Sunday, April 13, 2008

Debt Rattle, April 13 2008: Tradable and expendable

Dorothea Lange 1935: Migrant mother series

See also today’s earlier post Of bubbles past, the things that come and go

Ilargi: No, we’re not going to redefine inflation, not even when the head of the IMF confuses the term. Food-price inflation is a meaningless "definition". His point, though, is important. I foresee a lot of dead people throughout the world this year, victims of both hunger and riots over food. I also foresee governments being overthrown, and perhaps quite a few.

I’ve seen, in the past few days, calls for international control of food prices, but that will never work. We have wanted trade in food crops to develop just like the trade in other commodities. Well, we have it now. And that genie won’t be put back in the bag.

A government might be able to set fixed prices, subsidized or not, for domestically produced food. But for a majority of countries, that leaves substantial segments of produce sales, namely for those foods that are imported, vulnerable and beyond government control. Moreover, in many poor countries even the very means of food production are owned by foreign corporations.

The political power of corporations like Cargill, Monsanto, Dupont and Archer Daniels Midland in the US, and Syngenta, Bayer and Novartis in Europe, makes quick and effective change impossible, out of the question. A handful of companies, which work ever more tightly together, have a stranglehold on world food markets, and they won't give that up without a bitter fight. That fight will cost millions of lives, many millions. Ironically, most of these companies are not food producers; they are chemical consortia, who entered the "food business" to create a market for fertilizers, pesticides and related GMO crops.

If you allow a system to reign your society that treats food and water as tradable commodities, there is only one possible outcome. If basic human needs are traded in a market based on profit margins, people themselves become tradable, and thereby expendable. We have such a system, and I see no way that we can get rid of it.

Strauss-Kahn Warns Food-Price Inflation May Trigger Starvation
Further gains in food prices would be "terrible" for the world's poor and throw hundreds of thousands of them into starvation, International Monetary Fund Managing Director Dominique Strauss-Kahn said. Governments throughout Asia, Africa and the Middle East are seeking to combat food inflation and avoid social unrest by curbing exports or lifting import duties on basic food staples such as rice.

Global food prices surged 57 percent last month from a year earlier, according to the United Nations, and the World Bank warns civil disturbances may be triggered in 33 countries. If food inflation keeps accelerating at its current rate "the consequences will be terrible," Strauss-Kahn told reporters at the IMF's semi-annual meeting in Washington today. "Hundreds of thousands of people will be starving, leading to a disruption in the economic environment."

Haitian Prime Minister Jacques Edouard Alexis was voted out of office by the country's senate today after violent protests over rising food prices, news agencies reported today. President Rene Preval, who called the no-confidence vote "unjust," announced a 15 percent cut in the price of rice, which had doubled this week to $70 for a 50-kilogram (110-pound) bag, Agence France-Presse reported. No replacement for Alexis was announced.

Consumer-price inflation in poor or so-called developing countries will accelerate this year to 7.4 percent, compared with a January forecast of 6.4 percent, the IMF said this week. Food prices will probably remain comparatively high until at least 2015, the World Bank said in a separate report. "Economic progress made over the last years could be destroyed," Strauss-Kahn said.

Rice, the staple food for half the world, has surged 96 percent in the past year, reaching a record $21.60 per 100 pounds on April 8. That's forced China, Egypt, Vietnam and India, which export more than a third of the world's rice, to curb shipments of the grain. Argentina and Russia have also sought to discourage food exports in a bid to boost domestic supplies.

Ilargi: Looks like there’s a very, very ugly week about to unfold on Wall Street. Both Merrill Lynch and Deutsche bank seem to be entering a deeply precarious phase. Deutsche holds $54 billion in toxic debt. They will lose, in my estimate, a minimum of $30 billion on that.

Citigroup and Merrill Lynch reveal fresh $15 billion loss
Citigroup and Merrill Lynch will heap further pain on Wall Street this week as they reveal additional sub-prime write-downs totalling $15 billion (£7.6 billion) or more. In another sign of the intense pressure on leading banks, Deutsche Bank is attempting to offload some of its €35 billion (£28 billion, $54 billion) of toxic debt to a consortium of private-equity firms.

Huge exposure to American mortgages is expected to result in Citi taking a $10 billion hit to its accounts, dragging the bank to a first-quarter loss of almost $3 billion. Some analysts believe Citi’s write-downs could stretch to as much as $12 billion. Merrill will suffer $5 billion of write-downs, analysts say, which would push the bank $2.7 billion into the red. It is expected to knock a further 20% from the value of its sub-prime holdings, in spite of the fact that it announced $18 billion of write-downs only three months ago.

The new rash of Wall Street losses and write-downs come in addition to the billions that have already been recorded. The world’s biggest banks have suffered losses and write-downs totalling almost $250 billion since the beginning of 2007, according to analysts.

Last week the IMF shocked markets by saying that global losses from the credit crisis could rise to $945 billion. JP Morgan is expected to offer the only glimmer of hope from this week’s results, posting a small profit, in spite of huge exposures to leveraged loans.

Some of the world’s biggest banks are beginning to work on new solutions to relieve tension in the financial markets. Deutsche Bank is understood to be talking to a number of private-equity funds about a disposal of some of its backlog of loans to venture-capital firms.

The value of leveraged loans sitting on Deutsche’s balance sheet is greater than its shareholder equity.

The bank is planning to sell on the loans to the private-equity funds at a loss to free up its balance sheet, according to market sources. The plan mirrors a similar move by Citi to sell $12 billion of its leveraged-loan portfolio to private-equity firms including Blackstone, Apollo and Texas Pacific Group. The Citi deal is hoping to close the deal in time for this week’s results. It is one of a number of significant moves by Vikram Pandit, Citi’s new chief executive.

But the sale could be hampered by problems with the planned inclusion of loans related to EMI, the music business. Citi bankrolled its buyout last year by Terra Firma Capital Partners, and still holds about $5 billion of EMI debt. It was reported yesterday that Citi had been forced to remove some of these loans from the sale after buyers complained they did not have sufficient financial information on EMI. Citi announced plans to sell its Diners Club credit-cards business to Discover last week, and is also considering a sale of its German retail-banking operations.

City insiders believe job losses are inevitable. Pandit is thought to be considering a radical reshaping of the bank’s equity research organisation. Insiders say that it may be slimmed down to focus on its top 300 clients, rather than providing a wider service to investors. Some banks are looking to use the crisis to steal a march on their competitors. HSBC last week revealed its intention to use the tightening credit conditions as an opportunity to boost its 3% share of the UK mortgage market.

Abbey, which is owned by Spain’s Santander, has written close to 20% of all the mortgages handed out in Britain in the first quarter, according to sources close to the company. The bank is funding its expansion in the market by attracting more money from savers, analysts say.

Ilargi: The parameters are redefined every step of the way. Still, there’s no way you can interpret these numbers as getting prettier as we go along. Borrowing goes up as fast as non-borrowed reserves go down. Go to the site to play with the data and create your own graphs.
Kudos, François, for producing this very telling graph

Non-Borrowed Reserves/Borrowings of Depository Institutions at/from the Federal Reserve

Click to enlarge

  • Series ID:BORROW Source:Board of Governors of the Federal Reserve System
  • Release:H.3 Aggregate Reserves of Depository Institutions and the Monetary Base
  • Seasonal Adjustment: Not Seasonally Adjusted
  • Units:Billions of Dollars

    • 2007-12-01 15.430
    • 2008-01-01 45.660
    • 2008-02-01 60.157
    • 2008-03-01 94.523

Please note breaks in data:
  • Data prior to 2003-01-01 include adjustment, extended, and seasonal credit.
  • Data from 2003-01-01 to 2007-11-01 include primary, secondary, and seasonal credit.
  • Data from 2007-12-01 to 2008-02-01 include primary, secondary, seasonal, and term auction credit.
  • Data from 2008-03-01 forward include primary, secondary, seasonal credit, primary dealer credit facility, other credit extensions, and term auction credit.

Iceland bank accuses hedge funds of 'smear campaign'
Leading Icelandic bank Kaupthing has taken the extraordinary step of accusing four London hedge funds of illegally trying to drive it towards bankruptcy for their own profit. In what looks likely to lead to a massive legal showdown in financial markets, the bank, which has attracted billions from UK savers to its Kaupthing Edge accounts, claimed the hedge funds deliberately spread false rumours about financial difficulties at Icelandic banks to make profits on complex financial investments.

Kaupthing chairman Sigurdur Einarsson told the Reykjavik newspaper Frettabladid: 'It looks like four hedge funds have mainly led this run.' Einarsson named the funds, including one of the largest in Europe. The identities were also reported on the website Iceland Review until pressure from one of the hedge funds led to their removal.

Three of the hedge funds declined to comment. The fourth issued a vigorous denial of any wrongdoing and said it had handed its trading record in Icelandic stocks to the Financial Services Authority to prove its innocence. The claims of deliberate market abuse against Kaupthing come less than a month after UK bank HBoS saw its shares slump, leading to claims of a conspiracy - the accusations are being investigated by the FSA. A similar investigation is under way in Iceland over its banks.

The claims of deliberate market abuse centre on the market for credit default swaps, which in effect are insurance contracts against companies going bust. The price on a CDS, measured as a percentage of the debt to be insured, is an indication of how risky a company is regarded. In recent months, CDS rates for Icelandic banks have soared close to 10%, implying a huge risk of bankruptcy.

Einarsson claimed the hedge funds had gambled on CDS rates rising and then tried to spread rumours suggesting the banks were in danger to drive up the CDS rates and make a profit. Such activity would amount to market abuse both in the UK and Iceland and could constitute a criminal offence.

But Iceland's banks have their defenders among City experts. One leading economist said he had been phoned by a hedge fund trying to talk down the Icelandic economy. Professor Richard Portes of the London Business School told Financial Mail he had reported the hedge fund to the FSA in the UK and the authorities in Iceland.

'One fund rang me up and told me I was wrong and I should be concerned about damaging my reputation. But the fundamentals are strong for the Icelandic economy and the Icelandic banks,' he said. 'I think it is quite clear in the case of the banks that there have been rumours deliberately spread.'

Ilargi: When a plan goes from one vague term to the next opaque definition, I for one don’t believe in coincidence. These guys are not the idiots they like you to believe they are, they know very well what will happen here. This is simply yet another set-up that is intended to fail from the start. It’s window-dressing, talk-to-the-hand deception.

Still, as I said yesterday, I have some hope. There may be someone in the world, with enough clout to act in his or her own country, who takes this literally, and will require financial institutions to open their books in 100 days. And once one book is open, -much of- the rest will follow. So dictates international finance.

G7-backed financial stability plan is a 'first step' to calm crisis
Top financial regulators said today that an unprecedented reform package endorsed by the Group of Seven industrialized countries is a 'first step' toward calming financial turmoil. Bank of Italy governor Mario Draghi said the G7's embrace Friday of Financial Stability Forum (FSF) recommendations lays the groundwork for the regulatory response needed to ease the severe financial stress now taking its toll on the world economy.

Draghi, who also chairs the FSF, an international group that includes central banks, the IMF and other financial and regulatory bodies, said 'by and large this represents a first step in this regulatory response' to the crisis. Macro-economic policies and liquidity are also needed, he told a news conference during the spring meetings of the International Monetary Fund and World Bank here.

Draghi noted that the FSF had already begun to craft measures to improve the financial system before the US subprime home loan crisis erupted in August, roiling markets, seizing up credit and causing banks and securities firms into multi-billion dollar losses. The G7 -- Britain, Canada, France, Germany, Italy, Japan and the United States -- asked the FSF in October to speed up its work, he recalled.

In their own final statement Friday, the G7 finance chiefs agreed that banks should 'fully and promptly' disclose their risk exposures, write-downs, and fair value estimates for complex and illiquid instruments 'within 100 days.' They called for 'rapid implementation of the FSF report' to not only boost the resilience of the global financial system for the longer term but also to help 'support confidence and improve the functioning of the markets.'

Draghi, asked how quickly the FSF recommendations could practically be implemented, said: 'The 100-days deadline is certainly a tight one. ... We'll try our best to meet the deadline.'

Calls for Tight Bank Leash Have Influential Support
The leader of a global effort to head off the next credit crisis says his group's new report -- which calls for tougher oversight of financial institutions -- reflects a consensus among officials with the clout to change rules, not just another easy-to-ignore blast from experts.

"It's written by supervisors, not by economists, but by people who have very precise responsibility," Mario Draghi, Italy's central bank governor, said in an interview before presenting the Financial Stability Forum's report Friday to finance ministers and central bankers from the Group of Seven leading economies. "Things are going to be implemented. And there is going to be a follow-up process."

The 70-page report urges more vigilant oversight of capital and liquidity at financial institutions -- and of their preparations for threats to stability. "A striking aspect of the turmoil has been the extent of risk-management weaknesses and failing at regulated and sophisticated firms," the report says. The report recommends that, by year's end, teams of supervisors from major countries be assigned to monitor the largest institutions, whose operations stretch across international frontiers.

"While national authorities may continue to consider short-term policy responses should conditions warrant it, to restore confidence in the soundness of markets and institutions, it is essential that we take steps now to enhance the resilience of the global system," the report says. The Financial Stability Forum includes representatives of central banks, finance ministries and financial regulators from 26 countries. Its recommendations drew the G-7's endorsement Friday. Some others criticized the report.

"It's too timid, relies too much on self-regulation and relies too much on principle rather than specific actions," said Morris Goldstein, a former senior International Monetary Fund official now at Peterson Institute for International Economics, a Washington, D.C., think tank.

Ilargi: Just look at this inane BS coming from the Wall Street Journal. A major surprise? Well, not to me, for starters.
The forum's recommendations are a response to a major surprise: Many public and private-sector participants were persuaded that financial innovation was increasing the resiliency of the system and spreading risk more widely. But, at least so far, it appears risk wasn't spread as widely as had been thought; instead, it was concentrated in the banks, the most highly regulated corner of the financial system.

U.S., Europe Warn of Further 'Bad News': Strengthen Regulation
Finance chiefs from the U.S. and Europe said the eight-month credit squeeze is still festering and urged banks to take steps to relieve it. "The chain of bad news may not have come to an end," Italian Finance Minister Tommaso Padoa-Schioppa said yesterday as the International Monetary Fund held its semi-annual meetings in Washington.

The collapse of the U.S. subprime-mortgage market led to a seizing up in capital markets and has triggered $245 billion in asset writedowns and losses since the start of 2007. Finance ministers and central bankers from the Group of Seven are trying to strengthen market regulation and want banks to speed disclosure of losses and improve the way they value assets.

"The market is still adjusting, the turmoil has not yet settled down," Federal Reserve Vice Chairman Donald Kohn told reporters in Washington. "It's still a fragile situation out there." The G-7 on April 11 endorsed proposals by the Basel, Switzerland-based Financial Stability Forum to impose tougher oversight on financial markets. The cost of borrowing in euros and dollars for three months was still at the highest since December in the past week.

New York Fed President Timothy Geithner indicated that regulators may have relied too much on financial companies and investors to police themselves. "What we have to do is find a better balance between market discipline and regulation," Geithner said. "I don't think anybody can look at the system and say we got that balance right."

By the end of July, the G-7 wants financial companies to "fully" disclose in mid-year earnings reports their investments that are at risk of loss. Firms should also establish "fair-value estimates" for the complex assets that investors have shunned and boost their capital as needed, the G- 7 said.

Regulators must revise liquidity risk management rules, improve accounting standards for off-balance-sheet units and enhance guidance on how assets are fairly valued, the group said. International panels of supervisors will also be formed by the end of this year for each of the largest global financial companies.

Ben Bernanke lays credit crunch fiasco squarely on ratings agencies
Ben Bernanke, chairman of the Federal Reserve, has laid the blame for the credit crunch on the ratings agencies, the investors in sub-prime securities who believed them, and inappropriate incentive structures. Delivering the findings of the President's Working Group on Financial Markets, Mr Bernanke said: “Investors often took insufficient care in evaluating the risks of structured credit products, in part because they over-relied on the evaluations provided by the credit ratings agencies.

“Investors must take more responsibility for developing independent views of the risks of sub-prime mortgage securities,” Mr Bernanke added. He was speaking at a lunch in Richmond, Virginia, on behalf of the Working Group, which also includes Henry Paulson, the US Treasury Secretary, and Christopher Cox, chairman of the Securities and Exchange Commission.

Mr Bernanke also laid the blame on poor risk management practices among large financial institutions, and on incentives that rewarded bankers for the volume of mortgage-backed securities they had packaged, rather than the quality of the underlying assets. His recommendations included the introduction of nationwide licensing standards for more brokers and more consistent government oversight of mortgage lenders. The credit agencies, he said, should provide greater transparency.

Chris Whalen, of Institutional Risk Analytics, a US consultancy, said: “Bernanke's comments are fair but it's a bit rich telling investors they should have known when the Federal Reserve - which could have done a lot more to prevent the meltdown - has not admitted that it dropped the ball.” Many believe that the Fed could have reduced the severity of the credit crunch had it acted earlier.

The US central bank has reduced the base interest rate by 3 percentage points since last August in an attempt to spur the economy and lower the cost of mortgages. In recent weeks it has dropped the interest rate on its discount window of cheap loans from 3.5 per cent to 2.5 per cent. The Fed has also extended its availability from the commercial banks it has traditionally served to include securities firms, as it seeks to boost liquidity.

Ilargi: An interesting interview from CNBC.

Nobel economist Stiglitz predicts a whole lot more trouble

Ilargi: Don’t get me started on the government’s role in the housing crisis. You know what all these American Dream homeownership programs do? This is what they do: enabling more people to buy a home has one certain effect: it drives prices up. That is what we call perversion.

The government has no place in the housing market. None. But instead of getting out, it dives in deeper all the time. This can only make problems worse.

Amaranth's Hunter now making Peak (Ridge) money
A Boston money manager with plenty of Canadian content is shooting the lights out with help from Calgary energy trader Brian Hunter, best known for blowing up Amaranth Advisors LLC. Peak Ridge Capital Group started a commodity-based fund last November after buying the assets of a fund called Solengo Capital Advisors. Mr. Hunter tried to launch Solengo with a reported $800-million (U.S.) of backing shortly after Amaranth imploded in 2006, but ran into regulatory problems. Amaranth collapsed after losing $6.6-billion on natural gas trades.

Peak Ridge Commodity Volatility Fund gained 6 per cent last month and 103 percent since it was started in November, according to the investors in the fund who talked to the Bloomberg news service. On the money manager's website, the fund claims to have a "unique" strategy that plays on the volatility of relationships between different commodities.

Hr. Hunter, who has been fined by U.S. Federal Energy Regulatory Commission for his natural gas futures trading, is said to be an adviser to Peak Ridge, and is not listed on the company's website. Before his Amaranth positions went awry, Mr. Hunter was known as one of the top-performing and best-paid hedge fund managers in the business.

Peak Ridge runs a total of $1-billion, focused on real estate and small cap stock plays, and counts a number of Canadians among its eight partners. They include Scott Samuel, a Markham, Ont.-based small-cap stock specialist who is former co-head of corporate finance at Midland Walwyn and Gordon Capital. Other Peak Ridge principals include Jonathan Westeinde, an Ottawa-based real estate developer who focuses on environmentally friendly residential projects, and James McHale, an ex-JP Morgan banker who graduated from Carleton University and the University of Western Ontario's business school.

Washington Takes On the Mortgage Mess
What started as a slump in home building and rising delinquencies on dodgy mortgages has evolved into a financial crisis and a likely recession. U.S. authorities are scrambling to respond. Last week, the administration said the Federal Housing Administration may guarantee mortgages for up to 100,000 homeowners, many of whose homes are now worth less than they owe on their mortgages.

In addition, the Senate passed a package of measures including a tax credit for buyers of foreclosed properties, funds to state and local governments to buy and rehabilitate foreclosed homes, and tax breaks for home builders. The bill's prospects in the House and the White House are uncertain.

The expanded public backing for housing is ironic: Many experts believe the enthusiasm in both political parties for expanding homeownership in the past helped precipitate the crisis -- by encouraging people to buy homes with mortgages they ultimately could not afford. "In pushing homeownership over the past decade, social policies pushed the misuse of mortgage credit," says Joseph Mason, an economist at Drexel University.

Here's a closer look at the government's role in the housing market:
Q: Did government contribute to the housing crisis?
A: For well over a century, homeownership has been equated with the American dream. Both Democrats and Republicans have pushed homeownership, arguing that it reduces crime, increases civic involvement and fosters healthier communities. The economic proof for this is unclear: It may simply be that law-abiding, civic-minded people are more likely to own their homes.

Homeownership is implicitly subsidized by the tax code because most mortgage interest is tax deductible and rent is not. The federal government also guarantees hundreds of billions of dollars in mortgages through the FHA and a Veterans Affairs program. Finally, investors widely assume the federal government stands behind the shareholder-owned mortgage agencies Fannie Mae and Freddie Mac, which own or guarantee trillions of dollars in mortgages.

In the latest decade, politicians generally applauded the growth of subprime mortgage lending to higher-risk borrowers, as a way of boosting homeownership among lower-income and minority families with no apparent taxpayer commitment. Partly in response to Bush Administration pressure to do more to boost low-income homeownership, both Fannie and Freddie increased their purchases of securities backed by subprime mortgages.

Q: What steps has the government taken to expand its support for housing since the crisis began?
A: Last August, the Bush Administration said the FHA would guarantee the loans of some homeowners who otherwise would probably default as a result of an adjustable-rate mortgage resetting to a higher interest rate. That FHASecure program has helped only 3,000 homeowners, instead of the hoped-for 80,000, says ISI Group, a brokerage firm, because most troubled homeowners can't afford their mortgage at any interest rate.

A separate program encourages mortgage-servicing companies to modify the interest rates on some ARMs.
The administration and Congress also temporarily expanded the size of loans the FHA can guarantee. This is having some impact; with private investors reluctant to step in and buy mortgages, the FHA is backing a large portion of the new mortgages being made this year. The administration and Congress temporarily increased the size of mortgages that Fannie and Freddie can guarantee, from $417,000 to as high as $729,750 in some areas.

Meanwhile, the Federal Reserve has expanded its lending to banks and securities dealers. The idea is to make those firms better able to finance their own holdings of mortgage-backed securities, making them more willing to make new mortgage loans, thereby bringing down mortgage rates.

Q: What other steps are in the works?
A: Under the FHA expansion announced last week, homeowners whose homes are worth less than their mortgages get the agency's backing for their loans if the original lender writes down the principal of the mortgage to below the home's value, thus restoring some equity.

Democrats in Congress have proposed that approach be expanded to help more than a million homeowners, though that would increase the risk and cost to taxpayers. Republicans have signaled they don't want to go along with that.
However, some mix of further remedies could well make it through Congress. One pending bill would allow the FHA to insure loans with smaller down payments, and give it more flexibility in the premiums it charges for its insurance.

Fed in 2002 Feared Deflation, Newly Released Transcripts Show
The Federal Reserve's only interest rate cut of 2002 -- an aggressive half-percentage-point reduction -- was made, in part, to avoid the "scary prospect" of deflation. Transcripts of the Federal Open Market Committee's 2002 meetings show the panel looking to take stiff action to keep the U.S. economy from slipping back into recession, and worried about the prospect of deflation.

"We are dealing with what basically is a latent deflationary type of economy, and we are all acutely aware of the implications of that kind of economy," then Fed Chairman Alan Greenspan said at the FOMC's Nov. 6, 2002 meeting. At the previous meeting, held Sept. 24, policymakers held off on a rate cut. One governor, Ben Bernanke, agreed the economy's recovery was disappointingly soft.

"One concern I do have about easing now is that it might exacerbate the imbalances in the economy by further heating up sectors that are already strong, such as residential construction and autos, while only indirectly benefiting investment and the labor market," Mr. Bernanke said. "I also appreciate the dangers of excessive fine-tuning, oversteering, and overshooting," he said. "For these reasons, I understand that we may want to wait to see how events unfold before taking further action.

"I hope, though, that we will not set the threshold for taking action too high. The strategy of preemptive strikes should apply with at least as great a force to incipient deflation as it does to incipient inflation," Mr. Bernanke said."
The Fed releases verbatim transcripts of FOMC meetings after a five-year delay, a lag that strips the documents of much of their relevance. But the 2002 transcripts provide an unfiltered look at the FOMC's deliberations during an increasingly scrutinized period.

Mr. Greenspan has recently been second guessed for keeping interest rates too low for too long from 2001 to 2003. His critics say ultra-low rates helped create the current financial crisis. The transcripts also provide a glimpse into current Chairman Bernanke's early days as a Fed governor. He joined the Fed board in August 2002, months before the FOMC cut rates for the first and only time of the year.

The economy received massive stimulus as it descended into recession in the months after the Sept. 11, 2001 attacks. Congress passed a $1.3 trillion 10-year tax cut and the Fed slashed interest rates by 4.75 percentage points in 2001.
That helped the economy grow in the early part of 2002, but by the second half of the year growth fizzled as stock prices plummeted and consumer confidence waned. A series of corporate accounting scandals contributed to investors' malaise.

By November 2002, all 12 FOMC members thought a rate cut was necessary. The central bank surprised Wall Street with a half-percentage-point reduction that brought rates to a 41-year low of 1.25%. Mr. Bernanke noted that a number of factors were keeping firms from investing and consumers from buying. He argued that the appropriate response was lower rates.

"The FOMC has been quite patient," he said. "We've kept the funds rate unchanged now for almost a year. So I think it is time to consider taking some action. A significant rate cut at this point would not be a panacea obviously, but I do think it would help." "While the economy hasn't fallen down the stairs, I think it could use a push to make it up the next few steps," Mr. Bernanke said.

In Bush's America, Corporate Criminals Walk
It's nice to see the NYTimes pick up on the Department of Justice's shift toward the use of deferred prosecutions of corporations in large corporate crime cases. As far as I know, they are the first major media outlet to do so. The lack of coverage is pretty pathetic, considering that the issue has been hotly debated among corporate crime experts for years. For example, by the end of 2005 Justice had given so many corporations this "get out of jail free" card that the Corporate Crime Reporter issued a major report on the issue.

Under the policy federal prosecutors agree to never prosecute a corporation for a major crime (e.g. bribery, accounting fraud etc.), so long as the company agrees to help the feds identify the culpable individuals inside the firm. The use of deferred prosecutions was originally intended only for small cases, so that prosecutors could spend the bulk of their time going after the big fish. When asked to explain the Justice Department's shift, the common response has been that they don't want to be responsible for "causing another Andersen."

This bogus line has been thrown around by virtually every important white collar crime lawyer, and it's totally misleading.
For one, after Andersen employees were caught shredding Enron's documents, the firm was actually offered a deferred prosecution agreement before the feds decided to prosecute. So the policy was already in place. Plus, it's ridiculous to blame the feds for Andersen's demise. Enron was not the first case in which the auditors were caught aiding and abetting or, at a minimum, failing to catch the book-cookers.

Before that were Waste Management and Sunbeam. After Enron, there was WorldCom - arguably an even more egregious case considering the fraud was larger and simpler (and presumably should have been easier for AA auditors to catch). An auditor's business is staked on its reputation for honesty and integrity. For its role in all of these and other cases, Andersen did itself in. Don't blame the feds for doing their job.

But the more important point here is not the explanation for DoJ's shift in policy, but the result: As Russell Mokhiber of the Corporate Crime Reporter puts it, there is a "good chance that the rise of these agreements has undermined the general deterrent and adverse publicity impact that results from corporate crime prosecutions and convictions." In other words, one of the tools we have to preventing another big corporate crime on the scale of Enron is being gutted.

The response has been that instead of punishing an entire company (and thereby many innocent employees and shareholders who had nothing to do with the crime), the arrangements help the feds identify the specific culprits at fault and thereby protects so many innocent people from unjustifiable harm. Okay, but then why is Congress poised to pass a new bill that could make it almost impossible for the feds to get at these culprits?

I'm referring to the benign sounding Attorney Client Privilege Protection Act (S. 183 and H.R. 3013), which should really be called the 2008 Corporate Criminals' Immunity from Prosecution Act, because it would allow corporate attorneys to withhold potentially incriminating evidence under the doctrine of attorney client privilege. Someone needs to ask those pushing the bill exactly what deterrents will be left if it passes, and who these corporate attorneys are supposed to represent when they know of a crime -- the individuals who commit such crimes or the company and its shareholders?

I don't own more than a share here and a share there in certain companies (which lets me attend their annual meeting and give top executives hell now and then), but if I was a major shareholder or a fund manager, I'd be on the horn right now to tell my representatives that if they cosponsor or vote for this bill they won't ever get my vote again because they are effectively removing one of the key impediments to the next big Enron.
Let's see if the Times picks up on this scam.

Want to Save the Economy?
Insolvency's dark shadow hangs over Wall Street. One major player, Bear Stearns, has already gone under, and from the looks of it, another investment giant may be on the way down. It's getting ugly out there. The so-called TED spread*, which measures the reluctance of banks to lend to each other, has begun to widen ominously suggesting that the money markets think another dead body will be floating to the surface any day now.

The ongoing deleveraging of financial institutions and the persistent downgrading of assets has the Fed in a tizzy. Bernanke has backed himself into a corner by stretching the Fed's mandate to include everyone on Wall Street with a mailing address and a begging bowl. Now he's taken on the even larger task of fixing the plumbing that keeps credit flowing between the various investment banks. Good luck. There's plenty of more pain ahead. The IMF expects the final tally will be $945 billion, that means $3 trillion in lost loans for the banks. Bernanke better pace himself; this mess could last for years.

The US subprime fiasco has spiraled into what the IMF is calling "the largest financial shock since the Great Depression." America's capital markets are on the fritz. The corporate bond market is frozen, the banks are buckling from their losses, and the housing market is in a shambles. No one is buying and no one is lending. Private equity deals are off 75 per cent from last year and no one will touch a mortgage-backed security (MBS) with a ten foot pole. The mighty wheel of modern finance is grinding to a standstill and no one's quite sure how to rev it up again.

The US consumers are feeling the pinch, too. Credit cards are maxed out, student loans overdue, car payments in arrears, and mortgages entering foreclosure. Also, wages haven't kept pace with production and and the home-equity ATM has been shut down. Now that the credit tap has been turned off; the American worker is hurting, but no one is offering a bailout or a even helping hand; just a few table-scraps from Bush's "surplus package". 500 bucks will just about fill the tank of a normal-sized SUV.

A new survey from the Pew research Center "Inside the Middle Class-Bad Times Hit the Good Life", shows that working families are in debt up to their ears and that fewer Americans "believe they are moving forward" than anytime in the last half century. The study also shows that most people believe "it's harder to maintain a middle class life style" and that "since 1999, they have not made economic gains." Average families are struggling just to make ends meet.

That's why so many people bought homes when they should have opened savings accounts. They were duped into speculating on housing so they could get a chunk of money. It looked like a good way to overcome stagnant wages and crappy hours. The cheer-leading TV pundits offered assurances that "housing prices never go down". It was all baloney. Now 15 million homeowners are upside-down on their mortgages and the very same experts are scolding workers for fudging the facts on their income disclosure forms. It's all backwards.

No wonder consumer confidence has dropped to record lows. Working people don't need lectures on saving money; they need a raise. The big-wigs at Bear Stearns are still dining on crab-cakes at the Four Seasons while the working folk are just trying to make their way through Greenspan's nuclear winter living on beef jerky and Big Gulps. Where's the justice?

Volumes have been written about the current crisis; subprime-this, subprime that. Everything that can be said about collateralized debt obligations (CDOs) credit default swaps(CDS) and mortgage-backed securities (MBS) has already been said. Yes, they are exotic "financial innovations" and, no, they are not regulated. But what difference does that make? There's always been snake oil and there have always been snake oil salesmen.

Greenspan simply raised the bar a notch, but he's not the first huckster and he won't be the last. What really matters is underlying ideology; that's the root from which this economy-busting hydra sprung. 30 years of trickle down, supply-side gibberish; 30 years of idol worship for the waxy-haired reactionary, Ronald Reagun; 30 years of unrelenting anti-labor, free market, deregulated orthodoxy which inflated the biggest equity-Zeppelin in history.

Now the bubble is hissing out of the blimp and the escaping gas is wreaking havoc across the planet. There are food riots in Haiti, Egypt, and Kuwait. Wherever the local currency is pegged to the falling dollar, inflation is soaring and trouble is brewing. Also, European banks are listing from the mortgage-backed garbage they bought from brokerages in the US and need central bank bailouts to stay afloat. It's just more fallout from the subprime swindle. Finance ministers in every capital in every country are getting ready for a 1930's-type typhoon that could send equities crashing and food and energy prices rocketing into the stratosphere. And it can all be traced back to the wacko doctrines of neoliberalism. These are the theories that guide America's "screw-thy-neighbor" monetary policies and spread financial turmoil to every city and hamlet around the world.

The lazy, crazy middle class
Two years ago, several prominent economists gathered in Italy to debate the wide gap in annual working hours that separates the workaholic US from leisure-obsessed Europe. The conference was called: "Are Europeans Lazy? Or Americans Crazy?" The book that resulted from the conference is published this month by Oxford University Press.

But sometime in the intervening years, ordinary Americans - without stinting on craziness, of course - appear to have made their peace with laziness. On Wednesday, the Pew Research Center, based in Washington, DC, published an eye-opening study on the economic attitudes and prospects of middle-class Americans. Inside the Middle Class: Bad Times Hit the Good Life found that Americans' number-one priority - named by 68 per cent of respondents and topping children, marriage, career, wealth and religion - was "having enough free time to do the things you want".

The American middle class is not playing to type these days. The go-getting engine of the global economy is less work-obsessed than it looks and less confident. The percentage of middle-class people who say their life is better than it was five years ago is the lowest in almost half a century, according to Pew. Average Americans feel as though they are barely clinging to their position on the social ladder; 78 per cent say it is harder to maintain a middle-class lifestyle than it was five years ago. A middle-class squeeze (rising healthcare costs, rickety pensions, the collapse of housing prices and so on) has been at the heart of debates in both parties this presidential campaign season.

Low economic morale is a problem even when it is illusory. In this case it is not, US census data show. A majority of Americans of all races and regions tend to identify themselves as middle class (the figure is 53 per cent today). There are not enough perches in the middle class to accommodate all of them. A standard measure defines "middle-income" households as those earning between 75 and 150 per cent of median family income, now about $60,000 (£30,000). Where 40 per cent of American households met that definition in 1970, only 35 per cent do today. (Using "income" as a synonym for "class" is crude, but that is how US social scientists do it.)

This "hollowing out" of the middle class is an old story. It has been going on for three decades. But there are a couple of new twists. Rising inequality was always accompanied by rising prosperity. Certainly gains were unevenly apportioned: the rich, black people and single women gained disproportionately while high-school drop-outs and single men suffered disproportionately. But the system was thriving and so was the ordinary US worker, even if the meaning of "ordinary" was changing. The system was not managed to egalitarians' liking - but it retained the resources to set more egalitarian priorities if politicians chose. Now, even the resources are in doubt. For the first time since statistics have been gathered, the adjusted median family income actually declined from one economic boom to the next, from $61,227 in 1999 to $59,493 in 2006.

A transitional economy is sometimes hard to measure. Americans have trusted that the hard-to-measure bits concealed strengths, not flaws. True, they reasoned, the incomes of the poorest have fallen since 1970, but that included many of the 35m immigrants the country has added since then and the US offered them a way up. True, houses were growing more expensive, but the average new house is bigger, fancier and more efficient than the places the poor lived in decades ago.

Today, though, a large swath of Americans is being priced out of what the Pew authors call the "anchors of a middle-class lifestyle", starting with housing, medical care and education. And one of the economy's hard-to-measure phenomena (the housing boom) has become an easy-to-measure one (debt). The debt-to-income ratio for the middle class has risen from 0.45 in 1983 to 1.19 now.

Some of this shift is due to the rise in house prices: the percentage of middle-class income spent on housing rose from 26.8 per cent in 1981 to 33.7 per cent in 2006. In 1970, people tended to pay twice their family income for a home; now they pay five times. That money did not seem to be lost because it could be spent - you just had to borrow against your home to get it. Americans borrowed too much. In a world of "ownership" without equity, the difference between ownership and rental is not obvious.

The US middle classes have always had an empathy with the rich that is anomalous in a world context. They oppose milking high earners, thinking that they themselves might be rich someday. But that empathy is eroding. Only 42 per cent of the middle class think that "rich people achieve their wealth through hard work and ambition"; 47 per cent chalk up wealthy people's fortunes to "connections and family ties".

Who is to blame for this debacle? The answers will tell you a lot about the politics of this presidential election. The Pew analysts find a certain ambiguity. The middle class is more conservative than the very rich and the very poor, but it is tending towards the Democrats. Its sympathies are split - to borrow the terminology of that Italian economic conference - between a Lazy party and a Crazy party.

Republicans, the Crazy party, are twice as likely (by 17 per cent to 8) to blame "the people themselves", who thought they could use their home-equity loans to live like the rich. Democrats, the Lazy party, are twice as likely (by 35 per cent to 16) to blame the government. At least they blame the Republicans who thought the government, too, could somehow borrow without incurring debt. For now, the smart money is on the Lazy, rather than the Crazy, party. But, of course, they could both be right.


Anonymous said...


Just a word on the graph above from the St.-Louis Fed.

It is simply an update of a graph I saw elsewhere (unfortunately, I do not remember where). I cannot claim credit for it.

I recommend the Fred data base at the St.-Louis Fed.

There is a ton of info and you can play with and combine graphs to produce striking, very informative results. Have fun.


Anonymous said...

In The Slow Burn Catherine Austin Fitts writes:

"The “slow burn” is a political culture and economy managed through principles of economic warfare in which insiders systematically protect themselves and centralize control and ownership of resources by using:

Central banks
Currency and lending systems
Regulatory and enforcement policies
Controlled media and entertainment
The reason why it is difficult for sophisticated financial people to discern that a slow burn is taking place is because we have not yet collectively mastered the operational detail of how it is implemented. This is an extremely important subject."

It's said: "fish were the last to discover water." What I find so valuable about Catherine's work and TAE is you guys are providing tools to help us understand and manage financial waters.

Anonymous said...

Hi Stoneleigh,

You said recently that:

"...currency hyperinflation is possible following the credit deflation I believe is inevitable. That didn't happen after the Great Depression, but I think it may well this time, giving us the worst of both worlds."

Could you elaborate please?

Having sold my house, I'm sitting on the sidelines waiting to buy hard assets at some future date (i.e. a house, or a farm, or some land) I'm guessing about two years from now. What do you believe will signal the turning point from credit deflation to currency hyperinflation? (When do I trade cash for assets?)

I hope to use my wheelbarrow for vegetables, not stacks of bills.

Anonymous said...


Yet another house seller (Tripwire)!

I wonder how many people have sold or intend to sell their house (and how many spouses are saying we are going overboard) due to the current sitution and the information available on this site?

Here the snow is melting, so things should be going forward.


Anonymous said...

Hi Francois,

My fiancee and I live in a rented apartment in Ottawa. It is within 15 minutes of our workplace, shopping, etc and suits our needs. We had been talking about buying a house in the near future but after reading TAE, I've convinced her to put the idea on hold. In the meantime, I've been slowly working on our parents, trying to get them to sell their extra real estate.


Ilargi said...


email stoneleigh2006 at msn dot com

and we could get together

Stoneleigh said...


I think that if we get hyperinflation following credit deflation it would be quite a long time in the future (ie several years at least before inflation could take hold, and longer still before it would morph into hyperinflation). Unlike deflation that can strike a devastating blow with little warning, hyperinflation doesn't happen over night. If you have cash and you keep watch on events, you'd have plenty of time to turn it into hard assets before it lost value.

Deflation and depression reinforce each other, so the combination should be quite persistent. I'd be very surprised if this depression lasted less time than the last one.