Wednesday, August 13, 2008

Debt Rattle, August 13 2008: Not better, just different

Alfred Palmer Life in Wartime August 1942.
Pittsburgh: The comforts of home looked pretty good to Navy Radioman John Marshall Evans and Sergeant French L. Vineyard, who spent Sunday with the family of their poster colleague George Woolslayer.

Ilargi: As US Armed Forces get ready to move into Georgia (and other countries in the region, undoubtedly, including a few that border on Iran), Wall Street rivals the Caspian as a battlefield.

If there’s one thing the two have in common, it’s that we can’t trust politicians and media to tell us the truth on anything that is happening. And on Wall Street there’s a third party that plays hide-and-seek: the financial institutions themselves.

And that is where the hurt is startting to seriously show. Investors, without whom Wall Street can’t survive, are withdrawing in increasing numbers. A monetary system cannot run without trust; nobody keeps investing in entities that tell one lie after the other.

For a year now, the banks, aided by the press, the Treasury and the Fed, have been painting rosy pictures. They’ve all been revealed to be illusions. And that chases money away.

At least a full one-third of US homeowners who bought a house since 2003 owe more on their loans than their homes are now worth, and this trend will accelerate and get much worse, make no mistake.

Which pops one of the many delusionary balloons that was being floated by the moeny marker makers: There will be no return to real estate conditions as they were between 2002-2007, not anytime soon, and not for many years to come.

As that becomes clear (about two years after we started warning about it), the banks lose one of their main "hideouts".

They will either see their share prices tumble ever further down the mountain, or they have to come clean about ALL the toxic paper they hold. Their idea is to keep the paper hidden, till markets improve, an event that is always just around the corner.

But that is not possible; indeed, the number 1 condition for that improvement is the marking-to-market of the paper. We’ll soon realize that the longer they wait, the more value the paper loses. There may come a few more hiccups upward, but the trend can no longer be stopped, let alone reversed.

Banks are losing money everywhere you look: housing, buy-outs, debt sales, you name it. The writedowns and losses total $500 billion today, and according to Nouriel Roubini that means there’s $1.5 trillion left to write down.

According to me, Roubini is too optimistic; he still seems to believe that it’ll stop relatively soon. I think it’s time for him to look at systems and their inherent feedback loops.

I think the feedback loops pulling on the financial system are very powerful, so much so that a forecast of a 30% or even a 50% drop in US housing prices will soon prove just as delusional as all the stories we heard one year ago.

They will drop much more. I see nothing, absolutely nothing, in the American economy that could prevent it.

But a war could make everything different. Not better, just different.

Bank Stocks Drop Anew Amid Worry Over Falling Home Prices
Stuck with a growing glut of foreclosed houses, banks and investors are shedding them at increasingly steep losses, potentially adding to the banking industry's red ink this year.

Banks are selling foreclosed homes in some cases for less than half the price they fetched two or three years ago. The cuts are coming as the U.S. banking sector, slogging through its worst crisis in decades, bites the bullet out of fear that prices will keep falling.

Financial stocks fell sharply Tuesday, following J.P. Morgan Chase & Co.'s warning late Monday that it expects "a continued decline in U.S. housing prices." The dour assessment included a roughly $1.5 billion trading loss related to the largest U.S. bank's holdings of mortgage-backed securities.

J.P. Morgan shares fell 9.5% Tuesday, while Lehman Brothers Holdings Inc. and Wachovia Corp. fell about 12%. The declines marked a reversal in sentiment from recent optimism among some investors that the worst of the credit crunch might be over.

J.P. Morgan's warning was notable because the bank has been ahead of the curve over the past year in sounding the alarm about emerging troubles, such as mounting defaults in home-equity loans and credit cards. The New York bank has sidestepped the worst of the problems that have forced many commercial and investment banks to slash their dividends and seek capital infusions in order to plug their leaky balance sheets.

The steep losses on sales of foreclosed homes are painful for banks and investors in the short run but should help clear the backlog. That would allow for an eventual recovery of the housing market and clean up the banks' balance sheets.

One example of the deep price cuts on foreclosures: A 1,230-square-foot home in Corona, Calif., was sold by a unit of investment bank Credit Suisse in June for $198,000, down from $450,000 when the property sold in a regular transaction in December 2006. "I do not think this is the time to be holding onto [foreclosed homes] and hoping for a better day," Daniel Mudd, chief executive of Fannie Mae, said during a conference call Friday.

Banks and investors have grown more leery of the rising costs of holding onto vacant homes. Along with such expenses as insurance, lawn care and maintenance, banks are being hit with higher costs for complying with local regulations applying to vacant homes.

The price cutting may mean even deeper losses for banks, but in some areas price tags have fallen enough to entice bargain hunters back into the market. According to the S&P/Case-Shiller indexes, prices in Las Vegas, Miami and Los Angeles are back to 2004 levels, while those in San Diego have retreated to 2003 levels.

Losses to banks on foreclosed properties result from a variety of factors, including declines in the home value below the loan balance; missed payments by the owner before the foreclosure; real-estate commissions; and the costs of repairs, taxes, insurance and maintenance while the bank or loan investor owns the property. The sum of all these costs is called the "loss severity."

For subprime loans, those to people with relatively poor credit records, loss severities averaged 41% of the loan balance in 2005 and 54% in the 12 months ended in May, according to Fitch Ratings. For loans made in 2006 and 2007 that end up being foreclosed, severities are likely to average more than 60%, Fitch says. Analysts at Credit Suisse see a range of 63% to 71% on foreclosed subprime loans by late next year, depending on how far home prices fall.

Comparable historical data are sparse. Chandrajit Bhattacharya, a Credit Suisse analyst, says severities were slightly higher after the housing slump of the early 1990s, but "current severities are rising much faster and in probability will be higher than the mid-1990s peak."

Losses on prime loans also are growing, particularly on option adjustable-rate mortgages, or option ARMs. These loans allow borrowers to start with very low monthly payments, then face steep increases several years later. Wachovia disclosed last month that loss severities on option ARM foreclosures averaged 36% in the second quarter, up from 32% in the first quarter.

Fannie Mae says severities on prime and Alt-A loans (a category between prime and subprime) recently have reached 40% in California. The pain may get worse before it starts to ease. A recent report from Barclays Capital estimates that there are 721,000 bank-owned homes nationwide, up from 112,000 two years ago. Barclays expects the total to rise 60% more before peaking in late 2009.

Financial institutions are acquiring homes through foreclosure much faster than they can sell them. Fannie Mae, a government-sponsored mortgage investor, disclosed last week that it acquired 44,071 homes through foreclosure during this year's first half but sold only 23,627, leaving a balance of 54,173 as of June 30.

Fannie said it is opening field offices in California and Florida to try to speed sales of such homes and is evaluating offers from unidentified parties interested in "bulk" purchases.

Corona, considered one of the most desirable places to live in Riverside County, east of Los Angeles, has begun working through a huge inventory of foreclosed homes, says Pete Nyiri of Top Producers Realty, which is based in the city. A four-bedroom, 3,213-square-foot home at 1065 Trailview Lane was sold in June for $479,900 after fetching $685,000 in October 2005.

"In the last five months, there has been a dramatic increase in sales, which correlates to the decline in prices," Mr. Nyiri says. "In the lower price range, many homes are getting multiple offers." In the Anthem neighborhood of northeast Phoenix, a four-bedroom home was sold by a bank in February for $190,500. That compares with $275,000 paid by the former owners in November 2004.

Using two mortgages, the former owners financed 100% of that purchase. Joseph Cohan of International Realty Services, who was the listing broker for the recent sale, says the home needed new carpeting and paint; ceiling fans and light fixtures had been ripped out.

Not all foreclosed homes go for a song -- even though the loss to the bank can be stiff. In the Las Vegas neighborhood of Summerlin, a foreclosed three-bedroom home, built in 1999, sold in May for $259,900, the original listing price, after just three days on the market.

The same home sold for $215,000 in 2003; two years later, the owners refinanced the home for $408,500, apparently to extract cash from their home equity at a period when prices were soaring. William Jorgensen, the listing broker for the recent sale, said the Summerlin home sold quickly this year because it was in fairly good condition and in an attractive, upscale neighborhood.

Local governments are adding to the pressure on banks to sell foreclosed homes faster. Providence, R.I., recently imposed a property-tax surcharge on vacant properties to discourage banks and others from leaving them empty for long periods. Many cities now require banks to register the vacant homes they own and pay registration fees ranging from about $50 to $1,000.

Credit Crisis Still 'Far From Over,' Merrill Says
The credit crisis is "broad, deep, and global" and "far from over" for financial companies even after they reported $500 billion in writedowns and credit losses, Merrill Lynch & Co.'s chief investment strategist said.

"Investors are significantly underestimating both the scope and the extent of the credit bubble and the consequences of its subsequent deflation," Richard Bernstein wrote in a note to clients. "The problems are not confined to large institutions that are overexposed to U.S. subprime loans." The lingering effects of the crisis mean banks and brokerages need "massive" consolidation because of the glut of lending capacity worldwide, Bernstein said.

Profit for U.S. banks and brokerages tumbled 94 percent in the second quarter from a year earlier, according to Bloomberg data. Financial stocks in the Standard & Poor's 500 Index have tumbled 28 percent this year for the worst performance among 10 industry groups. The KBW Bank Index, a composite of 24 U.S. banking stocks, fell 4.5 percent today as of 11:26 a.m.

The stocks aren't likely to rebound soon, Bernstein wrote. "The problems in the financial sector appear to us to be far from over," he wrote. "We are skeptical that trying to bottom-fish will prove profitable."

One of the largest banks in Asia recently posted an earnings shortfall from losses on mortgage-related collateralized debt obligations and other troubled assets, showing the crisis has spread, Bernstein wrote. The pace of initial public stock offerings in India and Singapore has dropped "considerably," he wrote.

"The sector's underperformance clearly has been a global phenomenon," Bernstein wrote. "History shows that the U.S. tends to lead the world into slowdowns and recessions." The worst might still be ahead for smaller U.S. banks, he wrote. Banks and brokerage firms worldwide have recorded more than $500 billion of securities writedowns and increased costs related to bad loans, according to Bloomberg data.

One Third of New Owners Owe More Than House Is Worth
Almost one-third of U.S. homeowners who bought in the last five years now owe more on their mortgages than their properties are worth, according to, an Internet provider of home valuations.

Second-quarter home prices fell 9.9 percent from a year earlier, giving 29 percent of owners negative equity, said Zillow, the Seattle-based service that offers values for more than 80 million homes. For those who bought at the 2006 peak of the housing market, 45 percent are now underwater, Zillow said.

Negative equity and declining prices are making it difficult for homeowners to sell property for a profit. Almost one-quarter of U.S. homes sold in the past year were for a loss, Zillow said. That contributes to the foreclosure rate because some homeowners can't absorb the loss and end up surrendering their homes to the bank that holds the mortgage, said Stan Humphries, Zillow's vice president of data and analytics.

"For homeowners who need to sell, this is a gravely serious situation," Humphries said in an interview. "It can also be harmful to communities where the number of unsold homes adds more to inventory and puts downward pressure on prices."

The highest percentages of homeowners with negative equity were located in California. In four of the state's metropolitan areas -- Stockton, Modesto, Merced and Vallejo-Fairfield -- the number of homeowners whose mortgage debts exceeded the values of their properties topped 90 percent, Zillow said. In five more California areas -- the Inland Empire (Riverside-San Bernardino), Bakersfield, Yuba City, El Centro and Madera -- the percentages were more than 80 percent.

In Stockton and Modesto, more than half the sales in the second quarter were of foreclosed homes, Zillow said. Almost 15 percent of sales nationwide were foreclosures, the company said. Prices fell on a year-over-year basis in 140 out of 165 markets, Zillow said. Pittsburgh, Oklahoma City and Austin, Texas, were among the markets that saw rising home values, the company said.

The 9.9 percent decline in home values was the largest on a year-over-year basis in at least 12 years, Zillow said. The median home price of $206,919 was the lowest since the fourth quarter of 2004, the company said.

"Sellers are starting to adjust their expectations," Zillow Chief Financial Officer Spencer Rascoff said in a Bloomberg TV interview. "More sellers accepting a loss is actually a sign of optimism. It means that the transactions might start happening. There are so many sales contingent upon the buyer selling their home."

The Zillow Home Value Index is the median valuation for a given geographic area on a given day and includes the value of all single-family residences, condominiums and cooperatives, regardless of whether they sold within a given period, the company said. The index at the national and metropolitan area levels is calculated using a weighted average of the median home value for each county, Zillow said.

Banks remain exposed to risk after debt sales
Citigroup and Deutsche Bank are still retaining some of the risk from billions of dollars in loans backing leveraged buy-out deals that they have sold in recent months to private equity firms, according to securities filings and bank officials.

The sales were cheered by the investors as a sign the banks were cleaning up their balance sheets. But the banks’ remaining exposure to the loans is less well understood, in part, because of the lack of public disclosure. This year, banks including Citi, Deutsche and Royal Bank of Scotland have sold $25-30bn in buy-out loans to three private equity firms – Apollo; Blackstone, through its GSO Capital arm; and TPG.

The banks generally sold the loans at a price of about 85 cents on the dollar, people familiar with the deals said. The banks also granted the buyers new loans – at below market rates – to help them buy the old loans. The new loans amount to about 80 cents for each dollar of old loans bought.

If the old loans drop in value, the deals are structured so that the private equity firms take the first losses, up to about 20 cents on the dollar. If the old loans fall further – as could be the case in a severe economic downturn – the banks could suffer additional losses on the loans they “sold”.

Deutsche Bank acknowledged that it retained exposure to the original loans, but said that any further losses would be negligible.
For the bank to book more losses, it said, the old loans would have to drop to about 65 cents on the dollar – a calculation reflecting the 15 per cent writedown on the sales and the 20 cents on the dollar invested by private equity.

Of course, even if companies default or file for chapter 11 bankruptcy protection, lenders usually get some money back. In the bankruptcies this year, lenders have recovered an average of up to 60 cents on the dollar – less than in earlier economic cycles.

In a regulatory filing, Citi said its loan sales “substantially mitigate the company’s risk related to these transferred loans”, implying it retained some risk. The bank said it hedged retained risk by buying derivatives called total-return swaps but it declined to say how much it has paid for the instruments.

Analysts say such hedges can be expensive – sometimes costing more than the position being hedged. They say banks can be willing to pay so much because it is easier to tell shareholders they spent money on hedges than to report loan losses.

Michael Price Shorts Citigroup, Sees Few Banks to Buy
Billionaire investor Michael Price is betting that Citigroup Inc. and Wachovia Corp. will keep tumbling and says he found few banks to invest in after total losses from subprime mortgages increased to almost half a trillion dollars.

"Citigroup's got more pain coming," said Price, who runs New York-based MFP Investors LLC and was chairman and chief executive officer of Franklin Mutual Advisers LLC in Short Hills, New Jersey. Price, 57, is selling short both stocks even after Citigroup, the biggest U.S. bank by assets, tumbled 33 percent this year and Wachovia, the fourth-largest, lost 52 percent.

In a short sale, investors borrow shares and sell them on the expectation they can be purchased at a lower price before paying back the loan. Citigroup has reported $55.1 billion in writedowns and credit losses tied to the collapse of U.S. credit markets, while Wachovia had $22 billion in charges. Analysts project U.S. bank profits will fall 35 percent this quarter after $493 billion in losses from subprime lending sent them lower during the last four.

Price, a value investor who made his name buying shares of beaten-down lenders, shorted New York-based Citigroup when the shares traded in the "mid-20s," he said. The stock hasn't closed above $25 for more than three months.

Citigroup reported its first loss from credit-card securitizations since at least 2005 last week, signaling that risks may be growing in a business that generated $3.5 billion of revenue in the past three years, analysts said. The stock slipped 6.5 percent to $18.54.

Price bought shares to replace his short position in Wachovia during a 110 percent advance in July and August, then shorted the stock again last week, he said. Wachovia dropped 12 percent to $16 today. It fell to a 17-year low of $9.08 on July 15.

The Charlotte, North Carolina-based lender ousted Kennedy Thompson as chief executive officer on June 2 after cutting its dividend 41 percent and raising $8 billion. It hired Treasury Undersecretary Robert Steel as chief executive officer July 9, two weeks before reporting an $8.9 billion quarterly loss on a $6.1 billion charge tied to declining asset values.

"Their tangible book value is below $10 a share if they took the right markdowns" of assets, Price said in an interview in New York. "We like the guy who's running it -- it's not his fault. He's going to do the right things but the stock's not cheap enough." Wachovia reported book value of $30.69 a share as of June 2008, according to data compiled by Bloomberg.

Price, who sold his Heine Securities Corp. to Franklin Resources Inc. for more than $600 million in 1996, said bank shares may lead a decline in the Standard & Poor's 500 Index after the benchmark index for U.S. equities climbed 7.4 percent since July 15.

"This rally we've had, this huge rally, seems to me pretty premature," he said. "Dividend cuts are inevitable. You're going to have to see them. How can they pay out dividends if they have to raise capital?" Price said he plans to buy stakes in smaller banks that are replenishing their capital. He can't find many worth investing in, he said.

"In the next six months lots of banks are going to raise capital and we're going to probably put money into 5 or 10 of probably 50 or 100 we'll look at," Price said. "We're going to be very selective." Price bought a stake in Sovereign Bancorp Inc. earlier this year. The second-largest U.S. savings and loan by assets "is pretty well financed now with good management," he said.

"We're looking at the ones who need money," Price said. "If there are small banks who need to raise money, our office doors are open

Banks' Subprime Losses Top $500 Billion on Writedowns
Banks' losses from the U.S. subprime crisis and the ensuing credit crunch crossed the $500 billion mark as writedowns spread to more asset types.

The writedowns and credit losses at more than 100 of the world's biggest banks and securities firms rose after UBS AG reported second-quarter earnings today, which included $6 billion of charges on subprime-related assets.

The International Monetary Fund in an April report estimated banks' losses at $510 billion, about half its forecast of $1 trillion for all companies. Predictions have crept up since then, with New York University economist Nouriel Roubini predicting losses to reach $2 trillion.

"It just keeps spreading from one asset to another, so it's hard to know when these writedowns will stop," said Makeem Asif, an analyst at KBC Financial Products in London. "The U.S. economy needs to stabilize first. But even then, Europe could lag and recover later. There's still a lot more downside."

Auction-rate securities have begun adding to the losses as regulators and prosecutors force banks to buy back bonds they'd sold as safe investments. UBS set aside $900 million to cover potential losses from repurchasing the securities, while Citigroup Inc. and Wachovia Corp. estimated losses at $500 million each.

The collapse of the U.S. subprime mortgage market last year has saddled banks worldwide with $501 billion of losses from declining values of securities tied to all types of home loans and commercial mortgages as well as leveraged-loan commitments.

Banks and brokers have raised $353 billion of capital to cope with the writedowns, according to data compiled by Bloomberg. The gap between losses and capital infusions, which now stands at $148 billion, has regularly narrowed to about $80 billion as capital raising follows writedown announcements.

U.S. Stocks Fall on Banking Concern; JPMorgan, Goldman Retreat
U.S. stocks fell for the first time in three days after JPMorgan Chase & Co. said it may post more credit losses, pushing the worldwide costs for the collapse of the subprime mortgage market to more than $500 billion.

JPMorgan, the second-largest U.S. bank by market value, dropped the most since 2002 after saying trading conditions have "substantially deteriorated." Goldman Sachs Group Inc. had its worst decline in five months as Deutsche Bank AG analyst Mike Mayo and Oppenheimer & Co.'s Meredith Whitney cut profit estimates for the biggest securities firm.

Wachovia Corp. slid 12 percent and Morgan Stanley tumbled 6.4 percent as financial shares erased yesterday's advance.
The Standard & Poor's 500 Index slid 15.73 points, or 1.2 percent, to 1,289.59. The Dow Jones Industrial Average decreased 139.88, or 1.2 percent, to 11,642.47. The Nasdaq Composite Index slipped 9.34, or 0.4 percent, to 2,430.61.

Two stocks dropped for each that rose on the New York Stock Exchange. "It's going to be like a long, slow car crash to work through the housing situation," Joseph Veranth, chief investment officer at Dana Investment Advisors, which manages $2.8 billion in Brookfield, Wisconsin, told Bloomberg Radio. "We're still in the middle of it."

The S&P 500 has slumped 18 percent from its 2007 record as global credit losses, accelerating inflation and record fuel prices curb profit growth. Second-quarter earnings fell 23 percent for the 430 companies in the S&P 500 that released results since July 8, according to data compiled by Bloomberg. Financial industry earnings are down 91 percent.

Benchmark indexes extended losses after Freddie Mac said it will stop buying subprime loans issued in New York state and the Dallas Morning News reported that Dallas Federal Reserve Bank President Richard Fisher said the current financial turmoil is worse than the savings and loan crisis of the late 1980s and early 1990s.

JPMorgan lost 9.5 percent to $37.92 after saying it expects the global economy "to continue to be weak, for capital markets to remain under stress and for a continued decline in U.S. housing prices," according to a regulatory filing yesterday. "Sharply widened" spreads on mortgage-backed securities and loans have caused losses, the bank said.

Billionaire investor Michael Price is betting on further declines at Citigroup Inc. because the bank has "more pain coming," he said in an interview yesterday. Price runs New York- based MFP Investors LLC and was chairman and chief executive officer of Franklin Mutual Advisers LLC in Short Hills, New Jersey. He said bank shares may lead a decline in the S&P 500 after the benchmark index for U.S. equities climbed 7.4 percent from July 15 to yesterday.

"This rally we've had, this huge rally, seems to me pretty premature," Price said. "Dividend cuts are inevitable. You're going to have to see them. How can they pay out dividends if they have to raise capital?" Citigroup retreated 6.5 percent to $18.54. The biggest U.S. bank by assets has dropped 37 percent this year.

Goldman declined 6 percent to $167.30. Deutsche Bank cut its recommendation on the shares to "hold" from "buy." The brokerage also reduced its price estimate on the stock 8.1 percent to $192, saying earnings are likely to be weaker than consensus estimates. Oppenheimer's Meredith Whitney lowered her profit estimates for Goldman for 2008 and 2009.

Wachovia fell 12 percent to $16. The fourth-largest U.S. bank said its second-quarter loss was wider than reported last month after costs to settle a probe of auction-rate securities. Price said he also is betting Wachovia will continue falling.
Morgan Stanley

Morgan Stanley had the steepest drop in a month, retreating 6.4 percent to $42.50. Deutsche Bank's Mayo said continued credit market turmoil and global economic weakness will lessen 2008 and 2009 profit at the second-biggest U.S. securities firm by market value. He cut his earnings estimates and predicted $1.5 billion in third-quarter losses from "troubled" assets.

Other financial stocks dropped. Lehman Brothers Holdings Inc. sank 12 percent to $16.21. Washington Mutual Inc. tumbled 9.3 percent to $4.30. Bank of America Corp. fell 6.7 percent to $31.13. The retreat in banks, brokerages and insurers reduced the S&P 500 Financials Index's rebound from a decade low on July 15 to 22 percent.

Better-than-estimated earnings from Citigroup Inc. and Wells Fargo & Co. and a government rule to limit bets that bank stocks will decline have contributed to the group's surge during the past month. The industry is still the year's worst performer among 10 groups with a 28 percent drop for 2008.

"There's still a lot of hair and a lot of dirt on these financials," said Stephen Wood, who helps manage $213 billion as a senior portfolio strategist at Russell Investments in New York. "This is something the average investor at home should be very careful about."

Freddie Mac Will Stop Buying New York Subprime Mortgages
In its latest effort to deal with the fallout of the subrprime credit crisis, government-sponsored mortgage buyer Freddie Mac said it will not purchase subprime mortgages secured by properties in New York state with note dates on or after Sept. 1.

The move is Freddie's response to recent New York legislation, effective Sept. 1, that creates a new category of subprime mortgages. The state has said the legislation is intended to curb abusive lending practices. But Freddie said the pending law "creates the potential for heightened legal and business risk exposures for the purchasers or assignees of these loans," including secondary market participants such as Freddie and sister Fannie Mae that buy mortgages.

Freddie first announced last week that it planned to slow growth in its portfolio of mortgage-related securities after reporting a second-quarter loss on $2.5 billion in credit-loss provisions and $1 billion in securities write-downs.

In scaling back purchases of home mortgages, Freddie Mac - the second-largest buyer of mortgages in the U.S., following Fannie - will likely bring about higher borrowing costs for homeowners. It may also hobble the already weak market for home loans - and that weakness could feed back to hurt Freddie as well.

That's because its declining participation in buying home loans may trigger a loss of confidence among investors, leading to a broader sell-off of mortgage investments, freezing up the market. A fire sale of these securities wouldn't only hurt valuations of Freddie's existing portfolio, but also would perhaps force the company to squirrel away precious capital to provide for additional losses stemming from deteriorating credit conditions.

Fannie Mae, which also posted a large loss last week, is also reining in its support for the mortgage. It disclosed Friday that it's slowing its purchases of mortgage-related securities to preserve capital.

Wall Street Losses Hammer New York Tax Revenues
Wall Street's mortgage losses have grown so large that some firms may pay little or no taxes for years, widening New York City and state deficits and challenging their ability to provide services, Mayor Michael Bloomberg said.

Some companies are seeking refunds from the city on taxes they paid ahead of time, saying losses have cut their tax liability to zero. The banks pay tax on 110 percent of earnings in advance as a "safe harbor," protecting against penalties for underpayment. "It will be a number of years before Wall Street starts paying taxes again," the mayor said at a press conference yesterday in Manhattan. "They will carry forward all of those losses."

Financial firms posted $501 billion in writedowns and credit losses worldwide since the start of last year, a figure the World Bank predicts may rise to $1 trillion as the credit squeeze sparked by the subprime market collapse worsens. The tax drain is particularly serious in New York, where Wall Street accounts for 20 percent of state revenue and about 9 percent for the city, state Comptroller Thomas DiNapoli has said.

"If the World Bank's prediction that the large investment banks will book up to $1 trillion in writedowns because of the mortgage crisis is true, then Mayor Bloomberg is absolutely right," said Lynn Turner, former chief accounting officer of the U.S. Securities and Exchange Commission. "These guys won't be paying taxes for some time."

Citigroup Inc., the largest U.S. bank by assets, has taken about $55 billion in losses and slashed more than 14,000 jobs, while Merrill Lynch & Co. lost $51.8 billion and cut 5,220 jobs, according to data compiled by Bloomberg News. The mayor is founder and majority owner of Bloomberg LP, the parent company of Bloomberg News.

Merrill, the third-biggest U.S. securities firm, recorded a $4.2 billion global income tax benefit in 2007 and $4.8 billion in the first six months of 2008, according to company reports. The 2007 tax breakdown included $185 million in current and deferred benefits on the company's state and local taxes and $1.26 billion on federal tax benefits, according to the company's 2007 annual report.

Companies such as Merrill are allowed to use those benefits to get refunds on taxes paid in the prior two years and to offset tax payments going forward for as long as two decades, said Robert Willens, president and chief executive officer of Robert Willens LLC, a tax consulting company in New York. "They'll try to use that as quickly as they can," Willens said. "If you add up all of the Wall Street losses, you're talking about not paying taxes for five or six years easily."

While analysts expect firms including Merrill and Lehman Brothers Holdings Inc. to report losses for 2008, some other Wall Street firms will probably remain profitable and keep paying taxes. Goldman Sachs Group Inc. and Morgan Stanley, the two largest U.S. securities firms, are expected by analysts to record profits this year. Goldman had a net tax expense of $6.01 billion in 2007, including $488 million in current and deferred state and local taxes, according to the company's annual report.

New York Governor David Paterson called the Legislature back to work next week in an emergency session to address widening deficits as revenue, including tax receipts from Wall Street, declines. Sixteen of the state's largest banks sent taxes totaling $5 million to the state treasury in the most recent reporting period, a 97 percent decrease from a year earlier, when they accounted for $173 million in revenue, Paterson said.

The state faces a $26 billion deficit over the next three years and a $630 million shortfall in the current year that began April 1, Paterson has said. The governor yesterday outlined $630 million in administrative spending cuts he intends to apply this year, and he called upon legislators to cut at least $600 million more later in August.

"A lot of what we're facing now are the diminished revenues from Wall Street, with capital gains down 24 percent and personal bonuses down 20 percent, and Wall Street losing $40 billion in its last three quarters," Paterson, a Democrat who took over as governor in March following Eliot Spitzer's resignation, said yesterday.

In the city, where Wall Street provides about 5 percent of jobs and more than 20 percent of total personal income, deficits are projected to widen to $2.3 billion in fiscal 2010 beginning next July, growing to $5.96 billion and $5.4 billion in 2011 and 2012, city Comptroller William Thompson has said.

"We still haven't come to grips with how deep will be the impact on New York City's and the state's economy and budget resulting from this credit crisis," said Kathryn Wylde, president of the Partnership for New York City, a civic group of corporate chief executives organized to promote commerce. The mayor didn't name the firms that contacted the city seeking repayments of their taxes.

"You have to give them the money back," Mayor Bloomberg said. "We've already collected it, but we can't spend it because it's not ours."

Paterson's call for the state to reduce spending included his suggestion that the Legislature reduce support for the state's municipalities by 6 percent. While the mayor pledged to maintain good city services, he said the state and the city's difficulties with Wall Street would have an effect.

"When the state government says they are going to cut back, they are fundamentally going to shift that expense downstream to us, so it is the mayors or county leaders, in all 60 counties, that are going to have to deal with where the revenue goes," Bloomberg said. "I'm not preaching doom and gloom," the mayor said. "I am preaching that it is likely to be difficult and trying, and we have to work together."

When asked at a press conference today whether New York may consider asking public workers to pay more for their health insurance, Bloomberg said it's a trend prevalent among private employers that the city's unions have fought. "Anybody who thinks that the state and the city are not going to have to look at all these kinds of things to face the new economic reality is just making a mistake," he said.

New York City won its highest debt ratings in recent years, AA from Standard & Poor's and Aa3 from Moody's Investors Service, as Wall Street profits soared and the real estate market boomed. The largest Wall Street firms paid a combined $30 billion in bonuses in early 2007 because of record 2006 profits, Turner said.

New York state has $50 billion of outstanding debt. Ratings range from AAA for bonds backed by personal income taxes or sales tax, to AA for state general obligation debt and AA- for bonds that require appropriations by the Legislature, according to Standard & Poor's.

"I am worried about the state's bond rating, and it will start to fall if the governor doesn't do something about his budget problems now," Bloomberg said. "The rating agencies are cognizant of what's happening to our economy." The cumulative projected deficit the state faces over the next three years has widened 22 percent since May, to $26.2 billion from $21.5 billion, Paterson said. The current budget is $80.5 billion, excluding capital projects and federal aid.

JPMorgan Chase Got A Bad July Burn
JPMorgan Chase is demonstrating to Wall Street that, even after a year of credit difficulties, the pain just keeps coming back.

Late Monday, the bank revealed another big loss in its mortgage investments via a filing with the U.S. Securities and Exchange Commission. JPMorgan Chase said the ugly credit markets had caused it to lose about $1.5 billion, after hedges, in its mortgage-backed securities and loans to date in the July-to-September quarter. That is more than the $1.1 billion markdown the bank took in its investment banking portfolio during the second quarter.

As of June 30, the New York-based bank had $19.5 billion in exposure to prime and Alt-A mortgages, $1.9 billion in exposure to subprime mortgages and $11.6 billion in exposure to commercial mortgage-backed securities. Alt-A mortgages are not subprime grade but are classified below "prime."

"We knew the mortgage securities market was tough in July," said Jeffrey Harte, a brokerage analyst with Sandler O'Neill, "and we knew it was primarily Alt-A mortgages, but this is the first confirmation of the magnitude." Looking at the broader sector, Harte commented that it is impossible to know exactly what the magnitude will be, but the concept of losses in Alt-A mortgages is not specific to JPMorgan Chase.

As the bank itself describes it, though, things are ugly. The bank said trading conditions have substantially deteriorated in the third quarter versus the second, and spreads on mortgage-backed securities and loans have widened sharply. It also observed that if its own spreads tightened, the change in the fair value of certain trading liabilities would also hurt trading results.

Citing people close to the company, the Financial Times reported Tuesday that JPMorgan Chase had to write down the value of its $33.0 billion in mortgage-backed securities as prices continued to drop in July.

Talk of UBS sell-off after writedowns and restructuring
Stricken Swiss banking giant UBS has prompted speculation it will sell its investment bank by announcing a wide-ranging shake-up of the business. It also named high-flying City banker John Cryan as its new chief financial officer.
UBS said its three divisions - investment banking, private banking and asset management - would be run separately as it announced another $5bn (£2.7bn) write-down on credit positions in the second quarter, bringing the total since last year to $42bn (£23bn).

The reorganisation comes after pressure from shareholders, including Luqman Arnold, who was chief executive briefly before being ousted in 2001. Mr Arnold has built a 2.8pc stake in UBS through his private equity vehicle Olivant, and has called for change, including potentially selling the investment bank.

Olivant yesterday welcomed the new strategy, saying: "The separation of the divisions provides a basis for exercising strategic options." Olivant added that Peter Kurer, promoted earlier this year to chairman despite shareholder opposition, "has signalled his receptiveness to taking advantage of such opportunities".

Mr Kurer attempted to play down the likelihood of a fire sale. He said competitors were on the prowl for cheap assets, but that the group was not for sale and had not received any formal offers. "For the time being, there are no plans to divest," he said.

However, by conceding that the "one bank" model of running the three divisions was not working, UBS had abandoned a central tenet and was open to a break-up, some financial sources said. "We believe UBS investment bank will be not fully owned and even potentially disposed of by UBS over the next two years," said JP Morgan analyst Kian Abouhossein.

There has been speculation that Barclays might be interested. Any buyer would have to be prepared to take a big risk, analysts have said, as the division is the main source of UBS's problems because of US sub-prime mortgage assets bought in the past few years.

UBS yesterday reported a second-quarter net loss of $329m. The world's largest bank to the rich also said it had haemorrhaged $41bn in the second quarter, primarily from cash withdrawals due to fears about UBS's write-downs. Over the same period last year, the bank saw an inflow of $31bn.

Mr Cryan is currently head of UBS's financial institutions business in London. The 48-year-old Briton is among a handful of bankers whose client list spans big names in the UK and the US. He was one of ABN Amro's chief strategists in the auction of its business last year. Mr Cryan replaces Marco Suter, an ally of former chairman Marcel Ospel, who was toppled in the crisis.

UBS last week agreed to buy back almost $19bn of bonds after an investigation by US authorities over allegations it had steered clients towards auction-rate securities - debt which became impossible to sell after the market froze. UBS said this would cost it $900m.

Mechanism for Credit Is Still Stuck
A year after financial tremors first shook Wall Street, a crucial artery of modern money management remains broken. And until that conduit is fixed or replaced, analysts say borrowers will see interest rates continue to rise even as availability worsens for home mortgages, student loans, auto loans and commercial mortgages.

The conduit, the market for securitization, through which mortgages and other debts are packaged and sold as securities, has become sclerotic and almost totally dependent on government support. The problems, intensified by bond investors who have grown leery of these instruments, have been a drag on the economy and have persisted despite the exercise of extraordinary regulatory powers by policy makers.

“The mortgage finance system in the United States has been badly damaged,” said Anthony Lembke, co-head of investments at MKP Capital Management, a hedge fund firm that is a big investor in mortgages. “There is definitely some reinvention that will need to occur, and that will include some explicit involvement by the government.”

Bond investors first stopped buying private home mortgage deals, then shunned commercial mortgages. Now, they are becoming wary of credit card debts and auto loans. In the first half, private securitizations reached just $131 billion, down sharply from $1 trillion in the same period last year, according to data compiled by Thomson Reuters.

Some analysts say investors are acting like the “bond vigilantes” of the 1980s and early 1990s. Those traders drove a surge in interest rates because they feared inflation and a mounting federal budget deficit.

“The bond vigilantes took law and order in their own hands and pushed yields up, which would slow down the economy and bring down inflation,” said Edward E. Yardeni, an investment strategist who is credited with coining the term. “This time the bond credit vigilantes are refusing to go into the saloon and start drinking what Wall Street’s financial engineers are mixing.”

For their part, bond traders say that the weakening economy is making it harder for them to invest with confidence because even areas like auto loans, credit cards and commercial mortgages that once seemed secure now look vulnerable. They are also worried that demand for the securities they trade in will be weaker in the future as banks, brokerage firms and other investors are forced to sell.

Their reluctance to invest implies that credit, whether for businesses that want to expand or people who want to buy homes, will remain tight. That concern was underscored by the Federal Reserve’s most recent survey of loan officers, which on Monday showed that most domestic banks had tightened lending standards and that demand for loans had weakened in the second quarter.

The pullback is compounded by a continued rise in interest rates despite the Fed’s efforts to grease the wheels of finance by gradually slashing its benchmark rate to 2 percent, down from 5.25 percent last August. The average interest rate on a 30-year fixed mortgage climbed to 6.7 percent last week, from 5.89 percent in the spring.

“It appears that every time we peel away this onion, there is another layer,” said Curtis D. Ishii, the senior investment officer for fixed income at Calpers, the large California pension fund. He added that investors were starting to realize that the pain in the credit market would persist for some time.

One measure of that stress is found in falling home prices. “To the extent that home prices keep spiraling down, the need for capital keeps increasing,” said Alejandro H. Aguilar, a portfolio manager at American Century Investments, the mutual fund company. Investors will be able to better estimate the size of their losses once it becomes clear how far prices will fall and when they will hit bottom.

As they wait for the housing market to recover, many investors have continued to rush to safe havens like Treasuries and other debts with a government backing or a short payoff, a sign that investors remain unwilling to invest in mortgages, even though lending standards have improved from the go-go days of the housing boom.

Money market funds, the short-term cash alternatives, grew to $2.9 trillion in June, up from $2.1 trillion a year ago, according to Crane Data. Those funds, in turn, have more than tripled their holdings of Treasuries and other government debt while reducing the share of their portfolios invested in somewhat riskier corporate notes.

Patrick Ledford, chief investment officer at the Reserve, one of the nation’s largest operators of money market funds, said some institutional investors had moved assets into government funds from broader money market funds to avoid exposure to commercial paper, which are short-term debts.

Some of the slack in the credit market has been taken up by the government chartered mortgage finance companies Fannie Mae, Freddie Mac and Ginnie Mae. The three firms have securitized $692 billion in home mortgages through June, putting them on track to match, approximately, the $1.2 trillion they securitized in 2007, according to Inside Mortgage Finance, a financial trade publication.

But prices for these securities have fallen in the last two months, despite the backing of the government companies and initiatives by Congress and the Treasury to create a stronger government safety net for Fannie Mae and Freddie Mac.

The two companies, which reported big losses last week, have said that they might reduce or slow the amount of large loans they buy from banks, a signal that two giants that had been big buyers might become sellers. If so, that would lower the price of mortgage securities even more, raising the cost of borrowing for home buyers.

Because those developments have damped the private mortgage market, the Treasury Department has sought to revive activity by encouraging the use of covered bonds, which have been a popular investment in Europe.
Unlike a mortgage security, the home loans that back a covered bond stay on the issuing bank’s balance sheet.

If loans default, banks replace them, making the bonds less risky to investors but more so to the banks. In July, four big banks — Bank of America, Citigroup, JPMorgan Chase and Wells Fargo — said they would issue covered bonds.

But before jumping in wholesale, investors say they want to know more about the quality of loans backing the bonds and see more detailed federal rules about how the bonds will be handled if banks fail. “It may be a step in the right direction,” said Daniel O. Shackelford, a bond portfolio manager at T. Rowe Price, the mutual fund firm. “But I am not sure it will solve all the problems.”

Home Prices Hold Key
Credit Crisis Will End When Assets Stabilize

Back to the bunker. That was the message after J.P. Morgan Chase warned of $1.5 billion in mortgage-related losses in the still-nascent third quarter and after a pair of prominent analysts downgraded Goldman Sachs Group.

The moves reminded investors that, despite a brief rally in stocks since mid-July, credit markets are as unsettled as ever. And that will continue until the price of houses, the key asset underlying many credit products, starts to stabilize.

That doesn't look likely to happen soon. Housing inventory has hit about 11 months' worth of sales and is likely to peak at around 13 months' some time in early 2009, according to Credit Suisse. Mortgage company Freddie Mac recently increased expectations for national peak-to-trough home-price losses to between 18% and 20% from 15% previously.

Banks, meanwhile, are still hoping many of their mortgage-backed holdings will come through the storm unscathed. That wishful thinking is preventing the kind of capitulation, and balance-sheet clearing, needed to get markets trading again.

Once banks start selling houses and loans at bargain prices, buyers will return. The hits will be painful but are likely needed to spark the kind of meaningful trading volume required to restore some certainty to housing markets -- and by extension wider credit markets.

In the meantime, markets for mortgage-backed securities have worsened, largely because of the precarious positions of Freddie and Fannie Mae. Both firms last week said they are no longer able, due to ballooning balance sheets and shrinking equity bases, to provide unconditional support to mortgage-backed securities markets. That removes a source of stability.

This comes on top of the continued uncertainty over any support the government will have to provide to the firms. Although the government in mid-July effectively said it would bail them out, the fuzziness of the plans has led to more mortgage-market angst.

One gauge of the tension is the difference between the prices of mortgage-backed securities guaranteed by Fannie or Freddie and Treasurys, adjusted for the cost of hedging against prepayment risk. That has shown marked deterioration in the latter half of July and early August, according to Jim Vogel, an analyst at FTN Financial Capital Markets.

This measure has widened to 0.65% in recent days, compared with about 0.5% at the time of the Bear Stearns crisis in March. It was flat at the beginning of the year, and in early June, was about 0.16%. The widening of such spreads led to J.P. Morgan's warning of renewed mortgage-market losses, which caused its stock to drop 9.5% Tuesday. That raises the prospect that other banks sitting on piles of mortgage securities will feel similar pain.

It also is bad timing for investment banks like Goldman, given that their fiscal third quarter comes to a close at the end of this month. The financial crisis started a year ago with housing. That is where it also has to end. It is just going to take more time before that happens.

Morgan Stanley's $4.5 billion auction rate buyback rejected
Morgan Stanley has become the latest bank to offer to buy back illiquid auction rate securities from clients - only to be told its offer is "too little, too late".

The response to the investment bank's decision to repurchase up to $4.5bn (£2.25bn) of the frozen assets came from the office of New York attorney general Andrew Cuomo, who has been leading the push for banks to compensate clients.

On Monday, Mr Cuomo wrote letters to three banks - including Morgan Stanley - that had yet to offer to buy back the securities, after last week reaching deals with Citigroup, Merrill Lynch and UBS to buy back up to $36bn of the securities.

Morgan Stanley responded by issuing a document that said it would repurchase the securities from retail investors and charities, and said that it had communicated its plan with various regulators, including Mr Cuomo. But his office rejected the plan, and said: "Our investigation into Morgan Stanley continues."

It is not known which part of the bank's scheme does not satisfy the NY attorney general, but it is thought its plan to buy back the securities no later than September 30 may be too much of a delay. The $200bn auction rate securities market collapsed in February after major banks that had in the past added liquidity ended their support as the credit crisis worsened.

Wachovia, which received one of Mr Cuomo's three letters along with JP Morgan Chase on Monday, is thought to be close to reaching a deal with regulators on its own auction rate exposure.

Rotten Investments Hit Euro Financials
A drop in investment earnings hit Dutch financial services firm ING Groep less than feared, but investors shrugged off the better-than-expected results, focusing on the company's cautious outlook instead.

ING fell 0.5%, or 12 euro cents (18 cents), to 22.87 euros ($34.01), in Amsterdam. Net profits for the second quarter of the year fell 25.0%, to 1.9 billion euros ($2.8 billion), a smaller drop than analysts polled by Reuters had forecast. But that proved to be cold comfort, as Chief Financial Officer John Hele warned that the year ahead would remain challenging.

Like other financial services companies and banks, ING was directly hit by write-downs from assets linked to the U.S. mortgage market, and it also booked 44.0 million euros ($65.4 million) in write-downs from its exposure to subprime and Alt-A residential mortgage-backed securities and collateralized debt obligations, as well as a revaluation of 260 million euros ($386.8 million) through shareholders' equity.

Its write-downs were a fraction of those recorded by Belgian-Dutch financial services company Fortis, which reported impairment charges and write-downs totalling 479 million euros ($746.9 million) for the second quarter, last week.

ING's sliding investment income was the main reason behind its overall decline in profits. Revenue at its wholesale banking division was hit by lower real estate valuations, while a drop in private equity valuations and investments returns ate into profits at ING's insurance business. Together they accounted for 754 million euros ($1.1 billion) of the net decline in profits.

Chief Executive Michel Tilmant said that the company had made use of the brief rally in equities in April to reduce its equity investments, but warned that the year ahead would be challenging for the financial services sector, which faced "unprecedented market volatility, limited liquidity and intensified competition for deposits," into next year.

Countrywide sued by West Virginia over mortgages
Countrywide Financial Corp, now owned by Bank of America Corp, has been sued by West Virginia, which accused the mortgage lender of making risky and costly loans to consumers who couldn't afford them.

Darrell McGraw, the state's attorney general, announced the lawsuit against Countrywide and its co-founder and former chief executive, Angelo Mozilo, on Tuesday. West Virginia is at least the fifth U.S. state to sue Countrywide over its business practices, joining California, Connecticut, Florida and Illinois. Another state, Washington, has threatened to revoke Countrywide's lending license.

Countrywide had been the largest U.S. mortgage lender before Bank of America bought it on July 1 for $2.5 billion. A copy of the lawsuit was not immediately available.

Bank of America did not immediately return a call seeking comment. The Charlotte, North Carolina-based bank has repeatedly said it is committed to responsible lending practices. Countrywide was based in Calabasas, California.

McGraw accused Countrywide of making "unaffordable and unconscionable" home loans to West Virginia consumers. He said the lender improperly enticed consumers with loans that required no down payments, as well as with adjustable-rate mortgages that carried low initial "teaser" rates but which later reset at much higher rates.

The attorney general also said Countrywide inflated appraisals, saddling consumers with home loans that they were later unable to refinance.

Short sellers' trimmed bearish bets on many financial issues
"Short sellers" pulled back on their bearish bets in major financial stocks between July 15 and July 31, new data show.

Whether that had much or anything to do with the Securities and Exchange Commission’s attempt to quash the most aggressive form of shorting in 19 big financial issues, we’ll never know. It could just be a coincidence. And the data don’t suggest the shorts were running all that scared. In the case of at least one of the 19 stocks -- mortgage titan Freddie Mac -- the shorts were confident enough to keep raising their bets.

After six weeks of plummeting bank and brokerage share prices, the SEC on July 15 announced an unprecedented rule aimed at preventing "naked" shorting of 19 major financial stocks, including Freddie Mac, Fannie Mae, Citigroup and Merrill Lynch & Co.

SEC Chairman Christopher Cox has said the agency had no problem with legitimate short sellers -- bearish traders who borrow stock and sell it, betting the price will drop. But the SEC, Cox said, wanted to prevent so-called naked shorting, which is selling stock without having the borrowed shares lined up. Naked shorting can lead to a "bear raid" on a stock, pummeling it mercilessly.

The temporary rule that took effect on July 21 required that anyone shorting the 19 stocks "arrange beforehand to borrow the securities and deliver them at settlement." Many on Wall Street saw the rule as an attempt to jawbone even legitimate short sellers into backing off.

Whatever the SEC's intention, between July 15 and July 31 the number of shorted shares declined in nearly all of the 19 issues, according to New York Stock Exchange data reported late Monday. But the stock market overall was rallying in that period, and rallies often cause some short sellers to close out their bets.

The number of shares shorted on the NYSE overall (covering all listed stocks) fell 1.5% in the last two weeks of July, to 18.3 billion, the first drop since late March. Specifics on a few of the stocks on the SEC’s list:
  • The number of shorted shares of Fannie Mae dropped 5.2% betweeen July 15 and July 31, to 146.4 million. But that wasn’t much of a decline given that the short position has soared from 86 million shares at the end of April.
  • There were 54.9 million shares short in Merrill Lynch at the end of last month, a decline of 13.5% from the record high of 63.5 million in mid-July but still up sharply from 42 million at the end of April.
  • Lehman Bros. remained a popular short target: The total short position dipped less than 4% in the last two weeks of July, to 82.1 milllion.
  • As for ailing Freddie Mac, the shorts boosted their bearish bets by nearly 13% in the period, from 105.9 million shares to a record 119.4 million. The company’s shares have slumped from $8.17 on July 31 to about $5.60 today.

The SEC’s temporary rule expires today. Cox has said the agency won’t extend it but will soon propose a similar rule to restrict naked short selling across the entire market.

Japan Economy Shrinks 2.4% as Exports Decline; Recession Looms
Japan's economy, the world's second biggest, contracted last quarter as exports fell and consumers spent less, bringing the country to the brink of its first recession in six years.

Gross domestic product shrank an annualized 2.4 percent in the three months ended June 30 after expanding 3.2 percent in the first quarter, the Cabinet Office said today in Tokyo. The Nikkei 225 Stock Average fell 2.1 percent, the most since Aug. 1.

Exports dropped for the first time in three years, robbing Japan of the engine that drove its longest postwar expansion, while record fuel and food prices deterred spending at home. Toyota Motor Corp. last week reported its worst earnings decline in five years as U.S. sales slumped, and Japan Airlines Corp. said it will cut wages to counter rising costs.

"The economy will keep flying at a low level this year as demand weakens, even from Europe and Asia," said Hiromichi Shirakawa, chief economist at Credit Suisse Group in Tokyo. "Japan's economy is deteriorating." The yen rose because investors reduced holdings of riskier assets on concern that Japan's contraction signals a deepening global economic slump. The currency traded at 108.82 per dollar at 4:30 p.m. in Tokyo from 109.33 before the report.

Asia's biggest economy shrank 0.6 percent from the first quarter, when it grew 0.8 percent, today's report showed. The drop in GDP was in line with economists' estimates. Housing investment unexpectedly fell, causing the Topix Real Estate index to tumble 3.5 percent. Mitsui Fudosan Co. and Mitsubishi Estate Co., Japan's biggest property developers, led the declines.

The government last week described the economy as "weakening," language it hadn't used since 2001. Stalling growth and the fastest inflation in a decade have created a dilemma for the Bank of Japan, which will probably have to keep its benchmark interest rate at 0.5 percent for the rest of the year, according to economists surveyed last month.

Japan joins Canada and Italy among Group of Seven economies that have contracted this year. The European Union shrank 0.2 percent in the second quarter from the first, economists estimate a report will show tomorrow. The U.S. grew 0.5 percent last quarter, buoyed by a temporary boost from tax rebates that economists expect will fade.

Exports slumped 2.3 percent, the most since the 2001-2002 recession, the Cabinet Office said. Imports fell 2.8 percent.
Consumer spending, which accounts for more than half of the economy, decreased 0.5 percent from the previous quarter, compared with expectations of 0.6 percent.

"With prices rising, consumers are becoming cautious about spending," Economic and Fiscal Policy Minister Kaoru Yosano said today. Prime Minister Yasuo Fukuda plans to announce relief measures later this month to help companies and households cope with record energy costs.

Household sentiment fell in July to the lowest ever, after inflation outpaced wage growth. Summer bonuses at Japan's biggest companies dropped for the first time since 2002, according to the Keidanren business lobby. The world's second-largest economy has yet to contract for two consecutive quarters, one definition of a recession.

Still, rising costs and slowing exports have eroded profits, forcing businesses to cut production, investment and hiring. Domestic demand, which includes company and consumer spending, accounted for 0.4 percentage point of the economy's quarter-on-quarter contraction. Business investment slipped 0.2 percent, less than the 0.6 percent analysts predicted.

Toyota, Japan's biggest company, last week lowered its vehicle sales forecast by 3.5 percent for the year ending March 2009. Since June, Toyota has fired 800 workers at a Kyushu-based subsidiary that's making fewer sport-utility vehicles and Lexus sedans bound for the U.S.

Japan Airlines, the country's largest carrier by sales, said last week that it will reduce workers' pay by 5 percent to compensate for the increase in fuel prices. Housing investment slid 3.4 percent as homebuyers shunned new condominiums because of rising prices and banks tightened lending to developers. Economists anticipated a 1.4 percent rise.

"Demand for new homes has weakened and we believe residential investment is unlikely to recover much further in coming quarters," said Hiroshi Shiraishi, an economist at Lehman Brothers in Tokyo. Still, the current slowdown is unlikely to be as severe as past recessions because companies have paid off debt and shed extra workers and idle equipment, said Huw McKay.

"We're not in the kind of situation we were in at the end of previous expansions," said McKay, senior international economist at Westpac Banking Corp. in Sydney. "There's going to be a floor under this economy."

Companies plan to increase investment by 4.1 percent in the year ending March 31, according to a survey released last week by the Development Bank of Japan. While that's slower than last fiscal year's 7.7 percent, it's better than the 10 percent decline recorded during the 2001 recession.

The Bank of Japan's most recent business survey showed that labor demand is close to a 16-year high. The job-to-applicant ratio was at 0.91 in June, meaning almost every person who wants a job can get one. Seven years ago, there were two applicants competing for every position.

The recent decline in energy and material prices may also provide respite for Japan's companies and households. Oil has dropped 22 percent since exceeding $147 a barrel for the first time on July 17. "These are weak numbers but not disastrous," said Julian Jessop, chief international economist at Capital Economics Ltd. in London. "With global commodity prices now tumbling, this bad news is largely old news.'

Countrywide/Bank of America Merger Impacts California Defaults
The July 1 acquisition of Countrywide Financial Corp. by North Carolina-based Bank of America Corp. is clearly having an impact on California default activity, with notices of default falling statewide for the third straight month.

The vast majority of the drop is tied to loans with the now-combined mortgage operation, according to a report released Tuesday by property information providers ForeclosureRadar. Notices of default represent the first step in the foreclosure process; relative to June totals, the volume of NODs fell during July by 4.6 percent to a total of 40,219 filings, representing $17.71 billion in loans. (The July 2008 total was still well above the roughly 24,000 filings recorded in July 2007).

“Although the declines in Notices of Defaults seem promising, much of this can be explained by the actions of just one lender,” said Sean O’Toole, founder of ForeclosureRadar. “Ninety-one percent of the decline in Notices of Default since April can be attributed to Countrywide Financial. Unfortunately, this is more likely due to the challenges of integrating two companies the size of Countrywide Financial and Bank of America, than it is a fundamental shift in foreclosure activity.”

While NOD activity is flat to declining as BofA/Countrywide try to get their ducks in a row, actual foreclosures skyrocketed in California during July, ForeclosureRadar said. Sales at foreclosure auction jumped dramatically, increasing by more than $2 billion in combined loan value to $12.55 billion. This represents more than 1,300 properties being taken to auction per business day, up from 415 per day one year ago.

Average discounts offered by lenders from the outstanding loan balance at foreclosure auction reached 45 percent in Merced and San Joaquin counties; statewide, discounts increased to 33 percent on average, according to the data. San Francisco continued to see the smallest auction discounts, at 18 percent on average.

Despite lender’s best efforts to discount, third-party buyers largely yet remain on the sidelines. Foreclosures hit a total of 28,795 properties during July; of those, 27,817 received no bid higher than the lender’s opening bid, meaning REO inventories are mushrooming throughout key areas in the state.

Making matters worse, tightening credit standards and home prices that have yet to bottom out are putting borrowers in the hot seat. Of the 243,444 Notices of Trustee Sale filed in the last year that have concluded the foreclosure process, 85 percent resulted in the loss of the property at trustee sale.

That means that only 15 percent of severely troubled borrowers were able to avert foreclosure; and, of those, 30 percent have since had a new foreclosure notice filed. The total number of properties in the default pipeline and actively scheduled for auction increased to 64,598 at the end of July, up from 59,973 at the end of June, and 53,793 at the end of May. This indicates that further increases in foreclosure sales are still likely near term, despite the declining number of defaults.

Notices of Trustee Sale, which are typically recorded 105 days after the Notice of Default, and which set the auction date and time, increased 9.8 percent month-over-month to 39,010 filings in July — increasing NTS filings have helped push up the default pipeline within California in recent months.

Aussie Bank to Bring America’s Biggest Bankers to Their Knees?
July 25 was a particularly bad day for Australia’s four biggest banking stocks. In a matter of hours, $16.2 billion in stockholder value was erased from existence—the worst fall since Black Monday in October 1987.

Investors jumped ship following the decision by the National Australia Bank to take a 90 percent write-down on a chunk of mortgage-backed assets that were supposedly aaa-rated. Yet, the full implications of the announcement were largely missed by the media. To them, July 25 was just one more bad day in a bad year in which Australian financial stocks ground lower and lower.

The “aaa” assets in question were bundles of U.S. mortgages that National Australia Bank (NAB) had purchased for around $1.2 billion prior to the U.S. real-estate and lending bubble bust. The problem with the mortgages arose after American home valuations plunged and homeowners began defaulting on their mortgages in record numbers.

All of a sudden, the market for mortgage-backed investments dried up, and no one wanted to buy the formerly triple-A-rated securities anymore. So the accounting question that American banks faced was: What is a bundle of mortgages worth when nobody is willing to bid on them at auction? This was an important question because U.S. banks and investors held “trillions” worth of mortgages.

So banks used fancy computer models and mathematical equations to come up with the answer for accounting purposes—typically valuing their mortgage holdings near or somewhat less than what they paid for them. The result was the banks’ balance sheets continued to look strong, even though house prices were plunging and defaults were rising.

As long as no one technically knew what the true market value of the mortgage bundles were, no losses need be admitted, and the game could continue. But, if a bundle of mortgages was sold, then a market value could be determined, and the banks would have to adjust their accounting books accordingly, marking their investments to market value.

Because the mortgage attrition rate has been so fearful, U.S. banks have been doing just about everything possible to avoid having to find out what their investments are actually worth. But now NAB has let the cat out of the bag. NAB has revalued its package of U.S. mortgages down to about 10 cents on the dollar. Now U.S. banks will face pressure to similarly down-mark the value of their portfolios of mortgages. The losses could be huge.

“The National Australia Bank’s decision to write off 90 percent of its U.S. conduit loans will have dramatic repercussions around the world,” reports the Business Spectator. “Wall Street will be deeply shocked when they understand the repercussions of what NAB has done. It is clear global banks have nowhere near provided for their exposures to U.S. housing loans which … are experiencing a ‘meltdown.’”

But it could even be worse—and the losses are snowballing. The NAB write-down was apparently linked to Merrill Lynch’s recent write-down, which was announced four days later. Merrill Lynch sold a bundle of mortgages with a face value of over $30 billion for 22 cents on the dollar.

But here is the real kicker. Merrill actually sold the mortgages for much less than was reported to the media. In Merrill’s press release, it was revealed, “Merrill Lynch will provide financing to the purchaser for approximately 75 percent of the purchase price.”

According to analyst Morgan Housel, the sale terms also say that if the mortgages go bad, the buyer is not on the hook for the Merrill loan either. “To put it another way, if there wasn’t a we’ve-got-your-back loan attached to the sale, it’s almost certain that [the purchaser] would have only agreed to purchase the assets for much, much less than $0.22 on the dollar.” The real purchase price is probably closer to 6 cents on the dollar.

If you think it is beginning to sound like a peanut shell game, where banks have been desperately trying to cover up losses, you are probably more right than wrong. But U.S. banks’ balance sheets are probably about to get whacked again, as NAB and Merrill force the big banks to own up to the current market value of many of their mortgages.

“U.S. banks have written down $450 billion in bad housing loans,” notes the Business Spectator. “The revelation from NAB means that they will now certainly need to take provisions to $1,000 billion. But write-downs of $1,300 billion and perhaps even more are on the cards.”

Many banks will fail, merge or be bought out, and the credit crunch could easily intensify. Jobs will be lost, and it could become much more difficult to get a loan or qualify for a credit card. For an economy that is so reliant on consumer spending fueled by borrowing, the fallout from a banking crisis will not be pretty.

Britons must brace for a year of economic pain
The Bank of England's Governor braced Britain for a year of economic pain today, admitting that there is a real threat of recession, with growth set to grind to a halt and inflation likely to peak at about 5 per cent during the autumn.

In a stark message, Meryvn King left little doubt that tough times lie ahead as the Bank sharply cut its forecast for growth this year and next while predicting sharply higher inflation in the short-term, spelling further financial stress for families. "The next year will be a difficult one, with inflation high and output broadly flat," Mr King said. "The British economy is going through a difficult and painful adjustment."

The Bank's latest quarterly Inflation Report today made clear that it sees little scope for any early interest rate cuts to help shore-up the rapidly weakening economy. Soaring food and energy prices are set to drive inflation up from last month's 16-year high of 4.4 per cent, more than double the Bank's 2 per cent target, to a peak of about 5 per cent in the next few months.

But the Bank also eased fears over the threat that it could be forced to raise rates, and hinted at the chance of eventual cuts around the end of the year, as it predicted that inflation is set to fall very sharply from its autumn peak to drop under the 2 per cent target in two years' time, and then continue to decline.

City economists said that the Bank's latest forecasts pointed to interest rates remaining on hold for the moment, but said there was a chance that they could fall before Christmas. The more doveish than expected assessment of prospects from the Bank, led financial markets to move quickly to increase betting on the chance of a rate cut before the end of the year. Rising hopes over eventual rate cuts also triggered a fall in the pound.

"The tone is clearly doveish, with the economy now expected broadly to stagnate over the next year or so," Jonathan Loynes, of Capital Economics, said. The steep drop in inflation forecast by the Bank from the end of this year is driven by the severity of the downturn that it now expects Britain to suffer.

The economy is expect to stagnate for much of the coming year, with the annual pace of GDP growth dropping to zero, and a clear danger of an even worse outcome. Mr King conceded that the economy could slide into technical recession, with the economic output falling for two or more consecutive quarters, over the coming year. "I think with broadly flat output, it's bound to be the case that there is a possibility of a quarter or two of negative growth," he said.

The Governor was blunt about the rough ride that many households will face over the coming year as the financial squeeze from rising food and energy bills grows still worse. Families' incomes would grow only very weakly, and for some spending power would fall, leading to a further slowdown in consumer spending.

At the same time, he said that the economy would also continue to be blighted by the continuing credit crunch, the slump in the housing market, and anaemic investment activity by businesses. Mr King said that Britain's economy had been hit by a unique combination of shocks from the leap in energy and commodity prices alongside credit crunch, which he called "the biggest financial dislocation since the Second World War".

"The combination of these two shocks, which have originated primarily in the rest of the world economy, have meant that life is extremely difficult and will be for the UK economy over the next year," he said. The Bank's forecasts today suggest that the economy will grow this year by only about 1.5 per cent - below the 1.75 per cent minimum presently projected by the Chancellor.

Next year, the Bank sees even weaker growth of just 0.75 per cent - compared with Alistair Darling's existing forecast for a recovery to bring growth of 2.25 to 2.75 per cent. On its main forecast, the Bank expects the worst of the economy's slowdown to run from the present quarter until the end of the second quarter of next year, with growth close to zero throughout this stretch of stagnation, and only resuming next autumn

Bank of England slashes UK growth forecasts as slowdown deepens
The Bank of England has slashed its economic growth forecast as the sharp slowdown takes the UK to the brink of its first recession in almost two decades.
The economy will grow just 0.1pc in the first three months of next year, according to the Bank's much-awaited quarterly Inflation Report, which overall provides gloomy reading. The Bank has previously expected growth of 1pc in the first quarter of next year.

The downward revisions will be embarrassing for Chancellor Alistair Darling, who is still forecasting that the economy will grow by 2pc this year and 2.5pc next year. Mervyn King, the Bank's Governor, said that the outlook for both economic growth and inflation had deteriorated more sharply than it had expected when it published its last quarterly report in May.

If the UK economy does grow at such a low level, the chance of a technical recession, with two successive quarters of contraction, is significant.

The Bank also warned today that inflation is likely to hit 5pc in the coming months, rather than the 4pc peak it was expecting at the time of the last Inflation Report. The Consumer Prices Index - the Government's preferred measure of inflation - rose to 4.4pc in July compared with 3.8pc in May, figures from the Office for National Statistics showed yesterday.

Those figures, combined with the prospect of even higher inflation in the months to come, leave the Bank's Monetary Policy Committee with little room to cut interest rates in the short-term, despite the rapid deterioration in the economy.

Last week the MPC voted to hold rates at 5pc as it grappled with the twin threat of inflation, which is squeezing disposable incomes, and the economic slowdown, which has brought the UK housing market to a standstill.

However, economists believe that the MPC was split three ways over the decision for a second consecutive month, with Tim Besley supporting an increase and David Blanchflower arguing for a decrease.

UK jobless rate rises at fastest pace in 15 years
The number of people claiming unemployment benefits leapt by 20,100 in July, signalling the biggest rise since Britain's last recession in 1992.The sixth consecutive monthly rise took the claimant count to 846,700, up from 844,000 in June, official figures show.

The number of people out of work, calculated using the alternative ILO measure, rose by 60,000 in the three months to June, the biggest rise since mid-2006, taking the rate to 5.4 per cent, from 5.2 per cent in the first three months of the year. Total unemployment, including people not eligible for benefit, is now 15,000 higher than a year ago.

While employment was up by 20,000 in the three months to June, the rate of increase has slowed sharply.Analysts say that unemployment is set to rise even further as job cuts by housebuilders continue to feed through. The construction sector has shed 35,000 jobs since its peak last year. Influential surveys from manufacturers and service companies also indicated that employment is set to fall in these sectors.

Howard Archer, of Global Insight, the economic consultancy, said: "It seems inevitable that extended very weak economic activity and deteriorating business confidence will exact an increasing toll on the labour market over the coming months."
Vicky Redwood at Capital Economics, said tumbling house prices could also hasten a rise in unemployment as confidence suffered.

"It is only a matter of time before the resulting weakness in firms’ revenues results in more widespread job cuts," she said.
But in an encouraging development for the Bank of England, average earnings including bonuses rose by a weaker-than-expected 3.4 per cent in the three months to June, down from 3.8 per cent in the three months to May, signalling that the weakening jobs market is keeping a lid on pay deals despite rocketing inflation.

Pay deals excluding bonuses rose by 3.7 per cent, down from 3.8 per cent. However, while pay rose by a modest 2.8 per cent in manufacturing firms, private-sector pay deals were much higher at 4 per cent, although this was 0.2 percentage points lower than in the three months to May. Inflation rose to a 16-year high of 4.4 per cent in July, more than double the Government's 2 per cent target and the highest annual rate since 1992.

Prices were pushed higher by the soaring cost of food and fuel. There were fears that wages could start to rise as workers demanded bigger salaries to cover the increased cost of living, sparkling a wage-price spiral that would serve only to further entrench inflation in the economy as prices and wages pushed each other higher.

Mr Archer said that modest pay agreements in future months were key for future rate cuts. "It is absolutely critical that earnings growth remains muted, if the eventual next move in interest rates is to be down. Any sign that higher inflation and elevated inflation expectations are feeding through to push up pay significantly would add to already significant pressure on the Bank of England to lift interest rates," he said.

Renewed Heat On Canada ABCP?
The head of a committee overseeing the restructuring of $32-billion of frozen commercial paper says the investment dealers that sold the paper may be under pressure to "put more on the table" after U. S. regulators forced a slew of U. S. banks to buy back more than $40-billion of similarly flawed securities.

In a telephone interview, Purdy Crawford said he believes "there are similarities" between the blow-up in the U.S. market for auction-rate securities and the one in Canadian asset-backed commercial paper (ABCP), particularly in the way retail investors are treated.

Mr. Crawford said the expensive settlements being negotiated south of the border may motivate banks that sold ABCP in Canada to resolve the legal disputes around the workout and make it happen sooner, rather than later. "I'm not sure [the U. S. settlements] will motivate banks to put more on the table. They might and they might not," Mr. Crawford said.

So far, Canadian regulators have left it up to the industry to sort out the ABCP problem, and the industry would be loath to see a U. S.-style solution, which could happen if the workout fails. Today marks the one-year anniversary of the collapse of the ABCP market, which seized up after Coventree Inc., the biggest sponsor, failed to find buyers for maturing notes and banks that had agreed to provide emergency liquidity opted not to step up.

In the wake of the meltdown, a group of financial institutions put together a plan to rescue the frozen paper by restructuring it into longer-term notes. It is now tied up in court and the outcome is anything but certain. Even if the restructuring happens, the lion's share of the losses -- some of the notes are expected to trade at 20% of face value -- will be borne by investors, rather than the financial institutions that created and sold the ABCP.

Only retail investors will get all their money back, but the buyback offers put forward by Canaccord Capital Corp. and Credential Securities are contingent on the workout going forward. "This has been one of the most difficult years we have ever had," said Wynne Miles, an investor in Victoria who has "a significant amount" of her savings in ABCP. "It's hard for people to imagine the toll that the frustration and stress had on myself and my husband."

The US$330-billion market for auction rate securities seized up in February after financial institutions stopped buying them. Like ABCP, auction rate securities are complex debt instruments originally intended for sophisticated investors. New York Attorney-General Andrew Cuomo has accused the banks of misrepresenting the investments as "safe" and "liquid" when they weren't. On Monday, Morgan Stanley became the latest to announce a settlement with regulators, offering to repurchase US$4.5-billion of stalled auction rate securities.

Meanwhile, the ABCP restructuring has been almost completely free of regulatory intervention and is languishing in court. The latest hold up is a challenge by drugstore chain Jean Coutu and other corporate holders who say they want the same treatment as retail investors. They say they were victims of investment dealers and shouldn't be forced to suffer losses as a result.

The case is now before the Ontario Court of Appeal, but many observers predict that it will eventually be heard by the Supreme Court of Canada sometime in the fall. Mr. Crawford said he is "optimistic" that the restructuring will win court approval.

Many of the institutions backing the deal are said to be negotiating with the corporate noteholders, trying to persuade them to drop their objections. But the companies are holding their ground, sources say. If, as Mr. Crawford suggests, the banks agree to put more on the table, there may be grounds for hope that the companies will drop their appeal

Most Companies Escape Paying US Federal Income Taxes
Two-thirds of U.S. corporations paid no federal income taxes between 1998 and 2005, according to a new report from Congress. The study by the Government Accountability Office, expected to be released Tuesday, said about 68 percent of foreign companies doing business in the U.S. avoided corporate taxes over the same period.

Collectively, the companies reported trillions of dollars in sales, according to GAO's estimate. "It's shameful that so many corporations make big profits and pay nothing to support our country," said Sen. Byron Dorgan, D-N.D., who asked for the GAO study with Sen. Carl Levin, D-Mich.

An outside tax expert, Chris Edwards of the libertarian Cato Institute in Washington, said increasing numbers of limited liability corporations and so-called "S" corporations pay taxes under individual tax codes. "Half of all business income in the United States now ends up going through the individual tax code," Edwards said.

The GAO study did not investigate why corporations weren't paying federal income taxes or corporate taxes and it did not identify any corporations by name. It said companies may escape paying such taxes due to operating losses or because of tax credits.

More than 38,000 foreign corporations had no tax liability in 2005 and 1.2 million U.S. companies paid no income tax, the GAO said. Combined, the companies had $2.5 trillion in sales. About 25 percent of the U.S. corporations not paying corporate taxes were considered large corporations, meaning they had at least $250 million in assets or $50 million in receipts.

The GAO said it analyzed data from the Internal Revenue Service, examining samples of corporate returns for the years 1998 through 2005. For 2005, for example, it reviewed 110,003 tax returns from among more than 1.2 million corporations doing business in the U.S.

Dorgan and Levin have complained about companies abusing transfer prices — amounts charged on transactions between companies in a group, such as a parent and subsidiary. In some cases, multinational companies can manipulate transfer prices to shift income from higher to lower tax jurisdictions, cutting their tax liabilities. The GAO did not suggest which companies might be doing this.

"It's time for the big corporations to pay their fair share," Dorgan said.

Stage two of the gold bull market is just beginning
A war breaks out in the Caucasus, pitting Russia against a close ally of the United States. Inflation reaches a new peak in the euro-zone. The CPI reaches the highest in Britain since Bank of England independence. Rampant inflation sweeps the developing world. Yet gold crashes. It has failed to deliver on its core promises as a safe-haven and inflation hedge, at least for now. Why? Four possible answers:
  1. Nobody seriously believes that Russia will over-play its hand. The world could not care less about Georgia anyway. Ergo, this is a bogus geopolitical crisis.
  2. The inflation story is vastly exaggerated in the OECD core of countries that still make up 60pc of the global economy. The price of gold is already looking beyond the oil and food spike of early to mid 2008 (a lagging indicator of loose money two to three years ago) to the much more serious matter of debt-deflation that lies ahead.
  3. The seven-year slide of the dollar is over as investors at last wake up to the reality that the global economy is falling off a cliff. Indeed, the US is the only G7 country that is not yet in or on the cusp recession. (It soon will be, but by then others will be prostrate). As an anti-dollar play, gold is finished for this cycle.
  4. The entire commodity boom has hit the buffers. Looming world recession (growth below 3pc on the IMF definition) trumps the supercycle for the time being.

Gold has fallen from $1030 an ounce in February to $807 today in London trading. It has collapsed through key layers of technical support, triggering automatic stop-loss sales. The Goldman Sachs short-position that I have been observing with some curiosity has paid off.

For gold bugs, the unthinkable has now happened. The metal has fallen through its 50-week moving average, the key support line that has held solid through the seven-year bull market. This week is not over yet, of course. If gold recovers enough in coming days, it could still close above the line.

Courtesy of my old colleague Peter Brimelow - whose columns on gold are a must-read - note that Australia's Privateer point and figure chart has also broken its upward line for the first time since 2002. This is serious technical damage. So have we reached the moment when gold bugs must start questioning their deepest assumptions.

Have they bought too deeply into the "dollar-collapse/M3 monetary bubble" tale, ignoring all the other moving parts in the complex global system? Nobody wants to be left holding the bag all the way down to the bottom of the slide, long after the hedge funds have sold out. Well, my own view is that gold bugs should start looking very closely at something else: the implosion of Europe. (Japan is in recession too)

Germany's economy shrank by 1pc in Q2. Italy shrank by 0.3pc. Spain is sliding into a crisis that looks all too like the early stages of Argentina's debacle in 2001. The head of the Spanish banking federation today pleaded with the European Central Bank for rescue measures to end the credit crisis.

The slow-burn damage of the over-valued euro is becoming apparent in every corner of the eurozone. The ECB misjudged the severity of the downturn, as executive board member Lorenzo Bini-Smaghi admitted today in the Italian press. By raising interest rates into the teeth of the storm last month, Frankfurt has made it that much more likely that parts of Europe's credit system will seize up as defaults snowball next year.

As readers know, I do not believe the eurozone is a fully workable currency union over the long run. There was a momentary "convergence" when the currencies were fixed in perpetuity, mostly in 1995. They have diverged ever since. The rift between North and South was not enough to fracture the system in the first post-EMU downturn, the dotcom bust. We have moved a long way since then.

The Club Med bloc is now massively dependent on capital inflows from North Europe to plug their current account gaps: Spain (10pc), Portugal (10pc), Greece (14pc). UBS warned that these flows are no longer forthcoming.

The central banks of Asia, the Mid-East, and Russia have been parking a chunk of their $6 trillion reserves in European bonds on the assumption that the euro can serve as a twin pillar of the global monetary system alongside the dollar. But the euro is nothing like the dollar. It has no European government, tax, or social security system to back it up. Each member country is sovereign, each fiercely proud, answering to its own ancient rythms.

It lacks the mechanism of "fiscal transfers" to switch money to depressed regions. The Babel of languages keeps workers pinned down in their own country. The escape valve of labour mobility is half-blocked. We are about to find out whether EMU really has the levels of political solidarity of a nation, the kind that holds America's currency union together through storms.

My guess is that political protest will mark the next phase of this drama. Almost half a million people have lost their jobs in Spain alone over the last year. At some point, the feeling of national impotence in the face of monetary rule from Frankfurt will erupt into popular fury. The ECB will swallow its pride and opt for a weak euro policy, or face its own destruction.

What we are about to see is a race to the bottom by the world's major currencies as each tries to devalue against others in a beggar-thy-neighbour policy to shore up exports, or indeed simply because they have to cut rates frantically to stave off the consequences of debt-deleveraging and the risk of an outright Slump. When that happens - if it is not already happening - it will become clear that the both pillars of the global monetary system are unstable, infested with the dry rot of excess debt.

The Fed has already invoked Article 13 (3) - the "unusual and exigent circumstances" clause last used in the Great Depression - to rescue Bear Stearns. The US Treasury has since had to shore up Fannie and Freddie, the world's two biggest financial institutions.

Europe's turn will come next. We will discover that Europe cannot conduct such rescues. There is no lender of last resort in the system. The ECB is prohibited by the Maastricht Treaty from carrying out direct bail-outs. There is no EU treasury. So the answer will be drift and paralysis.

When EU Single Market Commissioner Charlie McCreevy was asked at a dinner what Brussels would have done if the eurozone faced a crisis like Bear Stearns, he rolled his eyes and thanked the Heavens that no such crisis had yet happened.

It will. Gold bugs, you ain't seen nothing yet. Gold at $800 looks like a bargain in the new world currency disorder.


Anonymous said...

The last article by Ambrose E-P was interesting. For now, the investing public has had markers that guide expectations on how gold prices 'should' behave: when the dollar goes down, gold should be expected to go up. When other commodities, like oil, decline then gold should be declining, too. Ambrose seems to be saying that he foresees a day when both the dollar and the Euro will be in the toilet, and it doesn't matter what they're worth relative to each other, they're both essentially worthless. And when that happens, gold prices will be very, very high. However, that scenario raises a question that I've wanted to put to Jim Sinclair, who has been arguing for some time that gold will eventually reach $1600/oz before 2011: by the time that happens, will there be nothing left of our financial system but a smoldering pile of ruins? What good will it do to hold a coin in your hand that is notionally worth the price of (two cows, two solar panels, 160 bushels of wheat, or 1600 green pieces of paper, take your pick) at today's prices, if no one has or is willing to trade with you?

wv farmer

Anonymous said...

This disconnect from"reality"is what I am concerned about.When the true state of affairs starts to impact/hurt j.q.public, is when I think it will get weird quick.To date,all of the real effects have been felt by the banks and traders ect.Its gotten tighter here in Oregon,but most folks are working,and although everyone knows the cowpie has hit the fan in the real estate market,it seems no real "bonepain" has been felt overall.

It is a little harder to get by,more beggars on the corners with their cardboard signs,Some neighborhoods are getting to "do not enter if you are smart",and overall the signs of hard times are starting.No starving hoards.Yet

I think you will start to see a whole lot of people who are making those 2-3thousand dollar house payments get itchy feet rather than watch their "investment"turn into a rent payment.I wonder [really]how much "jingle mail" is happening now.If you figure out you made a mistake,in you house choice,and money is short,lots of alternative living arrangements are there for use.

My god,1/3 of people upside down?This is news.And not ON the news either.

I sold most of the gold @ $970.Time to buy it back.


Anonymous said...

WV Farmer - If the Mad Max world comes, then wealth-protection takes the very distant back seat to self-protection. In the meantime, currency-in-hand, and silver and gold bullion coins offer one the best chance to pass through the present and coming financial storms...IMHO. GSJ

Anonymous said...

WVF- I would add that the real "pay-off" for owning silver and gold bullion coins would be the re-monetization/re-valuation/universal acceptance of the precious metals as the ultimate wealth conveyance. A distant prospect? Who knows...we may all be surprised! GSJ

Anonymous said...

Property assessments are like a huge nuke just sitting there waiting for someone to light the fuse. I cannot believe how many average people are still blind to this. It is as simple as taking a couple minutes of your time to look at comparables when you get your assessment.

I could not believe my assessment when I got it these year. Living in a relatively stable area for RE where things did not totally get out of control, the YOY assessment from '07 to '08 rose. Rose! And the assessment is at LEAST 10% over market value at this point with prices in the area clearly back to 2004 levels and hurtling IMO terrifyingly quick towards the 2002 level. Of course I contested this one.

For years the claim was that taxes were not being raised as the rate did not go up (but of course the assessments sailed higher). People were not blind to this but went along with it due to the euphoria. When the average dupe figures out he can drop his tax bill by hundreds of dollars by submitting a single form to the assessor board it will hit the fan in a way that I think most people are not even close to being prepared for.

Very frightening. If this is happenining here I can not imagine how CA, FL will even make it through this with out unprecedented social unrest.

Stoneleigh said...


I wouldn't think about buying that gold back now. IMO gold has begun the next phase of its decline, in step with the rest of the commodity complex. I reckon it's headed back to $600 per ounce (at least in this stage), and quite likely lower later. Deflation is an incredibly powerful force that should knock the stuffing out of gold prices, and almost everything else as well.

Ilargi said...

1/ There will come a point where literally almost everything can be bought for literally next to nothing. People's need for cash will rise so high that they'll sell everything they consider luxury for whatever price they can get. This is what deflation does.

2/ For any and all sales, from food to houses and everything in between, societies will need some sort of currency. At least, in cases where barter is not preferred. When paper money is deemed unacceptable for this purpose, and it should be obvious why that is, gold and silver are the obvious way to go.

3/ I have warned before that, in my view, gold and silver in the short term carry a huge manipulation risk. It may take a number of years of sitting out pretty crazy ups and downs for them to solidify as value stores.

This is because there are parties in the world who own enough of it to influence rates and prices. They can buy up a lot of gold -or options on it-, raising the price, and then sell it in bulk at a high point. That would make them a lot of money. And when the price is down, they can buy back the same gold at a much lower price.

We have, of course, seen the Ted Butler article on SemGroup, which suggests that a similar ploy was going on in oil. But, while it's an interesting ploy, it nowhere near as clean as the one that could be in the works for gold and silver.

I don't think, either, that there is much doubt that gold prices are being kept artificially low by central banks. Gold may no longer be the standard, but that doesn't mean it's not closely guarded.

Anonymous said...


do you expect the deflation/depression a worldwide event? who would benefit the most from the strong dollar and the depressed commodity prices?


Ilargi said...


Deflation will be worldwide for sure, since investments in hokey pokey paper have been. That doesn't mean it will all happen at the same time everywhere

But what's that strong dollar you're talking about?

Anonymous said...


my mistake. inflated dollar.


Anonymous said...

Interesting article on bubbles:

This is from a few months back.

Stoneleigh said...


Deflation will definitely be a world-wide event, since financial markets are globally integrated, but that doesn't mean it will affect everyone equally.

I am expecting China to experience something like our 1930s - a painful set back for the empire in the ascendancy, but not the end of its rise towards hegemonic power. Its export markets will collapse, as the consumer of last resort will no longer have purchasing power, and a huge excess of productive capacity will hang over its economy for many years.

For the US and Europe, I expect something considerably worse, although conditions may vary significantly in different regions of each. Both have seen their economies hollowed out as they transition to service economies (in other words trying to make money by doing each other's laundry rather than actually creating wealth). Both have economies that have been increasingly based on real estate, which is now collapsing in value, and its surrounding support structures. Both have seen huge real estate bubbles, with those in various European countries being the worst by far. Both have unsustainable levels of debt in what has become a debt culture, with anglo-saxon economies being the worst offenders.

Structural dependencies on imported energy will represent an enormous weakness for countries about to lose their purchasing power. Western Europe will discover, as Eastern Europe already did, that energy dependence on Russia is not a comfortable position to be in as it always comes with strings attached.

Anonymous said...

Stone leigh

i would add that the global economic integration is the 800 lb gorrila in the room.
If/when the US ans european economic system stumble food supplies around the world are in trouble, if thailand and eqypt are banning exports due to food prices now, what happens when global food markets fall apart? Without writing a book, the food, energy and financial systems are all interlinked at this point.