Sunday, July 19, 2009

July 19 2009: Late Batch, Early Morning

National Photo Co. Good Morning! Washington, D.C., circa 1921
Walker Hill Dairy. A milk truck that was old in '21

Ilargi: I guess I needed that sleep. Without further ado, here’s Sunday's batch. Monday's will follow later. Big week ahead, or so it seems. Tons of earnings reports.

Fiscal ruin of the Western world beckons
For a glimpse of what awaits Britain, Europe, and America as budget deficits spiral to war-time levels, look at what is happening to the Irish welfare state. Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15pc of GDP.

They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous debt compound trap. A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12pc and heading for 16pc next year.
Education must be cut 8pc. Scores of rural schools must close, and 6,900 teachers must go. "The attacks outlined in this report would represent an education disaster and light a short fuse on a social timebomb", said the Teachers Union of Ireland. Nobody is spared. Social welfare payments must be cut 5pc, child benefit by 20pc. The Garda (police), already smarting from a 7pc pay cut, may have to buy their own uniforms. Hospital visits could cost £107 a day, etc, etc. "Something has to give," said Professor Colm McCarthy, the report's author. "We're borrowing €400m (£345m) a week at a penalty interest."

No doubt Ireland has been the victim of a savagely tight monetary policy e_SEmD given its specific needs. But the deeper truth is that Britain, Spain, France, Germany, Italy, the US, and Japan are in varying states of fiscal ruin, and those tipping into demographic decline (unlike young Ireland) have an underlying cancer that is even more deadly. The West cannot support its gold-plated state structures from an aging workforce and depleted tax base. As the International Monetary Fund made clear last week, Britain is lucky that markets have not yet imposed a "penalty interest" on British Gilts, given the trajectory of UK national debt – now vaulting towards 100pc of GDP – and the scandalous refusal of this Government to map out any path back to solvency.

"The UK has been getting the benefit of the doubt, both in the Government bond market and also the foreign exchange market. This benefit of the doubt is not going to last forever," said the Fund. France and Italy have been less abject, but they began with higher borrowing needs. Italy's debt is expected to reach the danger level of 120pc next year, according to leaked Treasury documents. France's debt will near 90pc next year if President Nicolas Sarkozy goes ahead with his "Grand Emprunt", a fiscal blitz masquerading as investment.

There was a case for an emergency boost last winter to cushion the blow as global industry crashed. That moment has passed. While I agree with Nomura's Richard Koo that the US, Britain, and Europe risk a deflationary slump along the lines of Japan's Lost Decade (two decades really), I am ever more wary of his calls for Keynesian spending a l'outrance.

Such policies have crippled Japan. A string of make-work stimulus plans -famously building bridges to nowhere in Hokkaido- has ensured that the day of reckoning will be worse, when it comes. The IMF says Japan's gross public debt will reach 240pc of GDP by 2014 - beyond the point of recovery for a nation with a contracting workforce. Sooner or later, Japan's bond market will blow up. Error One was to permit a bubble in the 1980s. Error Two was to wait a decade before opting for monetary "shock and awe" through quantitative easing.

The US Federal Reserve has moved faster but already seems to think the job is done. "Quantitative tightening" has begun. Its balance sheet has contracted by almost $200bn (£122bn) from the peak. The M2 money supply has stagnated since January. The Fed is talking of "exit strategies". Is this a replay of mid-2008 when the Fed lost its nerve, bristling over criticism that it had cut rates too low (then 2pc)? Remember what happened. Fed hawks in Dallas, St Louis, and Atlanta talked of rate rises. That had consequences. Markets tightened in anticipation, and arguably triggered the collapse of Lehman Brothers, AIG, Fannie and Freddie that Autumn.

The Fed's doctrine – New Keynesian Synthesis – has let it down time and again in this long saga, and there is scant evidence that Fed officials recognise the fact. As for the European Central Bank, it has let private loan growth contract this summer. The imperative for the debt-bloated West is to cut spending systematically for year after year, off-setting the deflationary effect with monetary stimulus. This is the only mix that can save us. My awful fear is that we will do exactly the opposite, incubating yet another crisis this autumn, to which we will respond with yet further spending. This is the road to ruin.

7 Reasons Why Housing Isn’t Bottoming Yet
by Barry Ritholtz

Yesterday, I posted this chart and wondered why “Some people were calling for a housing bottom.” That generated a ton of emails asking about for further clarification.

The people I referred to were the usual happy talk TV suspects (and Cramer) who have been perpetually wrong about Housing for nigh about 3 years. I not only disagree with them, but don’t respect their opinion — essentially headline reading gut instinct big-money-losers. No thanks.

Then there were the slew of MSM who insist each month on reporting that 3% (+/- 11%) is a positive integer. We disposed of that silliness on Friday.

But the crux of the email was over this post. There are a handful of people whom I disagree with, but nonetheless have a great deal of respect for their methodology and process. Over the past year, these have included Doug Kass and Lakshman Achuthan and Bill of Calculated Risk. We may reach different conclusions about a given issue, or disagree on timing, but these are the folks whose opinions force me to sharpen my own.

When I tossed up that chart yesterday,  I had not yet seen Bill’s comments on the subject — but he is one of those people I can respectfully disagree with. We simply have reached different conclusions about the timing and shape of the eventual Housing lows.

There are a plethora of reasons why I believe we are nowhere near a bottom in Housing prices or activity. Here are a few:

Prices: By just about every measure, Home prices on a national basis remain elevated. They are now far off their highs, but are still remain about ~15% above their historic metrics. I expect prices will continue lower for the next 2-4 quarters, if not longer, and won’t see widespread Real increases for many years after that; Indeed, I don’t expect to see nominal increases for anytime soon;

Mean Reversion: As prices revert back towards historical means, there is the very high probability that they will careen past the median. This is the pattern we see after extended periods of mispricing. Nearly all overpriced asset classes revert not merely to their historic trend line, but typically collapse far below them. I have no reason to believe Housing will be any different;

Employment & Wages: The rate of Unemployment is very likely to continue to rise for the next 4-8 quarters, if not longer. This removes an increasing number of people from the total pool of potential home buyers. There is another issue — Wages, and they have been flat for the past decade (negative in Real terms), crimping the potential for families to trade up to larger houses — a big source of Real Estate activity.  Plus, more unemployment means more . . .

Foreclosures: We likely have not seen the peak in defaults, delinquencies and foreclosures. Many more foreclosures — which are healthy in the long run but wrenching during the process of dislocation — are very likely.  These will pressure prices yet lower. And Loan Mods are not working — they are redefaulting in less than a year  between 50-80%, depending upon the mod conditions themselves.

Inventory: There is a substantial supply of “Shadow Inventory” out there which will postpone a recovery in Home prices for a significant period of time. These are the flippers, speculators, builders and financers that are sitting with properties that they do not want to bring back to market yet. Given the extent of the speculative activity during the boom years (2002-06), and the number of foreclosures so far, my back of the envelope estimates are there are anywhere from 1.5 million to as many as 3 million additional homes that could come to market if prices were more advantageous.

Psychology: The investing and home owning public are shell shocked following the twin market crashes and the Housing collapse. First the dot com collapse (2000-03) saw the Nasdaq drop about 80%, then the Credit Crisis of 2008 saw the unprecedented near halving of the market in about a year. Last, Homes nationally have lost about a third of their value since the 2005-06 peak. Total losses to the family balance sheet of these three events are about $25 trillion dollars. These losses not only crimp the ability to make bigger purchases, it dramatically curtails the willingness to take on more debt and leverage. Speaking of which . ..

Debt Service/Down Payment:  Far too many Americans do not have 20% to put down on a home, have poor credit scores, and way too much debt. All of these things act as an impediment to buying a home. At the same time, to get approved for a mortgage, banks are tightening standards, including 1) requiring higher Loan to Values for purchases; 2) better credit scores to get approved for a mortgages; 3) Lower levels of overall debt servicing relative to income for applicants. Yes, the NAR Home Affordability Index shows houses as “more affordable,” but it conveniently ignores these real world factors.

Deleveraging: For the first time in decades, the American consumer is in the process of saving money and deleveraging their balance sheets. After a 40 year credit binge, its long overdue. The process is likely to go on for years, as a new generation is losing confidence in the stock market, Corporate America and their government. Think back to the post-Depression generation that were big savers, modest consumers, who eschewed credit and borrowing.  The damage is going to take a while to repair.

There are more reasons I expect the Real Estate market to remain punk for many years, but these are a good place to start when considering the question.

The Housing Boom & Bust, and the 2002-07 credit bubble created massive excesses. More than anything, it is going to take time to resolve them.

TARP Inspector Urges Treasury to Track Banks’ Aid More Closely
Treasury Secretary Timothy Geithner should press banks for more information on how they use the more than $200 billion the government has pumped into U.S. financial institutions, according to a new oversight report. When queried, banks are able to explain where the money goes in their businesses, said the report from Neil Barofsky, special inspector general of the Troubled Asset Relief Program, which covers a survey of the banks collected in March.

Barofsky’s survey collected information from 360 banks that have received TARP capital, including Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co. The responses, which the inspector general said it didn’t verify independently, showed that 83 percent of banks used TARP money for lending, while 43 percent used funds to add to their capital cushion and 31 percent made new investments. Existing Treasury surveys of TARP banks’ lending don’t show enough about what the banks are up to, said the report by the independent inspector general, which is scheduled for public release tomorrow.

The Treasury’s approach “fails to recognize that TARP recipients do far more with their TARP funds than simply originating loans: They have also used these funds in a broader array of interrelated activities, as demonstrated in this audit, such as making investments, acquiring other financial institutions and simply maintaining the capital as a cushion against future losses,” the report said. The Treasury questioned whether the report’s findings had broad implications for overseeing the TARP program, in an official response to the report that noted most banks don’t manage their TARP money separately from other funds.

“We think caution should be exercised in drawing conditions from this data,” said Herb Allison, the Treasury’s assistant secretary for financial stability. “Although it might be tempting to do so, it is not possible to say that investment of TARP dollars resulted in particular loans, investments or other activities by the recipient.” The report doesn’t include the responses from individual banks. The inspector general’s office said it is reviewing the responses for proprietary information and expects to post the banks’ answers by mid-August.

In China, Credit Glut Props Up Growth, Sowing Seeds of Trouble Down the Road
China’s GDP grew by 7.9% in the second quarter, buoyed by “extremely loose” monetary policy that has boosted investment growth to uncomfortably high levels. The economic growth promoted by investment alone looks likely to add to both imbalances in internal demand and pressures for economic adjustment in the future. A glut of cash is producing bubbles in the Chinese economy. The racing credit growth and the low costs for wholesale financing are leading to financing abuses and production surpluses in the real economy.

Even lower than usual interest rates have residents transferring their asset preference from bank deposits to the capital market, promoting frothy asset prices. Increasing real estate prices comprise the main bubble, but without high land prices, local governments cannot come up with the cash needed to fund the economic stimulus package. So, the central government allows the bubbles to inflate. On July 16, the National Bureau of Statistics released second quarter and first half figures for the year, according to which real GDP in the second quarter grew 7.9%, 1.8 percentage points higher than in the first quarter, and in the first half by 7.1%, year on year.

Many analysts see China’s economy rebounding strongly, but the figures from the real economy do not support this judgment. In the first five months of this year, the profit of industrial enterprises above designated scale totaled only 850.2 billion yuan, down 22.9%, year on year. Of that total, state-owned and state-controlled enterprise profits totaled only 246.7 billion yuan, off 41.5%. During the same period, value-added of nationwide industrial enterprises above designated scale grew only 6.3% year on year, while the growth in the same period last year was 16.3%.

Rapid GDP growth is still being boosted by fixed asset investment promoted by the loose credit policy. In the first half of 2009, fixed asset investment grew 33.5%, year on year, in urban areas by 33.6%. In railway and transportation, road transportation, and water facilities, environment, and public facilities management, fixed asset investment grew 126.5%, 54.7%, and 54.5%, respectively.
Negative growth in the trade surplus has had a negative influence on economic growth. According to earlier statistics, in June it dropped over 60%, year on year, pulling down the growth of trade surplus, which in the first half of the year stood at $96.94 billion, down 1.3%. The trade surplus grew 50.8% in the first quarter of the year, but dropped 40.3% in the second quarter.

In July, total value-added of enterprises above designated enterprise grew 10.7% year on year. This growth is apparently accelerating. However, that of state-owned and state-controlled enterprises and foreign invested enterprises grew only 1.7% and 1.2%, respectively, meaning domestic non-state-owned enterprises were making the main contribution. Although power consumption and tax revenue both saw positive growth in June, the dispute on whether industrial value-added has been overestimated will continue.

CPI has seen negative growth for five straight months and dropped 1.7% in June to a new recent low. PPI has also seen negative growth for seven straight months, and dropped 7.8% in June to a new low. As the liquidity surplus will not lead immediately to inflation, unseemly CPI growth is unlikely to occur in the second half of this year, and inflation is mainly restricted to assets prices. Housing prices in 70 major cities grew 0.2% year on year in June. If CPI is still controllable, then even if decision makers view assets price bubbles with increasing concern, they may make only slight adjustments to monetary policy.

Loan figures for June released by the central bank show new lending of financial firms reached 1.5304 trillion yuan, and deposits grew by 2.0022 trillion yuan over the previous month. Bank lending in the first half of 2009 reached 7.37 trillion yuan, while the total credit growth in 2007 was 3.6 trillion yuan, and in 2008 4.9 trillion yuan. As 2007 and 2008 GDP grew 11.4% and 9%, respectively, then with the nearly 7.4 trillion yuan of credit GDP growth in the first half of this year should be over 15%.

Without efficient demand, China’s too rapid credit growth puts great pressure on the fiscal and monetary policies. Lu Lei, an economist, comments, “Why do we need these investments? If the government hopes to increase resident’s disposable income, it can transfer these investments into fiscal subsidy. And if it aims to increase employment, it should adjust the economic structure, especially focusing on increasing the income of hundreds of millions of farmers, instead of reinforcing the existing structure. If the government can’t stand the temporary economic growth decline and allocate financial resources to structure adjustment, China’s road to economic rebound will be tougher and tougher.”

JPMorgan, Goldman Sachs Profit Surge is an Accounting Mirage, Not a Sustainable Sector Trend
It takes more than two to make a trend. JPMorgan Chase & Co. [this week] became the second major U.S. investment bank – following Goldman Sachs Group Inc. – to this week report windfall profits for the second-quarter. That’s helped fuel a four-day advance in U.S. stocks that’s seen the Dow Jones Industrial Average surge 7%. Unfortunately, these two decidedly positive developments don’t necessarily indicate that better days have arrived for the U.S. banking sector.

To the contrary, many analysts – including Money Morning Investment Director Keith Fitz-Gerald – say these profits are merely a mirage created by an obscure accounting rule that allows banks to transform “toxic debt” on their balance sheets into income. JPMorgan, the second-largest U.S. bank, said that that second-quarter profits were $2.7 billion, a jump of 36% from a year ago and 27% from the previous quarter. A $1.1 billion, one-time reduction that resulted from the decision to repay $25 billion in Troubled Asset Relief Program (TARP) funds was offset by strong gains at the firm’s investment banking division.

Profit at JPMorgan’s investment banking division more than tripled as a result of record investment-banking fees and the strong performance in the fixed-income market. The investment-banking operations generated $1.47 billion of profit, almost quadruple the amount earned in last year’s second quarter. Investment-banking fees – which zoomed 29% from a year ago and 62% from the first quarter – totaled $2.2 billion, and were a "record for any investment bank in any quarter," according to JPMorgan Chief Financial Officer Michael J. Cavanagh.

JPMorgan’s earnings in the first half of 2009 grew 11% to $4.86 billion, or 68 cents a share, from $4.38 billion, or $1.20 a share, in the first six months of 2008. Revenue jumped 43%, reaching $50.6 billion, from $35.3 billion last year. JPMorgan’s announcement follows an equally impressive earnings report by rival Goldman Sachs, the largest investment bank in the country. Goldman said Tuesday that its revenue in the three months ended June 26 was $13.8 billion, compared with $9.43 billion in the first quarter and $9.42 billion in the second quarter a year earlier. Net income rose to $3.44 billion, or $4.93 a share.

Still, despite these banks’ stellar results, analysts are hesitant to say that the U.S. financial sector has bottomed, meaning that a rebound is under way. Fitz-Gerald said last month that large investment banks like Goldman Sachs and JPMorgan would almost certainly generate record profits in the first half of the year as a result of less competition, favorable interest rates, and relaxed accounting standards. Indeed, the Financial Accounting Standards Board has made it possible for the biggest U.S. banks to book profits on loans that have not been fully repaid.

“Called ‘accretable yield,’ these mega banks will book income on loans that have ‘reduced credit quality’ by recognizing the value of the bonds on their balance sheets and the cash flow those securities are expected to earn,” Fitz-Gerald said. “Please understand, we’re not talking about cash that’s already been earned, and not cash in the bank … we’re talking about cash flow those banks are expected to earn.”

In JPMorgan’s case, the firm took on $118.2 billion in toxic debt when it acquired Washington Mutual Inc. last year. As a receiver of that debt, JPMorgan was allowed to mark that debt down to “fair value,” or  $88.65 billion. But now, the bank says that those same debts may appreciate by some $29.1 billion over the life of the loans. And as those loans are paid back, that money is booked as profit. Of course, this distorts banks’ earnings and camouflages the deterioration in other banking segments.

For instance, consumer-loan losses continued to rise, as did losses on businesses loans.  Retail banking earnings of $15 million were down sharply from earnings of  $474 million in the first quarter, and $503 million in the second quarter of 2008. The consumer lending division reported a net loss of $955 million, compared with a net loss of $171 million in the prior year and $389 million in the prior quarter.

Home equity charge-offs jumped 4.61% to $1.3 billion. The bank warned that prime mortgage losses may be $600 million “over the next several quarters,” and that subprime losses may be $500 million. Credit cards lost $672 million, compared to income of $250 million in the second-quarter last year. The bank warned that losses in its Chase credit-card portfolio may be 10% next quarter and will be “highly dependent” on unemployment after that. The unemployment rate rose to 9.5% in June, its highest level in two decades.

The managed charge-off rate, which generally tracks unemployment, climbed to 10.03% from 7.72% in the first quarter and 4.98% in the year-earlier period. “For JPMorgan Chase, the challenge going forward is going to continue to be deterioration of credit,” Gerard Cassidy, a banking analyst at RBC Capital Markets, said in a Bloomberg Radio interview

Reborn masters of the universe
Nine months ago, investment banks were left for dead, devastated by a global financial crisis so deep that only intervention by government prevented a complete meltdown. A business model that depended on aggressive lending and risk-taking was seen as one of the reasons that precipitated a slump that has put millions out of work. Following the collapse of Lehman Brothers, the former "masters of the universe" of Wall Street and the City were on the defensive: lambasted in the media, vilified by politicians, their top executives carpeted for paying themselves sky-high bonuses, their boards criticised for ineptitude and greed.

Now, it seems that they are making a comeback. Barclays Capital has gone on a hiring spree, Credit Suisse is making a tidy sum and JP Morgan reported a strong performance on Thursday. Goldman Sachs is on course to pay its staff a record $20bn (£12bn) in pay and bonuses after reporting a surge in second-quarter profits. Outsiders are bemused at how some investment banks are making so much money in the teeth of almost unprecedented global economic turmoil. But David Williams at broker FPK says: "If you have adequate capital, good risk controls and you haven't been knocked senseless by the credit crunch, then you are in an excellent position to go and chase business."

Not all are doing well, of course, with institutions such as UBS and Citigroup still struggling to stay afloat. But the winners, such as Goldman, are defying expectations. And while people are reluctant to speak of green shoots, fearful of granting a hostage to fortune, Doug McWilliams at the Centre for Economic and Business Research, one of the UK's leading commercial economic thinktanks, says that "signs of life in the financial sector could be interpreted as a forward indicator of recovery in the real economy". For evidence of what is going on, you need to scratch beneath the surface of the figures produced by Goldman last week to discover more precisely what areas of investment banking business are doing well, and why.

The debt issuance market, for instance, is exploding, with volumes well up on a year ago. Rather than battling to secure bank loans from institutions that have been poleaxed by the credit crunch, large companies are plumping for the easier option of issuing bonds to fuel expansion. Bonds are sold to City investors in much the same way as shares, in return for an annual "coupon", or dividend payment. With coupon rates as high as 5%, investors are in line for higher returns than if they simply keep the money on deposit, while at the same time they can avoid the risks associated with volatile global equity markets.

In the middle of these bond trades are the investment banks, which charge commissions at the point of sale as well as arrangement fees. As Goldman's latest figures suggest, this business has been going great guns since the turn of the year. Governments too, are using the banks to trawl for investors prepared to inject funds into fixed-income and floating-rate government bonds. These products are effectively IOUs (often referred to as gilts) that are underwritten by the state and which bankroll the yawning deficits that have been run up by countries throughout the developed the world.

"The bigger the deficits, the bigger the sovereign debt market," says McWilliams. "For investment banks with strong balance sheets, the opportunities are out there." But there is business elsewhere, too. With the return of confidence, investors of every kind - wealthy individuals, speculators, insurance and pension funds - are looking at how to hedge against risk. That means buying derivative products that insure investors against volatility on foreign exchanges, or future rises in the price of iron ore, nickel, tin and wheat. Call it insurance against an upturn, if you must - but once again, investment banks are sought-after intermediaries.

John Winter, head of investment banking at Barclays Capital, says: "There is no shortage of demand for investment banking products and services. Our clients need finance, and advice. But they are looking for players with copper-bottomed reputations." Investment banks also trade on their own account. A number of banks are said to be piling into oil in the belief that prices will be up by the end of the year. A City source says: "People don't know it, but many banks are risking their own money by investing in oil - renting tankers and space at ports - in the belief that the price will be up by around 25% in three to six months' time."

But the success of banks is bound to cause controversy. David Viniar, Goldman's chief financial officer, attempted to play down the bank's record remuneration prospects last week. "It's a pay-for-performance culture," he said. Nevertheless, the payouts are political dynamite: in Britain, the authorities are trying to reform the financial system in the wake of the crash and meet public criticism that big bonuses fuelled irresponsible risk-taking.

Vince Cable, the Liberal Democrat Treasury spokesman, hit out at the impending Goldman bonuses, saying: "Executives there clearly have short memories. In the space of 10 months, they've gone from taking a begging bowl to the US government to paying out massive bonuses. If we are to have stability in the finance sector, we must see pay restraint in all banks, irrespective of which country they are based in." McWilliams adds to the debate when he says that it is a bit disconcerting that Goldman is "promoting products to clients that they are also trading themselves, giving rise to a possible conflict of interest".

Goldman denies it has done anything untoward, but its success rankles with competitors. True, it has repaid the $10bn lifeline that it was thrown when the US government bailed out all the American banks in the wake of Lehman's collapse. But critics remember how the bank was the recipient of help a second time (and saved billions) when the White House bailed out AIG, the stricken insurer, last October. The authorities were concerned that if AIG was allowed to fail, it would drag the rest of Wall Street down with it, so steep were the counterparty risks. Banks were exposed to billions linked to AIG's collateralised debt obligations, with Goldman and Deutsche viewed as among the most vulnerable.

"Goldman is thriving, but it suffered a near-death experience and might have sunk if not for the intervention of government," says one corporate governance activist. Now all banks, not just Goldman, face a backlash from regulators. Last week, a preliminary review published by Sir David Walker in London said that bank bonuses should be more carefully controlled, and that non-executive directors should be better trained.

Walker's proposals are designed to prevent banks from endangering economic stability by providing more accountability and strengthened checks and balances. Among the measures is a suggestion that City high flyers be forced to reveal their pay and bonuses in a bank's annual report and accounts. But - unlike similar ideas aired in the US - the big earners would not be named: instead, only the numbers of employees within given salary bands would be disclosed annually. Walker argues that exposing pay structures for highly paid staff would discourage the excesses that fuelled the global credit crunch.

Not that Goldman is usually linked with systemic failure. Its comparative success during good times and bad is legendary and the dedication of employees is well known. Lloyd Blankfein, the chief executive, describes the culture as a blend of confidence and "an inbred insecurity that drives people to keep working and producing long after they need to. We cringe at the prospect of not being liked by a client." Even before the crisis, when Goldman was earning huge profits, Blankfein seemed more anxious than arrogant. Yet loyalty sometimes spills over into inexcusable behaviour, as when a female job candidate was asked if she would have an abortion rather than lose the chance to work on a big deal.

Over the years, Goldman has never flinched from a taking a long, hard look at itself. It was this kind of navel gazing that led to its own flotation in 1999, after years of often rancorous debate among the partners. The move gave the institution permanent capital with which to expand, but exposed it to the vagaries of stockmarkets - and, some said, loosened the ties that had previously bound its leaders closely together.

After its public offering, Goldman moved into "principal" investing, risking its own capital in markets, and its competitors followed its lead. Here, the profit margins are bigger than client-driven business, but so are the risks. In magnifying its bets with large amounts of borrowed money and peddling sub-prime securities, Goldman certainly played a role in bringing America to the brink of catastrophe. Even so, McWilliams says Goldman has demonstrated that it is in the camp of better-capitalised banks that are emerging leaner and fitter from the debris of the crisis. The rewards for survivors look bigger than ever after the disappearance of key competitors such as Lehman and Bear Stearns and the retreat of rivals such as UBS, RBS and Merrill Lynch - the latter being swallowed by Bank of America.

But snapping at Goldman's heels is the new kid on the block: Barclays Capital, part of Barclays Bank, which acquired Lehman's US business for a song at the height of the crisis. It has been recruiting aggressively as it tools up to take on the competition and plug gaps left by rivals that have gone to the wall. Barclays Capital has hired 460 people for its fledgling European and Asian cash equities business since last autumn and hopes to capitalise on trouble at bigger rivals to add another 300 by the end of the year.

The UK-based bank is starting from scratch after buying the Lehman Brothers unit last autumn and has hired more than 210 bankers, analysts and salespeople in London, continental Europe and Japan, as well as 250 back-office people to support them. "This is a phenomenal opportunity that we are seizing right now. We have built our businesses organically before with great success," says a spokesman, citing BarCap's decision to enter the commodities markets in 2000.

Rival firms across the City say top employees have been offered compensation in the low seven figures - much less than Barclays would have had to pay before the crunch, but more than many banks can currently match. Analysts say that Barclays Capital could generate up to 65% of the banking group's pretax profit in two years (up from 30% in 2008), but critics such as Sandy Chen at broker Panmure Gordon have warned that the bank's exposure to a potentially more volatile earnings stream could make the shares a riskier proposition. In May, he cut his rating on Barclays to "sell" from "hold".

Even Goldman is not immune to future shocks. Professor Richard Portes at the London Business School says: "I don't think there has been a resurgence at Goldman; its results reflect greater risk-taking in highly volatile markets. One wonders if things can stay this good." His words are tantamount to a health warning for the whole sector. And rightly so: history shows that though banks can increase profits year after year, they are capable of losing everything in a few short months. In the process, they turn the world on its head - as the recent crisis has brutally demonstrated. We forget at our peril.

In Washington, One Bank Chief Still Holds Sway
Jamie Dimon, the head of JPMorgan Chase, will hold a meeting of his board here in the nation’s capital for the first time on Monday, with a special guest expected: the White House chief of staff, Rahm Emanuel. Mr. Emanuel’s appearance would underscore the pull of Mr. Dimon, who amid the disgrace of his industry has emerged as President Obama’s favorite banker, and in turn, the envy of his Wall Street rivals. It also reflects a good return on what Mr. Dimon has labeled his company’s "seventh line of business" — government relations.

The business of better influencing Washington, begun in late 2007, was jump-started just as the financial crisis hit and the capital displaced New York as the nation’s money center. Then Mr. Obama’s election brought to power Chicago Democrats well-known to Mr. Dimon from his recent years running a bank there. One of them is Mr. Emanuel, who has accepted the invitation to speak to the board pending a review by the White House counsel. The Treasury secretary, Timothy F. Geithner, declined out of concern that he would be seen as too cozy with a company that has numerous business issues before the department, an administration official said.

"It’s a very nice thing for the board to have happen," said the chief of a major financial company. "But you’d have to have a lot of influence to pull it off." Mr. Dimon and his company enjoy a prominence in the city’s K Street lobbying world that parallels their recent rise on Wall Street; JPMorgan went into the crisis stronger than most rivals and reported robust quarterly gains last week that confirmed its place at the top of the heap.

With the crisis, Mr. Dimon, a longtime Democratic donor, has become even more politically engaged, in the process becoming perhaps the most credible voice of a discredited industry. Other onetime giants like Citigroup and Bank of America find themselves muted as wards of the state. JPMorgan gave back its bailout money quickly, though like all the country’s big banks it still benefits from government loan guarantees and lending facilities.

He is "one of the few Democratic C.E.O.’s in that line of work," said Representative Barney Frank, the Massachusetts Democrat who heads the House banking committee. "And look, he’s been less impaired by failure than some of the others, so that’s given him a kind of lead role." Mr. Dimon, JPMorgan’s chairman and chief executive, comes to Washington about twice a month, compared with maybe twice a year in the past. He requires senior managers to commute as well.

In recent months, he has met with officials including Mr. Geithner; the White House economic adviser, Lawrence H. Summers; and lawmakers of both parties. He phones or e-mails Mr. Emanuel at whim. Each week, his staff gives him the names of a half-dozen public officials to call. "It’s got to be a regular thing. You’ve got to have a few relations where people know and trust you; you can be an honest broker," Mr. Dimon said in an interview. "You can’t just fight everything."

While he has been quick to criticize the administration, JPMorgan has chosen its fights carefully, viewing his activism as a good investment, particularly as the government considers a historic rewrite of financial rules. Mr. Obama has singled out Mr. Dimon for praise more than once. Yet some Democrats say Mr. Dimon can be too outspoken, and deaf to the anti-bank sentiment of the country. When he complained in a March speech about Washington’s vilification of Wall Street, more than 40 House Democrats shot off a protest letter.

"That was nonsense," Mr. Frank said. Yet Mr. Dimon helped persuade Mr. Frank and Congress to ease the terms for banks, allowing JPMorgan to repay $25 billion in bailout money from the Troubled Asset Relief Program, known as TARP. He did so by complaining publicly and privately that JPMorgan only reluctantly took the money last year from the Bush administration to avoid stigmatizing more needy banks, and now was being hit with new limits — on hiring skilled foreigners, executive pay and more.

JPMorgan and the industry lost when a pro-consumer credit card bill became law. But it beat back a proposal to allow bankruptcy judges to lower the amount homeowners owe on mortgages. That victory came with a cost: JPMorgan angered Republicans by negotiating with Democrats and then enraged some Democrats when those talks collapsed. But Mr. Dimon and JPMorgan are willing to bear such defeats if it translates into victory on the broader financial regulation fight that is just beginning.

A centerpiece of that effort involves regulating the market for derivatives, which Mr. Dimon’s firm dominates. While JPMorgan favors new reporting requirements for the complex financial instruments, it opposes the administration proposal to force trades onto public exchanges; doing so would likely cut into the firm’s lucrative business of selling clients custom-made instruments. Like other banks, it also opposes a new consumer agency for financial products.

Meanwhile, the company’s reputation could be tarnished by investigations into the crisis. Among them, JPMorgan is under scrutiny from the Justice Department and the Securities and Exchange Commission for possible antitrust and securities law violations, including derivatives deals with local governments. As he comes into these battles, Mr. Dimon, 53, must relish his and his company’s hard-won status in both Washington and New York: For years, such pre-eminence was widely accorded to Citigroup, the financial supermarket that he helped build, and to Citigroup’s former chief, Sanford I. Weill, who was Mr. Dimon’s mentor and famously fired his protégé in 1998.

Mr. Dimon’s midcareer exile took him from his native New York to Chicago. There he rebuilt his career, reviving BankOne and merging it with JPMorgan in 2004 before returning to New York full time in 2007. In Chicago, he got to know the fast-rising Mr. Obama and his friends. Mr. Dimon and Mr. Geithner know each other well from the Federal Reserve Bank of New York, where Mr. Geithner was president and, as such, a JPMorgan regulator. Mr. Dimon sits on the New York Fed’s board. The two men spent untold hours negotiating in 2008 when the government enlisted JPMorgan to buy some of Bear Stearns’s assets and Washington Mutual to prevent their collapse. Mr. Dimon said the two had spoken by phone perhaps 10 times this year.

A recent conversation involved their impasse over the warrants the government received from JPMorgan last fall in return for the bailout money. When the bank insisted on a lower price, the two sides agreed to let the Treasury auction the warrants. Even then, Mr. Dimon called Mr. Geithner to argue that the government’s valuation was wrong, according to administration and company officials. But Mr. Geithner reiterated that the auction would protect the Treasury from any criticism that it had cut a backroom deal.

Mr. Emanuel was a senior adviser to President Bill Clinton when he met Mr. Dimon, and briefly entertained a job overture from him at Citigroup. When Mr. Dimon was fired, he got a supportive call from Mr. Emanuel, who recalled his own firing early in the Clinton years and how he worked his way back into the inner circle. "The bond here is both of us lost at some place in our career and both rebuilt," Mr. Emanuel said in an interview. Now, he added, "He’s not afraid to express his opinions and I’m not afraid to express mine."

He recalled that Mr. Dimon once phoned to protest the anti-business populism taking hold as voters tired of bailouts, and snapped, "Washington doesn’t get it!" "You guys don’t get the anger out there," Mr. Emanuel replied. "Jamie, you’re asking the American people to bail out the industry. And if they’re going to bail out the industry, it’s got to change its habits." Another Obama associate is on JPMorgan’s payroll. Mr. Dimon hired William M. Daley, a former commerce secretary and Chicago powerbroker, in 2004 as vice chairman and head of Midwest operations. Since 2007, Mr. Daley has overseen global government relations.

It was at that time that Mr. Dimon assessed his own performance for his board and gave himself a "D" for effort in Washington. He subsequently revamped the firm’s government affairs office, mindful of Democrats’ ascendance: They had won control of Congress and were favored to seize the White House in 2008. Rick Lazio, a Republican former congressman, was replaced as head of government relations, reporting to Mr. Daley, with a wired Democrat: Peter L. Scher, a former official in the Senate, the Commerce Department and the trade representative’s office. Despite his Chicago connections, Mr. Dimon said he did not know Mr. Obama well while he was there.

He met the future president during Mr. Obama’s 2004 Senate run, at a living room discussion with about 10 pro-business Democrats, and sent his campaign $2,000, the maximum. Now that Mr. Obama is in the White House, Mr. Dimon has been prominent when the president wants to talk to big business. During one such meeting in late March, as Citigroup’s chairman, Richard D. Parsons, was trying to explain banks and lending, the president interrupted with a quip: "All right, I’ll talk to Jamie."

Wall Street bankers back for big payoffs from the ‘volcano’
The rest of the country may be stuck in a nasty recession, but on Wall Street, where it all began, business is booming. Last week, Goldman Sachs reported a record profit for the latest quarter while J.P. Morgan Chase weighed in with record revenue, and other banks are set to exceed expectations. Compensation levels in some areas are returning to 2007 levels, and firms are once again offering big salaries and guaranteed bonuses to lure away top traders and investment bankers.

Good news or bad? Certainly we’re all better off now that some banks are healthy enough to remove themselves from government life support and pay back the Treasury loans. And if well-run banks can again earn an honest profit by taking smart risks and restoring the flow of capital into the markets — well, that’s what capitalism is all about. Then again, it seems outrageous that the geniuses whose excessive risk-taking brought on the crisis, and who had to be bailed out by the rest of us, are the first to recover and could soon be earning what they did before.

It’s the pay, of course, that gets everyone up in arms. Most firms are already revamping their compensation strategies to require bonuses to be earned over the long run. However effective this restructuring proves to be at dampening excessive risk-taking, it probably won’t reduce overall pay, which explains why Wall Street has been so quick to embrace it. The real problem with Wall Street pay is that these firms simply make too much money relative to the economic value they create.

If other industries were to enjoy such excessive profits, these would be eroded fairly quickly by competition as firms sought to increase market share by cutting prices. But in many segments of the financial services industry — investment banking being the best example — a natural oligopoly has developed in which a relatively small number of blue-chip firms dominate the market. These firms compete fiercely against one another in every way except price, which allows them to earn those extraordinary profits.

There are several reasons for this less-than-perfect competition. The most obvious is that, in this market, the relative reputation of the firm matters a whole lot more than price. If your company is floating a $10 billion bond issue, having a dependable lead underwriter sends a signal to most investors that you are a borrower who can be trusted, and so it’s worth paying an extra $10 million to get Goldman Sachs to do it. Or if your company is trying to fend off a hostile takeover by General Electric, you probably are willing to pay a premium to get Bruce Wasserstein as your investment banker. There may well be banks or bankers just as smart and capable as Goldman and Wasserstein who would do the job for less. But getting it wrong could prove very costly.

This is also an industry in which size and scope matter a lot, meaning that the largest players have a big advantage. At Goldman Sachs and J.P. Morgan, for example, much of last quarter’s profits were made by trading desks that bought and sold huge quantities of stocks, bonds, commodities, derivatives and other securities for their customers, as well as for their own accounts. Because so many trades pass through their hands, these large trading desks have the best real-time information about where markets are heading than anyone in the world, and they use that information to great competitive advantage — not only earning a little more than everyone else on each trade, but learning when to get into and out of markets.

Being big and having a good reputation don’t guarantee success on Wall Street — just ask Lehman Brothers, Bear Stearns and Merrill Lynch — but they surely help. That’s why a Wal-Mart hasn’t emerged and crashed the Wall Street party by offering lower prices. In fact, the few new entrants tend to be boutique firms started by industry superstars who trumpet their superior skills by charging more than the industry norm.

There is one other reason for Wall Street’s extraordinary profits — the safety net provided by the federal government. Most firms would have to pay a considerable amount of money to ensure a reliable source of liquidity in the midst of a financial crisis. But as a practical reality, big banks and financial houses have always gotten their liquidity backstop at a huge discount, courtesy of the U.S. taxpayer. Just because an industry earns outsize profits, of course, doesn’t mean that those profits will necessarily go to employees in the form of outsize compensation. But that is often the case.

That’s what happened in the auto and steel industries in the 1960s, when unions successfully captured most of those industries’ profits. It also happened at nonunion companies such as IBM and Microsoft, in the form of stock options and above-average pay. On Wall Street, much of the surplus is captured by superstar bankers and traders who generate a disproportionate share of those outsize profits, just as superstar actors have done in the movie business or superstar athletes in professional sports. And because these superstars work side by side with colleagues with similar skills doing similar work, firms tend to offer higher-than-market pay to everyone else to assure a modicum of workplace harmony.

For a brief moment, the financial crisis interrupted this compensation arms race as profits dried up. But now that profits are returning, there is no reason to believe that the inflated pay packages won’t be far behind. Because the government’s pay caps apply only to the firms that have been unable to pay back their loans from the Treasury, the effect of these rules won’t be to reduce pay levels at Goldman Sachs or J.P. Morgan, but to weaken the weakest firms even further as their top talent is lured away. In truth, the best way to restrain Wall Street pay is to restrain Wall Street’s profits, either by increasing taxes, reducing leverage or inducing more robust competition. Trying to cap industry pay is like trying to cap a volcano.

Windfalls for Bankers, Resentments for the Rest
There was a time in this country when a company reporting a few billion in earnings could count its money while basking in polite, reverent applause. That time ended Tuesday. It was the morning that Goldman Sachs reported net income of $3.44 billion, a number that surprised even analysts who follow investment banking. JPMorgan Chase came two days later with news that it had earned $2.7 billion in the second quarter, even more than it earned in the same period last year, before the economy had a cardiac infarction.

Then on Friday, Citigroup and Bank of America — two of the great basket cases of the meltdown — reported outstanding numbers, too. All of these companies were beneficiaries of gargantuan government bailouts, in assorted forms and varied sums, but if they assumed they’d hear bravos for prompt paybacks and quick turnarounds, they were in for a shock. At a time when so many people are struggling with foreclosures and are either unemployed or worried about losing a job, these earnings were bound to stir up some basic questions of fairness.

And along with those questions, a rebirth, perhaps, of a type of anger that hasn’t been widespread for a while: good old class resentment. It’s making a comeback. As recently as April, President Obama could say at a news conference at a Group of 20 summit meeting, that Americans "don’t resent the rich; they want to be rich," without raising eyebrows. Today, the first half of that comment is starting to sound like a stretch. And when it comes to people who earned their fortunes through the financial industry, it seems wrong.

Something closer to the current zeitgeist was captured last week by Bill O’Reilly, the Fox News commentator, who likened Goldman Sachs bankers to pigs during a scathing segment on his TV show. "You’ve got to make an example of the big boy," he fumed in a rant about the company’s tax-avoidance methods, suggesting Goldman ought to be punished for failing to cough up its fair share of taxes. "And this is the big boy."

Jon Stewart went the deadpan comedy route on his show this week: "Goldman Sachs makes $3.4 billion in profit from April to June. I guess the bailouts are working. For Goldman Sachs." Class resentment has waxed and waned in this country, but it is not typically a widespread, default emotion of the American middle class. This is at least in part because it’s an article of faith here that through some combination of hard work and luck, you might get rich, too. And why abuse, soak or heap scorn upon a group you at least have a theoretical chance of joining?

The recession — with its yawning gap between the bonus class on the one hand and the foreclosed upon and newly jobless on the other — is changing that. It’s not merely that Americans have, at least temporarily, abandoned the hope that they’ll earn scads of money. It’s the widespread sense that winners in this economy are produced by a game that’s rigged. Which is why the response to last week’s earnings bonanza has been a mix of, among other things, bafflement and anger.

If these companies can return to the festivities so quickly, were they really having the near-death experience they and the government claimed? And if taxpayers risked their money when they backstopped Wall Street’s misadventures, why aren’t they sharing in the upside now that the party has started again? And did these companies have the time to rethink the risk culture that landed us in this jam in the first place?

In private, Wall Street executives have questions of their own. Like, wait a sec — isn’t returning to profitability exactly what you wanted us to do? And if the nation’s circulatory system of money is beginning to flow again, isn’t that good news? Oh and by the way, we are paying you back. It’s telling that from politicians, there’s been mostly silence. Neither Representative Barney Frank nor Senator Chris Dodd — respectively, the Democrats who lead the House and Senate committees that handle banks — issued press releases about those earnings last week, according members of their staffs. Neither returned a call for this article.

The Obama administration, meanwhile, sounded like it was searching for the seam between cautious optimism and cautious skepticism. Mr. Obama’s press secretary, Robert Gibbs, was quoted in Time magazine saying that "the president continues to have concerns that compensation will be based on risky behavior instead of performance." But class resentment can be a powerful tool in politics, and you don’t need to stoke it explicitly to enjoy its upsides. House Democrats have proposed a 5.4 percent surtax on those earning more than $1 million as a means of underwriting health care reform.

Whatever the wisdom of this idea, it is easier to imagine it catching on now that Goldman has posted its largest quarterly profit in 140 years — enough to set aside more than $11 billion for bonuses, with the year only half over. Of course, taxing and tsk-tsking the rich might be gratifying, but like everything else in economics it is sure to have some unintended consequences. Already, conservative and libertarian scholars warn that if there’s enough blowback against bonuses, Wall Street will simply distribute windfalls in the form of salary — which might actually reduce incentives. Alternatively, the rich might just get better at shielding their wealth from the public.

And don’t expect the new class resentment to remain a Wall Street-only phenomenon for long. Last Monday, news broke that the "American Idol" host Ryan Seacrest would be paid $45 million to remain with the show for the next three years. With other TV and radio gigs, as well as investments in restaurants and media companies, the guy is walking the one-man-conglomerate trail blazed by Dick Clark. While Mr. Clark never inspired much hostility, a palpable irritation greeted the "American Idol" announcement. (Mr. Seacrest was called the "Viscount of Vapidity" in the widely read Deadline Hollywood Daily blog.) It’s true, Mr. Seacrest has never seemed as benign and lovable as Dick Clark. But there is also the question of timing. If you had to announce a multimillion-dollar raise, last week was the worst week ever.

Bonus boom time returns to Wall Street
It was back to normal on Wall Street last week, as though the banking crisis of the past year had never happened. Goldman Sachs declared second-quarter net profits rocketing up 89 per cent to $3.4bn (£2.1bn), while rival JP Morgan saw quarterly profits more than triple from $394m to $1.47bn. But even bigger news was that bonuses are back big-time and Wall Street titans Goldman was predicting that pay this year is set to beat the boom levels enjoyed even before the financial crisis.

If Goldman can maintain the growth levels reported so far this year, then staff are set to share total pay and bonuses of more than $22bn, which will mean they will earn huge amounts, just as they did in 2006 and 2007. In the event, Goldman's bankers will share $6.6bn for this period and they have set aside $11.4bn for pay for the first six months of the year. If the second half proves as good, it will pay out roughly $770,000 for each of the 29,400 workers – and maybe as high as $900,000 for the year.

Meredith Whitney, the star analyst who called the top of the banking industry in October 2007 when she warned that Citigroup was facing a capital shortfall of up to $30bn, added to the euphoria when she advised clients to get back into the share-buying market – and specifically back into Goldman Sachs. Not only did Whitney, now a bit of a media star in the US, tell CNBC viewers to expect the "mother of all mortgage quarters", but she predicted that Goldman would soar at least 30 per cent, so even she was surprised at just how good the results would be from fixed income, currencies and commodities trading.

Not everyone is celebrating. Financial analyst Max Keiser accused Goldman of running the US government, while US lawmakers attacked the firm for paying out juicy bonuses so shortly after the investment bank was rescued by the taxpayer. Mr Keiser, in the US magazine The Deal, described Goldman as "scum" and claimed it controls the Federal Reserve and Treasury, caused the financial crisis, and front-runs on every deal on the New York Stock Exchange.

But Goldman, used to such vitriol after a recent attack by Rolling Stone magazine, is defiant, arguing it has paid back the $10bn in taxpayers' funds it borrowed from the TARP scheme and paid out dividends to taxpayers. Analysts say Goldman chief executive Lloyd Blankfein has played a blinder by sticking to a business model which everyone deemed dead and broken only a few months ago. While rivals such as Morgan Stanley have cut back on risks, Goldman traders have been out making markets in their traditional areas.

At JP Morgan, chief executive Jamie Dimon reported equally fabulous figures, with record profits from trading and stock underwriting. JP Morgan put aside $14bn to pay its 229,000 staff for the first half and $6bn for the 25,700 investment bankers. Even the UK felt the benefit – Wall Street's bonanza boosted UK banking stocks as investors anticipated banks would outperform expectations – shares in Barclays rose 9 per cent last week, while shares in RBS, due to report next month, are up over 7 per cent.

Walter Cronkite on the Ruling Class

New, Hard Evidence of Continuing Debt Collapse
While most pundits are still grasping at anecdotal “green shoots” to celebrate the beginning of a “recovery,” the hard data just released by the Federal Reserve reveals a continuing collapse of unprecedented dimensions.

It’s all in the Fed’s Flow of Funds Report for the first quarter of 2009, which I’ve posted on our website with the key numbers in a red box for all those who would like to see the evidence.

Here are the highlights:

Credit disaster (page 11). First and foremost, the Fed’s numbers demonstrate, beyond a shadow of a doubt, that the credit market meltdown, which struck with full force after the Lehman Brothers failure last September, actually got a lot worse in the first quarter of this year.

This directly contradicts Washington’s thesis that the government’s TARP program and the Fed’s massive rescue efforts began to have an impact early in the year.

In reality, the credit market shutdown actually gained tremendous momentum in the first quarter. And although it’s natural to expect some temporary stabilization from the government’s massive interventions, the first quarter was SO bad, it’s impossible for me to imagine any scenario in which the crisis could be declared “over.”

Here are the facts:

  • We witnessed one of the biggest collapses of all time in “open market paper” — mostly short-term credit provided to finance mortgages, auto loans, and other businesses. Instead of growing as it had in almost every prior quarter in history, it collapsed at the annual rate of $662.5 billion. (See line 2.)
  • Banks lending went into the toilet. Even in the fourth quarter, when the meltdown struck, banks were still growing their loan portfolios at an annual pace of $839.7 billion. But in the first quarter, they did far more than just cut back on new lending. They actually took in loan repayments (or called in existing loans) at a much faster pace than they extended new ones! They literally pulled out of the credit markets at the astonishing pace of $856.4 billion per year, their biggest cutback of all time (line 7).
  • Meanwhile, nonbank lenders (line 8) pulled out at the annual rate of $468 billion, also the worst on record.
  • Mortgage lenders (line 9) pulled out for a third straight month. (Their worst on record was in the prior quarter.)
  • And consumers (line 10) were shoved out of the market for credit at the annual pace of $90.7 billion, the worst on record.
  • The ONLY major player still borrowing money in big amounts was the United States Treasury Department (line 3), sopping up $1,442.8 billion of the credit available — and leaving LESS than nothing for the private sector as a whole.

Bottom line: The first quarter brought the greatest credit collapse of all time.

Excluding public sector borrowing (by the Treasury, government agencies, states, and municipalities), private sector credit was reduced at a mindboggling pace of $1,851.2 billion per year!

And even if you include all the government borrowing, the overall debt pyramid in America shrunk at an annual rate of $255.3 billion (line 1)!

Asset-backed securities (ABS) got hit even harder (page 34). This is the sector where you can find most of the new-fangled “structured” securities — the ones Washington had already identified as a major culprit in the credit disaster.

Did they make any headway in stopping the ABS collapse? None whatsoever! The total outstanding in this sector (line 3) fell at an annual pace of $623.4 billion in the first quarter, the WORST ON RECORD!

U.S. security brokers and dealers were smashed (page 36). Brokers were forced to reduce their total investments at the breakneck annual pace of $1,159.2 billion in the first quarter, after an even hastier retreat in the prior quarter (line 3)!

What’s even more revealing is that they were so pressed for cash, they had to dump their Treasury security holdings in massive amounts — at an annual pace of $424 billion (line 7)! Given the Treasury’s desperate need for financing from any source, that’s not a good sign!

Government agencies got killed (page 43). Households dumped their Ginnie Maes, Fannie Maes, Freddie Macs, and other government-agency or GSE securities like never before in history, unloading them at the go-to-hell annual clip of $1,395.7 billion (line 6).

And the rest of the world (mostly foreign investors), which had started unloading these securities in the third quarter of last year, continued to do so at a fevered pace (line 10).

Mortgages got chopped again (page 48). Home mortgages outstanding were slashed at an annual clip of $87.3 billion in the second quarter of last year, $324.2 billion in the third quarter, $271 billion in the fourth, and another $61 billion in the first quarter of this year (line 2).

A slowdown in the collapse? For now, perhaps. But the first quarter also brought the very first reduction in commercial mortgages, an early sign of bigger commercial real estate troubles ahead (line 4).

Trade credit is dying (page 51, second table). If you’re in business and you don’t have cash on hand to buy inventories, supplies, or other materials, beware! Large and small corporations all over the country have been slashing trade credit at an accelerating pace (line 3).

In the first quarter of last year, this aspect of the credit crisis was still in its early stages; trade credit outstanding was shrinking at an annual pace of just $15 billion. But by the second quarter, this new disaster burst onto the scene at gale force, with trade credit getting docked at the rate of $151.2 billion per year. And most recently, in the first quarter of 2009, it was slashed at the shocking pace of $277.2 billion per year.

And I repeat:

With ALL of these figures, we’re not talking about a decline in new credit being provided, which would be bad enough. We’re talking about a collapse that’s so deep and pervasive, it actually wipes out 100 percent of the new credit and brings about a net reduction in the credit outstanding — a veritable dismantling of America’s once-immutable debt pyramid!

For the long-term health of our country, less debt is not a bad thing. But for 2009 and the years ahead, it’s likely to be traumatic, delivering …

The Most Wealth Losses of All Time

Who is suffering the biggest and most pervasive losses? U.S. households and nonprofit organizations (page 105)!

The losses have been across the board — in real estate, stocks, mutual funds, family businesses, life insurance policies, and pension funds.

In U.S. households alone, the losses have been massive: $1.39 trillion in the third and fourth quarters of 2007 (not shown on page 105) … a gigantic $10.89 trillion in 2008 … $1.33 trillion in the first quarter of 2009 … $13.87 trillion in all, by far the worst of all time.

And these losses have equally massive consequences for 2009 and 2010:

  • Deep cutbacks in consumer spending ahead, plus a virtual disappearance of conspicuous consumption …
  • More massive sales declines at most of America’s giant manufacturers, retail firms, transportation companies, restaurants, and more, plus …
  • Big losses replacing profits at most U.S. corporations!

Rescues That Make the Crisis Worse

The U.S. government has taken radical, unprecedented steps to counter this credit collapse. And for the moment, it HAS been able to avert a financial meltdown.

But no government, even one run amuck with spending and money printing, can replace $13.87 trillion in losses by households.

Consider just two of the government’s most egregious escapades:

  • On January 7, Fed Chairman Bernanke was so desperate to revive U.S. mortgage markets that he embarked on a new, radical program to buy up mortgage-backed securities. So far, he has pumped over a half trillion dollars of fresh federal money into that market. But it has barely made a dent; despite all his efforts, mortgage rates have zoomed higher anyway, snuffing out a mini-boom in mortgage refinancing.
  • Four months later, on May 17, the Fed was so desperate to revive other credit markets, it even caved in to industry appeals to finance recreational vehicles, speedboats, and snowmobiles, according to Saturday’s New York Times. But that has barely made a dent in those industries. And the expansion of direct Fed financing to these esoteric areas is not possible without greatly damaging the credibility — and credit — of the U.S. government. Result: Higher interest rates.

Can Mr. Bernanke take even MORE radical steps? Can he trek where no other modern-day central banker has ever gone before?

Not without shooting himself in the foot! It still won’t be enough to avert a continuation of the debt crisis. Indeed, all it can accomplish is to kindle inflation fears, drive interest rates even higher, and actually sabotage any revival in the credit markets.

Look. The nearly $14 trillion in financial losses suffered by U.S. households has inevitable consequences. And massive, nonstop borrowings by the U.S. Treasury in the months ahead — driving interest rates still higher — can only make them worse.

My urgent warning: If you fall for Wall Street’s siren song that “the crisis is over,” you could be in for a fatal surprise.

Don’t believe them. Follow the numbers I have highlighted here. Then, reach your own, independent conclusions.

Disclosure of Fiscal Risks of Financial Intervention Needed
A new staff note from the International Monetary Fund says countries should do more to disclose and quantify the risks of government interventions into financial markets.

The note, Disclosing Fiscal Risks in the Post-Crisis World, which is not official IMF policy,” discusses appropriate methods for disclosing fiscal risks from exogenous shocks and the realization of explicit or implicit contingent obligations of the government.” In essence it argues that  outcomes often deviate from what was intended when the intevention was made, but that this fact is often reflected in projections.

Its key recommendation is that countries should regularly prepare and publish a statement of fiscal risks, ideally accompanying annual budget documents, and including the different types of risks related to already-announced public interventions in support of the financial sector.

It provides an example of how this might be done:

Consider a country that experiences a financial crisis in year t, with the government’s interventions in support of the financial system leading to a large increase in direct liabilities, and the value of earlier outstanding debt and explicit guarantees (contingent liabilities) also increasing sharply due to valuation effects (e.g., because of an exchange rate depreciation). In this example, the debt-to-GDP ratio rises to 100 percent in year t. As a result, the government undertakes fiscal consolidation over the subsequent years.

At the same time, the government’s claims also increase. In this example, the government takes ownership stakes in, and obtains claims on, some financial sector institutions, opening the way for future privatization gains and asset recovery.

Given the uncertainty over the future realization of assets, it is useful to compare different scenarios for the path of gross public debt (see figure). Different scenarios can be run assuming different asset recovery rates, returns from privatization, and realization of contingent liabilities. All should be compared to a baseline scenario. In this example, the debt stock could vary between 65 percent of GDP and 85 percent of GDP at the end of a five-year period.


  • The baseline scenario assumes no immediate privatization, and a partial realization of other claims. Public debt falls as a share of GDP, reflecting fiscal effort and asset recovery.
  • Under a "no asset recovery" scenario, public-debt-to-GDP ratio declines solely as a result of fiscal consolidation. This scenario also includes the realization of a small contingent liability in 2011.
  • An intermediate scenario assumes that recovery of assets is only half of that under the baseline scenario.
  • A "positive" scenario assumes that in addition to the baseline recovery rates, the banks are gradually, but fully, privatized over the five-year period.

TC Derivative Regulation Proposals – Neat, Plausible and Wrong!
by Satyajit Das

Proposals for over-the-counter (OTC) derivative regulations are consistent with H. L. Mencken’s proposition that: “there is always a well-known solution to every human problem--neat, plausible, and wrong.”
A central omission is the speculative use of derivatives. Industry lobbyists focus on the use of derivatives to hedge and manage risk promoting investment and capital formation. While derivatives can play this role, the primary use of derivatives now is manufacturing risk and creating leverage.

Derivative volumes are inconsistent with “pure” risk transfer. In the credit default swap market (CDS) market, volumes were in excess of four times outstanding underlying bonds and loans. The need for speculators to facilitate markets contrasts with recent experience where they were users rather than providers of scarce liquidity and amplified systemic risks. Relatively simple derivative products provide ample scope for risk transfer. It is not clear why increasingly complex and opaque products are needed other than to increase risk and leverage as well as circumvent investment restrictions, bank capital rules, securities and tax legislation.

A central reform proposed is the central clearing house (the central counterparty - CCP) where (so far unspecified) “standardised” derivatives transactions must be transferred to an entity that will guarantee performance. The CCP centralises all performance in a single entity, surely the ultimate case of “too big to fail”. Effectiveness of the CCP depends on its ability to manage risk through a system of daily cash margins to secure exposure under contracts. Failure to meet a margin call requires the CCP to close out the position and offset any losses against existing collateral.

The level of initial collateral posted must cover the fall in value from the last margin call. There are inherent moral hazards in setting the initial collateral. Traders want the maximum amount of leverage by reducing the amount cash posted. Collateral models are based on historical volatility that may underestimate risk. For some products, such as CDS contracts, establishing the required levels of collateral required is difficult. Cross margining where traders can net all open positions expose the CCP to correlation problems in the offset methodologies. Additional problems may arise from the use of multiple CCPs.

There are significant issues in pricing and valuing contract and, for some products, reliance on complex models. The CCP assumes the ability to value contracts that relies, in turn, on liquid markets in the instruments, an unrealistic condition as events have showed. Mis-selling of “unsuitable”derivative products to investors and corporations remains a problem. Expertise of purchasers is sometime inversely related to the complexity of derivative products. Given significant information and knowledge asymmetry between sellers and buyers, the possibility of disallowing certain types of transactions altogether or with certain parties should have been considered.

Complex risk relationships created by derivatives are not addressed. AIG’s problems related to margin calls based on current “market” values on its derivative contracts. The CCP may inadvertently increase liquidity risk as more participants may be subject to margining and unexpected demands on cash resources. Systemic effects, such as the impact of CDS contracts on risk taking behaviour and also dealing with financial distress, are ignored. Concentrated market structures, where a handful of large dealers dominate dealing, are also not addressed.

For example, the OCC in the U.S. reported that largest five banks hold 96% of total notional volume of derivatives and the largest 25 banks hold nearly 100%. Familiar dictums - improved disclosure, transparency and operational processes - have been tried before with limited success.

The unpalatable reality that few, self interested industry participants are prepared to admit is that much of what passes for financial innovation is specifically designed to conceal risk, obfuscate investors and reduce transparency. The process is entirely deliberate. Efficiency and transparency is not consistent with the high profit margins on Wall Street and the City. Financial products need to be opaque and priced inefficiently to produce excessive profits. Until regulators and legislators understand the central issues and are prepared to address them, no meaningful reform in the control of derivative trading will be possible.

Can The Economy Recover?
There is no economy left to recover. The US manufacturing economy was lost to offshoring and free trade ideology. It was replaced by a mythical "New Economy." The "New Economy" was based on services. Its artificial life was fed by the Federal Reserve’s artificially low interest rates, which produced a real estate bubble, and by "free market" financial deregulation, which unleashed financial gangsters to new heights of debt leverage and fraudulent financial products.

The real economy was traded away for a make-believe economy. When the make-believe economy collapsed, Americans’ wealth in their real estate, pensions, and savings collapsed dramatically while their jobs disappeared. The debt economy caused Americans to leverage their assets. They refinanced their homes and spent the equity. They maxed out numerous credit cards. They worked as many jobs as they could find. Debt expansion and multiple family incomes kept the economy going.

And now suddenly Americans can’t borrow in order to spend. They are over their heads in debt. Jobs are disappearing. America’s consumer economy, approximately 70% of GDP, is dead. Those Americans who still have jobs are saving against the prospect of job loss. Millions are homeless. Some have moved in with family and friends; others are living in tent cities. Meanwhile the US government’s budget deficit has jumped from $455 billion in 2008 to $2,000 billion this year, with another $2,000 billion on the books for 2010. And President Obama has intensified America’s expensive war of aggression in Afghanistan and initiated a new war in Pakistan.

There is no way for these deficits to be financed except by printing money or by further collapse in stock markets that would drive people out of equity into bonds. The US government’s budget is 50% in the red. That means half of every dollar the federal government spends must be borrowed or printed. Because of the worldwide debacle caused by Wall Street’s financial gangsterism, the world needs its own money and hasn’t $2 trillion annually to lend to Washington.

As dollars are printed, the growing supply adds to the pressure on the dollar’s role as reserve currency. Already America’s largest creditor, China, is admonishing Washington to protect China’s investment in US debt and lobbying for a new reserve currency to replace the dollar before it collapses. According to various reports, China is spending down its holdings of US dollars by acquiring gold and stocks of raw materials and energy.

The price of one ounce gold coins is $1,000 despite efforts of the US government to hold down the gold price. How high will this price jump when the rest of the world decides that the bankruptcy of "the world’s only superpower" is at hand? And what will happen to America’s ability to import not only oil, but also the manufactured goods on which it is import-dependent?

When the over-supplied US dollar loses the reserve currency role, the US will no longer be able to pay for its massive imports of real goods and services with pieces of paper. Overnight, shortages will appear and Americans will be poorer. Nothing in Presidents Bush and Obama’s economic policy addresses the real issues. Instead, Goldman Sachs was bailed out, more than once. As Eliot Spitzer said, the banks made a "bloody fortune" with US aid.

It was not the millions of now homeless homeowners who were bailed out. It was not the scant remains of American manufacturing--General Motors and Chrysler--that were bailed out. It was the Wall Street Banks. According to, Goldman Sachs’ current record earnings from their free or low cost capital supplied by broke American taxpayers has led the firm to decide to boost compensation and benefits by 33 percent. On an annual basis, this comes to compensation of $773,000 per employee. This should tell even the most dimwitted patriot who "their" government represents.

The worst of the economic crisis has not yet hit. I don’t mean the rest of the real estate crisis that is waiting in the wings. Home prices will fall further when the foreclosed properties currently held off the market are dumped. Store and office closings are adversely impacting the ability of owners of shopping malls and office buildings to make their mortgage payments. Commercial real estate loans were also securitized and turned into derivatives.

The real crisis awaits us. It is the crisis of high unemployment, of stagnant and declining real wages confronted with rising prices from the printing of money to pay the government’s bills and from the dollar’s loss of exchange value. Suddenly, Wal-Mart prices will look like Nieman Marcus prices.

Retirees dependent on state pension systems, which cannot print money, might not be paid, or might be paid with IOUs. They will not even have depreciating money with which to try to pay their bills. Desperate tax authorities will squeeze the remaining life out of the middle class. Nothing in Obama’s economic policy is directed at saving the US dollar as reserve currency or the livelihoods of the American people. Obama’s policy, like Bush’s before him, is keyed to the enrichment of Goldman Sachs and the armament industries.

Matt Taibbi describes Goldman Sachs as "a great vampire squid wrapped around the face of humanity, relentless jamming its blood funnel into anything that smells like money." Look at the Goldman Sachs representatives in the Clinton, Bush and Obama administrations. This bankster firm controls the economic policy of the United States. Little wonder that Goldman Sachs has record earnings while the rest of us grow poorer by the day

Recession Lesson: Share and Swap Replaces Grab and Buy
The recession is reminding Americans of a lesson they first learned in childhood: Share and share alike. They are sharing or swapping tools and books, cars and handbags, time and talent.
The renewed desire to share shows up in a variety of statistics: A car-sharing service has had a 70 percent membership increase since the recession set in. Governments are putting bikes on the street for public use. How-to-swap Web sites are proliferating.

"I think what happens in a recession or any sort of economic contraction is that you have not only a loss of financial resources, but also you have a loss of emotional resources," said Shawn Achor, a Harvard University researcher and a consultant on positive psychology. "You don't have as much of the money or security or confidence or pride that goes with financial success," he said. "Our brains try to seek out those resources that are lost. The financial resources are beyond our control, but the emotional resources are not. And we seek out each other. We rely on each other."

The economy reflects the way Americans have cut back, especially on discretionary items: Department store sales dropped 1.3 percent in June. People are not buying cars, and auto sales dropped 27.7 percent last month. They are not paying others to do what they can do themselves -- Home Depot reports increased attendance at in-store do-it-yourself clinics. And although paint sales are down in general, according to Sherwin-Williams, individual consumers are still buying.

When Tom Burdett needed to cut some tile at his home outside Annapolis, he refused to buy expensive tools. So he asked his neighbors and friends for help. Sure enough, someone had just what he needed. And when that friend needed help installing a satellite dish, Burdett volunteered. "I'm not going to go out and buy a $500 tile saw just to do one project," said Burdett, a television producer who lives in Edgewater. "Just ask for help and help people out. I think the economy has kind of woken people back up to the old way of doing things instead of the crazy '90s of 'Oh just go out and buy it.' "

The sharing mind-set is not new to the American culture, but many Americans abandoned it when the nation shifted from an agricultural society to an industrial one, said Rosemary Hornak, a psychology professor at Meredith College in Raleigh, N.C. They moved farther from their families and did not have time to connect with new neighbors because they worked so much, she said. Now that people are experiencing financial distress, they don't want to be alone.

"You can't change the economy. You can't change the recession. Maybe you can get a better job, but that won't be instantaneous. What do you do?" she said. "Sharing is one of the things that first of all makes you feel better about yourself. . . . We're moving into 'How can we establish these kinds of personal connections, this helping others, sharing, being a bit more neighborly?' " Neighborhood conversations tell more of the story as the movement grows organically in communities across the Washington region and the nation. On one street in Arlington, for instance, neighbors are chipping in for mulch and dividing it among themselves.

Liz McLellan, a Web designer in Oregon, started a free yard-sharing community at Hyperlocavore ( in January. Friends, relatives or neighbors create a group, pool their resources and start a garden, then distribute the produce equally. The recession gardens, as she calls them, can save families with two children up to $2,500 a year. "We have people who are foodies and have become accustomed to outstanding taste and freshness," she said. "We have people who simply are trying to make ends meet."

In February, Robert Morse of New York started -- named for a friend known for helping his neighbors before he died at age 43 -- to connect groups of people who want to help one another out on home projects or share tools. "We hear stories about guys who have no money to go golfing anymore and are going to each other's houses and helping each other paint the house or fix the patio," he said. Women have flocked to the Web site to borrow or rent luxury bags and other accessories. Users of a book-swapping Web site, Bookmooch, have increased 30 percent to about 124,000 since the beginning of the year. The membership of the trading site SwapTree has grown tenfold in the past year.

"We're kind of coming out of an opulent time," said Mark Hexamer, co-founder of SwapTree. "People have seen the bad side of mass consumerism. Now everyone is kind of looking for ways to cut down on the family budget." Since the recession started, car-sharing company Zipcar has had a 70 percent increase in membership to almost 300,000. Sixty percent of the new members said they had sold their cars or abandoned plans to buy them and decided instead to use Zipcar, which charges a small annual fee. "The downturn in the economy has people thinking of buying less and sharing more," said Scott Griffith, chief executive of Zipcar.

Local governments and faith organizations are joining in. Arlington County runs to help residents carpool. For a $40 annual fee, the District offers access to 120 bikes at self-service racks around the city. Chris Ganson, 35, a city planner, has embraced the sharing mentality in several ways. He has joined the city's Smart Bike program as well as Zipcar. "It's convenient and it saves money," he said. Ganson also shares a house in Adams Morgan with five other people. He pays $955 a month for a room with a private bathroom, about $600 less than for most one-bedroom apartments in the neighborhood.

"It's a great thing for times like these," he said. Emily Richards, 27, a Falls Church marketing consultant, shares books with her mother-in-law, sister-in-law and friends. Whenever she visits her four sisters in Alabama, she uses their clothing so she does not have to pack a big bag and pay extra baggage fees. She also recently let a friend borrow the vases that were part of the centerpieces at her wedding. That friend is going to use them at her wedding. "I think I'm very frugal by nature, but it's nice to know that other people have embraced that mind-set," she said.

When the economy started getting worse, a friend persuaded Burdett to join with him. Burdett and his neighbors used to hire a handyman for small home projects. That is now a luxury. "With the recession, no one has extra cash," he said. Burdett's network grew to about 13 friends and friends of friends. In addition to the tile saw, he now has access to other tools such as air compressors. He also does his share of helping. He recently erected a fence around a friend's father's house.

"Almost everyone I know has lost a lot, I would say half of what they had as an investment," he said. "People are helping each other and getting back together. You're not the lone ranger anymore."

US Income Inequality Continues to Grow
In June 2009, the U.S. economy saw its second steepest decline in 27 years. New jobless claims increased, business inventories fell and exports plunged as bad economic news persisted. Will the once high-flying American wealth machine continue to produce the vast inequalities of the past?

Only two years ago, Steve Forbes, CEO of Forbes magazine, declared 2007 "the richest year ever in human history." During eight years of the Bush administration, the 400 richest Americans, who now own more than the bottom 150 million Americans, increased their net worth by $700 billion. In 2005, the top 1 percent claimed 22 percent of the national income, while the top 10 percent took half of the total income, the largest share since 1928.

In June 2009, the Merrill Lynch Global Wealth Report estimated the number of the world's wealthiest people declined by 15 percent, the steepest decline in the report's 13-year history. The number of millionaires in the U.S. fell by 19 percent to 2.5 million people. Analysts tell us the economy is being restructured, but how will the disparities in wealth between the rich and the poor play out?

"The source of wealth has changed over the past 30 years; corporations have become the engine of inequality in the U.S.," says Sam Pizzigati, associate fellow at the Institute for Policy Studies in Washington D.C. "In the past, wealth came from ownership: Today it comes increasingly from income." The highest incomes come from executive pay at top corporations. In 2007, the ratio of CEO pay to the average paycheck was 344 to 1, lower than the record 525 to 1 ratio set in 2001, but substantial.

This year's ratio is estimated to decrease to 317 to 1. In the '60s, '70s and '80s, the average ratio fluctuated between 30 and 40 to 1. Over 40 percent of GNP comes from Fortune 500 companies. According to the World Institute for Development Economics Research, the 500 largest conglomerates in the U.S. "control over two-thirds of the business resources, employ two-thirds of the industrial workers, account for 60 percent of the sales, and collect over 70 percent of the profits."

Corporations systematically created a wealth gap over the last 30 years. In 1955, IRS records indicated the 400 richest people in the country were worth an average $12.6 million, adjusted for inflation.

• In 2006, the 400 richest increased their average to $263 million, representing an epochal shift of wealth upward in the U.S.
• In 1955, the richest tier paid an average 51.2 percent of their income in taxes under a progressive federal income tax that included loopholes. By 2006, the richest paid only 17.2 percent of their income in taxes.
• In 1955, the proportion of federal income from corporate taxes was 33 percent; by 2003, it decreased to 7.4 percent. Today, the top taxpayers pay the same percentage of their incomes in taxes as those making $50,000 to $75,000, although they doubled their share of total U.S. income.

"Over the past 30 years, the income of the top 1 percent, adjusted for inflation, doubled: the top one-tenth of 1 percent tripled, and the top one-one-hundredth quadrupled," says Pizzigati. "Meanwhile, the average income of the bottom 90 percent has gone down slightly. This is a stunning transformation."

Meanwhile, wages for most Americans didn't improve from 1979 to 1998, and the median male wage in 2000 was below the 1979 level, despite productivity increases of 44.5 percent. Between 2002 and 2004, inflation-adjusted median household income declined $1,669 a year. To make up for lost income, credit card debt soared 315 percent between 1989 and 2006, representing 138 percent of disposable income in 2007.

According to Pizzigati, the wealth disparity is the result of corporations squeezing more profits from workers. "In the past corporations laid off workers because business was bad," Pizzigati says. "But over the past few decades, downsizing has been a corporate wealth generating strategy. Today, CEOs don't spend their time trying to make better products: they maneuver to take over other companies, steal their customers and fire their workers."

Progressive taxation used to prevent the rich from capturing a disproportionate share of national compensation, and the labor movement, which represented 35 percent of private sector employees and today represents 8 percent, once served as a political force to limit excessive executive pay. The Reagan backlash cut the top income tax rates, and saw the creation of right-wing think tanks that spent $30 billion over the past 30 years propagandizing for deregulation, privatization and wealth worship.

Bubble economies over the past 30 years helped CEOs pump up their income, and efforts to corral their pay are weak and ineffective. CEO pay may fall during these economic hard times, but disparity isn't going away. Without a strong movement for change, the wealth gap will only increase in this downturn.

"There won't be a restructuring of the economy unless we take on executive compensation," concludes Pizzigati. "Outrageously large rewards give executives an incentive to behave outrageously. If we allow these incentives to continue, we will just see more of the reckless behavior that has driven the global economy into the ditch."

Lloyds to stun City on profit
Lloyds Banking Group could shock the market with its first-half results by announcing that accounting trickery has helped it scrape into the black. Despite enormous bad-debt provisions – estimated at £13 billion – the bank is likely to post a modest headline profit for the first six months of the year. Some of its most toxic sub-prime investments have clawed back billions of pounds of value in recent months. Other credit instruments will also have recorded paper gains for Lloyds.

Under fair-value accounting rules, the paper gains will flow straight through to the bottom line. The rules have proved controversial throughout the credit crisis and have been widely blamed for accelerating the destruction of value on bank balance sheets. In the second quarter of the year, the prices of many distressed assets bounced back. Lloyds is expected to be among the first of the world’s big banks to chart big gains on the back of the rules now that some troubled assets have increased in price.

Lloyds took £14 billion of provisions last year to account for mark-to-market movements on its own balance sheet and that of HBOS. Even a small improvement could prove significant. The same accounting principles may allow Lloyds to release profits elsewhere on its balance sheet. Lloyds took a write-down of £13.8 billion on the HBOS loan book after the acquisition last autumn. Despite the continued bad debts being suffered on the book, analysts believe it could claw back some of those earlier charges.

The accounting write-backs, coupled with operating profits of £7 billion, will combine to outweigh the enormous bad-debt charges being suffered on the bank’s exposures to mortgages, corporate loans and commercial property. One analyst said: "There are a lot of big numbers involved here. When big numbers start moving around they can become very significant." The bank reporting season has already produced a number of surprises. Wall Street’s banking analysts were proved to be significantly wide of the mark last week in their forecasts for Goldman Sachs. The bank’s record quarterly profits of $3.4 billion (£2 billion) were roughly twice what the market had forecast.

Morgan Stanley is due to report second-quarter figures on Wednesday. Analyst expectations vary significantly but the consensus suggests the bank will post a small loss. Credit Suisse, widely considered to be one of the banks to win from the credit crunch, will also report second-quarter figures this week. Huge trading profits are expected to have been recorded by its foreign exchange, fixed income and commodities businesses.

Ex-Lehman traders to get huge bonuses
Barclays is to pay tens of millions of pounds to its investment bankers, who have made huge profits from trading in government debt, derivatives and foreign exchange. Some of the biggest payouts are expected to go to former Lehman Brothers traders hired by the British bank after it took over Lehman's US operations at a knockdown price in September. Some Lehman staff were granted guaranteed bonuses to ensure they stayed with Barclays rather than jump ship and sign up with rivals.

The bonuses are expected to cause outrage among Barclays UK employees, who are being balloted by the Unite trade union on strike action over the scrapping of the firm's final-salary pension scheme. Barclays has cut hundreds of jobs since the financial crisis erupted in 2007. Protests are also expected from Lehman creditors, who are fighting in the courts on both sides of the Atlantic for money that was owed by the US bank before it went bust. Barclays stepped in to buy Lehman's American business for $250m (£153m), while its European arm was sold to Nomura.

The Barclays deal was viewed as a coup for the UK clearing bank which is led by chairman Marcus Agius and chief executive John Varley. The Lehman acquisition has allowed the British institution to become a major player in investment banking, competing for mandates along with giants of the industry such as Goldman Sachs and JP Morgan. Analysts say that Barclays Capital, the bank's investment arm, has become so profitable that it could account for the lion's share of the £3bn of interim profit that the institution is expected to report in the first week of August.

BarCap's income is expected to more than make up for write-offs that Barclays is forecast to make against its domestic and commercial lending books. Brokers say that BarCap's contribution to 2009 pre-tax profit should rise from 30% of the total in 2008 to more than two-thirds. Goldman and Morgan reported a surge in second-quarter profit last week, setting the stage for lavish bonuses at the end of the year. The return of bonuses - Goldman's remuneration bill will top $20bn - has caused a political outcry, as big payouts were deemed to have helped cause the credit crunch by encouraging excessive risk-taking and irresponsible lending.

Last week, Liberal Democrat Treasury spokesman Vince Cable said that it "shouldn't be back to business as usual" for financial institutions. But investment banks have been able to take advantage of the explosion of activity in the bond markets, where governments are raising billions to cover increased expenditure. The banks left standing after the financial turmoil are also benefiting from a reduction of competition following the collapse of firms such as Bear Stearns and Lehman last year. Other profitable areas of activity are hedging deals, where financial institutions seek to profit by predicting the future price of currencies, equities or commodities such as oil.

Barclays has pleased investors by avoiding the need for a government bailout, unlike RBS and Lloyds. But it has been criticised on various fronts: shareholder activists have questioned the huge payouts to staff at its fund management arm, BGI, following the sale of the business to BlackRock for $13.5bn. Bob Diamond, BarCap chief and chairman of BGI, is in line for a payout of £22m from the sale, while the arm's chief executive, Blake Grossman, will collect about £55m. The ballot over strike action at Barclays will be held this summer. The scrapping of the final salary pension scheme - even for existing members - has been labelled "a betrayal" by Unite.

Lord Myners attacks bankers’ greed and finds God
Lord Myners, the minister appointed to clean up the City, is so disenchanted by bankers’ greed and self-aggrandisement that he is planning to become a theology student. Myners, who was blamed for failing to block Sir Fred Goodwin’s £16.9m pension payoff,and has spent the past few months trying to persuade the City to curb its casino culture, has attacked the "troubling absence of clear moral purpose" in banking. He amassed an estimated £30m fortune himself in business and financial services before joining Gordon Brown’s "government of all the talents" last year as financial services secretary. Several other "goats" have already resigned.

This weekend Myners said he no longer intended to return to the City full time when he steps down as a minister. He told The Sunday Times he was worried he may have "neglected" the moral purpose of life and was "increasingly exercised and concerned with the fact that we have compromised our lives". "This is very evident in the financial community – that money has become everything. People have lost their sense of purpose. The absence of clear moral purpose is something that is very troubling," he said.

Myners, a Methodist, said he was "not particularly observant" and had "not been a regular churchgoer". However, he said he would like to study comparative theology to see how different faiths treated moral questions. Asked whether he planned to be ordained, he said it was "far too premature" to say, but added, "you never know". Myners rose from humble beginnings. He spent his early years in a children’s home in Cornwall. He was adopted at the age of three by a butcher and a hairdresser, and won a scholarship to a Methodist school.

He started work as a teacher in London but switched to financial journalism. A career in the City led to him becoming a highly-paid fund manager. He is a former chairman of Marks & Spencer. He was brought into government last October to help rescue the banking system, but has become frustrated by the determination of many in the City once again to extract maximum short-term rewards.
Earlier this year he said: "I have met more masters of the universe than I would like to, people who were grossly overrewarded."

UK Tories say break up the big banks
George Osborne, the shadow chancellor, will this week publish his "white paper" on banking regulation, pledging to scrap the existing triparite system and the Financial Services Authority and hand back supervision to the Bank of England. His proposals, due tomorrow, are more keenly awaited in the City than most opposition statements, because the Tories are expected to take power next year.

Osborne will float the idea of a separate markets regulator, similar to America’s Securities and Exchange Commission, in addition to the Bank’s new supervisory role and a new consumer regulator for the financial-services industry, though no firm decision has yet been taken on this. He will be clear, however, that the Bank should have powers to order banks and other financial institutions to hold more capital when times are good, so that they are well-placed to cope with the losses that arise during downturns.

These counter-cyclical capital requirements, one version of which was the so-called dynamic provisioning used for Spain’s banks, are seen by Mervyn King, the Bank governor, as an essential part of the "macro-prudential" toolkit. The most controversial part of Osborne’s proposals, however, will be his response to the "too big to fail" problem for banks. He is expected to back King’s view, set out last month, that large and complex banks that combine retail banking with risky investment banking, should either not have their deposits guaranteed by the taxpayer or be discouraged by even larger capital requirements.

Osborne will make clear that he believes some banks were allowed to become too big. He will give the Bank the powers to intervene – and, if necessary, break up – banks whose size and structure threatens financial stability.
Vince Cable will also outline his blueprint to shake up Britain’s banking system tomorrow at the London Stock Exchange. The deputy leader of the Liberal Democrats will call for the government to break up the banks and end taxpayer guarantees for casino banking.

Cable told the Sunday Times: "It is the unavoidable issue which the government and people in the City seem to be determined to avoid – but we cannot accept a continuation of taxpayers underwriting global investment banking.
"The only way to stop it is to break up the banks, starting with those that have been semi-nationalised." The move would see the banks split off their retail divisions from their riskier commercial arms. Cable will also accuse the Conservatives of "mischief making in a turf dispute between two quangos" with its proposal to overhaul the tripartite regulatory system and hand more power to the Bank of England. He will say the Bank should retain overall responsibility for financial stability but the FSA should continue to play a key role.


Norman said...

Wow, you are late.

If I find a job, I'll send you some money not to be late.

Heh. I'll be here all week.

scepticus said...

"These counter-cyclical capital requirements, one version of which was the so-called dynamic provisioning used for Spain’s banks, are seen by Mervyn King, the Bank governor, as an essential part of the "macro-prudential" toolkit."

Sounds like an increase in bank reserve requirements to me.

Regarding housing: population decline, population aging and a coming baby bust will ensure that in the multi-decade long term ensure demand for housing remains extremely depressed. Vast tracts of former urban land will have to be abandonded and returned to nature. For example, large tracts of eastern germany, eastern europe, and parts of the US will become places where nobody wants to live. Populations will have to concentrate in sustainable urban arrangements to support themselves, and will tend to do so in areas where the energy requirements for living are minimised.

A transition from 300 years of very robust population growth to a future of possibly 300 years of population decline will require a complete rethink of everything we know about economics, even leaving the issues peak oil to one side.

Bigelow said...

We always said Walter Cronkite for President! Not corrupt enough though. Ronald Reagan was selected for us instead.

DIYer said...

Like I was saying about that housing start chart ... I can see an "inflection point" and a green shoot in it. The bottom is actually shown on the vertical axis, it is at 0. Give or take some statistical modeling, the starts will stop falling at that point.

And I still have my knickers in a twist about that "blame yourself" post the other day. As a matter of fact, Kucinich was off the ballot by the time the primaries came to Texas. I voted for Hillary instead. Then for the O-man.

I didn't really expect him to be anything but a politician, but it's less of an embarrassment when I meet people from overseas to have an "America's Mayor" who can string together complete English sentences.

And there hasn't been much I could do about my congressvarmints, either at the state or national level. Perhaps I'll donate to that local state rep I sorta like, instead of the TAE tipjar...

Glennjeff said...

A sleep well earned viewed from this end of the wire. (I'm wondering if you got lucky and wore yourself out till dawn)

snuffy said...

That man spoke more truth in 20 minutes than most do their entire lives...

I grew up listening to him...

The icons of America are almost gone.When you look at the pre-packaged ,blown dry hair,and I got it all smirk behind the carefully neutral exterior...or in the case of the fox "news"crews...Blatant propagandist....I can see how far we have fallen.

That tape should have been played more on you tube..

Its become clear now the "best and brightest[and most amoral?]are invited to join a club...the money making club[sorry,your not invited]
This club lets you have your hearts long as you continually figure out more creative ways of screwing everyone else...and by the way...politicians get to join for they are the ones who allow it in the name of "free enterprise"This kind of dreck is tolerated when times are good,due to the dream of many to join the monied class...but it soon becomes a sour,bitter taste that sticks in the throat and poisons the thoughts of those who see their own dreams shattered,their children leading hard-scrabble lives of desperation.
Beware the will come in spades...

I say this as someone who never re-fied,paid my second off,lived within[actually lower than]my income and carefully cut up all credit cards 12 years ago when wife and I figured out everything bought with a card is 20-30%more...[when you tally in card cost]

And it didnt make a bit of difference.I am screwed just as bad as someone who has been a total spendthrift.I am on the same roller-coaster to hell as the rest.The carefully built-up equity in my small farm is dropping so fast its scary,the only redeeming fact is my land payment is so low I could barely get a apt for that price

As I am back to work for the moment[which could change in a moment]I find myself frantically paying off the last doctor bills[clear the account]last dentist bills[total rebuild...way way too much]and trying to prep for a future that looks grim at best...and descends to terrifying

I have developed the ability to look outside my own experience to try and see what may come.Its a skill I honed while doing radiation safety[RADCON] during refueling operations in my younger days.You are taught to break down all actions/tasks to the minimums...and plan for as many "alternative endings" as seem rational..
Keep looking outside the box folks.Things are approaching a inflection point,and I have not a clue where it will go ,except its not on our radar now I think...
What we here at TAE are discussing is outside the norms of life here in the USA for the majority of the readers.The speed at which change is happening here will be seen in the future as breathtaking...though it does not now to the participants...just another day..and the challenges therein.We have been in a "consumtion rut"for way way too someone who "has not noticed"their weight go from 155 to 300....

This diets going to be hell...


VK said...

Imagine if you will a nice, sunny island but quite isolated from the rest of the world.

In a positive sum game, we would find 3 beautiful women isolated on that island and one lucky man. In a year all 3 women would be pregnant and life would be good even in the middle of nowhere.

Now that's the world we have grown up in but since we are now in a negative sum game where the wealth pie is shrinking, we find that we have 3 dashing chaps and one beautiful girl on the island. In one year 2 of the chaps would be dead or all 3 chaps due to injuries sustained from fighting and the girl might be killed to as the mentality might be ,"if I can't get her, no one else will". Either way it's a dangerous situation to be in.

That's the difference, same island, same nice sunny isolated spot but resources (women) were abundant in one situation and lacking in another.

Welcome to the negative sum game folks, the prize is the golden triangle going through the middle east where 60% plus of the worlds known oil reserves are thought to lie. The dicks fighting over this are the US, Russia, BRIC etc. The US strategy has been to create a cost free entry into the region with all their military bases and troops stationed strategically in Iraq and Afghanistan.

The mentality is, we get first access to those resources and if anyone else wants in, then no one will get anything.

el gallinazo said...

I for one, applaud scepticus's posts, not because I think he is correct, but because his challenges are articulate, intelligent, well constructed and thoughtful. Even if Ilargi doesn't have the time and energy to keep up the debate, Stoneleigh and VK are doing quite a job. The net result is a greater understanding of deep macro-economic issues for all of us.

I am amused by scepticus's cheerleaders, who I more than suspect, don't have a clue what the fcuk he is writing about, other than he is challenging a major theoretical construct of our hosts - namely that deflation is unavoidable with the collapse of the Ponzi scheme. If scepticus were arguing that the Earth was supported by giant tortoises, these assholes would be cheering him. However, this is no reflection on scepticus.

They harp on how boring this blog is, yet they keep hovering about it like yellow jackets around spilled antifreeze. Hopefully they will find the same fate. I think Starcade is right that Arnold is a shill. He probably isn't as dim as he presents himself.

For what it is worth, I made a resolution yesterday that I will not respond to, or even read, solely time stamped A's. If they have so little respect for their writings not to affix any consistent tag to it, I will treat it in a similar fashion. This time, I am going to stick to my resolution.


"Firstly, the way I see things in the US is that you have what I'd characterize as a benign, faintly fascist dictatorship. Its benign in the sense that it tries to avoid torturing, murdering and violently suppressing its own citizens (but only as a general principal, and only within its borders)."

As an American, I will have to disagree with you here. And it is important, because this idea is a cornerstone of your predictions regarding monetization.

The USA has the highest rate of prison incarceration of any country in the world. IIRC, it is currently higher than the Soviet Union under Breshnyev.

The USA spends more on its military than the rest of the world combined.

Diane Feinstein, supposedly "liberal" senator from CA announced that her mail regarding the bailout ran 10,000 against with none in favor. She voted for the bailout.

USNORTHCOM was established under the Cheney administration in October, 20002. It is a command for suppressing dissent or "disorder" in the USA, Canada, and Mexico, using the full force of the US military.

The so-called Patriot Act has eliminated most of the constitutional rights of citizens under the Bill of Rights.

The SCOTUS has an overt five member majority who are more than "faintly fascist," as you put it.

What the executive has not pushed through with the Patriot Acts, they accomplished with simple violation of the law. In the case of warrant less wiretaps, the congress expunged their criminal activity expo facto, and the criminal activities continues under O-nan.

O-nan refuses to rescind the Cheney executive usurpations.

The Lancet did a rigorous study trying to ascertain the actual number of Iraqi citizens killed by the most recent invasion and came up with the number of approximately 1 million. It is generally recognized that over three million Vietnamese civilians were killed in that war.

I could go on and on and on.

So scepticus, if you are basing your predictions that the USA is at this point only "faintly fascist," you are basing them on shaky soil indeed.

Stoneleigh said...

Anon @4:16 yesterday,

The predictions are set in stone. Yeah, I got that. I think we all do.

It is the big picture of our predicament that has not changed. We are further along the road, but it is still taking us in the same direction. We are still facing financial implosion, energy limits, water limits, carrying capacity limits, and a shift towards a very negative collective psychology that will make dealing with everything else that much more difficult.

At this stage, people need to address financial collapse with liquidity and no debt. They need to maintain flexibility in the face of uncertainty, minimize the consequences of being wrong and be prepared to work with others for the good of the group. This prescription, and a dollop of luck, is the best bet for carrying families through deflation. Note that it is not a guarantee.

As deleveraging runs its course, people will need to shift to hard assets in anticipation of the road taking a different turn.

Boooooring. Nothing new here. Move along, move along.

You aren't a patient person are you. Don't worry, the world will get very exciting (in the Confucian sense) soon enough, then we will see a collective shift from complacency and greed to panic and anger. Life will probably never be boring again, though we'll all wish it could be I suspect.

But by all means keep trying to force feed everyone your set-in-stone predictions. You have and will get some of it wrong, which diminishes the credibility of the bits you got right.

As you said, I am not a prophet. I am a thinker, and I choose to share my thoughts with others because I want to help. If you don't find it helpful then there's not much point in reading here.

And your rigidity and narrow thinking is losing you valuable feedback ....

I am a generalist. Breadth and synthesis are what I have been doing all my life. The picture of where we are going in general terms is quite clear in my mind, but I do incorporate fresh information all the time.

Bigelow said...


Ilargi can’t well call for open revolting; his blog and probably more would be endangered. Hence, the “blame yourselves”. That is a guess. [your fault]

Since we have yet to show the wisdom and unity [your fault] attributed to future humanity on a Star Trek television show, our suddenly rising and stopping these crooked systems has a low probability. [your fault] Unless a huge overwhelming number of people “get mad and won’t take it any more”, smaller groups will continue to be picked off by the security state.

Reading the comments here, the response to the authority of criminals seems to be either
1) resist them
2) ignore them
3) join them
Those approaches would not have worked well in Nazi Germany however –from the perspective of an individual’s extended life expectancy.

So blame all of us, in one big, expanding, mighty mass of active social awareness and activism. Otherwise, it is just an annoying assertion Ilargi keeps making. [your fault]

Greenpa said...

That's a fascinating bit from Uncle Walter. He knew.

And, yet, he chose to continue and support the illusion. I don't think he was bought- it feels like he saw the reality, and like so many of us, just decided on a subconscious level that the only thing to do was ignore it.

Very very interesting.

scepticus said...

El G, let me set out my view of our western political economy :

At the core of the onion we have the last remnants of the old feudal system, now revealed as an alliance of state and big business (formerly an alliance betwen the monarch and the nobility). This is the faintly fascist part.

The next layer is a thin veneer of socialism in the form of welfare and education, designed to mask the uncaring neo-feudal core.

On top of that we have an even thinner veneer of democracy to hide the totalitarian tendencies of the first two. The democracy changes nothing.

The outer layer is a froth of popular culture and simulated complexity designed to obfuscate the fact that nothing ever really changes.

Our society has operated in this way essentially forever, and if you think your freedom is significantly more constrained now than it was say 50 years ago, I think you're wrong.

What has changed is the methods by which the nation state is administered, and the current method is more or less free market oriented since the outer 3 layers of the onion are very complicated indeed, and also inherently unstable making more centralised forms of control untenable.

The operation of that market system is of course tilted in favour of the core - the method of administration has always been tilted in favour of the core (think of it like a gravitational force), and indeed how could it be any other way in a civilisation which plans to perpetuate itself?

If the system were tilted in favour of the outer layers, the civilisation thus subjected essentially to an anti-gravitational force would tend to distintegrate after which it would presumably coalesce into one or more new cores different in detail but essentially unchanged in the direction and polarity of the political and economic forces.

As such our aim for the future should be to ensure that the inevitable configuration of human society is appropriate to it's future environment and perpetuation of civilisation is possible. I beleive that future is best served by a process of decentralisation from one into a number of cores for reasons of robustness and redundancy which we'll need in the years to come.

However it's not clear to me that even in this configuration the freedoms of a given individual will be much changed, although quite possibly we'll have exchanged one freedom for another in this new layout. So is the object to be freedom (and if so which ones), or perpetuation of the species?

Anonymous said...

Interseting to note, no big media frenzy when the banks "generate" millions in "profits", let the oil companies make such "profits" and the media is ready to tar and feather them. I have yet been able to drive to town on a GS profit, yet am able to on an oil co. profit. Something to consider on this fine Monday morning. John

ca said...

Stoneleigh --

Lately, there seems to be more discussion in the blogosphere about using dollar devaluation to halt deflation.

Could you provide your thoughts on this?

Nnonnth said...

One question from an ignoramus:

If a government wished to take the same amount of money it spent on the cash injection, and instead, spend it on preparations for the crash (that is, helping people obtain basic necessities and putting emergency measures in place) could it actually do so?

Would it be able to conjure up that much money, if the (implied) use to which is was going to put it assumed a financial crash in the offing?

What would happen to the world markets if one government unilaterally decided to try and do that?

Stoneleigh said...


It would be a solution if you posit that interest rates be allowed to follow the market wherever required, +ve or -ve to ensure that the market supply of savings is always cleared.

The 0% bound represents an arbitrage in favour of savers, and as you should know an entrenched arbitrage will prevent markets clearing. It is an uncleared market for savings which leads to deflation.

Deflation will result from the collapse of the credit pyramid that has been built over decades. Credit acts as a money equivalent during the expansion phase, vastly inflating the effective money supply. It ceases to act as a money equivalent during contraction, crashing the money supply.

The nominal rate of negative interest required to compensate for the rate of credit collapse would be huge. We may well see negative nominal rates, but not at anything like that level.

Once interest rates reach the right level, savers will find borrowers and this will ensure we get back to a situation in which all savings are lent out rather than accumulating in bank reserves. When all savings are always recirculated, deflation will never be a danger - since it arises due to the market distortion created by the 0% bound.

I strongly disagree. Your economic model does not account for the role of credit, the extent of credit expansion, ponzi dynamics or the critical role of human emotional (ie non-rational) decision-making in the way markets and economies function. Economies are not machines which can be neatly controlled by pulling this or that lever. They do not behave linearly and are not based on negative feedback.

I said: "With the scale of credit collapse we are looking at, real interest rates will still be quite high (ie a negative nominal rate minus a larger negative inflation rate)."

Incorrect. With nominal rates sufficiently negative the market will clear and all money will continue to circulate in the economy as per usual.

I stand by what I said. We are not going to see nominal interest rates anything like negative enough to compensate for the collapse of credit. Real interest rates will still be significant.

Also, we are not going to see willing borrowers and lenders. Borrowers are mostly maxed out and lenders are belatedly becoming very risk averse. The rally has abated the degree of risk aversion slightly, but not for long. When the decline begins again, risk aversion will increase dramatically. The Fed will be pushing on a string.

Stoneleigh said...

Scepticus (continued),

When a bank makes a loan at say -1%, it creates 100% of the principal out of thin air but only requires that 99% is repaid. That 1% goes straight into the economy and ensures inflation.

It is real interest rates that are the important factor.

A -3% rate would make people like buffet and soros, as well as high net worth individuals think very carefully about what to do with their money, since -3% compounded over 20 years would take most of their wealth away.

People would still hold cash and cash equivalents at -3% if they would lose more by holding anything else. Cash will still be king in that it will be the least worst option. Asset markets will be collapsing at a much greater rate.

I said: "As for raising reserve requirements, this would be highly deflationary as it would act to increase credit contraction enormously. "

I agree it is deflationary in principle, but by the time that was enacted, if demand for credit is in the toilet anyway it won't add to deflationary pressures. That is, you can monetise debt and raise the reserve ratio to the extent that demand for credit can be relied upon not to return, without doing further damage to the economy.

We will see initiatives like this that try to repair balance sheets and introduce far more caution, but under conditions of credit contraction, risk aversion will aggravate the fall. Similarly at the individual level there is a disconnect between what would be needed to keep the economy going and what people need to do to keep themselves afloat.

The prudent actions of the individual in paying down debt and reducing unnecessary spending doom much of an economy that is critically dependent on the excess spending and borrowing that comes from throwing caution to the wind for years. The positive feedback loops that are activated as an era of excess ends are very powerful. Deflation and depression are mutually reinforcing.

The key is that it requires admission of a long term secular low growth or no growth future, and people in the administration and at the helm of the economy won't admit this in public - yet.

We're going to see a period of extreme contraction. Growth will be off the table while deleveraging runs its course, and that will take many years. Even beyond that time we are not going to see stability or growth as we have come to think of it. For us life will never be the same again. Manias such as the one we have lived through happen very rarely, and their aftermath is both devastating and prolonged.

Anonymous said...

Arnold and entities like Anon @4:16 and even Scepticus to an extent, are in the first stages of grief whether they know it or not. There's several more levels to go through. The predicament humanity will shortly face is so huge as to be incomprehensible to most.

I'm running into more people nowadays who are beginning to hear the steadily building roar of the giant waterfall of Deflationary Depression and are getting quite scared on a subconscious level. You can see it in they're eyes and body language.

This is precipitating odd little quirks of irrational behavior in them that remind me of the old joke about the person being told by their bank manager that they are totally broke. To which they answer, "I can't be broke, I still have checks!"

This what the majority of Americans will be saying shortly in unison.

As we approach the Waterfall of Deflationary Depression, people will be paralyzed with fear as they finally catch a glimpse of the rim approaching and the magnitude of the Reality of the Dilemma.

At that point many will realize that a dilemma of this unparalleled proportions has no solution at this very late hour of reckoning.

The mental stability of large portions of the populous is very much in question at this point.

Even with TAE to help 'boil the frog' of awareness one degree at a time towards grasping the outline of what faces us, I find it mind numbingly depressing to deal with.

A fatalism is creeping into me that I've never had. I guess it's almost a kind of lack luster spiritual resignation about one's inevitable end which must be dealt with some day anyway.

Thanks for running this site anyway, even though the truth of things is such a mess, it does seem a bit easier in a way to back into awareness baby steps at a time than to endure the total shock of this predicament in One Fell Swoop.

Taizui said...

Snuffy @ 8:48

Thanks for the Snuffy heading. That gets me to pay close attention from the start.

"I am screwed just as bad as someone who has been a total spendthrift. I am on the same roller-coaster to hell as the rest."

I wish I didn't know what the heck you're talking about -- I prepared well for a major recession, but "this" wasn't on my radar. You seem much better prepared than I, but it's somehow comforting to hear that even the best preparations now seem inadequate. Getting laid off last fall was perhaps a good thing, since that's when I started to pay more attention to I&S!

It's hard to keep up, as I'm busy with gardening and homestead constructioin, but I also appreciate scepticus' arguments -- maintaining my mental agility and flexibility -- I don't care who is "right."

bluebird said...

Chris Martenson has written about The Six Stages of Awareness, a very loose adaptation of the Kubler-Ross "Five Stages of Grief" framework.
Denial, Anger, Bargaining, Fear, Depression, Acceptance

you can read it at this link

Countersnarker said...

Stoneleigh said: If you don't find it helpful then there's not much point in reading here.

Some sad bastards like to feel as though they're smarter than blog owners. So they come on and drivel anonymous troll-snark. It lets them feel powerful, which is something they aren't in their insignificant meatworld lives. They could start their own blogs, but no one would read them, so they have a go at the kewl kidz. A pity, that they'd devote so much time and attention to something they purport to disdain. What a miserable existence some people must have.

Stoneleigh said...

Anon @10:29,

Thanks for running this site anyway, even though the truth of things is such a mess, it does seem a bit easier in a way to back into awareness baby steps at a time than to endure the total shock of this predicament in One Fell Swoop.

Being mentally prepared is very useful, as it does indeed reduce the shock. Having the rug pulled out from under one's feet suddenly can lead to an all-consuming panic that precludes any sensible action. When one is expecting it, and has gone through some of the adjustment process in advance, the capacity for sensible actions under pressure is greater despite the fear.

As I have said before, we aren't preaching fatalism here. Although there is nothing we can do to prevent living through a depression, we can prepare for a different life that has the potential to be more enriching in some ways on a human level than the lives we are used to. We will rediscover people and the relationships that are what really make life worth living. We will learn to appreciate the simple things in life again. Yes there will inevitably be hardship, but there are actions that are very much worth taking that (with luck) have a chance of reducing that hardship.

Good luck :)

CS said...

Earlier this morning there was a BBC business headline:

"Surge in mortgage lending".

Type that in to google now and you get the afternoon downgraded version.

"Summer rise in mortgage lending"

Must have clouded over at bbc hq, or perhaps the journo got his cc bill. Or something.

Reminds me of that edited '16.3 trillion' telegraph headline that was edited post haste to "European bank bail-out could push EU into crisis". Spin, spin...

Surge is one of those red flag newspeak uber emotive words isn't it?
A sucker rally call to arms - "Come on, if you're not with us, you'll miss the surge!"

Oh and Stoneleigh, your patience knows no bounds...respect..and your reponses have more gravitas because of your cool-headedness.

In the next five years do you anticipate (m)any more sucker rallies? IIRC there was a pull back of (e.g) 140% in Japan's stock market at one time over the last 20 years.

Do you think there may be other chances to sell property at (say) 80% of what it is now, depending on viability, initial exposure to the housing bubble, etc - or do you think this autumn/winter is really our last shot?


Stoneleigh said...


Thanks :)

There will be other sucker rallies of different scales as they represent movements at different degrees of trend. This rally is quite a large one, and there will be other large ones down the line. I would expect the next down phase to last at least as long as the one from October 2007-March 2009, and quite possibly longer. It should be a more powerful force than the last decline, but should end in a rally of a similar scale to the one we are in now. We might be living in quite a different world by then though.

I don't think there's any chance the next large rally would represent an opportunity to sell a property for 80% of present value unfortunately. The top of this rally is still such an opportunity, but once the psychology turns, the real estate market could freeze up again very quickly. Real estate tends to go illiquid faster than almost anything else.

CS said...

Thanks chuck, feared as much.

Right, on with tarting up the kitchem, more DIY. Tempus fugit and all that.

Are you sure my wife's not tipped you the wink just so we get the house up to scratch asap? ;)

Stoneleigh said...


Lately, there seems to be more discussion in the blogosphere about using dollar devaluation to halt deflation.

I expect to see a flurry of beggar-thy-neighbour competitive devaluations in the future, but not now. I think the dollar will rise on a flight to safety no matter what value central authorities would like it to have. Deciding to fight the market over currency valuations is a recipe for central authorities to lose a lot of money very quickly. Some have tried it, but the track record is awful and only speculators end up winning (like when Soros broke the pound in the 1990s).

Anonymous said...

CS at 11.06am
this summer is your last chance
winter is never a good time to sell

Anonymous said...

As a matter of fact, Kucinich was off the ballot by the time the primaries came to Texas. I voted for Hillary instead. Then for the O-man.

If you were going to vote for Kucinich, the next logical step would have been to vote for Ron Paul. They were the only one's declaring we should bring the troops home, along with other similar stances. Not Hillary or Obomba.

DIYer said...

About the stages of Grief/Awareness,

Someone over at TOD a while back said he just went straight to the depression step. No point getting mad at reality or trying to deny facts. It was pretty much that way for me, I'm just now recovering from hurricane Katrina/Rita as a born-again doomer. I don't really want to be anesthetized against it, as perhaps it will motivate me. Well I have started hoarding cash at least.

Haven't convinced the spousal unit so much...

I think that, among those of us with some scientific education, the initial stages of "NO! It can't BE!!" pass more quickly.

Miller Kephart said...

Stoneleigh said: As I have said before, we aren't preaching fatalism here. Although there is nothing we can do to prevent living through a depression, we can prepare for a different life that has the potential to be more enriching in some ways on a human level than the lives we are used to. We will rediscover people and the relationships that are what really make life worth living. We will learn to appreciate the simple things in life again. Yes there will inevitably be hardship, but there are actions that are very much worth taking that (with luck) have a chance of reducing that hardship.

Funny. Just a week ago, many people, including Arnold, were trying to point out the same exact things that Stoneleigh lays out here. They were asked what positives could come from collapse. The difference is that these people were laughed at and belittled and told they were delusional optimists stuck in the first stage of grief/denial.

Maybe you should read the primers Stoneleigh. You need to be reminded of your very own apocalyptic screed.

scepticus said...

Trust me, I've been round the loop a few times on the grief/fatalism thing. You'll find some of my posts at, and I have been there off and on for a good while.

Don't presume to judge what mentals states I have or have not visited, based on what is a more optimistic reading of the future than that which is generally fashionable in this little corner of the blogosphere.

Anyone who's going to abandon hope based on a hyper deflationary thesis should not do so unless they understand the macroeconomnics behind deflation, which in turn requires an understanding of what money is, and the relationship between savings and lending.

It seems to me this latter point has not been well understood here, and therefore the abandonment of all hope was not founded on true understanding.

Ahimsa said...

Re denial and those questioning the reality of collapse:

I think so many people are in denial about the intensifying multi-facet collapse because "Americans" (citizens and residents alike) believe -- consciously or subconsciously -- in the infallibility of the United States. Why is this? It probably has a lot to do with a culturally implicit British and Anglo-American heritage of "white supremacy" and the cultural pride and patriotism generated by having ruled the world in modern times.

Additionally, if one accepts the reality of US corruption and cruelty at home and abroad, then one also would have to question and examine one's personal values, role and lifestyle in this society. Alas, most people are either unwilling or unable to practice such self-scrutiny. Hence, denial will probably continue until reality becomes so painful that no one will be able to deny or rationalize it anymore.

scepticus said...

Stoneleigh I'll respond to your latest later on today.

Thanks for the constructive engagement, I appreciate it.

Anonymous said...

I am also enjoying the Skeptics posts and hope he sticks around. At the end of the day, however, and just before he departs, I imagine Scepticus will announce the grand opening of his own new blog site. That’s just the way it works in the blog world. In fact, I discovered TAE in exactly the same manner from the DKOS site. Another amusing tactic is when the head of another moribund site moseys on over to where the action is and make a “post” or two. It’s a coattail riding world out there.

Yeah Cronkite had character. Not like the grinning mannequins on display in the year 2009. Same with the sports world. Before the goofy ex-jocks and their banal locker room vernacular took over sports broadcasting world, there were real professionals with talent calling the games. Broadcasters such as Curt Gowdy,Al DeRogatis, Lindsay Nelson , Ray Scott, and Howard Cosell. Country music is a sad joke, a vapid ghost prancing in front of clapping idiots in faux cowboy hats.

We are the neon culture painted with a monotone brush in the color bright dull. The products of the taxidermy studio stuffed with pretense, arrogance, and an apathetic non-chalance


Wild Gypsy said...

Ilargi & Stoneleigh,

I have appreciated a number of articles lately including the ones on homelessness (last week)and this one from today, "Share and Swap Replaces Grab and Buy"

Just a further thought I would add to the notionary comments that "people are willing to work for free..." is that I hope we all take stock of sharing knowlege and skills freely. If people are more receptive to working for free in order to be more empowered, then I would think that teaching should come with the work as much as possible.

If you are passionate about bee-keeping, find a young person or six and inspire them too. You don't need to explain macro-economics or convert their politics, just plant a seed of hope an teach them how to nurture it.

--I've given up reading the blog commentary but I really appreciate the variety of news articles and your expressed views and analysis.

YD said...

To this reader, it seems the heart of the disagreement between Scepticus and Stoneleigh is the deflationary power of evaporating credit. I have been convinced by Stoneleigh and Ilargi that the credit contraction is deflationary, I am not seeing from Scepticus' argument why a lender would lend at a negative rate ever. A bank would but they don't actually have the "money". Scepticus may be right, the money we are using is already funnier, maybe they will conjure up some way of making it a true laugh riot, but that doesn't match my experience. Over the last almost two years I have seem much more of the TAE analysis born out than disproven. Ilargi is subject to hyperbole and gets grumpy, but so do I, so I am taking that into account rhetorically, in other words you can't always take him literally, but I don't think he claims you should. Anyhow...
Can anyone think of a society or currency for that matter, that survived 300 years of contraction? How about 30?

Stoneleigh said...

Miller Kephart,

Funny. Just a week ago, many people, including Arnold, were trying to point out the same exact things that Stoneleigh lays out here. They were asked what positives could come from collapse. The difference is that these people were laughed at and belittled and told they were delusional optimists stuck in the first stage of grief/denial.

The people who were being challenged were looking for societal solutions that would allow business as usual to continue virtually uninterrupted, or at least postpone the collapse beyond their own lifetimes. IMO this is not constructive, as a lower level of socioeconomic complexity lies in our future no matter what we do. Our efforts are better spent preparing for it than trying to prevent what cannot be prevented.

I have never said life would not be worth living in a depression, even one as serious as this will be. I do not regard my writing as apocalyptic screeds. Forewarned is forearmed (in the mental sense). If anything we can do helps people to take actions such as working together in advance, so that they are prepared when they need to depend on those social structures, then our efforts will have been worth it. This is not a time to give up on hope or on life, but business as usual will be history. Clinging to that as the only model is simple denial.

YD said...

On another note, I am selling a condo for high 140's, the last unit in the building sold for 172, the estimated peak value (nothing was sold) would be about 185 maybe even 190. I had a buyer, well qualified wanted a place for her son while attending medical school. But the banks don't seem to want to lend. In my case it is being blamed on new reporting requirements for condos that have made the buyer squeamish and to look for a single family home instead. But an ex-employee of mine's father is trying to buy her a condo so she will live in a good part of town, and he can't get financing either. There is nothing wrong with his credit or ability to make a down payment, just lots of reticence in the lending community. Anyhow my two data points conjecture as your will.

Jim said...

As a complete aside, whenever I hear about perpetaul growth, progress, technology, etc. I always picture the end game of this as that planet in the most recent Star Wars trilogy - Naboo I think - the one that is all city where the Jedi council meets.

Imagine that....Manhattan completely covers the planet. It's crazy. Where are all the building materials coming from? Where is the mining? Where is the food coming from? There is no plant life on the planet! How is ecological balance maintained? There doesn't even appear to be oceans. Where is the energy coming from? Can you imagine the pollution!!

I know it's science fiction, but I sometimes feel that that scenario is the goal for some of the BAU folks...

Anonymous said...

For what it is worth, I made a resolution yesterday that I will not respond to, or even read, solely time stamped A's.

Well that is one critic dealt with ... done in by his own hand too:)

Frank said...

@YD Rome. Hadrian broke ground for the wall in 122 AD. Romulus Augustulus was deposed in 476. Constaninople fell in 1453.

There were some serious sucker rallies along the way, but the trajectory was down.

Anonymous said...

Aesthete, you old cynic. The only way I'll be starting my own blog is if I get laid off and having nothing better to do, which I'm not expecting to happen any time soon.

On a more serious note, it does get repetitive explaining oneself over again in different places so I expect I'll just write it all up and publish online somewhere. But not for a while yet.

Meanwhile I remain to be fully convinced of my own bullshit, which is why I am here for the moment.


scepticus said...

"As we approach the Waterfall of Deflationary Depression, people will be paralyzed with fear as they finally catch a glimpse of the rim approaching and the magnitude of the Reality of the Dilemma."

Oh my god, get a grip.

jal said...

scepticus said...
Oh my god, get a grip.
It would be better to check out other opinions.
Then, try to make up your mind.
For starter check out the market ticker for today.

Commodus said...

Financial bailout's cost to U.S. could total almost $24 trillion

Guys I don't know if any of you have read this but this, if true, would mean game over.

VK said...

@ Ahimsa

"Americans" (citizens and residents alike) believe -- consciously or subconsciously -- in the infallibility of the United States.

An interesting point you bring up. Actually it is a key tenet of civilization that the center is divine. Myth is central to civilization.

In older times, the Incas used to worship the sun as well as the Egyptians. They believed their Kings were descendants of the Gods. The Romans had Jupiter and vested great power and influence on the Vestal Virgins who prayed for Rome and cleansed it daily. The Greeks had Zeus and their great heroes like Hercules and Achilles, while the Japanese believed their Kings were descendent from heaven.

In India there was great myth and pomp surrounding the ruling classes and even Kim Jong Il has required that he be known as a God in children's textbooks. In Libya Gadaffi has pictures of himself everywhere as being omnipresent.

People in America grow up in the belief that they live in the land of the free and blessed (with the highest number of prisoners in the world?) and that America has a divine right to exist and is heaven as promised by God. Leasers such as Washington, Jefferson, Lincoln and Benjamin Franklin become immortalized as time passes by.

The point being that the Center must be seen as having a divine right to rule. It serves a symoblic purpose and to create a sort of 'group think', where those within the culture are considered insiders and those outside are bad, bad people who must be fought against and kept outside like the Barbarians at the gate.

The prevailing view on the "War on Terror" is that Americans are good, freedom loving people who just want people to be free and that Muslims are bad and extremists. This leads people to conveniently forget that the US supported Iraq in the 80's and supplied it with weapons while they were fighting Iran, they also funded what became known as the Taliban during the Soviet invasion of Afghanistan in the 80's.

Every people think they are special and infact this appeals to our vanity and narcissism. That "I" am something special and unique and OH so wonderful. It makes us feel our little insecure selves seem a bit more secure if the Gods themselves had considered us a chosen people and how special is that, to be a part of that!

ps - Or maybe all people everywhere have Jewish envy ever since that incident in Egypt with Moses? ;-)

Ilargi said...

Yes, Commodus, the Treasury for some reason doesn't seem to like either Barofsky, the TARP Special Inspector General, nor Elizabeth Warren, who chairs the Congressional Oversight Panel to oversee TARP.

The Treasury this afternoon said that Barofsky is greatly exaggerating: "Treasury spokesman Andrew Williams said the U.S. has spent less than $2 trillion so far...."

There are a few options:

• Congress has appointed an absolute nincompoop in Barofsky (and by extension Warren)

• Barofsky and Warren are purposely frustrating the good people at the Treasury by incessantly making claims about numbers and lack of transparency (which Barofsky issues a separate report about today).

• The Treasury on purpose gives these people, appointed by Congress and with salaries paid by the American people, incomplete and/or faulty information.

• The Treasury thinks it can get away with anything it says and Congress won't dare act on the reports.

• Congress and Treasury both, and in unison, have elected to ignore the watchdogs.

Democracy functions in miraculous ways, doesn't it?

scepticus said...

It is real interest rates that are the important factor.

Agreed. If the real rate is estimated by the fed at -5%, and that seems like a reasonable estimate, and yet offered rates for credit are say +6% for a typical 30 yr mortgage, then no wonder no-one wants credit. Now if offered rates for credit were -1%, the borrower has some work to do to make sure repayments are maintained, but its doable, as long as the money supply is growing, which it would be.

People would still hold cash and cash equivalents at -3% if they would lose more by holding anything else.

You're forgetting about attitudes. Rates of just -1% would be a huge huge boost and send equities, commodities and house purchases soaring, though not back to pre-2008 levels. Before too long rates would climb back into +ve territory as demand for credit increases.

Now eventually people will realise thats not as easy money as it first appeared, since underlying growth is still -ve long term and then we'll likely have another bout of deleveraging, but eventually, over a period of a decade or two and people have learned their lessons, rates would eventually settle at levels appropriate for real underlying -ve growth.

The prudent actions of the individual in paying down debt...

A 300K 30 yr mortgage at 6% means you pay 647,514.00 for your house.

A 300K 30 yr mortgage at 1% means you pay 347,371.20

That debt is suddenly looking a whole lot more affordable!

The positive feedback loops that are activated as an era of excess ends are very powerful.

negative nominal rates would heal that pain by transferring wealth from hoarders to spenders and borrowers. It would change society powerfully for the good over the long term and give a massive boost to money veolocity.

why would banks lend at -ve rates?

Banks make money on the spread of rates between savers and borrowers. The bank can take deposits at -3% and lend at -0.5% and make a profit. Forcing this is achieved by charging banks for reserves held at the central bank, which then get passed on to savers.

scepticus said...

Denninger: "This is outrageous and threatens the very stability of our nation. How anyone can believe our banking system or indeed our nation's Treasury can survive the exposure of $24 trillion dollars, twice our GDP, is beyond me."

I have outlined exactly how it can be survived and the Chinese can be kept happy (ish).

Anonymous said...

"Congress and Treasury both, and in unison, have elected to ignore the watchdogs."

Winner, Winner, Chicken diner.

jal said...

scepticus said...
"Banks make money on the spread of rates between savers and borrowers."
Cough, cough ....

If they had we would not have had a credit meltdown.
All that "spread" income went into covering the expenses/bonus. Then they even borrowed against the projections of future revenue stream.

Credit was not just limited to consumers and gov.
The banking industry took on a lot of internal debt with the expectation of paying it back with an ever increasing revenue stream.

I wonder why they are issuing more bonds, preferred share, common shares?
Would it be because they have spent all of their cash (spread)?
Would it be because they are getting new investors so that they can have cash to pay off dividends to the old investors?
Would it be a credit ponzi scheme?

scepticus said...

Jal, there has been a credit ponzi. It was a ponzi because there is no way it could have been paid back because accumulating debt levels were so high.

The ponzi thus constructed can be safely drained and dismantled in an orderly fashion by negative rates, since negative rates remove debt from the economy rather than add to it.

The reason bankers have been making out like bandits is much more to do with the huge growth in volume of credit and due to fees made off securitisation.

There was alot more to the ponzi than spreads, and assuming those ponzi tendencies are controlled then the damage can be reversed in a controlled fashion over time by application of negative interest rates.

jal said...

Even karl, (and his commentators), who is faxing his proposal to the “lawmakers”, realizes that his proposals will not be enacted.;-Text-Edition.html
Yes We Can (Help Main Street); Text Edition
What makes you think that the “lawmakers” will follow your suggestions?


Anonymous said...

24 Trillion reasons to pillory Wall Street Wunderkind.

Coy Ote said...

From the Bloomberg article...

“TARP has evolved into a program of unprecedented scope, scale and complexity,” Barofsky said in testimony prepared for a hearing tomorrow before the House Committee on Oversight and Government Reform."

So, Barofsky may be overstating the case with the 24T figure, but the "...unprecedented scope, scale and complexity..." part even non-financial types like myself can understand.

I bet "they" are going to be quick to put a silencer on him.

Starcade, now from Leviathan said...

Norman: :P

VK, Re: Negative sum game:

Exactly why I think the rule of law is going to be very quickly replaced with the rule of the gun, and, as that one futuristic blog story put it, "Shoot, Shovel, and Shush".

We are about to become VERY expendable.

Frode said...

Stupid question: if deposit rates are -3%, why would I keep my savings in the bank? Why would this not cause a run on the bank?

I would certainly withdraw my hard-earned savings and buy (more) gold.

YD said...

Frode, that was my point I attempted to make earlier as well. With negative rates, cash is king.

Frank, What was the percentage of decline for Rome, is it equivalent to what we are undergoing? I think the other reason Rome might not be the best model for our stability is the nature of our networks. We are much more "optimized" for efficiency and are hence much more brittle and less resilient when faced with even localized failure than Rome would have been. Whether that just affects time scales or final effect I do not know.

scepticus said...

Jal, denningers plans will not ultimately change anything. Do what he suggests and we'll certainly be in a stoneleigh style depression.

Denninger, like many conservative commentators, wants to see the banks 'do the right thing'. The right thing will cause a depression, and contrary to conservative/austrian opinion, depressions do not clear markets and result in eventual recovery.

Making the banks come clean does nothing about wage arb, debt overhang etc. People like denninger spend a lot of time saying what they'll do now, but never address how things are going to work out 5,10,20 years down the line.

It's populism unfounded in reality. He offers no real solutions, just a short term bankster-bashing fest that would feel good for a while but would ultimately leave us all in penury.

My preference is to put in place a workable set of initiatives that will stabilise us for the long term, then make the banks come clean once the safety net is in place.

Greenpa said...

Ed Gorey, and El Gallispacho- a week ago or so you guys stated you were waiting for the S&P 500 to hit 1000, and then you were going to pull the trigger-

It occurs to me from the plain old Homo sap standpoint, there are probably a TON of folks with that identical idea. The nice round zeros are so attractive.

You might want to consider pulling the trigger either at 980; or at 1020, instead. It's hard to predict what the precise effect of "1000" will be- except a shipload of people will sell, immediately- dropping prices. How far is unpredictable; but if you're selling into a rapid drop, you might wind up selling lower than you wanted.

My own guess would be that after that drop- a few folks will jump back in- push it up OVER 1000, ever so slightly- then perhaps stop, breathe, look around, and slowly realize that the market, fundamentally, has no fundamentals left- and the long drop could start then.

:-) What fun it is to try to psych the market!

Anonymous said...

WASHINGTON—Some of the biggest recipients of the government's $700 billion financial bailout, including Bank of America and Morgan Stanley, increased their spending on lobbying in the second quarter as Congress began to look closely at revamping the rule system for financial institutions.

Alrighty then.

jal said...

Would 24T be enough of a detraction to derail the health care package?

VK said...

@ Frode

Exactly! That's why i'm sceptical of negative interest rates. If even 400 billion USD is withdrawn from the US Banking system in physical cash, that's THE END right there. There's only 800 bn in physical USD in the world.

@ Starcade

Greetings! How is sunny California?

@ Board

If anyone of you has excessive free time you could read this PDF paper by Wilem Buiter.

Can Central Banks go Broke?

scepticus said...

YD + Frode.

rates can't go seriously negative right away. Would need to start with say -0.5% to -1% on short term t-bills and bank reserves. That will tend to push investors out to longer duration bonds still in positive territory, which will flatten the long end of the curve and bring down the debt servicing cost, which is exactly what the fed is trying to achieve.

That may translate into say -1 ish rates on short term current accounts, longer duration CDs could still give +ve return if this action creates a plausible expectation of future inflation.

SO you'd have some options besides going to cash, such as longer term CD, equities or corporate bonds all of which gets your money out into the economy.

If rates were to go much more negative than that, some carrying cost would have to be attached to cash like a small discount whenever it is withdrawn form the ATM, and/or a subsequent tax when spent. Alternatively alllarge denomination bills could be withdrawn - so you can't keep large amounts of cash safely.

Gold, I'd expect a -1% rate to result in a bounce in gold only comparable to that which would result from 1 cut from +2% to +1% for example. Don't forget longer term savings and corp bonds would likely be paying positive, but low returns. Likewise seriously negative rates would see gold dissappear from circulation, and perhaps subsequently a transaction tax applied to it.

Frode said...


rates can't go seriously negative right away. Would need to start with say -0.5% to -1% on short term t-bills and bank reserves. That will tend to push investors out to longer duration bonds still in positive territory, which will flatten the long end of the curve and bring down the debt servicing cost, which is exactly what the fed is trying to achieve.

Are you talking about coupon rate or yield on bonds? You can set a coupon rate, but you can't set the yield. My understanding of the bond market is that bonds with a negative coupon rate could be sold for a lower price and therefore still have a positive yield. Basically, the yield is determined by the market, regardless of the coupon rate.

That may translate into say -1 ish rates on short term current accounts, longer duration CDs could still give +ve return if this action creates a plausible expectation of future inflation.

SO you'd have some options besides going to cash, such as longer term CD, equities or corporate bonds all of which gets your money out into the economy.

I'm just a regular guy, not an investor. I would definitely not buy any corporate bonds or even longer term government bonds. It would be much easier to just go to cash, which would crash the system.

If rates were to go much more negative than that, some carrying cost would have to be attached to cash like a small discount whenever it is withdrawn form the ATM, and/or a subsequent tax when spent. Alternatively alllarge denomination bills could be withdrawn - so you can't keep large amounts of cash safely.

I don't think people would go for this. It would (rightly) be viewed as theft. You can steal people's money through inflation because no-one understands what's going on, but outright taxing of cash I don't think you could get away with. Besides, long before taxing cash would be an issue, bank runs would have destroyed the financial system.

scepticus said...

Frode, yeah I meant the coupons - thanks for pulling me up on that.

And why wouldn't you go for a 2 year CD?

Clearly there are issues with cash hoarding. I agree its not a straightfoward issue, which is why I would not expect this to be tried for some time, perhaps 1-2 years.

I disagree that a tax on cash can be considered theft, any more than the inflation of the last 30 years can be considered theft. Many think that inflation is indeed theft, but I see it as a clunky attempt by the fed to set a real negative rate that simply reflects the actual situation of supply and demand for capital worldwide.

Inflation is simply contraction, and would be also exist under a gold standard in times of recession, so I have trouble seeing it as a tax. Besides, the medium of exchange in a democratic country should be what the people wish it to be, and faced with the alternatives, it might be the lesser of two evils.

But americans particularly will have issues with it ideologically, so maybe somewhere else with a more social democratic mindset will try it first. If it works, I'd expect the US to follow.

scepticus said...

Off to bed. Night night all.

Frode said...


Frode, yeah I meant the coupons - thanks for pulling me up on that.

And why wouldn't you go for a 2 year CD?

A CD would incur a penalty if I wish to withdraw my money. I would not want to tie my money up for 2 years, at a possible negative yield, mainly because that would be insane.

Clearly there are issues with cash hoarding. I agree its not a straightfoward issue, which is why I would not expect this to be tried for some time, perhaps 1-2 years.

If the interest rate on my bank account goes negative 1-2 years from now, I'll still pull out my money and I expect others to do the same. Which is why I would probably line up outside the bank early.

I disagree that a tax on cash can be considered theft

Whatever you call it, it will not be popular.

Look, negative interest rates is not possible because banks needs deposits. I don't think there's any point in making it more complicated than that.

VK said...

@ Frode

It's worse then I thought. Total vault cash in US banks amounts to a paltry 49 Billion dollars.

Go to the last data set,

If even 0.8% of the total guaranteed deposit base of 6.4 Trillion was withdrawn, the banking system is kaput :(

Ed_Gorey said...

@ Greenpa

"You might want to consider pulling the trigger either at 980; or at 1020, instead. It's hard to predict what the precise effect of "1000" will be- except a shipload of people will sell, immediately- dropping prices. How far is unpredictable; but if you're selling into a rapid drop, you might wind up selling lower than you wanted."

I see your basic point. The market will get very jumpy around the 1000 mark. However, I wouldn't be selling anything at that point since I'm 95% in cash equivalents at this stage. Instead, I'd be buying SDS which goes up 2x when the S&P goes down.

Coy Ote said...

@ ahimsa... bluebird... etc.

A little off the subject of our financial mess, unless you start counting up the costs.

C Hedges report

Coy Ote said...



John Grant said...

Let me get this straight:

Stoneleigh proclaims that she is providing nothing more than a public service to help people prepare for a bleak future. If you believe that you are providing a public service, why do you attempt to do it from behind a pseudonym? Many people I have tried to alert don't take it seriously as it is 'just another blog'.

I have tried on numerous occassions to forward your blog to my friends and family, particularly my father and uncle. They simply do not read it because of your anonymity/non-serious nature.

You can do whatever you want, and explain even further as to why you do not want to expose yourselves. I just find it odd that if your intention is to alert the public, getting your word out in news articles with a serious name might be a bit more helpful to people than hiding behind a pseudonym in this dark corner of the internet.

Anonymous said...

I'd say that, if you can't understand the ideas involved, then you shouldn't be surviving.

Consider it an intelligence filter.

jal said...

The same thing is being said, more and more everyday, by more and more bloggers.
It does not have to be said by a "famous name".

Check out “Of two minds”
Denial, Fear, Anger: The Real Depression Part I
July 20, 2009

Anonymous said...

John Grant: If you can't convince others, how do you think TAE, with all the extensive writings and discussions, and with all the different references and forwards will convince them? It's not you or me or Stoneleigh with the problem, it's "the others" that have the problem. John

Anonymous said...

Bernanke Says Low-Rate Stance Likely Needed for Extended Time

Bernanke says may need tighten policy to prevent inflation-WSJ


Anonymous said...

Obama hits out at Wall Street banks

His pimps are gonna bitch slap him if he keeps that up.

timekeepr said...

My wife got this book out of the library for our kids (teach them early about bubbles, manias and panics!):

The Great Tulip Trade

K-Gr. 2. Give Brust a bouquet of flowers. She takes a complicated topic, the Dutch tulip mania of the 1600s, and makes it into a credible story--for beginning readers! An author's note explains the history on which the story is based; tulips became valued beyond reason, finally plunging in worth and ruining investors. So how did Brust work the facts into a Step into Reading easy reader? Her story focuses on Anna, who lives in Holland in 1636. Anna's father grows the flowers, and he gives his daughter eight different tulips for her birthday, which she plants in a window box. People spy them and want to trade for sturdier items: livestock, furniture, paintings. Reluctantly, Anna trades, but when she is offered gold and diamonds for her father's rarest tulip, she refuses to relinquish the precious gift.

Stoneleigh said...

John Grant,

I am not some big name hiding behind a pseudonym. If you knew my name I guarantee you would never have heard of it, and knowing it would not help you to convince anyone who does not want to be convinced. I prefer people to think of the ideas I write about than who I might be anyway.

EBrown said...

I too have valued your contributions here at TAE. It is refreshing to have disagreements with S&I's central thesis aired in an intelligent manner.

I'm in the same boat as Frode though. If my bank tried to institute a -0.5% APR on my account I'd simply cash out entirely.

I might keep a few hundred dollars in a checking/debit card account because paying for the convenience of using those services would be worth it to me and a few hundred dollars isn't too large a chunk of my total savings to risk losing.

Oh wait, I already did that last year. I decided it was better to be early than late in the cashing out game. I put my extra money beyond my cash stash into short-term US Treasury notes. My savings over the last year have joined my Treasury Direct account. I don't expect to have said savings much longer as we're trying to buy a small farm. So while I will contribute to the real-estate market in the near future I won't be taking out a mortgage for a bank to make money on.

I don't expect we'll have a chance to get to negative rates before seizures in the credit market force bank holidays.

I realize that the government could declare certain currency (by serial number) worthless or worth less. There's any number of ways they can attempt to force people out of holding physical cash, but if it comes to that I think we'll be so far along the depressionary path that it will make little difference in the grand scheme of things. Of course it could make a world of difference to some one like me with several months of cash stuffed in my bed (no not literally).

Anonymous said...

EBrown said:

'm in the same boat as Frode though. If my bank tried to institute a -0.5% APR on my account I'd simply cash out entirely.

I haven't been following all the comments with Scepticus so this might not be relevant, but does he mean, not our own personal 'little all', but the banks rather humongous amounts that they have stashed away and need flushing out?

-Iem Gold-

Anonymous said...

There are innate abilities to discern commonsensical aspects to the world. Argumentative, in the forest, comments here belie this innate discernment. You either get it before it happens, or you don't get it when it is right in front of your face, sadly. Thank you TAE for the after-factual basis, knowledge, and fun facts to quote to friends whose children work on Wall Street from a former financial illiterate.

DIYer said...

"John Grant",

It isn't really all that unusual for someone to have multiple identities on the web. A lot of us have day jobs, and TAE has no relationship to them.

Six degrees, eh.

Anonymous said...

Scepticus said:

since it arises due to the market distortion created by the 0% bound.

Just a question of curiosity only, but why does this ,0% bound, weigh so heavily on your heart, would not another like a 0.25% be as substantial to your purpose?

BTW, there is such a maidin Canada one, all set there for your bounding ... you jolly dog, you:)

Iem Gold

EBrown said...

That article by Buiter was written in May 2008, once the credit problems were apparent to observant folks but prior to teh cascade in teh fall.

Fed has taken on private sector risk (Bear Stearns)
Ditto for the Bank of England (Northern Rock)
Ditto for the ECB

Risk may be priced poorly = gaping hole in central Banks' balance sheets. Leading to the following questions.

1. Does it matter if the central bank suffers a large capital loss?
2. Can the central bank become insolvent?
3. How and by whom should the central bank be recapitalised, should its capital be deemed insufficient?

Fed assets were less than 1/10th those of the large commercial banks in early 2008, and that doesn't include the shadow banking sector at all.

Bear proved the Fed unwilling to allow large systemic institutions to fail (Lehman disproves this postulate, but not at teh time of this writing), and LTCM adds hedge funds and others to the list of "too big/too connected".

Fed is leveraged 22:1. Bank of England 50:1. ECB about 19:1

By issuing currency the Fed can increase its balance sheet PRN (as needed). It is not hard to envisage at situation where the Fed's equity is exhausted.

Does it matter if the Fed is insolvent? What is insolvent?
Equitable insolvency(
that is, failure to pay obligations as they fall due)
and balance sheet insolvency (the condition that liabilities
exceed assets) - equitable insolvency is the relevant

Some math explanations leading to this paragraph - It should be obvious that the central bank can make the nominal present discounted value of current and
future seigniorage pretty much anything it wants it to
be. For instance, the Fed could buy up today, the entire
outstanding stock of privately held US Federal debt
("monetise the public debt"), around $4.5 trillion in
March 2008. If the Fed could act as a fiscal agent,
making transfer payments to the private sector, it could
engage in "helicopter drops of money" of any magnitude.

That goes through page 7. I need to go to bed now though. It's pretty interesting if anyone else wants to finish the summary.

Jim said...

I too am intrigued by Scepticus' comments. Upon initial reading and consideration it made absolutely no sense, but upon further reading I am now thoroughly confused (but not necessarily in disagreement). :) I believe it has to do with disincentivizing savings as high interest would discourage borrowing. I initially thought it was suggested as a more short term plan to deleverage banks hoarding cash, but I see he proposes it as a more long term sustainable option. I always thought you needed savings to allow lending (notwithstanding fractional reserves and printing). As you can see, I'm confused.

I agree, in the current system, why "save" at a negative rate when you can just put it under your mattess. What I think the big picture is - is that he is describing a system so different from what we think of as "normal", that I can't even begin to comprehend it. Yet I am intrigued.

Ilargi said...

New post up.

jal said...

@ jim
think potlatch