desperate, but not serious".

Americans need radical surgery to revive country's economy
The US economy is in recession. Period. And it has been in a recession since January. This is the mantra of David Rosenberg, the first Wall Street economist to predict America's current economic woes, back in January, and perhaps one of the most bearish in the economic fraternity.

Although the traditional definition of a recession is two consecutive quarters of negative gross domestic product (GDP) - something that has yet to occur - Rosenberg, in his role as Merrill Lynch's chief North American economist, is unphased.

"People who focus strictly on GDP would have missed a very big story in Japan," he points out from his rather chaotic corner office in one of Merrill's two towers in downtown Manhattan.

Rosenberg, who jokes at one stage that he is not simply an economist but also a part-time historian, cites the stagnation that plagued the Japanese economy in the 1990s as the perfect example of why the financial firmament tends to measure downturns in the wrong way.

"Much like the US, Japan had a credit crisis and a residential real estate crash early on, yet the first back-to-back negative quarters of gross GDP didn't happen until the second half of 1993," argues Rosenberg, adding that, by then, it was clear that the Asian nation was in a recession.

"Waiting for GDP to go down is sometimes like Waiting for Godot - a lot of action happens on the way," he quips, referencing the Beckett play in which the title character never actually shows up. Of course Rosenberg, not one to go with the flow, is more than aware that data out last week showed that the US GDP grew by 1.9pc in the second quarter of the year.

Maybe so, he says, but wait for the downward revisions to such numbers that are likely to come out later in the year. "These numbers are going to be revised six ways to Sunday," he smiles, pointing out that strong growth originally seen in the fourth quarter of 2007, according to GDP, soon dissipated based on the most recent revisions.

One of his problems with GDP is that 20pc of it relates to government spending, and so it is not an accurate measure of the real economy. Even the National Bureau of Economics Research - the final arbiter of an American recession in its role of measuring and tracking business cycles - is not solely focused on GDP.

No, Rosenberg argues, the NBER uses employment, industrial production, real personal income and real sales in manufacturing, retail and wholesale to make up its mind. "When I take a look at these four, they all peaked and rolled over at different times from last October to February of this year. "So when I do my homework, I can see that the recession started, I think, in January."

From his perspective, then, the current market, be it in shares, debt or housing, is now as far away from touching the bottom - as some bears predicted when the Dow rose 331 points on Tuesday - as it ever was. "Look, we are coming off three major shocks," says Rosenberg. "An oil shock, a housing shock and a credit shock.

"Housing is the quintessential leading indicator. Housing peaked in 1988 and then we had a credit crunch in 1989 and then the onset of a consumer recession in 1990. We're just replaying an old movie." This most recent movie was a Federal Reserve production, he argues, with chairmans Alan Greenspan and then Ben Bernanke attempting to "reflate the housing stock as an antidote to deflation in the tech markets in the early 2000s".

"This was like Mary Shelley's Frankenstein. They built the monster, and then they had to tear it down." Rosenberg largely dismisses recent signs of apparent green shoots in the housing market as mere foreclosure sales, saying that such sales are part of an "important chapter towards recovery", and instead seizes on mortgage applications, which have fallen six months in a row.

"The path to financial ruin is littered with calls of a bottom, and I don't think you want to confuse intermediate bottoms with fundamental bottoms; I think that is quite a dangerous game to play," he warns. "I think what separates my call, say from the consensus, is that I don't necessarily think this is going to be a mild flash in the pan. I think this is going to be a long recession."

For Rosenberg, who recites random statistics from two decades ago as if they happened yesterday, the current downturn should not be dismissed as a simple economic phenomenon. "This is an epic event; we're talking about the end of a 20-year secular credit expansion that went absolutely parabolic from 2001-2007."

The current downturn, he predicts, will continue until the middle of 2009, pointing out that historically the end of a recession usually comes within a month of the NBER declaring one. "Whether or not I'm right on the recession call ending, there's going to be an extended period of economic weakness once it does, as post-bubble deleveragings are a multi-year adjustment process."

In his view, that deleveraging has already begun - as seen in banks, such as Merrill itself, beginning to reduce balance sheets by selling off unwanted assets, while companies have begun to reduce stock levels based on the most recent data.

But more importantly, Rosenberg argues, is what must take place in the household sector - a sector already ravaged by rising fuel prices, a stagnant housing market and rising levels of unemployment.

In spite of all those problems, Americans are beginning to reduce their debt exposure - as seen in the savings rate, which rose from 0.3pc to 2.6pc in the last three months, the third steepest quarterly increase since the Second World War.

"I think that's pretty big news," he smiles. "This is going to be a painful but necessary surgery so that we can get out of the hospital and embark on the next bull market of economic expansion."

But before the US economy can truly begin to expand again, Rosenberg believes the savings rate must rise to pre-bubble levels of 8pc, that the US housing stocks must fall to below eight months' supply, and that the household interest coverage ratio must fall from 14pc to 10.5pc.

"It's important to note what sort of surgery that is going to require. We will probably have to eliminate $2 trillion of household debt to get there," he predicts, saying this will happen either through debt being written off, as major financial institutions continue to do, or for consumers themselves to shrink their own "balance sheets".

"American households own more than $4 trillion of consumer durable goods. So something tells me that is going to be a venue for shrinking the household side of the balance sheet. "We're talking about the silverware, the old antique couch in the basement, unwanted or expensive art," he goes on. "This is the future, the future is frugality."

To back up his vision of a frugal future, he runs through a list of those businesses that already appear to be hurting, based on the second-quarter GDP numbers, those that are becoming somewhat surplus to requirement when times are tough.

"People's expectations have changed and so their behaviour is going to change. Dry cleaning was down, upholstering was down, beauty salons were flat. It's about getting out the old tool kit and doing it yourself."

Ironically for someone whose nickname is "Rosey", he can be amazingly bleak. "I'm not going so far as to say we're going to live in a cave, but life is going to change. There are going to be some very hard decisions made over the household budget as to what to allocate to consumer discretionary spending."

Such deleveraging measures will be vital, he argues, if the US economy is to get back on track, something that he promises to monitor and flag early, just as he has done with the current downturn. The other measure that will be vital for the resuscitation of the economy is for reflation to occur, for the Fed to "move from reallocating items on its balance sheet to aggressively expanding its balance sheet".

Rosenberg gives the Fed some credit for its actions over the past 11 months since it began reducing interest rates. However, he still thinks it could have done more. "Half its balance sheet is in toxic waste," he says, with reference to its continuing bail-outs of the embattled financial sector.

"Usually 95pc of its balance sheet is in treasuries, now it's down to 50pc. I think the Fed's approach is going to have to change." That change, along with the changes at a household level, should help eventually to kick-start the US economy - until the next time, when Rosenberg, no doubt, will be on hand to foretell the next recession.

TIPS Show Inflation Expectations at Lowest Level in Five Years
Treasury Inflation Protected Securities show that traders' expectations for inflation over the next decade fell to the lowest in almost five years this week as prices of commodities tumbled.

The gap between yields on TIPS and conventional 10-year notes narrowed after the Federal Reserve signaled that it will keep borrowing costs steady after leaving interest rates unchanged at its Aug. 5 policy meeting. A basket of 19 commodities including oil fell to a four-month low.

"The bottom line is you've seen a significant turn in commodity prices," said Thomas Tucci, head of U.S. government bond trading at RBC Capital Markets in New York, the investment- banking arm of Canada's biggest lender. "Going forward you're more likely to see inflation erode."

Ten-year TIPS yielded 2.18 percentage points less than similar-maturity notes, the smallest difference since October 2003. The yield gap indicates the annual rate of inflation foreseen over the life of the security. The yield on the benchmark 10-year Treasury was little changed last week at 3.94 percent, according to BGCantor Market Data.

The 4 percent security due in August 2018 traded at 100 15/32. The two-year note's yield increased 1 basis point, or 0.01 percentage point, to 2.50 percent on the week. Yields on 30-year bonds decreased 3 basis points for the week to 4.52 percent as the securities, more sensitive to inflation than shorter-term debt, outperformed notes.

Oil fell for the fourth week in five, leading the Reuters/Jefferies CRB Index, a basket of 19 raw materials, to a four-month low. Crude traded on the New York Mercantile Exchange for September delivery fell 8 percent this week to $115.20 a barrel.

The government on Aug. 14 will likely say that consumer prices including food and energy rose 0.4 percent last month, after a 1.1 percent increase in June, according to the median forecast in a Bloomberg News survey of 52 economists. That would be the smallest monthly increase since April.

If "I am with the Fed right now, I feel pretty good about my statement that we expect inflation to moderate over time," Brian Edmonds, head of interest rates at Cantor Fitzgerald LP, said Aug. 5. Cantor is one of 19 primary dealers that trade with the U.S. central bank.

Fed policy makers left the benchmark rate for overnight lending between banks unchanged at 2 percent on Aug. 5 for a second straight policy meeting, saying inflation is a significant concern while risks to growth remain. The central bank reduced interest rates by 3.25 percentage points in a series of seven cuts between September and April.

"The Fed is making a bet inflation is going to take care of itself over the next six months," E. Craig Coats Jr., co- head of fixed income at Keefe, Bruyette & Woods Inc. in New York, said after the central bank's meeting. Traders increased bets the Fed won't raise the target rate through the end of the year.

They saw a 62 percent chance yesterday that the central bank will hold the rate steady through December, compared with 35 percent odds a week earlier, according to futures contracts on the Chicago Board of Trade. Auctions of 10- and 30-year Treasuries this week drew better-than-forecast demand, showing investors are still attracted to the safety of U.S. government debt.

The sale of $10 billion in 30-year bonds attracted the most participation in two-and-a-half years from a class of investors that includes foreign central banks. The group, known as indirect bidders, bought 42.9 percent of the auction, the most since February 2006. The sale, the biggest of the maturity since 2006, drew a yield of 4.609 percent, below the 4.662 percent average forecast of nine bond-trading firms surveyed by Bloomberg News.

Commodities Fall to Four-Month Low on Dollar's Jump
Crude oil, corn and silver tumbled, sending the Reuters/Jefferies CRB Index to a four-month low, as a stronger dollar and slower economic growth eroded demand for raw materials.

Crude oil fell to the lowest since May, corn tumbled to a four-month low and silver touched its cheapest since January. The dollar had its biggest increase in almost eight years against the euro after European Central Bank President Jean- Claude Trichet said economic growth will be "particularly weak" through the third quarter. Fannie Mae, the largest U.S. mortgage finance company, said the worst housing slump since the Great Depression is deepening.

"People have gotten very worried about demand for commodities because of this global meltdown," said Michael K. Smith, president of T&K Futures & Options in Port St. Lucie, Florida. "If all these major economies are going to slow down, people think that's really bad news."

The CRB Index of 19 raw materials declined 12.12, or 3 percent, to 387.42, the lowest since April 2. The measure is down 18 percent from a record 473.97 on July 3. The UBS Bloomberg Constant Maturity Commodity Index of 26 prices had advanced for six consecutive years, bolstered by surging demand for raw materials in China, India and other emerging markets.

Crude oil fell $4.82, or 4 percent, to $115.20 a barrel on the New York Mercantile Exchange. Earlier, the price touched $114.62, the lowest since May 2. Oil has dropped 22 percent from the record $147.27 on July 11.

"Crude was a safe haven at a time of a declining dollar, and now the dollar is going back up, so people are less interested in a haven," said Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts. "Increasingly gloomy" economic reports out of Europe and Asia have also helped weaken prices.

Singapore lowered its 2008 growth forecast today, warning of a "bumpy year ahead." Italy's economy unexpectedly shrank in the second quarter, edging closer to a recession. "People understand that we might face a difficult two or three quarters ahead of us," said Christoph Eibl, who helps manage more than $1 billion of commodities at Tiberius Asset Management AG in Zug, Switzerland. "Industrial-related commodities will not outperform."

Oil may fall next week amid weakening demand caused by the global economic slowdown, a survey showed. Thirteen of 35 analysts surveyed by Bloomberg News, or 37 percent, said prices will drop through Aug. 15. Corn fell to the lowest price since March 20, and soybeans also dropped to a four-month low as the dollar climbed.

Since reaching records this year, corn has tumbled 35 percent and soybeans are down 28 percent as favorable weather boosted crops. "When the dollar rallies as much as it has, it reduces the investment in commodities, including grains," said Roy Huckabay, an executive vice president for the Linn Group in Chicago. "People that bought in the past two days, looking for improved demand at lower prices, are getting beat up today."

Corn futures for December delivery fell 23.75 cents, or 4.4 percent, to $5.1825 a bushel on the Chicago Board of Trade, after earlier touching $5.1375. Soybean futures for November delivery fell 58.5 cents, or 4.7 percent, to $11.805 a bushel, after touching $11.735, the lowest since April 1. Gold fell for the sixth straight session, the longest slide since June 2006, as the euro slumped. Silver dropped almost 6 percent.

The metal generally moves in tandem with the euro as an alternative to the dollar. Gold reached a record $1,033.90 an ounce in March as the euro headed for an all-time high. "This is a rout," said Leonard Kaplan, president of Prospector Asset Management in Evanston, Illinois. "All those people who were bearish the dollar and bullish gold are getting their heads handed to them."

Gold futures for December delivery fell $13.10, or 1.5 percent, to $864.80 an ounce on the Comex division of the Nymex. The price has dropped 6.3 percent in six sessions. Silver futures for September delivery tumbled 92.7 cents, or 5.7 percent, to $15.33 an ounce. Earlier, the price touched $15.24, the lowest since Jan. 7.

Copper had the biggest weekly drop since May 2007, and aluminum, nickel, tin, lead and zinc also dropped in London. "The overriding theme of a weaker demand side is still prevailing," said Daniel Hynes, an analyst at Merrill Lynch & Co. in London.

Copper futures for September delivery fell 8.5 cents, or 2.5 percent, to $3.333 a pound on the Comex. The weekly drop was 6.9 percent. Ten of 19 analysts and traders surveyed yesterday and Aug. 6 forecast copper will fall next week. Eight expected an increase and one was neutral.

Fed Moves Propped Up Dollar
One year after the siege in money markets began, the Federal Reserve’s ground-breaking response has paved the way for the dollar’s biggest rally in years.

From outsized rate cuts — 1.25 percentage points alone in January — to massive liquidity injections and speeches directly addressing the greenback, the U.S. central bank has given currency investors a lot to digest in the past 12 months. Some market watchers say its expanded role has helped the U.S. move closer to recovery from the financial market crisis, just as the rest of the world moves further away.

And that is helping the U.S. dollar, which climbed to levels unseen since the start of 2008 against the euro Friday. Moreover, the U.S. currency’s losses on the foreign exchange market through July was part of a broad correction, now complete, say analysts. It served to ease global imbalances. As Federal Reserve officials like to point out, the dollar was overvalued in the late 1990s and early 2000s.

But the euro is overvalued at this point. While the Fed’s actions have played a role — the massive 3.25 percentage points in rate cuts since September sent investors in search of higher yield — they have also provided the dollar with the backdrop necessary to find its proper place against the common currency.

“The fact that the Fed is there supporting the financial system, that in itself is helping the dollar,” said Divyang Shah, senior foreign exchange strategist at Commonwealth Bank in London. The dollar is well positioned to gain off of euro-zone difficulties and ECB rate cuts down the line.

While global imbalances remain an issue, the dollar has done its part to solve the problem, say analysts. The dollar’s decline through mid-July has been a boon to the U.S. economy, providing a rare ray of light for the export and tourism industries amid the prevailing housing and financial sector gloom.

It has helped to address global imbalances by shrinking the U.S. current account deficit, the broadest measure of a nation’s trade and investment positions. The U.S. deficit narrowed to 5% of GDP at the end of the first quarter 2008 compared with 7% in the fourth quarter of 2005.

Once the housing market corrects — whenever that will be — and money markets improve, the Fed’s expanded role isn’t expected to stick. Many think it will take at least a year for conditions to return to normal. Until then, the Fed still has time to bump up the buck even more.

In wounded world, Japan's taste for risk only grows
Even as caution rules for investors around the world nursing wounds from the year-old credit crisis, Japanese households are still eager to take risks and buy exotic currencies in their relentless quest for higher yields.

In the past few months the South African rand has become the top currency for wealthy Japanese households buying uridashi bonds that are sold directly to them by securities firms, the first-ever Russian rouble uridashi was launched and the Brazilian real is now an option.

More surprisingly, Japanese currency day-traders, who make leveraged bets with borrowed funds, have snapped up the Australian and New Zealand dollars in a big, risky bet that their slide against the yen will be limited.

Such trades can backfire if those currencies fall sharply and wipe out the returns offered by higher rates. In the case of the kiwi, professional traders are worried that any rush to the exits by the Japanese day-traders could exacerbate any tumble.

But the hunt for yield in more exotic destinations highlights just how persistent Japanese investors are in selling their low-yielding yen to secure better returns via foreign currencies and bonds, especially with stock markets still looking shaky.

"Capital outflows are a structural trend in Japan," said Stephen Jen, chief global currency strategist at Morgan Stanley. The persistent flow of funds out of Japan has served as a source of liquidity while many banks are hoarding cash, and it has kept the yen weak against a wide array of currencies.

The yen's real trade-weighted value -- the broadest measure of its performance -- hit a seven-month low in July, down 6 percent since March when it reached a 13-year peak against the dollar. Over the past five years, the yen's broad value has fallen by 17 percent.

Analysts link the search for higher returns abroad with a generational change in Japan's ageing society and a break with the conservative stance of keeping so much money -- about 750 trillion yen ($6.9 trillion) -- in cash and deposits often yielding about 0.5 percent.

Royal Bank of Scotland said in a report that the household shift to foreign assets was a "demographically based regime change" that created a headwind against any yen gains. In July, Japanese workers investing summer bonuses were snapping up assets in Brazil and other Latin American countries.

Sixty-three new mutual funds were launched last month that attracted 338.4 billion yen ($3.2 billion). UBS Global Asset Management's Brazilian real bond fund was the most popular, according to data from fund tracker Lipper. The second most popular such "toushin" mutual fund was a UBS emerging currency vehicle.

At the same time, the government-affiliated mega asset managers -- the Government Pension Investment Fund, Japan Post Bank and others -- are slowly shifting funds out of low-yielding domestic government bonds.

An explosion in currency day-trading has been another that has made ripples in Tokyo's exchange market and typifies Japan's infatuation with all things foreign. Advertising for online margin trading brokerages dot Tokyo's subway lines, offering tight spreads and leverage that sometimes allows traders to boost bets by 100 times and more.

A survey among Tokyo's top banks and brokers showed a 56 percent jump in trading in minor currencies to a daily average of $29.1 billion in the year to April. The rising volumes mean professional FX traders track the trends of the individual traders, dubbed "Mrs. Watanabe" or the kimono traders because of the trade's popularity with women.

The appetite of Japan's individual traders for the sliding New Zealand dollar has worried the professionals because the kiwi is not as widely traded as other currencies, and thus moves can sometimes be very sharp. The kiwi has been hit by expectations of interest rate cuts from their steep levels of 8 percent as the economy appears to have fallen into a recession for the first time in a decade.

On the Tokyo Financial Exchange (TFX), one of the main intermediaries in the margin trading market, long New Zealand dollar positions have roughly doubled in less than two weeks to a record high as of last Friday.

Long positions in the kiwi and the Aussie make up about 80 percent of all long positions on the TFX. "That's a bit scary, quite scary really," said Gerrard Katz, head of North Asia FX trading at Standard Chartered in Hong Kong.

MBIA May Sue Short-Seller Ackman's Pershing Square
MBIA Inc. said it may sue Bill Ackman, striking back against the hedge fund manager who waged a six-year campaign against the bond insurer and said this year that the company may be insolvent.

MBIA is "assessing all our options, including litigation" against Ackman's Pershing Square Capital Management LP, Chief Executive Officer Jay Brown said on a conference call today after the Armonk, New York-based company reported a $1.7 billion profit. Ackman, in an e-mail, said he stands by his comments.

Brown's decision to consider legal action escalates a feud that began when Ackman wrote a 2002 report criticizing MBIA's use of credit-default swaps to guarantee debt. Ackman has appeared before Congress and written letters to the U.S. Securities and Exchange Commission, at the same time betting against the stock.

MBIA, which tumbled 86 percent during the past year, climbed as much as 15 percent today after the company posted a profit that beat analyst estimates and said it would resume a share buyback program. MBIA rose 29 cents, or 3.5 percent, to $8.57 in New York Stock Exchange composite trading after reaching as high as $9.48 earlier in the day.

Brown's comments came in response to an anonymously submitted e-mail question asking if MBIA planned to follow-up on New York State Insurance Superintendent Eric Dinallo's comments in a Financial Times article last month saying "rumor mongering" about a bond insurer's solvency "crossed a line."

In the July 31 article, Dinallo cited a New York State law against spreading false rumors or making statements "untrue in fact" about an insurance company's insolvency. He didn't name Ackman or his Pershing Square by name. Brown, 59, also said MBIA would cooperate with any regulators that decided to look into issues raised by Dinallo. "MBIA agrees that statements may have violated New York state insurance law," Brown said.

Ackman, 42, said in his e-mail that "we continue to believe that MBIA is insolvent" under one of two tests in state insurance law. The test relies on whether an insurer can afford to reinsure its liabilities in the current market. MBIA appears solvent under the other test, Ackman wrote, based on statutory filings which rely on management predictions of future losses, though he called those estimates "understated."

Ackman has said he stands to make hundreds of millions of dollars betting against MBIA and Ambac Financial Group Inc., owners of the two largest bond insurers before this year, if they file for bankruptcy.

Bond Insurers Say Rules-Driven Income Boosts Won't Last
Troubled bond insurer MBIA Inc. Friday became the latest company to benefit from accounting rules that translate weaker credit ratings into big earnings gains.

MBIA and other bond insurers issue credit derivatives contracts, which obligate them to make good on bonds when they default. Many of those contracts pertain to exotic securities backed by subprime debt. When the credit quality of the bond insurers' own debt drops, the perceived losses on its derivatives contracts also drops, which drives up the contracts' value.

In effect, the rule says: Since you're less likely to be able to pay your obligations, you can take a gain on the money you may not pay out. The accounting rule affects derivatives contracts that are valued, or marked to market, each quarter. "It is as if we were not selling an insurance policy, but selling MBIA's obligation to pay on the policy," said Chuck Chaplin, MBIA's chief financial officer, during the company's second quarter earnings conference call Friday.

MBIA, bond insurer Ambac Financial Group (ABK) and investment banks have all noted the effect, due to a controversial accounting rule set by the Financial Accounting Standards Board that allows companies to adjust the market value of liabilities - including credit default swap contracts - to take into account the risk that the company will not be able to pay what it owes.

The investment banks and bond insurers that have large subprime mortgage exposures all saw their own credit worthiness drop in the second quarter, which helped them book big market-value gains on the contracts. The effect is an accounting quirk that results in ephemeral gains and losses.

In past quarters, Lehman Brothers, Citigroup, JPMorgan Chase, UBS AG, and Morgan Stanley all took writeups, that were largely outweighed by losses on the companies' mortgage-related losses. Market-value writeups had a proportionately larger impact on bond insurers, who do not own the securities they insure, so don't have the same asset write- downs.

Company executives generally downplay the importance of the so-called mark-to- market changes. This quarter, the upswings have been so large that some companies are giving July updates on their June figures, to illustrate how quickly the numbers can change.

For MBIA and Ambac, whose credit profile improved in July as the companies' fortunes improved, the gain all but disappeared. Chaplin said that if it had reported its mark-to-market as of the end of July, the gain would have been about half the $3.3 billion it reported at the end of June.

"When our spreads return to normal, the value of this contingent liability would increase," Chaplin said. At the end of July, its mark to market gain was cut in half, to about $1.4 billion, he said. Spreads are the yield premiums on MBIA's or other issuers' bonds over other bonds with higher credit. "Without FAS 157, our change in fair value would be nearly nil," Chaplin said, referring to the Financial Accounting Standards rule regarding the derivatives accounting.

In June, both MBIA and Ambac were downgraded by Moody's Investors Service, which caused the spreads on their own debt to skyrocket. In July, the perception modified, and the spreads narrowed substantially. Ambac's second-quarter profit of $823.1 million included a $961.6 million market-value gain, which quickly evaporated as the company canceled a financial guaranty policy it had written for Citigroup, dramatically improving the market's view of its credit-worthiness.

"The $961 benefit would have been a negative $1.3 billion as of July 31 if we had used July 31 spreads and pushed that back to the June 30 state of affairs," said Sean Leonard, Ambac's chief financial officer.

ACA Terminates $65 Billion of Credit-Default Swaps
ACA Capital Holdings Inc., the bond insurer that lost its investment-grade credit ratings in December, terminated $65 billion in credit-default swap contracts and turned over most of the company to creditors.

Counterparties now own a 95 percent residual interest in New York-based ACA Capital's insurance unit through surplus notes, the company said in a statement today. Howard Seife, a lawyer at Chadbourne & Parke LLP representing 12 counterparties, provided the face value of the canceled credit-default swap contracts.

Bond insurers, seeking to limit claims and improve their capital position, are trying to get out of credit-default swap and other derivatives contracts that they used to guarantee securities linked to now-failing subprime mortgages. Merrill Lynch & Co. in January wrote down $1.9 billion in securities it tried to hedge through ACA, and Canadian Imperial Bank of Commerce had to sell more than C$2.75 billion ($2.6 billion) in stock after taking writedowns tied to ACA.

ACA has no more structured-finance exposure and now only guarantees municipal bonds, the Maryland Insurance Administration said in a statement today. ACA now has enough assets to meet its obligations to municipal-bond policyholders, the state said. "Given all of the problems faced by monoline insurers today, the resolution we achieved with ACA may well serve as a model for other companies," Seife said.

Maryland regulators must sign off on payment of the surplus notes, Seife said. ACA Capital retained 5 percent of the notes.
The insurance unit, ACA Financial, will go into run-off, meaning it will seek to meet its existing obligations and not write additional policies.

H. Russell Fraser, who helped turn Fitch Ratings into one of the three major rating companies, started ACA in 1997 to insure municipal bonds that AAA rated insurers wouldn't cover, including financing for nursing homes and rural hospitals. After Fraser left the firm in 2001, to run a beef jerky manufacturing company in Wyoming, ACA expanded into the structured finance business, guaranteeing securities mainly through credit-default swap contracts.

By the time the company was downgraded late last year, it had insured 10 times more structured-finance securities than municipal bonds. Credit-default swaps, conceived to protect creditors against default, are used to speculate on creditworthiness or to hedge against losses. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

ACA Financial was forced to seek reprieves after Standard & Poor's lowered its credit ratings 12 levels to CCC in December, suggesting potential default. Counterparty agreements required ACA to post collateral if its rating fell below A-. The unit had reached six forbearance agreements with counterparties since late last year under which banks waived their rights to receive collateral against guarantee contracts, to terminate contracts and to receive claims payments.

The company didn't have the assets to meet those collateral calls and would have been insolvent, Maryland regulators said.
ACA backed about $7 billion of municipal bonds, including $25 million of bonds sold by the Community Academy Public Charter School in Washington, D.C., and $8.2 million of securities sold by Tuskegee, Alabama, according to company disclosures earlier this year.

The value of ACA insured municipal bonds, many of which weren't rated on a standalone basis, tumbled, following the collapse of ACA's financial guarantee rating. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in interest rates or the weather.

Mortgages get more expensive - again
The good news: Mortgage giant Fannie Mae is taking steps to shore up its finances. The bad news: You're going to pay for it when you take out a mortgage.

Fannie plays a central role in the market for home mortgages by purchasing loans, securitizing them and selling them to investors. In announcing announcing a $2.3 billion loss on Friday, it also said it would make major changes that could have a significant effect on mortgage liquidity and pricing.

The company said it will increase its fees, stop buying certain high-risk loans and charge a higher risk premium for buying loans in the declining market. "[These actions] have raised the costs of mortgage credit and reduced its availability," said Mark Zandi, chief economist for Moody's "Policy makers had been hoping they would move forward to provide more credit and now they're just hoping they don't pull back."

The increases were inevitable, according to Keith Gumbinger of HSH Associates, a publisher of mortgage loan information. "The cost of mortgage credit is getting pushed higher by the issues in the marketplace," he said. "They can't reduce their market exposure and that means more expensive mortgages."

Fannie increased fees for some loans by a quarter of a percentage point, based on borrowers' credit scores and the amount of their down payments. It will charge, for example, 1% (up from 0.75%) for a buyer with a credit score of 680 paying 20% down.

And Fannie doubled its "adverse market delivery charge" to 0.5%. That is an across-the-board fee assessed against every loan Fannie buys, according to a Fannie spokeswoman. Fannie first instituted the charge this spring. "It's very negative," said Lawrence Yun, chief economist for the National Association of Realtors. "Any time there's an additional imposition of fees in obtaining a mortgage, it knocks some potential buyers out of the market."

Fannie's smaller cousin, Freddie Mac, which also announced a big loss this week, has been taking similar steps to shore up in finances and reduce its exposure to risky loans. The additional fees imposed by Fannie will hit newcomers particularly hard, according to Yun. First-time buyers are usually most on the margins and struggling to afford a home purchase.

The added fees will be passed on to borrowers and could mean quarter-point increases in interest rates.
Reducing the number of first-time buyers can have a domino effect on the market. Existing homeowners looking to trade up to bigger, more expensive homes may postpone doing so because they can't sell their present home.

Fannie will also eliminate buying Alt-A loans by the end of 2008. Alt-A loans, a category between prime and subprime, accounted for about 11% of the company's loans during the last years of the boom. They have been used mostly by people who couldn't or wouldn't document their incomes, their assets or both. These buyers will find it harder to obtain financing once Fannie stops buying the loans.

According to Yun, however, the cutback in Alt-A will hurt people buying second homes to rent out or resell, rather than first time homeowners. "These are people who often rely on their good credit to buy investment properties putting little or no money down," he said.

But removing some of them from the market will decrease demand in a market already struggling with high inventory.
Fannie and Freddie, as private companies created and sponsored by the government, have to foster home ownership while satisfying their shareholders. They have to maintain profitability or risk triggering a government rescue.

"They were created to provide liquidity in times of crisis," said Yun. "If they don't do that, what's the point of having Fannie and Freddie in the first place?" 

$1 trillion in losses? Bank on more
Make no mistake: The worst probably is not over for financial firms. Not by a long shot.

Many bank stocks have bounced sharply from their panic-induced lows of mid-July on hopes that the bleak second-quarter results represented the bottom. But the bigger-than-expected losses reported by Freddie Mac and Fannie Mae this week, accompanied by dismal forecasts for the housing market, are strong indicators that there are likely more credit-related woes to come.

"The banks are still at the mercy of writedowns. I don't think the worst is over for financials yet," said Liz Ann Sonders, chief investment strategist with Charles Schwab & Co. The International Monetary Fund forecasts that global losses tied to the credit crisis will be $945 billion. It's a widely used number, but Sonders thinks it's "potentially very conservative."

So how high could losses go? Sonders points to the $1.6 trillion forecast from hedge fund firm Bridgewater Associates or even the $2 trillion number from Nouriel Roubini, the highly-respected professor of economics at NYU's Stern School of Business. And based on the losses already reported, we're not even halfway through the crisis.

But as scary as those predictions sound, it's actually somewhat healthy to see forecasts of bigger losses. Sonders said that at some point, the market will probably even begin to discount the fact that there are more losses ahead. They key is that investors have to expect them in the first place.

The biggest problem that the market has had to grapple with this year is that investors can't believe the numbers that banks are reporting. We've been fooled a couple of times into thinking that banks finally had gotten the bulk of their most toxic loans off their balance sheets.

So instead of this death by a thousand cuts, we might just need a big bloodletting in the banking system. As bad as this financial crisis seems right now, only eight banks have failed so far this year. That pales in comparison to the 534 that collapsed in 1989 - the height of the savings and loan debacle.

With that in mind, some think the Federal Reserve is perpetuating the problem in banking by keeping interest rates as low as they are. The Fed held its key benchmark fed funds rate at 2% following its meeting earlier this week. John Lekas, founder and CEO of Leader Capital Management and portfolio manager of the Leader Short-Term Bond Fund, thinks the Fed should start raising interest rates before the end of the year.

Lekas argues that rate hikes would help to strengthen the dollar and reduce inflation pressures. He said it might also encourage more saving by consumers since rates on money-market accounts are closely tied to the fed funds rate. And a stronger dollar, reduced inflation and increased savings would be a positive for the economy, even if the consequence was more short-term pain for banks.

"The Fed's current policy is to bail out the weak hands in banking and punish the savers in this country," said Lekas. "But this is a Band-Aid policy that is not addressing the real problem of inflation. The Fed should be trying to save the whole system, not save the overextended and irresponsible."

Nonetheless, as I've argued for some time in this column, the markets and economy don't need the financial sector to be at 100% health in order to hold up. There are plenty of other industries that have been doing well despite all the economic headwinds.

It was encouraging to see that stocks actually rallied early Friday morning despite the bad news from Fannie Mae. The continued decline in oil prices and a resurgent dollar are helping to minimize the pain in the financial sector.
Still, until more banks come truly clean about how much worse their losses will get and until the Fed stops trying to save banks that should be allowed to fail in a free market, expect the financial sector to keep bleeding red ink.

UBS: The ARS Are Ours
UBS is going the extra mile to appease authorities and set things right with its clients. The Swiss bank made the reputation-saving move on Friday to outdo its rivals and buy back billions in auction-rate securities.

UBS is in discussions to buy back auction-rate securities worth $18.6 billion, plus a $150.0 million fine in the investigation led by New York Attorney General Andrew Cuomo, as well as $75.0 million to other regulatory agencies. That's on top of $3.5 billion the bank has already agreed to buy back from clients. "What we've established is the institutions are responsible," Cuomo told the Associated Press. "People will get their money, and get it back in the immediate future."

UBS has agreed to repurchase the bond-like securities from its retail customers, charities and small and mid-size businesses beginning Jan. 1 with customers holding less than $1.0 million in assets at UBS able to sell the securities back to the bank beginning Oct. 31. The bank will begin the repurchasing from institutional investors in 2010. The steep buy-back will stave off legal trouble down the road.

"Our leading position in supporting the market and providing liquidity is clear, and now, were the first firm to give all clients -- private, corporate and institutional the opportunity to be made whole," said Marten Hoekstra, Head of UBS Wealth Management Americas.

The UBS deal is bigger that those of Merrill Lynch and Citigroup, which agreed to buy back $12.0 billion and $7.5 billion in securities, respectively, but only from their retail clients.

Some analysts were skeptical that UBS would want to go the extra mile of reaching out to its institutional clients as well. "There is a view that institutional clients ought to be sophisticated investors who knew what they were buying," said David Williams of Fox-Pitt Cochran Caronia. "I can't see why UBS would want to settle with institutional investors now that Citigroup and Merrill Lynch have set the precedent."

UBS will probably have to take mark downs of around 10.0% on the bought-back securities for the third quarter, or a total of $1.9 billion. Auction-rate securities issued by municipalities are trading at discounts of around 10.0%, giving the only real indication of what they are currently worth. There are other far more toxic versions of the securities, including those issued by student loan companies, which are commanding far steeper discounts in the secondary market.

So what would this mean for UBS? "It would certainly be a concern as we did not expect them to repurchase all of those auction-rate securities. However it will also mean that the problem will be sorted out and the uncertainty won't drag on," said Jean Sassus of Raymond James Equities in Paris.

Sassus added that if the mark-downs came in at $1.9 billion, UBS would not need to raise extra capital. UBS has guided for flat earnings in the second quarter, after a 3.0 billion Swiss franc ($2.8 billion) tax credit. Analysts estimates for write-downs for the quarter vary between $4.0 billion and $5.0 billion.

UBS-NY accord offers 'first aid' to muni issuers
New York's auction rate settlement with UBS AG includes the first recovery of money for the state's issuers who sold this debt and hired the giant Swiss bank as their underwriter, according to terms of the deal unveiled on Friday.

Until now, the few settlements between banks and regulators have almost entirely focused on aiding investors who bought these securities, thinking they were nearly as safe as cash, only to get trapped with debt that could not be sold when the $330 billion market froze in January.

The fee recovery provision New York's Attorney General Andrew Cuomo won in the UBS settlement likely will be matched by other states with similar investigations, predicted Evan Rourke, a muni strategist with M.D. Sass in New York. At least 12 states are probing whether banks and brokers misled investors in auction rate paper, which is long-term debt whose rates are periodically reset at auctions.

States, cities, schools, hospitals and museums all sold this tax-free debt, which saved them money because they captured lower short-term rates. But when the market for auction rate debt collapsed, many issuers were briefly forced to pay punishingly high interest rates, in some cases up to 20 percent.

"I think that naturally any state that sees what New York state is getting and will have to spend money to refinance will do the same thing. They will press for the same treatment," Rourke said. "It's hard for banks not to do the same thing."

After all, Merrill Lynch on Thursday announced it would buy back auction rate securities from its retail clients, who hold about $12 billion of this debt after Citigroup said that it would repurchase more than $7 billion of its investors' auction rate paper. Though Citi also settled probes by New York and the U.S. Securities and Exchange Commission, New York and Massachusetts both warned Merrill their investigations are ongoing.


Financial analysts have estimated that muni issuers have refinanced about half of the outstanding auction rate paper, and sparing them extra fees could speed this process. Some issuers have cited the high cost of restructuring this debt as a major impediment. Underwriting can be quite lucrative for banks, many of which might prefer not to give up this income when their profits are plunging with subprimes.

New York's fee recovery provision with UBS does not appear to be an overwhelming expense, at least not yet, though this cost could grow if other states follow suit. Only a tiny universe of New York auction rate deals fit the time frame of the UBS settlement -- the debt must have been issued since August 1, 2007, which is the same month that spawned the global credit crunch.

For example, UBS helped underwrite a New York City Municipal Water Finance Authority offering that had $97 million of auction-rate debt, $78 million of this debt for New York City, and $350 million for the Port Authority of New York and New Jersey, according to Thomson Reuters data. Cuomo might try to wrest a fee recovery provision from other banks.

New York state issuers have restructured $1.6 billion of auction rate paper, the state's budget office said.
UBS was not on the list of underwriters distributed by the state budget office. That roster included Citigroup, Merrill Lynch and Goldman Sachs. In April, Goldman said regulators asked it for information about auction rate debt.

JPMorgan, one of many banks named as a defendant in an auction rate lawsuit filed by the City of Los Angeles, also appeared on that list of underwriters. So did Morgan Stanley , which is repaying two Massachusetts cities for auction rate investments.

UBS Fined $150 Million, Agrees to Buy Auction Debt
UBS AG, Switzerland's biggest bank, agreed to pay $150 million in fines and begin buying back $18.6 billion in failed auction-rate securities, the largest settlement in a U.S. probe into whether banks stuck clients with hard-to-sell bonds.

UBS will purchase $8.3 billion of the securities from its clients beginning on Oct. 31 under a settlement with New York State Attorney General Andrew Cuomo, the Securities and Exchange Commission, and a group of other state regulators, according to terms of the settlement announced today. The bank must also help its institutional clients sell an additional $10.3 billion in securities, and may have to buy back the bonds if they fail to find a market, Cuomo said.

The agreement is the second in two days, covering 80,000 individual investors who will get back more than $15 billion, Cuomo said. Citigroup Inc. settled state and federal claims yesterday, agreeing to buy $7.3 billion of the debt from individual investors and pay $100 million in fines, as well as pledging to help 2,600 institutional customers unload $12 billion of securities.

"The industry is beginning to take responsibility for correcting a problem they created, and that's a good thing," Cuomo said in a statement. "The fundamental goal has been to return money into the hands of investors, and that's what this deal has done.

UBS said the full cost of the settlement, including the fines and writedowns of auction-rate debt it will redeem, is estimated at $900 million on a pre-tax basis, which will be recognized in second-quarter earnings. The bank fell 53 percent in the year through yesterday in Swiss trading. The stock rose 1.3 percent to 22 francs as of 3:49 p.m. New York time.

The decision by UBS and other investment banks to abandon the auction-rate market may in the end compound their losses from the global credit-market contraction as they face fines and are forced to repurchase securities they sold. Zurich-based UBS reported a net loss of 25.4 billion Swiss francs ($25.6 billion) in the nine months through March, more than any other bank.

Bank of America Corp. analyst Jeffrey Rosenberg estimates banks that purchase the auction-rate debt may have to write it down by a total of $4 billion Regulators in Massachusetts, New York and Texas filed civil complaints against UBS, claiming it pressured financial advisers to sell the securities as the $330 billion market faltered.

Investors were left unable to redeem securities that were billed as equivalent to cash after the dealers that ran the periodic bidding to determine interest costs in February suddenly stopped supporting the market as they had for years.

Merrill Lynch & Co., which was sued by Massachusetts Secretary of State William Galvin, said yesterday it would voluntarily start repurchasing as much as about $10 billion of the securities in January. The bank hasn't reached a settlement with regulators, who said they are continuing their probe.

"There is no way for the institutions to win this fight, and they know that," Thomas Ajamie, a securities lawyer in Houston, who represents investors and won a $429 million arbitration award against Paine Webber Group in 2001.
Cuomo refused to rule out further complaints against individuals at the banks that have settled.

UBS executives allegedly sold $21 million in personal holdings of auction-rate securities while the company promoted the products to investors, regulators said. One of them, UBS's top U.S. legal official David Aufhauser, quit earlier this month.

Aufhauser, a former U.S. Treasury legal chief, was among seven unidentified executives mentioned by Cuomo in his July 24 complaint, referring to him only as "Executive A," two people familiar with the case said. The Swiss bank placed U.S. fixed- income chief David Shulman, identified by name in Galvin's complaint as an executive who sold his own holdings of the securities as the market faltered, on administrative leave, spokeswoman Karina Byrne said this week.

Separately, UBS has said it's cooperating with a tax- evasion probe by U.S. prosecutors. The bank hid as much as $17.9 billion for 19,000 Americans who didn't declare assets to the Internal Revenue Service, according to a Senate subcommittee report. Last month, UBS said it will stop offering offshore- banking services to U.S. clients through branches not licensed in the U.S.

The bank will begin offering some of its clients no-cost loans next month, and begin redeeming auction-rate securities for investors with less than $1 million of the debt on Oct. 31, according to the settlement. It customers will have until Jan. 1, 2011 to redeem their auction-rate debt.

UBS said it will begin redeeming the securities held by its institutional clients in June 2010 if it is unable to help liquidate their holdings, according to a statement it released today. The bank also agreed to reimburse it municipal clients in New York that have refinanced auction-rate securities sold since last August.

"Today's solution provides further relief, beginning in September, to investors who have been understandably frustrated by the industry-wide failure of the ARS market," said Marten Hoekstra, head of UBS Wealth Management Americas, in a statement.

UBS said on July 16, prior to the settlement, it planned to offer to buy back as much as $3.5 billion in auction-rate preferred shares it sold for closed-end funds. This is in addition to the $18.6 billion it agreed to begin redeeming today.

Citi, Merrill, UBS Auction-Rate Buybacks Won't End All Suits
The efforts by regulators to make brokerages buy back auction-rate securities from clients may reduce, but won't eliminate, the pile of class-action lawsuits accumulating against banks.

Lawyers had a field day filing lawsuits seeking class-action status when the market for auction-rate securities froze, leaving individual and corporate investors unable to access their money. Investors purchased auction-rate securities, thinking they were a safe, liquid investment that could be sold at will.

Other investors chose to go the arbitration route through the Financial Industry Regulatory Authority. To date, more than 170 arbitration cases involving auction-rate securities have been filed with FINRA. Investors are not able to participate in both an arbitration case and a class- action lawsuit. Now basically every large player on Wall Street is buying back - or likely to buy back - the securities from individual investors, small businesses and charities.

UBS AG (UBS) said Friday it will buy back $19.4 billion worth of auction-rate securities. Merrill Lynch & Co. (MER) is set to buy back an estimated $10 billion in auction-rate securities beginning in January. Citigroup Inc. (C) agreed to buy back $7.3 billion in illiquid auction-rate securities, and pay $ 100 million in civil penalties, with $50 million going to the state of New York.

A Merrill Lynch spokesman said, "Once investors are out of their positions, they're less likely to sue and even more unlikely to prevail." Representatives for UBS and Citigroup did not immediately return calls. With the buybacks, some investors will opt out of their class-action lawsuits and arbitration cases. However, the banks have agreed to make good with retail clients, not institutional clients.

The amount of money banks would have to pay back to institutions is likely too high, and banks can't afford to take it on their balance sheets, said Jacob Zamansky, partner at Zamansky & Associates, who is handling many ARS cases for investors.
Zamansky said he represents a number of institutions that will continue to fight in arbitration for their money, as some had large stakes of money invested.

Additionally, retail clients may not be satisfied with the money they will receive from the brokerages and may continue to pursue their cases. Many retail investors who were unable to access their money lost opportunities such as buying a home or paying bills for children's education. They may have received penalties for late payments on taxes, and accumulated attorney fees. These investors may proceed with their cases.

There might be fewer cases because some clients will be satisfied with the amount they recoup, said Zamansky, "but others will definitely go forward." Zamansky said the cases still hold merit, as "there was clear evidence of fraud" on the part of the banks. The banks have denied any fraud, saying the collapse of the market was unprecedented.

An example of an unwillingness to back down comes from Massachusetts Secretary of the Commonwealth William Galvin, who said Friday in a CNBC interview that his office would pursue "a better solution" by continuing a civil fraud case against Merrill Lynch, despite its intention to buy back the securities.

On Thursday, FINRA announced it established a special process for resolving the ARS claims in its arbitration forum. Eligible investors will be able to have their claims heard by a three-person panel of arbitrators who will solely handle ARS cases. The process, which was developed by FINRA, is a result of Citigroup's settlement with the Securities and Exchange Commission.

Georgia declares 'state of war' over South Ossetia
Georgia today declared itself at war as invading Russian forces said they were in control of the capital of separatist South Ossetia.
The conflict spread into Georgian territory as Russian planes attacked the town of Gori, killing civilians and leaving apartment buildings in ruins. Witnesses said the South Ossetian capital, Tskhinvali, has been severely damaged by Georgian bombardment and subsequent fighting.

Moscow says the fighting has killed 1,500 people since Georgia began attacking the region on Friday and Russia responded with tanks, air raids and ground troops. The US president, George Bush, in Beijing for the Olympic games, spoke to the Russian and Georgian presidents today to urge calm as the conflict verged on all-out war.

Moscow supports South Ossetia, which has had de facto independence since 1992 after a bloody war. Many people in the region have Russian citizenship. Georgia claims it as part of its territory. Addressing a televised meeting today, the Georgian president, Mikheil Saakashvili, described the conflict as open warfare. "I have signed a decree on a state of war. Georgia is in a state of total military aggression," he said, while calling for "an immediate ceasefire".

The decree allows for the mobilisation of reservists, among other measures. Georgia says it plans to remove its entire contingent of 2,000 troops from Iraq so they can assist in South Ossetia. Saakashvili dismissed Russian casualty claims as "a lie", saying very few civilians had died.

Vladimir Boldyrev, the commander of Russian ground forces, was quoted by Tass as saying Russian troops had "fully liberated Tskhinvali from the Georgian military". Georgia, which said today it had downed 10 Russian aircraft and destroyed up to 30 tanks, maintains it is holding Tskhinvali. Witnesses in the city said they could only see Russian forces.

Russia – which has confirmed the loss of two planes – says it first sent tanks and artillery to Tskhinvali to prevent Georgian forces attacking Russian peacekeepers and civilians. Aside from the regional impact, the fighting threatens to increase tensions between Russia and the US. Georgia is a close American ally and Russia's foreign minister, Sergei Lavrov, has said the US must bear some of the blame for arming and training Georgian soldiers.

Bush, speaking before heading to watch the US women's basketball team in Beijing, said he was "deeply concerned about the situation", notably Russia's bombing inside Georgia. "The attacks are occurring in regions of Georgia far from the zone of conflict in South Ossetia," he said. "They mark a dangerous escalation in the crisis. "We call for an end to the Russian bombings."

At the United Nations last night, Russian and Georgian envoys hurled accusations at each other as a divided security council failed to agree on language calling for an end to the fighting. Holding its second emergency meeting in under 12 hours, the council broke off in a stalemate late but was to reconvene today. There are fears of full-blown war in the region, which is a crucial energy transit route in which Russia and the west are vying for influence.

Adding to Georgia's concerns, officials in another breakaway province, Abkhazia, said today that separatist forces had launched air and artillery strikes to drive Georgian troops out. Sergei Shamba, the region's foreign minister, said Abkhazian forces intended to oust Georgian forces from the Kodori Gorge. The northern part of the gorge is the only area of Abkhazia that has remained under Georgian government control.

Russian President Dmitry Medvedev says Georgia must pull out of South Ossetia

A pullout of Georgian troops from the conflict zone is the only solution to the South Ossetian crisis, Russian President Dmitry Medvedev has told US President George W Bush. Bush earlier today had urged Moscow to halt the bombing immediately saying attacks by Russia outside the war zone of South Ossetia marked a "dangerous escalation" of the crisis.

"I'm deeply concerned about the situation in Georgia," Bush said from the Beijing Olympics. "The attacks are occurring in regions of Georgia far from the zone of conflict in South Ossetia. They mark a dangerous escalation in the crisis." He said Georgia's territorial integrity must be respected and "we call for an end to the Russian bombings".

Meanwhile, Georgia’s president Mikail Saakashvili has called for an immediate ceasefire claiming that Russia had launched a full-scale military invasion on his country, widening its offensive to force back Georgian troops seeking control over South Ossetia.

Georgia's parliament today approved a state of war across the ex-Soviet country, which Saakashvili decreed would be valid for 15 days. Russia's ambassador to NATO Dmitry Rogozin said that what was happening in Georgia's breakaway region could only be seen as "ethic cleansing and genocide".

Moscow sent hundreds of troops and armed convoys across the border and threatened to bomb Georgian military bases after Georgia, a staunch American ally, launched an offensive on Friday to regain control of South Ossetia. Russia, which has close ties to the province and posts peacekeepers there, has reacted firmly.

Russian forces have fought against Georgian soldiers alongside separatists in South Ossetia and Russian jets have bombed military and civilian targets in Georgia, including attacks on the Georgian town of Gori. Russian Foreign Minister Sergei Lavrov told reporters that the violence had already claimed the lives of 1,500 people.

Witnesses said hundreds of civilians had probably been killed and that most of the capital Tskhinvali was in ruins. Saakashvili claimed 30 Georgians have died in the fighting. Lavrov laid blame on the United States for supporting and training Georgian military forces.

Russian President Dmitry Medvedev has claimed the troops sent into South Ossetia were on a peacekeeping mission and were there to force Georgia into a ceasefire. Georgia claims to have shot down 10 Russian planes during the fighting. Deputy Chief of the General Staff Colonel General Anatoly Nogovitsyn, confirmed that two Russian planes were shot down during the fighting.

There have been worldwide calls for an end to the fighting. US Secretary of State Condoleezza Rice urged Russia to halt aircraft and missile attacks and withdraw its forces from Georgian territory. Rice said in a statement that the US wants Russia to respect Georgian sovereignty and agree to negotiations. The fighting is the worst outbreak of violence in the region since 1992.

Fannie Mae fears for future after posting $2.3 billion loss
America's largest mortgage finance company, Fannie Mae, slumped to a quarterly loss of $2.3bn (£1.2bn) after the housing market came down "fast and hard" prompting huge liabilities as borrowers defaulted on home loans.

Outlining the extent of its exposure to the downturn, Fannie Mae revealed that it set aside $5.3bn to cover credit losses over the three months to June. In figures released just weeks after the US government legislated for a possible support package, the company admitted it could not be sure it would satisfy statutory capital requirements next year.

"The housing market has returned to earth fast and hard," said Fannie Mae's chief executive, Daniel Mudd. "In the markets, conditions which many of us had already described as the worst in a generation took a turn for worse." Fears rippling along Wall Street last month generated headlines about the stability of Fannie Mae and Freddie Mac, the two main guarantors of mortgages in the US.

The two companies, which purchase loans from high street lenders and package them for investors in the debt markets, stand behind more than $5trillion of home loans. Mudd said the week of July 7, when alarm bells began to ring, was "one of the worst Fannie Mae has experienced on the debt and equity markets" in the company's 70-year history.

"It's been three months since our last [earnings] filing," said Mudd. "It seems even longer." To cope with the fallout, Fannie is cutting its operating costs by 10%, increasing its guaranty fees, slashing its dividend payout to shareholders by 85% and changing its guidelines to filter out high-risk loans.

Economists worry that a collapse of either Fannie or Freddie could cause turmoil throughout the financial system by effectively closing down a large chunk of the mortgage industry. The two companies were established with a mission to broaden US home ownership by making loans more affordable.

Fannie's capital balance of $47bn is $9.4bn above a minimum level set by regulators. But the company said volatile conditions meant it had "less visibility" of its likely position in 2009 and was preparing scenarios for breaching requirements as well as conforming to them.

Paul Miller, an analyst at Friedman, Billings, Ramsay & Co, told Bloomberg News the figures increased the probability of the government stepping in to bail out either Fannie or Freddie. "Neither of these companies have properly provisioned for what we're heading into. This thing is going to get worse and last longer and deeper than they originally thought," he said.

Fannie Mae admits it may need fresh capital
The possibility of a US government takeover of Fannie Mae, the mortgage finance giant, moved a step closer yesterday after the company said it may not have enough capital to make it through next year.

The company plunged to a larger-than-expected $2.3bn loss in the three months to the end of June, as American homeowners defaulted on their mortgages in record numbers.

Fannie and its fellow mortgage backer Freddie Mac together own or guarantee about half of all outstanding US mortgages, worth a total of $5.2 trillion, but a collapse in house prices has wiped billions from the value of the underlying collateral.

Fannie yesterday said it would open offices in Florida and California, two of the worst affected areas, because it had taken over so many foreclosed homes in these areas.

The company said it saw no let-up to the problems in the housing market and in the global credit markets, where it has a big portfolio of investments that have also declined in value. In fact, things had got worse in July, and the company said it would slash its dividend by 85 per cent to preserve cash.

"We have already undertaken a series of initiatives, including raising more than $7bn in additional capital in the second quarter, to help us manage through the most difficult US housing market in more than 70 years," said Daniel Mudd, Fannie's chief executive, but he added that there was considerable uncertainty about the outlook for 2009.

On some of its internal projections, Mr Mudd said, Fannie's capital cushion could be wiped out by additional losses in 2009. That would require it to raise additional funds. Fannie shares slipped 8 per cent in morning trading in New York as shareholders feared they could be wiped out by any rescue fundraising.

The US Treasury has said it would do whatever it takes to ensure that Fannie and Freddie do not fail, including injecting taxpayers' money in return for new shares, which could give the federal government de facto control of the companies.

Fannie Mae, Battling Losses, to End Alt-A Mortgages
Fannie Mae, the largest U.S. mortgage finance company, will stop buying and guaranteeing Alt-A mortgages because of surging losses from home loans to borrowers without proof of their finances.

Fannie won't accept new Alt-A loans after Dec. 31, according to a statement today. The mortgages, which make up about 11 percent of the $3 trillion financed by the Washington-based company, accounted for almost half of second-quarter credit losses, Chief Financial Officer Stephen Swad said today on a conference call.

The debt, generally considered between prime and subprime in terms of expected defaults, has "driven our credit expenses," Chief Executive Officer Daniel Mudd said on the call. "Alt-A foreclosures have doubled in southern California."
Government-chartered Fannie and Freddie Mac have been tightening standards and raising fees since last year to boost revenue and limit losses amid the worst housing slump since the 1930s.

Their changes, along with pullbacks in other sources of home financing and the rising yields over benchmarks being demanded on even the safest mortgage securities, have made borrowing harder or more expensive for consumers, contributing to deeper drops in property prices and surging foreclosures.

Fannie today reported its fourth straight quarterly loss. After the $2.3 billion loss, which included $5.3 billion in credit-related expenses, the company is also ramping up efforts to force lenders to repurchase defaulted Alt-A loans, Mudd said. The shares fell 90 cents, or 9.1 percent, to $9.05 in composite trading on the New York Stock Exchange, bringing the one-year decline to 86 percent.

Defaults may rise among borrowers in places such as California and Florida facing potentially higher monthly bills on adjustable-rate mortgages or other loans with only a few years of fixed payments because of Fannie's retreat from Alt-A business, said Dan Nigro, who helps oversee $5 billion as a bond portfolio manager at New York-based Dynamic Credit Partners.

"Many of these guys did ‘stated income' loans where they overstated their incomes, so they're going to find it hard to refinance," Nigro said in an interview. "You can't have a bottom in this cycle until you have credit."

Fannie owned or guaranteed $3 trillion in residential mortgages as of June 30. Changes over recent months have cut the company's Alt-A business by 80 percent, the company said. Earlier this week, Fannie said it will double the "adverse market delivery charge" it introduced in March for all mortgages that it helps finance, to 0.50 percentage point on Oct. 1.

The company also boosted fees on other loans. The increase in mortgage rates on Fannie loans from those adjustments will range between 0.06 percentage point and 0.18 percentage point, according to Barclays Capital. McLean, Virginia-based Freddie, which reported an $821 million quarterly loss two days ago, said that Alt-A mortgages were the biggest reason for a surge in its foreclosure losses.

The delinquency rate for the $190 billion of the loans owned by Freddie or underlying the bonds the company guarantees jumped to 3.7 percent on June 30, from 1.8 percent on Dec. 31.

Definitions of Alt-A lending vary. Fannie has said in securities filings that the Alt-A category "generally refers to a loan that can be underwritten with reduced or alternative documentation but that may also include other alternative product features."

UK mortgage lenders lose patience as repossessions jump
Mortgage lenders are more impatient with borrowers struggling to pay their interest bills than ever before, it has emerged.

Figures from the Council of Mortgage Lenders show that not only has the number of repossessions in the first half of the year risen by 50pc compared with last year, but the speed with which lenders are seizing properties is at the highest level since comparable records began in 1982.

Someone who has been in arrears for six to 12 months is almost twice as likely to face repossession now as was the case in the early 1990s, the figures show. The ratio of households in arrears to actual repossessions, around 20pc for most of the past two decades, has risen to 38pc in the first half of the years.

The rise in this "intolerance threshold" indicates the pressure felt by banks to shore up their balance sheets in the face of the sharpest housing slump since the early 1990s. Northern Rock recently introduced a "policy of rapid movement towards recovery where it is clear the borrower will not maintain payments and we have higher risk".

The CML said repossessions rose to 18,900 in the first half of the year, taking the rate of repossessions to 0.16pc - the highest in a decade.

British bailiffs could have your keys in three months
Here is a step-by-step guide to the repossession process:

Written warning : When you miss payments, your lender will ask you to pay back the arrears. If you do not, it should write to you, warning that it will apply to your local county court for a possession order. They are under no legal obligation to write before starting court action.

Court summons : If you do not respond to your lender's written warning, it will apply for a possession order and must provide evidence of the arrears. Provided it can do this, the court will issue a summons informing you of a hearing. This must be no less than 28 days from the issue of the summons and tends not to be delayed much longer.

Hearing : At the hearing, the judge will hear evidence from you and your lender or freeholder before making a decision. The court may adjourn the case, strike it out or - quite likely - allow you to stay in the property provided you keep to conditions, such as repaying in instalments. Otherwise it may give you time to sell, or decide that you should be evicted.

The court order : If the judge decides on repossession, the court order will set a date for you to leave. This can be no less than 14 days after the hearing - and is typically around six weeks after it.

The bailiffs : If you have not left by that date, your lender must apply to the court for a bailiff's warrant. The bailiffs will write to tell you when the eviction is to take place, and when they come, they can remove you from your home. A warrant takes between 14 and 28 days to be issued. Some lenders apply for the warrant straight after the hearing.

Afterwards : Once your lender has sold the property, it will take what it is owed from the proceeds, along with any fees. If money from the sale is not enough to repay what you owe, your lender will bill you for the shortfall and may go to court to force you to pay.

Parabolic Moves, Bubbles and the End Result
In the chart below I have included a weekly chart of the Nasdaq 100.  Beginning at the 4-year cycle low that occurred in October 1998, we can see that price rose sharply in February 1999.  In fact, in that 4-month period this index moved from a low of 1,063.74 up to 2,150.83. 

This was a 102% advance in only 4 months.   As we moved into October of 1999 this advance was much more orderly, but still managed to advance another 400 points during this time period and in doing so the Nasdaq 100 had advanced 143% in a mere 12 months.  As this move received more and more attention more and more people jumped on the bandwagon with the hottest tech stock. 

As a result, a bubble began to form.  From the October low at 2,299.95 the Nasdaq then advanced another 2,516. 39 points over the next 5 months.  It was at this point that the advance went parabolic and in some 17 months the Nasdaq 100 had altogether advanced from the 1998 4-year cycle low at 1,063.74 into the March 2000 high at 4,816.34 for a total advance of 352.77%.   From that high the Nasdaq 100 fell back to 795.25, which totally erased the entire move up from the 1998 4-year cycle low in which the dot-com bubble began and I still remember people talking about the tech stocks and why tech was back at the 2002 bottom.  To date the Nasdaq 100 is still off of its high by some 60%.




In another example of bubble mania I want to show you a weekly chart of the Shanghai Index.   We all know what’s been going on in China and the extreme growth that they have experienced over the last few years.  As the general population began to hear about China’s growth, investors flocked to their stock markets at record pace. 

I remember being at an investor conference last year and virtually everyone was talking about China.  If something was rising, then it was because of China.   I knew then that this was a sign of a bubble, especially given the parabolic advance that was underway.   But of course, no one could see that because “this time was different” and I pretty well left the subject alone. I was busy enough trying to convince my subscribers that our own equity markets were still making their 4-year cycle top.  

Anyway, this time turned out not to be so different after all.  From the 2005 low the Shanghai Index advanced from 998.23 into its 2007 peak of 6,124.04, which equates to an advance of 513.49%.   This is yet another example of how a parabolic advance unfolds.  These moves begin as normal advances out normal cyclical bottoms.  But, if an advance is strong enough to begin to attract a lot of attention, then at that point the herds begin to pile on board.  It is then this massive inflow of speculation that launches a move into a parabolic state. 

A parabolic advance will continue as long as there is an inflow of money to keep the move going.  But, then at some point the inflow of funds begins to fade and when it does gravity sets in.  It is at that point that price begins to soften.  As price begins to soften the smarter money begins to exit and prices begin to soften more.  In the end all parabolic advances end pretty much the same and the late comers to the party are typically left holding the bag.   To date, the Shanghai Index is down some 55% off of its top.

Next I want to show you what may be the biggest bubble of the last 34 years and I bet that only 1 in 1,000 people, or less, even know about it.   Below I have included a monthly chart of sugar for the period between 1967 and 1978.  At the low in September of 1968 sugar was selling for 1.31 cents per pound.  By January 1971 sugar had advanced to 5.32 cents a pound.  This was a 306% advance over a 28 month period.  

By December 1973 sugar prices had advanced to 13.53 per pound, which accounted for a 932.82% advance from the 1968 lows.   But, there was still more in this case as this is the point in which the parabolic price spike began and sugar finally peaked at 66 cents a pound in November 1974.  This bubble had then advanced 4,938%. 


But wait, at the time this was not viewed as a bubble.  There were “reasons” to justify such advance.  I found an article about the rising sugar prices in the early 1970’s and I thought that you might find this quote of interest.

“By the end of 1972, there had been four straight sugar seasons with record crops. Yet consumption actually outpaced supplies in 1972, literally eating into sugar inventories over the next year. The 1973-74 sugar season began with extremely tight supply conditions worldwide; demand continued to rise.

“There was evidence that some big industry users were stockpiling sugar in anticipation of higher prices. Soon people were grabbing sugar off the shelves in armloads to offset rising prices. Others were grabbing cubes off restaurant tables for home use. Dinner guests were arriving with five-pound bags of sugar instead of the traditional bottle of wine or bouquet of flowers.

Even people who had never given the sugar futures markets a moment's thought knew something was up when they walked into the local coffee shop and noticed that the sugar had vanished from the table. Quite simply, global demand for sugar had exceeded supply, and before long the price of sugar headed for the roof. 

“Everyone had a theory for the high prices. Sugar traders had no idea where prices might be when the US's long-standing price supports expired at the end of 1974; some blamed the high prices on a ‘scarcity of cheap labour to harvest sugarcane’; others pointed to the failure of the European sugar-beet crop. Others even suspected that both the Soviet Union, which had just suffered two bad production years in a row in its own sugar crop, and ‘Arab oil money’ (remember that oil crisis of the 1970s?) had moved into the sugar futures markets, along with a rise in speculation by others looking to make money from rising prices.”

Guys, does this not sound familiar?  Given the short fall of sugar inventories, increasing demand and a growing world of consumers, cheap sugar was a thing of the past.  It was a new paradigm. Yes, it was “Peak Sugar” and the world would never be the same again. For the most part if we replace the word sugar with the word oil in the above article it sounds like today.   As you can see on this sugar chart, by 1977 sugar had dropped back down to just over 6 cents and by 1985 sugar prices had dropped to 2.3 cents per pound.   Sugar has since recovered some, but even in this inflationary cycle sugar is still only trading at 14 cents a pound.   

Now I want to show you a weekly chart of crude oil, which can be found below. 

Many of you may not remember, but in December 1998 crude oil touched $10.35 per barrel.   I remember buying gasoline in December of 1998 in Texas for 68 cents a gallon.  Between 1999 and 2001 there were major longer-term cycles bottoming in most every commodity.  As price began to advance out of these naturally occurring cyclical lows no one gave too much thought to them. 

But, as price began to move up, commodities drew more and more attention.  This in turn drove prices higher and higher and higher.  Since we moved into 2008 the advance in crude oil become parabolic and has recently hit an all time high of $147.27.  As prices advanced, just as with sugar, people began to say that it was for this reason and that. 

Some say that it’s because of the weak dollar.  If that’s the case then why is it that oil was trading in the 14 to 20 dollar range between 1992 and 1995 when the dollar was trading in the low 80’s, which is less than 10% from where it is now?   Others say that it’s “Peak Oil.”   I’ll be honest here.  I simply do not buy the argument that Peak Oil is the sole reason oil prices have now advanced 1,281%. 

Now, this is not to say that long-term supply is not a factor, but in my opinion and based on the data that I have at hand, the real demand for oil has not changed so drastically over the last 9½ years to justify this sort of a move.   This advance in oil began like any other advance.  Sure, there may be some long-term supply issues just as there was with sugar in the early 1970’s. 

But, as this advance in oil has unfolded, it drew attention because of the stories of Peak Oil and China and so on.  As a result, people began to jump on the hottest trend and the normal advance was transformed into a parabolic mania.   I wrote about these parabolic moves here in both the June 27th and the July 25th WrapUps.

Since the break down from the July high, crude oil has declined some 20% and in doing so it has become oversold on an intermediate-term basis.  This in turn makes conditions ripe for a bounce and a retest of the recent highs. 

If you will look back at both the Nasdaq and the Shanghai charts, above, you will see that following the initial break out of these parabolic advances there was a bounce and in both cases that bounce failed to take price back above its high.  In doing so, a failed rally occurred and it was then, with this next leg down, that the parabolic advance really came unraveled.  

In the case of sugar, there simply was no bounce.     Point being, the current intermediate-term oversold conditions now make a bounce in oil very possible.  But, if such a bounce does in fact take root and if it fails to better the July high, then at that time even lower prices should soon follow. 


el pollo said...

Got this quote from a blog commenter in Mish yesterday. Really interesting. Critical comments?

"...When central banks intervene in the currency markets, they exchange their currency for dollars. Central banks then use the dollars they acquire to buy US government debt instruments so that they can earn interest on their money. The debt instruments central banks acquire are held in custody for them at the Federal Reserve, which reports this amount weekly.

On July 16, 2008 (the closest date of the weekly reports to the July 15th low in the Dollar Index), the Federal Reserve reported holding $2,349 billion of US government paper in custody for central banks. In its report released today, this amount had grown over the past three weeks to $2,401 billion, a 38.4% annual rate of growth. To put this phenomenally high growth rate into perspective, for the twelve months ending this past July 16th, assets in the Federal Reserve's custody account grew by 17.3%, which is less than one-half the growth rate experienced over the past three weeks.

So central banks were accumulating dollars over the past three weeks at a rate far above what one would expect as a result of the US trade deficit. The logical conclusion is that they were intervening in currency markets. They were buying dollars for the purpose of propping it up, to keep the dollar from falling off the edge of the cliff and doing so ignited a short covering rally, which is not too difficult to do given the leverage employed in the markets these days by hedge funds and others. So central banks pushed in one direction and funds and traders then stepped on board. In other words, central banks ignited the fuse of a bear market rally...."

Ilargi said...

el pollo

That's an interpretation

Another one is that ECB and BoJ have said enough is enough, and now damage the US economy by buying its very paper, in an act that equals spreading the hurt.

cb said...


My mother just passed away. She paid off the mortgage years ago and put my brother and my name on the title. We are under no illusions about the housing market, and are thinking of selling the home. The last place that we want to put the money is in a bank. Don't trust the government either. Any thoughts about investing in gold or silver, and how long before it might pay off. If not in one of those commodities where can one put ones wealth? Treasuries and bonds cant be safe either. Anything that this government touches turns to dust!



el pollo said...


As usual with economics, I am not sure I understand. Do you mean that the ECB and BoJ by buying USD treasuries in excess, intensionally forced the USD upward, thus curtailing USA exports, exacerbating the slowing of the USA economy, and making their own exports more competitive? And Trichet, making more noise than an angry donkey about the slowing of the Eurozone economy, gave this an additional push. And the firming of the USD was very unpleasant to Helicopter Ben and Bazooka Hank and they were not in on the game?

chris said...

Pardon me for exposing my ignorance here once again but isn't it a natural consequence of a deflationary situation for the demand for/value of a nation's (in this case, the United States') currency to increase? Or does this not apply to relative valuations between nations' currencies?

Obviously the global currency market is much more complex than this but is it at all fair to say that a rising US dollar is a consequence of a reduction in money/credit supply?

CrystalRadio said...

Well I'll be (ji)ggered and I thought the dollar was a reflection of the GDP, and when it were seen by all, that the cost of production was reduced (with the reduction in oil price)the dollar would rise. Instead it looks from what is being said here it depends more on who is feeling antsy on the day?

Well that sounds more realistic, more like us I guess.

Anonymous said...

(response to Stoneleigh said yesterday)

Yes, I believe you're right. It means nothing that USD is rising and DJIA ends in green more often.

It's a while before the next step of cascade will begin. It's a silence before the storm, I think.

The US farmer just sold the next tractor and he's just standing in front of his gate and showing that his pockets are full of money. But they are full just because he just sold the next piece of his equipment. And he forgot that he will need more time to do his work without that fine machine. And it will be harder to hold his step with the concurrents. As soon as he'll spend the money from his pockets, he will sink deeper to the mud, than he was before.

And the same with US economy. When the lawmakers will give your money to save something can't be saved, or FED will print new money from nothing. It will make the things seems to be better this week, but the money will be missing elsewhere. Things will go much worser in next months that they were before.

And if they'll enter into the next war, it will be the next nail to the US Empire coffin.

Greetings from Czechia

Bigelow said...

For months Richard Russell has been saying be in CASH & buy GOLD (by cash he means 3 month Treasuries). Very recently he changed to recommending only cash and holding gold.

Anonymous said...

With the escalation of war to the use of strategic bombers and missiles,as well as the best Russia has in the way of troops,I am starting to think there may have been a lot of "miscalculation" by a whole bunch of people...Georgia is essentially suing for peace after getting a real serious bloody nose,as well as probable loss of pipeline control...big gain for Russia...bad news for Europe,now the Russians would have the oil,AND the nat. gas control...

I can once again ask the question I ask at TOD..why did those in a position to do something about it allow Bush to remain in power...


super390 said...

Trying to explain to my fellow
Americans that we're in danger of bankruptcy from multiple sources is like trying to explain to them that we're in danger of blundering into wars against Iran, Pakistan and Russia at the same time.

el pollo said...


"I can once again ask the question I ask at TOD..why did those in a position to do something about it allow Bush to remain in power..."

Because they are almost as stupid and certainly as aggressive as Bush. The evil genius theory of the shadow government is pretty much debunked. See Prof. Peter Dale Scott's recent books for details of this. It is becoming fairly obvious that Bush and Darth Cheney are planning a grand finale spectacular for their (presumably) final days in office.