Wednesday, July 2, 2008

Debt Rattle, July 2 2008: Holidays of Reckoning

Pieter Bruegel the Elder Triumph of Death (detail) c.1562

Ilargi: Yeah, it may be real silly for all I know, but I still have this idea that I should warn people about the 8000 pound behemoth that is about to move into their living room. The first problem is that nobody wants to know, the second is that they have better things to do; the living room is about to be foreclosed upon anyway, so why would they care about a biblical hairball sitting there?

I read quite a lot, as you may by now have surmised, and a fair bit of it about housing sales and mortgages. And I just can’t believe there are still people buying homes these days. There’s always the 0.01% that have more money than they know what to do with, but the rest are nothing but loose screws, bolts and nuts. Reading, though, is one thing: meeting people face to face, and corresponding with friends, only to find that they refuse to listen and are about to close a mortgage and a purchase, that I find hard to take.

But how loud can I scream? There’s a limit, or I’ll be listed as a public nuisance. I know that nobody can foresee the future, but what we can do is see trends and trendlines. In the face of those, what I say here is not some tea leaf reading session. It’s the other way around: all those people who claim we’ll get out of this in good shape, and soon, have no other claims to support that view than faith-based ones. The government will save the day, or the central bank, or even: man is at his best when he’s challenged, and "someone" will find "something".

But I tell you, grasshoppers, change is going to come, and it will be sweeping and in many cases deadly, and I firmly believe you’d be better off if you would recognize that. In politics and finance, all the people you read about today, the Bernanke, Paulson, Gordon Brown, King and Darling and Trichets, they’ll be gone very soon, once the whips come down, only to be replaced by other hand-puppets. Who will also be presented as smart and wise and having your best interest in mind.

But that will be true no more for the new Punch and Judy’s than it is for the present ones. Not for them, and not for the oinking and bleating heads that give you the "news" on your plasma screen. Or for the folks who are supposed to educate your kids. All these people have priorities different from yours.

The only thing you can do that is real, that improves your chances of not having to eat from garbage bins or prostitute your duaghters, is to lower your demands and wishes, by a lot. And find people around you that you can trust, and keep them close; your world will become much smaller, travel will be a luxury that you can't afford.

As for me, sometimes I wonder why I don’t just go make money, get a sportscar and burn it all down; my view of the future differs little from Pieter Bruegel’s 16th century vision of the triumph of death, or Matt Simmons' "If we don't change, we'll just start fighting each other". I don't think we'll change; I don't think we are capable of changing, we're just another tragic species propelled by 3 billion year old amoebe brains.

Small Banks' Reckoning Day Is Coming
Wall Street is bracing for regional and small banks to fess up to large losses from their mounting volume of soured construction loans made primarily to home builders. According to the Federal Deposit Insurance Corp., $45.4 billion of the $631.8 billion in construction loans outstanding at the end of the first quarter were delinquent.

When banks announce second-quarter results in coming weeks, they are expected to report sharp increases in loans that builders can't repay. Banks are also facing intensifying pressure from federal and state regulators to deal with the problem loans on their books. That will put additional pressure on an already stressed financial system.

Banks have begun to dump bad construction and land loans at discounts, curtail new lending and halt construction projects that are under way to preserve capital. Some analysts even see a wave of bank failures as a possibility. "Across the industry, the second quarter is going to be a tough quarter," says Keith Maio, chief executive of the National Bank of Arizona, a unit of Zions Bancorp, which lent heavily to home builders and developers. "It's going to continue to be tough until the real-estate market hits a bottom."

Scores of banks were already suffering headaches by the end of the first quarter, according to a review by The Wall Street Journal of FDIC-filed reports by 6,919 banks that make construction loans. The smallest banks, those with total assets of less than $5 billion, faced the biggest problems. The WSJ analysis didn't include savings-and-loan institutions, or so-called thrift banks.

Nearly one in three of the banks analyzed -- or 2,182 -- had construction-loan portfolios that exceeded 100% of their total risk-based capital, a red flag to regulators, although it doesn't mean the bank is in danger of failing. Risk-based capital is a cushion that banks can dig into to cover losses. Even more alarming, 73 of those banks had construction-loan delinquency rates of more than 25%.

Larger regional banks also face mounting construction-loan problems, but are in decent shape. Thirty-eight of them had more than 100% of their total risk-based capital in construction loans at the end of the first quarter, but only nine of those faced delinquency rates of more than 10%.

Over the next few quarters, banks are expected to begin recording much larger losses. In 2007 and the first quarter of this year, U.S. banks wrote down just 0.7% of their residential construction and land assets as bad debt, according to Zelman & Associates, a research firm. Over the next five years that figure could rise to 10% and 26%, which would amount to about $65 billion to $165 billion, Zelman projects.

Japan Stocks Fall, Sending Nikkei to Worst Streak in 43 Years
Japan's stocks fell, pushing the Nikkei 225 Stock Average's losing streak to the longest in 43 years, as a decline in cargo fees and auto sales in India pointed to a slowdown in emerging economies.

Nippon Yusen K.K. dragged an index of shipping lines to its lowest in more than two weeks, while Komatsu Ltd., the world's second-biggest maker of earthmoving equipment, tumbled the most in three months. Suzuki Motor Corp., Japan's second-largest minicar maker, had the sharpest drop in three years after rising gasoline prices curbed demand in India, its biggest market.

"A slowdown in emerging markets looks unavoidable," said Toru Kitani, who manages the equivalent of $2.9 billion at Sompo Japan Asset Management Co. in Tokyo. "A 'decoupling' scenario, where emerging markets can continue growth despite a U.S. meltdown, is looking unlikely."

The Nikkei 225 Stock Average fell 176.83, or 1.3 percent, to close at 13,286.37 in Tokyo, the lowest since April 16. It was the 10th-straight day of decline, the longest since March 1965, according to the benchmark's Web site. The broader Topix index slumped 18.92, or 1.4 percent, to 1,301.15. All but three of 33 industry groups on the Topix tumbled.

The Baltic Dry Index, a measure of shipping costs for commodities, fell the most in a week yesterday on speculation Chinese iron-ore demand is weakening. Meanwhile, Suzuki's Indian sales grew at the slowest pace in four months, the company said.

Japanese companies are becoming increasingly dependent on growth in emerging markets as demand wanes in the U.S. and Europe. Sony Corp., which derives a quarter of its sales from the U.S., last month said it aims to double annual revenue over the next three years from countries including China, India and Russia.

'If we don't change we are just going to start fighting one another'
The era of globalisation is over and rocketing energy prices mean the world is poised for the re-emergence of regional economies based on locally produced goods and services, according to a former energy adviser to President Bush and the pioneer of the “peak oil” theory.

Matt Simmons, chief executive of Simmons & Company, a Houston energy consultancy, said that global oil production had peaked in 2005 and was set for a steep decline from present levels of about 85 million barrels per day. “By 2015, I think we would be lucky to be producing 60 million barrels and we should worry about producing only 40 million,” he told The Times.

His controversial views, rejected by many mainstream experts, suggest that some of the world's biggest oilfields, particularly in Kuwait and those of Saudi Arabia, the world's leading producer, are in decline. “It's just the law of numbers,” he said. “A lot of these oilfields are 40 years old. Once they roll over, they roll over very fast.”

Mr Simmons asserted that this, coupled with soaring global energy demand, meant that world oil prices were likely to continue rising. He said that even at present record highs of more than $140 a barrel, oil remained relatively inexpensive, especially in the US, the world's biggest market. “We are just spoiled rotten in the US,” he said. “It's still cheap.”

Rising prices will force a tectonic shift in the structure of the global economy by destroying the rationale for shipping many goods, such as food, over long distances, he said. “This is already happening. In the US, our local farms, ranches and dairies are booming. They are having a huge comeback.”

Mr Simmons set out a radical vision of the future, envisaging a society in which food and many other essentials are sourced and consumed locally and increasing numbers of people work from home. He claimed that the alternative was increasing political instability and conflict over the planet's diminishing resources. “We are living in an unsustainable society,” he said. “If we don't change we are just going to start fighting one another...So let's just start assuming the worst and plan for it.”

Wall Street Says 'Oops'
Wow… On June 6th, I forecast a dramatic fall in the stock market. However, even I didn't expect things would get as bad as they have this quickly. The S&P 500 has fallen nearly 9% since then. All told, stocks posted their worst June performance since the Great Depression.

Many pundits seemed shocked by this, despite the fact virtually every guest commentator on their shows stated that this was, in fact, the worst financial crisis since the Great Depression. Leading the pack downward were financials. The financial ETF (IYF) fell an incredible 18% in a mere three weeks. Sector-wide financial firms hit new lows, led by Lehman Brothers and Citigroup.

To me, this was deliciously ironic. These very firms were the first to pronounce the worst was over back in March. One by one, the big Wall Street CEOs made this claim. One by one they’ve had to issue rights offerings to raise capital. And one by one their stocks have fallen beneath the price of the rights offerings to new lows.

What’s truly incredible about all of this was that many firms were actually issuing buys in the sector a mere month ago. Goldman Sachs recently admitted to being “clearly wrong” on its recommendation of financials in early May. And Barron’s has admitted it was dead wrong to advise buying AIG in February.

However, Merrill Lynch holds a special place for being the most schizophrenic firm on the street. Between June 2 and June 11, Merrill Lynch analyst Guy Moszkowski—who incidentally was the top ranked brokerage analyst last year—changed his tune regarding Lehman Brothers four times. He first shifted his stance to “neutral” from “underperform.” He then told clients to buy twice—June 4 and June 10—before shifting back “neutral” on June 11.

I have to tell you, this scares me. Rarely if ever will Wall Street retract an assertion. However, to my knowledge Wall Street has NEVER in its history publicly admitted to being wrong. God only knows how bad things are going to get if they’re doing this now.

So as badly beaten down as financials are today, I expect we’ll see greater carnage in future. Most of the 1Q08 profits in the sector came from either over the counter derivatives—non-regulated investments—or fuzzy accounting—counting debt write-downs as profit or moving rapidly depreciating assets to Level 3 to get them away from market valuations.

Given the recent action in financials stocks—as well as the self-deprecating admissions from Wall Street analysts—it's clear the market has caught on that the worst was definitely not over in March. It's not over now either. The primary revenue streams for financial firms—lending, M&A, and debt issuance—are drying up. I believe 2Q08 results will disappoint in the sector, pushing financial stocks even lower.

So as cheap as financials are getting, I say steer clear. Even Wall Street is telling people not to buy financials right now. It's nice to see a conflict of interest that actually helps investors for once.

Is Lehman Brothers for Sale?
Lehman Brothers just can't catch a break. News of an impending buyout is usually some of the best news investors can hear. Share prices typically rise in anticipation of an offer coming in at a premium, and can sometimes soar even higher if investors think a bidding war will ensue.

But as we've learned in recent months, when it comes to gossip, Lehman seems to always find itself on the rotten end of the rumor mill. Shares tanked around 11% Monday on rumors that British bank Barclays would make an offer for the troubled investment bank at a price below what it was trading for, although the target price isn't known. Rumors and gossip aside, some critical questions have to be addressed before Lehman could be picked up at these battered prices. Here're just a few.

Shareholders are already fuming
When JPMorgan Chase made a last-ditch offer to pick up Bear Stearns in March, the initial $2-per-share offer was quickly scoffed at, to the extent that JPMorgan had to quintuple the offer soon after. With Lehman shareholders already a bit peeved by short-seller attacks and a constant barrage of rumors about its ability to survive, it's unlikely they'll accept an offer that comes in at astonishingly low levels.  

What would happen to financial markets?
By many measures, the period right around when Bear Stearns flatlined marked a capitulation of confidence and a crescendo of fear. If yet another massive bank like Lehman came crashing down, the amount of uncertainty might be too much for the market to handle, causing another downward spiral of fear that could mean some serious trouble for market and consumer confidence. In what would normally be seen as a vote of confidence, a Barclays takeover might be seen as an attempt to save a bank that can't stand on its own.

What does Barclays see in Lehman?
With big bank stocks like Citigroup, Bank of America, and Wells Fargo all trading at or near five-year lows, it's clear investors have just about given up on financial stocks. Maybe these stocks are screaming bargains, or maybe investors are coming to terms with the fact that the sector's record profits were the result of a business environment we may never see again.

Sure, if Barclays scooped Lehman up, questions regarding Lehman's ability to survive would end, but that doesn't mean it'll be all roses and daises from here on out. Lehman excelled on many fronts, but one of the big ones was the mortgage-backed bond industry that's since gone kaput. Regardless of who owns Lehman, those problems won't go away anytime soon.

It's quite a coin toss
Lehman's likely in one of two positions: It's either absurdly cheap, or it's on its way out. From that point of view, a buyout at anything near these prices could be a severe slap in the face, or one of the last remaining hopes.

Lehman's rivals come out against fire sale rumours
Rivals rallied around Lehman Brothers as rumours of a "fire sale" swirled around the market, forcing the bank's shares to eight-year lows. In the face of continued speculation that Lehman chairman Dick Fuld is negotiating a below-asset sale to any number of potential suitors, leading analysts at rival banks, including Morgan Stanley, supported Lehman's shares by arguing that such a sale was unlikely.

Despite the support, Lehman's shares touched a low of $19.24 at one stage yesterday, slightly lower than Monday's $19.81 close, which was its lowest closing price since 2000. In addition, the bank's credit-default swaps (CDS), which measure the risk of default, widened by 11 basis points to 286 points. This means it now costs $286,000 to protect $10m of debt.

The increased volatility in Lehman's shares ensured it dominated CDS trading in June, according to new data released by interdealer GFI. Traders appear to be continuing to act on rumours that the bank is due to be sold to any number of would-be purchasers, including Barclays, on idle gossip that its exposure to the debt market is taking a heavy toll. Canada's Toronto-Dominion bank has also been named as a "saviour", along with various private equity houses.

Banking analyst Richard Bove dismissed the rumours, saying there is "no reason" for the bank to be sold. "Someone started the rumour that Barclays was going to under-bid for Lehman and buy the company for $15 per share. This rumour ranks up there with 'the moon is made out of green cheese' " in terms of validity, he said. He added that whatever a company says it will be disbelieved.

Morgan Stanley's Patrick Pinschmidt said the company was vulnerable, but added that "near-term concerns appear overdone". "We see a forced fire sale at a distressed discount to book value as highly improbable, and thus see little reason for the firm to explore a sale at this juncture," he added, saying he thinks the bank has enough capital to cover more writedowns.

The comments will be welcomed by Lehman and banking regulators alike, with the latter particularly keen to ensure that the bank does not fall prey to the sort of rumours that led to the collapse of Bear Stearns in March.

Merrill may write down $5.8 bln in Q2 - analyst Whitney
Merrill Lynch & Co Inc may incur $5.8 billion of write-downs in the second quarter, said Oppenheimer analyst Meredith Whitney, who also forecast a loss for the world's largest brokerage for the period. Whitney's estimate is the highest yet among Wall Street analysts, who till date expected write-downs to range from $3.5 billion to $5.4 billion.

She also expects Merrill to announce some sort of capital raising plan along with the quarterly earnings. "Our best guess is that MER will elect to monetize both BlackRock Inc and Bloomberg prior to the second-quarter earnings release." Merrill's 49 percent stake in BlackRock is worth roughly $10.2 billion based on BlackRock's market value as of June 30 and it may not be enough to solely generate the desired capital, estimated to be more than $5 billion, Whitney said.

One of the major problems facing financial institutions, including Merrill, is that new equity raised is merely going toward plugging holes in company capital structures and not toward funding new growth opportunities, she said. "So after MER reports what we believe will be a loss for the second quarter and a capital raise, it will merely be where it began the second quarter with a book value in the mid-$20s," she added.

Whitney, who maintained her "underperform" rating on the stock, expects Merrill to post a second-quarter loss of $4.21 a share, compared with her prior profit view of 20 cents a share. She widened her 2008 loss estimate for Merrill to $5.37 a share from 45 cents a share.

Judge orders UBS to reveal clients’ names
A federal judge on Tuesday cleared the way for prosecutors to force the Swiss banking giant UBS to turn over the names of wealthy clients as part of an investigation of its offshore private banking practices.

An order signed by Judge Joan A. Lenard of Federal District Court in Miami gives prosecutors and the Internal Revenue Service the authority to request the information. It was unclear whether UBS would turn over the names or appeal the process. The decision is a setback for UBS, which is struggling to maintain its tradition of Swiss banking secrecy amid the rapidly unfolding investigation.

The bank said in an e-mailed statement Tuesday that “UBS looks forward to working with the I.R.S. to address the summons.” The embattled bank, which is struggling against investor concerns about further write-downs and its ability to retain vital private clients, also announced a major overhaul of its corporate governance rules on Tuesday.

It said it would replace four directors and more clearly separate the responsibilities of the board from those of the executive management to end what some critics called a cozy relationship that had led to the bank’s becoming one of the first and largest casualties of the subprime mortgage turmoil. Federal prosecutors have accused UBS of helping American clients hide $20 billion overseas in secret offshore accounts, evading $300 million or more in taxes.

The I.R.S. and prosecutors want UBS to turn over the names of all American clients who had accounts from December 2002 through 2007 at the Swiss offices of UBS, its subsidiaries or affiliates — and for which UBS did not have a tax form known as a W-9.

The request covers any taxpayer with the authority to receive account statements or trade confirmations or to withdraw money from the Swiss-based accounts. And it covers accounts that were not just managed by but also maintained and monitored by UBS. Included in the request are the names of clients for whom UBS did not accurately or timely file 1099 forms, which report income earned, or taxes withheld.

“As we have noted, UBS takes this matter very seriously and is working diligently with both Swiss and U.S. government authorities, consistent with Swiss law and the legal frameworks for intergovernmental cooperation and assistance,” the UBS statement said.

UBS Plans Shake-Up as Worries Mount
A major overhaul of corporate governance rules at the Swiss banking giant UBS was overshadowed on Tuesday by persistent concerns about further write-downs and the bank’s ability to retain vital private banking clients.

UBS said Tuesday that it would replace four directors and more clearly separate the responsibilities of the board from those of the executive management to end what some critics called a cozy relationship that led to the bank becoming one of the first and largest casualties of the subprime mortgage turmoil. Some shareholders welcomed the changes, promised by the chairman, Peter Kurer, two months ago.

But they did little to solve a range of problems that the bank faces, including a role in a tax-evasion investigation in the United States and the possibility of tighter Swiss banking regulation. “What the market is really worried about at the moment is their wealth management business,” said Adrian Darley, a fund manager at Resolution Asset Management in London. “If the management can hold the business together and the outflow is small, then people will be relieved.”

Shares in UBS fell more than 5 percent Tuesday in Zurich to 20.30 Swiss francs ($19.93), their lowest level in almost a decade, and have lost 15 percent in the last four trading sessions. UBS led other financial services shares lower as investors braced for banks’ second-quarter figures, which will be published in the next two months.

Some analysts predicted that UBS would have at least $4 billion in write-downs in the second quarter when it reports the figures on Aug. 12, following $38 billion in write-downs in the three quarters before, and that it might need to raise additional capital to cushion the markdowns. The write-downs were mainly in UBS’s investment bank, which the Swiss bank expanded at great costs at the peak of the market.

That led some shareholders, including Olivant, a London-based investment fund founded by a former UBS president, Luqman Arnold, to suggest a split of the investment banking business from the crown jewels of its wealth management unit. Some shareholders voiced concern that the recent losses at the investment bank had tarnished the UBS brand as the biggest wealth manager and could prompt some wealthy clients to seek investment advice somewhere else.

UBS’s wealth management unit added a net 5.6 billion francs in the first quarter, down from 31.5 billion francs in the previous quarter. A Justice Department request to UBS on Monday for the names of wealthy American clients suspected of evading taxes through secret offshore accounts could further spook clients. The request is the result of a broadening investigation that initially focused on a former UBS private banker, who pleaded guilty last month to a single fraud charge.

As UBS continues to reduce risk at its investment banking unit, it will become increasingly dependent for its profits on its wealth management and other units. New regulation to be introduced later this year may make it even more difficult for UBS’s investment bank to compete globally.

The Swiss federal banking commission said it would announce proposals in the coming days for stricter capital requirements and rules for debt ratios that UBS and Credit Suisse, the country’s two largest banks, will have to adhere to. “This is a necessary precaution in a small country with two large financial institutions with businesses in the United States,” Alain Bichsel, a spokesman for the banking commission, said Tuesday.

Countrywide Could Bring Bank of America Misery
Bank of America on Tuesday closed its $2.5 billion acquisition of Countrywide Financial, but the pain caused by the deal may only be beginning. The all-stock deal, originally worth $4 billion when it was struck in January, makes Bank of America the nation's leading mortgage originator and servicer, while protecting its $2 billion preferred stock investment made in 2007, along with another $3 billion invested in Countrywide's common stock.

"Mortgages are one of the three main cornerstone consumer financial products along with deposits and credit cards," BofA Chairman and CEO Kenneth Lewis said in a company statement. "This purchase significantly increases Bank of America's market share in consumer real estate, and as our companies combine, we believe Bank of America will benefit from excellent systems and a broad distribution network that will offer more ways to meet our customers' credit needs."

The market, however, is clearly biased against the deal. BofA shares have fallen nearly 40% since the deal was initially announced in January and nearly 12% since Countrywide shareholders approved it last week. BofA shares were recently trading at $23.46 on Tuesday, or just 75% of book value.

BofA said it "will continue its long-established policy of not originating subprime mortgages" and will discontinue certain nontraditional mortgages, such as option-adjustable-rate mortgages. These are mortgages that give borrowers the option of making a monthly payment lower than the interest that accrued the previous month. When borrowers take the lowest payment option, the loan balance increases, a process called negative amortization. BofA also will "significantly curtail" certain low-documentation loans and other nontraditional loans.

Despite BofA's de-emphasis on exotic loans, the bank is taking on $27 billion in option-ARMs among the $95 billion portfolio of Countrywide mortgages held for investment. As of March 31, the majority of the option-ARMs -- $24.8 billion -- had accumulated negative amortization of $1.3 billion. Considering that the original loan-to-value ratios of many of these loans approached 100%, most are likely to be "upside down," meaning loan's balance exceeds the value of underlying home, in light of the decline in property values.

BofA coveted Countrywide's mortgage servicing business. For 2007, Countrywide reported net loan servicing revenue of $910 million on its $1.45 trillion servicing portfolio, down from $1.3 billion in 2007 and $1.5 billion in 2006. The slide was due to impairment charges, which were partially offset by gains on servicing hedges. Countrywide's fair value estimate of the mortgage servicing rights was $19 billion as of March 31.

While Countrywide's first quarter net loss may have seemed relatively modest at $893 million, there were $3.1 billion in total credit charges during the quarter. Loan loss reserves totaled $3.4 billion as of March 31, or 3.58% of the mortgage portfolio held for investment. Reserves covered a decent 66% of nonaccrual loans. Loan loss provisions for the quarter totaled $1.5 billion, greatly exceeding net loan charge-offs for the first quarter of $606 million.

"Losses absorbed by credit-sensitive retained interests" totaled $923 million, the company reported in a Securities and Exchange Commission filing. In a June 4 research report, Merrill Lynch's Edward Najarian reiterated his underperform rating on BofA, estimating a 13% loss rate on Countrywide's mortgage portfolio, which "could produce about a $10 billion to 12 billion purchase accounting mark-to-market." The Merrill report set a price objective of $28 for Bank of America's common shares, and stated that the collection of businesses would have considerable value "after credit related costs finally begin to normalize (in 2010-2011)."

BofA will inherit quite a few legal headaches from Countrywide, starting with civil proceedings initiated by the states of California, Florida and Illinois. Connecticut is expected to follow shortly. California's civil complaint against Countrywide, outgoing CEO Angelo Mozilo and Countrywide Home Loans President David Sambol, alleges Countrywide pushed hybrid mortgages such as option-ARMs that were hard for borrowers to understand, "emphasizing the very low initial 'teaser' or 'fixed' rates while obfuscating or misrepresenting the later steep monthly payments and interest rate increases or risk of negative amortization."

The California complaint goes on to accuse Countrywide of encouraging costly "serial refinancing," routinely soliciting borrowers to refinance their relatively new Countrywide loans, thus generating more fees. In some cases, borrowers looking to refinance before expensive payment resets would be surprised to find out that there was a prepayment penalty.

The complaint delves into many practices that exploded industry-wide during the housing boom, including piggyback loans -- called "piggies" in the suit -- which allowed borrowers to take a simultaneous second mortgage to fund some or all of their down payments. Sometimes these arrangements would push the loan-to-value ratio above 100%.

DEFLATING Wednesday - Wake Up America!"
Merrill Lynch cut GM's price target to $7.  They had a hell of a bounce yesterday, but in their note they also said they can't rule out bankruptcy.  Well duh.  GM has been a zombie for years; their embedded and unrecognized costs are seriously skewed in the wrong way, and have been for more than 20 years. 

The facts of the matter are that their embedded health care "promises" are unsustainable and this was the fault of both management and labor over a very long period of time.  Will they be able to "adjust" to reality?  I have my doubts. I'm quite sure we're going lower.  Much lower.  And those polyannas who say "No Recession" are, frankly, 100% full of crap.  Never mind that the average bear market costs you 35%, and we've only lost about half that, which means we've got the second half yet to come.

Speaking of which, what if its worse? Why would it be worse? Well, let's go down the list. We have SIVs, "Covenant Light" (the businessman's version of "no ratio" mortgages), fog-a-mirror mortgages, toggle bonds, securitization with cooked ratings and "errors" in computer programs, negative amortization, rolling balances forward in auto lending and more.  We have consumers who have been rolling credit card debt from one zero-interest balance transfer card to another in a desperate attempt to avoid having to make payments they don't have. 

We have commercial real estate construction loans going out with cap rates that are insanely light - all "on the come" of appreciation in "values", and our Boomers have spent the false appreciation that they never had, destroying the largest store of wealth they owned - their homes.  (BTW, GM is still writing negative rollover auto loans!  If you're wondering whether GM can or might actually go under, the answer is "yes", and that's why.)

None of this is coming back and none of it CAN come back, because there is no underlying asset base left to leverage nor enough earnings power to make the debt service payments! There is not one damn thing that Bernanke, King or Trichet can do about the course of events at this point, other than make it far worse by allowing the fraud to continue to be stretched out rather than reconciled and recognized. 

The Central Banks need to drain the swamp now - the longer they wait, the worse this gets as the compounding of interest is murderous when you're in the hole - and the only way to stop that is to force the debt to be either paid down or defaulted. The game started to collapse last spring with the "Subprime" problem but we were told it was "contained." 

That was false; whether it was a knowing lie or the worst sort of incompetence isn't all that important when you look at the truth - which is that "Subprime" was simply the first pustule to show up on the Acne-infested face of The American Family's balance sheet. We have now seen that this disease is spreading to student loans, automobile loans, credit cards and commercial real estate.

No sector of the credit system is immune because all of them "ate their own cooking" and believed their own lies over the last few years. The usual claim is that our government (or The Fed) will "print" - that is, we'll get an inflationary spiral that will be used to "save the creditors", and some even think we'll go down the road of Weimar Germany or Zimbabwe.

We can't get an inflationary boom out of this mess in the United States because there is no tightness in the labor market; there is in fact ramping unemployment and soft labor conditions everywhere you look.  We have outsourced most of our production to places like Vietnam and China, destroying the ability of US workers to demand and receive wage increases. 

Instead of a wage/price spiral what we are and will get is a squeeze on standards of living and discretionary income, which means that debt-to-income ratios are going to continue to rise and as a consequence credit quality will continue to decline, forcing more and more defaults and the further constriction of credit through the economy!

Britain and The United States are in for the worst on the deflationary credit collapse side, because we "levered up" the worst and our "greatest outputs" - financial engineering - are totally unnecessary when there is nobody left to defraud and rob, as the rubes have all wised up after losing money for the 234th time.  Witness the fact that the "Sovereign Wealth" guys haven't been knocking for a while and even Wilbur Ross is pissed to high hell about the bill of goods he bought when he ponied up for AHM's portfolio, thinking he got a "screaming deal." 
He's screaming all right.

Outlook for 2nd half weakens, Fed official says
The U.S. economy is likely to remain sluggish over the remainder of the year, according to Dennis Lockhart, the president of the Atlanta Federal Reserve Bank. "My base case forecast for the economy involves a stronger-than-expected first half of 2008 with growth of 1 to 2 percent but not much pickup in the second half," Lockhart said in remarks on a panel on outlook at Georgetown University.

Fed officials had earlier been more upbeat about the second half of the year, with the challenges for the economy supposed to clear up as the year went forward. The drag of high energy costs, continued financial market stress and a still weak housing sector "may continue for a while with gradual improvement of growth in 2009," he said. All Fed officials have toughened their rhetoric about rising prices.

Lockhart was no exception. In his remarks, he said he is taking the recent inflation pressure "very seriously." If the economy picks up but inflation remains high, it would be a defeat for the central bank, he said. "A path to recovery involving stronger growth but with higher and persistent inflation would fit the old adage about winning the battle but losing the war," Lockhart said.

Lockhart is the first senior Fed official to speak publicly after the central bankers decided to hold short-term rates steady at 2% at their closed door meeting last week. In its policy statement, the Fed put new emphasis on the inflation outlook, saying there was a risk of inflation getting out of hand. "Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased," the Fed said.

Lockhart said the Fed would have to react swiftly if consumers and businesses begin to act like higher inflation is a fact of life. "Policy needs to react decisively against signs of the onset of formal compensating practices, including contracts, that treat inflation as a persistent reality -- in other words, something that must be lived with," Lockhart said. "Such signs are not apparent, and I don't expect them to materialize," he said.

Ilargi: Sometimes I simply can’t believe that reporters, investors and analysts are truly surprised by developments such as these. As if there’s any chance that the global economy will continue while all the of biggest banks are left for dead in the gutter. That’s a crazy notion, and it has been for a couple of years by now. Should we change the name of this site to The Automatic Land of the Blind?

Global slowdown could be the next crisis for business
Big U.S. multinationals riding high on revenue from overseas operations may find that wave is about to break. For the past year, the stock market has rewarded those companies that have been able to offset subpar U.S. performance with stellar overseas profits. But recently, that has not been enough to keep investors happy.

Nike’s shares tumbled last week after reporting its quarterly earnings when investors focused on its U.S. weakness rather than strong international results by the world's largest shoe and apparel maker. So why the shift in focus? The multinational play was based on a combination of strong global growth and a weak U.S. dollar.

But now with Europe slowing sharply, a cyclical economic slowdown in emerging markets and inflation rearing its head across the world economy, continued strong global demand is anything but certain. “Disappointing guidance from U.S. multinationals regarding global earnings could be the next shoe to drop on the U.S. equity markets,” Joseph Quinlan, chief market strategist of global wealth and investment management at Bank of America, wrote in a note to clients.

“While there remains an investor bias toward large-cap U.S. equities, this asset class could be in for some difficult times ahead if the global economic slowdown ... gathers pace in the second half of this year,” he added. Earnings estimates for the S&P 500 are already falling fast. For the second quarter, analysts polled by Thomson Reuters now expect earnings to fall by 11.1% -- compared with expectations of a fall of 2% at the beginning of April.

The biggest contributor to that drop in earnings expectations are financials and consumer discretionaries. But analysts are also beginning to scale back expectations for some of the sectors which have been doing relatively well. Earnings growth expectations for industrial companies have been cut nearly in half – to 5% from 9%, according to Thomson Reuters data. Technology sector profit growth estimates have slipped to 17%, from an April estimate of 18% growth.

While U.S. domestic profits declined 3% in 2007, overseas earnings rose 17%, making up the only real strength in corporate profits over the past year, said Bank of America’s Quinlan. But that may be about to change. The global economy only expanded by a 3 percent annual rate in the first half of 2008 compared to a 5 percent rate a year ago, according to Bank of America.

U.S. foreign affiliate income, a proxy for global earnings, declined 4.5% year-over-year in the first quarter, the bank’s data showed. This deceleration in growth will ultimately take some wind out of the sails for U.S. global earnings, Quinlan wrote. This view is beginning to be echoed across U.S. equity markets. “International business trends may no longer provide an incremental benefit,” said Tobias Levkovich, Citigroup’s chief U.S. equity strategist.

“Weakening trends in Europe likely will weigh on profits earned abroad which had been a key area of strength over the last six to nine months, with clear problems also increasing in some developing countries, such as Turkey and Vietnam,” Levkovich said. But that does not mean that one should throw the global earnings story out with the bathwater, said Subodh Kumar, chief investment strategist at Subodh Kumar & Associates.

The companies that have been benefiting from global earnings are often also bigger and "best in class" companies, and therefore more likely to weather economic storms than their smaller competitors. Aside from Nike, package delivery services Federal Express and United Parcel Service – both with hefty overseas exposure –warned on profits due to soaring fuel prices. Many analysts expect more earnings revisions to come.

Citi’s Levkovich said earnings revisions look risky for capital goods and tech hardware & equipment, based on the view that capital expenditure trends are likely to slow. Earnings estimates for areas within the industrial and technology sectors “look excessive,” he said.

At Midyear, the Economic Pain Persists
Many policy makers and bankers said this credit mess was contained. Boy, were they wrong. More than a year after the crisis first flared, the financial industry, and with it the broader economy, seems to be caught in a vicious circle.

As home prices sink, people are falling behind on their mortgages in growing numbers. As more homeowners run into trouble, banks must write off even more loans. And as the bad loans mount, financial companies are increasingly unable or unwilling to extend credit, making it even harder to buy homes or expand businesses.

This process is playing out painfully on Wall Street, where on Monday the stock market rounded out its worst 12-month run since the spring of 2003, when the United States invaded Iraq and the market was beginning a tenuous recovery from the bursting of the technology bubble. The Standard & Poor’s 500-stock index is down 12.8 percent for the first half of the year. The index just had its worst June (down 8.6 percent) since 1930 (down 16.5 percent).

The Dow Jones industrial average is off 14.4 percent for the first half of the year. Financial shares keep falling. Even as the broader market posted a small gain on Monday, shares of banks and brokerage firms in the S.& P. 500 fell 2.1 percent, to a five-year low. Lehman Brothers, which has been struggling to persuade investors that it can survive as an independent firm, fell 11 percent Monday, bringing its loss for the year to nearly 70 percent.

“Eventually, the financial sector’s troubles will be communicated to the rest of the economy,” said Douglas M. Peta, market strategist at J.& W. Seligman and Company in New York. “As there is less investment available that restrains consumer spending, it restrains corporate spending.”

One measure already signals that the woes of the financial system are straining the economy. In the last 13 weeks, total bank loans, leases and securities holdings have fallen at an annual rate of 9.1 percent, its fastest decline since 1973, when the data was first collected, according to Jan Hatzius, chief domestic economist at Goldman Sachs.

Even as the Federal Reserve and the government have tried to reinvigorate the economy with lower short-term interest rates and tax rebates, rates on mortgages and corporate loans have climbed to their highest levels this year. The average interest rate on a 30-year fixed rate home loan was 6.45 percent last week, up from 6 percent at the start of the year. Investment-grade corporate bonds are yielding 6.2 percent, up from 5.7 percent at the start of the year.

Until recently, “we haven’t had the sense that we had the downward spiral in anything other than housing,” said Jane Caron, chief economic strategist at Dwight Asset Management, a bond-trading firm based in Burlington, Vt. “What I am worried about is that we are headed in a direction where those negative feedback loops expand and intensify.”

That cycle will not be broken, Ms. Caron and other analysts say, until the decline in home prices slows significantly or ends, allowing the market to tally the full cost of the recent credit binge and restoring confidence among bankers and investors.

Ilargi: Pension funds are to become one of the worst stories in the years to come. It will be a bloodbath of proportions we cannot yet imagine. Don’t count on getting a penny.

Shares gloom leaves UK pension funds with £30bn deficit
Three-quarters of pension schemes are now in deficit after £36bn was wiped off the value of the top 200 largest UK privately sponsored pension final salary schemes in June. Research revealed yesterday by Aon Consulting, a pension, benefits and human resources consultancy, showed the aggregate pension scheme deficit of these companies now stands at £30bn.

The deficit - which is the biggest since January - is a result of falling equity markets and higher inflation, though it was slightly offset by bond yields rising over the month. Marcus Hurd, senior consultant and actuary at Aon Consulting, said: "Pension schemes' finances are expected to be volatile. The argument for trustees to conduct more frequent monitoring than an annual assessment gets only stronger as the economic outlook worsens."

The Aon200 Index, which tracks the funding levels of the UK's 200 biggest privately sponsored schemes, showed that, over the past few weeks, the overall proportion of schemes in surplus fell from 56pc of schemes to just 25pc. June's £36bn plunge was the biggest monthly swing recorded since the index was created in March 2005.

Research by consultants Watson Wyatt also unveiled yesterday revealed that FTSE 100 pension schemes slipped back into the red in June. It calculated the aggregate financial strength of UK blue-chip company pension funds fell from a surplus of £23bn at the end of May to a deficit of £8bn a month later.

Rashpal Bhabra, head of corporate consulting at Watson Wyatt, said the aggregate funding position of FTSE 100 schemes has worsened by nearly £50bn in the space of three months - a factor which will particularly strike home for companies working on interim trading statements. "Falling share prices and news that inflation has broken through the Bank's target has come at a bad time for finance directors preparing half-yearly updates.

Some who could have hoped to report a pension surplus a few weeks ago will have to report a deficit instead. Surpluses reached a record level by the end of March, partly because of the way the credit crunch increased corporate bond yields, but pension funds are now back in the red."

Volatile equity markets have wiped billions off pension funds as the FTSE All Share Index, in which most pension funds invest the bulk of their assets, fell by almost 10pc last month because of continued concerns about the credit crisis.

Though rising bond yields have cushioned pension funds, Watson Wyatt said pension liabilities rose by £11bn in June due to rising inflation expectations. This makes the pension guarantees offered by companies to members of defined benefit pension schemes more costly.

Ilargi: And what is this "fear of recession”? Are we going to keep on blabbering about that till the cows are home, fed, bathed and tugged in, or will we prepare to face the depression that we have minus zero chance of avoiding? I can only advice people to stop listening to the cheerleaders (they sing out of key by now). I honestly don’t think you will fare better by holding on to these illusions of soft landing. Won’t happen. It’s going to come crashing down. Get ready.

Look: average home prices in the UK went down £14,000 in just 8 months. That means on a yearly basis homes are poised to lose $40.000. Unless the downward pace increases. Which is what has been happening. It could well be $50.000 by October. That is not gloom, that is reality. You can choose to disregard what I say, but don’t forget: we have been warning for a long time about what happens in England now, as our regular readers will confirm. We have been dead on throughout so far, and I can assure that’s not going to stop.

UK: Recession fears as business activity slows, equities tumble
Shares in London have suffered their biggest slide since the collapse of Bear Stearns in March, amid a barrage of bad news on the domestic and international economy.Markets were shaken by a double dose of bad news for housing and manufacturing, followed by rumours that some of Europe's biggest banks are about to see their profits plunge even further.

As the second half of the year started, the FTSE 100 index of leading UK shares was 146 points or 2.6pc down to 5479.9 - the lowest close, and biggest fall, since March. It came as:
  • Economists warned that the manufacturing sector is now in recession territory after activity unexpectedly collapsed in June.
  • Nationwide said house prices are now falling at the fastest rate in 16 years, with the average property having lost £14,000 of its value since prices peaked in October last year.
  • Oil prices touched a new record high, with crude touching $143 a barrel.
  • A YouGov/Citigroup survey showed that households' expectations for the rate of inflation leapt to a record high of 4.6pc in June, putting more pressure on the Bank of England to consider raising interest rates.

Markets were perhaps most shaken by the Chartered Institute of Purchasing and Supply's surprise announcement that manufacturing activity has fallen to the lowest level since the aftermath of the 9/11 attacks. In what economists described as a "truly dreadful report" on industry, its purchasing manager's index dropped to 45.5 points last month - well below the 50 point that separates expansion from contraction. The May reading was also revised down to 49.5.

The news will disappoint many economists, who had predicted that the pound's recent weakness would help drive manufacturing in the coming months, supporting the wider economy. In fact, most measures of activity, including exports, dropped again in June, the report showed. The pound touched the $2 mark briefly yesterday, although it finished the day up only slightly at $1.9914 against the US currency.

In a sign that the Bank of England may not be able to cut interest rates any time soon, the survey also showed that price pressures remain extremely high, with the input price index up to 82.1 and output prices up to 62.9 - both the highest levels since the series started a decade ago.

Howard Archer of Global Insight said: "This is a truly dreadful report in every respect, which encapsulates the extremely difficult position that the Bank of England is in. It shows sharply contracting manufacturing output, orders, backlogs of work and employment in June but still rising price pressures."

However, Holger Schmieding of Bank of America said: "The Bank of England, presiding over the City of London, one of the top two financial centres of the world, will be likely to pay more attention to the recent drop in equity prices than other central banks." In a further blow, a report published today by accountant BDO Stoy Hayward shows that confidence among businesses has fallen to a 16-year low, in a sign that companies are gearing up for a major slowdown or recession.

Activity in the construction industry has collapsed, a report from the Royal Institution of Chartered Surveyors shows, as workloads fall for the first time in 11 years. Meanwhile, amid suspicions that the financial sector will have to make further write-downs and raise more cash in the coming months, all major bank shares fell. The atmosphere in the City was febrile, with rumours floating around that UBS and Deutsche are poised to deliver more bad news in the coming weeks.

Fraud high in UK finance and insurance sectors
Fraud cost UK businesses over £705m in the last six months, up 74 per cent from the same time last year, according to BDO Stoy Hayward.

The latest FraudTrack analysis shows that the finance and insurance sectors incur the most reported fraud, costing the sector more than £636m in the last six months. This represents 90 per cent of the total cost of fraud in the first 6 months of 2008. BDO Stoy Hayward says management fraud accounts for 46 per cent of fraud cases and third party fraud for 32 per cent, costing businesses a total of £541m.

Head of the fraud services team Simon Bevan says: “The combination of spiraling personal debt and desperate employees spells real danger for business. Especially when, sadly, our figures provide clear evidence that commercial organisations of all types and sizes throughout the UK are currently failing, in some cases quite spectacularly, to get to grips with the fraudulent activity of their staff.

“We are seeing a dramatic increase in banks, corporates and public sector organisations contacting us directly about our fraud investigation and prevention services and we expect this to rocket further still. Interest is coming from Board level as senior executives at British businesses are becoming increasingly concerned about fraud risk as the credit crunch bites.”

UK businesses 'feel worst' for 16 years
UK business confidence has fallen to its lowest level since 1992 in June, according to BDO Stoy Hayward. Its Business Trends Report showed confidence about the next three months fell to 97.7 in June from 98.3 in May. It is the lowest figure since Black Wednesday, when the pound was removed from the Exchange Rate Mechanism.

The report comes as consumer confidence levels were seen to be near record lows, buffered by falling house prices, a slowing economy and a credit crunch. BDO said that the low business confidence figures would suggest that companies were expecting annualised economic growth of 1.3% in the next three months. That would be less than the chancellor's forecast of between 1.75% and 2.25% for 2008.

"UK businesses are struggling to see any light at the end of the tunnel," said Peter Hemington from BDO Stoy Hayward. "An interest rate rise next week aimed at curbing inflation could be crippling for business and could worsen the effects of the economic slowdown," he warned.

British new-build flat prices hammered
To the inexperienced eye, Phoenix Pavilions might have seemed a great investment. The three small blocks of new-build apartments, sold for between £210,500 and £345,000 during 2006, overlook the lovely blue flag beach of Dovercourt Bay near Harwich in Essex.

But while local estate agents say tenant demand is strong for the flats, landlords have struggled to achieve rents which cover their mortgage payments. One has had his property up for sale for several months at £250,000, which would make him a £9,500 profit, but his estate agent, Bairstow Eves in Harwich, admits he hasn't a hope of achieving that price - more than double the level that other Phoenix Pavilions flats are asking at auction.

Three of the development's flats, all repossessions, have been doing the auction-room rounds for months, their price gradually dropping, but not by enough to find buyers. Flat 17, originally bought for £225,950 in September 2006, and repossessed a year later, has failed to sell at auction six times. Last week it had a reserve price of £120,000, but the highest bid was £102,000 - 55 per cent down on the original sale price.

Those new-build flats which did sell in the same auction achieved on average 45 per cent less than their original price. The figures come as no surprise to David Sandeman of auction information firm Essential Information Group. Three months ago, EIG revealed that former new-build flats were selling at auction for 26 per cent less than the original purchasers paid.

"Prices will have to drop a lot further," he says, "and when our next report comes out (in three months' time) I expect them to be showing falls of at least 45 per cent to 50 per cent ." New-build flats have been hardest hit by the property downturn. Over-building in some areas, leading to a glut of properties competing for buyers, and tenants, has sent values and rents spiralling downwards.

Many novice landlords bought new-build flats through property investment clubs, tempted in by smooth-talking salesmen. These clubs claimed to have negotiated discounts from the developer, offering buyers "instant equity" in exchange for a finder's fee. Often mortgages were based on the higher value, meaning a buyer being offered a 15 per cent discount could take out an 85 per cent mortgage without putting any money down.

Critics believe such discounts were illusory, added on by clubs and some developers, to give the appearance of a bargain when they were taken off again. Many buyers of new-build flats in oversupplied areas are now in negative equity, and have found rents far lower than expected.

Surge in oil price sparks fears of food crisis
A supply crunch and mounting fears of an Israeli air strike on Iran propelled oil to $143 a barrel at one stage yesterday, prompting warnings from the International Monetary Fund (IMF) of a severe economic crisis in poorer regions. "Some countries are at a tipping point," said Dominique Strauss-Kahn, the IMF's managing-director.

"If food prices rise further and oil prices stay the same, some governments will no longer be able to feed their people." The energy markets have been seriously rattled by comments from a top Pentagon official warning that Tel Aviv may launch raids on Iran's Natanz nuclear facilities to pre-empt its acquisition of Russian air-defence missiles.

The source told ABC News that Israel would not wait until the Ahmadinejad regime had accumulated enough enriched plutonium to make a bomb. "The red line is not when they get to that point, but before they get to that point," he said. Iran has threatened to close the Straits of Hormuz if attacked, cutting off a quarter of the world's oil supply. Such a move could drive oil to $200 or higher, bringing the global economy to its knees.

The International Energy Agency yesterday slashed its forecast for oil demand growth by over 3m barrels per day (bpd) by 2012 as economic growth slows and consumers take drastic steps to cut fuel use, but said the oil market would remain "tight" because of supply shortfalls. "Over 3.5m bpd of new production is needed each year just to hold steady," it said. China's imports will rise from 4m to 5.7m bpd within four years.

"With oil prices hitting $140 we are clearly in the third oil shock. Truck drivers are going on strike. Airlines are closing down," said Nobuo Tanaka, the IEA's director. Lower demand may help ease strains in the crude markets - lifting spare capacity to 4m bpd - but will merely defer a deeper crisis caused by lack of investment.

The Kashagan oil field in Kazakhstan is unlikely to produce much before 2013, while Russia has hobbled its oil sector with a costly tithe. Its output will fall below 10m bpd a year by next year. Matters would be worse without biofuels, which will reach 1.9 bpd in four years and make up almost half the growth in non-OPEC supply growth.

Even so, Sheik Ahmed Yamani, Saudi Arabia's former energy tsar, said the oil spike feels very different from the 1970s when there was a lack of supply. "Now it is because of problems with the price-setting system in the futures market. Traders buy and sell depending on rumours, not supply and demand. So much money is flowing into the market, it's almost like gambling," he told Japan's Nikkei Net. This is the "OPEC View".

The big western oil companies, however, blame the demand in Asia, the Mid-East, and Latin America - and the refusal of the petro-states to open up to western know-how. The IEA said it was facile to blame speculators. "All producers are working virtually flat out and there is no sign of any abnormal stockbuild giving a strong indication that current prices are justified," it said.

Hedge fund managers questioned this on Capitol Hill last month, saying the price would fall to $60 overnight if there was a clampdown on trading. It is a fine line between speculation and the activities of pension funds buying long-term futures, but there can be little doubt that financial flows have begun to distort the market. Spain's industry minister, Miguel Sebastian, told the World Petroleum Congress that investors were using 850,000 bpd, enough to upset the wafer-thin balance.

The US Congress passed a bill last week authorising - or pushing - the Commodity Futures Trading Commission to take "emergency" action to halt the alleged abuses. This has not been done for nearly 30 years. The most likely option is to tighten margins on futures trading, which was used in 1980. It is unclear whether this would work today.

Paul Horsnell, commodity chief at Barclays Capital, says speculators are now net "short". If so, higher margins would force them to cover positions, pushing prices even higher. Oil prices fell back in late trading, with Brent up $2.54 to $142.37 in London, and sweet crude in New York $1.93 higher at $141.93.

Ilargi: Haven’t heard anything of any value from Paulson in ages; he must be up for the award for most useless "public servant".

Paulson calls for better process to manage investment bank failures
U.S. Treasury Secretary Henry Paulson said on Wednesday that the United States must strengthen its process for regulators to unwind failing investment banks without threatening the stability of the financial system.

Adding some flesh to his plan for the Federal Reserve to take a broader regulatory role, Mr. Paulson said his first priority was to maintain market stability amid the current turmoil, but he wants to move quickly to address regulatory deficiencies exposed by the credit crisis which began nearly a year ago.

“In my view, looking beyond the immediate market challenges of today, we need to create a resolution process that ensures the financial system can withstand the failure of a large, complex financial firm,” Mr. Paulson said in remarks prepared for delivery to the Chatham House think tank in London.

“To do this, we will need to give our regulators emergency authority to limit temporary disruptions. These authorities should be flexible and – to reinforce market discipline – the trigger for invoking such authority should be very high, such as a bankruptcy filing,” he added. He said the perception should be avoided that an institution is “too interconnected to fail or too big to fail” and added that “we must improve the tools at our disposal for facilitating the orderly failure of a large, complex, financial institution.”

On the final leg of a five-day trip to Russia, Germany and Britain to discuss trade and economic issues, Mr. Paulson was due on Wednesday to meet in London Prime Minister Gordon Brown, finance minister Alistair Darling, Financial Services Authority Chairman Callum McCarthy and Conservative Party Leader David Cameron.

Mr. Paulson's remarks, made available in advance, come amid debate over what additional regulation is needed in the wake of a rescue of Wall Street investment bank Bear Stearns. In March the Fed helped engineer a takeover of Bear Stearns by JPMorgan Chase & Co. (JPM.N) and guaranteed a $29-billion (U.S.) loan to facilitate the transaction out of concern that a Bear Stearns bankruptcy could trigger a financial panic. It also started making emergency loans to investment banks for the first time since the Great Depression.

Mr. Paulson last month said the Fed should be given permanent authority as a “market stability regulator” to make liquidity available to a broader range of financial institutions under certain circumstances if the financial system's stability is threatened. The United States has procedures for the orderly unwinding of insolvent commercial banks with insured deposits, in which their regulators, including the Fed for smaller state-chartered banks, administer claims and control insolvency proceedings.

Mr. Paulson on Tuesday said using these procedures for larger, complex institutions such as investment banks could mitigate market disruption but would not impose enough market discipline on the private sector. And simply subjecting investment banks to normal bankruptcy proceedings “imposes market discipline on creditors, but in a time of crisis could involve undue market disruption,” he said.

Ilargi: I don’t want to play the smart ass here, but I tell you, if you think this is a major problem, then you have something else coming. Wait till people want to move because they no longer feel safe, and then find they can’t sell. There are millions of US homeowners who’d better hope that a judge enables them to get out without a $half-million stone around their necks. Still, those same people need to realize that while that would be great for them, it will be murder for the mutual and pension funds that their remaining savings are stashed away in.

Vacant homes spread blight in suburb and city alike
In Mesa, Ariz., officials are trying to decide what to do about boarded-up McMansions that become party pads, trashed in raucous "raves" where invitations come by text message. In Atlanta, thieving from abandoned properties is so bad that police caught one man building a new house entirely of pilfered materials from empty homes.

Flint, Mich., has had to add firefighters and ladder trucks recently even though its population has declined. Up to 90 percent of fires start in homes where no one lives. From Atlanta's urban core to leafy neighborhoods filled with chirping crickets in Charlotte, N.C., some 2.2 million homes are expected to go through foreclosure – and stand empty – by the time the mortgage meltdown ends, according to Global Insight, an economic research firm.

As the housing dominoes fall far from Wall Street, growing urban "ghost towns" of vacant houses are resulting in a costly crush of weeds, trash, and dereliction on a scale unseen in American cities since the Great Depression, economists say. As a $4 billion package to help municipalities deal with foreclosure-related blight hangs fire in the US Senate, US mayors met last weekend in Miami to vent about the scourge of abandoned homes.

Cash-strapped cities are now scrambling – often using on-the-fly ingenuity – to rescue neighborhoods suddenly vulnerable to crime and stunned by millions of dollars in lost equity wrought by loose credit, opportunistic speculators, and predatory lending.
"Economists and folks from the lending industry will talk about it as a market correction, which doesn't adequately describe it," says Joseph Schilling, an urban affairs professor at Virginia Tech's Metropolitan Institute in Blacksburg.

"This isn't just blight in the urban core; it's blight and abandonment in new suburban communities, and that's just never happened before." In some Sun Belt cities like Orlando, Fla., and Charlotte, officials have tripled or quadrupled the number of liens they've placed on vacant homes in the past year, hoping to recoup at some point the money cities are spending to try to keep the properties from going to ruin.

In California and Arizona, neighborhoods of half-million-dollar homes stand nearly empty, with some lonely residents using their former neighbors' yards as driving ranges. Meanwhile, long foreclosure lag times and uncooperative note-holders mean swimming pools go green, rain gutters fall off, weeds grow high, and ne'er-do-wells move in.

Some 44.5 million homes in the US now stand next to an empty house, resulting in a drop of at least $5,000 in property value per house. By that calculation, a total loss of home value of $220 billion across the US can be attributed to the vacancy problem. "This is a man-made disaster that's had more dramatic impacts on real estate markets than natural disasters [have]," says Bruce Katz, a housing analyst at the Brookings Institution, a think tank in Washington. "In a way, we have a lot of mini-Katrinas across the country."

Banks and other mortgage lenders acknowledge they've been overwhelmed by the sheer number of foreclosures, finding themselves ill-equipped to be long-term landlords of so many properties. But they say the problem is complex, and that a long foreclosure process and the fact that people walk away before trying to work with lenders to rescue their mortgages also play into the dereliction of many neighborhoods.

Last year, mortgage lenders helped 889,000 families avoid foreclosure and stay in their homes, according to the Mortgage Bankers Association website. "You can guarantee that none of our members wants to be a landlord," says John Mecham, a spokesman for the Mortgage Bankers Association in Washington. "Of course, we can also see where local officials are coming from – abandoned and distressed properties are not only a blight, but they drive down property values for entire neighborhoods.

India's Economy Hits the Wall
Just six months ago, India was looking good. Annual growth was 9 percent, corporate profits were surging 20 percent, the stock market had risen 50 percent in 2007, consumer demand was huge, local companies were making ambitious international acquisitions, and foreign investment was growing. Nothing, it seemed, could stop the forward march of this Asian nation.

But stop it has. In the past month, India has joined the list of the wounded. The country is reeling from 11.4 percent inflation, large government deficits, and rising interest rates. Foreign investment is fleeing, the rupee is falling, and the stock market is down over 40 percent from the year's highs. Most economic forecasts expect growth to slow to 7 percent -- a big drop for a country that needs to accelerate growth, not reduce it. "India has gone from hero to zero in six months," says Andrew Holland, head of proprietary trading at Merrill Lynch India in Mumbai. Many in India worry that the country's hard-earned investment-grade rating will soon be lost and that the gilded growth story has come to an end.

Global circumstances -- soaring oil prices and the subprime crisis that dried up the flow of foreign funds -- are certainly to blame. But so is New Delhi. Much of the crisis India faces today could have been avoided by skillful planning. India imports 75 percent of its oil to meet demand, which have grown exponentially as its economy expands.

he government also subsidizes 60 percent of the price of such fuels as diesel. In 2007, when inflation was a low 3 percent, economists such as Standard & Poor's Subir Gokarn urged New Delhi to start cutting subsidies. Instead, the populist ruling Congress government spent $25 billion on waiving loans made to farmers and hiking bureaucrats' salaries.

Now those expenditures, plus an additional $25 billion on upcoming fertilizer subsidies, is adding $100 billion a year -- or 10 percent of India's gross domestic product, or equivalent to the country's entire collection of income taxes -- to the national bill. This at a time when India needs urgently to spend $500 billion on new infrastructure and more on upgrading education and health-care facilities.

The government's official debt, which dropped below 6 percent of gross domestic product last year, will now be closer to 10 percent this year. "Starting last year, the government missed key opportunities" to fix the economy, says Gokarn. In fact, he adds, "there has been no significant reform done at all in the past four years" -- the time the Congress coalition has been in power.

Even the most bullish on India are hard-pressed to recall any significant economic reforms made in the recent past. A plan to build 30 Special Economic Zones is virtually suspended because New Delhi has not sorted out how to acquire the necessary land, a major issue in both urban and rural India, without a major social and political upheaval. Agriculture, distorted by fertilizer subsidies and technologically laggard, is woefully unproductive. Simple and nonpolitical reforms, like strengthening the legal system and adding more judges to the courtrooms, have been ignored.

A June 16 report by Goldman Sachs' Jim O'Neill and Tushar Poddar, Ten Things for India to Achieve Its 2050 Potential, is a grim reminder that India has fallen to the bottom of the four BRIC nations (Brazil, Russia, India, and China) in its growth scores, due largely to government inertia. The report states that India's rice yields are a third those of China and half of Vietnam's. While 60 percent of the country's labor force is employed in agriculture, farming contributes less than 1 percent to overall growth.

The report urges India to improve governance, raise educational achievement, and control inflation. It also advises reining in profligate expenditures, liberalizing its financial markets, increasing agricultural productivity, and improving infrastructure, the environment, and energy use. "The will to implement all these needs leadership," points out Poddar. "We have a government in New Delhi with the best brains, the dream team," he says, referring to Oxford-educated Prime Minister Manmohan Singh and Harvard-educated Finance Minister P. Chidambaram. "If they don't deliver, then what?"

Ilargi: Antal Fekete argues that abolishing the gold standard led to the Great Depression, and if it’s not reinstated, a new depression will be the result. His Gold Standard University is no more, due to lack of funding.

They dare not speak its name
Gold and the theory of interest. The latter cannot be understood without the former. We have to incorporate the theory of hoarding into the theory of interest. We have to study the problem of capital destruction in the wake of gyrating interest rates, the main consequence of ousting gold from the monetary system.

Gold and the theory of speculation. To understand the causes of the Great Depression we must understand speculation. The theory of speculation covers such topics as arbitrage, futures trading, basis (especially gold and silver basis), contango, backwardation, short squeeze and corner. Speculation is virtually ignored by conventional economic theory. The hurly-burly on the floor of the exchanges apparently does not reach the ears of inhabitants of the ivory tower.

Once these two gaps are filled, it becomes clear that the gold standard is naturally ordained as the only system that can stabilize interest and foreign exchange rates. By contrast, the regime of irredeemable currency has been inflicted upon the people through fraud and chicanery. Its foundation is no firmer than the gullibility of people who are, for the time being, willing to exchange real goods and real services for irredeemable promises to pay. But as the prices of crude oil and various foodstuffs convincingly show, there are definite limits to gullibility.

The claim of John Maynard Keynes parroted by most mainstream economists, that the Great Depression was due to the "contractionist tendencies of the gold standard", is untenable. Just the opposite is true. Here is what happened.

In 1933, the forcible removal of gold signaled to bond speculators that the one and only competition to government bonds had been knocked out. They were quick to realize that their chance to bid bond prices sky high had come. The result was continually falling interest rates, causing widespread capital destruction as well as falling prices. Producers were bankrupted en masse. Economists have never bothered to study the untoward consequences of the forcible removal of gold, even though common sense would suggest that it cannot be done with impunity.

A careful and impartial examination of the record shows that the scuttling of the gold standard, as advocated by Keynes, was the main cause of the Great Depression and, unless it is rehabilitated with all deliberate speed, a new depression may be waiting in the wings. Speculation is man's main tool to deal with risks and future uncertainties. Mainstream economics fails to make a distinction between risks created by nature and risks created by man. This distinction is fundamental. Speculation can effectively confront the former, while it will only aggravate the latter.

Risks created by man include risks involved in foreign exchange and interest rate fluctuations. They are certainly not created by nature, witness the fact that such risks are non-existent under a gold standard. Clearly, they were created by governments while abandoning the gold standard. It is untenable to assume that, under the regime of irredeemable currency, speculation will tame the fluctuations in foreign exchange and interest rates. Just the opposite is true.

Futures markets make them even less stable and more volatile. It is not possible to predict whether bond prices go to zero as they would under hyperinflation, or whether they go sky high as they would under hyperdeflation. This problem is crucial and it can be approached only through understanding bond speculation, especially as it is helped by tail-winds provided by the central bank.

The following facts are either not widely known or not well-understood. Open market operations of the US Federal Reserve (Fed) were introduced in the 1920s in violation of the Federal Reserve Act of 1913. They were legalized retroactively in the 1930s. There was hardly any public discussion of the wisdom of the move or the stakes involved. Pre-1936 economics was categorical in its condemnation of the monetization of government debt. Introducing the catchy name "open market operations" has made it possible to monetize government debt through the back door.

Economists failed to predict the disastrous consequences of this ex post facto legislation. Bond speculators were given a risk-free opportunity to profit. In pre-empting the Fed, they would buy the bonds beforehand, dumping them after the Fed had completed the purchase of its quota. Risk-free speculation imparted a bias to the market favoring rising bond prices or, what is the same to say, falling interest rates.

It speaks volumes about the degradation of economics in the wake of the Keynesian revolution that an illegal trick could be elevated to the holiest of gestures whereby high-powered money is created, and nobody points to the downside of the prestidigitation. Most importantly, economists have also failed to identify falling interest rates as the main cause of the Great Depression. They have concentrated on falling prices, not realizing that in doing so they are confusing cause and effect. The true chain of causation is as follows.

Persistently falling interest rates result in the erosion (ultimately, destruction) of capital deployed by the producing sector. In effect, bond speculators siphon off money stealthily from the capital accounts of the producers. The latter are unaware of being victimized by this vampirism of the financial sector. But they are, whether they recognize it or not.

Profits of the bond speculators do not come out of nowhere. They are the flipside of the opportunity loss suffered by the producers, who have to continue financing their capital at the higher rate. Unable to escape from the clutches of debt, the producers are squeezed. They scramble to sell more of their product at fire-sale prices in order to fend off bankruptcy. In this way a downward spiral of prices is created.

The prevailing optical illusion suggests that money is scarce. Everybody cries out for the Fed to create more money. The Fed complies and enters the open market to purchase more bonds. In doing so it provides bond speculators with another opportunity to make risk-free profits. Interest rates fall further and producers are squeezed more. A vicious circle is activated. At the end of the spiral producers go bankrupt in droves.

According to my revisionist theory the Great Depression, far from being caused by overproduction as suggested by Keynes, was caused by wholesale destruction of capital. The ultimate cause was risk-free profits granted to bond speculators through the Fed’s open market operations.

Ilargi: And this is what Fekete talks about: losing the dollar’s value.

Oh the glories of paper money
A picture isn't worth a thousand words but it does crystallize things:


bicycle mechanic said...

Bloomberg has coverage of the speech Paulson gave today. The article in todays TAE said much but it didn't directly say this., Wait till Denniger see's this one, of course they are just trying to legalize the theft, Pretty surreal.,

" Secretary Henry Paulson called for regulatory changes that would allow financial firms to fail without threatening broader market stability.

The Treasury chief also proposed steps providing for the president to approve of any use of taxpayer funds to aid a financial company. In a speech in London today, ...

So when a corporation screws up, just have the President without congress, just wave his magic pen and put the monkey on the publics back.

if this does get legs, then, its more than lights out

Anonymous said...

Bike Meck,

Maybe a game of 'hot potato'? Would congress want it? Seems to me that even a cripple with an undistinguished IQ would not like that one either.

Anonymous said...

Would someone be willing to play devil's advocate and describe the storyline that allows all of this to smooth out and end in a recovery? The story line that a mainstream politician or someone with power is trying to sell?

Also, a chart in the Rattle today shows the Dow traced over the last 100 years and the drop off after the tech bubble is very pronounced.
Ilargi - were you paying enough attention then to know what was happening and what our prospects for recovery were?

Thanks for all your work -

Anonymous said...

The Free Fall continues:

DJIA ends on 11216, -166 today

General Motors -14% during the last 24hrs...

scandia said...

I met a woman on the street to-day who did me a great kndness some years ago. She asked. " what are you doing? You're always doing something interesting." Well, I just couldn't resist this opportunity to do her a return kindness. I filled her in on the economy. I left her running up the stairs to her gov't job office to call her advisor to sell, even willing to pay a penalty to retrieve her capital! I skipped the rest of the way home happy to have helped her in particular.
One for our side!
Ilargi, I love Bruegel, both the Elder and the Younger. Great photo selection for to-day!

Anonymous said...

Forest, I think you pose a hard one .
I was going to try to play along and suggest that maybe we would all suddenly see the light and do right, just like we did about quitting smoking years ago. Then I took a look at the smoking statistics and gave up.

Early 2006 I made a match book guess, that if we had an economic collapse that ran into the decline of oil, there would be no bounce. At that time I thought 2010 would be the year of that event and purchased some back loaded 3 year mutual funds. I have, this year, moved them to money market for safety with no cost but think I should redeem them early. How about you, what are you doing to keep yourself safer?

Here is something from TOD Canada Khebab Ace et al.

Possible future supply scenario for crude oil and NGL based on the Wikipedia Oil Megaproject database. The resource base post-2002 decline is a linearly increasing decline rate from 0% to 4.5% between 2003 and 2008 then constant at 4.5% afterward. The decline rate for each annual addition is 4.5% after first year.

Anonymous said...

I keep re-reading Fekete's article and am not understanding the fundamentals of what he's saying. I'm definitely dumb as dirt. He writes:

The result was continually falling interest rates, causing widespread capital destruction as well as falling prices. Producers went bankrupted en masse.

Trying to find out how falling interest rates causes capital destruction, I went to his web site and found this article where he says:

The mechanism that transmits the fall in the interest-rate structure to a fall in the commodity price structure is the rising bond price. It makes the present value of debt rise. As it does, the liquidation-value of enterprise also rises. Here is a paradox: falling interest rates squeeze the profits of productive enterprise. This is also the missing link economists have failed to find: the rise in the liquidation-value of enterprise causes an uncontrollable increase in the cost of servicing capital deployed in production. As costs increase, profits fall. We conclude that the squeeze on profits is not caused by the falling price-structure as previously assumed. Falling prices are themselves an effect, not a cause. The real cause is the falling interest-rate structure which reveals that productive capital has been financed at rates far too high. As a result of the squeeze, profits are turned into losses. Many firms fail, taking others down with them in a domino-effect as receivables get harder to collect. Demand collapses, prices fall.

I don't have the background to see the dynamic he's describing. Does anyone know any sources that might help?

super390 said...

So Fekete is saying the Great Depression started in 1933? The folks going hungry the prior 4 years were the judges of that, and the 1932 election was the trial.

But capitalist apologists will do anything to bring back the gold standard, under which the workers of the West got the crap kicked out of them twice per decade for 70years while the rich just got richer in the deflations.

All the FDR-haters and gold bugs forget what the workers were doing before 1933: they plotted revolutions. So bring back the gold standard. I want a revolution.

Anonymous said...

Looks like ron paul shares your fears...

Something Big is Going On

Bigelow said...

The restoration of glittering generalities like Liberty and Freedom is pushed to the front of public awareness, urging us to take charge of our own circumstances and jettison our unreasonable expectations –while criminals and their enablers who have ruined our public systems escape with the money. Free will never went away, even while the public has been continuously defrauded. The complaining about our greedy expectations is getting louder.

Insurance is a reasonable idea; a little tax money from many people will pay for large losses that a few of them will experience. Similar individually small amounts of money, when aggregated for the whole community allow for reasonable expectations of public pensions and universal health care. But endless opportunities to defraud these systems exist, false claims, exclusions, excessive overheads or diverting money elsewhere (like the Pentagon). The public systems are slowly corrupted, failing finally to assist those that should be their beneficiaries and we are left with sloganeering.