Monday, June 30, 2008

Debt Rattle, June 30 2008: Red flags and black holes

Dorothea Lange Feeling low in Toppenish August 1939
"Sick migrant child. Washington, Yakima Valley, Toppenish."
The daughter of migrant laborers harvesting hops in Washington State

Update 3.20 PM EDT
Ilargi: I see the Dow is up, about 0.5%, but I think it’s a false comfort. The reason why is the numbers for the large financial corporations. They are getting absolutely "anvilled" again today, after most of them have already lost 50% or more of their value. I wonder how much stretch is left; it has to stop somewhere. What got me thinking about that this morning, even before the markets opened was that the 2nd article below says:
Profitability in financial services is falling at its fastest rate in at least 19 years as the credit crisis continues to hurt, a new study indicates. A balance of 44pc of firms have reported a fall in profits in the quarterly financial services survey released today by the CBI and PricewaterhouseCoopers. It is the worst result since the survey began in 1989.

source: Yahoo finance June 30, 3.15 PM EDT

Fannie and Freddie announced today they will both sell billions of dollars in bills in Dutch auctions (where successful bidders pay the price of the lowest accepted bid, not the actual price). Not a very strong call, to put it mildly. Moody’s put Morgan Stanley on downgrade watch, so that goes down. As for Lehman, see the first article: (I’m not a big fan of the idea that Lehman will be the next to go, because of their prominent place in the Fed ownership hierarchy).

Lehman Decline Gathers Steam
Shares of Lehman Brothers Holdings Inc., which were hovering around $21.50 through most of the trading session, have dropped sharply in the last hour, lately down nearly 9% in yet another examples of credit-related concerns manifesting in individual names.

Lehman has been one for the brave and nervous for months now, ever since Bear Stearns Cos. imploded in March. The company got through that month, but as credit concerns have come to the fore again, it’s been a popular target for short-sellers. Options activity leans to the side of put-buying as the stock sinks.

Quarter-end issues could be coming into play, as some dump shares of a stock they don’t want listed among their holdings. The company’s credit-default swaps, which measure the risk of default, cost more than on Friday. To protect $10 million in bonds for five years, it costs a bondholder $285,000, compared with $275,000 on Friday.

Ilargi: Over the weekend, we’ve seen multiple sources list the growing number of reports that warn of crashes and collapses to come. These reports, from RBS, Barclay’s, Fortis and others, are nothing new for those of you who follow The Automatic Earth on a daily basis. We have posted these and many other warnings for a long time.

Today, yet another grim picture is painted by the Bank for International Settlements, the central banks’ bankers. And more such warnings will be forthcoming. As we have always said, the economic downfall that is now starting to shape up for real, is inevitable. You can not "invent", out of the blue, trillion after trillion dollars of credit, and expect all of it to be accepted as any kind of "real" capital or money forever into the future.

It is not going to happen; it has to come down. The game is over. We already know the outcome. It’s just a matter of seeing HOW we will get to where we must go. What we’ve seen so far amounts to nothing more than a fart in a hurricane, if you will excuse my French. This entire economy of ours is faith-based, it's a religion whose priests dress assets in leveraged emperor's clothes.

The amount of deluded credit, still perceived by most people as having true value, that will soon vanish into the black hole of nothingness, from which not a penny will ever be seen again, is stunning in sheer quantity. The $3 trillion lost so far in the US housing market is but a tiny percentage of what will be going going gone.

The recent reports, and the increasing attention they are generating in the main media, are waking up increasing numbers of people these days. I’m afraid for most it will be too late to do much about their situations. The warnings now come from the players themselves, those who stand to lose their own shirts and shorts and socks and sweaters. That in itself is an extra warning, a giant blood red flag; it indicates that we are indeed fast approaching the edge of the cliff.

Note: I find it interesting to see people starting to understand that we are entering the mother of all deflations, and all the talk of inflation is not worth the paper it’s printed on. As US home prices plunge, homes become more expensive to buy. Think about that one.

Global economy faces deep slowdown and deflation threat, BIS warns
The global economy may be heading for a far deeper crisis than is expected and a bout of deflation in the world's biggest economies is now a possibility, according to one of the world's most highly regarded economic institutions.

The Bank for International Settlements has warned that many in the City and elsewhere may have underestimated the scale of the coming economic downturn in one of its most sombre portraits yet of the international financial system. The Swiss institution - known as the central bankers' bank - issued the alert in its annual report, released today.

It warned that the sub-prime crisis in financial markets was merely a reflection of growing debt burdens in the developed world, which could soon contribute to a deep slowdown. "The difficulties in the sub-prime market were a trigger for, rather than a cause of, all the disruptive events that have followed," it said. "Moreover... the magnitude of the problems yet to be faced could be much greater than many now perceive."

The warning will cause particular concern among participants in the financial sector, as the BIS was among the earliest major institutions to warn that the world could face a credit crisis and financial slump. The report draws stark comparisons between the current crisis and a variety of others including the Great Depression.

It said: "Historians would recall the long recession beginning in 1873, the global downturn that began in the late 1920s, and the Japanese and Asian crises of the early and late 1990s respectively. " In each episode, a long period of strong credit growth coincided with an increasingly euphoric upturn in both the real economy and financial markets, followed by an unexpected crisis and extended downturn.

"In virtually every instance, some form of new economic discovery or new financial development provided a further 'new era' justification for rapid credit expansion, and predictably became a focus for blame in the downturn." Most sobering is the report's warning that developed economies including the US and Britain could face deflation.

It said: "The eventual global slowdown could prove to be much greater and longer lasting than would be required to keep inflation under control. This could potentially even lead to deflation, which would evidently be less welcome."

•Profitability in financial services is falling at its fastest rate in at least 19 years as the credit crisis continues to hurt, a new study indicates. A balance of 44pc of firms have reported a fall in profits in the quarterly financial services survey released today by the CBI and PricewaterhouseCoopers. It is the worst result since the survey began in 1989.

BIS renews slump fears as global economy pays the price
A year ago, the Bank for International Settlements startled the financial world by warning that we might soon face challenges last seen during the onset of the Great Depression. This has proved frighteningly accurate.

The venerable body, the ultimate bank of central bankers, said years of loose monetary policy had fuelled a dangerous credit bubble that would entail "much higher costs than is commonly supposed". In a pointed attack on the US Federal Reserve, it said central banks would not find it easy to "clean up" once property bubbles have burst.

If only we had all listened to the BIS a long time ago. Ensconced in its Swiss lair, it has fired off anathemas for years, struggling to uphold orthodoxy against the follies of modern central banking. Bill White, the departing chief economist, has now penned his swansong, the BIS's 78th Annual Report, released today. It is a disconcerting read for those who want to hope the global crisis is over.

"The current market turmoil is without precedent in the postwar period. With a significant risk of recession in the US, compounded by sharply rising inflation in many countries, fears are building that the global economy might be at some kind of tipping point," it said.

"These fears are not groundless. The magnitude of the problems yet to be faced could be much greater than many now perceive," it said. "It is not impossible that the unwinding of the credit bubble could, after a temporary period of higher inflation, culminate in a deflation that might be hard to manage, all the more so given the high debt levels."

Given the constraints under which the BIS must operate, this amounts to a warning that monetary overkill by the Fed, the Bank of England, and above all the European Central Bank could prove dangerous at this juncture. European banks have suffered worse losses on US property than American banks. Their net dollar liabilities are $900bn, mostly short-term loans that have to be rolled over, a costly business with spreads still near panic levels. Mortgage and consumer credit has "demonstrably worsened".

The BIS cautions the ECB to handle its lending data with great care. "The statistics may understate the contraction in the supply of credit," it said. The death of securitisation has forced banks to bring portfolios back on to their balance sheets, while firms in need are drawing down pre-arranged credit lines. This is a far cry from a lending recovery.

Warning signs are flashing across Eastern Europe (ex-Russia) where short-term foreign debt is 120pc of reserves, mostly in euros and Swiss francs. Current account deficits are 14.6pc of GDP. "They could find it difficult to secure foreign funding if global financing conditions were to tighten more severely," it said. Swedish, Austrian and Italian banks have drawn on wholesale markets to lend heavily to subsidiaries across the region. This could "dry up".

China is not immune, although the BIS has dropped last year's comment that growth is "unstable, unbalanced, unco-ordinated and unsustainable". The US accounts for 20pc of China's exports, but that does not capture the inter-links across Asia that ultimately depend on US shopping malls. "There is a risk that China's imports overall could slow down sharply should the US economy weaken further," it said.

Global banks - with loans of $37 trillion in 2007, or 70pc of world GDP - are still in the eye of the storm. "Inter-bank money markets have failed to recover. Of greatest concern at the moment is that still tighter credit conditions will be imposed on non-financial borrowers. "In a number of countries, commercial property prices are beginning to soften, traditionally bad news for lenders. These real-financial interactions are potentially both complex and dangerous," it said.

Do not count on a fiscal rescue. "Explicit and implicit debts of governments are already so high as to raise doubts about whether all non-contractual commitments will be fully honoured." Dr White says the US sub-prime crisis was the "trigger", not the cause of the disaster. This is not to exonerate the debt-brokers. "It cannot be denied that the originate-to-distribute model (CDOs, CLOs, etc) has had calamitous side-effects.

Loans of increasingly poor quality have been made and then sold to the gullible and the greedy," he said. Nor does it exonerate the watchdogs. "How could such a huge shadow banking system emerge without provoking clear statements of official concern?" But there have always been excesses in booms. What has made this so bad is that governments set the price of money too low, enticing the banks into self-destruction.

"The fundamental cause of today's emerging problems was excessive and imprudent credit growth over a long period. Policy interest rates in the advanced industrial countries have been unusually low," he said.The Fed and fellow central banks instinctively cut rates lower with each cycle to avoid facing the pain. The effect has been to put off the day of reckoning.

They could get away with this as long as cheap goods from Asia kept a cap on inflation. It seduced them into letting asset booms get out of hand. This is where the central banks made their colossal blunder. "Policymakers interpreted the quiescence in inflation to mean that there was no good reason to raise rates when growth accelerated, and no impediment to lowering them when growth faltered," said the report.

After almost two decades of this experiment - more or less the Greenspan years - the game is over. Debt has reached extreme levels, and now inflation has come back to life. The easy trade-off has metamorphosed into a vicious trade-off. This was utterly predictable, and was indeed forecast by the BIS, which plaintively suggested in this report that central banks might like to think of an "exit strategy" next time they try such ploys.

In effect, this is an indictment of rigid inflation targets (such as Britain's), which prevent central banks from launching a pre-emptive strike against asset bubbles. In the 1990s, they should have torn up the rule-book and let inflation turn negative in light of the Asia effect. The BIS suggests that a mix of "systemic indicators" should be used.

The crucial objective is to slow credit growth and make sure that the punchbowl is taken away before the drunks run riot. "We need policy measures to lean against credit-drive excess," it said. If there are going to be more bail-outs on both sides of the Atlantic - as there will be - the "socialised risks" should be taken on by political systems, and not dumped on the books of central banks.

"Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off. "To deny this through the use of gimmicks and palliatives will only make things worse in the end," he said. Let us all cheer Dr White off the stage.

See How U.S. Home Prices Have Changed
The S&P/Case Shiller Home Price Indices have been measuring the average change in single-family home prices since 1987. These indices are thought to be the best indicators of home price trends in the United States.

Ten of the cities that have been tracked since 1987 include: Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington D.C. The indices have reported a lot of ups and downs in these cities. Home prices soared especially high between 2002 and 2005. The average median home price increase in the 10 cities was nearly 75 percent during this three year period.

Of course, prices have been falling since 2006. Between April 2006 and April 2008, the average median home price fell nearly 42 percent in the 10 cities mentioned above. Prices are expected to decline further in most cities.

Bears close in as US shares slide
Wall Street's outlook for the second half of the year has soured as US stocks stare into the jaws of a bear market. All eyes will turn to the opening of London's FTSE today, as it responds to Friday's fall in New York's benchmark Dow Jones index. Barring a miracle, today will see the end of Dow Jones' worst June since the Great Depression.

Alexander Young, a strategist at Standard & Poor's, said: "People realise they've underestimated the second-half drag to earnings from all these macro issues we are dealing with. The outlook for stocks is pretty bad." At Friday's closing bell in New York, oil prices had yet to relent, surging to new highs of more than $142 a barrel. Meanwhile, fears that the financial sector would announce further writedowns in the second half sent banking stocks tumbling.

Shares in JP Morgan slid more than 7pc to $35.05 (£17.57), the lowest price since October 2005. Bank of America's shares were down more than 9pc, and Citigroup - the biggest US bank by assets - saw its shares dive to a nine-year low of $17.25, down 11pc. David Kostin, a Goldman Sachs strategist, said that expectations for profits this year and the next are "too optimistic".

The Dow closed down 4.2pc at 11346 on Friday evening - just 0.1pc away from the 20pc fall from its high in October that would mark an official bear market. The Standard & Poor's 500 index also slipped on Friday to 1278.38, closing at a three-month low, down 3pc. Analysts in the US are expecting companies in the S&P 500 to announce an average 11pc fall in earnings for the second quarter.

In London, the FTSE 100 has shown some resilience, mainly due to the string of natural resources companies that it now boasts. Strip them out and the index is trading at just above the 4800 level, compared with its Friday closing of 5529

Let the Banks Go Under, Sell 10 Million Houses for $1 Each
Today's target: the notion that the collapse of the insolvent U.S. banking system would be so terrible. Really? Terrible for who? Certainly not the nation at large. In fact the dissolution of the insolvent parts of the U.S. banking sector--yes, the investment banks, the money-center banks, the regional banks, and the savings and loans--would actually be an enormously positive development for the nation and indeed the world.

Let's start with the fact that a huge number of these lenders are insolvent. If all their bad loans, bad derivative bets and off-balance sheet losses were forced to be marked to market/liquidated to raise capital, then major bank after major bank would fold/enter bankruptcy.

And what exactly would be so bad about that? Businesses go under all the time. The truth is these banks will never ever recover the loans they wrote, so why try to prop them up with taxpayer funds? To bail out the ultra-wealthy owners of those banks, of course. Recall that 1% of the citizenry own the bulk of all stocks and bonds.

Look at this chart: most of the banks have already lost half or more of their value. And has civilization fallen because the poor owners have lost half or more of their investment in the banking sector? No.

Even at its peak of bubble hubris, the entire sector was less than 20% of the S&P stock index's value. Now it's under 10%, like it used to be. The world didn't collapse when the banking sector declined, and it won't fall when insolvent banks are ushered through the bankruptcy process.

Look, WAMU has already fallen from $35/share to under $5/share. So what if it goes BK? Banks are businesses, and businesses go bankrupt all the time. United Airlines went BK and the next day employees showed up and the planes flew. When banks are liquidated/go BK, then the tellers will come to work and people will go in and do their normal banking.

If a bunch of branches close, people will adapt. It will be tough on the employees let go, but how different is this than when millions of industrial and manufacturing jobs vanished over the past 20 years? It's called creative destruction, and it's like the tide: you can't stop it, and all the government-funded sand castles in the world can't stop the tide.

That's what the Japanese government tried, and look what it got them: two decades of malaise and decline. Trying to cover up losses and keep bad debt off the books doesn't solve anything; the money's already lost. All these absurd bailouts have one goal: enable insolvent homeowners to bail out insolvent lenders with new loans which will inevitably go bad, too. Only it will be the taxpayer who's stuck with the bill, not the banks who wrote the loan in the first place.

So let me repeat: not only should we as a nation let the banks go belly up, we should insist on it. Regulators should force every lender to declare all its assets and liabilities and mark them to market immediately. If the bank is insolvent, then let it enter bankruptcy. The money's already lost; let's just be honest about, repudiate the debt and move on.

Yes, some pension funds and 401K accounts have suffered losses due to banking sector ownership. But those losses have already be chalked; there's not much downside left, so the big losers will be the fat cats, not the pensioners whose retirement fund owns a shriveling piece of WAMU or Citicorp.

Now let's move to the other big topic: how housing costs have essentially impoverished average Americans. The number one cause of poverty in the U.S. is housing prices and rents which have risen three times faster than income since the 1960s.
As David Fischer noted in The Great Wave: Price Revolutions and the Rhythm of History (page 219):

"The cost of rent and real estate in the United States multipled sixfold from 1960 to 1992, while the consumer price index increased threefold. Prime real estate went up tenfold or more."

Take a look:

If you go the BLS CPI page and fire up the CPI inflation calculator, you'll find that $100 in 1965 works out to be $600 in 2005. Meanwhile, housing prices rose 20-fold or more in that timeframe even as real wages dropped:

Hmm--productivity (and profits) soar, but wages actually decline, even as house prices skyrocket.

Put this all together and there is only one conclusion: to restore housing and rents to their rightful, historic levels, all 10 million distressed/foreclosed houses should be auctioned off for a $1 each. Let's give the current tenant or former homeowner first dibs, with the caveats (written into the deed) that they must maintain the property and that they have no other real estate property or assets.

Homes Less Affordable as Prices Fall, Rates Rise
Rising mortgage rates are driving up the cost of buying a house even as prices fall, making property more expensive across the U.S., according to a new study by, an online provider of home valuations.

Monthly payments on 30-year fixed mortgages are 6 percent to 10 percent higher in 41 of the top U.S. housing markets than they were two months ago. First-quarter prices have declined from a year earlier in 88 percent of those areas, Zillow said. "We're going to need about a 30 percent decline in house prices if you are going to keep payments stable," said Morris Davis, a former senior economist with the Federal Reserve and now a real estate professor at the University of Wisconsin-Madison's School of Business.

Seven Federal Reserve benchmark cuts since September have failed to lower mortgage rates as banks have curtailed lending after taking writedowns or credit losses of more than $400 billion from investments in mortgages. Rates for 30-year fixed-rate home loans were about 6.3 percent when the Fed first reduced its target federal funds rate nine months ago. They're now just under 6.45 percent, data from show.

Zillow based its calculations on almost 25,000 mortgage offers to potential homebuyers with credit ratings of at least 680 out of a possible 850. The would-be buyers sought bids through Zillow's Mortgage Marketplace, a new service that helps consumers shop for home loans. Zillow's main business provides U.S. home valuation estimates based partly on sales data.

The average monthly mortgage payment rose $131, or $1,572 a year, since the beginning of April in the 41 areas surveyed, Zillow said. The figure is controlled for population. "The story here is not so much how much more it will cost you over the life of the loan, but how much less house you can buy," said Greg Rand, managing partner of Prudential Rand Realty in Westchester County, New York. "It's an unfortunate pickle that we're in."

Engineering the Housing Bubble Through Monthly Payments
I wanted to actually ’see’ the effects that exotic loan programs had on home price appreciation and I believe this chart, together with my written ‘bubble-years event log’ below, tells quite a story.

This simple visual clearly demonstrates how ‘low monthly payment’ engineering through the creation of exotic loan programs was almost exclusively responsible for the major housing bubble in CA. If you substitute the CA data with data from your state, I am sure it will look similar. Recently, Greenspan said exotic loan programs were not responsible for the bubble prices. I think he is mistaken.

*household income is not inflation-adjusted. Monthly payments based upon typical interest rates for that period

Chart Findings and Facts:
-Until 2002, before the age of exotic loan programs, housing prices were driven by tradition economic factors such as supply and demand, the broader economy and interest rates. The rate of appreciation was in-line with previous Real Estate market expansions. Loan programs were mostly traditional.

-In 2002, payments for the median home reached the upper end of affordability at the time.  All of a sudden in mid-2002 the intermediate-term 3/1, 5/1, 7/1 and 10/1 fully amortized and interest only loan programs were introduced. These programs carried a much lower rate than a traditional 30-year fixed rate for the respective 3, 5, 7 or 10 years. These were among the best-selling loan programs in the bubble states.

At the time if 30-year fixed rates were at 5.5% a 5/1 interest only for example, may have been priced as low as 4.5% with qualifying at the interest only payment rate allowed. These programs brought affordability back and housing prices soared nearly 50% in a little over 2-years. In 2004, as payments once again got to the upper end of affordability, limited documentation programs such as Stated, No Ratio and No Doc were rolled out, which carried home prices even higher.

- In mid-2004, payments again were making affordability out of reach, so lenders began pushing the Pay Option ARM as one of their top offerings. This program had been around for years at World Savings (now Wachovia) and WAMU, but when the investment banks got into the Pay Option ARM game, every middle market mortgage banker, mortgage broker and bank became a Pay Option pusher.

These loans were branded as a ’safe’ alternative to traditional loans and a way to ’save’ money by paying a rate as low as 1%. Borrowers were told ‘negative amortization does not matter because your home value will increase faster than the negative amortization and you can always refi.’ We now know this is not the case.

-By 2006, payments again reached the upper end of affordability but there was no other loan programs that they could invent that could compete with a Pay Option ARM. At the time you could get a 100% stated income Pay Option ARM! Values went flat.

-In 2006 with nothing left to sell, the banks went into the Home Equity Line of Credit (HELOC) game. This allowed people to easily borrow up to 100% of the value of their homes, which kept values stable for a year despite home sales volume falling off of a cliff. This HELOC liquidity injection lasted until the end of summer 2007 when prices everywhere fell off of a cliff. This marks the end of the great housing bubble.

-As of May 2008, prices are down some 30% in the past 12-months but payments are still far above the current affordability level. The market needs to find equilibrium and a clearing level but given the state of the economy, elevated interest rates, inflation. massive supply, consumer confidence over Real Estate, tightening lending standards and the lack of any affordable loan programs do not draw a line in my chart straight across from 2004 adjusting for rising income.

This is because all of these negatives almost make it certain that housing prices have a long way to go and will overshoot to the downside, as all popping bubbles in the past have done.

Ilargi: Ireland’s Economic and Social Research Institute (ESRI) "... estimates that house prices were overvalued by 12.5 per cent in 2007 and is projecting a 6.3 per cent decline in house prices this year, followed by a further 1.5 per cent fall in 2009." "..overall, prices for new houses will fall by 24 per cent when adjusted for inflation".

Oh, really, boys and girls? Last week’s Elliott Wave report would seem to indicate that Irish homes are overvalued by 100’s of percentage points. So I would estimate that in Ireland, as in the rest of the "rich world" (perhaps it’s time to start using the phrase "formerly rich world") home prices will come down 80% or more, peak to trough.

Ireland teetering towards recession as bubble bursts
The Celtic Tiger appears to have lost its bite as the threat of recession stalks Ireland. These are the conclusions of a report by the Republic's Economic and Social Research Institute (ESRI), which last week forecast a recession - the first since 1983 - and a return to net emigration.

Critics have said that Ireland has become blasé about its economic success over the past 15 years and its transformation from being one of Europe's poorest nations to one of its wealthiest. It was, therefore, unsurprising that a quarterly economic commentary from the ESRI was splashed across newspaper front pages and has generated debate from the Dail, the Irish parliament, to pubs.

The institute expects that the economy will contract by 0.4percent this year after growing by 4.5percent in 2007, and, most disturbingly, that an outflow of 20,000 emigrants would be necessary to stop the unemployment rate rising above 8 per cent.
The markets reacted badly to the report, with shares in Irish companies falling and bank shares being hit particularly badly.

The main reason for the fears of recession is Ireland's overreliance on a construction boom, which has come to a crashing halt. About 75,000 units were built last year, compared with an expected 30,000 this year. House prices have fallen by an estimated 15 per cent, with no sign of the bottom having been reached. The ESRI estimates that house prices were overvalued by 12.5 per cent in 2007 and is projecting a 6.3 per cent decline in house prices this year, followed by a further 1.5 per cent fall in 2009.

From the new-house price peak in February 2007 to the expected trough early next year, the ESRI estimates that, overall, prices for new houses will fall by 24 per cent when adjusted for inflation. Although the institute is optimistic about other areas of the economy, particularly exports, the property crash is so serious that it has wiped out growth elsewhere.

As a consequence, public finances will plunge into the red next year, sparking potential sanctions as borrowing exceeds European Union limits. Alan Barrett, a senior ESRI researcher, acknowledged that the economy may actually perform worse than his gloomy forecast. “Everyone knows the downturn in the public finances is because Government blew the finances from the boom which everybody knew would be temporary,” he said.

Personal spending is slowing significantly. Retail sales slowed by 3 per cent in April alone. Consumption growth is expected to decline to only 1 per cent at year end. The ESRI expects tax revenues to be €3 billion (£2.37 billion) below government targets this year. From an overall budget surplus of €5.2 billion in 2006, the Government is expected to incur a deficit of €7.4 billion in 2009 - a turnaround of more than €12.5 billion in three years.

Even if the Government manages to reduce public spending growth by 6.6 per cent next year, from this year's planned 9.3per cent increase, it will breach EU rules on borrowing by some €2 billion. If that happens the Government will be obliged to present a plan to the EU Commission to return the deficit below the permitted 3 per cent of GDP.

British banks may need to pump billions into compensation scheme
Cash-strapped banks may be forced to pay billions of pounds upfront into a compensation scheme for the victims of bank failures under reforms to be proposed by the Government tomorrow.

The proposals, which come in the wake of Northern Rock’s near-collapse last September and have been backed by Mervyn King, the Governor of the Bank of England, will be announced by Alistair Darling in his latest consultation on banking reform. In the biggest shake-up of banking practices in decades, the consultation will also give further details on the triggers that the Government will use to decide when to take control of a failing bank.

The final reforms will be included in the Queen’s Speech and will be implemented next year. Having undergone their most punishing business quarter in almost 20 years, banks are desperate to avoid further costs. The financial institutions fear the Treasury will demand that they pump billions of pounds into the compensation scheme, to be held until the cash is needed to repay deposits.

The banks would prefer to pay compensation as and when it is needed. They also want a “sensible” limit on the level of savings covered by the scheme. Customers are guaranteed to receive back all savings up to £35,000 under the existing compensation scheme, but this could be raised to £50,000 or even higher.

The deposit protection scheme in America has a $50 billion compensation pot, built up over many years, but even this sum would barely cover the £25 billion of deposits held by Northern Rock before savers queued to withdraw their money. About £1,000 billion is held in British bank accounts. Bankers accused the Government of competing unfairly with the industry.

National Savings & Investments (NS&I) will be exempted from the scheme, despite being the UK’s second-biggest provider of savings products and an increasingly aggressive competitor in the savings market. A source said: “The industry is aggrieved that there’s one rule for the Government and one rule for banks and building societies. People are increasingly resentful about NS&I, which seems to enjoy unfair competitive advantages.”

It is not clear whether Northern Rock, the nationalised bank, will be required to pay into the scheme. If not, rival banks are certain to complain that it has been given another unfair advantage, on top of its government funding. The European Commission is due on Thursday to conclude its investigation into Britain’s decision to take the Rock into public ownership. Separately, the Chancellor is expected to meet Henry Paulson, the US Treasury Secretary, who is in Britain this week to discuss issues relating to financial stability.

Mr Darling will also announce details of a number of new working groups, including their membership, as part of a reorganisation of the existing high-level group that advises him on business matters. One of the groups will focus on competitiveness. Richard Lambert, Director-General of the CBI, and other business leaders have criticised Mr Darling for making policy changes that undermined the country’s competitive edge. Other groups will look at rights issues, insurance and long-term savings.

It has been a painful second quarter for the City’s biggest companies, which have not been as pessimistic about their outlook since the start of the last recession in 1990, according to the CBI. A dash by investment banks to fire staff by today could have been driven by the belief that workers are less likely to sue for an unpaid bonus if in the first half of the year.

UK consumer confidence plummets as surveys reflect gloom
Consumer confidence is at its lowest level in 18 years and house prices are continuing to fall, surveys out today show. The latest consumer confidence barometer from GfK/NOP shows overall confidence dropped five points to -34 in June, only one point above the record low of -35 reported in March 1990 as the economy headed into its deepest postwar recession. The survey goes back to 1974.

"With rising inflation, gloomy forecasts for interest rates and soaring fuel, utility and food prices dominating the front page headlines, it's no surprise that confidence in the general economy is almost in freefall," said Rachael Joy, an analyst at GfK. All five of the index's subcomponents showed a fall, with confidence in the economy over the next 12 months at -45, 42 points down on this time last year. The survey was taken in the first half of June.

A separate consumer survey from Lloyds TSB released today shows job security and employment confidence have fallen to their lowest level since the survey began in November 2004. It also shows that people's expectations of inflation have risen to 4.8%.

Consumers have scaled back hope of interest rate cuts, as the Bank of England has made it clear it is as concerned about rising inflation, at a 15-year high, as it is about economic growth, which dropped to a record low of 0.3% in the first quarter of this year, according to data released on Friday.

Meanwhile, the research group Hometrack reports that house prices fell for a ninth successive month in June. The average price dropped 1% between May and June, leaving prices 3.2% lower than a year ago - the worst figure in almost three years. Hometrack also said new buyer inquiries were down 5.7% in June from May and 52% lower year on year.

Sub-prime chill reaches the Arctic
At this time of year, night does not fall in Narvik, a Norwegian town 140 miles north of the Polar Circle. The midnight sun shines over the industrial town and the stunning mountains and fjords surrounding it. But the town has been plunged into a dark financial storm.

This Arctic municipality of 18,000 inhabitants is the surprise victim of the US sub-prime mortgage crisis, an example of how far-reaching its impact has been. Narvik, together with seven other small communities across Norway, have lost tens of millions of pounds in complex investments that went south as a direct result of the global financial squeeze.

This means that Narvik, the site of the second world war battle, faces an uphill struggle to ensure the funding of its public services. "There are going to be cuts in healthcare, schools, elderly care, youth clubs, sport activities," lists opposition local councillor Torgeir Trældal. "People don't understand that the crisis will have such an impact. They have a right to be angry. It's sad."

At the heart of the crisis is the decision by Narvik to invest £24m of its public funds into securities put together by US bank Citigroup. These products were marketed and sold via a Norwegian brokerage firm, Terra Securities. Narvik's leaders say they did not know these products were high-risk, with most thinking that they were investing in domestic companies, rather than outside Norway, as was the case.

When the credit crunch hit last summer, the town lost around £18m, coming on top of other debts Narvik ran up. The city will get back some of the money it lost, but in the end, the total debt could reach as high as £20m – small change to the banks responsible for the credit crunch, but around a fifth of the city's £100m annual budget.

Unlike in Britain with the Northern Rock scandal, the Norwegian government said it would not bail out Narvik and the other "Terra towns", arguing that the government is not an insurance policy for bad management decisions. So now the people of Narvik must find ways of paying off the loss.

"We are looking at possible 10% budget cuts over the next four years," reckons Trældal, who is a fireman by trade. "Right now we have a 24/7 fire service. In future, it could be only a daytime service, with firemen on call at home, at nights and weekends. It will delay the response time to ten minutes. And you must be on site in five minutes in order to save lives." All future investments, such as building a new school, have been frozen while the politicians try to find a solution.

Many in Narvik fear they will lose out. Edvart Solvang is a 44-year-old teacher working in Elvegaard, a small community set in a valley surrounded by breathtaking mountains 20 miles away from the city centre. He is concerned that rural schools like his, which caters to just 45 children, will be closed to make priority for the bigger ones in town. "The children could end up studying in Narvik, which means that progressively, families will not move to this area anymore," he says in the school's courtyard, surrounded by some of his pupils. "It will turn into a place where only old people live. It makes me sad, I don't like it."

"We have to pay for this, it's very unfair," says Turid Rosvoll, a 61-year-old pensioner, outside the Narvik Boy pub in the city centre. "I have two grandchildren. I am worried about what will happen." Like many other residents, Rosvoll is at a loss as to why a crisis such as this one hit her town. "I went to a town hall meeting, where they tried to explain what happened, but coming out of it, I was still none the wiser," she recalls.

So how could such a crisis happen? One of the main reasons is that the Norwegian brokerage firm failed to inform local politicians about the risks posed by investing in sub-prime mortgages. "Terra Securities misled them," says Eystein Kleven from Norway's Financial Supervisory Authority.

It investigated the firm and found that Terra brokers did not explain that the products they bought could be cashed out, at a loss, if their market price fell below 55% of its face value. This happened last summer, when the credit crunch began, with Narvik having to pay more money in the hope they would lose less. "Terra Securities did not disclose this mechanism to the municipalities. We are not sure whether the broker understood the mechanism himself," Kleven said.

Kleven also reckons that the local politicians did not have the required technical expertise. "Citigroup said these products should be for sophisticated investors only. The municipalities were definitely not sophisticated investors … It's the old rule: you shall not buy a financial product that you do not understand." The financial authority concluded that Terra Securities failed to respect good business practice and revoked its license last November. Terra Securities declared bankruptcy the next day.

The municipality also had such confidence in Terra Securities that it did not check the information it provided, according to a KPMG investigation. The local authorities regarded the firm as the city's financial adviser and ignored their interests as product salesmen, it concluded. Part of the reason for this trust is that Terra Securities was part of the same group as a chain of local savings banks across Norway that had been doing business with municipalities for decades. The politicians assumed they were in safe hands.

The current mayor, Karen Margrethe Kuvaas, who was not yet mayor but was part of the city council when the financial decisions were made, has now apologised to the people of Narvik. "On behalf of everyone involved in the Terra case, past mayors and councillors, past and present chief executives, I would like to offer my deepest apologies for putting the community of Narvik, with the Terra case, in a more difficult economic situation," she told the local paper, Fremover, this month.

"Many people have done wrong, but we also have our responsibilities for the whole affair. Therefore an apology is necessary," she told Fremover, adding that she would do her utmost to minimise the impact of the crisis on Narvik. She is also planning to reform internal procedures to avoid a repeat of the same crisis.

For observers, such as Kleven, the Terra case "shows the extent to which the financial markets are so integrated, and how fast the risk spread from California to the rest of the world". And for the residents of Narvik, it could mean that essential public services are cut to atone for mistakes made both at home and abroad.

Why we should be worrying about deflation
Now that the housing market is clearly collapsing, many of the pundits who said that soaring prices were perfectly justified, are now scrabbling to find reasons why the current slump is a unique, unforeseeable and entirely new phenomenon.

According to this particular group, rampant house price growth was justified. The world was in a new era, where interest rates could remain permanently low because of the internet and globalisation and ‘independent’ central banking, and all the other good things that have happened to us over the last decade. So needless to say, the credit crunch came as a bit of a surprise for them.

And now they expect the Government to step in and bail us out. This would make things worse of course, so it’s a good thing the Government is basically too broke to do anything of the sort. The reality is that all of this was in fact predictable. You’d have to be psychic to pick the exact date, and the exact manner of the collapse. But it was obvious that there was too much money flying around the world. The bubble was bound to pop sometime.

So can we learn anything from this? And more to the point, will we listen to the lessons? The idea that monetary policy has been far too lax for the past decade at least, is not especially controversial. It’s just that people were having too much fun in the boom times to accept that it was true. No less authority than the Bank for International Settlements (also known as the central banker’s central bank) makes it pretty clear where it believes the fault for the current crisis lies.

“The fundamental cause of today’s emerging problems was excessive and imprudent credit growth over a long period. Policy interest rates in advanced industrial countries have been unusually low,” says Dr Bill White in the BIS’s latest annual report. As we’ve said many times before, Alan Greenspan and the rest of the world’s central bankers got away with keeping interest rates ludicrously low, because price inflation was kept down by cheap Asian imports.

In fact, for a short while a few years ago, the Bank of England’s biggest challenge was to keep Consumer Price Index (CPI) inflation from falling below 1%, which would have also entailed writing a letter to Gordon Brown, the Chancellor of the time. But of course, keeping interest rates low merely fuelled other imbalances in the economy. All that borrowed money ended up in the housing market, and we know where that got us.

So what should central banks have done differently, if anything? Ambrose Evans-Pritchard argues that “in the 1990s, they should have torn up the rulebook and let inflation turn negative in light of the Asian effect.” This is a good point. But the use of the word ‘inflation’ gives away what the core problem is. When Evans-Pritchard talks about inflation here, he means the consumer price index, or some other measure of prices.

Now most central banks and policy-makers fear negative inflation, or deflation, more than anything. That’s partly because genuine deflation goes hand-in-hand with depression, but mostly because Western societies have become obsessed with the idea that the key to constant growth is consumer spending. The worry is that if prices are falling, then people will stop spending – because why buy now if you can buy cheaper later? And why spend your savings now when they increase in value by the day?

But the trouble with judging inflation and deflation by what’s happening to a basket of specific individual prices, is that it makes no distinction between ‘good’ price changes, and ‘bad’ price changes. Take milk for example. If all the cows in Britain became twice as productive overnight, and the price of milk halved tomorrow, would you buy more or less? Well, you’d probably buy the same, or maybe a bit more and stick it in the freezer. Would you put off buying it at all because you thought it might halve again next week? Of course not, it’s milk.

What would be bad about milk price deflation? Assuming it was down to higher productivity, and profit margins along the line from farmer to retailer stayed the same, then nothing. In fact, it would be a good thing. If you need to spend less on milk, that means you can spend more on something else. Or heaven forbid, you might even want to save some of that money.

All the stuff we get from Asia has been getting cheaper anyway. Computers are undoubtedly cheaper. I remember that when I bought my first laptop in 2001, the cheapest entry level PC I could find was around £700. Now you can get a far more advanced laptop for about half that price. Does this rampant price deflation stop people from buying computers? Not that I’ve noticed.

So the real problem is in the way that we measure inflation and deflation. Price changes happen for lots of reasons. Oil demand is up, supply is stable or falling, so the price goes up. Computers get cheaper to make, there are lots of factories competing to make them, so the price goes down. But none of this is about inflation. What inflation really is, is an increase in the money supply. Deflation is a decrease in the money supply.

When the amount of money available to the economy is rising, it’s got to go somewhere. In this case, it largely went into chasing house prices higher. Now that the supply of money has been cut off, as banks stop lending, house prices are falling.
And the real problem with deflation like this, is that as people get more and more concerned about the availability of money, they start to hoard it. That means that not only does no one spend money, they don’t invest it either.

They don’t take the sorts of entrepreneurial risks with their money that are necessary to make an economy grow, because they are too scared of losing their scarce cash. So the truth is that, even though prices are rising at a rate of knots just now, deflation is also a very genuine threat to Western economies. How it plays out remains to be seen, but a period of inflation followed later be a longer period of deflation does look quite possible.

But what does this mean for ‘policy’? Well, arguably, if central banks are going to target anything, they should be looking at something objective like the money supply, rather than something subjective like a basket of goods that is believed to be representative of the average person’s spending. Using the term ‘average cost of living’ when referring to the various price indices, rather than inflation, might help make the distinction clearer for everyone.

Better yet, we could just scrap central banks and let the market decide where interest rates should be. After all, that’s pretty much what’s happening now that everything’s gone horribly wrong.

The ECB's eurobankers are beating the Fed at their own game
For my entire adult life, I've assumed - and argued - that "Anglo-Saxon" policy-makers are best. Give me free markets and low tax any time. Not for me the cloying statism of Continental Europe. It's hard not to notice, though, that since sub-prime exploded last summer, while the US Federal Reserve has made a hash of it, the European Central Bank has played its cards quite well.

In theory, America's central bankers - having been educated in the Anglo-Saxon tradition - should be the most vigilant about inflation, the most determined to rebuff populist pressures. And one would have expected the eurocrats of the European Central Bank - trained in les grandes écoles and the German corporatist school - to react to a financial crisis by caving in and bowing down to their political masters.

But it hasn't happened. The Fed has cut rates willy-nilly while the ECB has stood firm. I don't downplay America's economic predicament for one second, but the Fed has been outclassed. The credit crunch has clearly sent the world's two largest economies into a financial tailspin. On Friday, equity markets worldwide were heading for their worst first-half performance since the early 1980s - with America and Western Europe leading the way.

The Dow Jones index of leading US stocks ended the week 20 per cent off last October's record high. The FTSE Eurofirst finished 21 per cent down on the start of the year. And London's FTSE100 is now more than 14 per cent down year-to-date. We're clearly in a bear market.

The eurozone economy, in particular, just endured a slew of bad data. Price pressures are rising - with eurozone inflation leaping to 3.7 per cent in May, a 16-year high. And index-linked government bonds are now priced for annual inflation above 2.4 per cent over the next six years - way above the ECB's 2 per cent target.

But amid this inflation, eurozone growth has stalled. The region's purchasing managers' index fell in May - the first drop in private sector output for five years. Not just Spain and Italy, but now Germany and France are facing a serious slowdown. It was striking, though, that when the eurocrats weighed this inflation-growth policy dilemma last week, they came out firmly in favour of tackling inflation.

The ECB remains on "a heightened state of alertness", said its President, Jean-Claude Trichet. And because he has held rates at 4 per cent throughout the sub-prime crisis, his words rang true. In the face of disappointing growth data, the ECB's tone became slightly more hawkish - so building credibility and convincing the markets rates will rise to 4.25 per cent at next week's meeting. That is smart central banking.

The ECB is now actively trying to emulate West Germany's widely admired Bundesbank - which built a formidable inflation-fighting reputation during the 1970s and early 80s. Back then, as now, high oil costs threatened the Western world - derailed growth, while pumping up price pressures. But through tight money and higher rates, the Bundesbank kept inflation low, providing the platform for West Germany's strong economic performance.

Trichet also made intelligent noises about oil last week. As crude soared once more - touching $142 on Friday - he rejected notions that sky-high prices are being driven by speculators. "The major issues," he said, "are associated with supply and demand" - which shows the ECB gets it. High oil is here to stay.

Many claim $100-plus crude is a "bubble" - with the implication prices will soon come crashing down. But the plain truth, for those allowing themselves to accept it, is that by 2025 the world will be consuming at least 50 per cent more oil than now and global reserves are falling. So the more central bankers point to "speculation" in the oil markets, the more they damage their inflation-fighting credibility.

We should worry, then, that America's Commodity Futures Trading Commission - a body with close links to the Fed - last week launched an investigation into commodity traders. This not only shows an important regulatory body to be tackling the wrong problem, but also that it's ultimately controlled by ignorant, finger-pointing politicians.

I'm afraid that much the same can be said of the Fed itself. Since sub-prime broke, US rates have dropped 325 basis points - all the way down to 2 per cent - despite headline inflation now running at 4.2 per cent. This is way too lax - and the resulting negative real interest rates will pump inflation higher still.

Earlier this month, Fed Chairman Ben Bernanke began to tackle his inflationary demons, suggesting the rate cuts were over, and the next move would be up. The markets took him at his word - and priced in a rate rise, so immediately reining in inflationary pressures.

Within a week, though, the Fed's resolve was spent. Officials briefed the markets that a rate rise may, in fact, not happen. And last week, Bernanke dropped the ball again. It wasn't that the Fed kept rates on hold. To have increased now, having cut just weeks ago, would have smelt of panic.

But, in a statement alongside its decision, the US central bank missed an opportunity to show how seriously it takes inflation by conveying that inflationary expectations are flat, and oil prices could soon tumble. Both assumptions look badly wrong.

Above all, at this crucial juncture, the Fed failed to make clear that when it comes to a straight choice between spiralling inflation and slower growth, it would always chose to stamp on inflation. In this regard, US policy-makers would do well to look to their counterparts in Continental Europe. And I don't say that very often.

Sunday, June 29, 2008

Debt Rattle, June 29 2008: Deafened by silence

Dorothea Lange Grandmother October 1939
Soper grandmother, who lives with family. Farm Security Administration borrower. Willow Creek area. Malheur County, Oregon

Ilargi: We’re taking a bit of a break today. The lull before the storm, that sort of idea. It gives the rest of the world a chance to catch up with us, and with what we've been proclaiming for so long. Sometimes we tend to forget it's all still new and unexpected for most people.

The time has come for the cheerleaders to get off the field.

The game is on. And it's over before the opening whistle.

But you must play.

American ‘Meltdown’ Reason for Capital Raising - Fortis
Fortis expects a complete collapse of the US financial markets within a few weeks.

That explains, according to Fortis, the series of actions by the bank of last Thursday to raise €8 billion.

“We have been saved just in time. The situation in the US is much worse than we had thought”, says Fortis chairman Maurice Lippens.

Fortis expects bankruptcies for 6000 capital-starved American banks.

But also with Citigroup, General Motors, a complete meltdown in the US is beginning.”

Saturday, June 28, 2008

Debt Rattle, June 28 2008: Here's why the game is over

Russell Lee A Poor Diet December 1936
Christmas dinner in home of Earl Pauley near Smithfield, Iowa.
Dinner consisted of potatoes, cabbage and pie.

Ilargi: A pair of news articles coming out of Britain, see below, provide the perfect backdrop to explain one -perhaps last- time why 99.9% of those who buy real estate today, and for at the very least the next ten years, in the rich countries of the world, are flaming douchebags who deserve all they will get. And to explain why, whether they buy or not, makes no difference to the fact that the game is over. Stick a fork in and turn it over. It's done.

First, UK household debt is now so high that it’s poised to enter the Guinness Book of Records as the highest for any major country. In history!!. Note: Ireland is not seen as a major (G7) nation, but things are even worse there.

Second, an expert government adviser claims the British housing market won’t "return" till 2015. Fair enough, you would say, 2012-15-20, it’s all just tea leaves, expert or not. Still, note Stoneleigh’s reaction: "Try 2115".

Now, what yanked my crank when I read that article was that he emphasizes not the sky-high UK housing prices (which are at 300% of what they were 10 years ago), but instead focuses on the fact that mortgages are harder to get. Poor poor first time buyers: they can’t get a mortgage to purchase a grossly overvalued home.

Well, those first-timers should get on their knees every single evening before going to sleep to thank a lord of their choice for making it impossible to get that mortgage. 99.9% of those who do "qualify", and do purchase, today, are lost souls beyond the powers of salvation of any deity.

Not only WILL the credit tightening inevitably lead to collapsing real estate prices in Britain (and everywhere else), it SHOULD cause such a collapse. There is no other reason for the skyrocketing prices, and subsequent household debt, than too easy credit and the (self-)deception that has led people to believe, against all reason, that the price rises and the easy money-for-nothing credit will last forever. It won’t, it can’t, and if you know what’s good for you, you shouldn’t wish for it.

But even if and when sometime in the future home prices have come down to "normal" levels, and loans are once more available to purchase the homes, the overall economic situation will still be completely out of whack, far from equilibrium, and even miles away from what it was only 10 years ago, right before the casino economy got started for real.

Why is that, you might ask?

Look at what I started this little rant with: UK household debt is the highest for any major country in history. In Britain, it stands at 173% of income. That will take many years to pay off, if ever. Even if everyone could pay back 20% of their income every year, it would take 8.5 years to do so. Pay back 10%, and you’re looking at 17 years. But that is without the interest owed, which will add quite a few years. Still, when put in that light, it might somehow be doable.

What defeats the notion of Britons paying off their debt, are two things:

1/ A huge part of their debt is held in real estate, and as we’ve seen, home prices will plummet, 100% certain, simply because there are no loans and no buyers. Hence, the collateral for the loans will lose a huge chunk of its value, which will cause the actual household debt to increase just as much and just as fast as the homes lose value. And that will lead to lenders, who are also in very bad shape by now, putting increased pressure on borrowers to pay up or else.

2/ The fall-out from plunging home prices and vanishing credit will send a giant tremor through the entire economy. The same lenders who have extended far too much credit to private households, have done the same for businesses. Company credit too will now tighten, just as the sky-high and increasing household debt will cut private consumption into smithereens.

The result is predictable: mass lay-offs, both in private business and in the public sector. I know we haven’t even mentioned the latter yet, but believe me on this one: the UK government is borrowing far more than it can afford, and that will soon grind to a halt, and then reverse. Simultaneously, the precipitous decrease in property tax revenues is going to cut off local government services at the very roots.

Let me add a third reason why Brits won’t pay off their debts for a long, long time to come, which will force home prices and available credit downward for the same period:

3/ Energy producers have announced that their prices, the ones for home heating and lighting, will rise by 40% or more, just in the second half of 2008. Add rising oil prices, and maybe by now you’re starting to get the picture.

This scenario, the very same, applies equally to the US, and to every single country in the rich part of the world. Which in turn will sink China and other emerging "powers". There may be different percentages, there may be variations in legal issues, or in -doomed- attempts to salvage an economy, but the outcome will be identical all over. If nothing else, the globalized economic system will take care of that.

There are of course the usual parties people put their faith in to save the day. But look at them: Private banks: they are imploding, they are covering losses with losses, and are in no shape or form to rescue the economy; most will not even be able to rescue themselves. Governments: they are in debt so much further than even their citizens, it seems laughable to even hope they'll save you. Quite the opposite, in fact: their debt adds on to your debt. Central banks: they can only act in accordance with, and at the expense of, governments. Which, well, see above.

And that is why the game is over. And it won't be back for a very long time. Not within your lifetime.

You will spend your entire lives paying off some kind of debt, whether it's yours, or your government's, or that of the financial system that your government absorbs. And all the time someone will be pushing you to pay more. Or else.

British household debt is highest in -global- history
British households are now more indebted than those of any other major country in recorded history, it has emerged.

Families in the UK now owe a record 173pc of their incomes in debts, official figures have shown. The ratio of debt to income is higher than any other country in the Group of Seven leading industrialised economies, and is sharply higher than the 129pc of incomes it was five years ago.

The figures, published by the Office for National Statistics as part of its National Accounts, underline the scale of the coming slowdown facing the UK, economists warned yesterday. Michael Saunders of Citigroup warned that - at 173pc of household incomes - the debt burden is higher even than Japan's when it peaked in 1990, before more than a decade of deflation.

"Not only are we the highest in the G7, we are the highest a G7 country has ever seen," he said. It came as the City warned Britain to prepare itself for a possible recession after the official economic growth rate dropped to the slowest in three years and consumer confidence came close to its lowest since the mid-1970s.

Economists across the Square Mile slashed their forecasts for economic growth next year after the ONS revised down its estimate for output growth in the first quarter of the year. It said Gross Domestic Product - the broadest measure of Britain's economic activity - was 0.3pc, rather than the 0.4pc it had previously thought. It means the annual GDP growth rate is 2.3pc rather than 2.5pc.

Fresh figures also showed that households' optimism about the economy has plumbed new depths. Market researcher GfK said its consumer confidence barometer dropped five points this month to -34 points - the lowest since 1990, when the worsening economy contributed to the downfall of Margaret Thatcher. GfK warned that the measure is now only a point away from hitting its lowest ebb since comparable records began in 1974.

Economists warned that the combination of data, which also included news of the saving ratio dropping to the lowest level since 1959 and of household disposable incomes falling at the fastest rate since 1999, suggested Britain is heading for a sharper downturn than many had anticipated.

Jonathan Loynes, of Capital Economics, said: "With growth already so weak in the first quarter before the full effects of the credit crunch and housing downturn had been felt, the economy looks set to slow significantly further over coming quarters. "We now expect GDP growth to slow to just 0.5pc in 2009, with a very real chance of a technical recession."

Philip Shaw of Investec said: "Although we take the view that the economy will avoid a recession, our confidence is ebbing." The ONS figures showed that the services sector grew by only 0.3pc in the first quarter, with the lull in financial services activity suffering its worst performance in five years in the wake of the credit crunch.

House prices won't recover until 2015, ex-MPC expert warns
The housing market will not return to its pre-credit crunch health for at least six or seven years, an expert adviser to Gordon Brown has warned. Families must wait until 2015 for the property market to start booming again, according to Stephen Nickell, who heads up the unit which advises the Prime Minister on housing planning.

He also warned that the "severe rationing" of mortgages was preventing first time buyers from taking advantage of falling house prices, preventing affordability from improving. Prof Nickell, the warden of Nuffield College, Oxford and the chairman of the National Housing and Planning Advice Unit, said he was extremely worried that the credit crunch would keep first time buyers from getting onto the property ladder.

It comes as a slew of mortgage lenders raise their interest rates and arrangement fees in a bid to mend their balance sheets. "They are severely rationing first time buyers in every way they can think of, from raising rates to increasing their fees and the amount of deposit they are demanding," he said.

"The consequence is that house prices fall. But despite the fall in house prices they still find it hard to get into the market because of the difficulty in getting hold of credit." Prof Nickell, a former member of the Bank of England's Monetary Policy Committee, said that it would take "years, not months".

"The collapse in lending and new mortgages is quite severe at the moment, and that's going to take quite a long time to reverse," he said. "The housing market - in terms of the price of houses - will not look much the same as it did before the credit crunch until after six or seven years." He also warned that the problems facing Britain's housebuilders threatened to put back the Prime Minister's promises to build 3m more homes by 2020.

The prognosis may come as a surprise to homeowners, many of whom had hoped that the housing market would regain its strength within a matter of two to three years. Official data from the Land Registry showed yesterday underlined the growing scale of the slump, showing that property sales have halved in the past year.

It said that the number of houses sold fell from 106,047 in March 2007 to 53,080 in March this year. London, Rutland and Wales were particularly affected as buyers abandoned the home market in the face of higher mortgage and financing costs. In the capital sales of homes below £200,000 fell by more than 60 per cent, a further sign that first time buyers remain trapped outside the housing market.

Experts said the figures were likely to deteriorate even further in the coming months, since house prices have fallen even further since March. Seema Shah, property economist at Capital Economics, said: "Transactions are now half the level they were a year ago. This is certain to further depress house prices.

"What's more, in recent days we have seen a further slump in mortgage approvals and growing evidence of slowing economic growth, while the mortgage credit squeeze shows no signs of easing. "Overall, the balance of evidence is pointing to further sharp falls in house prices in the months ahead."

Ilargi: Even as home sales drop by 50%, overall prices still rise -albeit marginally-. That is a sure sign of a deluded population.

House sales fall 50% as prices stagnate
House prices rose by just 1.8 per cent in the year to May, with the North East emerging as the worst hit regions in England. According to the Land Registry, the average house price in England and Wales reached £183,266 - a small rise on last year but unchanged on April.

In the North East, prices slumped by 1.3 per cent in the year to May, the South East recorded a 0.8 per cent fall. On an annual basis, both regions were also the biggest casualties of the housing slump on an annual basis, with prices falling by 2 per cent in the South West and by 2.4 per cent in the North East.

In contrast, prices in London rose by 6.9 per cent, where the average house price reached £354,714. The Land Registry also disclosed that house sales dived by 50 per cent during March, falling from 106,047 house sales in the same month last year to 53,080. The Land Registry publishes sales volumes with a two-month time lag to take into account the time that housing transactions take to complete

Morgan Stanley Wallowing In Risk
One wonders what Morgan Stanley's ex-Chief Executive Phil Purcell is thinking now that the firm's risk-taking has come home to roost. On Friday credit rating agency Moody's said it was reviewing Morgan Stanley's long-term ratings for a possible downgrade. Morgan currently carries an investment-grade Aa3 senior unsecured rating from Moody's.

The credit ratings firm says the likely outcome of the review would be a one-notch downgrade to A1, which is still considered investment grade. While the news is unpleasant, it's nothing the market hadn't already priced in. The brokerage house's stock took a hit when the news broke, but was quick to recover to $36.77 in afternoon trading, effectively unchanged from Thursday's closing price of $36.83. Over the past year Morgan's stock has lost 57.0% of its value.

Moody's said that Morgan Stanley's financial performance and risk management has been inconsistent since the mortgage and credit markets began to fall apart in mid-2007. Richard Bove of Ladenburg Thalmann agreed. "I believe Morgan Stanley doesn't understand risk management," Bove said.

For Bove though, Friday's roots date back to the high profile struggle for power a few years ago between Morgan's former CEO Phil Purcell, and the group of eight outsiders--with the help of some insiders--that eventually led to Purcell's ouster and current CEO John Mack taking the reins. The eight outsiders, known as the"Group of 8", consisted of eight former Morgan Stanley executives.

At issue was Purcell's risk-averse style of management. Purcell's argument was when there was too much risk, he would invest in building profit margins instead of expanding revenue. Margins grew, but the lack of revenue expansion infuriated the "Group of 8" and others.

"John Mack comes in and goes after revenue, and reallocates assets to the trading department, completely shakes up the money management operation, and the whole thrust of what he does is give Zoe Cruz more liberty to take more risk on the trading desk," Bove said. "But who was right? Purcell by the conservative approach, or Mack by increased risk? In hindsight if they followed Purcell instead of Mack Morgan wouldn’t have Moody's threatening a downgrade."

Citigroup: Worth Less and Less Every Day
Citigroup’s newly resuscitated motto maintains that “Citi never sleeps.” The bank’s investors, coincidentally, also are suffering some insomnia-filled nights. The topper? With the stock opening this morning at $18.06, Citi’s market cap has fallen below $100 billion.

That is quite a drop from the 52-week high of $52.97 the stock was trading at in July 2007. The bank’s shares are thus trading at about one-third of where they stood at their yearly peak. It has also set a new 52-week low of $17.57 in mid-morning trading. Citigroup also has taken a drubbing at the hands of skeptical Wall Street analysts, who reduced their forecasts for Citigroup’s earnings and their price targets for the stock this week.

Credit Suisse analysts predicted another $6 billion to $10 billion in write-downs for Citigroup, while Goldman Sachs Group analyst William Tanona–consistently bearish on Citigroup’s prospects–wrote: “We see multiple headwinds for Citigroup including additional write-downs, higher consumer provisions as a result of rapidly deteriorating consumer credit trends, and the potential for additional capital raises, dividend cuts, or asset sales.”

Tanona downgraded Citigroup shares to a conviction sell, reduced the price target to $16, and suggested that investors go long on Morgan Stanley shares while shorting Citigroup stock, or betting that the stock price will fall. Ouch.

At this point, there’s little to do about it but some rubbernecking at just how bad the situation is with Citigroup shares. Here is a random aggregation of banks and companies whose market values are higher and lower than Citigroup.
  • Citigroup’s market value is higher than….
    Morgan Stanley at $42 billion, Wells Fargo at $82.57 billion and Goldman Sachs at $70 billion.

  • Citigroup’s market value is roughly equal to….
    Nokia at $99 billion.

  • Citigroup’s market value is less than….
    Google at $173 billion, or Apple at $156 billion, or Novartis at $123 billion.
    Bank of America at $118.5 billion. J.P. Morgan at $129 billion.

And Citi has about half the market value of HSBC Holdings, whose U.S. market value is $191 billion. And General Electric, with a market cap of $272 billion, could buy Citigroup twice over with its stock and still have $72 billion in shares left over. That’s still nothing compared to Exxon Mobil with its $467 billion market cap, which could buy four Citigroups.

Update: One apparently harried Citi employee replies, “I believe the issue at Citi is that ‘Citi never sleeps.’ Perhaps if Citi got a good night’s sleep it wouldn’t lose as many billions each quarter.”

Citigroup Winds Down Distressed-Debt Desk
Citigroup Inc. is winding down a proprietary trading desk that specializes in distressed debt and plans to essentially outsource the business to a new hedge fund, according to people familiar with the matter.

Under pressure to conserve its scarce capital, Citigroup is restructuring its so-called global special situations group, reorienting it to focus primarily on its customers' trading needs instead of trading for Citigroup's own account. The part of the group devoted to using Citigroup's capital to buy and sell distressed fixed-income assets is being dramatically downsized, the people said.

Jeff Jacob and John Humphrey, who came to Citigroup in 2004 from Merrill Lynch & Co. to start a proprietary distressed-debt trading business at Citigroup, will be leaving the company in two or three months, the people said. They and about six associates plan to launch a distressed-debt hedge fund by early next year that will be seeded by a significant but undetermined amount of capital from Citigroup, the people said.

Other members of the special situations group will be folded into other Citigroup divisions, the people said.
The special situations group manages billions of dollars in assets, much of it Citigroup's proprietary capital. The restructuring won't affect customers who have trading accounts with the group, the people said. As it downsizes, the proprietary trading business has been conducting an "orderly wind-down" of some of its assets, one person said, but emphasized that there hasn't been a "fire-sale."

The downsizing of the proprietary trading business comes as Citigroup is reeling from billions of dollars in credit-related write-downs and is trying avoid unnecessary risk-taking. This week, the division is laying off a significant number of its roughly 65,000 employees as part of a company-wide effort to slash costs.

Merrill concerns reignite Bloomberg speculation
Expectations for more write-downs by Merrill Lynch and concern that the brokerage firm has limited options to raise new capital reignited speculation Friday that it may sell its stake in financial information provider Bloomberg LP.

Merrill still has more than $26 billion in exposure to collateralized debt obligations, complex securities that are sometimes backed by mortgage securities. The firm hedged some of that risk by buying guarantees from bond insurers including MBIA Inc. and Security Capital Assurance. However, those insurers have been downgraded by ratings agencies recently. That's making those guarantees worth less, possibly triggering more write-downs at Merrill.

Brad Hintz, an analyst at Bernstein Research, said on Thursday that Merrill may take a $3.5 billion write-down when it reports second-quarter results soon. Lehman Brothers analyst Roger Freeman is looking for a write-down of as much as $5.4 billion from Merrill.

Merrill has raised more than $10 billion in new capital to make up for the big mortgage-related write-downs that the firm has already taken. In April, Chief Executive John Thain said the firm wouldn't have to raise more capital. However, since then, the stock market has swooned again, the housing market has deteriorated further, unemployment has climbed and bond insurers have been hit by damaging downgrades.

That's sparked renewed concerns that Merrill may try to raise more capital. But the firm faces some restrictions on how it could raise that money. A sale of common stock would require a large payout to those investors who purchased more than $12 billion Merrill common and preferred shares earlier this year, The Wall Street Journal reported on Friday.

Merrill could sell more preferred stock. But the firm has so much of this type of capital that ratings agencies might not give it credit for any additional preferred, the newspaper also said. That leaves Merrill's valuable stakes in Bloomberg and BlackRock Inc.

Merrill's stake in BlackRock was recently worth $13 billion, while the firm's 20% stake in Bloomberg was probably worth $5 billion to $6 billion, Thain said during a conference call with analysts and investors on June 11. He said the BlackRock stake was "more strategic," while describing the Bloomberg stake as "just a very good investment."

"There are some liquidity restrictions on BlackRock and Bloomberg, but I don't believe that that would prevent us, if we decided to, from using either of them as means of raising capital," Thain said, according to a transcript of the call. "We definitely at least considered and particularly we considered the Bloomberg stake at the end of last year, about whether or not we wanted to sell that," he added.

Deleveraging, now only in early stages, will transform the banking industry
The process of taking leverage out of the financial system, only now in its early stages, will put an increasing drag on economic growth and corporate profits. Deleveraging - cutting back on the amount borrowed as compared to equity - is the dominant theme in markets and economics in 2008, as the financial system recoils from the massive losses in structured finance and the housing bubble.

Those losses - which are still mounting and being recognized - have piled up faster than banks can raise new capital, leaving the system today more extended than it was before the crisis began. JPMorgan Chase has estimated that banks have raised more than $300 billion in new capital, as compared with $400 billion in recognized losses, a figure others have estimated could ultimately reach $1.3 trillion.

And since markets are now more volatile, which requires more equity as a cushion, and in light of what will be huge regulatory pressure to take less risk, investment and commercial banks will be trimming their sails for a long time to come. While banks and other financial companies scramble to cut back on lending, there is also pressure to make what debt financing remains longer-term, especially among investment banks chastened by the flameout of Bear Stearns.

"Broker-dealers were very reliant on short-dated funding," said Jan Loeys, head of global asset allocation at JPMorgan in London. "To avoid all going the Bear Stearns way, they are scrambling to get proper long-dated funding. That is an avalanche at the moment which the bond market is having trouble absorbing."

Borrowing short and lending long, the basis of all banking, was taken to extremes though numerous bank-affiliated programs that counted on the willingness of money market investors to provide a steady stream of funds for that little extra in interest. Loeys thinks those programs, which provided $5.9 trillion in financing at their peak, were actually a large contributor to the "bond conundrum" that puzzled Alan Greenspan in 2005 when long-term rates fell even as he increased short-term ones.

So now that that's over, what will be the costs? Loeys argues that the cost of borrowing will go up across the board, but even more for those who wish to secure long-term funding. He expects inflation-adjusted government bond returns to return to their historic averages. That implies an extra 1.75 percent of yield on a 10-year bond above current rates at today's expected rate of inflation.

While a steeper and higher yield curve will help banks to make money, ultimately easing the credit crunch, structurally higher interest rates will be a big brake on economic growth, hitting both businesses and consumers. To get a sense of exactly how early we are in the process of deleveraging, look at U.S. data on commercial and industrial lending.

Commercial and industrial loans by U.S. commercial banks are actually up almost 20 percent compared with May 2007, while consumer loans are up 9 percent. But much of that lending was either made under existing contracts that banks would love to be rid of, or was a result of banks not wanting to burn client relationships before they absolutely had to.

They now absolutely have to burn clients and preserve capital, so we can assume that the effects of deleveraging on the wider economy, particularly on corporations, are only beginning to be felt. Credit spreads - the extra interest that lenders charge corporate borrowers - are likely to remain elevated until deleveraging runs its course.

"Credit investors have one very clear message for equity investors: The duration of the slowdown will be longer than the stock markets think, and the effects of the credit crisis will stay with us for many years," the Dresdner Kleinwort credit strategist Willem Sels wrote in a note to clients. "Tighter financing conditions and higher corporate defaults will directly or indirectly affect almost any corporate."

Are equities entering Great Crash territory?
Since the credit crisis broke a little under a year ago, there have been a number of attempted rallies in the London stock market, but the overall trend in share prices has been decisively down. In certain sectors – notably banks, property, housebuilding, retail, leisure and media – there has already been a severe bear market.

Defensives, oils and mining stocks have mitigated the effect to some extent, but in the past month even these industries have stalled. Can stock prices hope to recover from these traumas, or are they about to plunge further and unambiguously into a full-scale bear market?

The answer to this question depends crucially on what view you take on the economy. The present toxic mix of inflationary and recessionary pressures makes for the most challenging economic conditions we have seen in more than a decade. Should central bankers be putting interest rates up to choke off nascent inflation, or cutting them to stimulate growth?

So far, they've chosen to fudge it in a wait-and-see approach. The inflationary problem is depicted as more of an imported phenomenon resulting from high energy and food costs than a home-grown one, and therefore something that the Bank of England is largely powerless to do anything about.

Second-round inflationary effects – where workers attempt to recoup their loss of purchasing power with higher wages – have so far been muted, though there are some worrying straws in the wind. Inflationary expectations have risen strongly, and there's plenty of evidence of companies from transport to chemicals and consumer products trying to push through price increases to offset rising energy costs.

In Britain, unions are warning of a summer of discontent. None the less, wage pressures ought in the round to remain subdued if slowing growth causes the labour market to become more difficult. The key question for stock markets is whether the cycle is ending in an inflationary or a deflationary nemesis.

Though much has been written and said about the possibility of a return to the stagflation of the 1970s, the bigger long-term threat to share prices would be the deflationary outcome. Experience from the 1930s and Japan from 1990 onwards shows that deflationary influences are profoundly more destructive of equity values than inflationary ones.

Conventional wisdom is that in the long term, shares always outperform bonds, whose value and income tend to be destroyed by inflation. Shares are inherently more risky, but they compensate by delivering higher returns. In fact this may not even be true in the long term, as statistical analysis tends to focus on stock markets that survive economic implosions and ignores those completely wiped out by them. Yet on shorter time frames it is very definitely not the case.

In the past 10 years (which takes in the boom, the bust, the partial recovery and now potentially the bust again in share prices), equities have returned no more than government bonds. You would, frankly, have done better by sticking your money in a high interest rate bearing deposit account, assuming you could find a safe one.

Certainly you would have done better by investing in housing, as many did, thus replacing the previous bubble in equities with a new bubble in house prices. That bubble, too, has now gone pop, and with its deflation have come some early signs of the onset of a wider deflationary environment, in particular a growing lack of both supply and demand for credit.

The present dash for cash among investors if it takes hold must logically result in some perverse outcomes, with interest rates eventually falling because of the paucity of demand for credit or capital for business expansion. One equity strategist who is firmly in the deflationary, ultra-bearish camp is James Montier of Société Générale. "Debubbling" is the word he has coined for the present unwinding of bubbles in the credit, property and equity markets.

In support of his thesis that we are in for a long and very serious bear market, he cites some worrying parallels with 1929. Then, as now, conventional analysis initially regarded the crisis that engulfed financial markets as a temporary phenomenon that was unlikely to have any prolonged effect on the wider economy.

There was a generalised refusal to believe that the golden era of prosperity which had characterised the previous decade had drawn to a close. Policymakers were in a state of denial, and so too were many investors, resulting in a series of sharp rallies – or sucker's rallies – as the stock market descended into the abyss.

Is history about to repeat itself? We've already seen it happen with the Japanese stock market. Though I wouldn't place myself in the Montier camp, the possibility of it happening in America and Europe, with investment in productive assets plunging to levels synonymous with a depression, shouldn't be discounted.

A worrying aversion to equity investment is fast asserting itself. Even so, it still doesn't look to me like the way to bet. The world is a very different place from the way it looked in the interwar years. Political instability and protectionism were arguably more important causes of the Great Depression than the "debubbling" that took place in financial markets.

Undoubtedly the developed world is in for a very difficult couple of years. Living standards will get squeezed, unemployment will rise and equity markets must logically suffer along with all other asset classes. At the bottom of the last bear market five years ago, Edward Bonham Carter, chief executive of Jupiter Asset Management, said that it would take until 2010 for the stock market to return to its turn of the century peak.

At the time, this seemed unduly pessimistic. If anything, it now looks on the optimistic side. But in the round it seems about right. A similar period of sideways trading took place from the mid-1960s. In that case it was 17 years before the Dow broke free of the rut it was in. A prolonged period of adjustment, rather than an outright crash, still seems to me the most likely outcome.

But who knows. Mr Montier may be right. As things stand, the newsflow certainly seems to support his doom-laden prognosis. The latest consumer confidence and house price data from the US are among the worst on record.

Citigroup warns of Barclays rights issue deficit
Barclays' £4.5bn fundraising falls about £9bn short of what is necessary to absorb credit-related writedowns and bring the bank's capital in line with European peers, Citigroup claims in a note to clients.

The British bank's shares came in for more heavy selling following the note, dropping to 289?p at one stage yesterday before ending the day down 5? at 298p.

Citi analysts said that simply moving Barclays' core tier one capital in line with its closest peer, Royal Bank of Scotland, would require an extra £2.5bn. If Barclays was to write down its credit-related positions to the same degree as RBS the figure "increases to circa £9bn".

Barclays has taken just £1.7bn of writedowns this year, compared with £5.9bn at RBS, leading some to believe that it has not been sufficiently prudent in its assumptions. The bank thought it had allayed some concerns this week by securing backing from several existing shareholders as well as new ones from Qatar and Japan for its £4.5bn recapitalisation.

One leading institution said: "Investors of some repute have studied the numbers properly and they've decided the shares are attractive enough to buy. That is clearly positive."

Citi estimates that Barclays will have a tier one capital ratio of 5.8pc at the end of 2008, which would be the "ninth worst [of 66 banks] in Europe". It adds that "Barclays has adopted a somewhat unusual accounting practice" with regard to its credit assets.

UBS E-Mails Show Conflicts With Auction-Rate Clients
UBS AG was attempting to liquidate an $11 billion "albatross" of auction-rate bonds by selling the debt to individual investors as the market for the securities started to collapse, according to company e-mails.

While executives at the Zurich-based bank identified the hazards of auction-rate securities in August, they simultaneously began to "mobilize the troops," holding more than a dozen conference calls with salesmen and giving them new marketing materials to promote the bonds, according to e-mails from David Shulman, the head of UBS's municipal securities group. "The pressure is on to move inventory," he said in an Aug. 30 note.

The e-mails between Shulman and UBS executives were disclosed in a lawsuit filed yesterday by Massachusetts Secretary of State William Galvin, who claimed the bank committed fraud by selling the bonds as the equivalent of money market securities without disclosing to investors that the $330 billion market was lurching toward a breakdown. Investors who own the bonds now can't get their money.

UBS officials considered pulling out of the auction-rate market, where yields are set through periodic bidding, as early as September, five months before the company stopped supporting the programs, the e-mails show. The bank accumulated bonds by acting as a buyer of last resort to prevent auctions it managed from failing. Yields are set through auctions every seven, 28 or 35 days.

"I have legal looking into options to exit some business lines," Shulman wrote on Sept. 6 to Panagiotis Koutsogiannis, a risk manager at the firm in London. "We are looking into discounting the paper to distribute as well as potentially resigning from supporting as senior manager."

Demand for auction-rate bonds evaporated last year as corporate cash managers stopped buying after an accounting ruling determined that they should be classified as long-term, not short-term, investments. Companies liquidated $70 billion of auction-rate securities in the last half of 2007, according to Chicago-based Treasury Strategies, which consults with companies on money management.

Investors, who viewed the securities as money-market instruments, also began to flee because much of the market was insured by companies facing losses from guaranteeing subprime mortgage-related debt. Securities firms that supported the auctions for almost two decades abandoned the market in February, causing thousands of auctions to fail. Issuers such as the Port Authority of New York & New Jersey were left paying penalty rates as high as 20 percent and investors got stuck with bonds they couldn't sell.

The U.S. Securities and Exchange Commission and at least nine state regulators are investigating how banks sold the bonds. Individual investors have also filed lawsuits and complaints with state and federal regulators. "Here you've got these e-mails, and that could give prosecutors a more favorable forum," said John Coffee, a Columbia University professor who specializes in corporate law.

Karina Byrne, a spokeswoman for UBS in New York, said in a statement yesterday the bank was "disappointed" with Galvin's complaint and "will defend the specific allegations." Zurich-based UBS is cutting 5,500 jobs, shutting businesses at the investment-banking unit and trying to stem client defections after posting the highest net losses in the subprime crisis of any bank in the world. The U.S. Justice Department is also investigating whether it may have helped clients evade American taxes.

The bank sold $42 billion of auction-rate securities for municipalities and student loan corporations between 2002 and 2007, second to New York-based Citigroup Inc., according to data compiled by Thomson Reuters. The bank earned fees from underwriting and managing the auctions.

Wall Street to Washington: We Broke It. You Fix It.
This week, as I was wrapping up a conversation with an investment banker, he suddenly sounded hurried. “Heidi, I have to go,” he said. “The Fed is here.” As I was picturing my source being led away in handcuffs by brisk, bespectacled economists, he explained that the Federal Reserve is stepping up its examinations of investment banks.

All of which points out how, in a world of massive bank write-downs, balky credit markets and the subprime-mortgage imbroglio, regulation is every banker’s business now. The latest case in point? Vikram Pandit, CEO of Citigroup–whose shares were murdered and left for dead by Goldman Sachs Group analyst William Tanona Thursday. He wrote an op-ed in today’s Wall Street Journal under the headline, “Toward a Transparent Financial System.”

Why the sudden urge to communicate? Because the business of making deals–mergers, financings, the corporate money machine that keeps this country going and depends on investment banks–is waiting nervously for a regulatory storm to pass. And to make sure it passes without tearing down Wall Street’s houses, Wall Street types are taking to the Op-Ed pages to tell the Fed and other Washington types exactly how to flip those regulatory burgers.

In some ways, this outpouring of opinion is an odd choice; after all, Treasury Secretary Hank Paulson is a former investment banker; can’t all these bigwigs just pick up the phone? But there’s a broader hearts and minds battle to be fought here, apparently. We take you on a tour of what these Wall Streeters want to see happen to Wall Street, organized by their two major themes.

Theme No. 1: Regulators, Please Do More
Olivier Sarkozy and Randall Quarles of the Carlyle Group argued in The Wall Street Journal this week that regulators need to loosen rules on private-equity ownership of financial firms. Current regulations limit even nonvoting investors to 15% ownership of a financial institution. Sarkozy–a former UBS banker–and Quarles, who was a high-ranking Treasury official in the administrations of George Bush pere and fils, wrote,

“..he limitations on capital investment are far stricter than necessary to maintain these barriers, and can be amended by administrative intervention that is entirely consistent with the existing laws governing the country’s depository institutions….Private equity is ready and willing to step forward in large amounts–restoring lending capacity, encouraging efficiency, and protecting the taxpayer. The Federal Reserve and other banking regulators can help remove obstacles to this important pool of capital.”

Vikram Pandit, similarly, asked regulators to get more involved…in investment banks. Ok, he doesn’t actually say “investment banks,” but his euphemistic vocabulary points toward brokerage houses like Goldman Sachs and Lehman Brothers Holdings that have been Citigroup’s rivals in investment banking and lending.

Pandit argues that the Fed should keep a close eye on capital ratios at “systemically significant financial institutions” and on “transparency.” This is a common line from commercial-banking CEOs; Bank of America’s Ken Lewis argued for similar measures at the Wall Street Journal’s Deals & Deal Makers Conference this month.

Essentially, Pandit argued that investment banks should be as tightly regulated as commercial banks like his Citigroup: “An uneven application of regulations and accounting standards in an environment where capital and talent are mobile and where traditional classifications are being redefined.”

Theme No. 2: Jingoist Patriotism Is No Advantage in Matters of Finance
In a searing op-ed in the Financial Times last week, Blackstone Group CEO Steve Schwarzman warned the U.S. to ignore sovereign-wealth funds at its own perils. Schwarzman reminded readers, “The US is the world’s largest debtor nation and we are now in an uneasy relationship with our creditors. We cannot afford to get this wrong.”

And what is the U.S. getting wrong? The outpouring of hostile rhetoric about some sovereign-wealth funds, those foreign investors that are putting much-needed cash into our nation’s troubled banks. “[China Investment Corp] is not alone in its frustration with political grandstanding on SWF investments in the west. When I talk to some of the SWFs (and I have been dealing with them for more than 20 years), they are both amazed and annoyed that their actions, which are such a positive for the US economy, have been met with such hostility and anger in some quarters.”

MBIA Position 'Tenuous' After Moody's Downgrade, Fitch Says
MBIA Inc. faces a "tenuous situation" as the bond insurer seeks to cover payments and collateral calls on $7.4 billion of securities triggered by a credit-rating downgrade, Fitch Ratings analyst Thomas Abruzzo said.

MBIA may need to tap assets pledged to back other commitments as it comes up with the money, potentially opening the company up for further downgrades, said Abruzzo, who yesterday withdrew his rating on MBIA and Ambac Financial Group Inc. after the companies refused to give him information.

MBIA, based in Armonk, New York, is being forced to post collateral and make payments to some investors after Moody's Investors Service cut its insurance rating five levels to A2 from Aaa last week. Some of that money may come from assets backing an $8.1 billion medium-term note program, potentially creating a new liability for MBIA's insurance company, Abruzzo said. MBIA may be forced to sell some securities at a loss to fund the collateral payments, he said.

"It exposes the company to event and market risk," Abruzzo said in a telephone interview. Abruzzo cut MBIA to AA from AAA in April. "It wasn't something that was envisioned when the company was AAA with a stable outlook." "We have more than sufficient liquid assets to meet any additional requirements arising from any terminations or collateral posting requirements," MBIA said in a statement last week in response to the Moody's downgrade.

In addition to its main business of insuring bonds, MBIA also manages assets for clients such as municipalities. The asset management unit issued guaranteed investment contracts and medium-term notes, which carried AAA ratings because they were backed by the company's insurance unit, according to company filings. The unit makes a profit by investing in lower-rated securities that have higher yields, filings show.

The downgrade of the insurance subsidiary triggered provisions in the investment contracts requiring MBIA to post collateral or repay investors, who include cities and states. The asset management unit has $15.2 billion "available to satisfy" the demands, the bond insurer said in its statement. Those assets, though, also back the medium-term note program run by MBIA Global Funding LLC, the filings show.

Taking $7.4 billion as collateral and cash payments would leave $7.8 billion to back the $8.1 billion program, a gap of $300 million that could widen if assets are sold at a loss, Abruzzo said. "It's a concern that the liquidity in the asset management business has been further encumbered," Abruzzo said. "It's a bit like robbing Peter to pay Paul. Ultimately, the insurance company is on the hook for any shortfalls."

Abruzzo said he withdrew all his ratings on MBIA and Ambac because the companies refused to provide him private information, making it impossible for him to accurately rate them. MBIA said Fitch directly rated only about 30 percent of its portfolio so couldn't produce accurate assessments of its potential writedowns.

The recent downgrades "impact the companies' business prospects and the companies' reactive strategic and capital management planning creates a volatile credit variable," Abruzzo said in the report. Should MBIA's ratings fall to BBB or lower, the guaranteed investment contracts terminate and MBIA would be forced to repay holders.

Agency Mortgage-Bond Yield Spreads Rise to Highest Since March
Yields on agency mortgage securities relative to U.S. Treasuries rose for the sixth day out of seven, reaching the highest since March 14, as spreads rose on competing investments amid concern that the economy is weakening, according to data compiled by Bloomberg.

The difference between yields on the Bloomberg index for Fannie Mae's current-coupon, 30-year fixed-rate mortgage bonds and 10-year government notes widened 2 basis points, to 191 basis points. The spread has climbed 16 basis points since June 18.

Forced bond sales in March by funds using borrowed money helped drive the spread to a 22-year high then and contributed to the collapse of Bear Stearns Cos. Today, investors are demanding higher spreads amid concern about the economy and on speculation that some banks are reducing holdings as the quarter ends to make up for capital-depleting losses or to reduce reported leverage.

"Mortgages have cheapened over the past week in line with the widening cross spread products reflecting an increase in economic uncertainty," Credit Suisse Group analysts in New York including Chandrajit Bhattacharya and Mukul Chhabra wrote in a June 25 report. Yields over benchmarks on the safest types of AAA rated commercial-mortgage bonds rose yesterday to the highest since April 14.

Simple spreads between 10-year Treasuries and securities backed by Washington-based Fannie Mae reached 238 basis points on March 6. An increase boosts the cost of new mortgages for the most creditworthy consumers. "Super-senior" commercial-mortgage bond spreads over 10-year swap rates have climbed 48 basis points since June 18 to 192 basis points, compared to a record 312 basis points on March 10, according to Bank of America Corp. data.

Ginnie Mae Ramps Up Securitization of Reverse Mortgages
An emerging area of the secondary market appears to be gaining steam, even as a large part of the private-party securitization market remains in the deep freeze. That emerging area? Reverse mortgages, of course.

Ginnie Mae said Friday that Financial Freedom, the reverse mortgage lending subsidiary of IndyMac Bancorp Inc. , has issued two fixed rate reverse mortgage transactions and one LIBOR transaction under Ginnie Mae’s Home Equity Conversion Mortgage Mortgage-Backed Securities, or HMBS, program. The $177 million fixed rate issuances and the $104 million LIBOR issuance are among the first MBS pools backed by FHA-insured fixed rate and LIBOR reverse mortgages.

The three pools pushed the Ginnie Mae HMBS program to $648 million in issuance, the agency said in a press statement. “The fixed rate and LIBOR HMBS are important next steps in the evolution of a secondary market for reverse mortgages,” said Michael J. Frenz, executive vice president of Ginnie Mae. “This will go a long way toward adding liquidity to the market and increasing the investor base for HECM products by providing another alternative to investors backed by the full faith and credit of the U.S. Government.”

Creating a reverse mortgage securitization product that is attractive to the secondary market is critical to the long-term success of the program. The ability to achieve strong, reliable, and sustainable execution in the secondary market ultimately lowers costs for the consumer by expanding product access as more lenders, attracted by the viable business opportunity, begin to offer the products to borrowers.

“The advent of the Ginnie Mae program is timely, as its full faith and credit guarantee addresses credit concerns investors might have,” said Michelle Minier, CEO of Financial Freedom. “We see these two issuances as important steps toward the development of a liquid and efficient market in Ginnie Mae HMBS.”

The Ginnie Mae HMBS allows issuers to securitize an individual HECM loan into multiple HMBS transactions as lenders distribute funds to borrowers over time. Issuers can securitize the initial loan draw, all subsequent loan draws, the mortgage insurance premium, servicing and guarantee fee, and receive market pricing on the entire loan amount; issuers only need to pass through HMBS payments to investors as homeowners pay off the HECM loan.

Before the HMBS, reverse mortgage lenders only received a premium on the initial loan draw and investors reimbursed the lender on subsequent loan draws, dollar for dollar. Deutsche Bank AG, a leading global investment bank, sold the $102 million HMBS pool to secondary market investors on behalf of Financial Freedom.

“Deutsche Bank is proud to help establish a new and innovative capital markets exit for HECMs. We have a dedicated reverse mortgage team that is one of the market leaders in this space,” said David Fontanilla, a vice president at Deutsche Bank responsible for trading the reverse mortgage product. Since Ginnie Mae launched the HMBS program, six HMBS pools have been issued.

Ilargi: Come on, get real. There is no way that GM can sustain yet another 30% drop in sales. Its latest desperation move is more free money for buyers, but that is provided by its finance units which are already tens of billions of dollars in quicksand. Please pull the plug, this is torture!!

Deep -15.4%- June Car-Sales Slump Seen in J.D. Power Estimate
J.D. Power & Associates sees the market for U.S. light vehicles contracting 15.4% in the month of June compared to a year ago, according to a report released Friday, as cash-conscious consumers put off major purchases. The three domestic auto makers are expected to suffer the worst declines as buyers favor smaller cars with better gas mileage than the fuel drinking trucks and SUVs built by the Detroit companies.

According to J.D. Power's forecast, generally accepted as among the most accurate in the auto industry, General Motors Corp. will see a 26.2% decline, Ford Motor Co. a 31.4% drop and Chrysler LLC a 30.1% fall. Toyota Motor Corp., which is closing in on GM as the biggest car seller in America, saw a slimmer decline of 6.6%, according to the Westlake Village, Calif., research firm. J.D. Power relied on data collected over the first 17 selling days of June for its projections.

The winner in June is Honda Motor Co. which is projected to see a 9.3% jump in June sales, thanks to limited exposure to large vehicles. J.D. Power sees GM retaining its spot as the biggest car seller with 19.2% of the market, with Toyota hot on its heels with 18.7%. GM is expected to receive a substantial boost in sales from a major incentive program announced this week with large cash rebates and favorable interest rates.

The car companies plan to announce June sales on Tuesday. Sales may have picked up in the second half of June as the companies put more incentives on the table to lure reluctant buyers. Last week, J.D. Power forecast a 25% drop in sales based on the first 11 days of the month. The Westlake Village, Calif., research firm said early recordings of cash rebates indicate a 30.1% increase compared to last year and higher support for subvented interest rates on loans for consumers looking to finance cars at lower rates.

The firm expects the closely watched seasonally adjusted annual rate of sales to fall to 12.5 million vehicle rate, well below the 16.3 million rate set in the same period last year. Traditionally, June is a hot month for auto sales, with dealers and manufacturers rolling out summer clearance initiatives in an effort to clear dealer lots for new models slated to hit showroom floors in the second half of the year.

The Beginning of the End for High Oil Prices
Oil prices are up sharply (again) today. But stocks in oil companies are not. For most of the run-up in oil prices, the stocks of the oil companies have moved right along. But lately, that has not been the case.

The divergence came after June 4, a day when oil prices fell to $122.30, and the Amex Oil Index (a group of oil stocks) also fell sharply. As I write this, the oil price is up to $137.90, a rise of nearly 13 percent. Oil stocks are up less than 1 percent.

Today, the oil price is up more than 2 percent, and oil stocks are down almost 1 percent. It may be that the stock market is growing worried that high oil prices contain the seeds of their own destruction.

“At some point, it is likely to dawn on people who own oil shares that rising oil prices are raising global recession risks, and that a global recession would be really bad for oil companies,” said Robert Barbera, the chief economist of ITG.

Envisioning a world of $200-a-barrel oil
Three months ago, when oil was around $108 a barrel, a few Wall Street analysts began predicting that it could rise to $200. Many observers scoffed at the forecasts as sensational, or motivated by a desire among energy companies and investors to drive prices higher.

But with oil closing above $140 a barrel Friday, more experts are taking those predictions seriously -- and shuddering at the inflation-fueled chaos that $200-a-barrel crude could bring. They foresee fundamental shifts in the way we work, where we live and how we spend our free time.

"You'd have massive changes going on throughout the economy," said Robert Wescott, president of Keybridge Research, a Washington economic analysis firm. "Some activities are just plain going to be shut down."

Besides the obvious effect $7-a-gallon gasoline would have on commuters, automakers, airlines, truckers and shipping firms, $200 oil would drive up the price of a broad spectrum of products: Insecticides and hand lotions, cosmetics and food preservatives, shaving cream and rubber cement, plastic bottles and crayons -- all have ingredients derived from oil. The pain would probably be particularly intense in Southern California, which is known for its long commutes and high cost of living.

"Throughout our history, we have grown on the assumption that energy costs would be low," said Michael Woo, a former Los Angeles city councilman and a current member of the city Planning Commission. "Now that those assumptions are shifting, it changes assumptions about housing, cars and how cities grow." Push prices up fast enough, he said, and "it would be the urban-planning equivalent of an earthquake."

With every penny hike in the price of gas costing American consumers about $1 billion a year, sharply higher pump prices would lead to "significant bankruptcies and store closings," said Scott Hoyt, director of consumer economics at Moody's

Consumer spending has held up surprisingly well in the face of skyrocketing pump prices -- bolstered in part, perhaps, by federal tax rebates. But the same day the government reported a 0.8% rise in May consumer spending, a research firm said consumer confidence had plunged to its lowest level since 1980 -- hinting at the catastrophic effect another big gas price surge could have on retailers and customers.

"The purchasing power of the American people would be kicked in the teeth so darned hard by $200-a-barrel oil that they won't have the ability to buy much of anything," said S. David Freeman, president of the L.A. Board of Harbor Commissioners and author of the 2007 book "Winning Our Energy Independence."

BIGresearch of Worthington, Ohio, said more than half of Californians in a recent survey said they were driving less because of high gas prices. Almost 42% said they had reduced vacation travel and 40% said they were dining out less. If any retailers would benefit, it would be those on the Internet. In a recent survey by Harris Interactive, one-third of adults said high gas prices had made them more likely to shop online to avoid driving.

Vehicle sales, too, would probably continue to tank. Sales of new cars, sport utility vehicles and light trucks fell more than 18% in California in the first quarter compared with a year earlier. Although some consumers have been shopping for smaller, more fuel-efficient vehicles, many dealers are demanding premiums for gas-sipping hybrids, wiping out much of the financial advantage of buying one.

Analyst Predicts Mass Exodus of U.S. Cars
Oil at $135? That was just the opening skirmish in the “peak oil” wars. The latest smart money? $200 oil in 2010, with gasoline at $7 a gallon. And that is going to turn Americans into car-shunning Europeans once and for all—poor Americans, at least. That’s the latest gloomy forecast from Jeff Rubin at Canadian brokerage CIBC World Markets, who just a few months ago figured $200 oil would be a thing of the distant future—like 2012.

Mr. Rubin laughs off recent attempts to take the steam out of global oil markets. Saudi production promises of 200,000 barrels a day doesn’t dent the 4 million barrel-per-day decline from aging fields every year, for starters. And it will just be “gobbled up” by increasing domestic consumption in Saudi Arabia, like other oil-producing countries that subsidize fuel.

So what about China’s flirtation with market reality by unwinding some fuel subsidies? No luck in curbing demand or prices, either. Not only does China’s recent move translate into $3.25 a gallon gas—still a steal, relatively speaking—it’s given fresh legs to beleaguered Chinese refiners who’ve been operating in the red, thanks to Chinese price controls. So now they are producing even more gasoline and fueling even more cars than they were before. The upshot?

Over the next four years, we are likely to witness the greatest mass exodus of vehicles off America’s highways in history. By 2012, there should be some 10 million fewer vehicles on American roadways than there are today—a decline that dwarfs all previous adjustments including those during the two OPEC oil shocks.

And who will be parking their cars? The 57 million American households that have both cars and access to something resembling public transit. Gasoline at $7 begins to approach prices Europeans have paid for years, meaning that chunk of America “will start to act more and more like Europeans,” Mr. Rubin says. Not soccer moms in a minivan—soccer fans, searching for tokens:

Our analysis suggests that about half of the number of cars coming off the road in the next four years will be from low income households who have access to public transit. At their current driving habits, filling up the tank will have risen from about 7% of their income to 20%, an increase that will see many start taking the bus.

Gas prices already appear to be reshaping suburbia. But what Mr. Rubin is predicting is a far bigger shock to the American system. Europe has had decades to develop a society based on expensive energy. What will happen if Americans suddenly are forced to shoulder European-style energy prices — but without the European-style society to cope with them?

Libya's threat to cut oil sends out the jitters
Analysts yesterday dismissed a threat by Libya to cut its oil production in response to legislation that would allow the US to sue Opec members for manipulating international oil prices. The Libyan threat caused oil prices to jump above $142 a barrel for the first time yesterday, serving as a stark reminder of the nervousness in the oil market stemming from the small amount of spare production capacity available to absorb any supply shock.

Traders jumped on the threat, buying oil futures as the market's cushion to absorb a supply disruption has fallen to one of its lowest levels in the past decade. Oil prices in New York yesterday surged to a fresh record of $142.26 a barrel. The world's spare capacity stands at about 1.5m barrels a day, almost all of it in the hands of Saudi Arabia.

Libya - a medium-sized Opec member - last month pumped about 1.73m barrels a day, according to the International Energy Agency. But some traders yesterday were sanguine, warning that Libya's menace was more hype than reality. "Never mind that this measure has practically zero chance of getting through, but [oil market] participants nevertheless latched on to it as yet another reason to buy," said Ed Meir of MF Global in New York.

Other Opec countries, from Venezuela to Iran, have in the past threatened to cut their supplies for other reasons, without taking action. The measures that provoked the Libyan threat were passed by a 324-84 margin in the House of Representatives last month, as part of the Gas Price Relief for Consumers Act. The bill would have made it illegal for foreign states "to act collectively" to limit the production or distribution of oil.

This would have allowed the US Department of Justice to charge Opec members with violating antitrust laws. The White House has said that President George W. Bush would veto the legislation - arguing that it would invite retaliation from Opec members - and the Republican leadership has vowed to block it in the Senate. Those roadblocks make it unlikely that the measure will become law during the current administration. But pressure is mounting for the US to stand up more aggressively to Opec, amid deepening public concern about soaring energy price

OPEC Leader Khelil Says Dollar Will Drive Oil to $170
OPEC President Chakib Khelil predicted that the price of oil will climb to $170 a barrel before the end of the year, citing the dollar's decline and political conflicts. "Oil prices are expected to reach $170 as demand for fuel is growing in the U.S. during the summer period and the dollar continues to weaken against the euro," Khelil said today in a telephone interview. The leader of the Organization of Petroleum Exporting Countries also serves as Algeria's oil minister.

Political pressure on Iran and the depreciation of the U.S. currency have caused a surge in oil prices, Khelil said. New York- traded crude has more than doubled in a year and touched a record $142.99 a barrel yesterday on the New York Mercantile Exchange. OPEC ministers generally say that oil output is sufficient, even as Saudi Arabia, the biggest producer, pledged to pump an extra 200,000 barrels a day next month to calm the market.

"The market is completely supplied," Venezuelan Oil Minister Rafael Ramirez said yesterday. Libya announced possible production cuts, calling the market oversupplied. The rising cost of crude is not linked to supply, Khelil said today. "There is more than enough oil in the market to meet the international demand," added the OPEC president, who will take part June 30 in an international energy forum in Madrid.

Prices, which are up 38 percent this quarter, are heading for the biggest quarterly gain since the first three months of 1999, when oil traded between $11 and $17. "The decisions made by the U.S. Federal Reserve and the European Central Bank helped the devaluation of the dollar, which pushed up oil prices," Khelil said.

Oil may extend gains if the ECB boosts rates on July 3, further weakening the U.S. currency. The dollar has declined 15 percent against the euro in 12 months. ECB President Jean-Claude Trichet reiterated June 25 that policy makers may increase the main refinancing rate by a quarter-percentage point next month to contain inflation. The Federal Reserve left the benchmark U.S. rate at 2 percent on June 25. On Sept. 18 the Fed began cutting rates to bolster an economy already reeling from the credit crisis.

Intervention Will Not Stop the Dollar's Slide
by Peter Schiff

This week the Federal Reserve took a step closer to acknowledging reality. Unfortunately it didn't let that admission move it from a policy course firmly guided by fantasy. In its policy statement, Bernanke & Co. took the important step in noting that inflation expectations had taken hold in the country at large.

However, in asserting that it expects inflation to moderate this year and next, the Fed gave no indications that these heightened expectations are gaining traction within the Open market Committee itself. As a result, it signaled no likelihood that it was actually prepared to do something to fight a problem which it doesn't really believe exists in the first place.

In fact, by indicating that they expect inflation to moderate, the Fed is saying that elevated expectations are unwarranted. In other words, Bernanke claims that despite the fact that so many people are carry umbrellas, he still believes it will be a sunny day. The takeaway from the statement is that no rate hike is forthcoming. The markets saw this position for what it is....capitulation to inflation and a weakening dollar. No surprise then that the gold responded with the biggest single day gain in more than 20 years!

With the ensuing carnage on Wall Street, many Thursday morning quarterbacks claimed the Fed missed an opportunity to reverse the dollar's slide by either talking tougher or perhaps actually raising rates a quarter point. If the Fed really believed it could talk the dollar up, or that a small rate hike would do the trick, they would have given it a try.

I believe they chose a dovish route because of a greater fear of having their hawkish stance casually disregarded. Imagine what would happen if the Fed raised rates and the dollar kept falling? It would be like one of those horror movies where someone holds a cross up to a vampire, and the Count tosses it aside with nary a cringe.

Others claim that now is the time for coordinated central bank intervention to reverse the dollar's decline. Those who place their faith in such a plan, overlook the fact that Asian and Middle East central banks have been unsuccessfully intervening on the dollar's behalf for years. Those nations maintaining dollar pegs must constantly intervene in the foreign exchange markets by buying dollars to keep their own currencies from rising in value.

Over the past few years the scope of this intervention has been unprecedented, with foreign central banks accumulating trillions of excess dollar reserves. Yet despite these Herculean and misguided efforts, the dollar has fallen drastically. Intervention advocates must believe that if the ECB and a few other central banks joined the fray, that a better outcome would be achieved.

However any additional efforts to artificially prop up the ailing dollar will be equally ineffective. Even if ECB intervention could slow the dollar's decent, what possible reason would they have for doing so? The ECB is already concerned about inflation and is preparing to raise rates as a result. Intervention to support the dollar will only worsen Europe's inflation problem and run counter to these efforts.

This is because to buy dollars the ECB must increase its own money supply. That is exactly what is happening in countries like China and Saudi Arabia, which is why inflation in those nations is already much higher than it is in Europe.

Further, since the ECB is asking Europeans to endure higher interest rates to fight their inflation battle, why should they have to make additional sacrifices to help Americans fight their own inflation? Especially when our own central bank has held interest rates at the ridiculously low level of 2%, and has effectively excused Americans from the conflict.

Since we can't count on any help from our friends, the only option would be for the Treasury to intervene unilaterally. However, the U.S. government should think twice about bringing a knife to a gunfight. The Treasury only has about $75 billion in foreign currency reserves with which to intervene. The war chest is just a spit in the ocean.

To put this number in perspective, Poland has $77 billion, Turkey has $78 billion, and Libya has $79 billion. On the other end of the spectrum, China has $1.7 trillion (not counting Hong Kong's $150 billion) Japan has $1 trillion, Russia has $550 billion, India and Taiwan each have about $300 billion. Singapore, a nation with fewer than 5 million people, has $175 billion.

In fact, the United States holds just about 1% of the world's $7.6 trillion of foreign currency reserves, and our total position amounts to just 2.5% of the total daily volume of foreign exchange trading. Talk about Bambi vs. Godzilla! In other words, if the dollar is going to fall, the Treasury is completely powerless to do anything to stop it.

The high road, the hard road, and the low road
Yesterday, there were more ghost sightings. Many analysts and commentators thought they saw the spectre of the ’30s. Others could have sworn it was a poltergeist from the ’70s. The U.S. stock market got smacked down yesterday – ending the day with a loss of 355 points on the Dow. The proximate cause of this punishment, according to the papers, was yet more bad news from the oil market.

The oil pot bubbled up yesterday. The price of crude rose more than $5 to close at its highest point ever – $139. Hey, where’s all that cheap oil the neo-cons promised when they invaded Iraq? We seem to recall three major routes to the war. First, of course, was the high road – we were going overthrow the wicked Saddam Hussein; the Iraqis would kiss our feet and become good democrats; the world would be a better place for it.

Second, there was the hard road – where the world’s leading hegemon shouldered its imperial responsibility by dutifully eliminating weapons of mass destruction, establishing a base of freedom and military force in Mesopotamia; as a result, the world was supposed to a safer place, remember? And then, there was the low road – where if we could knock off Iraq’s legitimate leaders, we would have the country’s oil to ourselves; we could pump up the world’s supply of oil and lower its price; the world would surely be more prosperous as a consequence.

But all the roads led to Hell. And today’s news tells us that 75% of Americans blame George W. Bush for it. Wait a minute. That’s a lot of blame to lay on single man. It doesn’t seem fair. Poor George W. is getting the highest DISapproval ratings of any president in history. He’s dissed because he got us into the Iraq War...he’s dissed because oil has gone up 40% this year...he’s dissed because houses are falling in price...and he’s even dissed because inflation is increasing.

We hate to kick a man when he’s down. But we like kicking George W. Bush so much, we’ll make an exception. Better yet, we’ll prop him up...just so we can have the pleasure of kicking him down again. Let us make one thing perfectly clear; as another disgraceful ghost of the ’70s would put it, all these problems are not the president’s fault. Let’s face it, invading Iraq seemed like a good idea at the time – at least to most right-thinking Americans.

And as for the price of oil, who could have imagined that all those people in the East would start using so much of the stuff? And who could have imagined that the Iraqis would be such meatheads as to drag this war out so long...and make such a mess of their own most profitable industry? Well, anyone might have, but we’re talking about George W. Bush.

Yes, poor George II lacked imagination. But is it his fault that houses are going down in price, or that Americans have too much debt, or that when the going was good, Wall Street went too far? Meanwhile, our favorite metal seemed to take advantage of all the commotion yesterday to sneak up a full $32. Before 1935, you could have bought a whole ounce and a half of gold for that money. Today, you get 1/27th of an ounce.

Of course, you could have bought the whole Dow for the amount the Dow fell yesterday, too. And, not forgetting the black goo, you could have purchased a barrel of oil for yesterday’s price increase. As to the ’30s, the ghost apparently spooked Wall Street...and then flew off to scare ordinary people coast to coast. “More Pain Seen for US Banks,” reported the International Herald Tribune . “Low rated borrowers squeezed out of debt markets,” the Financial Times followed up. “Fears grow of a new stage of credit crisis,” the FT went on.

Homeowners continue to get slapped around. From California, the latest report says the typical house is worth only about two-thirds as much as it was two years ago. Nationwide, houses are down for the first time since the Great Depression...with the go-go markets of Miami, Las Vegas and Washington, D.C. area, hit hardest. With house prices falling so much, you’d think that fewer people would be left without roofs over their heads. Not so.

USA Today tells us that the ranks of those with no roofs over their heads are swelling with “new faces” of those who hitherto had passed for normal, folks-next-door. Among those most haunted by the spectre of the ’30s are the people who were always closest to that era – old people. They’re going broke faster than any other age group. What is driving these fossils into the poor house? We can guess. They live on fixed incomes.

While the ghost of the ’30s lowers the price of their main asset – their houses – the ghost of ’70s inflation is making their bare lives more and more expensive. Everyone is driving less, as a consequence of higher fuel prices; but these graybeards didn’t drive very much anyway. Everyone is cutting back on air travel; but even before the price increases, these antiques didn’t get into the air very often. Everyone is trimming his budget, taking out the whimsical and witless spending; but old people often don’t have much left in their budgets but the necessities.

They’re in a classic ’70s trap – hard against the rock of fixed income, crushed by the boulder of rising prices. Yesterday, the CRB commodity index rose to a new record high – at 595. “Buffett says inflation is exploding,” according to CNNMoney.
What can people do? A report in today’s news tells us that many are “delaying health care.” Probably a good move for the oldsters. If they put it off long enough, they won’t need it at all.

You could hang George W. Bush for inflation too. It would be fine with us. He let government spending get out of control. “Deficits don’t matter,” said his #2, Dick Cheney. More new federal spending and US financial commitments were added in the Bush years than under all the rest of America’s presidents put together; and more new money was created while George W. Bush was president than in all the years since the Declaration of Independence combined.

Legally, we don’t know if that charge is enough to hang a man. Besides, it seems extreme. In the middle ages, if the keeper of the mint allowed monetary inflation, the king had him castrated. That seems like punishment enough.