Monday, June 23, 2008

Debt Rattle, June 23 2008: Crossroads in Wastelands

Dorothea Lange Crossroads October 1939
"Crossroads off the highway in a cut-over area. Boundary County, Idaho."

Ilargi: Banks can no longer find investors to shore up their capital. At the same time the monolines are trying to negotiate with the same banks to not call them on $125 billion worth of swaps.

The reason, presumably, is simply that nobody has this kind of money, no matter how much the banks need it. And there’s far more swaps yet to surface.

What’s less pronounced in the financial media is the fact that around these negotiating tables, no-one actually knows what the risks are, how much is at stake, or even who owns which swaps, and certainly not who are the counterparties.

Not because they’re so dumb (though that’s a story in itself), but because the inherent structure of credit default swaps resembles quantum mechanics in that some things by nature cannot be known.

So what to do? Well, they start firing people by the thousands. Yet, that has a major disadvantage: the pink slippers can no longer make money for them. And if there’s one thing the banks really cannot do without at present, it’s cash flow.

Meredith Whitney a few days ago said that $2 trillion in credit card "space" is prone to disappear; that cuts out a lot of cash flow too, while large banks have many billions of dollars in daily requirements to fulfill.

Don’t forget, the system has been held up so far by selling the most liquid assets, and by appealing to a sentiment that markets would "soon" recover. The first $100 billion may well be 100 times easier to raise than the next $100 billion.

The losses for those who invested on that sentiment are already "shameful", and that, they now fear, could turn to "shattering". And that’s while much of the first round of outside financing -Merrill, Citi- has come at a price of 8-9% interest rates. Want to guesstimate the rates for the next round?

Another way to picture where we are: Goldman, the only major Wall Street firm to report a "profit", has started laying off its staff like they’re toxic ticks. Why do you think that is?

I can’t top this fine line from Aaron Krowne about Citigroup laying off 10% of its investment staff, to illustrate where we have traveled so far through the wasteland:

How long until the Onion headline: "Citigroup to cut 100% of staff; exit banking." That would certainly be the safest bet given their managerial history of the past two decades.

But first, we talk human lives, not their wallets:

Scientists warn of lack of vital phosphorus as biofuels raise demand
Battered by soaring fertiliser prices and rioting rice farmers, the global food industry may also have to deal with a potentially catastrophic future shortage of phosphorus, scientists say. Researchers in Australia, Europe and the United States have given warning that the element, which is essential to all living things, is at the heart of modern farming and has no synthetic alternative, is being mined, used and wasted as never before.

Massive inefficiencies in the “farm-to-fork” processing of food and the soaring appetite for meat and dairy produce across Asia is stoking demand for phosphorus faster and further than anyone had predicted. “Peak phosphorus”, say scientists, could hit the world in just 30 years. Crop-based biofuels, whose production methods and usage suck phosphorus out of the agricultural system in unprecedented volumes, have, researchers in Brazil say, made the problem many times worse.

Already, India is running low on matches as factories run short of phosphorus; the Brazilian Government has spoken of a need to nationalise privately held mines that supply the fertiliser industry and Swedish scientists are busily redesigning toilets to separate and collect urine in an attempt to conserve the precious element.

Dana Cordell, a senior researcher at the Institute for Sustainable Futures at the University of Technology in Sydney, said: “Quite simply, without phosphorus we cannot produce food. At current rates, reserves will be depleted in the next 50 to 100 years.

She added: “Phosphorus is as critical for all modern economies as water. If global water supply were as concentrated as global phosphorus supply, there would be much, much deeper concern. It is amazing that more attention is not being paid to ensuring phosphorus security.”

In the past 14 months, the price of the raw material - phosphate rock - has surged by more than 700 per cent to more than $367 (£185) per tonne. As well as putting pressure on food prices, some researchers believe that the risk of a future phosphorus shortage blows a hole in the concept of biofuels as a “renewable” source of energy. Ethanol is not truly renewable if the essential fundamental element is, in reality, growing more scarce, researchers say.

Within a few decades, according to forecasts used by scientists at Linköping University, in Sweden, a “peak phosphorus” crunch could represent a serious threat to agriculture as global reserves of high-quality phosphate rock go into terminal decline.

Because supplies of phosphates suitable for mining are so limited, a new geopolitical map may be drawn around the remaining reserves - a dynamic that would give a sudden boost to the global importance of Morocco, which holds 32 per cent of the world's proven reserves.

Beyond Morocco, the world's chief phosphorus reserves for export are concentrated in Western Sahara, South Africa, Jordan, Syria and Russia.

Bond insurers want $125 billion of cover wiped out
Bond insurers such as Ambac, MBIA and FGIC are talking to banks about wiping out $125bn of insurance on risky debt securities in what could be the only way to limit the financial damage surrounding the bond insurers.

Discussions about “commuting” these insurance contracts, which were sold by bond insurers to banks in the form of credit default swaps, have taken on a renewed sense of urgency amid a rash of ratings downgrades in the bond insurance, or monoline, sector last week.

If agreements are struck about the value of these CDS contacts – and the discussions could take months – it could be significant for the entire financial system, which is clogged up by the uncertainty around the value of derivatives and complex bonds linked to mortgage-backed securities.

“If firms and their counterparties can get across the finishing line in their commutation negotiations, a shadow of uncertainty would be lifted from the monoline sector, with the prospect of better rating stability,” said Matthew Elderfield, chief executive of the Bermuda Monetary Authority, which regulates a number of bond insurers.

Bond insurers are in different stages of financial trouble, with smaller ones such as FGIC already rated in the junk category. Last week, Ambac and MBIA lost their last triple A credit ratings after Moody’s downgraded them to double A and single A respectively. Both ratings have a negative outlook.

The talks centre on CDS contracts issued by bond insurers to guarantee payments on collateralised debt obligations, complex debt securities often backed by mortgages which have plunged in value amid a wave of foreclosures on mortgages issued in recent years.

The nominal value of these CDSs on CDOs is about $125bn, according to estimates by Standard & Poor’s, and banks with the most exposure, such as Citibank, Merrill Lynch and UBS, have already taken writedowns related to the hedges as the credit quality of the bond insurers has deteriorated in recent months.

To commute an insurance contract, the policyholder usually receives an upfront payment in exchange for agreeing to tear up the policy. There is little certainty about whether or not these CDSs will ever have to be paid out. In theory, bond insurers could be on the hook for billions of dollars, but it is possible that if market conditions stabilise and improve, their actual pay-outs might be low.

It’s All Unravelling - Bond Insurers Beg Banks for $125 Billion "Forgiveness"
Bond insurers are begging banks to tear up $125 billion in credit default swaps in order to save their lives. You never know, this could be a blackmail situation…”hey, you rip up these Credit Default Swaps or you will take big losses when we fail”.

Yes, I ride these guys hard and always assume the worst first. Why shouldn’t I? Since New Century failed in March of 2007 we have been lied to at least in 99% of the cases regarding potential serious problems with companies claiming ’there is nothing to see here’ and by officials, analysts and famous investors when talking about the mortgage, housing or credit crisis in general.

My standard operating procedure it to assume they are lying and let them prove they are not. What generally happens is a story like this breaks and the company says ‘there is nothing to see here’. The other companies involved and some sort of official, regulator or large scale investor backs up their story. Then, they find someone on which to blame the story as being ‘misconstrued’. Two months later it comes full circle where the worst case scenario was true all along. I believe that this story could be big.[..]
"The nominal value of these CDSs on CDOs is about $125bn, according to estimates by Standard & Poor’s, and banks with the most exposure, such as Citibank, Merrill Lynch and UBS, have already taken writedowns related to the hedges as the credit quality of the bond insurers has deteriorated in recent months. To commute an insurance contract, the policyholder usually receives an upfront payment in exchange for agreeing to tear up the policy.

There is little certainty about whether or not these CDSs will ever have to be paid out. In theory, bond insurers could be on the hook for billions of dollars, but it is possible that if market conditions stabilise and improve, their actual pay-outs might be low.”

This reminds me of when I make my typical $50 bets with friends on a sporting events and half way into it I am getting killed. I always ask, “how about I pay you $5 now and we call it even” before the game is over knowing my odds of losing $50 are near a sure thing. Hey, you never get anything in life unless you ask for it, right?

This desperate act comes as reports are surfacing that the public mutual fund universe has not been truthful about their structured mortgage debt marks. Sources say that most mutual fund managers have their MBS holdings mis-priced, which puts the public at significant risk. The job that structured mortgage debt did on hedge funds and banks has been bad, but a mark-to-market across the public mutual fund universe could be worse because it’s larger and directly effects Ma and Pa America.

Investors Hide as Banks Come Knocking
Once bitten, twice shy. As banks rack up billions of dollars in losses from bad loans and blundered investments, large investors are becoming skittish about pumping more money into them. In the past several weeks, bank executives have encountered unexpected resistance from investors, who have expressed reluctance to participate in the capital-raising transactions sweeping through the industry, according to people familiar with the situation.

Already bruised by big losses and fearing that bank shares haven't yet hit bottom, some of these investors are choosing to tighten their purse strings. "The window for capital-raising is closing" says Brad Evans, a portfolio manager for Heartland Advisors Inc., a money-management firm in Milwaukee that invests in small, regional banks. "Investing in a bank right now means investing in a large portfolio of loans that are essentially a black box."

The change in sentiment could have sweeping implications for financial institutions that are trying to shore up their balance sheets by issuing stock and other securities to their investors. Some may be forced to lure investors with sweeter terms, further raising the costs of doing these deals.

Before announcing plans earlier this month to raise $1.5 billion, KeyCorp, of Cleveland, quietly reached out to more than a dozen of its largest institutional shareholders to gauge their interest in participating in a transaction, according to people familiar with the matter. A number of those investors rebuffed the offer, expressing concern about their existing exposure to the poor banking environment, these people said. KeyCorp's stock price fell 24% when it announced the capital-raising deal. It is down 3.8% since then.

Dozens of Wall Street firms and commercial banks have raised capital, and many more financial institutions are expected to follow the same path in coming months, particularly as regulators clamp down on these institutions to ensure they have adequate capital levels to withstand the credit crunch.

That is particularly the case for small, regional banks and mom-and-pop lenders just starting to be hit hard by losses in their real-estate and construction-loan portfolios. With so many banks already having gone hat in hand to shareholders, these financial institutions ultimately may be forced to deal with a limited pool of investors who still would be willing to pump in money.

Investors have good reason to be skittish. Most of the banks that issued new securities in recent months have continued to see their share prices slide, some by 40% or more. That means investors who bought into those transactions are far underwater. And existing investors who didn't bite have had their holdings diluted by the issuance of piles of new shares. "Investors are tired of trying to catch a falling knife," says one investment banker who specializes in the financial-services industry.

Even the smart money isn't looking so smart. In April, private-equity firm TPG and other investors agreed to pump $7 billion into Washington Mutual Inc. in a transaction that valued their investment at $8.75 a share. The deal represented a discount to the bank's share price of about $13 at the time. Not anymore. WaMu's stock closed Friday at $6.38 on the New York Stock Exchange.

"Obviously, the investors who jumped in early are down materially, but I don't feel by any measure that the market is closed or dead," says John Duffy, chief executive and chairman of KBW Inc., a boutique investment firm in New York that is advising a number of financial institutions on the prospects of raising additional capital. Mr. Duffy attributes much of the recent decline in stock values to "the sentiment that the banks didn't raise enough capital and will be back to the market at even lower prices."

In a report last week, Mr. Fenech attributed the slides in the share prices of banks that recently raised capital partly to skepticism as "investors began to assess the possibility that many companies would soon be back to the well for additional capital and/or began to more fully digest the massive dilution associated with these actions."

The latest test of investor fortitude: BankUnited Financial Corp., a Coral Gables, Fla., bank announced late Wednesday a $400 million public offering. Terms of the deal weren't disclosed, but BankUnited's stock-market value is less than $100 million.

Growing queasiness could force some banks to downsize their capital-raising ambitions. That is how some analysts and investors interpreted the actions of Fifth Third Bancorp, which on Tuesday said it would raise $1 billion through an offering of convertible preferred stock and sell $1 billion in assets. The Cincinnati bank also cut its dividend for the first time in three decades. "The decision we made speaks for itself," a Fifth Third spokesman said.

Job fears mount as Goldman sheds staff
Bankers fear the pace of job losses in the investment banking industry is set to accelerate over the summer after it emerged that Goldman Sachs, the sector’s star performer, cut staff at its investment banking division last week. The Wall Street bank is now expected to cut up to 10 per cent of staff in the division that handles mergers and acquisition advice and corporate fundraisings over the course of 2008, with a fresh round of trimming starting last week.

The latest cutbacks, which come in spite of impressive second-quarter results, are separate from Goldman’s annual performance review, which typically sees the worst-performing 5 per cent of staff leave the bank. Wall Street rival Citigroup is already in the midst of a 10 per cent reduction to its 65,000 strong investment banking staff. People at the bank say half of the layoffs have been made with further cuts likely in the coming weeks.

Goldman has so far suffered the least damage in the global credit crunch and remains the leading M&A adviser. But in an environment where mega buy-outs have disappeared and M&A activity has fallen sharply, even Goldman has felt the squeeze. Goldman, in common with the rest of the industry, has been gradually shedding staff this year, or sending bankers previously based in the US and Europe to the Middle East and Asia, where business remains buoyant. Group headcount fell by about 400 between the first and second quarter.

However, job losses across the industry have been less severe than many expected this year, and Goldman’s heightened pessimism about its need to retain its more experienced staff during the rest of 2008 could prove a pretext for other banks to wield the axe with greater force. Job losses are now gathering pace in Europe, which bankers say is lagging behind the US in adapting to slower conditions. Credit Suisse last week confirmed a fresh round of 75 job cuts in investment banking and support services in the UK, a move which it said reflected market conditions.

The Centre for Economics and Business Research anticipates 11,000 job losses in London this year, and a further 8,200 in 2009. Bankers said business lines that had proved resilient so far – such as equities, rates and currencies – looked particularly vulnerable given mounting pressures on banks to reduce risk as well as the investment community’s continued attempts to reduce leverage.

The fixed-income business has suffered the brunt of the assault so far, but was in some firms now approaching a level where further cuts risked creating a competitive disadvantage. One senior banker said back-office functions were likely to attract the attention of senior managers. “It is always the front office that gets hit first, because no one is quite sure what back office does and they are less visible. Back office is also helped because that is where human resources is based,” he said.

Goldman is still expected to increase its overall headcount this year, although its staffing mix will change as it recruits aggressively from universities. “Any bank that says it’s not cutting is lying,” said one industry insider on Sunday. “It’s getting to halfway through the year and everyone can see that business hasn’t picked up.”

Citigroup to Cut 10% of Investment Banking Jobs
Citigroup Inc., in the latest sign of bloodletting on Wall Street, is set this week to embark on an aggressive round of layoffs within its investment-banking division, people familiar with the matter said.

The New York bank, which has suffered $15 billion in losses over the past two quarters and is likely to rack up billions of dollars in additional write-downs in the second quarter, this week will dismiss thousands of investment-banking employees world-wide as part of a plan to cut the roughly 65,000-employee group by 10%, the people said. Pink slips are likely to be handed out Monday.

"Citi indicated earlier this year that it would be resizing this business in response to market conditions and as part of our ongoing re-engineering efforts," spokesman Dan Noonan said, without confirming specifics. Across Wall Street, investment banks are adjusting to meager times as they deal with drop-offs in everything from mergers to initial public offerings. Citigroup, which has more than 350,000 employees around the world, had fired at least 9,000 workers as of March 31.

Still, the coming cuts are unusual in their scope and severity. Mergers-and-acquisitions bankers are expected to see especially sharp cuts, in part because their ranks were not trimmed as much as other units earlier this year. But no major department is likely to be spared, aside from some businesses in emerging markets and Citigroup's lucrative transactions-services arm.

Entire trading desks in New York and other cities are expected to be eliminated. And unlike Citigroup's other recent reductions, this round will feature layoffs of dozens of senior managing directors, the people said. The cuts are the first big move by John Havens, who took the helm of Citigroup's institutional-clients group, which includes the investment bank, in late March.

Mr. Havens, a longtime lieutenant of Citigroup Chief Executive Vikram Pandit, has concluded that some of the investment bank's businesses have been rendered obsolete by the credit crunch, while he sees others as operating inefficiently and generating inadequate returns. Mr. Pandit's goal is to reduce the firm's annual expenses by $15 billion.

Dexia to provide $5 billion credit to monoline under Ackman Pershing attack
Dexia, the Belgian-French financial services group, on Monday said it would give a $5bn credit line to FSA, its US bond insurance business, and stated its commitment to maintaining the subsidiary’s triple-A credit ratings. The credit line will last for five years initially, and will not be unsecured by collateral.

Last week, Bill Ackman, a hedge fund manager, revealed that his $6bn Pershing Square Capital Management fund was betting against FSA because the bond insurer, or monoline, sold investment contracts backed by mortgage securities that had fallen in value and the fund believed it might be insolvent despite its top credit rating.

Robert Cochran, chairman and chief executive officer of FSA, said in a statement on Monday that the business had ample liquidity to meet its obligations but “within a context of highly nervous financial markets”, the company wanted to remove any doubt that it would have the resources to hold investment assets to maturity. In an interview with Reuters, Dexia’s chief financial officer Xavier de Walque said on Monday that the move was an answer to the attack from Pershing.

“We have received no call from the rating agencies asking for us to [extend the credit line]. What we intend to do is remove any doubt on the quality of the signature of FSA given the noise from Pershing.” Dexia bought FSA for $2.6bn in 2000. FSA operates in the US market, insuring asset-backed bonds, the main source of finance for municipal authorities. The New York-based subsidiary makes around 12 per cent of Dexia’s earnings.

The top credit rating is crucial to FSA’s business model, since it uses its triple-A rating to guarantee municipal bonds which lowers the cost of capital raising by the municipal authorities. In return, it is paid fees over the bond’s lifetime. FSA has avoided many of the mortgage-related losses plaguing rivals such as Ambac and MBIA. Last week, these competitors lost their last triple-A credit ratings after downgrades by rating agency Moody’s.

Deutsche Bank Lost in Vegas as Defaults Make Lenders Decorators
Workers building the $3.5 billion Cosmopolitan Resort & Casino on the Las Vegas strip are getting used to their financiers from Deutsche Bank AG. Lately, the weekly visitors from 60 Wall Street have been critiquing plans that called for a black-and-white decor.

"They are considering changing the color palettes and finishes," said Travis Burton, a vice president for lead contractor Perini Corp., who outfits the bankers with safety vests and hard hats before touring the site. Since January, when New York developer Ian Bruce Eichner defaulted on a $760 million loan, Frankfurt-based Deutsche Bank has been cutting Perini a monthly check for $70 million to continue construction, now in full swing with 2,800 workers on site and a dozen cranes towering overhead.

Deutsche Bank, which declined to comment about the Cosmopolitan, is one of a dozen investment banks that rode a five-year boom in commercial real estate by financing developers and landlords while profiting by packaging loans into securities. Then credit markets seized up in 2007, sticking banks and brokerage firms with commercial mortgages and bonds. The amount for large U.S. banks alone: $169 billion, according to Fitch Ratings Ltd.

The resolution may take more than providing advice on drapes as the economy falters and mall vacancies increase. "Wall Street banks have a lot of exposure to commercial real estate, and it's definitely a concern," said Ryan Lentell, an industry analyst at Chicago-based Morningstar Inc. "They really pushed through lending and principal investing. The exposure has a lot to do with their problems."

Not far down the strip is the Tropicana Resort & Casino, whose parent filed for bankruptcy protection in May. Tropicana Entertainment LLC defaulted in April on a $1.3 billion syndicated credit line arranged by Zurich-based Credit Suisse Group to help finance the purchase of the casino in 2006, according to bankruptcy papers. Credit Suisse spokesman Duncan King declined to comment.

The economic slump that began in the U.S. housing market has spread to commercial real estate, Wachovia Corp. senior economist Mark Vitner wrote in a June 4 note. Retail vacancies in the first quarter were up 8 percent from a year earlier, he said. And he predicts average prices for U.S. commercial real estate may drop by 15 percent to 20 percent as demand for office and industrial space declines.

New Wall Street regulations imminent
The Federal Reserve and Securities Exchange Commission (SEC) are finalizing an agreement to start the process of redrawing how Wall Street is regulated, the Wall Street Journal said on its Web site on Sunday.

The agreement, which could be announced this week, aims to fill gaps in regulatory oversight and will increase cooperation between the central bank and the SEC in the wake of the near-collapse of Bear Stearns Cos, the report said. The type of information to be shared between the two would include data regarding settlements, trade and positions.

The SEC will also get information from the Fed on short-term financing from the banks that clear trades and hold collateral for the securities firms, the report said. Under the agreement, the Fed would be able to see an investment bank's trading positions, its leverage and its capital requirements, the Journal said. The change will expand the Fed's oversight of the financial system to include investment banks, the report said.

Currently, the SEC has oversight of brokerage firms while the Fed has oversight of bank holding companies and commercial banks.

Ilargi: The SEC was founded at the same time, and for the same reasons, as the Glass-Steagall Act: basically, to make sure bankers has less chance to fleece the system and the population.

It’s starting to look like a decade after the first died, the latter will soon follow. Why do I get the idea that Cox was brought in as a Trojan Horse? Maybe it’s just me.

This WSJ article is much longer than the excerpt here. Click on the link to see the whole piece.

SEC Chief Under Fire as Fed Seeks Bigger Wall Street Role
One Friday in March, with investment bank Bear Stearns Cos. teetering toward collapse, the chieftains of U.S. financial regulation dialed into a 5 a.m. conference call to craft a bailout plan. When they were done, the Treasury secretary informed the president. The head of the Federal Reserve Bank of New York called Bear Stearns.

Christopher Cox, chairman of the Securities and Exchange Commission, didn't call anyone. Though the SEC was Bear Stearns's regulator, he didn't take part in the meeting. In an interview, Mr. Cox said the time of the call changed overnight and no one told him. SEC staff members were on the early call and Mr. Cox says he was involved in calls later that day and throughout the weekend with his peers.

Big crises put Washington's regulators to the test. At pivotal times during the current financial turmoil, Mr. Cox has appeared peripheral. The next night, as Fed and Treasury bosses negotiated a bailout, Mr. Cox was at a birthday party. He was missing from a Sunday conference call announcing the sale of Bear Stearns and the Fed's plan to lend funds to investment banks. The following weekend, he left town for a family vacation.

Critics say America's top securities regulator didn't act boldly enough to restore confidence when the financial world shuddered. His profile was low just when the SEC may have most needed an outspoken champion: The Bear Stearns meltdown has fueled calls to reorganize U.S. financial regulation, just as a proposal was published to eliminate the SEC and shift responsibility for Wall Street to the Fed.

On Thursday, Treasury Secretary Henry Paulson called for broadening the Fed's oversight role over a range of institutions, likely including investment banks. The SEC and the central bank are in the final stages of negotiating an agreement that would start that process. Congress is planning hearings on the matter beginning next month.

Mr. Cox's defenders say he acted within his powers as an SEC chief and didn't step beyond them. Some advocates say that as the Bear Stearns crisis swirled, he worked closely with the Fed and damped potential panic with his optimistic take on investments banks' financial health.

"Your activities in regard to the recent credit crisis events were proper responses in an extremely difficult emergency situation," former SEC chief David S. Ruder wrote to Mr. Cox on Friday in an email that was also addressed to The Wall Street Journal. Mr. Cox says his area of expertise is corporate law and that he put his best markets team in place to deal with the crisis.

Still, many of Mr. Cox's predecessors were more visible in times of turmoil. In 1990, amid debate over a possible bailout of investment bank Drexel Burnham Lambert Inc., then-SEC Chairman Richard C. Breeden worked alongside Federal Reserve of New York President Gerald Corrigan and Treasury Secretary Nicholas Brady. On Sept. 12, 2001, as officials scrambled to reopen markets after the 9/11 terrorist attacks, then-Chairman Harvey Pitt boarded an Amtrak train for New York to meet with the heads of the brokerage firms and major exchanges.

Some of these predecessors are getting vocal. Ex-Chairman Arthur Levitt has been peppering Mr. Cox with emails urging him to move more aggressively to preserve the SEC's authority. At a recent public round-table meeting at the SEC, Mr. Cox asked a panel of former chairmen for advice. In talking about plans to change future financial regulation, Mr. Pitt responded the SEC should "lead the discussion, instead of being led in the discussion."

Mr. Breeden said in an interview that during the Drexel crisis, the SEC took the lead in interagency discussions. "We were the primary regulator charged by Congress with overseeing all aspects of the securities markets," Mr. Breeden said. "Drexel was our responsibility, and we had no hesitation about exercising our powers to protect investors and the integrity of our regulatory system."

If anything, the Bear Stearns demise was more serious, Mr. Breeden said. Drexel unraveled after illegal conduct there, limiting the risk that trouble would spread, he said. "The context at Bear Stearns was far worse due to market conditions, liquidity constraints and confidence issues affecting many firms around the world," Mr. Breeden said.

Mr. Cox says the Bear Stearns and Drexel matters weren't comparable. In a two-hour interview in his office overlooking the Capitol building, the 55-year-old Mr. Cox said he was deeply involved the week of the Bear Stearns meltdown. He has since asked Congress to mandate the SEC's oversight of investment banks and says SEC staff immediately began working with the Fed to strengthen investment banks' risk-assessment models.

Early rate rises not in Fed’s Plan A
The Federal Reserve is likely to indicate some increased concern about inflation following its policy meeting this week, but to do so in a manner than avoids any suggestion that interest rate rises are imminent.

Indeed, it may not say that it now sees the risk to inflation as greater than the risk to growth. If it does, it will probably qualify the assessment either by stating that the risks remain quite closely balanced, or by emphasising economic uncertainty. Interest rates will stay on hold at 2 per cent.

The US central bank is trying to walk a fine line. It wants to convince investors and the public it will do whatever it takes to stop high rates of inflation – pushed up by oil and food prices – becoming entrenched in inflation expectations. But it also wants to avoid an excessive run-up in market interest rate expectations, since that would push up the actual cost of loans unduly, putting pressure on a still-fragile economy.

Larry Meyer, a former Fed governor, says recent hawkish talk by Fed officials represents a “conditional commitment” to raise rates if the sources of inflation risk deteriorate. But he says the market has difficulty distinguishing this from an “unconditional signal that policy tightening is imminent”. By the start of last week the market was pricing in three or four rate rises this year. Investors scaled back these bets following reports in the Financial Times and other newspapers that policymakers did not expect to raise rates so quickly.

Senior officials appear to think in terms of a base case for rate increases and a risk case. The base case may have some tightening this year – but probably at most one or two increases by year end. The logic here is that interest rates at 2 per cent, while accommodative, are not wildly stimulative owing to persistent financial stress. This may be about right, given the weak growth forecast and remaining downside risks – highlighted by the decline in bank stocks, which are now trading below their March lows.

This suggests no need to raise rates rapidly. However, it would still be necessary to raise rates in a calibrated manner as the economic outlook improved and financial stress moderated, easing overall financial conditions. But these officials also appear to think of a risk case in which they would have to raise rates sooner and faster to contain inflation.

Ben Bernanke, Fed chairman, outlined the main triggers for the more rapid rate increase scenario in a speech on June 9. He promised to pay “close attention” to “the pass-through of high raw materials costs to the prices of most other products and to domestic labour costs”. And he stressed that the central bank would “strongly resist an erosion of longer-term inflation expectations”.

The Fed – in its economic forecasts – has indicated its desire to take an extended period to bring inflation back to more normal levels following the oil shock, in order to moderate the cost in lost output and employment, particularly given the simultaneous shock from the credit crisis.

Mark Gertler, a professor at New York University, says the rise in oil prices “cannot continue indefinitely” and, when it ceases, headline inflation should fairly quickly fall to the lower core rate that excludes food and energy. But as Don Kohn, Fed vice-chairman, emphasised in a speech on June 11, the central bank’s ability to tolerate above-normal inflation for a while is “tempered” by the need to ensure inflation expectations remain broadly stable during the period of fast-rising prices. This is the crux of the internal Fed debate.

Opec rift fuels new fears for oil prices
Fears that the price of oil could reach new highs in the coming weeks have intensified following the emergency meeting of the world's oil powers in Saudi Arabia. Saudi Arabia, the world's biggest exporter of oil, confirmed well-trailed plans to raise production by 200,000 barrels to 9.7m barrels a day - a 30-year high - at yesterday's emergency summit.

However, oil traders warned that a lack of other concrete measures, threats by other OPEC members to decrease production in response to Saudi Arabia's move and news that Nigeria's production had been further hit by rebel attacks on pipelines could drive prices up even further. "There is the danger that the markets will be disappointed and the price will increase again," said Germany's economy minister Michael Glos.

OPEC president Chakib Khelil dismissed Saudi Arabia's pledge to increase oil production, saying that it was not a lack of supply that was driving prices up but speculative investment. Asked if he thought that oil prices would fall after the meeting, Mr Khelil, the Algerian oil minister, said: "I don't think so."

Jeroen van der Veer, chief executive of oil giant Royal Dutch Shell, agreed that there would be no "silver bullet" solution to curb spiralling oil prices. "What I've heard so far are basically all good ideas, but it will probably not change the price tomorrow morning," he added.

Signs of a growing split between OPEC countries were clear, with Venezuela, Libya, Algeria, Iran and Qatar opposed to an increase in oil production on the grounds that speculative investment in financial markets was to blame for the price hikes, not a lack of supply. Libya said that it would consider reducing production in response to Saudi Arabia's statement that it would increase supplies. Kuwait, however, suggested that it would follow Saudi Arabia and increase production.

Venezuela's finance minister Ali Rodriguez, a former head of OPEC, also said that he expected prices to rise further. The meeting in Jeddah was attended by 35 countries, seven international organisations, and 25 oil companies. It was called by the Saudi government to discuss spiralling oil prices, which have doubled to almost $140 a barrel in the past year.

Prime Minister Gordon Brown and US energy secretary Sam Bodman were among the high-level delegates who attended. A large number of delegates at the urgently convened meeting called for greater regulation of oil investors. The head of Libya's national oil company said that it was unrealistic to come up with a quick fix to such a major issue: "We are coming to discuss a very important subject, supposedly, and expected to get an important decision in three hours," he explained. "That's impossible."

Mr Brown called for greater market transparency, and reiterated the view, shared by the US, that oil-producing countries should produce more. He also called for an increase in the supply of alternative energy sources, including nuclear power, and invited foreign oil producers to invest in renewable energy production in the UK, and the next generation of nuclear power.

While Saudi Arabia is seeking to increase oil production, it emerged that Nigeria, Africa's second largest oil producer, is producing at its lowest level in 25 years after rebel attacks on facilities operated by Royal Dutch Shell and Chevron. It is estimated that Nigeria's output has been cut by around 300,000 barrels a day as a result of the violence.

"Onshore production has been shut in order to protect the environment. We're hopeful that production can be restored as soon as possible," said Chevron. Over the weekend Chevron said its Abiteye-Olero pipeline had been attacked by rebels on Thursday, halting the shipment of about 120,000 barrels of crude oil a day.

Blame central banks, not speculators for oil price
The price of oil is unlikely to be reduced sustainably either by Saudi Arabia increasing its production or by mad Austrian schemes to tax speculators out of the oil market, both of which got an airing at the oil summit in Jeddah at the weekend. As was the case in the 1970s, the oil price is rising in response to a falling greenback and rising inflation at the end of a long period of economic expansion.

Slower world growth, lower inflation and a firmer US dollar would set the market back to rights. The question is whether that can be achieved gradually or will be forced through the shock of a global recession. Politicians would like a simpler solution. Kevin Rudd railed in parliament last Friday against "excessive speculation within the oil industry itself and increasing evidence that some financial institutions may be trading in oil as an investment like shares and currencies".

There are echoes around the world. While the Austrians want a tax on oil speculation, Italian Finance Minister Giulio Tremonti wants to raise the minimum deposit before investors are allowed to acquire oil futures contracts. He says of rising oil prices: "The causes are not structural, but on top of the barrel price (of oil) there is a magnum of speculative champagne." French President Nicholas Sarkozy has called for an end to "capitalism of lies, of frivolity".

The speculator is the age-old scapegoat in economic uncertainty. Investment in commodity indexes, as an asset class, have certainly taken off, rising from $US13 billion to $US260 billion ($273 billion) over the past five years. Energy prices make up about 70 per cent of their value. However, if investors in these indexes were forcing prices higher by generating demand for oil in excess of that from refiners, the result would be an accumulation of oil inventory and this has not been the case.

An honest assessment would look to the culpability of the world's central banks in running loose monetary policy over the past decade. The slashing of US rates over the past six months in response to recession fears raises the prospect of one last inflationary wave of excess liquidity washing into world markets.

We have been here before. Some of the best oil industry market analysis comes out of Rice University in Texas. A recent paper by Amy Myers Jaffe and Mahmoud Amin El-Gamal from Rice traces the cycles of boom and bust in the oil market back to the dawn of the oil age in the middle of the nineteenth century.

Periods of increased trade and globalisation increase demand for energy and, since supply cannot respond quickly enough, bring higher prices in their train. Higher energy prices become caught in the momentum of inflation, which becomes self-perpetuating as negative real interest rates develop. Inflationary cycles have typically ended with recessions following currency and banking crises.

The high oil prices of the 1870s, the late 1920s and the early 1970s were all accompanied by a period of financial turmoil. Jaffe and El-Gamal contrast the movement in the price of gold with that of oil. Gold is the classic hedge against inflation and was the central measure of value until the collapse of the Bretton Woods agreement on global currencies in 1971. They suggest that if you focus on gold as the measure of value, the volatility caused by loose monetary policy in a dollar-centred world becomes apparent.

Reconsidering the "Home-ownership Rate"
[The New York Times on June 21st 2008 ran this article: "Rise in Renters Erasing Gains in Ownership".] The story is based on home-ownership data released by the Census Bureau back in April. The article bemoans the fall in the home-ownership rate from 69.1% in the first quarter of 2005 to 67.8% as of the first quarter this year. Yet I wonder: did the home-ownership rate ever really reach 69.1%?

What I doubt isn’t the Census Bureau’s figure, I doubt their definition of home-ownership. With approximately 110 million households nationwide, the decline to 67.8% represents 1.7 million households that shifted from owning to renting. But who were these 1.7 million households? How did they come to own their house and how much of their house did they actually own?

It’s no secret that financial “innovation” in the mortgage market made “home-ownership” possible for millions. That’s what the “proponents” of subprime lending say and perhaps for a few thousand borrowers it was true. But clearly we had a case of too much of a good thing. Wall Street funneled hundreds of billions of dollars at increasingly easy terms to folks who’d never had access to the mortgage market before. Probably for a good reason.

In 2006 alone, $600 billion worth of subprime mortgages were handed out. From 2004-2006, Moody’s estimated that 21% of all mortgages originated were subprime: low teaser rates and, crucially, little or no downpayment. Having put little or no money down, subprime buyers’ paid mostly interest to the bank each month. Their mortgage payments purchased little or no equity in their homes.

It’s ironic, but you could say they were effectively renting—from the bank instead of a landlord. Subprime lending didn’t make true home-ownership possible, merely the illusion of ownership. This is why it’s foolish to lament the fall in the “home-ownership rate.” No gains in ownership were actually made. Instead, we should lament the fall in home equity, which is a more precise gauge of ownership to begin with.

The Fed reported in early June that homeowners’ portion of equity in their homes has fallen to 46.2%, a new all-time low. More frightening was this quote from the same article: A homeowner’s equity is the market value of a property minus the mortgage debt. And homeowners’ percentage of equity has declined steadily even as home values surged during the housing boom due to a jump in cash-out refinancing and home-equity loans, plus an increase in 100 percent financing.

Not only have the gains evaporated, but in Americans’ race to cash-out—and spend—those artificial gains, many now owe more on their house than it is worth. And since their house is often their only asset, their net worth is negative. So much for the "ownership society."

Did Bank of America write the Dodd bailout bill?
Those following the progress of the Dodd-Shelby mortgage rescue plan in the Senate might want to check out two solid pieces of enterprising reporting on the bill this weekend.
First, the Examiner's Tim Carney reports that the bailout section of the Dodd-Shelby bill is, in the words a lobbyist,
"exactly what Bank of America and Countrywide wanted." 
Is there a connection between Bank of America and Sen. Christopher J. Dodd (D-Conn.)?  There is. Carney: "Bank of America's political action committee (PAC) has donated $20,000 to Dodd since he became chairman of the banking panel 17 months ago. From January 2007 to March 2008, Bank of America employees have donated at least $50,400 to Dodd's campaigns, according to the Center for Responsive Politics."

National Review's the Corner follows up, citing an internal Bank of America document:
"National Review Online has obtained an internal Bank of America "discussion document" (PDF here) on the subject of the FHA Housing Stabilization and Homeownership Retention Act of 2008, a.k.a. the Dodd-Shelby mortgage-lender bailout bill .... This discussion document (dated March 11, 2008) would appear to support the contention that BofA essentially wrote the bailout section of the bill."

Faithful readers of the blog will remember that Bank of America has been pushing hard for a big federal intervention for months. This was from a New York Times story on BofA's lobbying efforts back in February: 
"Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates. 'We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market,' the financial institution noted. In practice, taxpayers would almost certainly view such a move as a bailout.

A defense borne of hubris, or stupidity
What we’re seeing this Monday morning from North Dakota Senator Kent Conrad is nothing less than either blind stupidity or record-setting hubris. In an op-ed “defense” published Monday by the Wall Street Journal, Conrad says that he never asked for special treatment on a series of mortgages he obtained from Countrywide, and that while he did talk with Angelo Mozilo about his mortgage, he wasn’t aware of special treatment:
Here are the facts: In 2002 I was looking for a mortgage and went to several lending institutions. I also called a close friend of mine who knew a lot about mortgages for advice. My friend happened to be with the head of Countrywide Financial when I called and put him on the line. I spoke with a gentleman by the name of Angelo Mozilo for about 30 seconds …
In 2004, I also financed an eight-unit apartment building in Bismarck, North Dakota. It is true Countrywide did not typically finance buildings with more than four units. But …

Conrad says in his “defense” that Countrywide waived fees and points on a mortgage he received, but that he didn’t see it as special treatment — and he adds the obligatory “nothing is more important to me than the public’s trust” line.

We’re not buying any of it. Not after he scrambled to donate money to charity equaling the past value of a benefit he received from Mozilo. Not after he admits to getting a multi-family loan from Countrywide that the company didn’t offer other borrowers. The fact that he finds it to be non-sensational that he called Angelo Mozilo to get a mortgage, or that he blindly followed a friends “advice” on who to call to get a great mortgage, is disturbing.

This is a U.S. Senator we’re talking about here, for crying out loud. How many HW readers have called and spoken to Ken Lewis when opening a savings account at Bank of America? And if you had, would you have characterized the experience as nothing out of the ordinary? In the end, we don’t know which is more troubling: if Conrad is lying through his teeth, or if he’s actually telling the truth and was oblivious to his status.

Both Conrad and fellow Senator Chris Dodd would have us believe that being a VIP — being a Senator of the United States of America — didn’t lead them to believe they were getting VIP treatment from Countrywide. There’s either extreme hubris in that sort of defense, or extreme stupidity. Neither are what we should expect from our elected officials

Has Europe's terminal crisis begun with a triple no vote?
The ultra-Europeans have overplayed their hand. We can now glimpse a chain of events that will halt, and reverse, this extremist push towards an Über-state that almost no one wants.

The attempt to override the triple "No" votes of the French, Dutch, and Irish peoples has brought the EU to a systemic crisis of legitimacy. A line too many has been crossed. Any sentient citizen can see that the process has become unhinged.

While "Europe" blunders on as if nothing has happened, it is now an open question whether the Lisbon Treaty - née Constitution - will ever come into force, whether the EU will ever acquire the machinery of an economic, diplomatic, and military power, and whether the euro will ever have a polity to back it up.

Henceforth, Brussels will struggle to retain powers already amassed. Functions will flow back to the nation states, the proper venue for authentic democracy. For three decades - from Rome to the Single European Act in 1986 - there were no treaties. Then the pace quickened: Maastricht, Amsterdam, and before the ink had dried on Nice, the ideologues hatched the Constitution.

This was the final throw of the Monnet Project: an attempt to lock in the framework of a proto-state, crowned by a supreme court with overweening jurisdiction, before the ex-captive nations of eastern Europe joined and rendered such ambitions impossible. The deadline slipped.

The failure of this gambit became clear this weekend when the Czechs and Poles refused to mug Ireland; or put another way, when they insisted on upholding the Vienna Convention on the Law of Treaties, unlike our own craven government.

It is fitting that the central Europeans should emerge as the champions of due process. Their own memories of Soviet methods are fresh. Radek Sikorski, the Polish foreign minister, cut his teeth as a journalist with Afghan guerrillas fighting Soviet forces in the Hindu Kush. Whatever the Irish decide to do, he said, "we'll respect it". How refreshing.

It was France's Nicolas Sarkozy who set off this debacle, sweeping aside the verdict of his own electorate to revive a rejected text. He aimed to score points as Europe's mover and shaker: instead, he charged into the complexities of EU politics with his trademark flippancy. Well might Mr Sarkozy rail at the Irish. "Bloody fools. They've been stuffing their faces at Europe's expense for and now they dump us in the s***," he yelled.

Mr Sarkozy still thinks that Ireland can be made to vote again in a few months. Who is the bloody fool? Yes, the Irish voted twice on Nice. That was another world. The Nice "No" came below radar, on a tiny turnout, after scant debate.

This time the contest has been electric. The Irish were warned day after day that rejecting Lisbon would be catastrophic. They rejected it any way, by national instinct, unwilling to sign a blank political cheque. As premier Brian Cowen now admits, Ireland's swing from boom to bust played its part in the vote. "That overall economic landscape is not likely to improve in the short term," he said. Quite.

A property bubble - caused by EMU interest rates of 2pc until 2005 - has left Ireland with frightening household debt of 176pc of gross domestic product. The country now faces a quadruple shock: a credit crunch, rising interest rates in Frankfurt, a plunge in sterling and the dollar, and a sharp slowdown in its Anglo-Saxon export markets.

Note that German foreign minister Frank Walter Steinmeier said Ireland should "exit" the EU temporarily. Did he forget that Ireland is an integral part of monetary union? His reflex is not only unpleasant, it also reveals that Germany views peripheral members of the eurozone as dispensable. It is an invitation for hedge funds to "short" EMU bonds from Club Med states.

Can one still presume that Germany will do whatever it takes to shore up EMU in a crisis, if only to safeguard its half-century investment in Europe's new order? Clearly, the euro break-up risk has been hugely mispriced. The survival of EMU does not depend on Lisbon as such, although the failure of the treaty would make it harder for the EU to orchestrate a covert bail out.

But there is a deeper issue at stake. As the Bundesbank warned long ago, EMU will eventually buckle under strain over time without the cement of political union. This means a de facto EU treasury, a unified wage system, and the plausible prospect of a debt and pensions pool. None of this exists. Nor will it.

China's property bubble is about to burst
The sizzle is off China's property markets, and that's potentially bad news for the country's social stability. In the past two years China's property market has enjoyed a spectacular rise, with average prices in some cities doubling.

But that raised a red flag with Chinese economic policymakers, and in late 2007 the central government made controlling the rise of asset prices a policy priority. Since then, the State Council has rolled out a series of regulations—from credit ceilings to a 40% down-payment requirement for second mortgages—in order to combat property speculation.

The effect was immediate. In early 2008 previously soaring housing markets in southern China began to go into a tailspin. The prospects for other key markets are not good either. With China continuing to struggle with high inflation, the central bank is likely to keep tight reins on monetary policy. Indeed, on June 7th it increased commercial banks' reserve-requirement ratio by 100 basis points, in effect taking out over Rmb400bn (US$58bn) from the financial system.

Property investors around the country are now holding their breath to see whether markets in other major cities will follow the spectacular tumble in Shenzhen, a city that borders Hong Kong, where the average per-square-metre price of new residential units dropped from over Rmb16,000 in February to Rmb11,000 at the end of May.

Reports of last-minute discounts, free renovation, free cars and "cost sharing" for down payments abound, suggesting even bigger concessions to come. Yet there are few signs of relief in sight. According to the Shenzhen Bureau of Land and Housing Management, some 27m sq metres in housing are under construction in the city. This comes on top of the 5m sq metres in leftover stock from 2007.

In sharp contrast, sales of new properties totalled only 1.2m sq metres between January and May. At the current rate (2.88m sq metre per year), it would take developers in Shenzhen more than a decade to sell all this stock of properties. This calculation, moreover, does not take into account the large supply of second-hand units held by investors, who are increasingly eager to dispose of their holdings.

Housing prices are also vulnerable in Beijing, Shanghai, Hangzhou, Ningbo and Haikou on the coast, and Wuhan, Nanning, Xi'an, Lanzhou and Urumqi in the interior. All these cities experienced spectacular growth in 2007. Curiously, though, official figures released by the National Development and Reform Commission (NDRC) do not bear that out. They show flat prices in all of them, with small declines in Lanzhou, Chengdu and Fuzhou.

How reliable are the NDRC data? Not very, it seems. They do not tally with local press reports, and the NDRC's methodology is vague. Consider its figures on Shenzhen. The NDRC reported that in March the city's average new residential property price fell 4.9% compared with one month earlier. But the Shenzhen Bureau of Land and Housing Management—presumably with its ear closer to the ground—reported a month-on-month drop of 16.5%. For April the NDRC again reported a decline of 2.2%, while Shenzhen's own figure was a 12% fall.

Vietnam: Fear of new meltdown
Is Asia again heading towards an exchange rate and financial crisis of the kind it experienced in 1997? Then the trigger was a collapse in Thailand's exchange rate as foreign investors rushed for the exits. A question increasingly being asked in the region and canvassed by investment banks in their client research is whether Vietnam could be the next Thailand.

There has been a remarkably rapid turnaround in perceptions of Vietnam in recent months, including by the International Monetary Fund and the Asian Development Bank, the speed and extent of which has not been picked up in the global media. The contrast with even six months ago is remarkable.

Despite a sharp dip at the time of the 1997 Asian crisis, Vietnam has enjoyed an average annual growth rate in real GDP of 7.5 per cent over the past decade, one of the fastest in Asia. In March Shogo Ishii of the IMF's Asian and Pacific Department said that in recent years Vietnam was one of the world's most attractive new investment destinations.

It has even been described as the new China and, particularly after its accession to the World Trade Organisation in 2007, money has been pouring in, with the world's banks scrabbling for a piece of the action. However, over the past three years its booming growth has increasingly outrun Vietnam's growth potential. There are infrastructure bottlenecks, inflation has risen sharply - from just over 8 per cent last year to over 25 per cent in May - and there is escalating industrial action plus rising wage demands.

The country's trade deficit has been widening rapidly as capital goods and other imports pour in to feed the boom and its current account deficit is about 10 per cent of GDP. Domestic credit has been growing at over 50 per cent a year. In short, all the familiar signs of a dangerous economic overheating. Not surprising then that the IMF warned in March that domestic and external imbalances were becoming a major concern for Vietnam. Private sector assessments have since become much sharper.

For example, last week a research note to international clients from Goldman Sachs, the US global investment bank and securities firm, began: "Rising cyclical risks have aggravated investors' fears that macroeconomic instability in Vietnam will soon translate into a balance of payments crisis or a significant currency devaluation." Goldman Sachs noted that forward currency markets were pricing in a depreciation of the Vietnamese dong of over 30 per cent in the next year.

Once currency markets start doing that, often it isn't long before the forecast adjustment is telescoped into a much shorter period. According to Goldman Sachs, there are anecdotal reports of Vietnamese rushing to buy gold or US dollars on the black market as a hedge against devaluation. The price of Vietnam's five-year sovereign debt credit default swaps, another measure of international confidence, has shot up by about a full percentage point from its end-of-May level and Vietnam's share market has plunged some 60 per cent so far this year.

There are other indicators; ratings agencies have lowered their ratings on Vietnam's sovereign debt. The Vietnamese Government and central bank have taken a series of actions aimed at cooling inflation and the economy. In late March the Government announced a seven-point plan that included a tightening of monetary policy, cutting government spending and public investment projects, promoting exports, encouraging saving, measures to stop speculation and prioritising agricultural production.

It has raised the reserve requirement ratio for banks, and increased the official interest rate three times since January, the latest increase - from 12 per cent to 14 per cent - on June 11. On the same day it announced a 2 per cent devaluation of the official exchange rate of the dong. The Government has elevated control of inflation above economic growth as a policy objective, but has failed to take effective action to sterilise the impact of large capital inflows on money growth and inflation.

Goldman Sachs has so far concluded that the probability of a balance of payments crisis is not large enough to make it the bank's baseline scenario. However, it looks increasingly like Vietnam has not done enough to avoid a crisis.

Australia commodity exports tipped to boom
Australian commodity exports are forecast to surge 40 per cent during the coming financial year, led by massive growth in the minerals and energy sectors. Indicators are also good for agriculture, with a 65 per cent increase in winter crop production forecast for 2008-09.

The booming forecast is contained in this month’s issue of Australian Commodities, issued by the Australian Bureau of Agricultural Resources Economics today. Farm sector exports are predicted to rise 12 per cent to about $30 billion, with the good news covering everything from wheat and barley to sorghum, sugar and wine. But the rosy forecast does depend on good rainfall as parts of the country remain in drought, ABARE acting executive director Karen Schneider said.

“Seasonal conditions will be a critical factor in achieving those estimates,” she said. Farming may be experiencing a renaissance, but it is mining and energy which is making the big bucks. Commodity exports are predicted to be a record $212 billion next financial year - and $178 billion of that is minerals and energy, up from $120 billion in 2007-08.

“While the forecast recovery in farm-sector performance is very encouraging, the strength of Australia's minerals and energy exports continues to underpin commodity sector performance,” Ms Schneider said. Demand for minerals and energy was strong, but world production was still growing modestly, ABARE said.

That means price rises. The report tips further prices rises for iron ore, coal, crude oil, gold and aluminium in 2008-09. The volume of Australian mineral exports is forecast to “rise markedly”.

Bernanke's Inflation Cure Wanes as Import Costs Rise
What's good news for U.S. businesses may turn out to be bad news for Federal Reserve Chairman Ben S. Bernanke's fight against inflation. The surging oil prices that are raising exporters' costs to ship everything from steel to sofas to America are encouraging customers to buy more domestically made goods -- and giving the producers of those goods more room to raise their prices.

The result: As Bernanke and fellow policy makers meet in Washington this week, they may find themselves starting to lose the benefit of the flow of inexpensive imports the chairman cited in a June 3 speech as a key force holding down living costs. "It's changing global costs," says Jeffrey Rubin, chief economist at CIBC World Markets in Toronto. "It's a huge inflationary threat."

If competition from abroad wanes, Fed policy makers may in the future have to rely more on higher interest rates and less on trade to contain inflation. Traders in the federal funds futures market are betting the Fed will keep rates unchanged this week, then raise them in August or September to keep price pressures in check. For importers, the rising cost of shipping is "like an increase in tariffs," says San Francisco Fed economist Reuven Glick.

Just as duties on imported goods give domestic industries cover to raise their own prices, higher shipping costs have the same inflationary effect, Rubin says. He reckons that transport costs are currently the equivalent of slapping a tariff of more than 9 percent on imports into the U.S. Fuel costs have made it so expensive to ship low-priced bookshelves to the U.S. that Ikea is starting to make them in America.

Asian steel exporters, saddled with higher freight rates, are losing U.S. market share, allowing domestic producers to boost their prices. According to Rubin, who's written several reports on the subject, the expense of shipping a standard 40-foot container from East Asia to the East Coast of the U.S. has nearly tripled since 2000. Freight costs would almost double again, he says, if oil prices head toward $200 per barrel from about $137 today.

Ilargi: A court can rule what it wants, but the banks simply can’t afford to do the BCE deal on original terms. This morning, rumors were that banks had suggested $39.25 per share instead of $42.75, but that won’t fly either, I would say.

By the way, BCE has delayed the whole thing till late September, seemingly erasing all the reports yesterday that it will be completed within two weeks. Where will BCE share prices be 3 months from now?

BCE Buyers, Banks Wrangle Over Funding After Court Salvages LBO
BCE Inc.'s buyers and their banks are fighting over financing for the $C52 billion ($51 billion) takeover, threatening to derail the biggest leveraged buyout after it was kept alive last week by Canada's top court.

The banks, led by Citigroup Inc. and Deutsche Bank AG, are pushing Ontario Teachers' Pension Plan and Providence Equity Partners Inc. to accept more onerous terms on the C$34 billion in debt needed to fund the LBO and perhaps kick in more equity, according to two people familiar with the talks. Both banks were among the lenders that held out for a lower price and higher borrowing costs in the Clear Channel Communications Inc. buyout.

"This puts the focus back on the banks," said Rick Nathan, a managing director at Kensington Capital Partners Ltd. in Toronto, which oversees C$400 million in private-equity assets. "Now they will have to agree on the terms." Negotiations continued over the weekend following the decision on June 20 by Canada's Supreme Court that blessed the deal, said the people, who asked not to be identified because the talks are private.

The justices overturned a lower court ruling that had blocked the acquisition on the grounds it short- changed bondholders of Montreal-based BCE, Canada's largest phone company. BCE jumped 6.9 percent to C$37 on electronic markets following the ruling, which was released after the close of regular trading in Toronto. That's where the stock was before the appeals court surprised investors by siding with the bondholders in their effort to kill the LBO.

After the high court's announcement, BCE delayed scheduled completion of the transaction to the end of the third quarter from June 30. Ontario Teachers', Canada's third-largest pension manager, and Providence, Rhode Island-based Providence Equity agreed a year ago to pay C$42.75 a share, or C$34.2 billion, for BCE. Madison Dearborn Partners LLC in Chicago and New York-based Merrill Lynch & Co. joined in the deal.

Including the assumption of debt, BCE would be the largest buyout on record, topping the $43.2 billion takeover of Dallas- based power producer TXU Corp. in October by Kohlberg Kravis Roberts & Co. and TPG Inc. "We continue to negotiate the financing documents in good faith with the sponsors and stand behind our original commitment to the transaction," the banks said in an e-mailed statement after the decision was announced by the court, which said it would give the reasons for its ruling later.


Anonymous said...

Hello Stoneleigh,

Yesterday you wrote:
"My own natural instincts are progressive, but I recognize that most aspects of the progressive agenda are ill-informed and hopelessly naive."

Those are my feelings EXACTLY.

I am constantly amazed here in my country by how many people simply have no idea how a business or the economy in general operate and worse, they do not care. They thrash around, making unrealistic plans, programs and policies, and then are surprised when they do not succeed.

I am also heavily involved in a number of associations and must again observe that many people are simply not interested in improving how things operate. Professionalisation is simply not an option.

Le Monde today reports that Sarkozy wants to reduce the size of the army because we have massive deficits. The Socialist party protested, saying that the policy was "guided by budgetary considerations". That was intended as a stinging criticism. Sigh. Should we laugh or cry?

So yes, the general thrust is kind, generous and humane, but the thought processes are addled to the point of being dysfunctional.

For what it is worth,

P.S. Stoneleigh, do you still see a spike upward in the dollar before a significant fall?

Anonymous said...

Hi guys!
I've been gone and just finished reading Stoneleigh's patient and clear answer to my question June 11.

I wish we were neighbors so I could give you a heart-felt, (useful) gift other than words to thank you for your work. As it is, I'll have to rely on Paypal to relay what I cannot.

When I was a kid in the 60's, I imagined mature grown-ups devoted their their lives to truth, beauty, and integrity; those who pursued money seemed sadly crippled. In middle age, it broke my heart to find such ideals hard to find in mainstream society. I find them at TAE.

Greenpa said...

In case anyone needed further evidence of cuckoos running CitiBank- I just got a letter today from my friends there. I have two credit card accounts with them; decades old; business and personal. Substantial balances on them, alas for me- but the accounts are in good standing; always have been.

So, today they are offering me something new. IF I enroll in the new program; and actually DO pay my bills on time- they will kick back 10% of the payments!

That's it; that's all. No tricks anywhere after I read the fine print; no penalties if I fail to pay on time; they're just kind of desperate to be sure they will have SOME cash flow over the next 8 months (the term of the offer.)

So- I've got a track record- 20 years long- of ALWAYS paying on time. I'm not giving out any signals really that I'm going to quit. But some bonzo in the upper echelons has decided to - give me money back- which means THEY will be making less, yes? Something they can't afford?

The smell of desperation is pretty scary; and the signs that the inmates are running the asylum are getting more obvious-

Am I missing something?

Stoneleigh said...

Thanks Ric :)

Warning people is something we feel we have to do as a matter of conscience. So much is going on behind the scenes and there's misinformation almost everywhere you look. Some of that is deliberate or self-serving or malicious, but much is simple cluelessness. The financial authorities can only cheerlead, hoping to sustain confidence in order to avoid bank runs and a general rush for the exits. All they can do is postpone however, not prevent, and that generous postponement is for the benefit of wealthy insiders, not the general public.

People won't find out what they need to know from the MSM or from most financial advisers, as most of them parrot received wisdom without ever really thinking about it or questioning the assumptions upon which it is based. We do our best here to bring you the information you need and provide some interpretation, while leaving you the space to make up your own minds.

Ilargi said...


Am I missing something?

I don't know, sounds like you did your diligence.

Still, it's also yet another reminder, and we've seen plenty of those the past few weeks, that Citi is not at all in good health. It's of course very hard to get a full picture from where we are all sitting, but there is a realistic possibility that keeping your money in their hands and vaults and digital accounts may be turning into a risky proposition.

That will have to be your call.

If and when the warnings turn out to be truthful, and it may topple, I wouldn't count on seeing any last minute signs, better than the ones we have, before it's all over; I'd expect a shock scenario.

Check the tone, the wording, of the correspondence they sent you; something in there may give you more clues.

scandia said...

I don't recall where I read it, maybe TAE, that in the Depression of the thirties something like 700billion of " wealth" was trying to squeeze into 5 billion of cash. If that is the case now in a contraction what is the scale of that scenario in 2008 How much is trying to convert into how much available cash. I don't grasp the scale of it.

Stoneleigh said...


That line was a quote from the end of The Resurgence of Risk (the paper I wrote at TOD:Canada in August 2007. I don't think anyone could give you a truly accurate picture of the numbers today, but suffice it to say that the comparison would be vastly more asymmetrical now. After all, the derivatives market alone is worth hundreds of trillions of dollars.

Anonymous said...

Maybe greenpa's story means he is about to receive dozens of offers from various CC companies...

scandia said...

Thanks Stoneleigh. Yes I recall reading that excellent article!Boggles my mind trying to imagine this scale! Quite a stress on the system, a system lacking resiliency. I just don't see how it can hold.

EBrown said...

Again you eloquently express thoughts I've had and spoken in the past about politics. I want a system that looks after the poor, the unlucky, the disabled, and yet I see so many unworkable "solutions" bandied about.
And a few days ago there was some discussion on the Depression 2.0 trumping peak oil in the short-term (meaning the next five to ten years in my book). When I first became peak oil aware a number of years ago I knew intuitively, subsequently backed up by further research, that it would have dire economic implications, and I still believe it does. But thanks to your writing on TOD, and now here, I have a more nuanced view of how it will generally play out. I find that the "deflationists" make a far stronger case than the "inflationists" at this time.
And I've decided that parking a bit of my savings in cash at home is a good idea, and I've started building that up. Better to have cash at home than "money" in the bank that I can't access...

EBrown said...

Another question - Stoneleigh, you called the market top with impressive prescience this spring. Both you and Ilargi have made a few comments about the next round down being more chaotic and coming "out of the blue" so to speak. Well, aside from all the signals those of us watching currently see on the horizon.

There are few warnings being aired in the MSM about this autumn being bad economically. I guess my question is timing related and I understand if you are hesitant to attempt an answer since gauging mob behavior is difficult at best, but here goes. When do you think the cash crunch (as opposed to the current credit crisis) will hit? Do you think it will play out as traditional bank runs with the FDIC unable to cover losses? I interprete your writing to this point as such...

I e-mailed the FDIC a few weeks ago and asked how long it takes to have savings restored after a failure. The reply I got was "typically within a week or two". I still have a hard time trusting this answer since I KNOW the FDIC does not have the reserves to cover even a fraction of the accounts it supposedly backstops.

My thought process then goes to the goverment passing emergency legislation to allow for the Treasury to fully fund the FDIC and keep it solvent. I wonder if such and attempt would simply be overwhelmed by bank implosions or whether it would impair the Federal Goverment's ability to borrow at favorable rates...

Stoneleigh said...


I think we're in the early stages of the next phase of the credit crunch. The DJIA has been declining for about a month and has decisively broken a trendline dating back to 1974. The fall could give way to a relatively small bounce in the not too distant future, as it is quite common for the market to test the underside of a broken trendline before continuing to decline. I think we should see new lows first though.

Short-term bounces notwithstanding, this segment of the credit crunch should work its way lower over the next few months, probably culminating (I would guess) in at least a mini-crash this autumn. Fear is always greatest as we approach a market bottom, as was the case in late March (at the end of a declining phase that had been underway since October).

I think we'll see more bank failures/consolidations (like Bear Stearns) near that time, if not before, and quite possibly traditional bank runs (like Northern Rock) as well. A tipping point will inevitably be reached as the crisis goes systemic, but it is difficult to guess exactly when that might occur.

I think, on balance, that the worst will probably unfold next year, but that's not to say that access to cash might not be lost earlier. Given that it can take time to extract cash in such as way as to avoid causing difficulties for yourself, it's best not to wait too long. It's far better to be early than even a day too late, as being early carries no real penalty while being late would be dire.

FDIC couldn't hope to cover more than a fraction of the losses resulting from a systemic crisis (although they may pay out on a few early casualties). They won't tell you that though, as they exist to inspire enough confidence (or foster enough complacency) to prevent bank runs from happening in the first place. It's a bluff and they know it.

The treasury is highly unlikely to attempt any bailout either, as bailouts are for big players, not for ordinary people. When ordinary people realize this, they are going to be very angry.

I think the interest rate on government borrowing is set to rise anyway though, especially for long term borrowing, and that will raise rates for other forms of borrowing as well. If long-term government rates are rising and so are spreads (the premium over government rates for riskier borrowing), rates on most borrowing will go through the roof, even as the ability to pay drops like a stone. That's when we'll see what a credit crunch really means.

Greenpa said...

Stoneleigh- "So much is going on behind the scenes and there's misinformation almost everywhere you look. Some of that is deliberate or self-serving or malicious, but much is simple cluelessness."

I'm familiar with a hybrid form of mis/disinformation in my own world of science, and I'd assume it goes on in finance, too. It works like this: the malicious agent (we'll call them The Boss) hires a well credentialed specialist to serve as the spokesperson for the company. We'll call the specialist The Flunky.

Because that's what they are- the ones who got their credentials by the skin of their teeth, barely avoiding flunking out- because, they are just not very bright.

The Boss, who is an accomplished liar; tells The Flunky- who is desperately grateful for this job- "Look, we're nice people here; THIS is how it is! We all BELIEVE in this, and we want YOU to be one of us."

The Flunky is also desperately grateful to belong, anywhere. So they go out and speak to the press, and the public- and sell The Boss's lies- with the full fervor of sincere belief. They DO believe it.

Nothing sells like sincerity- and oh, The Boss knows it. It's kind of Affirmative Action for the Mentally Deficient Academics. Hire the handicapped; it's good business.

And there's a bountiful supply; if this Flunky doesn't work out- there's another one available immediately.

I'm reasonably convinced that this is a specific public relations strategy- not taught in the MBA program- but taught, very clearly, in the back rooms.

(Of course, the just plain genuinely clueless folks are out there, too.)

Stoneleigh said...


Yes, I still think the dollar will spike. It has been rising recently, which could be the beginning of such a spike (although it's too early to tell at the moment).

Stoneleigh said...


I remember the world of academic science from my early days as a medical researcher (tracking neurotransmitter pathways in rat brains using immunohistofluorescence). Suffice it to say that academia and meritocracy have very little in common.

In the case of finance where confidence is everything, cheerleading is essential, however bad central bankers or politicians may know the situation to be. If they even hint at difficulties, they can cause them to unfold immediately. Unfortunately for their reputations, the fatal problems are very real and are only getting worse all the time. Our system is in a hole, yet we keep digging.

Confidence IS liquidity. Without it, no amount of funds injected by central bankers will keep credit from drying up. When banks will no longer lend due to lack of trust, and borrowers either try to reduce balances outstanding or simply default en masse, then it's game over. Ben Bernanke will be lucky not to be lynched at some point.

Anonymous said...

"Affirmative Action for the Mentally Deficient Academics"