Monday, April 7, 2008

Debt Rattle, April 7 2008

Ilargi: I don’t know why really, but today we have an overflowing basket of articles. And there’s no way I can promise there won’t be more.

Three remarks:
1/ I like George Soros’s views on the situation: "I think we have come to the end of the road", "It is not business as usual but the end of an era.". I might pick up his new book and make him even richer...
2/ All of a sudden, the IMF is all over the news, pushing for global market intervention, and hinting at bailing out entire countries, specifically Iceland and Estonia. For a moment, I wondered what boosted their relevance. Then I realized: they got permission to sell a lot of their gold a while back. I guess they closed that deal.
3/ Steve Waldman shares my discomfort about Robert Shiller’s latest NYT piece (Shiller, like Feldstein, is taken seriously across the board). See the last article in this long Rattle: "Central banks are dangerous".

Updated 4.00 pm

Ilargi: Here's to all Americans who think they'll have functional road systems in their towns and counties in 2010. Low level small governments make me think of a virtuous maiden sucked dry overnight by a Count from Transsylvania, and all of his family.

They are bleeding money all over the place. To repeat myself from a long time ago. 1/ They'll lose a lot of tax revenue (property and other). 2/ Borrowing cash -flow- through bonds is cut off. 3/ Most are invested in lousy paper. 4/ Costs keep going up. IT. IS. SO. OVER.

Auction Collapse Quadruples Fee for Bond Alternatives
U.S. state and local borrowers from Denver to Atlanta, battered by rising interest costs from the collapse of the auction-rate bond market, now face higher fees to replace the debt. Denver found only five banks willing to provide backing for new variable debt to replace $208 million of auction bonds, down from 30 five months ago, said Margaret Danuser, the city's debt administrator.

The cost to line up a buyer of last resort in case such bonds, variable-rate demand obligations, go unsold when yields are reset jumped as much as fourfold to $400,000 on $100 million of securities a year, borrowers say. "It's a lot of headaches," Danuser said. Denver's costs for a so-called liquidity facility on the new debt were double the fees on a similar agreement last year, she said. "It's pretty telling of the tightness of the market."

States, cities, hospitals and other municipal borrowers that sold $166 billion of auction-rate securities plan to replace at least $36.7 billion of the debt by May 23, according to data compiled by Bloomberg. The auction-rate market collapsed in February after investors shunned the securities and dealers that run the periodic bidding to set interest costs stopped committing their capital to prevent failures.

The extra costs for Denver are still lower than keeping bonds in the auction market, where interest costs rose to as high as 10 percent in February, from 3.5 percent in January. "They were a lot higher than we ever anticipated," Danuser said. "As we were getting up over 5 percent, it was apparent to us that we were paying more than we thought we needed to."

Average rates on bonds with interest determined through bidding at dealer-run auctions every seven days rose to 5.67 percent April 2 from 3.63 percent in January. That compares with 1.89 percent on top-rated variable-rate demand bonds, whose rates are set by bankers, according to data from the Securities Industry and Financial Markets Association, or Sifma. The auction-rate index reached a record of 6.89 percent on Feb. 20.

When there aren't enough bids on auction debt, a "failure" results and rates are set at levels spelled out in bond documents. Investors who wanted to sell are left holding the bonds. When there isn't enough demand for variable-rate demand obligations at the time rates are reset, the provider of the backstop agreement buys debt that can't be immediately sold to other investors.

"The cost of liquidity facilities is so expensive now because those few who can provide them can charge huge premiums," Utah Treasurer Ed Alter said. The ability to forgo the added cost of so-called standby purchase agreements or letters of credit made auction securities popular among borrowers until the subprime-mortgage crisis sparked $232 billion in credit losses at banks worldwide. Dealers abandoned the market where they routinely bought unwanted securities to avoid failures.

Let's move to Greenspan's priceless Who? Mea? Never No Culpa in today's Financial Times.

The Fed is blameless on the property bubble
By Alan Greenspan

I am puzzled why the remarkably similar housing bubbles that emerged in more than two dozen countries between 2001 and 2006 are not seen to have a common cause. The dramatic fall in real long-term interest rates statistically explains, and is the most likely major cause of, real estate capitalisation rates (rent as a percentage of a property's value) that declined and converged across the globe. By 2006, long-term interest rates for all developed and main developing economies declined to single digits, I believe for the first time ever.

Doubtless each individual housing bubble has its own idiosyncratic characteristics and some point to Federal Reserve monetary policy complicity in the US bubble. But the US bubble was close to median world experience and the evidence that monetary policy added to the bubble is statistically very fragile. Paul De Grauwe, writing in the Financial Times' Economists' Forum, depends on John Taylor's counter-factual model simulations to conclude that the low funds rate was the source of the US housing bubble. Mr Taylor (with whom I rarely disagree) and others derive their simulations from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. Counter-factuals from such flawed structures cannot form the basis for policy.

Mr De Grauwe asserts that "signs of recovery" (I assume he means sustainable recovery) were evident before 2004 and hence the Fed should have started to tighten earlier. With inflation falling to quite low levels, that was not the way the pre-2004 period was experienced at the time. As late as June 2003, the Fed reported that "conditions remained sluggish in most districts". Moreover, low rates did not trigger "a massive credit . . . expansion". Both the monetary base and the M2 indicator rose less than 5 per cent in the subsequent year, scarcely tinder for a massive credit expansion.

Bank loan officers, in my experience, know far more about the risks and workings of their counterparties than do bank regulators. Regulators, to be effective, have to be forward-looking to anticipate the next financial malfunction. This has not proved feasible. Regulators confronting real-time uncertainty have rarely, if ever, been able to achieve the level of future clarity required to act pre-emptively. Most regulatory activity focuses on activities that precipitated previous crises.

Aside from far greater efforts to ferret out fraud (a long-time concern of mine), would a material tightening of regulation improve financial performance? I doubt it. The problem is not the lack of regulation but unrealistic expectations about what regulators are able to prevent. How can we otherwise explain how the UK's Financial Services Authority, whose effectiveness is held in such high regard, fumbled Northern Rock? Or in the US, our best examiners have repeatedly failed over the years. These are not aberrations.

The core of the subprime problem lies with the misjudgments of the investment community. Subprime securitisation exploded because subprime mortgage-backed securities were seemingly underpriced (high-yielding) at original issuance. Subprime delinquencies and foreclosures were modest at the time, creating the illusion of great profit opportunities. Investors of all stripes pressed securitisers for more MBSs. Securitisers, in turn, pressed lenders for mortgage paper with little concern about its quality. Even with full authority to intervene, it is not credible that regulators would have been able to prevent the subprime debacle.

Ilargi: Germany's banking system is not doing nearly as well as we are being led to believe. Nor are they very honest there. She resigned for health reasons? If you try to hide something that obvious, what else is in the closet?

KfW Group Chief Quits as Costs of IKB Bailout Rise
KfW Group said Chief Executive Officer Ingrid Matthaeus-Maier is stepping down and set aside an additional 1.8 billion euros ($2.8 billion) in reserves for the bailout of German lender IKB Deutsche Industriebank AG. Matthaeus-Maier resigned after 18 months as CEO for health reasons and retires from the management board in September at the age of 63, KfW said in a statement today. The Frankfurt-based company made additional provisions to cover first-quarter markdowns at Rhineland Funding, a finance affiliate it took over from IKB.

KfW has now put aside 6.8 billion euros to prop up IKB, which was the first German casualty of the U.S. subprime- mortgage meltdown. The value of its stake in IKB has fallen by 400 million euros. Matthaeus-Maier, who will be temporarily replaced by board member Wolfgang Kroh, said the "turbulence" of the rescue no longer allowed her to focus on the job.

"In order to protect IKB against risks and thus to stabilize the financial markets in Germany, KfW has taken on an extraordinarily heavy burden," Matthaeus-Maier said in a statement today. KfW's profit would have been almost 1 billion euros for 2007 excluding costs related to IKB, she added.

KfW, Germany's government-owned development bank, reported a full-year operating loss of 6.18 billion euros after a profit of 1.54 billion euros in 2006, based on International Financial Reporting Standards. The German government and banking associations also contributed to rescue efforts for IKB.

IKB declined 14 cents, or 3.5 percent, to 3.86 euros in Frankfurt trading. The company has lost 85 percent of its market value since July 30, when it cut its full-year forecast and received emergency funding less than two weeks after saying the subprime crisis wouldn't affect it. The bank, which is being sold by KfW, has a market value of 374 million euros.

Bayerische Landesbank reported 4.3 billion euros in writedowns from the subprime-market collapse last week, double its previous estimate and the biggest of any German state bank. Smaller competitor WestLB AG posted its first loss in three years after 2.01 billion euros in markdowns.

The world's biggest financial companies have announced more than $232 billion in writedowns and losses, a sum that may rise to $600 billion, according to German financial regulator BaFin. Deutsche Bank AG, Germany's biggest bank, marked down 2.5 billion euros for the first quarter alone and said last week that conditions are "significantly more challenging.'

Feldstein says U.S. in recession
Martin Feldstein, who leads the group that is considered the arbiter of U.S. recessions, said Monday that he personally believes the economy has been sliding into a recession since December or January.

“I think that December/January was the peak and that we have been sliding into recession ever since then,” Mr. Feldstein, the president of the National Bureau of Economic Research, said on CNBC television. Mr. Feldstein said he believes that the recession will linger. ”I think it could go on longer” than the “last two recessions [which] lasted eight months peak to trough,” he said, adding the current recession could last about twice as long.

He also said the first quarter U.S. gross domestic product number will be a “misleading” number in that it may not reflect the economy was in a recession in the first three months of the year. The NBER, a non-profit research organization, typically declares start and end dates for U.S. recessions. The group has not officially declared the U.S. is in a recession.

Soros predicts end of the road for cheap and easy borrowing
The City of London faces a severe recession and the UK economy is set to follow the US into a sharp downturn, according to a gloomy prognosis from the billionaire financier George Soros. Faced with over-valued houses, mountains of personal debt and a rise in unemployment, the UK is especially vulnerable to the effects of the credit crisis sweeping through financial markets, Mr Soros said, and he warned not to expect a rebound at any point in the near future.

Indeed, the crisis is so serious that it will up-end 25 years of free-market thinking and bring to an end an era of cheaper and easier borrowing, he predicted. "It is not going to be like the 1930s – we are not going to allow financial institutions to fail – but this is a historic event like the Great Depression was."

In the UK, as in the US and the rest of the developed world, "ever looser lending standards and more aggressive supply of mortgages" have contributed to a house price bubble but, said Mr Soros, "I think we have come to the end of the road".

"To say that it won't affect the real economy is untenable, because it affected it on the upside, so it will affect it on the downside. Recession in the US is inevitable. There will be implications for the globalised economy and the UK happens to be as vulnerable as the US, but in different ways. The finance industry is much more important to the UK because London is a financial centre and the industry is going through a painful process of deleveraging.

The housing market in the UK has at least not seen the building boom that we have seen in the US and the supply of new homes has not gone up, but on the other hand, the indebtedness of UK households is actually even greater relative to income than in the US." Mr Soros's warning of the inevitability of a US recession came as new figures revealed an increase in unemployment of 80,000 people, significantly ahead of economists' forecasts. The jobless rate in America rose to 5.1 per cent in March, the highest level since September 2005, and a rise from February's 4.8 per cent.

The views of a man who was born in Hungary and made his fortune in US hedge funds have always had a particular piquancy in the UK, where he is feted as the man who "broke the Bank of England". His heavy bets against sterling helped force it out of the European exchange rate mechanism in 1992, netting himself an estimated $1bn profit that Black Wednesday.

He deems the issue of sterling's value as too sensitive to discuss in interviews with British journalists these days, but in his new book, The New Paradigm for Financial Markets, he notes grimly that "the overvaluation of the euro and sterling is going to hurt European economies".

Mr Soros's main concern, though, is for the dollar, whose status is being eroded by the credit crisis, pushing up import prices and causing a dilemma for those who want still more interest rate cuts to stimulate the US economy. "The Federal Reserve is constrained by the reluctance of the rest of the world to hold dollars," he said. "We face the double jeopardy of recession and inflation."

Soros Lambastes Market Theory, Says It Created 'Super-Bubble'
For 20 years, George Soros has challenged the theory that markets, however choppy, always move toward equilibrium. Now a meltdown has handed him rich evidence that the hypothesis isn't just flawed, it's dangerous. We are facing the worst financial crisis since the Great Depression, Soros writes in "The New Paradigm for Financial Markets," a book rushed online this week.

The culprit, he says, is a misconception that markets can correct themselves, no matter how we short-circuit them with easy money, massive leverage and brain-bending synthetic instruments. "The belief that markets tend towards equilibrium is directly responsible for the current turmoil," the billionaire philanthropist writes. "It encouraged the regulators to abandon their responsibility and rely on the market mechanism to correct its own excesses."

His solutions, laid out here in uncluttered prose, range from abandoning some financial instruments to curbing lending to creating an exchange or clearing house for credit-default swaps. Soros also gives glimpses of the trading strategies he's using to shield his wealth: He has bet against U.S. and European stocks, the dollar and 10-year Treasuries, preferring non-U.S. currencies and equities in China, India and the Gulf states.

This is a deeply philosophical, often frustrating book that refines ideas that Soros has written about before. Parts of it are, by his own admission, hard going. Yet bankers, hedge-fund managers and regulators should pay heed. For Soros is raising questions that cut to the core of how a credit bubble became a Godzilla that pushed the financial system to the brink, damaged the U.S. dollar and made a recession inevitable.

"This will have far-reaching consequences," writes Soros, 77. "It is not business as usual but the end of an era."

Washington Mutual to Get $5 Billion
Private-equity firm TPG and other investors are close to a deal to invest $5 billion in Washington Mutual Inc., people familiar with the matter said Sunday. The injection of new capital would allow the country's largest savings and loan to ease its pressing capital requirements, the people said, amid punishing losses from the national mortgage crisis.

But it would substantially dilute current WaMu shareholders, who have already lost 74% of their investment over the past year. WaMu's market capitalization on Friday was just under $9 billion, after its shares dropped 11% that day. The planned investment marks a humbling hand-in-hat moment for the 119-year-old Seattle stalwart. Having parlayed the country's housing boom to a nationwide reputation and immense profits, it is now paying dearly for delving into subprime mortgages.

Much of the subprime focus has been trained on Wall Street's leading banks and brokerages. But the investment shows how troubles have hit such main street banks as WaMu and Cleveland's National City Corp. TPG's effort could be viewed as an encouraging sign for the nation's ailing banking system, and Wall Street will be watching to see whether it is an indication that the worst is over. It comes as virtually every large mortgage company in the country has hit financial distress. Countrywide Financial Corp. had to seek an emergency sale to Bank of America Corp. earlier this year, while others have gone bust amid mortgage losses.

Still, an investment could expose TPG and its partners to a financial hit if the mortgage-market shakeout continues.
While banking regulators were likely apprised of WaMu's plans, the government was not directly involved in forging a deal as in the recent purchase of Bear Stearns Cos., say people familiar with the matter.

As currently envisioned, the $5 billion investment would be structured as both a common- and preferred-stock offering. The preferred stock could be converted into common shares in the future, subject to a shareholder vote. TPG -- formerly Texas Pacific Group -- is expected to maintain a "substantial minority holding" in WaMu, said one person familiar with the matter, though exact terms weren't clear. The amount is expected to fall under 25%, a threshold that would require TPG to register as a financial holding company under government rules.

Is merger Monday back?
Capital continues to flow to troubled financial institutions, encouraging investors to believe that the worst of the mortgage mess may be over. Troubled mortgage lender Washington Mutual is the latest player in the subprime-mortgage game to get a capital infusion, The Wall Street Journal reported. WaMu is close to receiving $5 billion from private-equity firm TPG, the Journal said.

The investment will remove the threat of a takeover by JPMorgan Chase or another bank, at least for now, the report said. Shares of WaMu soared $1.35, or 13.3%, to $11.52 in pre-open trading. The stock had plunged 70% over the past six months, as of Friday's closing price.

At least 14 financial institutions have turned to outside investors for capital infusions in the past year, as the mortgage meltdown forced them to accept more than $230 billion in write-downs on mortgage-related investments, Bloomberg statistics show. Many are hoping that last week's stock market rally and Friday's reaction to the dismal jobs report are signals that things are starting to turn around.

"The market has pretty much priced in a pretty good portion of the recession scenario," said Owen Fitzpatrick, head of U.S. equity trading at Deutsche Bank, to MarketWatch. "Given that the Fed is doing what it can to pull us out of this, the market is expecting a shallow and short recession, not a deep and extended one."

U.S. housing crisis comes to McMansion country
Million-dollar fixer-upper for sale: five bedrooms, four baths, three-car garage, cavernous living room. Big holes above fireplace where flat-screen TV used to hang. The U.S. housing crisis has come to McMansion country. Just as the foreclosure crisis has hollowed out poorer neighborhoods, “for sale” signs are sprouting in upscale developments so new they don't show up on GPS navigation screens.

Poor people weren't the only ones who took out risky, high-interest loans during the housing boom. The sharp increase in housing costs – and the desire to live in brand-new, spacious houses with modern features – led many affluent buyers to take out loans they couldn't afford. “People had in their head, ‘I need a mud room, I need giant columns, I need a media room, and I'm going to do anything to get it,”' said Robert Lang, co-director of Virginia Tech's Metropolitan Institute, a research organization that focuses on real estate and development.

The crisis has hit especially hard here in Loudoun County, Virginia, where upscale developments have supplanted horse farms over the past fifteen years. About an hour's drive from Washington, Loudoun is one of the nation's most affluent counties, with a median household income of $98,000 (U.S.), more than double the national figure.

The county has also ranked as one of the nation's fastest growing in recent years as developers built thousands of super-sized, amenity-laden houses to keep pace with the booming high-tech economy. These houses are sometimes nicknamed “McMansions,” disparaging both their extravagance and their look of mass production – like hamburgers from a McDonald's restaurant.

Between 1990 and 2005, the county's population tripled to 272,000. Many of those moving here relied on risky, high-interest loans to buy the house of their dreams. “People pushed the limits to be able to buy. They couldn't afford to buy there otherwise,” said Virginia Tech consumer-affairs professor Irene Leach.

High-interest loans accounted for 16 per cent of the total during the height of the mortgage boom in 2005, less than other outer-ring suburban counties in the region but more than neighbouring counties closer to Washington. Now the bill has come due. One out of every 69 households in the county was in foreclosure in the last three months of 2008, well above the national average of one filing for every 555 households, according to RealtyTrac.

Lenders retreat as housing market plummets
As the nation's housing market swoons, lenders are tightening their grip on their money. Last month, that credit crunch reached Brent Meyers. To all appearances, he's an unlikely victim. A well-paid chief executive of a small consulting firm, he owns a substantial investment portfolio and a million-dollar house in Moraga.

He pays his bills on time and has no credit card debt. His credit score, he says, is around 800, a rating more or less in the stratosphere. But in mid-March, Bank of America cut off his home equity credit line of a little more than $180,000, citing a decline in the value of his property. Meyers, 40, is now scrambling to come up with $75,000 to pay for a major landscaping project and is canceling other big spending plans.

"My wife would like a new car, but that's going to have to wait," he said. "We're taking a $75,000 cash-flow hit, and I want to boost savings." The credit crunch made big news last month when brokerage giant Bear Stearns Cos. was forced to sell itself on the cheap after it was unable to borrow money to cover losses in its portfolio of mortgage securities. But the chill in the credit markets is not something that's hitting just big banks and securities firms.

In thousands of ways big and small, across the Bay Area and the nation, lenders are retreating after booking losses in the mortgage market. Households and businesses are suffering the consequences as money becomes tougher to get and more expensive to borrow. That in turn spells bad news for the economy. Credit is the grease that lubricates the economic engine by giving individuals and businesses the means to spend.

Borrowed money pays for everything from new outfits at the clothing store to house purchases and major home improvement projects. When individuals and entrepreneurs can't get loans at interest rates they can afford, they spend and hire less. Tight credit ripples through the economy. The result is a slowdown, and, if severe enough, a contraction of economic activity, in other words, a recession.

By 2004, Americans were taking out $180.5 billion in home equity loans, according to the Federal Reserve. Much of that cash was pumped right back into the economy, buying cars and furniture, renovated bathrooms and kitchens, airline tickets and hotel rooms. But as home prices started to sink, homeowners had less equity to draw on. Lenders including Bank of America, Washington Mutual and Countrywide Financial cut back on home equity loans to reduce their exposure to the housing market.

By the last three months of 2007, home equity borrowing dropped to an annual rate of $26 billion, the Fed calculates. And home equity borrowing has undoubtedly fallen further in 2008. Cutbacks in home equity loans and other forms of consumer credit are one of the factors behind a stall in retail spending. Total retail sales fell 0.6 percent in February, according to the U.S. Commerce Department, led by slumping car and truck purchases.

Forecasters predict consumers will barely boost spending above the rate of inflation this year, the worst performance in more than a decade. Consumer spending represents about 70 percent of all economic activity in the United States. "For the economy to expand, it will have to come from the other 30 percent," said Carl Steidtmann, chief economist at the consulting firm Deloitte Research.

Financial crisis: "no end in sight"
The financial crisis is not over by a long chalk. The United States looks almost certainly set to go into recession and the rest of the world will suffer the consequences, says Dutch Central Bank president Nout Wellink. Rising inflation and an expensive euro are the global results of the mortgage crisis in the US. The Americans are in trouble, but Europe's economies are also facing difficulties.

The International Monetary Fund is even going as far as to talk about the biggest financial crisis since the Great Depression of the 1930s. Not only banks in the US but also European financial institutions are feeling the pain. Mr Wellink believes an end to the problems is not in sight:
"The economies of a few European countries are being affected by housing market problems. But the European housing market as a whole is not as problematic as that of the US. And the European economy is much more robust because of the numerous structural reforms introduced over recent years."

The International Monetary Fund reckons there is about a 25-percent chance of a global economic crisis resulting from the problems in the US loans market. A crisis will mean less trade and that will hit European economies which are already less competitive because of the expensive euro. The value of the euro has almost doubled against the US dollar in just a few years, Mr Wellink again:
"The growth in world trade is the deciding factor in whether your exports remain stable. But if growth decreases - and it's under pressure at the moment - then the strong euro will become more noticeable. And that could easily cause us more trouble."

Fear of Iceland bail-out could signal new future for the IMF
It's the most unlikely comeback since Lazarus and the most grisly since the return of Rambo. Given up almost for dead by its managing director last year, berated by everyone from Tony Blair and George Bush to the leaders of Brazil and China, the International Monetary Fund (IMF) is now quietly but determinedly wrestling its way back centre stage.

Against the most unlikely background - the carnage of the global financial crisis - the Washington-based institution is hoping to come into its own once more. Analysts think that if the credit crunch worsens, there is a chance the IMF may be called upon to bail out Iceland in what would be the first rescue of a developed country since Britain had to call upon the fund in the 1970s. Some even think that if there is a genuine rout of the dollar, the IMF might have to pump cash into the US economy.

Even if neither of these doomsday scenarios materialises, the fund, which holds its spring meeting next week in the American capital, suddenly finds itself back in demand as a potential future referee for the global financial system. Its new managing director - former French finance minister Dominique Strauss-Kahn - appears to have kicked a programme of reform and modernisation into action, taking the painful decision to sack staff and cut budgets.

The story was far bleaker only last summer. After five years of relative inaction, the IMF was being accused of sliding into irrelevance. It had been forced to apologise for doling out poor advice to the economies caught up in the Asian crisis in the late 1990s. Critics questioned whether it was serving a fundamentally useful function.

After their dismal experience in the late 1990s, most Asian nations were determined never to have to return to the IMF, building up massive mountains of savings to ensure they had enough cash to see them through future downturns. Some set up sovereign wealth funds which, in the early stages of the financial crisis, seemed to do the IMF's job for it, injecting much-needed cash back into the Western financial system.

To top things, off, the IMF was forced to admit last year that it was facing an unprecedented deficit in its own accounts. Having funded itself off the interest payments from loans to struggling economies for so many years, the IMF found itself in a financial fix of its own since most of the recipient countries had paid back their emergency loans.

Against this bleak background, the fund's comeback might seem unlikely, but it is precisely what is in prospect. With a number of countries seeing their currencies ravaged by the financial crisis, it is the old-fashioned view of the IMF as a financial saviour which is hoving back into view. Although, at the margins, sovereign wealth funds have done much of the work the IMF did in previous decades, their generosity has its bounds. These investors are precisely that - not charities - and the flow of cash from China and the Middle East has slowed in recent months.

"If it doesn't come into its own in this crisis, the IMF will never be able to claim any relevance," says Julian Jessop, chief international economist at Capital Economics. "It has been derided as a talking shop, but now is not the time for talk. It is possible that it might have to rescue one of the smaller countries from possible shocks. Iceland and Estonia are the names that come to mind."

In some ways, the problems facing Iceland are the financial crisis writ large: the country has built up a massive current account deficit by borrowing beyond its means for years. Worse still, its banking sector, which is similarly over-extended, is eight times the size of the overall economy. Should it topple, it seems unlikely the central bank would be able to mop up the mess.

IMF boss wants intervention on credit crisis
Government intervention at a worldwide level is needed to address the credit crisis, the head of the International Monetary Fund said on Monday. "I really think that the need for public intervention is becoming more evident," IMF Managing Director Dominique Strauss-Kahn told the Financial Times in an interview.

Strauss-Kahn's comments come just days before world finance ministers and central bank governors gather in Washington for the meetings of the IMF and the World Bank, where steps to address the crunch in financial markets will be discussed. Strauss-Kahn told the paper that government intervention -- in the securities market, the housing market or the banking sector -- would act as a "third line of defence" to support monetary and fiscal policy.

"Effort has to be made on loan restructuring. With respect to the banks, if capital buffers cannot be repaired quickly enough by the private sector, use of public money can be examined," he said.
Finance officials and central banks from a host of countries have been putting their heads together in past months to find ways to tackle the crisis, to prevent it from spiraling out of control and to stop such conditions from recurring.

Strauss-Kahn said the credit crisis was far more than an American problem. "The crisis is global," he said. "The so-called decoupling theory is totally misleading." Developing countries such as China and India would be affected, the paper said. He added that the IMF this week will revise down its global economic forecasts to below the current private and official consensus.

"The forecasts we are going to release in a few days are not very optimistic. The downside risks we underlined in the last world economic outlook have materialized," he said. The IMF's twice-yearly World Economic Outlook is due to be released on April 9.

Bear Blowup: Why it Wasn’t a ‘Short’ Conspiracy
As the saga continues, the plot thickens: The blame-it-on-the-shorts bandwagon got quite a push last week, but this battle cry is likely to go the way of all others if Roddy Boyd’s attempt in the current Fortune to put together the pieces of the puzzle is anywhere near close to what really happened. If it is, it would appear the shorts, yet again, were reacting to market events — not causing them.

Just last week Congressman Barney Frank was quoted everywhere saying there needed to be more of a probe into the role of the manipulative short-selling of the stocks of investment bankers. He and others have pointed to the sharp rise in volume, starting on March 10, as proof there might have been collusion among those who profit when the stock price falls. But take a look at the timetable of events, as Roddy did, and draw your own conclusion:

March 10, the day the volume started to rise, and Bear’s stock started to plunge, Bear Stearns issued a press release saying there “is absolutely no truth to rumors of liquidity problems.”
March 11, as volume spiked higher, Bear’s CFO, emphasized on CNBC that the rumors were false. But on that same day, according to Roddy, “the credit derivatives group at Goldman Sachs sent its hedge fund clients and e-mail” saying “it would no longer step in for them on Bear derivatives deals.” This was important, Roddy points out, because in the weeks leading up to the Bear blowup, Goldman “had done a brisk business…agreeing to stand in for institutions nervous, say, that Bear wouldn’t be able too cough up its obligations on an interest rate swap.”
By March 12, “when word of the Goldman e-mail leaked out,” Roddy writes, “the floodgates opened. Hedge funds and other clients, eventually running into the hundreds, began yanking their funds.” At the same time, he says, banks other banks refused to issue any further credit protection on Bear’s debt.

That, as we know now, was the beginning of the end. And as it turns out, the Goldman e-mail may very well have been the tipping point, with market participants, both long and short, doing what they always do: Acting now, asking questions later.
Furthermore, as one short-seller notes, with other banks no longer writing credit default insurance on Bear debt, the best way to hedge Bear counter-party risk was to short its stock. Rather than manipulation, it was the free market acting as a free market should. More on the topic:

If you haven’t already done so, read Floyd Norris’ take on his excellent blog at the New York Times. As is usually the case, in “A Search for Scapegoats,” Floyd puts it in perspective only the way Floyd can.
Maybe some hedge fund manager was dumb enough to send an e-mail message saying something like, “I know Bear is really fine, but let’s spread rumors it can’t borrow money any more.” Then we would have someone admitting he did not believe the rumor he was spreading, even though it happened to be true. Better yet, maybe they can find someone admitting to spreading a false rumor about Lehman or some other bank.

But even if that did happen, the ones who deserve the real blame for Bear’s collapse are those who made the firm so weak that it could be vulnerable to such talk. There are no shorts in that group. It consists of Bear’s managers, directors and regulators.

Dollar Bottom Elusive Before G-7; Bearish Bets Double
Optimism for a dollar rebound that pervaded the currency market at the start of the year is fading. Futures traders doubled bets against the greenback in the past two months, data from the Commodity Futures Trading Commission in Washington show. Citigroup Inc., Deutsche Bank AG and Royal Bank of Scotland Group Plc, which handle almost 40 percent of global foreign exchange trading, say the currency may slump to $1.65 per euro by October.

While the dollar rose April 1 when UBS AG and Lehman Brothers Holdings Inc. said they're raising $19 billion to boost their capital, it declined the rest of the week after Federal Reserve Chairman Ben S. Bernanke acknowledged for the first time that a recession is possible. Officials of the Group of Seven nations meet this week in Washington, and are unlikely to agree on a plan to support the dollar because rising exports may be the only blessing of a weak currency in a slowing economy.

"The dollar will continue to move lower in the next couple of months until the U.S. economy improves markedly," said Adam Boyton, senior currency strategist in New York at Deutsche Bank. The Dollar Index, which measures the currency against six of its main counterparts, tumbled the past two months after trading little changed between October and mid-February. It's down 5.8 percent in 2008, after dropping 8.3 percent in each of the past two years.

The problem is unimaginably, indescribably big
Between 1986 and 1989 the United States' Federal Savings and Loan Insurance Corporation closed or otherwise disposed of almost 300 institutions with US$125 billion in assets. The Resolution Trust Corporation created by the US Congress in 1989 disposed of 747 thrifts with total assets of US$394 billion. Over 1000 institutions and according to varying estimates, a minimum of US$519 billion in assets went on the block.

Regardless of controversy over value, the numbers capture the difference in scale - chicken feed to the potential meltdown that the US central bank, the Federal Reserve, in conjunction with JPMorgan Chase, has now intervened to cauterise. The problem is unimaginably, indescribably big. Conservative estimates put the US housing market at US$20 trillion, and the residential mortgage market at US$12 trillion.

Much as extreme laissez faire market advocates might wish, it seems impossible to contemplate a hands-off attitude on the part of the Fed. Unsurprisingly, Wall Street moguls themselves approached the authorities. Is this system biased towards corporate welfare or what? What of those huge pay packets and bonuses? Will some of this be contributed to assist? Are these questions only for the naive to ask but not to be answered?

Consider the difference 20 years of financial innovation makes. First, in those good old days of '88, mortgages could be specifically identified and valued because of a second difference between then and today. Wall Street-initiated securitised holdings straddling the globe from New York to Geneva on to Mumbai, did not yet exist. Then, the issue was a subset of the financial system and structure; now it is the whole and global.

Today's problem resembles more the lead up to the crash of 1929 than that of the 1980s savings and loan institutions, their borrowers, creditors and collateral. Banks and financial houses exist on confidence as they negotiate divergent needs, wishes, and fears of those who create wealth and those who hold wealth, people who want to borrow and to save. Savers want a safe place to store funds. A place from which they can retrieve funds at will.

Borrowers want a place from which to access capital resources at reasonable cost with predictable, preferably guaranteed flow.
This is what the financial system provides. In the midst of all this locate the profit motive or capitalism, or greed, or whatever you wish. Reality: this system works. Each participant requires 'a turn' from the wheel, a cut off the proceeds. Innovation in 'products' tends to increase the returns from a turn at the wheel.

German banks chief signals interest in super bank
The head of the German banks association signalled on Monday that he was in favour of a merger combination of a number of German banks because the country's lenders were underweight. There has been speculation in Germany about a merger involving three banks. Commerzbank, Postbank and Allianz's Dresdner Bank have been flagged as would-be partners.

Answering a question from Reuters as to whether such a tie-up was desirable, German banks association chief Klaus-Peter Mueller signalled that it would be, saying that the country's banks were too small as they were.

"Even if you put them all (German commercial banks) together, we would only come around the middle of the European league," said Mueller, who is also chief executive of Commerzbank. "Germany's banks are too small on their own."

Ilargi: Time for a UK Mortgage Implode-O-Meter.

Credit Crunch Hits IFAs
With mortgages being withdrawn by many of the big lenders, the UK’s financial advice industry is starting to suffer. There are about 30,000 IFAs (Independent Financial Advisors) and another 30,000 mortgage advisers, but the number of mortgage products available to the advisers has fallen from 15,000 last year to only 4,500.

Two thirds of the nation's mortgages are sold through IFAs and mortgage advisers, so the downturn in the credit market is having a negative impact on their businesses. Adrian Kidd, of Unleash Advice Partnership, was quoted in The Times as saying: “It's an absolute disaster and a minefield out there at the moment. Companies are pulling stuff from the market every day now. Brokers don't seem to want anything over £1million on their books.”

Legal and General estimate IFAs will gain less than 20% of their business through mortgage applications in the next three months. This compares with a typical figure of 30-50% of their income being generated through mortgage applications. Halifax, Britain's biggest home-loans bank, has today become the latest of a string of mortgage lenders to clamp down on its offerings in recent weeks. The bank, owned by HBOS, has upped its mortgage interest rates and penalised customers that lack large deposits

UK bank rates 'will fall by a point'
Interest rates will be cut by a full percentage point by the end of the year as the credit crisis continues to cause turmoil in the mortgage markets and the wider economy, financial experts predicted yesterday. The forecast came before the Bank of England's monetary policy committee (MPC) meeting this week, which is widely expected to cut rates from 5.25 per cent to 5 per cent.

That would be the Bank's third since last December, although homeowners have struggled to benefit, with tighter credit conditions causing nervous lenders to withdraw many of their mortgage deals and increase rates on many others. Members of the MPC will be concerned that the current uncertainty could feed through into sharply lower economic growth. Mortgage experts said that if the turmoil continued, rates could fall to as low as 4.25 per cent by the start of 2009.

Howard Archer, the chief economist at the financial analysts Global Insight, said: "We believe the increased downside risks to growth, stemming from tighter credit conditions and coupled with signs that the economic downturn could be deepening, will lead the MPC to cut interest rates from 5.25 per cent to 5 per cent on Thursday, despite the inflation pressures." He said he expected rates to finish the year at 4.25 per cent.

Philip Shaw, chief economist at Investec Securities, added: "We consider that a June easing to 4.75 per cent is likely to follow this week's reduction and after that, the critical determinant will be whether there are signs of normalisation in credit markets. "There are mounting risks that credit conditions will remain dysfunctional for some time to come, in which case the Bank rate could fall to 4 per cent or below."

However, it will be difficult to reduce rates further, because the MPC's mandate is to keep inflation at 2 per cent. The Consumer Prices Index, the official measure of inflation, is already above target at 2.5 per cent, and further cuts would be likely to push that higher. The committee will therefore have to be more cautious than policymakers in the US, where rates have been reduced aggressively this year.

But experts believe the aggressive tightening of credit supply by mortgage lenders will carry greater weight than inflation when the MPC meets. Philip Shaw, the chief economist at Investec Securities, said: "We consider that a June easing to 4.75 per cent is likely to follow this week's reduction." The research consultancy Capital Economics believes interest rates will fall to 4 per cent by the end of the year and will be cut even further to 3.5 per cent in 2009.

UK: Tide turns on ludicrous boom in house prices
In the US, the housing market is in a dire state. House prices are already about 10pc down with no sign of stopping. Over here, prices have started to edge down, but so far the fall has been small. Don't relax, though. We may be behind the US - but we are following. The adjustment in the market which I and other commentators have expected is finally here.

There are two major causative factors at work. First, houses have become extraordinarily expensive, to the point where ordinary people can barely afford a shoe box. And second, the ample supply of credit which allowed this to happen is now tightening. The second may be the proximate cause of the coming fall in prices.

But don't let anyone fool you into believing that it is the fundamental cause. That prize goes to the ludicrous over-inflation of prices. In order to get on the "ladder" you have either to own property already or mortgage yourself up to the eyeballs. This has been a bubble waiting to be pricked.
That is the picture given by that tried and trusted indicator of value, the house price to earnings ratio, as shown in our chart. Its message has been uncompromising - this is far and away the biggest distortion in the housing market that we have ever had.

That is not quite the message, however, given by the indicator most favoured by professionals in the industry. Funny that. They favour the so-called affordability ratio, which shows the percentage of a person's income which will be taken up by mortgage payments when they first take out a mortgage. Mind you, this hardly gives a bullish message. Unaffordability stands at about the same level that it reached at the end of the late 1970s run-up. But it is way below the peak level reached in the downturn of the early 1990s. So that's all right then.

The problem is that in today's circumstances this affordability measure is seriously flawed. Even the word should worry you. Do you hear people talking about the "affordability" of cars or holidays? They talk about the price of these things and of what value they place on them but there is no presumption that people are bound to want as much of them as they can "afford".

Or do you hear people speaking of the "affordability" of equities? The word smacks of a world in which house prices are bound to go up forever. In such a world, it makes sense for you to buy as much housing as you can afford. This is the world we have lived in for some time. It is not the world that we are in now.

Global economy battling 'crisis of confidence' - OECD head
Prospects for the global economy are worsening more quickly than expected amid 'a crisis of confidence,' the head of the Organisation for Economic Cooperation and Development (OECD) said Monday. 'Things became worse than we thought. We thought 2008 was going to be difficult for the first two quarters and then it was going to get better,' said OECD secretary general Angel Gurria.

'Now everybody is saying 2008 is going to be difficult,' he told reporters here, adding that business and consumer confidence have been badly damaged by the severe market turmoil sparked by the US subprime mortgage crisis.

'The problem is the crisis of confidence. This is going to take longer to sort itself out. Everybody becomes ultra cautious,' he said.

Hedge fund managers make mint on housing crisis
Millions of Americans may be facing the prospect of losing their homes, but a handful of fund managers have become the best paid in their industry – taking home 10-figure paycheques last year – by betting against mortgages.

John Paulson, who ran a medium-sized fund until last year, zoomed to the top of the industry's earnings table when he took home an estimated $3-billion in 2007, double what the top earner made in 2006, according to data released by magazine Trader Monthly Monday.

By standing conventional wisdom on its head and deciding that housing prices could decline on a national level, and that investment-grade mortgage bonds would be subject to default in record numbers, Mr. Paulson, 52, set a new record for payouts on Wall Street, industry analysts said. Mr. Paulson's $3-billion payout is equivalent to $26 for every U.S. household (114.4 million in 2006).

This year seems to be no worse for Mr. Paulson as his Advantage Plus fund was up roughly 8 per cent through the middle of March. Many other hedge funds, however, are suffering heavy losses, with industry analysts estimating the average fund lost 5 per cent in the first quarter. Hedge funds often promise to make money in all markets by using tools, such as shorting, that are off limits to other money managers.

Bankruptcy filings expected to soar as economy slides
The law that drastically changed the Bankruptcy Code in October 2005 was supposed make it tougher to escape debts and reduce the number of filings. It worked, for a time. Although the law made filing for bankruptcy more complex and expensive, the number of cases locally and nationally is rising again. Experts predict a big hike later this year, triggered by the nation's wobbling economy and heavy levels of consumer debt.

National statistics indicate the trend is well under way, with bankruptcy filings by individuals up 27 percent nationwide in the first quarter of 2008 compared to the year-ago period, according to new figures from the American Bankruptcy Institute, a research and education group. Individuals' bankruptcies nationwide rose 40 percent in the 2007 calendar year compared to 2006. The ABI, which bases its figures on data from the National Bankruptcy Research Center, said the increase is due to rising household debt and growing mortgage problems.

The full impact of the nation's sliding economy is not reflected in the most-recent figures — that may take a few more months — and many lawyers believe there will be a lot of bankruptcy-related business up for grabs this year. "Nationally, people think that the No. 1 area of growth this year will be bankruptcy," said Carrie Titus, division director of Robert Half Legal, which provides legal staffing to law firms and corporate legal departments.

Titus based her comments on results from a Robert Half survey that asked large firms and corporations about staffing needs in the next 12 months. The results were released last week. The reason the increase is expected later this year is because the impact of bad economic developments doesn't translate immediately into a sharp hike in bankruptcy filings, said Jack Williams, scholar-in-residence for the Alexandria, Va.-based Bankruptcy Institute. He's also a bankruptcy professor at Georgia State University College of Law in Atlanta.

"That spike generally lags about six to nine months behind the economy," Williams said. "Bankruptcy is a lagging economic indicator." Because of this, Williams predicted that the number of filings across the country, including business and individual cases, will rise to between 1.2 million and 1.4 million by the end of 2008. Most cases are filed by individuals.

"This is a huge number…"…. This is fast approaching previous levels," he said, referring to the period before the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 took effect. "It's the very thing that Congress sought to fix. It will turn out to be a legislative failure."

Spain's gain from wind power is plain to see
Windmills pay. On a breezy Saturday at the end of March, Aeolian Parks scattered across the hill-top ridges and off-shore sandbanks of Spain produced 40.8pc of the country's electricity needs - 9,862 megawatts to be precise. The much-derided turbines produced enough wattage to power the great cities of Madrid, Barcelona, Seville, Valencia, Toledo, Cordoba, Granada, Santander, Bilbao, and Zaragoza combined. The workday record on a Tuesday, March 5, was 28pc.

Years of nurture by the Spanish government have paid off. Spain is a global superpower in the wind race, with 15,000 MW of capacity. The region of Navarra is 70pc green, shielded against gas-shocks, Russian politics and soaring oil prices. Today's wind turbines are a far cry from the archaic mini-mills that scar the landscape for little return, and provoke such fury in the English shires. They are vast. Each mast can power a neighbourhood.

Here in the wet misty mountains of Asturias, the German power group E.On is erecting a battery of mills that tower 410ft into the sky. They are higher than the dome of St Paul's Cathedral or the US Congress on Capitol Hill. The rotors alone dwarf the wingspan of an Airbus A380 super jumbo. "We are beyond the boutique phase," said Frank Mastiaux, the head of E.On's green operations. "When this began in the 1970s it was a niche play, a nice tax break for German dentists and doctors. Now it is turning into an industrial business. Productivity has grown by 150 times in 25 years."

Every mill costs €2.6m (£2m) to buy and erect, yet the Danish manufacturer Vestas is sold out until 2010.
E.On is coy about profit margins. The European operations are flirting with break-even cost, but the company's huge 10-mile wind farms in the Texas outback have reached the magical level of €50 per megawatt hour (with US government subsidies), far below natural gas at the current market price.

America is the new Mecca for wind power. The ranchers are fully signed up. They collect an annual royalty of $5,000 to $10,000 for each turbine, and cattle can still graze underneath

Chinese Commercial Banks Suffer Foreign Exchange Losses
China's commercial banks would suffer huge foreign exchange losses for US dollar- denominated assets due to the faster appreciation of Chinese currency. In the first quarter of 2008, the Chinese currency Yuan has risen by nearly 4 percent against the US dollar. It is widely expected that the Yuan would appreciate at least 7.5 percent this year.

Except for the central bank, the Industrial and Commercial Bank of China, China Construction Bank, and Bank of China are the largest holders of foreign currency assets. According to their 2007 annual reports, nearly USD 40 billion foreign exchange assets are at risk exposure, which would lose over CNY 20 billion based on the 7.5 percent appreciation pace of Yuan.

ICBC had net CNY 137.6 billion or USD 18.8 billion equivalent foreign currency exposure as at December 31, 2007. It has confirmed CNY 6.88 billion exchange losses. BOC had net USD 4.1 billion foreign currency exposure at the end of 2007. CCB has yet to publish its audited annual report, but it has said in its third-quarter report that exchange losses have reached CNY 5.49 billion. It may have the similar foreign currency exposure as ICBC.

Market slump makes divorce more difficult
Back in the days of the housing boom, I knew a couple whose marriage went sour, but they continued to live together for years after their divorce went through. Turns out the holy grail of stability wasn't their affection for one another, but a rent-controlled apartment. They simply couldn't afford to move on.

I wrote then about the way the white-hot real estate market was burning families going through divorces. Now, ironically, the sharp downturn in the market is taking a similarly painful toll on couples who are breaking up. It's not that they can't afford their next home but that they can't get rid of the old one. I have friends who are taking turns living in their marital home even as they hope to sell it.

But in the new era of homes going stale in an oversupplied market and their owners going underwater on their mortgages, this is but the tip of the domestic iceberg. According to divorce lawyers, the quickly shifting real estate landscape is making breaking up harder to do than ever.

"The housing market is having a major impact on divorce cases," says Stephen Ruben, a certified family law specialist in San Francisco. "If a house doesn't sell, it has a major impact on cash flow for child support, on where people live, on future taxes." Indeed, the mortgage crisis and moribund market have made for some strange bedfellows.

"There is a whole new aspect of divorce that most couples never had to face," explains Janell Weinstein, a partner in the law firm of Federbusch & Weinstein in New Jersey. "Many couples are forced to live under the same roof because they can't afford to move on until their home gets sold. This can go on for months or even years as the real estate market across the United States slows down tremendously. Homes that used to sell in weeks are now not moving at all."

This month, Weinstein wrote about the phenomenon of cohabitation after divorce for the Web site She told me that for most couples, living with an ex is a choice of last resort. "If you have a substantial amount of assets, then one person moves out. Some people are moving in with family members," she says. "But for some people, all their savings are in their homes and with the house not selling, they have no other choice."

The Deficit Reduction Act of 2008
Ok folks, sit down because this one is going to piss a lot of people off. I am faxing this Ticker to the IRS. Yes, to the Internal Revenue Service. Why?

Because I believe they need to collect the taxes actually due, and as someone who's paid my share for an awfully long time (and a big share it is), and as I finish up my 2007 1040 (which is the size of a damn book, with a check attached that is giving me writer's cramp filling out), I've gotten increasingly pissed off at the people who have exploited the system not only to get us into this housing bubble, but also to force my tax rates higher.

Hillary, Obama, McCain - you all need to listen to this as well, and yes, you're getting a copy of this in your fax "inbox" also. We all know that "Stated" income and asset loans were a mainstay in the "housing bubble." Well, who took those loans out?

Two groups of people:
  • Those who were lying about their incomes. They are W2 folks who actually pay their taxes on what they really owe, but lied to lenders in order to get into a house they can't afford. Those people are defaulting left and right and will continue to. I have no sympathy for them.
  • Those who are cheating the IRS, that is, they are cheating you and I.

I believe the IRS needs to go after these Stated Income folks. God knows we need the revenue right now. We have $9 trillion and counting in public debt and everyone is clamoring for a bailout (which will be disaster if it happens, as I've outlined multiple times.) We just added $165 billion in additional deficit (which will turn directly into debt) via handouts in the "stimulus" program.

I'm willing to bet the IRS can collect all of that and more through this program. Please understand one thing folks - there is no statute of limitations on willfully understated income. The statute of limitations on a mistake is 3 years, but on a willful failure to pay that does not apply. Yes, the IRS can come after you 5, 10, even 20 years later, and while they can jail you for that sort of thing its usually far more productive to bankrupt you instead (its hard to get money out of someone sitting in a jail cell)

So here's my proposal:
The IRS should subpoena all loan servicers and originators for all "stated income" loans, then match each and every one against tax returns. If there is a discrepancy in claimed income then those persons should be audited, starting with the performing loans. For those people where the IRS scores a "hit" on the first examination, they then need to go back through that person's entire tax file and see for how long - in both directions - the deception on income reporting goes!

While many of these people will turn out to have overstated income to defraud lenders, a good number of them, especially those loans that are performing, are going to be people who are cheating the IRS!
We can call it "The Deficit Reduction Act of 2008." I like it.

Central banks are dangerous
I really thought that Michael Shedlock was overstating the case:
The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing...

Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem...The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

But then I read this piece, by Robert Shiller, and all of a sudden I'm frightened. It's one thing when Hank Paulson proposes turning the Fed into the macroeconomy's philosopher king. Paulson will be gone in a blink of an eye. But Robert Shiller is an increasingly influential economist. He's already got Mark Thoma signed up for the plan. These guys are smart, they matter, and they will continue to matter next January. So let's think about this very, very carefully.<

Shiller points out that...
In recent years, central banks have not always managed macro confidence magnificently. The Fed failed to identify the twin bubbles of the last decade — in the stock market and in real estate — and we have to hope that the Fed and its global counterparts will do better in the future. Central banks are the only active practitioners of the art of stabilizing macro confidence, and they are all we have to rely on.

He's right on both counts. For now, central banks are all we have to prevent a catastrophic unwinding of our unstable financial system. But they had everything to do with getting us here. It's not just the Fed, with its famous "serial bubble-blowing", its cheering on of any novelty as beneficial innovation, its absolute refusal to peer into the magical sausage factory that Wall Street had become. The problem with central banks is much bigger than that.

If you haven't been obsessing over every word Brad Setser has written for the past several years, you owe yourself an education. A growing "official sector" has largely defined the global macroeconomy in the first years of this millenium. In the USA, Japan, China, Europe, central banks have indeed been "active practitioners of the art of stabilizing macro confidence". For most of those years, it seemed like they were succeeding.

They were never succeeding. Call it what you want, call it "Bretton Woods II", call it "financial imbalance" or a "global savings glut" or "exorbitant privilege". Each central bank, while trying to stabilize its own bit of the world, found itself with little choice but to support and expand unsustainable financial flows on a scale so massive they have reshaped the composition of every major economy on the planet. As Herb Stein told us, what cannot go on forever won't. "When the music stops, in terms of liquidity, things will be complicated." Remember that? The music may have stopped already for Citibank, but it's still playing for the USA. The record is just beginning to skip.

The Federal Reserve can keep every major US bank and investment house on life support for as long as it wants to. The "credit crunch" can be made to disappear in an instant, if we are willing to pay sufficient ransom to hostage-takers. But what the US economy produces is no longer well matched to what Americans consume, and we are structurally unprepared to generate tradables, goods or services, in quantity adequate to cover the difference. The Fed's magic wand will be of no use if manufacturers in Asia and oil producers in the Gulf stop giving us stuff for free, using central-bank financial alchemy to hide their generosity.

Things may turn out okay. We've already begun to "adjust", and knock on wood, we'll manage a worldwide reequilibriation before things get too ugly. But it'll be a close call. That financial alchemy by central banks is the ultimate source of skyrocketing inflation in China and the Gulf states, and an ominous sign that Stein's Law is beginning to bite. We may yet escape, but we have been drawn very close to something very dangerous, to a genuine crisis of scarcity in the United States and a catastrophic failure of Say's Law in China, to mass unemployment, social instability, and fingers and missiles pointed in both directions across the Pacific. This is serious stuff. And central banks are largely to blame.

Private, profit-seeking actors would not have generated the corrosive financial flows that have characterized this millennium. "Financial imbalance", a euphemism for real resource misallocation, would have quickly been corrected, had Wall Street and the City of London not learned that the official sector could be their best customer. Less politically-independent monetary authorities could have leaned against unsustainable financing. A bit of capital-account protectionism might not have been bad policy for the United States during this period, but a central bank blind to obvious "facts on the ground", accountable only to an economic orthodoxy, did not even consider such a thing.

As readers of this blog know, I'm not a laissez-faire, the-private-sector-is-always-right kind of guy. I like to think about the "information architecture of the financial system". That leads me to dislike actors large enough to unilaterally move markets, especially when their motives might not be aligned with wise resource allocation. I dislike large private banks, and think they should be broken into itty-bitty pieces or turned into safe, regulated utilities. For the same reason, I dislike central banks. They have the power to act consequentially, but they do not have, and cannot have, the information or the wisdom to always be right. And when they are wrong, the consequences are devastating.

So, what to do? For now, we have no choice but to "use the army we have". Our long-term plan, though, ought not be to canonize central banks, but to render them obsolete. It won't be easy. The usual "sound money" trope, reviving the gold standard, is not a good idea. Much as it is suddenly out of fashion, we will need some "financial innovation" to build a new monetary architecture. Just because we've had a glut of snake-oil on the market recently doesn't mean there's no such thing as penicillin. We'll have to do a better job of distinguishing novel idiocies from good ideas. But we will need the good ideas. We can and should liberate money from the bankers, central and otherwise.

(NB: I want to express my sympathy for those who have today forced the Olympic torch rally in Paris to a grinding halt. I know it's not just China, we all have bloody hands, but that doesn't justify flaunting a symbol of unity through the world "in a symbolic manner". Not when blood flows. I find it perverted that western governments beat up on their own citizens for protesting that flame; and therefore, the French and UK governments are just as guilty as the Chinese. I hope many countries will be brave enough to stay away from Beijing altogether come August. However, I know that won't happen, unless something fundamental changes. Since gold medals allow politicians easy -exposure- gains with their voters, they'll insist politics and sports don't mix, while cashing in on the fact that they do.)


Anonymous said...


"I find it perverted that western governments beat up on their own citizens for protesting that flame; and therefore, the French and UK governments are just as guilty as the Chinese."

Clearly, the solution was to consider the torch a "trouble à l'ordre public", i.e. a significant disturbance to public order and safety.
I fully understand when a political party, that I happen not to appreciate, is allowed to demonstrate in the streets.
It is a different situation when the Chinese parade the torch of brotherhood in France and kill in Tibet. So yes, the French government really misjudged that one.

Dutch central-bank president:
"The economies of a few European countries are being affected by housing market problems. But the European housing market as a whole is not as problematic as that of the US."

That is an initial response to my questions yesterday. But it is so vague that one comes away still wondering about the relative vulnerabilities and strengths in the various countries.

Did you see the Spiegel article about the head of the KfW bank, who resigned today.,1518,545883,00.html


Ilargi said...


I have a Bloomberg article on KfW posted. The fact that the official statement is that Matthaeus-Maier resigned for health reasons tells me a lot about the "truth" level in europe so far.

Also, I hope that our readers who have insisted Germany is so much better off than the rest will read this. There's an article on a German Superbank in this Rattle, and my first thought with that was: "wonder what that will do with the writedowns and losses".

I think that Superthing is a ploy to shift losses to the public. Don't forget, it runs counter to the entire German baking system; for all I know, they may have to change a whole slew of laws to enable that move.

Don't take the Dutch guy on his word. Look at Spain, UK, Ireland. Or yesterday's piece saying that mortgage laws in Holland, Denmark are as lax as in the US.

snuffy said...

Would that Greenspan slink off to the cocktail parties and private showings of the wealthy,of whom he has been a dependable servant for all these years,and leave us free of his sickening musing
I do not know if/how we will be able to unwind this Gordans knot of interlocked interests that comprise our financial system.With the repeal of the laws that forbid the mixing of corp.investment and banks,the mess that has resulted may require the starting from scratch...after systems collapse.

This has been the historical precedent.As wars have stirred the gene pool,and reset the national boundaries,so have financial panics and collapses changed the financial landscape.
Problem is this time we will need all of our institutions operating and fully intact to supply the wherewithal to try and keep something resembling civilization in the next few decades as peak starts to bite into the core of our existance

Anonymous said...

Hello, all.

quite agree with Ilargi, seems to me every western government move to transfer private bank debt to national tax payers .. France experienced it with Credit Lyonnais, German superbank project looks similar, and US Fed did n't do anything else when rescuing the Bear ...

how long national taw payers will stay quiet ? my guess is that public protest is on the way worldwide ... i'm afraid of what to come after protests ..


to François : yes, I planned to sell my house for a while before I did, and was helped in my convictions when reading TAE, Mish CR and french written "la déflation arrive". All these guys are very usefull to us. thanks again to them.

Stoneleigh said...


Do you have a URL for the French site you mention? I'd be interested in reading it, and we can translate articles from French if there's something that we think other TAE readers would appreciate.

Farmerod said...

Has anyone here read Garth Turner's Greater Fool? I just bought it for friends of mine who are contemplating following through on the purchase of a retail space in which to relocate their kids' books store. Naturally, people like "expert" opinions when making decisions like this; my personal credibility is lacking, apparently.

Ilargleigh: Turner's got a link to TAE from I suspect some of your CDN readers might be interested in his book.

Ilargi said...

Salut Vincent,

J'ai fait un Google pour "la déflation arrive", puis, ça donne plusieurs sites web. Est-ce que tu parle de Tropical Bear?

I posted a review of Turner's book a while ago. Also wrote to him twice, but no response. Got my eye on him, but have yet to figure out what to do next.

PS where's my beer and scotch and chefurka?

scandia said...

Outtacontrol,thanks for the reference to the Turner site. I've sent it on to my friend with the condo in Toronto.

Farmerod said...

I'm not convinced that that reviewer read more than the publisher's promotional material.

Here's a pretty good review

where's my beer and scotch

Good god, man! What bodily pain must you blunt with booze now? As for chefurka, maybe he outdoomed even himself.

Ilargi said...

I'm sorry guys,

I've been aware of Turner's link to us for months now, through site traffic referrals. I tried to do something with that, but if he never replies, it kind of stops there. Don't even have a clue why the link is on his site. Bit of a shame.

OC your ass is mine. Mental pain counts too.

Farmerod said...

Ilargi, first of all, that's kinda creepy. Second, peace man. I just tried to blogwhore for you (My comment is "awaiting moderation"; I suspect you won't see it until it passes Garth's censorship)

scandia said...

I happened to be in the TD Bank yesterday depositing receipts from my job. Thought it was a good time to get some first hand info on the balance sheet of the banks. Three people fluttered around my request. I watched one go to the branch manager who peered out at me but didn't get out of his chair. In the end I was offered the 2007 report. An expensively bound tome. I asked for more current information but none was available. It makes me mad that the banks are presenting themselves to the public on last years performance without any reference to these changing times!
It makes me mad that Carlyle Group is starting a new bottom feeder fund that will enrich those that impoverished so many investors! Destroy, then conquer, is the motto of the day!

Anonymous said...


About your comments on the Olympic Torch disorder these days at the end of the Rattle:

You seemed to imply that blood was spilled in Tibet. Where are the evidences, any evidences, of any blood spilled there as a result of a "crachdown"?

Hong Kong
P.S. Sorry I don't have an id to post as an user.