Wednesday, April 29, 2009

April 29 2009 1: Going to zero

Unknown John Henry October 1863
John Henry, servant, at headquarters, 3d Army Corps,
Army of the Potomac, Bealeton, Virginia

Ilargi: As the calls for US president Obama to finally start applying the rule of law are set to grow louder, much louder, something I’ll address soon, there's another theme I'm playing around with. For me it remains a purely theoretical exercise, because it's one more piece of murky conspiracy territory, and as such of no use. Still, my interest was triggered by Felix Salmon, who in an article from his Reuters blog I posted yesterday, When countries go to zero, talks about a coffee conversation he had with Mohamed El-Erian, the CEO of bond behemoth PIMCO:
We also talked a bit about the probabilities of a big secular shift into a whole new world of class warfare or even real warfare. El-Erian asked me what I thought the probability of that was, and I pulled a number out of thin air: 20% to 25%. After all, it’s simply a truism to say that historically speaking, long periods of peace and prosperity end with war and destruction. And the rise of global markets and economies since 1945 has certainly been a long period of time, which seems in many ways to be coming to an end.

El-Erian’s response was to say that probabilities that high aren’t remotely priced in to the market, which I think is undoubtedly true. People are happy talking about big-picture geopolitical risks, but they tend not to invest on that basis; instead, they habitually revert to thinking about "bottoms" and the like. Old emerging-market hands like El-Erian and myself are probably more prone to thinking about entire countries going to zero than most investors are — but I suspect that more and more people are going to be thinking along such lines over the coming months.

This reminded me of recent posts by Dan W. at Ashes Ashes concerning what he perceives as the likelihood of a coming -carefully prepared- US invasion of and war theater in Pakistan. Now, as I said, I'm not that into hypothetical conspiratory constructs, but today Dan approaches the situation from a point of view that I do find interesting: the economics and economical consequences of warfare, in particular those of the World War II era.

Wars, when executed large scale, necessarily and greatly change national economies. Even more than in the US, the German economy under Hitler transformed itself in just a few years from an utter shipwreck into a smooth sailing machine, in which citizens, at least as long as they were "pure", were well taken care of, which was a huge difference from what they experienced no more than a decade before. The only way to do that, however, was to find victims that could be declared "impure" enemies, domestically and abroad. Much like a shark, the 3rd Reich, in order to maintain the war machine and keep the soldiers happy and well-fed, had to keep on moving, and to conquer new lands. Which of course was doomed to fail. That should be a lesson, you're right. But is it ever learned? The economics just look so tempting while the going's good. Here's Dan:

Dan W: Why War Won't Work

Data: Bureau of Economic Analysis, US Department of Commerce

U.S. GDP is poised for an epic collapse. (With a national GDP of somewhere around $14.6 TRILLION, the USA must experience GDP growth of about $425 BILLION in 2009 to maintain a minimally acceptable level of economic growth. But remember, this need for 3-4% growth exists within a regime in which consumer spending in 2008 comprised 72% of GDP. And, 17% of this consumer spending represented consumer debt of over $2.5 TRILLION. At the same time, U6 unemployment stands at roughly 16.5% and is getting worse by the week. Consumer spending is collapsing. Everyone, every business, is broke.

In light of these realities, it is becoming increasing clear that the Obama Administration plans to artificially grow GDP via increases in government expenditure. And since consumer spending and business investment are in utter free fall, the only way to stimulate 3-4% per annum GDP growth is to do so by increasing GE to 60+% of GDP. (Such levels of government spending would correlate well with those witnessed during the early and mid-1940s.) And it doesn't take a genius to recognize that only through the development of a war economy---while not necessarily the preferred route productive of such debt-based (and thus eventually inflationary) spending---can such expenditure possibly be "justified".
From Blanchard's online:"' We tried to finance the Vietnam War and the Great Society programs without a tax increase,' admits Charles L. Schultze, Johnson's budget director at the time, 'and clearly that started our course of inflation.'"Political leaders always have tended to take the view that in time of war the nation must do whatever is necessary to succeed, and the financial repercussions can be dealt with later. Johnson was only following the pattern that had been adhered to by his predecessors: Lincoln during the Civil War, when inflation in the Union from 1861 to 1865 was 117%; Wilson during World War I, when prices rose from 1917 to 1918 by 126%; and Roosevelt during World War II, when prices rose from 1941 to 1945 by 108%."...from Money Meltdown, Judy Shelton

Now, referring to the graphic above, one can see that between 1941 and 1944, government spending as a measure of GDP did in fact quadruple: from $26.5 billion dollars in 1941 to over $105 billion in 1944. This growth in GE kept overall GDP in positive territory, thus presenting the appearance of a growing economy and precipitating an apparent terminus for a decade of economic depression. And sticking with the same data set above, one also notices that during the same 3-year period (circa 1941-1944), net exports reflected deficits in overall trade. HOWEVER, please note that these years of export stagnation were rapidly remedied with the end of war in 1945. And the reason for such a dramatic turn around in trade (from a trade deficit in 1945 to a 7+% trade surplus in 1946) is that American military economy was able to quickly and successfully make the shift from war machine to production machine:
"...Many Americans feared that the end of World War II and the subsequent drop in military spending might bring back the hard times of the Great Depression. But instead, pent-up consumer demand fueled exceptionally strong economic growth in the postwar period. The automobile industry successfully converted back to producing cars, and new industries such as aviation and electronics grew by leaps and bounds. A housing boom, stimulated in part by easily affordable mortgages for returning members of the military, added to the expansion. The nation's gross national product rose from about $200,000 million in 1940 to $300,000 million in 1950 and to more than $500,000 million in 1960. At the same time, the jump in postwar births, known as the "baby boom," increased the number of consumers. More and more Americans joined the middle class..." (

Based upon the aforementioned analysis, it seems logical to assume that our political leaders believe that a similar dynamic to that which took place during the 1940s could be manufactured in the coming years as a means by which depression could be halted and economic growth reestablished. In other words, it seems to make sense that government spending on a large-scale and protracted military campaign would in fact fuel growth in the U.S. economic engine in the short term---keeping GDP artificially elevated and thus allowing the government to claim an end to economic hardship and an arrest of our incipient deflationary depression---and allow our leadership to employ, over the longer term, strategies similar to those employed in the immediate post WWII period viz the evolution of the economy from a war-making engine to a new, productive proto-industrial economy.

But what of inflation you ask? Certainly such massive infusions of government spending into a war economy would leave our nation with staggering inflation in the years to come. As Blanchard online puts it: "...The type of inflation that is associated with wars usually arises from increases in aggregate demand. In time of war, government spending for military purposes stimulates demand throughout an economy, at the same time that a shift of workers from productive labor into war production causes a decline in aggregate supply..."

So, based upon the previous statement from the Blanchard's piece, it would seem apparent that our leaders could believe that the creation of a war-economy would in fact provide jobs for (for example) unemployed GM workers and unemployed Boeing workers as the nation built bombs and planes and new-fangled tanks and whatever else the nation could produce that would help us successfully prosecute the new war. And that accordingly, as productive supply contracted, demand for goods and services would increase, thus arresting the entrenchment of deflation and eventually establishing a growing regime of short-term "healthy" inflation.

But how do we fund this war? Well, as I stated earlier, through government spending. And since our government is already deeply in debt, this spending would translate into massive never-before-seen levels of debt:
"...Senator Judd Gregg, a Republican senator from New Hampshire, has been making the rounds on political news programs this week, criticizing President Barack Obama's budget as too costly. Gregg has repeated one statistic over and over to make his point: that Obama's budget plan would increase the national debt to 80 percent of gross domestic product." Seventeen trillion dollars worth of debt at the end of 10 years, $11 trillion at the end of five years," Gregg said. "This translates into a debt-to-GDP ratio which we have not seen in this country since the end of World War II when we were trying to pay off the war debt. Basically, you take national debt up to about 80 percent of gross national product. That's the public debt. Historically, it's been about 40 percent..." (

So, what does all of this mean:
  • Based upon the information provided above, the conclusion of war would indeed precipitate a not insignificant bout of inflation that, at least on the surface, would appear catastrophically crippling to an economy in recovery.
  • Our political leaders are counting on the fact that, just as happened in the post-WWII era, the resilient USA will quickly and effectively be able to convert our war-making economy into a new, highly productive post-war export economy. That just as our fathers and mothers and grandparents did some 70 years ago, we will be able to once again become the leaders in a new cutting-edge of production and export-driven economic growth.
    Our political leaders are betting that we, as a nation, will be able to successfully repeat (with some subtle differences) the dramatic economic about-face that took place in the decade between 1936 and 1946. They believe that war IS in fact the answer, and that our rise-from-the-ashes of economic disaster will come from our creation of a massive war-economy (To ultimately save the world from Islamic Extremism) and to subsequently turn that war economy into the epitome of the post-modern, post-war, green, sustainable productive economy.

OK, but will it work? The answer is a deafening no. Why?
  • Production in 1946 was industrial production within a regime of US economic hegemony. In 2009 industrial production is all but dead. What are we going to do, start exporting cars again? The USA is no longer a production-level economy. Our GDP is over 70% driven by consumer spending. AND, we spend most of those monies on services and goods imported from abroad.
  • Green and sustainable production cannot rise out of the ashes of military production. What are we going to do: Turn war planes into giant solar planters and bombs into wind turbines. There is no correlation---as there was 70 years ago---between the type of industrial economy that could evolve out of a war economy.
  • Economic growth in the 1940s was predicated on the abundant availability of affordable fossil fuel-based energies. This is decidedly NOT our reality in 2009. The era of fossil fuels, and thus the eras of fossil-fuel-enhanced production, is in decline.

In conclusion, the assumption being made by our political leaders---that we could, as we did AFTER WWII, once again become a productive, growth-oriented, society---is false. And as such, the bout of massive inflation that we would experience in the immediate aftermath of a "new" war would be more than simply debilitating. It would be ruinous. We would not simply be a nation in default; we would be an impoverished, humiliated nation of desperate souls. A once mighty nation, torn to shreds by our own hubris and fiscal insanity. And there is no way that we would EVER recover from such a disaster. None.

Economy in U.S. Shrank at 6.1% Rate in First Quarter
The U.S. economy plunged again in the first quarter, capping its worst performance in five decades, reflecting a record slump in inventories and further declines in housing. Gross domestic product dropped at a 6.1 percent annual pace, more than forecast, after contracting at a 6.3 percent rate in the last three months of 2008, the Commerce Department said today in Washington. The report, which marked the weakest six months since 1957-58, comes as Federal Reserve policy makers meet for a second day. Smaller stockpiles may set the stage for a return to growth in the second half of the year amid signs Fed efforts to reduce borrowing costs and unclog lending are starting to pay off. The recession persisted even as lower gasoline prices and larger tax refunds helped bring an end to the worst slump in consumer spending in almost three decades.

"The economy is not out of the woods yet, but as inventory levels get brought down in line with sales, factory production may see a restart," Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said before the report. Stock-index futures were higher, with futures on the Standard & Poor’s 500 Index up 0.9 percent at 859.2 as of 8:40 a.m. in New York. Treasuries were little changed, with benchmark 10-year notes yielding 3 percent. The median forecast of 71 economists surveyed by Bloomberg News projected GDP, the sum of all goods and services produced, would shrink at a 4.7 percent pace. Estimates ranged from declines of 2.8 percent to 8 percent. The world’s largest economy shrank 2.6 percent in the first quarter compared with the same period a year earlier. Today’s advance report on GDP is the first of three estimates on first- quarter growth.

Consumer spending, which accounts for about 70 percent of the economy, climbed at a 2.2 percent annual pace last quarter, the most in two years. Purchases dropped at an average 4.1 percent rate in the last half of 2008, the biggest slide since 1980. Companies trimmed stockpiles at a $103.7 billion annual rate last quarter, the biggest drop since records began in 1947. Excluding the reduction, the economy would have contracted at a 3.4 percent pace. "This is the combination you want for a turn in the economy -- better sales and an inventory correction," John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, said before the report. Companies cut total spending, including equipment, software and construction projects, at a record 38 percent annual pace. Residential construction also decreased at a 38 percent pace last quarter, the most since 1980.

One reason for the larger-than-projected decline in GDP was that government slashed spending at a 3.9 percent pace, the most since 1995. The drop reflected cutbacks in defense spending and the biggest decrease in state and local government outlays since 1981. A smaller trade gap added 2 percentage points to growth last quarter. The deficit shrank as imports collapsed at a 34 percent annual pace, the most since 1975, which reflected the reduction in stockpiles. Should the economy shrink again in the second quarter as projected by economists surveyed this month by Bloomberg, the recession that began in December 2007 would be the longest since the Great Depression. Recent announcements by companies including General Motors Corp. indicate that will be the case. GM last week said it will idle 13 U.S. assembly plants for multiple weeks to trim production by 190,000 vehicles from May through July. Sales in its home market fell 49 percent this year through March. General Motors and Chrysler LLC are threatened with bankruptcy as sales have plummeted since credit markets seized last year.

Still, data in recent weeks, including signs of stability in home sales, residential construction and consumer confidence, signal the world’s largest economy may shrink at a slower pace. Part of the improvement may be due to government efforts to stem the recession. In its last meeting on March 18, the Fed pledged to double mortgage-debt purchases to $1.45 trillion and buy as much as $300 billion in long-term Treasuries. That’s helped bring down rates on mortgages and auto loans. The central bank’s statement today, due at around 2:15 p.m., may acknowledge that the pace of economic decline has moderated in the past six weeks and may reiterate it will keep the benchmark rate low for an extended period and continue to boost its balance sheet to revive lending.

The Fed’s preferred measure of inflation, which tracks consumer spending and excludes food and fuel costs, rose at a 1.5 percent annual pace last quarter, toward the lower end of central bankers’ longer-term forecasts. Ford Motor Co., working to avoid a federal bailout, is among companies seeing some improvement. The automaker last week posted a first-quarter loss that beat analysts’ estimates. "We’re not quite sure where the bottom is," Ford’s Chief Executive Officer Alan Mulally said in an April 24 Bloomberg Television interview. "But we believe with the stabilization of the banks, freeing up the credit, and the stimulus packages we have, both monetary and fiscal, that we’re going to see an uptick in the third and fourth quarter."

German Government Predicts Sharp GDP Contraction for 2009
On Wednesday, the German government corroborated what leading economists had predicted last week -- that 2009 would see the German economy contract by a massive 6 percent. But the Economics Ministry does see a rosier 2010 than the think tanks do. The German government on Wednesday predicted a 6 percent contraction of the nation's gross domestic product for all of 2009, which would be the largest shrinkage since World War II and a massive revision from its January forecast of 2.25 percent. Still, the announcement wasn't exactly a surprise, since the nation's leading economic institutes had predicted last week that Germany's GDP would shrink by around 5 percent to 6 percent.

The government's Growth Forecast Review presented Wednesday by Economics Minister Karl-Theodor zu Guttenberg also looks forward to an end to the recession sometime in 2010. The government predicts a small increase in growth next year of 0.5 percent. However, this number is more optimistic than the assessments being made by independent institutes, which gave a consensus forecast last week that the GDP would contract in 2010 by 0.5 percent. The main reason for Wednesday's dramatic revision of the 2009 forecast from January is this year's 23 percent decline in exports. The German economy relies on high-value exports, which have fallen off sharply since January. The country's economy has never contracted by more than 1 percent in a single year since World War II, and a contraction of 6 percent is the worst 2009 forecast for all advanced economies except Japan's, which is predicted to shrink by 6.2 percent.

Ireland to Shrink Most of Any Developed Economy Since 1930s
Ireland’s economy may shrink almost 12 percent in the three years through 2010, the biggest decline of any industrialized country since the Great Depression of the 1930s, the country’s Economic & Social Research Institute said. Gross domestic product may decline 8.3 percent this year, the Dublin-based institute said in its quarterly report today, more than double the contraction it forecast in December. The contraction over the three years would be the worst in an industrialized economy since an 11 percent decline in Finland between 1990 and 1993, the ESRI said. Ireland, once the fastest- growing economy in the euro region, is struggling to contain a swelling budget deficit and deal with a surge in unemployment after the collapse of a housing boom and as companies from Dell Inc. to Royal Bank of Scotland Group Plc cut jobs.

"We’re remarkably exposed" to the global slump, said Alan Barrett, senior economist at the ESRI. "But it always comes back to housing," which during the boom accounted for more than 20 percent of economic growth. Ireland’s $240 billion economy will probably shrink 1.1 percent in 2010, according to the institute. It receded by 2.3 percent last year, the first full-year contraction in a quarter century. Unemployment rose to 11.4 percent this month, the highest in 13 years, the country’s statistics office said today. Some 188,800 people have joined jobless queues over the last 12 months, increasing benefit applications to a record 388,600 and adding to pressure on the public finances.

The budget deficit may climb to 12 percent of GDP this year, four times the European Union limit, even as Prime Minister Brian Cowen’s government raises income taxes and cuts spending on public services, according to the ESRI. The institute said the measures, announced in an emergency budget on April 7, as well as an additional levy on public workers to cover their guaranteed pensions, may limit the deficit to 11.5 percent in 2010. "Our assessment of the fiscal measures introduced in February and April is broadly positive and we see these as important moves in the direction of restoring fiscal sustainability," the report said. It said unemployment may climb to 16.8 percent by the end of 2010.

Let's nail Wall Street with a racketeering charge
'Goldman Conspiracy': RICO? Or Medal of Freedom?

Last week's reader comments made it quite clear that the "Goldman Conspiracy" and Wall Street's growing power and control of our American democracy are deeply disturbing hot-button issues. Many demand bold, aggressive actions, even criminal prosecution, like those coming from the new administration and the New York attorney general. So what about a federal prosecution under RICO, the Racketeer Influenced and Corrupt Organizations Act?

First off, conspiracies are tough to prove. In 1933, a group of wealthy Americans, bank and corporate leaders with ties to Germany allegedly attempted to recruit a Marine general to lead a military coup against FDR. The general later testified before Congress about "The Business Plot," as it became known. Congress hinted to the existence of a political conspiracy but, if so, it never went beyond talk. Everyone denied. No charges. But lots happened after Congress passed the RICO Act in 1970, originally to fight organized crime. The feds tried it against the Hell's Angels, Montreal Expos, Key West police department and Michael Milkin's insider trading at Drexel Burnham. Last year the SEC used RICO against 50 hedge funds accused of naked short-selling. Earlier this month, RICO was the basis of federal indictments against 24 members of a San Diego mortgage company in an alleged conspiracy fraud involving 220 properties. Maybe next the new administration will go up the ladder to the banks that securitized the mortgages?

The beauty of prosecuting a conspiracy under RICO is that the conspiracy is a separate crime. And all members may be guilty of conspiring to commit each crime in pursuit of the conspiracy's overall agreement. RICO's list includes: Fraud, extortion, embezzling, theft, gambling, money laundering, bankruptcy, securities violations and obstruction of justice. And right now, that may even cover bankers "cooking the books" using taxpayers' TARP money to generate doctored, phony earnings to deceive investors. And hidden behind the individual crimes may be a collective act of treason to take over control of the American economy as the moneyed "superpower." With Henry Paulson at Treasury earlier, Goldman Sachs had absolute power, with the absolute backing of the party then in control of Washington. Flash forward: Now, with all their people, programs, lobbyists and connections left behind like landmines inside Washington's new administration, the power of the "Goldman Conspiracy" may now be absolute, as in Lord Acton's historic warning that "power corrupts and absolute power corrupts absolutely."

The 'Goldman Conspiracy's' far-reaching global power No wonder many investors, citizens and taxpayers feel helpless, worried that nobody, not even, as we wrote last week, "Jack Bauer can stop the 'Goldman Conspiracy.'" Still, Americans want blood. You can feel the public's pulse. Sense a rebellion, beyond teabags, beyond a torture debate -- a revolution's brewing, and not a weak-tea-bag one. Revolution? Yes, so for a moment consider a bizarre alternative to RICO indictments. Think back to 1776: There were 57 signers of the Declaration of Independence that triggered the first American Revolution. They risked their lives and fortunes by committing treason against the British. Death was the penalty. Many were wealthy, educated professionals, lawyers, physicians, merchants, farmers, landowners. Self-interest and politics motivated them.

But they also believed that "all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness." True heroes. Today they'd be awarded the Presidential Medal of Freedom. How would you vote? A RICO indictment? Or a Medal of Freedom for service to country? True, Goldman Sachs played a major role in creating the credit meltdown that's destroying the portfolios of an entire generation. And some say the awards to former CIA Director George Tenet and Iraq liaison L. Paul Bremer tarnished the Freedom Medal. And yet, many of those in the "Goldman Conspiracy" have served honorably in government, in spite of (or because of) their money, biases, errors in judgment and political ideologies. So before "voting," read on, learn more about who's in the global "Goldman Conspiracy:"
  • The United States Treasury Yes, Goldman is an elite training program for government leaders. Robert Rubin was Clinton's Treasury Secretary. Paulson was with Goldman for almost 30 years, made $38 million the year before he became Treasury secretary. He got a sweetheart tax deal at the top of the market when he put his $700 million fortune in a trust. All that before the market meltdown that he helped set up. Paulson was a big winner, while America lost trillions. When all hell broke loose last fall, Paulson brought in Neel Kashkari (as assistant secretary) and other Goldman staffers to spread around TARP's $700 billion. Earlier we read a perfect summary of the "Goldman Conspiracy's" goal in Matthew Malone's Portfolio piece: "Obama's victory and Geithner's appointment are the completion of Goldman's meticulously crafted plan to become a superpower. The firm now has the clout to impose its will on the financial markets -- and the world." They have become the ruler of the American democracy. And if that's true, then arguably the new president is also a party to their agreement by relying on Goldman's brains and power.
  • The World Bank When Paulson became Treasury secretary, Robert Zoellick, a former deputy secretary of state became chairman of Goldman's International Advisors. Then in 2007, Zoellick became president of the World Bank, which lends billions to over 100 nations.
  • Fannie Mae and Freddie Mac The portfolios of the two mortgage giants total $5 trillion. Their stock lost 90% of its value last year. So Paulson hired his old Goldman buddies to develop strategies. The conclusions were preordained by that White House: Nationalize only as a last resort.
  • Commodity Futures Trading Commission Reuben Jeffery spent eighteen years at Goldman, became chairman of the commission from 2005-2007 while derivatives rapidly expanded, setting up the credit meltdown. He was appointed an undersecretary of state in 2007.
  • Securities and Exchange Commission Former SEC Chairman Christopher Cox is a no alumni, but not for lack of trying: Bear Sterns and Lehman complained of traders panic-shorting their stock, but got no help. They failed. But when short-sellers turned on Goldman, Cox pushed thru an SEC ban.
  • Federal Reserve Bank Chairmen Alan Greenspan, Ben Bernanke and the next likely Fed Chairman Larry Summers are unquestionably tied in with the manipulative games of Wall Street, most noticeably kowtowing to the "Goldman Conspiracy" and its free-market ideology.
  • Foreign Intelligence Advisory Board Stephen Friedman spent about three decades with Goldman, was chairman in the 1990s. He headed George W. Bush's National Economic Council before becoming Chairman of the President's Foreign Intelligence Advisory Board.
  • AIG Hank Paulson installed Goldman vice chairman Ed Liddy as AIG's CEO to protect his old firm's $20 billion derivatives exposure in AIG. Then Hank and his Fed buddy Bernanke gave AIG another $150 billion to keep AIG out of bankruptcy, and to make sure AIG's derivative contracts were paid off, including Goldman's $20 billion.
  • Bank of America and Merrill Lynch Before becoming Merrill's CEO, John Thain headed the NYSE, and earlier was Goldman's co-president under Paulson, who planted Thain in Merrill Lynch. Paulson later forced Bank of America's CEO Ken Lewis to buy Merrill, avoiding a Merrill bankruptcy and saving face for his old friend, and himself. Last week, Lewis admitted in Congress that Paulson forced him to make the Merrill deal ... and shut up about it.
  • Citigroup Robert Rubin spent 26 years at Goldman, a contemporary of Paulson. Rubin rose to co-chairman and left to become Clinton's Treasury secretary. Obama's economic adviser Larry Summers succeeded Rubin at Treasury. From 2007 to January 2009 Rubin was chairman of Citigroup, where he made $126 million. Last fall, Citigroup's stock dropped over 60% in a week. Paulson gave Citi another $20 billion TARP on top of $25 billion previously committed, to help an old Goldman buddy.
  • Bank of Canada Former Goldman executive Mark Carney has been at the Bank of Canada since leaving Goldman in 2003. Recently he received a seven-year term as its new Governor.
  • Bank of Italy Mario Draghi is an banker and economist who was a partner of Goldman from 2002 to 2006 when he was appointed to a six-year term as governor of the Bank of Italy.
  • State government New Jersey Governor John Corzine was with Goldman for 24 years until 1998, serving as CEO and chairman for five years before running for the U.S. Senate.
  • President's chief of staff Joshua Bolten, a former Goldman Sachs executive director in the '90s became director of the Office of Budget and Management, then George W. Bush's Chief of Staff.
  • Goldman Sachs Recently Jon Winkelried, Goldman's co-COO, resigned after 26 years. He made $67.5 million in 2007 just before the great meltdown. The current CEO, Lloyd Blankfein, also made $68.5 million, earning a total of $210 million during the five-year bull. Back in 2007, the average bonus for the "average Goldman staffer" was an a whopping $600,000, 10 times what the average American makes, while America's markets lost trillions and taxpayers were saddled with trillions in new debt.

What are they -- and many more who lurk in the shadows -- all guilty of in the "Goldman Conspiracy?" Over the years they have passed back and forth between Wall Street and Washington. Many more anonymously support these Trojan Horses from the sidelines, enjoying big bonuses. Goldman's staff was among the president's biggest donors. But they are bi-partisan. They bet on winners. No matter which political party or which politicians win, Goldman, a master at hedging, always wins. So yes, Goldman is the "superpower" running America and the world. Who would indict them? Not Obama, maybe New York Attorney General Andrew Cuomo? Or should we just give up, let them have it, even give them Freedom Medals? A bigger question: Do we really have a choice!?

Fed Finds at Least Six of 19 Biggest U.S. Banks Need to Raise More Capital
At least six of the 19 largest U.S. banks require additional capital, according to preliminary results of government stress tests, people briefed on the matter said. While some of the lenders may need extra cash injections from the government, most of the capital is likely to come from converting preferred shares to common equity, the people said. The Federal Reserve is now hearing appeals from banks, including Citigroup Inc. and Bank of America Corp., that regulators have determined need more of a cushion against losses, they added. By pushing conversions, rather than federal assistance, the government would allow banks to shore themselves up without the political taint that has soured both Wall Street and Congress on the bailouts. The risk is that, along with diluting existing shareholders, the government action won’t seem strong enough.

"The challenge that policy makers will confront is that more will be needed and it’s not clear they have the resources currently in place or the political capability to deliver more," said David Greenlaw, the chief financial economist at Morgan Stanley, one of the 19 banks that are being tested, in New York. Final results of the tests are due to be released next week. The banking agencies overseeing the reviews and the Treasury are still debating how much of the information to disclose. Fed Chairman Ben S. Bernanke, Treasury Secretary Timothy Geithner and other regulators are scheduled to meet this week to discuss the tests. Geithner has said that banks can add capital by a variety of ways, including converting government-held preferred shares dating from capital injections made last year, raising private funds or getting more taxpayer cash. With regulators putting an emphasis on common equity in their stress tests, converting privately held preferred shares is another option.

Firms that receive exceptional assistance could face stiffer government controls, including the firing of executives or board members, the Treasury chief has warned. Today, Kenneth Lewis, chief executive officer of Bank of America, faces a shareholder vote on whether he should be re- elected as the company’s chairman of the board. While Lewis has been at the helm, the bank has received $45 billion in government aid. Scott Silvestri, a spokesman for Charlotte, North Carolina- based Bank of America, declined to comment on Lewis yesterday. Lewis said earlier this month that the firm "absolutely" doesn’t need more capital, while adding that the decision on whether to convert the U.S.’s previous investments into common equity is "now out of our hands." Citigroup, in a statement, said the bank’s "regulatory capital base is strong, and we have previously announced our intention to conduct an exchange offer that will significantly improve our tangible common ratios."

Along with Bank of America and New York-based Citigroup, some regional banks are likely to need additional capital, analysts have said. SunTrust Banks Inc., KeyCorp, and Regions Financial Corp. are the banks that are most likely to require additional capital, according to an April 24 analysis by Morgan Stanley. Bank of America advanced 2.6 percent to $8.36 in German trading and Citigroup climbed 3.5 percent to $2.99. SunTrust slipped 0.2 percent to $13.69 in Germany. By taking the less onerous path of converting preferred shares, the Treasury is husbanding the diminishing resources from the $700 billion bailout passed by Congress last October. "Does that indicate that’s what the regulators actually believe, or is it that they felt politically constrained from doing much more than that?" said Douglas Elliott, a former investment banker who is now a fellow at the Brookings Institution in Washington.

Geithner said April 21 that $109.6 billion of TARP funds remain, or $134.6 billion including expected repayments in the coming year. Lawmakers have warned repeatedly not to expect approval of any request for additional money. Some forecasts predict much greater losses are still on the horizon for the financial system. The International Monetary Fund calculates global losses tied to bad loans and securitized assets may reach $4.1 trillion next year. Geithner has said repeatedly that the "vast majority" of U.S. banks have more capital than regulatory guidelines indicate. The stress tests are designed to ensure that firms have enough reserves to weather a deeper economic downturn and sustain lending to consumers and businesses.

He also said there are signs of "thawing" in credit markets and some indication that confidence is beginning to return. His remarks reflected an improvement in earnings in several lenders’ results for the first quarter, and a reduction in benchmark lending rates this month. Financial shares are poised for their first back-to-back monthly gain since September 2007. The Standard & Poor’s 500 Financials Index has climbed 18 percent this month, while still 73 percent below the high reached in May 2007. Finance ministers and central bankers who met in Washington last weekend singled out banks’ impaired balance sheets as the biggest threat to a sustainable recovery. Geithner has crafted a plan to finance purchases of as much as $1 trillion in distressed loans and securities. Germany has proposed removing $1.1 trillion in toxic assets.

Citigroup scrambles to raise capital
Citigroup has told US regulators it wants to fill the capital shortfall identified in the government's "stress test" by selling large businesses, asking more investors to convert their preferred shares into common stock and shrinking its balance sheet. With a few days to go before the results of the tests are announced, the troubled financial group, which has been bailed out three times by the authorities, is scrambling to find ways to raise capital without relying on more government funds. Bank of America, another lender whose test has highlighted the need for funds, is also in talks with regulators over its capital needs and the possibility of converting the government's preferred shares into common stock, bankers said. Citi executives argue that divestitures, such as the planned $5.2bn sale of Japan's Nikko Cordial, the expansion of an existing conversion offer, and renewed efforts to cut costs would ensure the company has enough capital to withstand the crisis.

People close to the situation said Citi could sell several units and had not ruled out shedding businesses it deemed as core to its strategy of being a global financial group. Citi is also looking at adding to its plan to convert $52bn of preferred shares held by the government and other investors by including trust preferred shares, a hybrid of debt and equity. However, some insiders said that could be difficult because those securities rank as debt and pay annual interest, giving holders little incentive to exchange them for common shares. People close to the situation said both Citi and BofA were contesting some of the conclusions of the stress tests. In Citi's case, the company's executives, led by finance chief Ned Kelly, are believed to have told regulators their estimates for losses on credit cards - based on rising unemployment - are too high.

Citi is also asking regulators to take into account the capital boost it will receive from the expected sale of a majority stake in its brokerage unit Smith Barney to Morgan Stanley as well as the Nikko disposal. That deal is expected to generate an accounting loss, because Citi's acquisition price for the business is higher than the likely sale price. However, the Nikko deal would still result in a cash boost for Citi. BofA is also understood to have told the authorities it expected lower losses than they projected. People close to the situation cautioned that the discussions between Citi, Treasury and the Federal Reserve were fluid and details of the plans could change ahead of the release of the results of the stress tests next week.

Some Citi executives believe the government will still have to convert more of its preferred shares into common stock, raising its holding above the 36 per cent it is due to take following the latest bail-out in February. Citi shares closed down 5.9 per cent. Citi's need for fresh capital - first reported by the Financial Times on Saturday - comes after the country's 19 largest banks were given preliminary results of the stress tests on Friday. Analysts have estimated BofA could require up to $70bn in new equity. BofA shares closed down 8.6 per cent at $8.15. BofA declined to comment. Citi said its capital base was "strong" but added regulators prohibited banks from discussing the tests.

The Banks Push Back
As Washington pushes banks to mend their finances, the banks are pushing back. Emboldened by newfound profits and eager to shake off federal control, a growing number of banks are resisting the Obama administration’s proposals for fixing the financial system. Lenders that skirted disaster only months ago with the help of taxpayer dollars are now balking at government prescriptions. Despite pressure from federal regulators, industry executives are taking issue with major elements of the president’s bank plan. Administration officials characterize each part of their three-pronged approach as crucial to bolstering banks and restarting the economy. But bankers are increasingly eager to extricate themselves from the government’s grasp, and worry that Washington will impose new restrictions on their businesses if the government’s already considerable role in the industry grows.

"The pushback has been pretty hard," said Frederick Cannon, the chief equity strategist of Keefe, Bruyette & Woods and a specialist in banking stocks. "If we don’t address these issues, that could have a negative effect on economic growth, which in turn makes the banks’ problems worse." As the Obama administration marks its first 100 days, the banks’ resistance is complicating the government’s effort to solve some of the thorniest problems of the financial crisis. Opposition is building on several fronts. Citigroup, Bank of America and other big banks are disputing so-called stress tests that are being conducted by federal examiners to determine how these institutions would withstand a deep, prolonged recession. The banks contend they are in better shape than the early findings suggest, although it is likely several will need to raise capital.

A Treasury plan to purge banks of their troublesome assets — a seemingly intractable problem — has received a lukewarm response in banking circles. Several big banks have declared they have no intention of participating in the program. Another major effort, one to revive credit for things like car loans to equipment leases, has also gotten off to a slow start. Administration officials said Tuesday that their efforts were going according to plan, saying, for instance, that more than 100 private money managers had signed up for the program to buy troubled assets. "We are not flipping a switch here," said one administration official, calling for patience. "These are intricate programs." But the disputes over the bank stress tests, which have been administered to 19 big banks and are being closely watched on Wall Street, as well as a lackluster reception to the third effort, the Term Asset-Backed Securities Loan Facility, or TALF, are potential worries as well.

Large banks are being put through a battery of tests to see whether they will hold up under pressure in the worst-case economic assumptions over the next two years. Big banks like Citigroup, Bank of America, PNC Financial and Wells Fargo are disputing some of the early findings, which suggest some banks may need to raise capital, according to people briefed on the exams. Because of the protracted negotiations with the banks and regulator infighting over how much information to disclose, federal officials now plan to announce the results of the stress tests on May 5 or 6, the third time the date has been put back. "There is concern among the banks that the stress test has led to uncertainty, the opposite of what is intended, and they would be diluting their shareholders based on a scenario that the regulators say themselves are unlikely to happen," said Edward L. Yingling, the head of the American Bankers Association.

According to people briefed on the situation, the disputes center on several assumptions that regulators made in administering the tests. These include the severity of losses on assets like mortgages, credit card loans and commercial real estate loans, as well as the banks’ potential to generate earnings. In a further challenge, the banks are also pushing regulators to relax the timetable for them to obtain new capital. Some investors are prepared to buy problem assets from banks. What is less certain is whether banks will be willing to sell. Big money managers like BlackRock and Bank of New York Mellon said they had applied to raise money for the troubled-asset funds. While administration officials say they never expected every bank to participate, large banks whose involvement was regarded as vital to the plan’s success have said they will not be involved. Executives worry that whatever assurances the White House gives them, an angry Congress might impose new rules on banks that participate, particularly on pay.

Officials from Citigroup, Morgan Stanley, PNC Financial and a number of other big lenders that have received multibillion-dollar government bailouts are reluctant to participate or have refused so far to commit until more details are offered. Bank of America has expressed interest. Jamie Dimon, JPMorgan Chase’s chief executive, has said he believes that the Public-Private Investment Program — which depends on loans from the Federal Deposit Insurance Corporation — could be "good for the system" but that his bank has no intention of being either a seller or buyer. "We’re certainly not going to borrow from the federal government, because we’ve learned our lesson about that," he said earlier this month in a conference about earnings. Many banks are reluctant to sell their nonperforming loans because they could suffer big losses in the process, forcing them to raise more capital. Others want to avoid the stigma of latching on to another federal program.

"Never mind the price," said James E. Rohr, PNC’s chief executive, in a recent interview. "I wouldn’t want to be the first person and be perceived as a weak bank." D. Bryan Jordan, the chief executive of First Horizon, a big lender based in Tennessee, said the likelihood that his bank would participate was somewhat low. "We think we can get a lot more value out of them by working them out ourselves," he said earlier this month in a conference call about first-quarter results. Art Murton, an official at the F.D.I.C. who is helping to devise the troubled-loan program, said there had been "encouraging" levels of interest. To test the investor waters and demonstrate the plan can be a success, the F.D.I.C. is planning a pilot auction in June.

The TALF program has also struck some observers as underwhelming. It was to ignite the market for securities backed by consumer and small-business loans, which dried up last year. Policy makers said they planned to lend up to $1 trillion under the program, but the facility got off to a modest start in its first two months. Investors took only $4.7 billion in loans in the first installment in March, and a further $1.7 billion in April, according to the Federal Reserve Bank of New York. Administration officials said, however, that the plan was beginning to restart lending and would grow in coming months. "The mere existence of these programs is having an impact," an official said.

Bank of America CEO’s Support Erodes Ahead of Annual Meeting
Bank of America Corp. Chief Executive Officer Kenneth Lewis is losing shareholder support heading into today’s annual meeting amid speculation that government stress tests will show the bank needs more capital. Lined up against Lewis’s re-election as chairman of the biggest U.S. bank by assets are the California Public Employees’ Retirement System -- the nation’s largest public pension fund -- as well as proxy advisers Glass Lewis & Co., RiskMetrics Group Inc. and Egan-Jones Proxy Services, among other investors. Shareholders have also targeted 70-year-old lead director Temple Sloan Jr. Ballots will be cast at the bank headquarters in Charlotte, North Carolina, on whether to re-elect directors and split the chairman and CEO jobs held by Lewis. Dislodging Lewis after eight years as chairman may depend on how mutual funds and brokerages vote, opponents including CtW Investment Group said.

"It’s largely up to the big mutual fund companies and they are usually very hesitant to cross with the management of financial services companies," said William R. Atwood, executive director of the Illinois State Investment Board, which will vote its 1.5 million shares against Lewis’s re-election. Lewis, 62, may face demands from regulators to raise capital after results of government stress tests are released May 4. The bank needs $60 billion to $70 billion of capital, according to Friedman, Billings, Ramsey Group Inc. analyst Paul Miller, who cited separate tests performed by his firm, which assumed a 12 percent jobless rate, compared with about 10 percent used by the government test.

Bank of America is among 19 U.S. financial institutions assessing the results of the Treasury’s stress tests. Lewis has vowed the bank can recover without any more U.S. aid, while Treasury Secretary Timothy Geithner has said regulators may replace management and directors of banks that need "exceptional" assistance. Lewis has presided over a 79 percent decline in Bank of America shares over the past year, and a $1.79 billion fourth- quarter loss, amid a worldwide credit crisis and recession. The bank slipped 77 cents, or 8.6 percent, to $8.15 yesterday in New York trading. Scott Silvestri, a Bank of America spokesman, declined to comment on Lewis yesterday. The CEO has come under fire for failing to divulge spiraling losses at Merrill Lynch & Co. before shareholders voted in December to endorse Bank of America’s purchase of the largest securities brokerage. The Merrill Lynch acquisition was completed on Jan. 1, after the U.S. government provided loan guarantees to prop up the deal.

Lewis’s future "is probably out of his hands at this point," said Christopher Whalen, managing director of Institutional Risk Analytics, a California research firm that rates banks. "The time for Ken Lewis to hang tough was when he could have told the government, ‘No, I won’t buy Merrill Lynch,’" Whalen said in an interview yesterday. The bank’s 18-member board solidly supports Lewis and shares his view that the acquisitions of Merrill Lynch and mortgage lender Countrywide Financial Corp. will be among its best long-term purchases, said Robert Stickler, a bank spokesman. Both sides have said the vote may be close. Stuart Plesser, an analyst at Standard and Poor’s Corp., said a move against Lewis could deprive the bank of a 40-year company veteran skilled at handling acquisitions. "Ken is the guy to integrate this thing, now that they own Merrill and Countrywide," Plesser said in an interview. "He’s great at this kind of stuff."

Included in today’s vote is a resolution to divide the jobs of chairman and CEO. Such a split, whether by shareholders or at the behest of the board, has been a precursor to the ouster of other bank CEOs including Wachovia Corp.’s Kennedy Thompson and Washington Mutual Inc.’s Kerry Killinger. Lewis may be aided by improvements at Merrill Lynch’s bond- trading business, plus a surge in home-loan refinancings that spurred a $4 billion profit in the first quarter. Because the profit included extraordinary gains from selling shares of a Chinese bank and accounting changes, the quarterly profit didn’t quiet critics or impress investors who drove shares down 24 percent on April 20, when the finances were disclosed. "Now is the appropriate time to change management because Mr. Lewis has lost the confidence of the investing public and the confidence of his employees," said John Moore, a Charlotte insurance-agency owner who urged Lewis to drop his chairman’s title at last year’s annual meeting.

Lewis may face pressure also from federal regulators, whom he accused of pushing Bank of America to keep Merrill Lynch’s losses secret and to complete the acquisition, according to New York Attorney General Andrew Cuomo. The Wall Street Journal reported yesterday that a leak of the stress-test results shows that Bank of America may need billions of dollars in capital. "The timing of this leak a day before the annual meeting is not any coincidence," said Tony Plath, a University of North Carolina finance professor. "This is a clear attempt to bring down a sitting CEO." Lewis’s opponents include pension funds representing judges in Illinois, teachers in Ohio and state government employees in Virginia, and the TIAA-CREF investment fund for educators. Yesterday, Lewis lost the support of Calpers, the California pension fund, which said it will vote its 22.7 million shares against the entire board. The largest group to announce public opposition to Lewis’s re-election, TIAA-CREF, controls less than six-tenths of 1 percent of the bank’s 6.4 billion shares. Phone calls to Hye-Won Choi, TIAA-CREF’s head of corporate governance, weren’t returned.

Proxy adviser RiskMetrics Group’s ISS Governance Services has said it will vote against Lewis; Sloan, the lead director; and board members Frank P. Bramble Sr., 59, a former vice chairman at MBNA Corp.; Monica C. Lozano, 52, publisher of Impremedia LLC’s La Opinion magazine; Robert L. Tillman, 65, former CEO of Lowe’s Cos.; and Jacquelyn M. Ward, 69, a former managing director at Intec Telecom Systems Plc. In addition to Lewis and Sloan, proxy adviser Glass Lewis said it will vote against directors Virgis W. Colbert, a former executive vice president at Miller Brewing Co.; Joseph W. Prueher, a retired Navy admiral; and Charles O. Rossotti, a Carlyle Group Inc. adviser. Houston investor Jerry Finger and his son, Jonathan, plan to speak at today’s meeting after running a TV and Internet campaign aimed at removing Lewis and Sloan from the board. The Fingers acquired more than 2 million shares of Bank of America after selling their Houston-based bank to the lender in 1996. They have since sold about half of their shares.

Much of the opposition to Bank of America’s board slate has been stirred by the CtW Investment Group, a group of unions whose pension funds own shares in the bank, said Atwood of the Illinois investment board. While each state pension fund makes its own decision, CtW has provided information and encouragement, he said. CtW expects a significant shareholder vote against Lewis and Sloan, though not victory, said Michael Garland, the group’s director of value strategies. To bolster its case for its director slate Bank of America hired proxy solicitors Georgeson Inc. and Laurel Hill Advisory Group. Most of their attention is likely to focus on institutional investors, who control about 60 percent of the bank’s shares, Atwood said. While shareholders meet inside a theater next to Bank of America’s 60-story headquarters in downtown Charlotte, the Service Employees International Union and political-activist group plan a protest nearby, according to Steve Lerner, a union official.

Lewis Says Bank of America's Merrill Deal Had to Be Completed Amid Crisis
Bank of America Corp. Chief Executive Officer Kenneth Lewis said shareholders weren’t told about losses at Merrill Lynch & Co. because aborting the deal might have destabilized the financial system, and the decision was "not about selfish desire" to keep management jobs. Lewis said a meltdown in the financial system could have been triggered by the bank’s failure to complete the takeover, according to the prepared text of a speech Lewis will give at today’s annual shareholders meeting, held in Charlotte, North Carolina, where the bank is based. The board "took very seriously" the possibility of systemic risk and the damage to Bank of America if the Merrill deal collapsed, according to Lewis’s speech. Disclosing talks with the government on how to resolve the matter might have created the "very crisis" they wanted to prevent, he said.

Lewis has been fending off calls for him to quit amid speculation that government stress tests will show the bank needs more capital. He’s drawn fire from investors for agreeing to buy Merrill Lynch last year and then failing to tell shareholders before they approved the deal in December that losses at the brokerage were soaring. U.S. Attorney General Andrew Cuomo revealed this month that Lewis had testified then-Treasury Secretary Henry Paulson may have threatened to remove the bank’s management and directors in December if the lender tried to back out of buying Merrill. Lewis balked at completing the deal as the quarterly loss soared toward $15.8 billion, only to have U.S. officials tell him to proceed, according to testimony released by Cuomo. Regulators also instructed Lewis not to disclose Merrill’s losses, his desire to back out of the takeover or the intervention of regulators, according to Cuomo.

Lewis has also been criticized for allowing bonus payments to Merrill Lynch employees before the takeover was completed in Jan. 1. He said today there was "no perfect solution" on bonus payments to Merrill employees, citing the threat that talent might be lost to competitors. "Every major bank" is under pressure, Lewis said in the prepared text. Shareholders vote today on whether to re-elect directors and split the chairman and CEO jobs held by Lewis, 62, who has been CEO since 2001. Dissidents also targeted 70-year-old lead director Temple Sloan Jr. Splitting the job of chairman and CEO, a move typically favored by advocates of better corporate governance, has been a precursor to the complete ouster of Wachovia Corp.’s Kennedy Thompson and Washington Mutual Inc.’s Kerry Killinger last year. Both lenders were overwhelmed by loan losses tied to the mortgage and credit-market routs.

Shareholders of Morgan Stanley rejected a similar resolution today that would have required the chairman of the board to be an independent director, and Wells Fargo & Co. voted against such a split yesterday. Lewis has presided over a 79 percent drop in Bank of America shares during the 12 months ended yesterday amid a worldwide credit crisis and recession. He’s said the acquisitions of Merrill Lynch and mortgage lender Countrywide Financial Corp. will be among the bank’s best long-term purchases. The stock rose 50 cents, or 6.1 percent, to $8.65 a share in 11:10 a.m. New York Stock Exchange composite trading.

Swine flu deflation
The markets have been remarkably relaxed about the rise in the World health Organization pandemic alert Phase 4 (sustained human to human transmission) - and tonight perhaps to Phase 5. They seem not to care that confirmed cases of H1N1 avian-swine flu have spread to Israel, Spain, France, New Zealand, and Korea. This surprises me. The WHO alert is the best objective indicator we have of rising risk, and the potential implications of Phase 4 or Phase 5 are .. well .. awful. We can all argue about the likely damage from a "severe pandemic" along the lines of 1918 'Spanish Flu' or the Neapolitan pandemic of 1775. The World Bank has floated a figure of $3 trillion, or 4.8pc of global GDP. The US Congressional Budget Office has come up with something similar. These are arbitrary telephone book numbers. But even if losses are less, we are still talking about a further deflationary shock to a world economy already tipping into debt deflation (though it might not be a uniform deflation, if shortages push up local food and fuel prices). It would certainly finish off half the global banking system. It is too frightful to think about. That perhaps is why investors are doing exactly that: refusing to think about.

Over the last couple of days I have been deluged by notes from City analysts and economists suggesting that H1N1 avian-swine flu poses no great threat to the global economy because the authorities showed during the 2003 SARS epidemic in Asia that outbreaks can be contained. This is a misreading of the threat we face. SARS is a coronavirus. It is extremely hard to catch. Just 8,000 people were infected worldwide during the entire epidemic (10pc died). Today's H1N1 outbreak is an influenza virus, which is far more contagious. Dr. Keiji Fukuda, the WHO's assistant director-general, said it is already too late to stop the spread of the disease. "At this time, containment is not a feasible option." It is entirely possible that we may see a very mild pandemic. I think we have to be mindful and respectful of the fact that influenza moves in ways we cannot predict.

The worst pandemic of the 20th century occurred in 1918, and it also started out as a relatively mild pandemic that wasn’t very much noticed in most places. Then in time it became a very severe pandemic, one of the most severe infectious disease episodes ever recorded. Perhaps because so few market players studied science, or have a current link to science, they seem not to realize that the world’s virologists and flu experts are in a state of nail-biting, ashen-faced, fear. Rob Carnell, chief economist at ING, is one of the exceptions. "We believe fear of infection will lead to drastically altered behaviour. It may be that swine flu does not tip the human fear scale sufficiently, but if it did, with the economy already in tatters, the results could be catastrophic," he said in a note today. We may be lucky. The virus may indeed prove mild - like the Hong Kong flu in 1968 - or burn out altogether as it mutates. The early cases in the US and Canada give hope. So does the apparent fall-off in the fatality rates in Mexico. But as Dr Fukuda said, nobody can pre-judge the virulence of this pandemic. Least of all the markets.

European Commission unveils tough hedge fund directive
The European Commission has vowed to ensure that no hedge fund manager or private equity fund escapes "effective regulation and oversight" in a tougher-than-expected directive on alternative investment funds published on Wednesday. The directive, which will horrify managers in London where over 80pc of the alternatives industry is based, proposes imposing "demanding regulatory standards" on all funds over the value of €100m (£89m). The directive says "hedge funds, private equity funds, commodity funds, real estate funds and infrastructure funds, among others, all fall within this category". Giles Jury of KPMG said: "This essentially means all funds will be effected. It is almost impossible to set up a feasible business with less than €100m." Under the directive’s proposals, the funds will be forced to meet new levels of transparency not just to regulators, as industry leaders had hoped, but also to "supervisors, investors and other key stakeholders".

The Commission plans to impose a standard set of rules regarding marketing of hedge funds and private equity across the European Union that foreign funds will also be subject to. The regulations will also extend to "all major sources of risks in the alternative investment value chain" including "key service providers... depositaries and administrators". The directive says they will be "subject to robust regulatory standards". The funds will also have to prove standards of governance including areas of risks, liquidity and conflicts of interest. Florence Lombard, executive director of the London-based Alternative Investment Management Association, said: "This directive is not a proportionate regulatory response to any of the identified causes of the current crisis." She said that all of the major reports which analysed the crisis in-depth, including the de Larosiere report and the Turner Review, concluded that hedge funds neither caused nor played a significant role in the crisis.

"This directive undermines the findings of these reports and the vast amount of work that is currently being undertaken by the G20, IOSCO and the Financial Stability Board," she said. "It also conflicts with the G20’s global plan for recovery and reform which calls for regulators and supervisors to "reduce the scope for regulatory arbitrage" and to "resist protectionism." Charlie McCreevy, EC internal market commissioner, said: "Alternative investment fund managers have become important participants in the European financial system and their activities have had a significant impact on the markets and companies in which they invest. "There is now a global consensus – as expressed by the G20 leaders – over the need for closer regulatory engagement with this sector ... I look forward to working with the European Parliament and Council to secure the adoption of this important piece of legislation."

Citi Seeks Approval to Pay Out Bonuses
Citigroup Inc., soon to be one-third owned by the U.S. government, is asking the Treasury for permission to pay special bonuses to many key employees, according to people familiar with the matter. The request comes as Citigroup is grappling with broad government pay restrictions that could break apart its legendary energy-trading unit. People at that unit, Phibro, are threatening to leave because of pay caps tied to the U.S. bailout of Citigroup. Phibro has been the source of hundreds of millions of dollars in profits for the bank, and has paid out hefty compensation, including a roughly $100 million windfall last year for the unit's leader, Andrew Hall.Citigroup is looking for ways to free Phibro from the federal restrictions, including a spinoff of the unit, according to people familiar with the matter. Separately, Sumitomo Mitsui Financial Group and Citigroup reached a deal in which the Japanese bank will acquire a large chunk of Citigroup's operations in Japan.

Citigroup is trying to get U.S. approval for special bonuses for many of its employees. In a meeting earlier this month with Treasury Secretary Timothy Geithner, Citigroup CEO Vikram Pandit made the case for the stock-based bonuses. Executives are describing the bonuses as "retention" awards to perk up demoralized employees who the company worries are vulnerable to poaching by rival firms, people familiar with the matter said. A person familiar with Mr. Geithner's thinking said the Treasury hadn't made a decision on whether to allow the bonuses. It is unclear how much Citigroup would pay out in bonuses if the government approved the move. A Citigroup spokesman declined to comment on details of the proposed compensation plans. Citigroup's request comes after Congress, the public and the president blasted pay practices on Wall Street. Bonuses at American International Group Inc. and Merrill Lynch & Co. ignited political infernos in Washington.

Citigroup has already gotten its own share of criticism for excessive spending, thanks in part to its aborted plans earlier this year to buy a new corporate jet. The company has received $50 billion in taxpayer aid, and the U.S. government is protecting Citigroup against most losses on $301 billion of its assets. The Treasury is poised next month to become Citigroup's largest shareholder, owning as much as 36% of its common stock. All this essentially gives the government veto power over the New York banking giant's employee-pay plans. The Treasury late last year signed off on a 2008 bonus pool that was smaller than in past years and more heavily weighted toward performance-based stock awards instead of cash bonuses. Citigroup executives say they are worried that employees, who have seen much of their past bonuses wiped out by the collapse of Citigroup's share price, will jump to U.S. and foreign financial institutions that aren't tethered by federal pay restrictions.

In the Phibro situation, Mr. Hall, who runs the energy-trading unit, has been agitating to leave Citigroup to avoid the pay curbs, people familiar with the matter said. Phibro has long been an autonomous unit within Citigroup, and its employees are paid based on how much revenue they produce. The government pay restrictions, however, put a ceiling on that compensation. Citigroup is looking for ways to free Phibro from federal pay constraints so it can hold on to the staff of the lucrative unit, the people said. The bank is discussing plans to either spin off Phibro into an independent hedge fund or open it to outside investors, the people said. The unit currently only invests Citigroup's capital. Phibro has been a lean and largely hidden profit center within Citigroup's investment bank. For 2008, Citigroup reported $667 million in pretax revenues in commodities trading, saying Phibro was the primary contributor to that figure.

New federal pay limits are forcing banks that received aid to rethink their compensation structures. One recent law requires banks to limit bonuses to no more than one-third of their overall compensation pools. Top Citigroup executives, including Mr. Pandit and John Havens, who runs Citigroup's giant investment-banking division, have been briefing managers on the possible one-time bonuses, according to people familiar with the matter. Citigroup hasn't settled on a specific bonus plan, with several possibilities currently on the table, the people said. Under one scenario presented to some managers, the payouts would be composed largely of stock that vests over at least three years, and the awards likely would be worth the equivalent of at least 50% of an employee's cumulative pay over the past three years, said one person briefed on that plan.

Citigroup's stock price has lost about 95% of its value since peaking around $55 in May 2007. That has taken a severe toll on the fortunes of employees, who hold a total of about 245 million stock options, warrants and rights to buy shares, with a weighted average exercise price of $41.84, according to Citigroup's latest proxy statement. With the stock below $3 a share, most of those awards are essentially worthless. Citigroup isn't the only Wall Street firm looking for exemptions to pay restrictions. At Morgan Stanley, which has received $10 billion in federal aid, executives are considering a plan to spin off the company's proprietary-trading business to insulate it from federal pay limits.

AIG acts to avoid default risk
AIG has moved to stave off the risk of default on $234bn of derivatives by persuading a senior executive at its troubled financial products division to rescind his resignation and remain with the stricken insurer to unwind the complex trades. AIG insiders said James Shephard, the deputy chief executive of Paris-based Banque AIG, had decided to stay on as the unit’s chief less than a month after resigning in the midst of the political furore over the insurer’s bonuses. Mr Shephard’s U-turn, which could be announced on Wednesday, is likely to deter several European banks that bought the derivatives from taking legal action to force AIG to repay them, according to people familiar with the situation. The move should also avoid a showdown between US regulators, which control AIG after bailing it out, and their French counterparts.

French banking regulators had threatened to appoint their own manager of Banque AIG, which is part of the insurer’s financial products unit, after Mauro Gabriele, the unit’s chief executive, and Mr Shephard announced their departures in late March. Mr Gabriele has not changed his mind but will remain with Banque AIG for a while to ensure an orderly transition, according to people familiar with the matter. AIG has maintained the departures of the two executives did not affect the status of its derivatives book. But legal experts said the appointment of an external manager chosen by the French authorities could have triggered a default on the derivatives because it could have constituted a change in control of the contract. That would have meant AIG having to repay the European banks before the contracts came due.

A default would have also forced the banks, which bought the products to lower the amount of regulatory capital they need to hold against certain assets, to buy new derivatives or raise equity. A confidential AIG document estimates that banks such as Royal Bank of Scotland, Banco Santander and BNP Paribas might have to raise some $10bn if the financial unit collapsed. In March, AIG said Mr Gabriele and Mr Shephard had left because they felt they could not work "in the current hostile environment" – a reference to the political backlash triggered by AIG’s decision to pay $165m in retention bonuses to staff in its financial products division. The two executives had volunteered to return their bonuses and Mr Shephard will stick to that promise even after his decision to stay, said people familiar with the matter. Mr Shephard’s new compensation had not yet been set, they added. AIG and Mr Shephard declined to comment.

Derivatives Hit Austrian Railroad With Record Loss as Milan Seizes Assets
OeBB-Holding AG, Austria’s state- owned railroad company, reported a record 966 million-euro ($1.3 billion) loss after writing down the value of derivatives that went awry. OeBB’s 2008 loss compared with a profit of 42.4 million euros a year earlier after the company wrote down the entire 613 million-euro notional value of synthetic collateralized debt obligations. The Vienna-based company, which bought the contracts from Deutsche Bank AG in 2005 and 2006, is appealing a February court ruling dismissing a claim that the lender didn’t disclose the risks associated with the derivatives. State-owned companies and local authorities from Germany to Italy reported more than 1.13 billion euros of losses on derivatives that allow buyers to speculate or protect against risk, leaving taxpayers to pick up the tab.

"There was a climate that pressured publicly owned companies to look for creative ways to finance themselves," said Thomas Hofer, the Vienna-based owner of H&P Public Affairs, which advises political campaigns. "They were given the feeling of being financially negligent if they didn’t invest in derivatives." Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in interest rates or weather. CDOs, which package other bonds and loans into notes of varying risk and yields, are losing money as their holdings get downgraded. "Deutsche Bank didn’t fully disclose all the risks attached to the CDOs," Bettina Gusenbauer, an OeBB spokeswoman, said in a phone interview from Vienna. The derivatives and the risks were fully reviewed with OeBB, a Deutsche Bank spokesman, who declined to be identified, said in an e-mail. OeBB initiated the transaction, not Deutsche Bank, the e-mail said.

Taxpayers shouldn’t "have to pick up the bill for speculative investments," said Susanne Enk, a spokeswoman for Austria’s Federal Ministry of Transport, when asked about OeBB’s investment. OeBB’s CDOs package credit-default swaps tied to debt including asset-backed securities and company bonds and expire between 2013 and 2015, the company said. OeBB made provisions on the securities of 420 million euros in 2008, and 157 million euros the year before, it said today. The provisions are a "precautionary measure," OeBB Chief Financial Officer Josef Halbmayr said at a press briefing in Vienna today. "We’ve taken all relevant measures to ensure that deals of this kind won’t take place again," he said. Credit-default swaps are derivatives used to protect against debt losses or speculate on credit quality, and pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to meet its obligations.

Municipal authorities across Europe are reporting losses from derivatives since credit markets unraveled in the slump triggered by the collapse of the U.S. subprime mortgage market in August 2007. Milan’s financial police seized 476 million euros of assets from UBS AG, Deutsche Bank, JPMorgan and Depfa Bank Plc this week in an investigation into alleged fraud linked to the sale of interest-rate swaps, which are designed to protect buyers against losses caused by fluctuations in borrowing costs. The city is suing the banks after losses on derivatives purchased in 2005, and alleges the lenders misled municipal officials on the advantages of the securities. Officials at the banks declined to comment, as did a spokesman for Milan’s city council.

In Germany, the Wuerzburg Regional Court ordered Deutsche Bank in March 2008 to cover a third of the 2.6 million euros city utilities lost in interest-rate swaps bought from the lender. A court reduced a loss claim against Frankfurt-based Deutsche Bank in July by the city of Hagen, Germany, to 1 million euros, from 47 million euros. Both decisions are being appealed. A Deutsche Bank spokesman said the bank disclosed all risks and informed the municipalities "comprehensively" when selling derivatives in Germany. "Swaps are like anything else where there’s a sophisticated seller and a simple-minded client," said Anthony Neuberger, Professor of Finance at Warwick Business School in Warwick, England. "Anything complex can have effects that are different from those anticipated."

French local authorities are susceptible to buying derivatives because the country’s rules are lax, according to a July report by Fitch. "The French rules, which do not limit the risk taken by local authorities using structured debt, favored the growth" of derivatives, the ratings company said. About 25 percent of the 132 billion euros of debt owed by local public administrations in France was tied to derivatives as of January, according to Christophe Parisot, a Fitch analyst in Paris. French Budget Minister Eric Woerth said in February that structured finance holdings don’t pose "a systemic financial and budgetary threat." "Structured credits are proposed only to certain clients with significant borrowings and with teams capable of following them," Dexia SA, which received a 6.4 billion-euro bailout last year by France, Belgium and Luxembourg and which is the biggest lender to local governments, said in a January report to clients.

Losses on derivatives led some European governments to ban local authorities or state-owned companies from investing in derivatives. The U.K. High Court ruled that about 3.2 billion pounds ($4.7 billion) of swap contracts entered into by Hammersmith and Fulham Council were unenforceable in the 1980s. The 1997 Local Government (Contracts) Act banned investment in the derivatives, according to a spokeswoman at the Department for Communities and Local Government. Polish municipalities can’t use derivatives, according to local-government Web site, which cites the Finance Ministry’s May 2008 interpretation of the Law on Public Finances. In Finland, "city fathers learned it the hard way -- there’s no speculation" in the derivatives market because, "in the previous recession, some municipalities speculated on currencies" and lost, said Reijo Vuorento, planning manager at the Association of Finnish Local and Regional Authorities.

Fiat-Chrysler Tie-Up Said to Be Planned With or Without Bankruptcy
Fiat SpA plans to form an alliance with Chrysler LLC whether the U.S. automaker goes into bankruptcy or not because of deals reached with banks and unions in the past week, a person with direct knowledge of the situation said. The preferred option still is to avoid bankruptcy by getting all 46 of Chrysler’s secured lenders to agree to a deal to take $2 billion in cash in exchange for eliminating $6.9 billion in secured debt. If that can’t be accomplished, Chrysler would be put into bankruptcy and quickly purchased by a new company formed by the government that would have an ownership structure similar to that envisioned without a bankruptcy filing, said the person, who declined to be named because the matter is private. "This thing could happen," Senator Carl Levin, a Michigan Democrat, said in an interview. "If they do have to go into bankruptcy, it could really be an in-and-out deal."

Fiat would take an initial stake of 20 percent in Chrysler in exchange for giving the U.S. company access to its small-car technology, the company said in a presentation last week. It could get 15 percent more by achieving government-set milestones. Fiat has an option to then purchase a majority interest in the company after all government loans are repaid. "I think Fiat wants it," said David Cole, chairman of the Center for Automotive Research in Ann Arbor, Michigan. "They have been working together pretty intimately now and they’ve decided this makes sense. I don’t think there is any doubt that Fiat will be the senior partner in this, but it has the foundational elements that DaimlerChrysler never had."

Chrysler was part of DaimlerChrysler AG from 1998 to 2007, when Cerberus Capital Management LP bought an 80 percent stake. Cerberus took the remaining 20 percent from Daimler AG yesterday, the German automaker announced. Chrysler won agreement today from its four largest banks, which have about 70 percent interest in the $6.9 billion debt, to take the cash payout. It needs all of the lenders to agree to settle the issue out of bankruptcy court. The Auburn Hills, Michigan-based automaker also won new money-saving labor contracts from the United Auto Workers union and Canadian Auto Workers union in the past week. UAW members are voting on the agreement; CAW members ratified their contract over the weekend.

"As we enter the homestretch there’s going to be a tremendous amount of speculation and it would be inappropriate to comment," said Shawn Morgan, spokeswoman for the company. The U.S. Treasury set April 30 as a deadline to have a deal sealed for a Fiat alliance in order to get as much as $6 billion in new U.S. loans. Chrysler already has a $4 billion loan. The government also required the automaker get the union deals and debt reduction. A Chrysler bankruptcy remains a possibility, said a person familiar with the bank negotiations. A quick type of bankruptcy may be needed to bring any dissenters into an agreement, according to the person.

Shell follows BP with 62% profits plunge
Royal Dutch Shell's earnings plunged by 62 per cent in the first quarter of 2009, as oil prices tumbled from last year's record levels and the demand for energy faltered amid the economic downturn. Profits before tax fell from $9.08 billion in the first quarter of 2008 to $3.48 billion in the three months to March — a rate of decline that exactly matched that reported by BP, its rival, yesterday which said its income dropped by 62 per cent to $2.5 billion. Jeroen van der Veer, Shell's chief executive, conceded that "first quarter 2009 performance was affected by the weaker global economy, with a challenging upstream and downstream business environment".

The company gave little indication of the full year outlook, although Mr van der Veer did say that "industry conditions remain challenging" in a clear signal that there was little hope of immediate improvement. He said that the company would focus on "capital discipline and costs" as a result. The oil major received an average of $42.16 for ever barrel of oil it sold, more than half last year's $90.72. Last July, oil prices peaked at $147 a barrel. Shell produced 3,396 barrels of oil and gas a day on average throughought the period, and said that its production was "broadly similar" to last year — down 3 per cent — allowing for the impact of weaker pricing, OPEC restrictions and problems stemming from the security of its Nigerian fields.

Natural gas volumes were down 13 per cent to 3.06 million tonnes, again reflecting the problems in Nigeria. Elsewhere gas production was stable. Gas prices achieved were $5.57 per thousand standard cubic feet, compared with $6.52 this time last year. A downturn in share prices meant that Shell's pension fund would also face some pressure. The company signalled that it would take a $1.1 billion charge this year, reflecting a writedown of assets held by the fund, which more than wiped out last year's $600 million gain. Shell said that it would pay a dividend of 42 cents a year, an improvement of 5 cents in dollar terms, compared with earnings per share of 57 cents. Cash flow generated in the quarter totalled $7.9 billion, while capital investment was $7.1 billion.

Rotterdam, Europe's Largest Port, May Run Out of Space to Store Crude Oil
Rotterdam, Europe’s largest port, may be running out of space to store crude as global oil demand posts its first back-to-back annual drop in a quarter-century. The harbor is Europe’s largest refinery center and a trading hub for refined products such as gasoline and diesel. Some ships have been diverted or are waiting outside the port until space is available, said Jeroen Kortsmit, manager for commercial affairs at Royal Dirkzwager. "A lot of tanks are fully loaded," Kortsmit said by phone from Rotterdam April 27. He joined the company, which provides shipping information to terminal operators around the port, 24 years ago and said he has never seen storage this full before. The Organization of Petroleum Exporting Countries, accounting for about 40 percent of global supply, agreed to cut output three times since September as demand crumbled. Oil prices have plunged 66 percent from a record $147.27 a barrel reached in July.

Rotterdam can store 11.9 million cubic meters of crude, port data from 2007 show. That’s equal to about 75 million barrels or enough to supply the 27-nation European Union for about five days. Some on-shore storage tanks for oil products are either full or have no unreserved space available, Pieter Kulsen, a Rotterdam-based refined oils consultant at PJK International BV, said by phone yesterday. The port doesn’t monitor how much capacity is left in on- shore tanks, Sjaak Poppe, a spokesman for the Port of Rotterdam, said by phone on April 27. Companies with oil-storage facilities at Rotterdam include The Hague-based Royal Dutch Shell Plc, Europe’s biggest oil company, London-based BP Plc, the second-largest, and Rotterdam- based Royal Vopak NV, the world’s largest oil and chemical storage company. Company officials declined to comment.

New Zealand May Defer Payments to Pension Fund
New Zealand faces widening budget deficits that may force the government to defer payments into a fund set up to pay future pensions, Finance Minister Bill English said. "The government will run a deficit this year and will do so for the foreseeable future," English said in a speech today in Christchurch. "That’s why we’re considering this issue and that’s why the fund’s rules allow the government to vary its contributions to reflect changing fiscal conditions." English is preparing to deliver a budget on May 28 as the economy struggles to recover from its worst recession in more than three decades. He is reviewing payments to the New Zealand Superannuation Fund as well as future income-tax cuts after Standard & Poor’s said in January it may lower the nation’s sovereign credit rating unless progress is made in narrowing the deficits and reducing debt.

"Households and businesses facing the same kind of decisions will understand the trade-offs," English said. "They tend to save and spend during times of plenty and cut back when times are hard." The government contributes about NZ$2 billion ($1.1 billion) a year to the fund, which is expected to grow to NZ$100 billion by 2025, when it will start being used to help pay for future pension needs. "The idea of the fund was to invest budget surpluses," English said. "Those surpluses have disappeared." In December, the government forecast its deficit would widen from NZ$1 billion in 2009 to NZ$8.5 billion by 2011. The government’s books are now in "much worse shape," English said today, reiterating comments he made on April 22.

Potash Corporation
On 24 April 2009 I was a guest judge on Canada’s national business channel Business News Network’s show Stars & Dogs with host Andrew Bell and Boyd Erman and the exchange is available. The company under discussion was Potash Corporation and I realize some may be wondering what potash is. Potassium carbonate, or potash, has been used since antiquity in the manufacture of glass, soap, and soil fertilizer. Potash is important for agriculture because it improves water retention, yield, nutrient value, taste, colour, texture and disease resistance of food crops with wide application to fruits, vegetables, rice, wheat, grains, sugar, corn, soybeans, palm oil and cotton, which all benefit from the quality enhancing properties.

Potash Corporation of Saskatchewan Inc. (POT) engages in the production of potash from six mines in Saskatchewan and one mine in New Brunswick and the sale of fertilizers and feed products in North America. The company controls approximately 22% of worldwide potash capacity. Obviously, if you own a lot of something it makes sense to engage in behavior to drive its price up which is precisely what Potash Corp. does. Nevertheless, during The Great Credit Contraction capital has sought the safest and most liquid assets. Like during the Great Depression capital has stampeded into the safest and most liquid assets resulting in tumbling commodity prices and decreased decline for potash with rising stockpiles which are now 56% above the 5-year average. After Boyd presented the bull case and Andy presented the bear case then I was asked for my opinion.

I found Boyd’s argument about ‘when’ the economy recovers leading to increased use of potash in essential staples like rice to be unpersuasive. The nature and scope of The Great Credit Contraction is too large, fair value lying with single digit midget banks is rapidly evaporating any remaining confidence and unemployment numbers are soaring. Because of the leveraged nature of earnings with commodity producers the bottom line is horrifically affected by dissipating top lines. Therefore, I sided with Andy the bear. I did state that we do not know how low Potash Corporation will go but that I would consider purchasing it for between 3-5 ounces of gold per 100 shares. There were some interesting acknowledgements when I briefly explained my reasoning for performing the mental calculations of value using the golden currency.

Notice how steep the price decline was from 20 ounces to 10 ounces per 100 shares? If you own a lot of something, like potash, why run a cartel to keep the price suppressed? The central bank’s ability to issue what everyone uses as currency is infinitely more valuable than the price of a portfolio asset. The gold price suppression scheme is ending. On 8 April 2009 in Global Quantitative Easing I wrote, "The IMF gold sales will be like a single piece of sushi appetizer to a starving dragon." Since that time China has announced an increase in gold reserves from 600 to 1,054 tons. Given my analogy to Japan with official gold reserves of 765 tons; I was slightly off on my calculations but the balance sheets of the various central banks are not very transparent or China has not reported their entire gold reserves.

If gold were treated as a mere portfolio asset, which it is not, then the case could be made that it is getting fairly expensive at the current price level. Given its seasonality and tendancy to lag during the summer I may even agree. But as I explain in The Great Credit Contraction political currency illusions are doomed to either implode in a deflationary depression or explode in hyperinflation. Significant amounts of political currency illusions need to evaporate in the coming inferno. The FRN$ is doomed. The mainstream Western press such as Bloomberg reports that the IMF "is working on a plan to sell bonds to several developing countries as Brazil and China seek more power over its decisions." But the real news comes from the East where "India and China may press for the sale of the entire gold reserves of the International Monetary Fund (IMF) to raise money for the least developed countries. The IMF holds 103.4 million ounces (3,217 tonnes) of gold that, if sold, can fetch about $100 billion."

It appears that stealthy China has been preparing for the coming inferno for many years and has now publicly blasted the clarion call on the golden trumpet signaling the next gold rush. China is not satisfied with flimsy ineffectual substitutes like GLD or SLV which have problems but demand the physical metal. When fiat currency illusions lose confidence it can happen with blinding speed. While there may be some short term gains to be made by briefly venturing up the liquidity pyramid I would not recommend it. The Great Credit Contraction has only begun and preserving capital in these times will be hard enough. During the end of the interview on BNN I said, "If cash is king then gold is emperor in this particular environment." The time may come when gold will not be for sale at any price so for now just hoard it and make sure you get cold, hard real physical gold and silver.

Flawed Credit Ratings Reap Profits as Regulators Fail Investors
Ron Grassi says he thought he had retired five years ago after a 35-year career as a trial lawyer. Now Grassi, 68, has set up a war room in his Tahoe City, California, home to single-handedly take on Standard & Poor’s, Moody’s Investors Service and Fitch Ratings. He’s sued the three credit rating firms for negligence, fraud and deceit. Grassi says the companies’ faulty debt analyses have been at the core of the global financial meltdown and the firms should be held accountable. Exhibit One is his own investment. He and his wife, Sally, held $40,000 in Lehman Brothers Holdings Inc. bonds because all three credit raters gave them at least an A rating -- meaning they were a safe investment -- right until Sept. 15, the day Lehman filed for bankruptcy. "They’re supposed to spot time bombs," Grassi says. "The bombs exploded before the credit companies acted."

As the U.S. and other economic powers devise ways to overhaul financial regulations, they have yet to come up with plans to address one issue at the heart of the crisis: the role of the rating firms. That’s partly because the reach of the three big credit raters extends into virtually every corner of the financial system. Everyone from banks to the agencies that regulate them is hooked on ratings. Debt grades are baked into hundreds of rules, laws and private contracts that affect banking, insurance, mutual funds and pension funds. U.S. Securities and Exchange Commission guidelines, for example, require money market fund managers to rely on ratings in deciding what to buy with $3.9 trillion of investors’ money.

State regulators depend on credit grades to monitor the safety of $450 billion of bonds held by U.S. insurance companies. Even the plans crafted by Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Timothy Geithner to stimulate the economy count on rating firms to determine how the money will be spent. "The key to policy going forward has to be to stop our reliance on these credit ratings," says Frank Partnoy, a professor at the San Diego School of Law and a former derivatives trader who has written four books on modern finance, including Infectious Greed: How Deceit and Risk Corrupted the Financial Markets (Times Books, 2003). "Even though few people respect the credit raters, most continue to rely on them," Partnoy says. "We’ve become addicted to them like a drug, and we have to figure out a way to wean regulators and investors off of them."

Just how critical a role ratings firms play in the health and stability of the financial system became clear in the case of American International Group Inc., the New York-based insurer that’s now a ward of the U.S. government. On Sept. 16, one day after the three credit rating firms downgraded AIG’s double-A score by two to three grades, private contract provisions that AIG had with banks around the world based on credit rating changes forced the insurer to hand over billions of dollars of collateral to its customers. The company didn’t have the cash. Trying to avert a global financial cataclysm, the Federal Reserve rescued AIG with an $85 billion loan -- the first of four U.S. bailouts of the insurer. Investors, traders and regulators have been questioning whether credit rating companies serve a good purpose ever since Enron Corp. imploded in 2001.

Until four days before the Houston-based energy company filed for what was then the largest-ever U.S. bankruptcy, its debt had investment-grade stamps of approval from S&P, Moody’s and Fitch. In the run-up to the current financial crisis, credit companies evolved from evaluators of debt into consultants. They helped banks create $3.2 trillion of subprime mortgage securities. Typically, the firms awarded triple-A ratings to 75 percent of those debt packages. "Ratings agencies just abjectly failed in serving the interests of investors," SEC Commissioner Kathleen Casey says. S&P President Deven Sharma says he knows his firm is taking heat from all sides -- and he expects to turn that around. "Our company has always operated by the principle that if you do the right thing by the customers and the market, ultimately you’ll succeed," Sharma says. Moody’s Chief Executive Officer Raymond McDaniel and Fitch CEO Stephen Joynt declined to comment for this story.

"We are firmly committed to meeting the highest standards of integrity in our ratings practice," McDaniel said in an April 15 SEC hearing. "We remain committed to the highest standards of integrity and objectivity in all aspects of our work," Joynt told the SEC. Notwithstanding the role the credit companies played in fomenting disaster, the U.S. government is relying on them to help fix the system they had a hand in breaking. The Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF, will finance the purchase by taxpayers of as much as $1 trillion of new securities backed by consumer loans or other asset-backed debt -- on the condition they have triple-A ratings. And the Fed has also been buying commercial paper directly from companies since October, only if the debt has at least the equivalent of an A-1 rating, the second highest for short-term credit. The three rating companies graded Lehman debt A-1 the day it filed for bankruptcy.

The Fed’s financial rescue is good for the bottom lines of the three rating firms, Connecticut Attorney General Richard Blumenthal says. They could enjoy as much as $400 million in fees that come from taxpayer money, he says. S&P, Moody’s and Fitch, all based in New York, got their official blessing from the SEC in 1975, when the regulator named them Nationally Recognized Statistical Ratings Organizations. Seven companies, along with the big three, now have SEC licensing. The regulator created the NRSRO designation after deciding to set capital requirements for broker-dealers. The SEC relies on ratings from the NRSROs to evaluate the bond holdings of those firms. At the core of the rating system is an inherent conflict of interest, says Lawrence White, the Arthur E. Imperatore Professor of Economics at New York University in Manhattan. Credit raters are paid by the companies whose debt they analyze, so the ratings might reflect a bias, he says.

"So long as you are delegating these decisions to for- profit companies, inevitably there are going to be conflicts," he says. In a March 25 report, policy makers from the Group of 20 nations recommended that credit rating companies be supervised to provide more transparency, improve rating quality and avoid conflicts of interest. The G-20 didn’t offer specifics. As lawmakers scratch their heads over how to come up with an alternative approach, the rating firms continue to pull in rich profits. Moody’s, the only one of the three that stands alone as a publicly traded company, has averaged pretax profit margins of 52 percent over the past five years. It reported revenue of $1.76 billion -- earning a pretax margin of 41 percent -- even during the economic collapse in 2008.

S&P, Moody’s and Fitch control 98 percent of the market for debt ratings in the U.S., according to the SEC. The noncompetitive market leads to high fees, says SEC Commissioner Casey, 43, appointed by President George W. Bush in July 2006 to a five-year term. S&P, a unit of McGraw-Hill Cos., has profit margins similar to those at Moody’s, she says. "They’ve benefited from the monopoly status that they’ve achieved with a tremendous amount of assistance from regulators," Casey says. Sharma, 53, says S&P has justifiably earned its income. "Why does anybody pay $200, or whatever, for Air Jordan shoes?" he asks, sitting in a company boardroom high over the southern tip of Manhattan. "It’s the same. People see value in that. And it all boils down to the value of what people see in it."

Blumenthal says he sees little value in credit ratings. He says raters shouldn’t be getting money from federal financial rescue efforts. "It rewards the very incompetence of Standard & Poors, Moody’s and Fitch that helped cause our current financial crisis," he says. "It enables those specific credit rating agencies to profit from their own self-enriching malfeasance." Blumenthal has subpoenaed documents from the three companies to determine if they improperly influenced the TALF rules to snatch business from smaller rivals. S&P and Fitch deny Blumenthal’s accusations. "The investigation by the Connecticut attorney general is without merit," S&P Vice President Chris Atkins says. "The attorney general fails to recognize S&P’s strong track record rating consumer asset-backed securities, the assets that will be included in the TALF program. S&P’s fees for this work are subject to fee caps."

Fitch Managing Director David Weinfurter says the government makes all the rules -- not the rating firms. "Fitch Ratings views Blumenthal’s investigation into credit ratings eligibility requirements under TALF and other federal lending programs as an unfortunate development stemming from incomplete or inaccurate information," he says. Moody’s Senior Vice President Anthony Mirenda declined to comment. Sharma says it’s clear that his firm’s housing market assumptions were incorrect. S&P is making its methodology clearer so investors can better decide whether they agree with the ratings, he says. "The thing to do is make it transparent, ‘Here are our criteria. Here are our analytics. Here are our assumptions. Here are the stress-test scenarios. And now, if you have any questions, talk to us,’" Sharma says.

The rating companies reaped a bonanza in fees earlier this decade as they worked with financial firms to manufacture collateralized debt obligations. Those creations held a mix of questionable debt, including subprime mortgages, auto loans and junk-rated assets. S&P, Moody’s and Fitch won as much as three times more in fees for grading structured securities than they charged for rating ordinary bonds. The CDO market started to crash in mid- 2007, as investors learned the securities were jammed with bad debt. Financial firms around the world have reported about $1.3 trillion in writedowns and losses in the past two years. Alex Pollock, now a resident fellow at the American Enterprise Institute in Washington, says more competition among credit raters would reduce fees.

"The rating agencies are an SEC-created cartel," he says. "Usually, issuers need at least two ratings, so they don’t even have to compete." Pollock was president of the Federal Home Loan Bank in Chicago from 1991 to 2004. The bank was rated triple-A by both Moody’s and S&P. He says he recalls an annual ritual as he visited with representatives of each company. "They’d say, ‘Here’s what it’s going to cost,’" he says. "I’d say, ‘That’s outrageous.’ They’d repeat, ‘This is what it’s going to cost.’ Finally, I’d say, ‘OK.’ With no ratings, you can’t sell your debt." Congress has held hearings on credit raters routinely this decade, first in 2002 after Enron and then again each year through 2008. In 2006, Congress passed the Credit Rating Agency Reform Act, which gave the SEC limited authority to regulate raters’ business practices. The SEC adopted rules under the law in December 2008 banning rating firms from grading debt structures they designed themselves. The law forbids the SEC from ordering the firms to change their analytical methods.

Only Congress has the power to overhaul the rating system. So far, nobody has introduced legislation that would do that. In a hearing on April 15, the SEC heard suggestions for legislation on credit raters. Some of the loudest proponents for change are in state government and on Wall Street. But no one’s agreed on how to do it. "We should replace ratings agencies," says Peter Fisher, managing director and co-head of fixed income at New York-based BlackRock Inc., the largest publicly traded U.S. asset management company. "Our credit rating system is anachronistic," he says. "Eighty years ago, equities were thought to be complicated and bonds were thought to be simple, so it appeared to make sense to have a few rating agencies set up to tell us all what bonds to buy. But flash forward to the slicing and dicing of credit today, and it’s really a pretty wacky concept."

To create competition, the U.S. should license individuals, not companies, as credit rating professionals, Fisher says. They should be more like equity analysts and would be primarily paid by institutional investors, Fisher says. Neither equity analysts nor those who work at rating companies currently need to be licensed. Such a system wouldn’t be fair, says Daniel Fuss, vice chairman of Boston-based Loomis Sayles & Co., which manages $106 billion. An investor-pay ratings model may give the biggest money managers a huge advantage over smaller firms and individuals because they can afford to pay for the analyses, he says. "What about individuals?" he asks.

Eric Dinallo, New York’s top insurance regulator, proposes a government takeover of the rating business. "There’s nothing wrong with saying Moody’s or someone is going to just become a government agency," he says. "We’ve hung the entire global economy on ratings." Insurance companies are among the world’s largest bond investors. Dinallo suggests that insurers could fund a credit rating collective run by the National Association of Insurance Commissioners, a group of state regulators. "It would be like the Consumer Reports of credit ratings," Dinallo says, referring to the not-for-profit magazine that provides unbiased reviews of consumer products. Turning over the credit ratings to a consortium headed by state governments could lead to lower quality because there would be even less competition, Fuss says. "I would be strongly opposed to the government taking over the function of credit ratings," he says. "I just don’t think it would work at all. The business creativity, the drive, would go straight out of it."

At the April 15 SEC hearing, Joseph Grundfest, a professor at Stanford Law School in Stanford, California, suggested a variation of Dinallo’s idea. He said the SEC could authorize a new kind of rating company, owned and run by the largest debt investors. All bond issuers that pay for a traditional rating would also have to buy a credit analysis from one of these firms. SEC Commissioner Casey has another solution. She wants to remove rating requirements from federal guidelines. She also faults investors for shirking their responsibility to do independent research, rather than simply looking to the grades produced by credit raters. "I’d like to promote greater competition in the market and greater discipline," she says. "Eliminating the references to ratings will play a huge role in removing the undue reliance that we’ve seen."

Sharma, who became president of S&P in August 2007, agrees with Casey that ratings are too enmeshed in SEC rules. He wants the SEC to either get rid of references to rating companies in regulations or add other benchmarks such as current market prices, volatility and liquidity. "Just don’t leave us the way it is today," Sharma says. "There’s too much risk of being overused and inappropriately used." Sharma says that even with widespread regulatory reliance on ratings, his firm will lose business if investors say it doesn’t produce accurate ones. "Our reputation is hurt now," he says. "Let’s say it continues to be hurt; it never comes back. Three other competitors come back who do much-better-quality work. Investors will finally say, ‘I don’t want S&P ratings.’" S&P will prove to the public that it can help companies and bondholders by updating and clarifying its rating methodology, Sharma says. The company will also add commentary on the liquidity and volatility of securities.

S&P has incorporated so-called credit stability into its ratings to address the risk that ratings will fall several levels under stress conditions, which is what happened to CDO grades. The company has also created an ombudsman office in an effort to resolve potential conflicts of interest. Jerome Fons, who worked at Moody’s for 17 years and was managing director for credit policy until August 2007, says investors don’t have to wait for a change in the rating system. They can learn more about the value of debt by tracking the prices of credit-default swaps, he says. The swaps, which are derivatives, are an unregulated type of insurance in which one side bets that a company will default and the other side, or counterparty, gambles that the firm won’t fail. The higher the price of that protection, the greater the perceived risk of default. "We know the spreads are more accurate than ratings," says Fons, now principal of Fons Risk Solutions, a credit risk consulting firm in New York. Moody’s sells a service called Moody’s Implied Ratings, which is based on prices of credit swaps, debt and stock.

In July 2007, credit-default-swap traders started pricing Bear Stearns Cos. and Lehman as if they were Ba1 rated, the highest junk level. They pegged Merrill Lynch & Co. as a Ba1 credit three months later, according to the Moody’s model. Each of those investment banks was stamped at investment grade by the top three credit raters within weeks of when the banks either failed or were rescued in 2008. Lynn Tilton, who manages $6 billion as CEO of private equity firm Patriarch Partners in New York, says she woke up one morning in August 2007 convinced the banking system would collapse and started buying gold coins. "I predicted the banks would be insolvent," Tilton says. "My biggest issue was credit-default swaps. When the size of that market started to dwarf gross domestic product by six or seven times, then my understanding of what defaults would be in a down market became clear: There’s no escaping."

Investors like Tilton watched as the financial firms tumbled while credit raters held on to investment-grade marks. "If the ratings mandate weren’t there, we wouldn’t care because the credit-default-swap markets can tell us basically what we want to know about default probabilities," NYU’s White says. "I’m a market-oriented guy, so I’m more inclined to be relying on the collective wisdom of the market participants." While credit-default-swap traders lack inside information that companies give to credit raters, swap traders move faster because they’re reacting to market changes every day. San Diego School of Law’s Partnoy, who’s written law review articles about credit rating firms for more than a decade and has been a paid consultant to plaintiffs suing rating companies, says raters hold back from downgrading because they know the consequences can be dire. In September, Moody’s and S&P downgraded AIG to A2 and A-, the sixth- and seventh-highest investment-grade ratings. The downgrades triggered CDS payouts and led to the U.S. lending AIG $85 billion. The government has since more than doubled AIG’s rescue funds.

"When you get into a situation like we’re in right now with AIG, the rating agencies are basically trapped into maintaining high ratings because they know if they downgrade, they don’t only have this regulatory effect but they have all these effects," Partnoy says. "It’s all this stuff that basically turns the rating downgrade into a bullet fired at the heart of a bunch of institutions," he says. Sharma says S&P has never delayed a ratings change because of potential downgrade results. He says his firm tells clients not to use ratings as triggers in private contracts. "We take action based on what we feel is right," Sharma says. While swap prices may be better than bond ratings at predicting a disaster, swaps can also cause a disaster. AIG, one of the world’s biggest sellers of CDS protection, nearly collapsed -- taking the global financial system with it -- when it didn’t have enough cash to honor its swaps contracts. Loomis’s Fuss says relying on swap prices is a bad idea. "The market is not always right," he says. "An unregulated market isn’t always a fair appraisal of value."

Moody’s was the first credit rating firm in the U.S. It started grading railroad bonds in 1909. Standard Statistics, a precursor of S&P, began rating securities seven years later. After the 1929 stock market crash, the government decided it wasn’t able to determine the quality of the assets held by banks on its own, Partnoy says. In 1931, the U.S. Treasury started using bond ratings to analyze banks’ holdings. James O’Connor, then comptroller of the currency, issued a regulation in 1936 restricting banks to buying only securities that were deemed high quality by at least two credit raters. "One of the major responses was to try to find a way -- just as we are now with the stress tests and the examination of the banks -- to figure out how to get the bad assets off the banks’ books," Partnoy says. Since then, regulators have increasingly leaned on ratings to police debt investing. In 1991, the SEC ruled that money market mutual fund managers must put 95 percent of their investments into highly rated commercial paper.

Like auditors, lawyers and investment bankers, rating firms serve as gatekeepers to the financial markets. They provide assurances to bond investors. Unlike the others, ratings companies have generally avoided liability for errors. Grassi, the retired California lawyer, wants to change that. He filed his lawsuit against the rating companies on Jan. 26 in state superior court in Placer County. The white-haired lawyer discusses his case seated at a tiny wooden desk in his small guest bedroom, with files spread over both levels of a bunk bed. Grassi says in his complaint that the raters were negligent for failing to downgrade Lehman Brothers debt as the bank’s finances were deteriorating. The day Lehman filed for bankruptcy, S&P rated the investment bank’s debt as A, which according to S&P’s definition means a "strong" capacity to meet financial commitments. Moody’s rated Lehman A2 that day, which Moody’s defines as a "low credit risk." Fitch gave Lehman a grade of A+, which it describes as "high credit quality." "We’d like to have a jury hear this," Grassi says. "This wouldn’t be six economists, just six normal people. That would scare the rating agencies to death."

The rating companies haven’t yet filed responses. They’ve asked the federal court in Sacramento to take jurisdiction from the state court. S&P and Fitch say they dispute Grassi’s allegations. "We believe the complaint is without merit and intend to defend against it vigorously," S&P’s Atkins says. Fitch’s Weinfurter says, "The lawsuit is fully without merit and we will vigorously defend it." Mirenda at Moody’s declined to comment. S&P included a standard disclaimer with Lehman’s ratings: "Any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision." Grassi isn’t deterred. "They’re saying we know you’re going to rely on us and if you get screwed, you’re on your own because our lawyers have told us to put this paragraph in here," he says. The companies have defended their ratings from lawsuits, arguing that they were just opinions, protected by the free speech guarantees of the First Amendment to the U.S. Constitution.

McGraw-Hill used the First Amendment defense in 1996 after its subsidiary S&P was sued for professional negligence by Orange County, California. S&P had given the county an AA- rating before the county filed for the largest-ever municipal bankruptcy. Orange County alleged in its lawsuit that S&P had failed to warn the government that its treasurer, Robert Citron, had made risky investments with county cash. The U.S. District Court in Santa Ana, California, ruled that the county would have needed to prove the rating company’s "knowledge of falsity or reckless disregard for the truth" to win damages. The court found that the credit rater couldn’t be held liable for mere negligence, agreeing with S&P that it was shielded by the First Amendment. Sharma says rating companies shouldn’t be responsible when investors misuse ratings. "Hold us accountable for what you can," he says. He compares the rating companies to carmakers. "Look, if you drove the car wrong, the manufacturer can’t be held negligent. But if you designed the car wrong, then of course the manufacturer should be held negligent."

The bigger issue is whether the credit rating system should be changed or even abolished. From California to New York to Washington, investors and regulators are saying it doesn’t work. No one has been able to fix it. The federal government created the rating cartel, and the U.S. is as dependent on it as everyone else. So far, the legislative branch hasn’t cleaned up the ratings mess. "This problem really is like a cancer that has spread throughout the entire investment system," Partnoy says. "You’ve got a body filled with little tumors, and you’ve got to go through and find them and cut them out." As the U.S. has spent, lent or pledged about $12.8 trillion in efforts to revive the slumping economy, and as President Barack Obama and Congress have worked overtime to find a way out of the deepest recession in 70 years, no one has taken steps that would substantially fix a broken ratings system. If the government doesn’t head in that direction, all of its efforts at financial reform may be put in jeopardy by the one piece of this puzzle that nobody has yet figured out how to solve.


Penn said...


Anonymous said...

The "smooth sailing ship of our economy", has been on the backs of conquered people and lands…no world war needed, just the corporatocracy …however now TPTB might think a war (or pandemic flu) is needed to shift attention away from the increasing calls for our elected officials to uphold the rule of law. To shift the attention away from them and the blame they own.

VK said...

The bond markets react differently, the last bastion of sense along with gold? The 10 year treasury is at 3.10%. Quite a move for one day.

Anonymous said...

One of the economic byproducts of a 'war economy' is that everyone works for really low wages, you know, for the Fatherland.

Corporate management would love a 'war economy' for this reason alone. Low wages and no one can complain without looking unpatriotic.Working for low wages in a 'war economy' effectively camouflages depression wages and hey, everybody gets a job ( a really low wage job), no unemployment. The inbred inflation of a fractional banking ponzi is 'reset' by several years (decades?) of low wages.

The difference between the low wages of a 'war economy' and what they normally would have been is effectively being used to 'pay down debts'. Kind of like a forced 'time out' on buying consumer junk.

An enforced low consumption (war) economy, and the Sheeple, who have no excess wages for consumption anyway in such a system, still have to work all day for little more than food and shelter (for the 'war effort' comrade citizen)

The Glorious War Effort replaces WalMart with civilian PXs. One kind of paper towel, one kind of canned beans, kind of everything that the military already uses, but now, so does the whole civilians population. One big happy corporate-military complex family experience. BJs and Costco are essentially PXs. This will just make it offical.

Where's the money to pay for a 'war economy'?

The Criminal Class knows that the current massive deleveraging deflation will end in the veil of tears known as hyper inflation.

The hyper inflation will eventually get here, why not beat it to the punch with a 'war economy'.

One way the Sheeple suffer for no reason other than greedy banksters, the other way they suffer for the Motherland, their suffering is justified by fake conjured up self defense.

A 'war economy' also blesses total dictatorial powers for the central government, you know, for the defense of the Homeland and the Supreme Maximum Uber Leader.

This 'war economy' thing is on rails. It's a no brainer.

Will it work? Probably not for the reasons Dan W gave. But it still won't stop the Empire from a good old college try.

rapier said...

The truism that the increase in government spending on the Vietnam war and social programs was the cause, the one main cause, of the inflationary trend is wrong. A few percent of GDP in extra government borrowing did not and cannot explain such a secular trend. The truism serves a political purpose.

As CPI inflation was killed in the early 80's the deficit and government portion of GDP were right in the ballpark of the Vietnam period if not higher.

In the 60s and forward, Americas appetite for imports grew and the flow of dollars offshore grew. The monetary forces which soon lead to the breakdown of the gold based interbank system of currency valuation took hold. When the damn broke and the dollar floated it didn't float, it sunk. Inflation rose.

Credit and monetary expansion were institutionalized on a global scale. Eventually the world figured out how to inflate financial assets and depress commodity assets and wages, and the rest is history.

Now don't get me wrong I am no Austrian School scold. I've got nothing against monetary expansion so long as it operates in a highly democratic manner. I suppose the Austrians might say this is impossible. Sadly the pseudo Austrians seem to grab most of the money power and then make sure it isn't possible. That's another story I suppose.

I'll reject the war thing because we are in two already. Look what good that did. The Keynesian benefit such as it was has been so concentrated by corruption as to be useless. At any rate a big ground war would not be in the cards for Pakistan. Iran maybe.

We are at the limit of Treasury borrowing already. It's pure printing press now and no Pigman wants to print to buy guns or wine and beer for little people. They want every penny for themselves.

Anonymous said...

Calculated Risk has declared the worst of GDP downturn as over.

Merry Christmas, Chaps

Anonymous said...

Dan: I was about to leave this on your blog, but you don't allow anon comments. Here's hoping that you read it here.

Excellent post, Dan. I enjoy your analytical analysis, backed up by real numbers. It's a refreshing view, compared to many who can't do this sort of thinking.

One minor nit, if you will. When you state "Production in 1946 was industrial production within a regime of US economic hegemony", this is a serious understatement.

It's a critical piece of information, but it doesn't bring out the entire situation in just one quick sentence.

A lot of the industrial world had been pretty much destroyed by war, along with suffering heavier casulties than the U.S. did.

In short, the U.S. had the main industrial capacity, along with the workers to support it.

So we got to pay off our War Bonds by exporting a lot of our production. Exports used to make up a large part of our economy for decades, IIRC.

And, as you well point out, we can't do that, thanks to the Financial Engineers of the past decade.

So pardon this nit, but I do think it serves well to emphasize this point and the difference between then and now.

Greenpa said...

The current influenza kerfuffle should serve, at least, to remind us that the knife-edge balanced world economy is - IS - going to get whacked by some large natural event. Soonish, perhaps.

Any good paranoid could come up with a zillion possibilities. A major movement of the New Madrid Fault in Missouri? The Big One, for Los Angeles? The emergence of a new volcano in Yellowstone Park? A category 4 or 5 typhoon for Tokyo? Guangzho? Hong Kong? A little city-killer asteroid strike in France - on a nuclear power plant?

"Stuff happens" - on a regular basis. When that big tsunami hit Thailand, etc; it hurt, a lot; but the world economy absorbed it.

Not today, I think- there is no resilience in the system.

VK said...

What i'm wondering is how on earth did consumer spending go up?

From the 2nd article posted,

"Consumer spending, which accounts for about 70 percent of the economy, climbed at a 2.2 percent annual pace last quarter, the most in two years."


So how is it possible that government tax revenue is declining and so many businesses and stores are going into bankruptcy or barely holding on, when nearly 2 million jobs have been lost in 3 months. That consumer spending is the strongest in 2 years??

Statistical skulduggery IMO. The downward revisions will we worth keeping an eye on.

VK said...

This is what Michael Panzner wrote yesterday,

Now, though, as some deflationistas grow ever more confident that we are set for a replay of what took place 80 years ago, I am in the process of switching sides. As I see it, the combination of intellectual hubris and a relentless determination by central bankers and politicians to beat the GD 2.0 rap, as well as an increasingly contagious urge to embrace all manner of fiscal insanity, suggest we are nearing the point where people will begin to lose faith in those who control the pursestrings -- and the printing presses.

He's been one of the few who've called the crisis pretty accurately and to see him change positions possibly is enough to give me room for thought. Maybe Steve Keen is right and we do need 25 trillion dollars to stimulate real inflation but time will tell, we must remain vigilant.

rapier said...

While skepticism of the consumer spending number is mandatory it must be understood how little the bottom 30% or so of Americans really mean in the big picture. They are expendable and they are being expended.

Absent all the icky social problems America could work great with a much much larger underclass as long as we didn't spend much on them, especially on health care.

Anonymous said...

Any thoughts on the below link?

Anonymous said...

The war scenario is a total non-starter. For one thing, the rest of the world isn't going to war with us. They got burned on the weapons-of-mass-destruction boondoggle and won't fall for that again.

Secondly, we're at war. It's put very few to work here and most of the money goes to Blackwater and Halliburton to build infrastructure in Iraq (and stuff their own corporate pockets.)

This isn't 1940. We aren't the greatest generation. We play video games as adults and use our smart-phones to vote for amateur singers on TV. We watch Nascar for the crashes and ice hockey for the fights and sue McDonalds if we spill our coffee on ourselves.

We've already sent pretty much everyone we have to Iraq, meaning everyone idealistic enough to fall for the patriotic call. That call is looking more shallow every day.


rapier said...

hypertiger! OMG

Step away slowly.

I won't follow the link.

Puffer said...

"Jesus Killed Mohammed - The crusade for a Christian military" Harpers, May
by Jeff Sharlet, is a report pointing out how Obama has inherited a military fighting not just overseas but at home, in a civil war over its own soul.

Thought separation of church and state (First Amendment) is strongest within our U.S officer corp? Check out the Air Force Academy current mind-set. Where fly boy pilots learn to fight the war on spiritual terrorism at a pew or in an F-16.
Meanwhile, the commander-in-chief adopts a hands off approach to religion in the military AND the relationship between church and state.

Anonymous said...

VK -- The question I have for those calling for inflation is this -- what are the mechanics to reverse the asset destruction and wage reversals we're seeing? How exactly would it work?

I think we all agree that the spending bubble, on houses, cars and everything else, was facilitated to a large degree by credit. That credit is drying up and many are reduced to living on their incomes.

Even if banks go back to throwing uncollateralized credit at the population, how many want to go into debt unless they borrow with no intention of repayment?

Maybe that's the scenario -- the govt mandates the banks extend credit to all, and everyone acknowledges secretly that it doesn't actually have to be paid back. That would cause massive inflation, for sure.

I wonder how long other nations would ship us their goods under that scheme? After a while we'd all be rolling in high credit limits with nothing to spend our money on. I suppose we could go back to flipping houses to each other and buying each other's low-mileage used cars.


jal said...

A good piece by Dan W.

It can be summarized by one word/concept

is considered to have originated in the military's need to supply themselves with arms, ammunition and rations as they moved from their base to a forward position. In ancient Greek, Roman and Byzantine empires, there were military officers with the title ‘Logistikas’ who were responsible for financial and supply distribution matters.

Recovery, (The objective does not need to be war), depends of being able to fill the pipeline with the required assets needed by the end users.
Sustainability depends of being to keep it going and going. (There’s that rabbit again)


Anonymous said...

from upthread --

"Absent all the icky social problems America could work great with a much much larger underclass as long as we didn't spend much on them, especially on health care."

Haha! Rapier, I like your wit :)


VK said...

@ KJ

Well there's one guaranteed way to inflate, the government may decide that either way the economy is going to hell and just start printing money, not via quantitative easing, but simply paying govt employees, contractors on projects, tenders for goods with printed money.

No need for tax revenue or borrowing money, simply print and spend directly into the economy like Zimbabwe. But this would mean that the International bond investors would flee and the dollar's reserve status would come to an end. But even in a deflationary depression that eventuality might come to pass. So the govt might just go craaaazzyy.

I mean they can print a quadrillion dollars overnight, just by a few keystrokes. They're not doing it so far because they are scared of what the consequences will be for world trade, output, the natural resources that flow into America most notably OIL by sending paper notes in exchange.

I'm still very much in the deflationista camp as the govt so far seems to genuinely believe that recovery is coming and are doing all they can to preserve the status quo, But, things might change next year when the status quo can no longer be preserved.

Bigelow said...

Inflation will return when cash and credit increase again. Waiting.

In the mean time:

“According to the BIS, which acts as a central bank for central banks, total bank claims shrank by $1.8 trillion in the fourth quarter, or 5.4%, to $31 trillion. This was the largest decline ever recorded.

In other words, there never was a global run on the banking system such as the one seen in the final three months of 2008, which followed the bankruptcy of Lehman Brothers and the near-collapse of American International Group (ticker: AIG) in September. The numbers serve to confirm the extent of the tsunami that swept through the world's financial system.

To be sure, banks, including the I-banks, have benefited from the actions of the Fed and the Treasury. But that is separate from the question of the macroeconomic impact of their actions.

Those who contend that the expansion of central bank balance sheets is inflationary ignore the contraction of balance sheets in the banking system, as well as the so-called shadow banking system of assets and liabilities not recorded on banks' books.”
Fed Fights a Record Global Bank Run Barrons

Unknown said...

With regards to the article about the Austrian railroad system being seized... it seems to me that this is about to start happening EVERYWHERE. Amtrak trains, public water production systems, dams, police cars, fire trucks, public buildings, freeways, bridges, etc. It seems that all over the world municipalities put up the public assets as collateral for loans and other financial transactions to cover budgetary shortfalls. With this huge collapse causing even more problems, banks are going to be owning many of these public assets. We were warned by many people how putting banks in control would leave to slavery. I always wondered how that would work. I think we have our answer.

Anonymous said...

The govt is busily re-filling the holes in the financial system, seemingly assuming that once the FIRE economy is bailed out it will automatically lift the rest of the economy. It seems to me they have the cart before the horse there, but what do I know.

At any rate -- not to sound too simplistic or state the obvious, but I think our biggest problem is that our shelter costs have inflated way too much.

Housing is priced at the 2-income ability to pay and singles or one-earner families are having to compete with 2-income high-earners for a place to live. It's skewing the entire economy. Housing has to come down. Cheaper housing means more money to spend elsewhere.

If Obama's goal is to stimulate spending, then the average family's biggest expense, housing, has to become a smaller percentage of their paycheck.


Anonymous said...


Re: just printing, I think thats actually a better plan than the govt borrowing to spend. Borrowing just creates debt. Then you have to borrow more to pay the interest.

There's been so much 'wealth' destruction that I think the govt can get away with some raw printing. But if it works out well, they'll do it every time they want something, which is often!


Tripwire said...

I have to do something with the cash I already have in my IRA. I believe the consensus view here is that following the deflationary period, inflation will eventually return and the dollar will be toast. So I just bought some gold ETFs: DGL and GLD. This is a first for me. Any gold bugs out there have an opinion they care to share?

Ilargi said...


You hit on a mostly still hidden theme, that we'll see so much, we have no idea. A huge number of municipalities, utilities etc have hired external agencies to invest their funds. These agencies, often representing a dozen or more clients, in many cases have gone from risk to riskier, chasing yield. Ironically, the best performers were employed more and more, and nobody looked at why their performance was so much better. In most cases, they wouldn't have had the knowledge, which is why they looked for external sources. But these fund managers meet on the golf track, boast about revenues and fees, exchange tips, tit for tat, and the risk level kept increasing.

Now, the game is up. And many clients will simply find they are broke, completely bankrupt, while many can expect collecting agencies to come calling because more was invested in their name, whether they knew it or not, than they had or have.

The only possible reaction: tax rates go up, utility rates go up.

And that in turn makes the discussion about inflation so funny. Yes, services will get more expensive. But that is not inflationary: the increased funds are needed to pay off previously incurred obligations. And even then people within the community will be laid off by the dozen, another counter-inflationary development.

The same, of course, is true on a federal level. What is "keystroke printed" is almost exclusively used to pay off previous debt. And then there''s far more debt than there is money being printed. 99% doesn't enter the economy. We see fake moves today with Obama's stimulus and TARP and TALF. But all of those plans only serve to make deflation worse. A trillion here and there will create the appearance of improvement, but it's all nothing but a mirage. Down the line, you'll have to produce something, not borrow money, to make matters better. And the US produces less every single day, not more, just look at unemployment numbers.

fewer people have anything to spend, and those that do are reluctant to spend. That contradicts inflation.

Gravity said...

Wars begin when you will,
but they do not end when you please.

Many of the common people in the armies were desolate, fearing future poverty; and so they sold their guns and the cowards returned
to their own homes.

Anonymous said...

In response to KJ, you are right. Housing costs are too high. For a 1 bedroom in a southern california city where I live, a 1 bedroom unit goes for $800-1100 a month. I pay $895 a month for RENT and that amount represents %30 of my take home pay. This results in only a small amount of money left over for discretionary spending. If rent was to come down as a percentage of income, it would free more money for consumer spending.

Ahimsa said...

"Swine Flu Smoking Gun? CDC was Combining Flu Viruses in 2004"

Persephone said...

Illinois Sen Dick Durbin just declared on national television that the U.S. Senate is owned by the banks.

Anonymous said...

Swine Flu Martial Law Bill Clears Massachusetts Senate
April 29, 2009
It took corporate media swine flu hysteria to ram through a martial law bill in Massachusetts. S18 gives the Governor the power to authorize the deployment and use of force to distribute supplies and materials and local authorities will be allowed to enter private residences for investigation and to quarantine individuals.

there goes my supplies......

Greenpa said...

For a quick lesson in the ability of the average "Homo sapiens" to comprehend science, reporting, or just keep facts straight: Pork industry suffering flu-In case anyone here needed to be reminded.

“People in Mexico ate some pork and got sick, right?” said Ms. Tran, who was looking for selections in the beef case. (That is not what happened, as far as anyone knows.)

Yvonne Enard, a retired warehouse worker, said she too believed there was a connection between pork and swine flu but figured it would be safe to eat anyway. “I’ll buy it, but I wouldn’t buy it from just any store, and I would season it and cook it very well,” she said."

Anonymous said...

VK if you haaven't already, take a look at denninger today. Sounds like he thinks there there is a fishy smell to the consumer spending numbers.GDP? What GDP?

"So we had some rebound in consumer spending. But where's the money coming from?"


Anonymous said...

Besides lies, lies, lies, the meltdown has been diversion, diversion, diversion.

Three-card Monte and The Shell Game, which walnut is the pea under?

In the initial phase, diversion was to distract the Mark's attention, a misdirection if you will, in order to pick more from their pockets.

Diversion in the final phases is to enable escape with the loot and to misdirect the mob's livid homicidal anger at being cheated, once they inevitably Wakeup.War has historically been very good at this last phase. However, so is scapegoating of internal enemies.

It will be one or the other or a combo one-two punch.

It is Not going to be people reasonably and rationally discussing this meltdown, coming to a consensus and a plan of action and then singing Kumbia.

It's Not going to be people adjusting to instant poverty and quietly and meekly accepting their lot in life.

Recovery of any kind is flatly impossible without confidence.

Confidence that what went wrong is fully understood.

Confidence that steps have been put in place that reassure us that it won't happen again any time soon.

And finally, Confidence that those responsible, from top to bottom, from the Ritz to the Pits, are punished.

Not a slap on the wrist, not country club minimum security jail, not even forfeiture of assets.

Punishment with a capital "P"Punishment as Spectacle.All three have to be addressed or no confidence. Two out of three is not gonna cut the mustard, not by a long, long shot.

A lack of confidence will drive the most base, destructive instincts you have ever witnessed in your life.

Jon Stewart directed a ripping sarcastic piece at Obama saying he just wanted to look forward and not blame people for past 'wrongs', like for instance war crimes and torture. He just wants to 'look forward'.

Well Mr O, that dog won't hunt.

Anyone advocating we just 'look forward' will be seen as a criminal co-conspirator, not a thoughtful solution guy.

Looking Back is where the evidence for this fiasco lives, not in the future.

You Will be judged as either part of the solution, or part of the problem, very, very few gray shades lie up ahead.

The best horror shows are in Black and White.

VK said...

Ken Lewis is out!

VK said...

oops I wrote to soon :-( He's just out as Chairman and stays on as CEO. Silly me, I was excited that people are being held accountable for their fraudulent actions.

I forgot it was 2009 and we don't believe in this anymore.

Anonymous said...

Hey VK you were excited you even left your link behind. Good thing it wasn't your pants;)


Persephone said...


Do you think anyone has told them Swine flu can pass human to human?

Greenpa said...

Persephone- I used to know a few top Egyptian science officials personally- they would know exactly how it works.

Persephone said...


Then the scientists would understand that the slaughter of the swine is to no avail, right?

I just don't follow the logic.

Greenpa said...

Persephone- sorry to be obtuse. The muslim majority are taking this opportunity to whack the Copts, again. It will add quite a bit of powder to the keg; and maybe light some fuses. Nothing to do with flu- just an excuse.

Persephone said...

Thanks Greenpa!
THAT I can understand.

Stoneleigh said...

People are going to start to worry about inflation during this rally, but inflation is not our problem. In the face of a quadrillion dollar ponzi scheme (otherwise known as the derivatives market), and the sobering effect of the bond market, we won't be seeing inflation any time soon. Those who are changing their minds will change them back soon enough once the rally is over.

I agree with Ilargi that we are going to see substantial tax increases as governments at all levels grab whatever they can, but are still increasingly starved of funds. They won't care that they will squeezing people with less and less ability to pay as jobs disappear. When a body is hypothermic, circulation to the extremities is shut down to save the core, and we are the extremities. Money will flow from us to the centre, but will not circulate back to us while the centre still stands.

My concern regarding the flu is not the illness itself, at least not yet (perhaps in a couple of years). My concern has to do with the use of a crisis to grab a far higher degree of social control using health as an excuse. Freedom and privacy will be early casualties of this depression and this is how that process begins. You may need to be creative about the things you store on your property.

Greenpa said...

A story with multiple versions, but which I first heard in Egypt:

A frog, sitting happily on the banks of the Nile, was approached by a scorpion, on the bank.

"Friend Frog", said the scorpion, "Please be so kind as to carry me across the river, as I cannot swim, and I need to visit my relatives on the other side."

"Friend Scorpion," said the frog "Do I look stupid?? You'll sting me, with your stinger, and I'll die! No, thank you!"

"But think, Friend Frog. If I were to sting you while you were swimming- I would die too! I'd never be so stupid!"

The frog finds this argument convincing; and being a good soul says- "Very well, Friend Scorpion- climb aboard; I'll carry you."

In the middle of the Nile- the scorpion hauls off and WHACK! - stings the frog right between the eyes.

As the frog is sinking, and dying- and the scorpion is drowning- the frog gasps "Why?? why?? You fool? Now we'll both die!! Why would you DO that???"

The scorpion replies; "Why?? This is the Middle East!"

Told to me, I think, by a Coptic cabbie.

bluebird said...

With so many banks being insolvent, how would they be able to own anything? My brain was leaning toward privatization (maybe some government) that would control our water supplies, electricity, food, police, roads, etc. And charge whatever fee they wanted. And who would be able to afford these fees if they have no cash?

Anonymous said...


The banks will seize the assets in foreclosure court but will then sell the assets to their other non-insolvent subsidiaries at bottom dollar. I think that the best indicator that this is happening is widespread stories of people wanting to refinance or repackage their mortgage but the lenders basically ignoring their calls and foreclosing anyway. My parents refinanced only up to 70% LTV at the peak but because values have dropped about 55% from the peak are left upside down. They are trying to renegotiate but the lender wont even call them back. If they could get on a 30 yr fixed at today's rates they would be fine, even without lowering the principal. Instead they are stuck on an 11% ARM.

Anonymous said...

The Flying Pork Choppler Effect:

FAWKS news reports that Swine Flu has caused Sirius, our brightest star, to noticeably wobble.

The World Health Organization is even now considering raising the Pandemic threat level to OMFG! pending confirmation of the disease in extra-terrestial life forms and has issued a travel advisory throughout the galaxy.

The Egyptian's have responded by calling for the sacrificial slaughter of Christian dogs and an outright ban of Pigs in Space, pigs in pokes and of course, pigs in a blanket.

Stay tuned to your television set 24-hours a day for further must-see news updates, although please be aware the message you receive may sound very different from the one we broadcast depending upon on your location in our universe.

Anonymous said...

Conversation overheard at work today.
The setting;
A hospital recovery room (post anathesia care unit), early evening, a man and a woman, both veteran nurses but true believers in the Ponzi scheme that is the modern global economy, talking about pay cuts some of the casual RN staff are now having to endure;

Guy: "Yeah, this hospital has really screwed itself. Now, I bet you we loose half our per diem pool. And when the economy picks up again, they are really gonna be hurting for staff. We already got a nursing shortage on our hands, now we have to deal with this?"

Gal: "I've been a nurse for 22 years, and every time they have a lay off, they end up having to hire even more folks back. When the economy turns around, hospital administration is really gonna be up the creek looking for staff to replace everyone they laid off.

Guy: "Yeah, when the economy turns around...
Gal:" When it turns around...

They then went back to watching a clip of "American Idol" on Youtube.

I thought about telling them that the last thing any sane person would do right now is quit a job in this economy, and that even RN's are going to be hurting for work before too much longer, but I figured they wouldn't listen to me, and besides, they seemed really interested in "American Idol" and I didn't want to bother them with bad news.

By the way, these folks think of Jim Cramer as being some kind of genius.

Chaos said...

@ Subkommander Dred:

Thanks for that cultural snapshot. I have to say that I've heard many snippets like this, ending with exactly the same language "when the economy recovers...."

Apparently, these people's education/indoctrination doesn't permit them to consider..."what if"

Anthony said...

It's quite ironic to push for a "war economy" to create jobs while having a carefully laid out "green platform" at the same time.

Anonymous said...

i speak to friends/relatives/coworkers etc. about an article i read on

regarding social security and how it won't be available to everyone, the response i get is: it'll never happen the people/public will go up in arms or congress/senate will ensure that it's for everyone.

I don't know, but listening to Barry McGuire singing "eve of destruction" while reading TAE dosen't help things.

"ah ya don't believe we're on the eve of destuction"

true words could never been said!

Anonymous said...

The Congress is filled with enablers incapable of raising their voices against the Wallstreet thugs. Most people in Congress either do not understand the complexity damage being inflicted on American people or are worshiping the Wallstreet guys paying for their elections

Anonymous said...

It's alright you can scream with me, it goes like this..


Halls of justice painted green
Money talking
Power wolves beset your door
Hear them stalking
Soon you'll please their appetite
They devour
Hammer of justice crushes you

The ultimate in vanity
Exploiting their supremacy
I can't believe the things you say
I can't believe, I can't believe the price you pay
Nothing can save you

Justice is lost
Justice is raped
Justice is gone
Pulling your strings
Justice is done
Seeking no truth
Winning is all
Find it so grim, so true, so real

Apathy their stepping stone
So unfeeling
Hidden deep animosity
So deceiving
Through your eyes their light burns
Hoping to find
Inquisition sinking you
With prying minds

The ultimate in vanity
Exploiting their supremacy
I can't believe the things you say
I can't believe, I can't believe the price you pay
Nothing can save you
Justice is lost
Justice is raped
Justice is gone
Pulling your strings
Justice is done
Seeking no truth
Winning is all
Find it so grim, so true, so real

Lady Justice has been raped
Truth assassin
Rolls of red tape seal your lips
Now you're done in

Their money tips her scales again
Make your deal
Just what is truth, I cannot tell
Cannot feel

The ultimate in vanity
Exploiting their supremacy
I can't believe the things you say
I can't believe, I can't believe the price we pay
Nothing can save us

Justice is lost
Justice is raped
Justice is gone
Pulling your strings
Justice is done
Seeking no truth
Winning is all
Find it so grim, so true, so real

Seeking no truth
Winning is all
Find it so grim, so true, so real