Kontent News

My take on the commodity supercycle zeitgeist...and the rise of the precious metals, uranium (just bottomed, btw)and alternate energy. Get ready for peak everything, the repricing of the planet and "black swans" all over the place..

Wednesday, April 16, 2008

The rise of the new energy world order

By Michael T Klare

Oil at US$110 a barrel. Gasoline at $3.35 (or more) per gallon. Diesel fuel at $4 per gallon. Independent truckers forced off the road. Home heating oil rising to unconscionable price levels. Jet fuel so expensive that three low-cost airlines stopped flying in the past few weeks. This is just a taste of the latest energy news, signaling a profound change in how all of us, in this country and around the world, are going to live - trends that, so far as anyone can predict, will only become more pronounced as energy supplies dwindle and the global struggle over their allocation intensifies.

Energy of all sorts was once hugely abundant, making possible the worldwide economic expansion of the past six decades. This expansion benefited the United States above all - along with its "First World" allies in Europe and the Pacific. Recently, however, a select group of former "Third World" countries - China and India


in particular - have sought to participate in this energy bonanza by industrializing their economies and selling a wide range of goods to international markets. This, in turn, has led to an unprecedented spurt in global energy consumption - a 47% rise in the past 20 years alone, according to the US Department of Energy (DoE).

An increase of this sort would not be a matter of deep anxiety if the world's primary energy suppliers were capable of producing the needed additional fuels. Instead, we face a frightening reality: a marked slowdown in the expansion of global energy supplies just as demand rises precipitously. These supplies are not exactly disappearing - though that will occur sooner or later - but they are not growing fast enough to satisfy soaring global demand.

The combination of rising demand, the emergence of powerful new energy consumers, and the contraction of the global energy supply is demolishing the energy-abundant world we are familiar with and creating in its place a new world order. Think of it as rising powers/shrinking planet.

This new world order will be characterized by fierce international competition for dwindling stocks of oil, natural gas, coal and uranium, as well as by a tidal shift in power and wealth from energy-deficit states like China, Japan and the United States to energy-surplus states like Russia, Saudi Arabia and Venezuela. In the process, the lives of everyone will be affected in one way or another - with poor and middle-class consumers in the energy-deficit states experiencing the harshest effects. That's most of us and our children, in case you hadn't quite taken it in.

Here, in a nutshell, are five key forces in this new world order which will change our planet:


Intense competition between older and newer economic powers for available supplies of energy. Until very recently, the mature industrial powers of Europe, Asia and North America consumed the lion's share of energy and left the dregs for the developing world. As recently as 1990, the members of the Organization of Economic Cooperation and Development (OECD), the club of the world's richest nations, consumed approximately 57% of world energy; the Soviet Union/Warsaw Pact bloc, 14%; and only 29% was left to the developing world. But that ratio is changing: with strong economic growth in the developing countries, a greater proportion of the world's energy is being consumed by them. By 2010, the developing world's share of energy use is expected to reach 40% and, if current trends persist, 47% by 2030.

China plays a critical role in all this. The Chinese alone are projected to consume 17% of world energy by 2015, and 20% by 2025 - by which time, if trend lines continue, it will have overtaken the United States as the world's leading energy consumer. India, which, in 2004, accounted for 3.4% of world energy use, is projected to reach 4.4% by 2025, while consumption in other rapidly industrializing nations like Brazil, Indonesia, Malaysia, Thailand and Turkey is expected to grow as well.

These rising economic dynamos will have to compete with the mature economic powers for access to remaining untapped reserves of exportable energy - in many cases, bought up long ago by the private energy firms of the mature powers like Exxon Mobil, Chevron, BP, Total of France and Royal Dutch Shell. Of necessity, the new contenders have developed a potent strategy for competing with the Western "majors": they've created state-owned companies of their own and fashioned strategic alliances with the national oil companies that now control oil and gas reserves in many of the major energy-producing nations.

China's Sinopec, for example, has established a strategic alliance with Saudi Aramco, the nationalized giant once owned by Chevron and Exxon Mobil, to explore for natural gas in Saudi Arabia and market Saudi crude oil in China. Likewise, the China National Petroleum Corporation (CNPC) will collaborate with Gazprom, the massive state-controlled Russian natural gas monopoly, to build pipelines and deliver Russian gas to China. Several of these state-owned firms, including CNPC and India's Oil and Natural Gas Corporation, are now set to collaborate with Petroleos de Venezuela SA in developing the extra-heavy crude of the Orinoco belt once controlled by Chevron. In this new stage of energy competition, the advantages long enjoyed by Western energy majors has been eroded by vigorous, state-backed upstarts from the developing world.

The insufficiency of primary energy supplies. The capacity of the global energy industry to satisfy demand is shrinking. By all accounts, the global supply of oil will expand for perhaps another half decade before reaching a peak and beginning to decline, while supplies of natural gas, coal and uranium will probably grow for another decade or two before peaking and commencing their own inevitable declines. In the meantime, global supplies of these existing fuels will prove incapable of reaching the elevated levels demanded.

Take oil. The US DoE claims that world oil demand, expected to reach 117.6 million barrels per day in 2030, will be matched by a supply that - miracle of miracles - will hit exactly 117.7 million barrels (including petroleum liquids derived from allied substances like natural gas and Canadian tar sands) at the same time. Most energy professionals, however, consider this estimate highly unrealistic. "One hundred million barrels is now in my view an optimistic case," the chief executive officer of Total, Christophe de Margerie, typically told a London oil conference in October 2007. "It is not my view; it is the industry view, or the view of those who like to speak clearly, honestly, and [are] not just trying to please people."

Similarly, the authors of the Medium-Term Oil Market Report, published in July 2007 by the International Energy Agency, an affiliate of the Organization for Economic Cooperation and Development, concluded that world oil output might hit 96 million barrels per day by 2012, but was unlikely to go much beyond that as a dearth of new discoveries made future growth impossible.

Daily business-page headlines point to a vortex of clashing trends: worldwide demand will continue to grow as hundred of millions of newly-affluent Chinese and Indian consumers line up to purchase their first automobile (some selling for as little as $2,500); key older "elephant" oil fields like Ghawar in Saudi Arabia and Canterell in Mexico are already in decline or expected to be so soon; and the rate of new oil-field discoveries plunges year after year. So expect global energy shortages and high prices to be a constant source of hardship.

The painfully slow development of energy alternatives. It has long been evident to policymakers that new sources of energy are desperately needed to compensate for the eventual disappearance of existing fuels as well as to slow the buildup of climate-changing "greenhouse gases" in the atmosphere. In fact, wind and solar power have gained significant footholds in some parts of the world. A number of other innovative energy solutions have already been developed and even tested out in university and corporate laboratories. But these alternatives, which now contribute only a tiny percentage of the world's net fuel supply, are simply not being developed fast enough to avert the multifaceted global energy catastrophe that lies ahead.

According to the DoE, renewable fuels, including wind, solar and hydropower (along with "traditional" fuels like firewood and dung), supplied but 7.4% of global energy in 2004; biofuels added another 0.3%. Meanwhile, fossil fuels - oil, coal and natural gas - supplied 86% of world energy, nuclear power another 6%. Based on current rates of development and investment, the DoE offers the following dismal projection: In 2030, fossil fuels will still account for exactly the same share of world energy as in 2004. The expected increase in renewables and biofuels is so slight - a mere 8.1% - as to be virtually meaningless.

In global warming terms, the implications are nothing short of catastrophic: Rising reliance on coal (especially in China, India and the United States) means that global emissions of carbon dioxide are projected to rise by 59% over the next quarter-century, from 26.9 billion metric tons to 42.9 billion tons. The meaning of this is simple. If these figures hold, there is no hope of averting the worst effects of climate change.

When it comes to global energy supplies, the implications are nearly as dire. To meet soaring energy demand, we would need a massive influx of alternative fuels, which would mean equally massive investment - in the trillions of dollars - to ensure that the newest possibilities move rapidly from laboratory to full-scale commercial production; but that, sad to say, is not in the cards.

Instead, the major energy firms (backed by lavish US government subsidies and tax breaks) are putting their mega-windfall profits from rising energy prices into vastly expensive (and environmentally questionable) schemes to extract oil and gas from Alaska and the Arctic, or to drill in the deep and difficult waters of the Gulf of Mexico and the Atlantic Ocean. The result? A few more barrels of oil or cubic feet of natural gas at exorbitant prices (with accompanying ecological damage), while non-petroleum alternatives limp along pitifully.

A steady migration of power and wealth from energy-deficit to energy-surplus nations: There are few countries - perhaps a dozen altogether - with enough oil, gas, coal and uranium (or some combination thereof) to meet their own energy needs and provide significant surpluses for export. Not surprisingly, such states will be able to extract increasingly beneficial terms from the much wider pool of energy-deficit nations dependent on them for vital supplies of energy. These terms, primarily of a financial nature, will result in growing mountains of petrodollars being accumulated by the leading oil producers, but will also include political and military concessions.

In the case of oil and natural gas, the major energy-surplus states can be counted on two hands. Ten oil-rich states possess 82.2% of the world's proven reserves. In order of importance, they are: Saudi Arabia, Iran, Iraq, Kuwait, the United Arab Emirates, Venezuela, Russia, Libya, Kazakhstan and Nigeria. The possession of natural gas is even more concentrated. Three countries - Russia, Iran and Qatar - harbor an astonishing 55.8% of the world supply. All of these countries are in an enviable position to cash in on the dramatic rise in global energy prices and to extract from potential customers whatever political concessions they deem important.

The transfer of wealth alone is already mind-boggling. The oil-exporting countries collected an estimated $970 billion from the importing countries in 2006, and the take for 2007, when finally calculated, is expected to be far higher. A substantial fraction of these dollars, yen and euros have been deposited in sovereign wealth funds (SWFs), giant investment accounts owned by the oil states and deployed for the acquisition of valuable assets around the world.

In recent months, the Persian Gulf SWFs have been taking advantage of the financial crisis in the United States to purchase large stakes in strategic sectors of its economy. In November 2007, for example, the Abu Dhabi Investment Authority (ADIA) acquired a $7.5 billion stake in Citigroup, America's largest bank holding company; in January, Citigroup sold an even larger share, worth $12.5 billion, to the Kuwait Investment Authority (KIA) and several other Middle Eastern investors, including Prince Walid bin Talal of Saudi Arabia. The managers of ADIA and KIA insist that they do not intend to use their newly-acquired stakes in Citigroup and other US banks and corporations to influence US economic or foreign policy, but it is hard to imagine that a financial shift of this magnitude, which can only gain momentum in the decades ahead, will not translate into some form of political leverage.

In the case of Russia, which has risen from the ashes of the Soviet Union as the world's first energy superpower, it already has. Russia is now the world's leading supplier of natural gas, the second largest supplier of oil and a major producer of coal and uranium. Though many of these assets were briefly privatized during the reign of Boris Yeltsin, President Vladimir Putin has brought most of them back under state control - in some cases by exceedingly questionable legal means.

He then used these assets in campaigns to bribe or coerce former Soviet republics on Russia's periphery reliant on it for the bulk of their oil and gas supplies. European Union countries have sometimes expressed dismay at Putin's tactics, but they, too, are dependent on Russian energy supplies, and so have learned to mute their protests to accommodate growing Russian power in Eurasia. Consider Russia a model for the new energy world order.

A growing risk of conflict. Throughout history, major shifts in power have normally been accompanied by violence - in some cases, protracted violent upheavals. Either states at the pinnacle of power have struggled to prevent the loss of their privileged status, or challengers have fought to topple those at the top of the heap. Will that happen now? Will energy-deficit states launch campaigns to wrest the oil and gas reserves of surplus states from their control - the George W Bush administration's war in Iraq might already be thought of as one such attempt or to eliminate competitors among their deficit-state rivals?

The high costs and risks of modern warfare are well known and there is a widespread perception that energy problems can best be solved through economic means, not military ones. Nevertheless, the major powers are employing military means in their efforts to gain advantage in the global struggle for energy, and no one should be deluded on the subject. These endeavors could easily enough lead to unintended escalation and conflict.

One conspicuous use of military means in the pursuit of energy is obviously the regular transfer of arms and military-support services by the major energy-importing states to their principal suppliers. Both the United States and China, for example, have stepped up their deliveries of arms and equipment to oil-producing states like Angola, Nigeria and Sudan in Africa and, in the Caspian Sea basin, Azerbaijan, Kazakhstan and Kyrgyzstan. The United States has placed particular emphasis on suppressing the armed insurgency in the vital Niger Delta region of Nigeria, where most of the country's oil is produced; Beijing has emphasized arms aid to Sudan, where Chinese-led oil operations are threatened by insurgencies in both the South and Darfur.

Russia is also using arms transfers as an instrument in its efforts to gain influence in the major oil- and gas-producing regions of the Caspian Sea basin and the Persian Gulf. Its urge is not to procure energy for its own use, but to dominate the flow of energy to others. In particular, Moscow seeks a monopoly on the transportation of Central Asian gas to Europe via Gazprom's vast pipeline network; it also wants to tap into Iran's mammoth gas fields, further cementing Russia's control over the trade in natural gas.

The danger, of course, is that such endeavors, multiplied over time, will provoke regional arms races, exacerbate regional tensions and increase the danger of great-power involvement in any local conflicts that erupt. History has all too many examples of such miscalculations leading to wars that spiral out of control. Think of the years leading up to World War I. In fact, Central Asia and the Caspian today, with their multiple ethnic disorders and great-power rivalries, bear more than a glancing resemblance to the Balkans in the years leading up to 1914.

What this adds up to is simple and sobering: the end of the world as you've known it. In the new, energy-centric world we have all now entered, the price of oil will dominate our lives and power will reside in the hands of those who control its global distribution.

In this new world order, energy will govern our lives in new ways and on a daily basis. It will determine when, and for what purposes, we use our cars; how high (or low) we turn our thermostats; when, where, or even if, we travel; increasingly, what foods we eat (given that the price of producing and distributing many meats and vegetables is profoundly affected by the cost of oil or the allure of growing corn for ethanol); for some of us, where to live; for others, what businesses we engage in; for all of us, when and under what circumstances we go to war or avoid foreign entanglements that could end in war.

This leads to a final observation: the most pressing decision facing the next president and Congress may be how best to accelerate the transition from a fossil-fuel-based energy system to a system based on climate-friendly energy alternatives.

Michael T Klare is a professor of peace and world security studies at Hampshire College and the author of Resource Wars and Blood and Oil. Consider this essay a preview of his newest book, Rising Powers, Shrinking Planet: The New Geopolitics of Energy, which has just been published by Metropolitan Books.

Thursday, April 10, 2008

The Black Death of financial collapse

By James Cumes

The financial and economic crisis now upon us is by far the most menacing of the past century - even more so than the Great Depression of the 1930s. It is not just a "subprime" crisis; it is systemic - affecting the entire financial system. It is also global, affecting various countries in various ways but affecting them all. In achieving a certain "globalization", we have been uniquely successful in globalizing collapse, chaos and misery. It is a globalization which, in our short-sighted negligence, we never envisaged.

In this crisis, even a country such as Australia is no more than a subordinate, neo-colonial, financial and economic dependency. In essence, we have reverted to what we were before and during the Great Depression of the 1930s, when Whitehall, Westminster and the Bank of England played the tune to which we jigged. Then, from 1945 to 1969, for the first time, we played our own tune of full employment and stable economic growth. Wild radicals such as minister Eddie Ward in the governments of John Curtin (1941-45) and Ben Chifley (1945-49) warned us to be wary of Wall Street.

The cynics might now say that Eddie, who died in 1963, was right. After 1969, we forgot his warning. Indeed, the Americans themselves forgot to guard against the chicaneries of Wall Street, where eternal vigilance should always be the watchword. They forgot what the mania of Wall Street can do to the reality of Main Street; and we shared their amnesia.

From 1969 and especially from 1971, when the United States cut the dollar link with gold, Australia surrendered any worthwhile independence in its economic and financial thinking. We swallowed American financial and economic formulae, whether we were academics or policymakers, industrial entrepreneurs, banks or providers of "financial services."

We did not entirely switch off tunes played by Britain, the more so as its prime minister Margaret Thatcher formed her slapstick band with US president Ronald Reagan to drum up support for "free" markets, "free" trade, privatization, globalization and the free flow of almost everything, including speculative capital in unqualified pursuit of private profit. Corporation and consumer greed marched in step towards global disaster.

Rational economics based on real investment, productivity and production died in favor of speculative and often Ponzi pretensions. The cowboy junk-bond merchants of the 1980s metamorphosed into respectable, mostly young and usually idolized financial wizards who "perfected" sophisticated, highly complex credit devices. From the 1990s, these highly leveraged instruments took the form of derivatives, private-equity, hedge-fund and mortgage securities, abbreviated to CDOs, SIVs and the rest.

Allied with "free" markets, deregulation and the uninhibited flow of all kinds of finance, those financial devices destroyed industries and the jobs that go with them. With casual indifference, they also destroyed the self-reliant working and middle classes until then typical of robust free-enterprise economies.

Theirs was not Joseph Schumpeter's "creative destruction" but wholesale destruction of their own economies and, eventually, their own financial "system". They destroyed personal savings and created massive indebtedness. They undermined the power and security of the United States itself as they "outsourced" real economic strength and stability to countries especially in Asia.

The Asian Tigers, China and others grew into "powerhouses" whose creation, historically, would otherwise have taken them generations. Our eminently creditable aim of peaceful change through development of developing economies was distorted, largely through negligent inadvertence, into financial, economic and social self-destruction. Looming global collapse, with political and strategic uncertainties, are our inevitable legacy.

Consumerism rages, industry gutted

The speculative, Ponzi mania spread especially to Anglo-Saxon countries and to other developed countries in lesser degree. Australia took to "free" markets, "free" trade, free-floating currencies, deregulation, privatization, globalization, derivatives, hedge funds, private equity, wildcat mortgages and leverage-without-limit as a duck to water. Consumerism raged. Industry was gutted. Debts ballooned. The value of the currency fell at home and abroad. Despite low-cost imports, inflation flourished. In 2008, the Australian dollar can perhaps buy as much in real terms as five or 10 cents did in 1969.

A situation in which real public and private investment was replaced by "ownership investment", massive leverage and speculative finance, in which consumption grew and debts spread, could not persist, except so long as ever more money flooded in to support the insupportable. Once the flood slowed or stopped, a Ponzi-type collapse was inevitable.

But few saw it that way. Warren Buffet belatedly called derivatives weapons of mass destruction; but most saw the financial devices as belonging to a "new era". They represented a "new paradigm". Far from being a threat to stable growth in a stable financial system, they "spread risk" and made everyone more secure and of course more wealthy.

The wealth effect was a particular feature of the residential mortgage business. Funds were available from many new banking and non-banking sources, including hedge funds and private equity, as well as pension and mutual funds; and sources that, in their magnitudes, were new, such as the carry trade. Funds marketed wholesale and retail mortgages. Liability could be shifted even or especially for debt in the deepest sense sub-prime. Mortgages also enabled homeowners to expand consumption through mortgage-equity withdrawals (MEW).

In a real sense, MEWs were symptomatic of multitudes of individuals - and, in effect, whole societies - high-living it off their capital. That enabled a process of growth that was both irresistible and inherently unsustainable.

However, the Ponzi scheme to shame all others may yet be waiting to deliver its coup de grace. One commentator has drawn attention to "the bad news [which] is the US$500 trillion derivatives market". He says that "This is an area that the general public does not even know exists. Few professionals understand this market. There is no regulation as government just let it go ... and go it did. You must expect a 5% default problem. That is a $25 trillion number ... It can create insolvent institutions all over the world ... It is the making of the first global depression. The world is not ready."

Unprepared for depression

Australia is not ready either. Prime Minister Kevin Rudd told us late in March that Australia's economic prospects remain "sound, strong and good". The Reserve Bank of Australia shares that view. Eerily, they echo US President Herbert Hoover in 1929 immediately before the stock market crash of that year.

Australia's situation contains some positive features. High commodity prices, it can be argued, are likely to persist, even though volatile, at least in the short term. A member of Iceland's central bank board recently said that "fears of a meltdown in my sub-arctic homeland are vastly overblown. True, the current account deficit was 16% of GDP last year, but that's an improvement from more than 25% in 2006. And while net private-sector debt is about 120% of GDP, there is virtually no public debt in Iceland. This is largely the result of unparalleled political stability and continuity."

Australia's situation may not be as dire as Iceland's; or indeed as dire as that of the United States or New Zealand; but all three of us have some negatives like those of Iceland.

Like all booms of such size and speculative character, the Australian housing boom must soon demand payment of its account. From their peak, prices could fall 30% to 50%. Industry researcher BIS Shrapnel does not agree; but we must expect that our housing boom, even more robust than the American, will collapse along the same general lines as the bust occurring right now in the United States.

The high "unaffordability" of housing for the average home-seeker, as distinct from speculator, suggests that the bust will be savage. The real-estate, building and associated industries will suffer severely, with massive job losses. Simultaneously, profitable investment opportunities elsewhere may have vanished with the widespread collapse of the "financial services industry".

How likely is such a collapse? So far, although some non-banking financial institutions have gone to the wall, the four major banks have seemed largely immune. "The take-up of the Australian economy is still good," Rudd said last week in New York. Australia had "limited exposure" to the subprime mortgage woes that erupted in the United States last year, he said. "We have excellent balance sheets in terms of our principal corporates and the banks themselves ... The default rate in Australia is minuscule by Organization for Economic Cooperation and Development standards."

We don't know how far banks and other potentially exposed institutions have concealed their liabilities and to what extent and how soon they will be forced to reveal whatever bad news there is. Within this broad question, we also do not know how far they are exposed to losses from the massive and still largely mysterious menace of derivatives.

In some measure, Australia's major banks have certainly been involved in the wide range of structured securities - CDOs, SIVs, and the rest. A report on April 4, 2008, that local councils in New South Wales have lost US$200 million and perhaps up to $400 million on investments in CDOs is a worrying sign that other and even bigger losses may yet be revealed in a variety of institutions, including banks. It seems scarcely credible that an economy which, for so many years, has absorbed so much of American theory and practice - so much of the American financial character - can be wholly immune from the penalties inflicted on its American model.

The subprime crisis first hit the United States after a housing about-turn that began as far back as 2005 or 2006. An unequivocal downturn in housing in Australia has yet to check in; but non-bank lenders are already withdrawing from the market. Wholesale mortgage lenders are closing shop, perhaps as a prelude to a sharp housing decline.

The carry trade which has presumably provided funds for mortgages and other financial services in Australia has been volatile for some time. If it unwinds completely, that could not only intensify mortgage problems but also impact on Australia's external balances.

Our deficits have so far tended to persist at a less healthy level than the commodity boom might have encouraged us to hope. Our aggregate private overseas debt is said to amount to the order of half a trillion dollars. Against that background, the current depreciation of the United States dollar might foreshadow what awaits our own currency.

Lagging impact

Economic and financial change in the United States tends to have a lagging impact on Australia. An acute awareness of the severity of our crisis may consequently not emerge before the second half of 2008.

When it does, what will the Rudd government do? Currently, it seems as unaware of the magnitude of the challenge it faces as the James Scullin government was in 1929. So the present government might become just as bewildered as Scullin and stagger just as blindly and ineffectually when they are called on to act. In the 1930s, we listened to the likes of Otto Niemeyer of the British Treasury who was also a director of the Bank of England. Will the Rudd government this time listen to the Americans and the likes of US Federal Reserve chairman Ben Bernanke? If they do, catastrophic outcomes might not be in short supply.

Our only real hope lies in clear, independent thinking by those not too steeped in the flawed policies responsible for our current crisis. We must see clearly that fundamental, comprehensive financial and economic reform is imperative. We must adapt that fundamental reform to our own needs, as the John Curtin and Ben Chifley governments did between 1941 and 1949. As we did then, we must simultaneously try to guide the international community out of the calamitous course that has evolved since 1969, and return it to the goal of stable, peaceful, global change which, as a primary objective, we pursued between 1945 and 1969.

While we embark on this journey, a high level of political volatility in Canberra is inevitable. Rudd might succeed; but the Labor Party and government might split two or three ways as they did between 1929 and 1932. Another Joe Lyons, prime minister from 1932 to 1939, might emerge. Whoever he might be, the odds are that he will be even less likely to find quick or easy solutions than Lyons was during the long and bitter years of depression. Those years ended only in the even deeper tragedy of world war.

-----------------------------------------------

James Cumes is a former Australian ambassador to the European Union and Australian representative at the United Nations. He is the author of among other works The Human Mirror: The Narcissistic Imperative in Human Behaviour.

Wednesday, April 09, 2008

Greenspan is a sociopath or liar

"Former Federal Reserve Chairman Alan Greenspan told CNBC that he had little to do with the housing bubble or credit crisis despite criticism that the Fed kept interest rates too low under his watch.


RE: Greenspan on exotic mortgage alternatives, 2004 TheWolf NEW 4/8/2008 5:23:47 PM
February 23, 2004, Chairman Greenspan spoke to the Credit Union National Association 2004:

"Fixed-rate mortgages seem unduly expensive to households in other countries. One possible reason is that these mortgages effectively charge homeowners high fees for protection against rising interest rates and for the right to refinance.

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home."

RE: Greenspan on exotic mortgage alternatives, 2004 taichi NEW 4/8/2008 5:33:37 PM
Alan Greenspan, praising subprime lending in a speech on April 8, 2005:

"With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . .

As we reflect on the evolution of consumer credit in the United States, we must conclude that innovation and structural change in the financial services industry have been critical in providing expanded access to credit for the vast majority of consumers, including those of limited means. . . . This fact underscores the importance of our roles as policymakers, researchers, bankers and consumer advocates in fostering constructive innovation that is both responsive to market demand and beneficial to consumers."


RE: Greenspan on Glass-Steagall 1999 TheWolf NEW 4/8/2008 5:34:53 PM
Testifying before the House Committee on Banking and Financial Services, February 11, 1999, Greenspan declared,

“we support, as we have for many years, major revisions, such as those included in H.R. 10, to the Glass-Steagall Act and the Bank Holding Company Act to remove the legislative barriers against the integration of banking, insurance, and securities activities. There is virtual unanimity among all concerned--private and public alike--that these barriers should be removed. The technologically driven proliferation of new financial products that enable risk unbundling have been increasingly combining the characteristics of banking, insurance, and securities products into single financial instruments.”

RE: Greenspan on exotic mortgage alternatives, 2004 TheWolf NEW 4/8/2008 5:40:57 PM
Feb 23, 2004 Greenspan gems...continued

"Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country … With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. … Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s."

RE: from his "autobiography" pencilneck NEW 4/8/2008 5:59:54 PM
page 230

"The gains were especially dramatic among Hispanics and blacks, as increasing affluence as well as government encouragement of subprime mortgage programs enabled many members of minority groups to become first-time home buyers."

I don't think history will view him as well as he views himself.

Tuesday, April 08, 2008

Analogies to 1929 abound according to some

April 6, 2008

Elaine Meinel Supkis


Time to read old newspapers about the Great Depression. The mirror this holds up to us today is nearly exact. The Federal Reserve is lending money to Wall Street SPECULATORS, not just to bankers! The sums they are handing out like candy to a big fat baby has shot upwards and is now nearly $40 A DAY and I bet, will be $100 billion A DAY next week until these pirates unload all the useless paper they hold. And the Fed has stationed officers in these pirate coves to see if they will cheat us. HAHAHA. Gads, laugh to death, eh? The Fed's fools will be thwarted, of course. Break out the Champagne, everyone. Party time with Miz Risky!


Wall Street brokerages borrowing $38.1 billion a day from Federal Reserve
Big Wall Street investment companies are stepping up their borrowing a bit from the Federal Reserve’s unprecedented emergency lending program.

The Federal Reserve reports Thursday that those firms averaged $38.1 billion in daily borrowing over the past week from the new lending program. That compared with $32.9 billion in the previous week and $13.4 billion in the first week the lending facility opened.

The program, which began on March 17, is part of the Fed’s effort to aid the financial system.

The Fed, for the first time, agreed to let big investment houses temporarily get emergency loans directly from the central bank. This mechanism, similar to one available for commercial banks for years, will continue for at least six months. It was the broadest use of the Fed’s lending authority since the 1930s.


Time to review history: the Great Crash of 1929. It always pays to read old newspapers. More than one person has noticed how we seem bent on repeating the Great Depression, chapter and verse. What is really grim is that we are running on exactly the same time schedule, too. Last winter we saw global hesitation in trade the last week of February and the first week of March. This was explained away, at the time. But I said it was due to a near ending of the Japanese carry trade. This is the ultimate source of most global inflationary processes as the Bank of Japan keeps interest rates so low compared to Japanese inflation, it is literally giving away money but ONLY to exporters and foreign borrowing.


Between this source of infinite liquidity which feeds off of US red ink overspending and the continuing need in the US for funny money churned out by this process, we saw the investing world creating many, many bubbles in their efforts to park this easy lending where it would make infinite profits, effortlessly. The Great Depression was preceded by a similar process. The US was the world's biggest creditor nation and like Japan, was churning out huge loans...overseas as well as at home. The money this created flowed back into the US as Europe concentrated on building up their industries for imperial expansions while needing lots of US farm products to feed increasing populations. So the US farmer produced heroic amounts of produce which was shipped post-haste, to Europe.


When Germany finally gave up paying war reparations since they were cut out of world markets by England and France who were anxious to have maximum trade for manufactured goods. The US had already cut off our markets to this flood of English and French goods. This was necessary or we would have been de-industrialized by 1940 instead, we had an extra 60 years of industrial might before self-destructing today.


So on this grim note, let's look at past headlines in the New York Times:


January 18, 1929: LOANS TO BROKERS RISE $71,000,000
Reserve Bank Reports Total of $5,384,000,000 for Week, Only $10,000,000 Below Record. $90,000,000 DROP FOR CITY The Out-of-Town Institutions and "Others" Responsible for Gain-- Decline in Bills Discounted.

An increase of $71,000,000 in brokers' loans for the week ended Wednesday, the result entirely of expanded operations by out-of-town banks and the miscellaneous group of lenders classed as "others," was ...


March 6, 1929: Advising Caution.
The Watchful "Pools." Banks Withdraw Loans. Bonds Dwindling Fast. Brokers' Loans Are Reduced. Stocks for Bonds.

Copper stocks were in the lead early yesterday in a day of mixed trading in which there was alternate strength and weakness. News of the proposed retirement by the Anaconda Copper Company of its bonds and a strong metal market gave a filip to the metal issues, and most of this ...


Note that metal prices were up. Not gold, of course, this was government-regulated by England, France and the US. Why did the banks withdraw the loans?


March 26, 1929: STOCK PRICES BREAK HEAVILY AS MONEY SOARS TO 14 PER CENT
Tightening of Country's Credit Causes One of Broadest Drops in Exchange's History. 90 ISSUES AT YEAR'S LOW Expectation of Drastic Action by Reserve Board a Factor in Liquidation. 5,862,210 SHARES TRADED Radio and International T.& T. Go Up Against the Tide--Wall Street Expects a Rally. STORK PRICES BREAK AS MONEY SOARS $25,000,000 Call Money Withdrawn. Decline of Last Seven Days. Wall Street Looks for Rally. Recessions From 1929 Highs. Radio Common Up 4 . TIGHTEST CREDIT IN 9 YEARS. Call Rate Goes to 14 Per Cent as Banks Withdraw Funds. Seasonal Increases in Demand. PRICES BREAK ON CURB. Liquidation Extends to All Parts of the List. CALL HUNDREDS OF MARGINS Brokers Issue Demands by Wire-- Say Accounts Are Satisfactory. CHICAGO BORROWERS AIDED. Corporations and Individuals Lend to Banks and Brokers. COAST WITHDRAWING FUNDS. Bankers Say Movement Is to Meet Quarterly Dividends.

Tightening of the strings on the country's supply of credit, a development foreshadowed last week, but not considered seriously by speculators in the stock market, brought about yesterday one of the sharpest declines in securities that has ever taken place on the Exchange.


The rising use of Federal Reserve buying of Treasuries and then reselling bonds ended up feeding Wall Street speculators. The differentials between European, South American and US money values was used in virtually the same way it is being used today only the currency in trouble was not the dollar but the POUND. Britain's eternal imperialist wars was bankrupting the nation. No matter how much they exported goods, the cost of imperial overreach coupled with the tremendous debts from the Great War was finishing off the British economy. The Brits don't think about the 1929 Great Depression as this singular thing. This is because their Great Depression began in 1919! They were in a continuous Great Depression. One that ran all the way until the late 1950's. Indeed, the war production of WWII was the only ray of light in that long, dark tunnel as yet another world empire slid off the cliff and into the dark deeps of total economic ruin.


Let's go back to the headlines: The Federal Reserve began to tighten up the money supply by raising interest rates in order to stop first, the housing bubbles in Florida and California [hahaha]. But this brought in a flood of gold from England and pounds were pounded by the international traders. The high interest rates attracted money from overseas which poured in and this helped fuel our stock markets. The Fed was new at this game and didn't understand quite how they were digging a channel for more money to flood into the system rather than building dikes to keep out the flood of money seeking some way of gaining ground.


April 15, 1929: W.C. DURANT DEMANDS RESERVE BOARD KEEP HANDS OFF BUSINESS
In Attack Over Radio, He Says It Wields Autocratic Power Over the Stock Market. PREDICTS FIGHT TO CURB IT Says of 500 Industrialists He Queried, 463 Replied and Only 12 Backed Its Policy. WANTS 3% BANK RATE And the Restoration of $700,000,000 Drawn From Market--Upholds Mitchell Action as Patriotic. Predicts Nation-wide Fight.

Suggests Three Steps Now. ASKS BOARD TO KEEP HANDS OFF BUSINESS Text of Mr. Durant's Speech. Submitted Question to Leaders. First Real Test in 1931 Called Money Terms Outrageous. Charges Creation of Panic. He Quotes Authorities. Wants 3 Per Cent Bank Rate. Sees Board Alone Responsible. Sees Move to Destroy Credit. Hails Foes of Board's Policy.

William C. Durant made an outspoken attack last night on the Federal Reserve Board for its efforts to curb speculation through restriction of brokers' loans.


As usual, the brokers wanted infinite money. Every time the Fed or the government tried to restrict endless lending in the new carry trade system that WWI created with the huge financial overspending by the three major European empires, this infuriated speculators. They LOVED to speculate using cheap money from this massive bubble of military overspending on wars! They needed more, not less, wild war money debts flowing like crazy though the banking systems of the world! As with today, any attempt to slow down or stop this madness causes great fury. President Carter is still remembered as a 'bad' President because he managed to slow down the financial collapse of our banking system due to too much red ink flowing. Reagan is regarded as a great President for resuming this monstrous super bubble system.


May 16, 1929: THE CREDIT SITUATION
Reserve Bank Lends Indirectly on Security Collateral. PROFITS IN SUGAR. Suggestion That the Consumer Pay $134,000,000 More Is Not Well Taken. Improving the Parks.


Inflation redoubles because the financial speculators were rewarded with a resumption of free funny money. The stock market took off like a rocket. So did other systems in pretty much the same way as today. Gold was totally government controlled in price but NOT the pound! So speculators began to buy British gold at the government set price and then move it to the US where the dollar was stronger so the same gold at the same 'price' bought more. And they bought stocks.


September 30, 1929: SEES SUPPORT HERE FOR BRITISH GOLD
Bank of America Declares Continued Inflow From LondonIs Undesirable.SHIFT IN AUTUMN FUNDSNew York Will Handle Most of the Seasonal Financing, BankReview Predicts.

Efforts of the Bank of England to stop the flow of gold from London, which movement, since mid-June, has amounted to about $150,000,000, and to improve the position of sterling exchange in foreign markets are likely to receive some support from...


Note that by the end of September, London had to take measures before the entire Treasury was emptied out. Indeed, their solution was the exact same one the US used in identical circumstances: they decoupled gold from the pound. The effort to strengthen the pound was similar to the US efforts: rising interest rates. Note that all stock market bubbles pop due to rising interest rates. The Dot Com bubble, for example, was popped this way. The present bubble was popped when rates rose from 1% to 6%. It is now being dropped like a proverbial rock, of course. In order to restart wild speculative buying.


October 6, 1929: Sharp Week-End Recovery in Stocks, Trading Large
Sterling Holds Strong. The recovery in prices, whose failure to appear during the earlier days of the week had caused some consternation in Wall Steet, came yesterday. The day's advance of active individual stocks ranged from 5 to 10 points, with even larger gains in a few closely held stocks.


Even though it was obvious that the entire banking system of Europe was under tremendous stress because the Germans could not pay their war indemnities, the status quo flow of funds was reasserted thanks to the US and England cooperating to strengthen the pound. Just like this last fall when the G7 worked very hard to keep the status quo running a little longer, so it was then. Too many people were sucking at the teats of the System for them to let it dry up. They wanted desperately for the British Empire to continue its rule of the world banking systems. It wanted to keep the System flowing effortlessly even if it meant taking buckets of red ink and hauling it uphill.


October 24, 1929: Where the Blow Was Hardest.
Margin Calls. Causes of the Day's Decline. Will the Market Be Supported? Back to Work. Railroad Shares Suffer. "It's An Ill Wind."

In the most sweeping and farreaching decline of the year, and one which was made on a tremendous volume of liquidation, the market crumbled yesterday afternoon, most stocks breaking through the "old low prices" of the October break and some to the year's minimum points


Just like this year: stocks fell in the Fall to the same point where they were before the big debt-fueled run up.


October 27, 1929: OUTLOOK FOR CREDIT BELIEVED CLEARED
Great Drop in Brokers' Loans Expected as Result of Break in Stocks. FUNDS FREED FOR BUSINESS Economists Believe Large Supply of Cheaper Money May Stimulate Hesitant Industries.

With the collapse of the stock market last week, in the opinion of bankers, the chief factor of uncertainty in the credit outlook was removed. Attempts earlier in the year to obtain the release of some part of the billions of dollars tied up in speculative loans had been frustrated by the irresistible bull movement of securities.


Incredible, isn't it? The EXACT same solutions used back then are being used today! Exactly! How can anyone miss this? Note how they talk about 'irresistible bull...securities'. The demand for more and more and more loans drove up interest rates. The Fed decided to fix this mess by using every tool possible to make lending cheaper. But back then, this failed. Just like it will fail today.


I went to the biography of the Federal Reserve Chairman from the Great Depression, Mr. Eugene Black.


History of the Atlanta Federal Reserve Office:
The Sixth District economy was building up steam in 1928. Credit demand was strong, and rediscounts surged to $1.3 million that year, easily the most credit activity the Bank had seen since 1921. Interest rates moved up rapidly between February and July, as the discount rate was raised from 3.5 percent to 5 percent, and rates on commercial loans went as high as 6 percent. Rediscounts continued to rise in 1929.

Reining in stock speculation
Concern spread in 1929 about bank lending to stock speculators. A rush among investors to capitalize on rising stock prices was driving up interest rates and making it difficult to stop credit from flowing to Wall Street. The Board in Washington wanted member banks to restrict their lending to local businesses and not “export” money to New York, especially if they were rediscounting with the Fed. Even early in the year, the Fed wanted to avoid financing the stock speculation of 1929.

Chairman Oscar Newton, the Mississippi banker who had succeeded Joseph McCord in 1925, noted that Sixth District member bank loans to New York brokers and dealers dropped from $28 million to $22.5 million between October and December 1928. The Atlanta Bank evidently succeeded in persuading member banks to stop such lending because Black was able to report in August 1929 that only two member banks that were borrowing from the Fed were lending on call in New York, and then only a total of $334,000.

Jitters in Florida

As early as May of that year, Black was urging caution in extending credit to member banks and sounding rather unlike Wellborn: “We are giving close study to credit conditions in our territory and are endeavoring to protect the bank in all lendings to member banks. . . . In the case of any bank in a weakened or extended condition, we are protecting our bank by the requirement of additional collateral. In the case of some banks we are declining any rediscounts because of the impaired capital of such banks. . . .”

Florida remained particularly touchy. The failure in July of a bank in Tampa set off bank runs in Gainesville and St. Augustine and led the banks in St. Petersburg and Orlando to invoke their right to require 60-day notice for withdrawals from savings accounts. Black and his deputy rushed to the Tampa area with $6 million in cash to turn back runs on two member banks there in October.

Such activity would become all too common before the Depression hit bottom, but in 1929 it was novel and experimental. About the efforts to slow savings withdrawals, Black noted, “We are watching this drastic measure with these banks in an effort to learn whether such a step can be successful with a commercial bank.” There certainly was concern about what Black called “general unrest among the depositors in a large number of Florida banks,” but there was no reason to see the problem as anything other than local and temporary. After all, the trouble in Florida stemmed from the appearance that spring of the Mediterranean fruit fly. To fight the fruit fly, the Florida Citrus Exchange had slapped an embargo on fruit and vegetable shipments, which left many growers unable to repay loans.


Since helicopters didn't exist nor did computers, Black had to use the trains, He couldn't call on the phone and tell them to manufacture money on the spot by adding a bunch of numbers to their bottom line. Back then, the Fed was still paranoid about money being seen as non-existent. They had to show some paper, at least. And handle that with greatest care. The alterations they made a year earlier to the standard dollar bills was to eliminate much of the text on the bills that talked about the various laws and regulations concerning the manufacturing and handling of paper fiat bills. It was eliminated, in other words. And people noticed this. Suspicious people would look at the smaller, newer bills and think, 'Hell, there isn't any of that stuff about Section 23A by the OCC on this bill.' Heh. Actually, they did notice. And this was a worry for the Fed. When money began to vanish as all the loans to all the speculators vanished in a tsunami of bankruptcies beginning in the Fall of 1929, people clung to the paper bills since at least, they were REAL. Unlike loans that were totted up on some ledger. And they bought more and more goods as deflation spread its dark negative energy wings.

Here is a Wall Street Journal debate back when rising interest rates broke the crazy Dot Com Bubble markets:


April 10, 2000: Margin Calls: Should the Fed Step In?
Yes, It may Avert Disaster

By Robert Shiller

The stock market is in its most dramatic boom ever. Despite last week's declines in tech stocks, the Standard & Poor's composite price-earnings ratio (real prices divided by the 120-month average of trailing real earnings) stands at 46. Until the present boom, the highest it had ever been (the data go back to 1871) was 33, in September 1929 -- the month before the crash. The dividend yield on the Standard & Poor's index stands at 1.1%, the lowest ever. The previous low was 2.6% in January 1973, just before the 1973-74 crash. Margin debt is soaring; it has increased 87% in the past year.

In the midst of this record-breaking boom, the Federal Reserve Board remains silent about the speculative level of the market, neither commenting that the market is too high nor using its powers over margin requirements to dampen the markets. This inaction is unfortunate. Distortions of saving and investing behavior, driven by the public's illusion of stock-market wealth, are rampant, and the risks of economic dislocations and massive wealth redistribution are very serious if the market continues to soar and then crashes.

There are, of course, some who assert that the market is rationally high because of new technology that makes the outlook for future corporate profits very bright. But people have hailed "new eras" before -- in 1901, they cited the formation of giant corporations that would supposedly produce economics of scale; in 1929, it was electrification, chain stores and the spread of automobiles; in 1973, advancing productivity and technology. All of these "new eras" turned out not to be so revolutionary after all, and odds are today's market won't be any different.


This economist was begging Greenspan to intervene and stop the NASDAQ collapse. He is correct to note that margin debt was taking off. Once upon a time, our regulators forbade such margins because they correctly saw that it was going to cause another bubble/bust like the Great Depression. But discontent with this severity meant it was loosened greatly to the vanishing point and of course, instantly, we got a massive margin-fed bubble. Once the game of using debts to place bets at the Wall Street casino took off, it doubled every year, a classic sign of a bubble. Let's look at Mr. Bartlett's side of this debate:


April 10, 2000: No, Meddling Makes Things Worse

By Bruce Bartlett
Federal Reserve Chairman Alan Greenspan has expressed concern about the level of margin debt, which has rocketed upward since October. In February it hit $265.2 billion, up 45% in just four months. Anecdotal evidence suggests that much of this increase came from increased borrowing through online brokers and was channeled into the high-flying Nasdaq. As long as that market kept rising, it was a win-win situation for everyone. Investors achieved higher gains by leveraging their investments, while online brokers made much of their profit from margin loans.

Congress in 1934 gave the Fed power to control initial margin requirements, in the belief that margin calls had been largely responsible for making the 1929 stock market crash so severe. At that time margin debt equaled 30% of the market's value. Between 1934 and 1974 the margin requirement was changed 22 times. But for the past 26 years it has been fixed at 50%, meaning that investors may borrow no more than half the purchase price of equities directly front their broker. (The margin requirement has been as high as 100%, meaning no margin debt at all was allowed.}


This guy wanted no controls or requirements. As did many of the money bags handing out goodies to politicians. When the Dot Com bubble burst, they all went howling to Greenspan to save them. And Greenspan also wanted to reward Bush, a family buddy. So he waited in the wings until Bush took the oaf [sic] of office and then began to shower money down upon their heads. The interest rates on loans collapsed. Taxes on earnings in stocks nearly vanished. Money flowed into the system at a crazy rate. 9/11 simply was viewed as a great excuse to extend and deepen this rescue operation. Astute people such as a number of us online bloggers, warned that this would be very dangerous and would spawn many bubbles that would grow out of control.


As usual, we were right. So let's go back to today's news:


Federal Reserve staff move into offices of investment banks to monitor activities
The US Federal Reserve has sent staff into some of Wall Street’s biggest firms and its New York branch is gathering evidence on key traders’ activities as America’s central bank raises its scrutiny of risk to an unprecedented level.

Fed staff have set up shop in Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch, and Bear Stearns to monitor their financial condition just days after Henry Paulson, the US Treasury Secretary, proposed that the Fed become the financial industry’s “risk czar”.

This is the first time in more than a decade that the Fed has put staff in securities firms and is a response, in part, to its decision to extend to investment banks the “discount window” of cheap loans traditionally offered only to the commercial banks. The Fed argues that if it is to act as lender of last resort to the securities firms, it should keep a closer eye on their activities.


HAHAHA. The simple action of dropping interest rates to Bank of Japan levels isn't enough! Now, the Fed itself is lending not to banks but directly...to the speculators!!!! AAARRRGHHH. This is pure, total insanity. They are parking agents in brokerages to insure what? That not ALL this loot is flowing directly into the greedy mouths of the pirates? No, it will take a pious round about route! HAHAHA. Gads! I think I will go mad. Grrrr. Note how pirate Henry Gollum Sachs Paulson suggests the Fed be a 'risk czar.' HAHAHA. Like in, 'YOU move OUR risks to the American People!'


As I keep saying, all these 'rescues' are not for you or me. They are to keep a flotilla of pirate ships afloat. I just learned that Hill and Bill Clinton used offshore pirate coves to enrich themselves and evade taxes. We had so many pirates running for President this year, we shouldn't have given them all American flag pins, we should have demanded they wear eye patches and a dead parrot!-


And how is Bernanke going to 'keep an eye' on these desperadoes? Eh? Note, he doesn't say. Do the agents sit in on phone calls? HAHAHA. HAHAHA. Laughing to death hurts. Are they sitting the meetings like vultures, Watchers, sitting there, behind the chairman, taking notes and glaring? HAHAHA. Right. I can picture that.


Nope. Otherwise, they would hire me. I could look into the books. I love doing that. And poke in the desks and play 'spy for the CIA' as I did as a child when I used to practice the dark art of becoming invisible and walking through walls. Actually, if a child is silent, it is easy to be invisible to adults. Except if you stare at them like a vulture. Then they jerk and look over. Heh.


Here is a recent speech from Mishkin of the Fed.


Governor Frederic S. Mishkin
At the Princeton University Center for Economic Policy Studies Dinner, New York, New York
Starting in the 1970s, the economics profession began to recognize that the evolution of economic activity and inflation--and hence the design of optimal monetary policy--depends crucially on how households, firms, and financial market investors form their expectations regarding the future course of policy.3 This recognition of the central role of expectations in macroeconomic outcomes led to the discovery of the time-inconsistency problem, a concept that sounds highfalutin but is actually quite intuitive.4

This problem arises whenever the possibility of short-run gains creates a temptation to renege on an existing plan, even though following that plan would produce a better outcome over the longer run. In essence, if a good long-run plan will not be followed consistently over time because the short-run gains of deviating from the plan are too tempting, then that plan is said to be time-inconsistent. In such a setting, the time-consistent policy is to reoptimize every period, whereas the preferable alternative would be to establish a firm commitment to the optimal long-run plan.

To take a common example that illustrates the time-inconsistency problem, someone may make a New Year’s resolution about starting a diet. At some point thereafter, however, it becomes hard to resist having a little bit of Rocky Road ice cream, and then a bit more, and pretty soon the weight begins to pile back on.

The time-inconsistency problem arises in the context of monetary policy, because there is a temptation to give a short-run boost to economic output and employment by pursuing a course of policy that is more expansionary than firms or workers had initially expected.5 Nevertheless, if the economy is already at full employment, then this boost is merely transitory: As economic activity rises above its sustainable level, wages and prices begin to rise, and the private sector's inflation expectations start to pick up. Of course, the central bank must eventually remove the policy stimulus to avoid a continuous upward spiral of inflation. At that point, economic activity drops back to a sustainable level. However, inflation settles in at a permanently higher rate because prospects of future monetary expansions become embedded in expectations, and hence in wage and price adjustments, and the higher average inflation rate generates undesirable economic distortions.6 Thus, failing to address the time-inconsistency problem poses the risk of ending up with a higher average inflation rate, with detrimental long-run consequences for economic efficiency and the general standard of living.

As my mother often told me when I was growing up, "The road to hell is paved with good intentions." Similarly, discretionary monetary policy, even though well intended, can lead to poor economic outcomes.


Well, he comes close to talking about the Outer Darkness. The easy road suddenly turns and becomes extremely painful, you know. This 'time-inconsistency problem' is funny as hell. Always, the politicians want the easy road. They want money to flow. They hate time which isn't on their side. They are anxious about the next election! They need lots of pirate loot. Note how this foolish Fed man worries that wages will rise. Since when? The unions are dead. Wages have been FALLING and falling for many years even with the fake inflation statistics used by the fake Federal Reservists.


The Fed has no 'long range plans.' If they did, they wouldn't be making one bubble after another or making the Super Bubble, would they? They would talk about the budget deficit AND the trade deficit AND the dollar's woes all the time, not nearly never. They NEVER connect ANY of the things we are doing wrong when discussing ANY plans for ANY future! They just refuse to do this. This is why they can't talk about inflation and how cheap prices is directly connected to free trade, not the Fed's interest rates. And how this is connected to the collapse in wages, not inflation in wages. Wages are falling through the floor in nearly all previously unionized industries. The dire effects are not yet felt due to the remaining union members who are rapidly being bought out. Their economic distress still isn't huge only because they are getting huge payouts. But in 10 years, there will be no workers in the US except at the lowest possible wages.


THAT is what is the cause of Great Depressions: workers can't buy anything and money is dear. And everyone is denied loans because of low wages, not the reverse. And this is our future, alas, thanks to our government working with PIRATES to destroy the American Dream. Thanks a trillion, guys.

Monday, April 07, 2008

Carter endorses Obama --- Great for McCain

He didn't pander to fantasy like the raygun, he demanded morality in US foriegn policy, what a creep, he made a real asshole of himself building poor people houses on a cooperative basis with Habitat for humanity and stooped to talking about the downside of Israeli policy just because he sponsored the Camp David Accords. What a hide! He promoted energy efficiency and lifting price controls on domestic oil when he shoulda been planning world domination.

He collected all these worthless awards:

LL.D. (honoris causa) Morehouse College, 1972; Morris Brown College, 1972; University of Notre Dame, 1977; Emory University, 1979; Kwansei Gakuin University, 1981; Georgia Southwestern College, 1981; New York Law School, 1985; Bates College, 1985; Centre College, 1987; Creighton University, 1987; University of Pennsylvania, 1998
D.E. (honoris causa) Georgia Institute of Technology, 1979
Ph.D (honoris causa) Weizmann Institute of Science, 1980; Tel Aviv University, 1983; Haifa University, 1987
D.H.L. (honoris causa) Central Connecticut State University, 1985; Trinity College, 1998
Doctor (honoris causa) G.O.C. University, 1995
Silver Buffalo Award, Boy Scouts of America, 1978
Gold medal, International Institute for Human Rights, 1979
International Mediation medal, American Arbitration Association, 1979
Martin Luther King, Jr. Nonviolent Peace Prize, 1979
International Human Rights Award, Synagogue Council of America, 1979
Conservationist of the Year Award, 1979
Harry S. Truman Public Service Award, 1981
Ansel Adams Conservation Award, Wilderness Society, 1982
Human Rights Award, International League for Human Rights, 1983
World Methodist Peace Award, 1985
Albert Schweitzer Prize for Humanitarianism, 1987
Edwin C. Whitehead Award, National Center for Health Education, 1989
Jefferson Award, American Institute of Public Service, 1990
Liberty Medal, National Constitution Center, 1990
Spirit of America Award, National Council for the Social Studies, 1990
Physicians for Social Responsibility Award, 1991 Aristotle Prize, Alexander S. Onassis Foundation, 1991
W. Averell Harriman Democracy Award, National Democratic Institute for International Affairs, 1992
Spark M. Matsunaga Medal of Peace, US Institute of Peace, 1993
Humanitarian Award, CARE International, 1993
Conservationist of the Year Medal, National Wildlife Federation, 1993
Rotary Award for World Understanding, 1994
J. William Fulbright Prize for International Understanding, 1994
National Civil Rights Museum Freedom Award, 1994
UNESCO Félix Houphouët-Boigny Peace Prize, 1994
Great Cross of the Order of Vasco Nunéz de Balboa, Panama, 1995
Bishop John T. Walker Distinguished Humanitarian Award, Africare, 1996
Humanitarian of the Year, GQ Awards, 1996
Kiwanis International Humanitarian Award, 1996
Indira Gandhi Prize for Peace, Disarmament and Development, 1997
Jimmy and Rosalynn Carter Awards for Humanitarian Contributions to the Health of Humankind, National Foundation for Infectious Diseases, 1997
United Nations Human Rights Award, 1998
The Hoover Medal, 1998
International Child Survival Award, UNICEF Atlanta, 1999
William Penn Mott, Jr., Park Leadership Award, National Parks Conservation Association, 2000
Grammy Award for Best Spoken Word Album, National Academy of Recording Arts and Sciences, 2007
Berkeley Medal, University of California campus, May 2, 2007
Freedom of the City of Newcastle upon Tyne, England[17] awarded on the occasion of his visit to the city (6 May 1977)[18]
Honorary Fellow of Royal College of Surgeons in Ireland (conferred on the 18 June 2007)
Honorary Fellow of Mansfield College, Oxford (conferred on the 21 June 2007)

And then to prove his complete ignorance, didn't go off to work for a hedge fund and wasted his time writing 27 books.

what a looser, Obama is doomed getting his endorsment, how can that compare with the maestro's endorsement of McCain, who recently decided to bone up on economics 101 by starting with the autobiography of that same Central Banker, such mutual love is indomitable. Greenspan, after all was voted central banker of the year by the milky way bankers association.

McCain is a shoe in, for sure.

RE: Raygun: bigger deficit than all before combined...... PulpLogger NEW 4/7/2008 3:26:18 AM
...and started media ownership conglomeration.

RE: Yes that was Brilliant aussiebear NEW 4/7/2008 3:45:43 AM
Reagan stressed tested budget deficits and proved they don't matter, giving endless scope for the wonders to come, who could have a problem with that. I'm sure McCain will draw on that legacy and ensure the triumph of US hegemony for the next thousand years. If anyone mentions anything unpleasant he nuke em while spittle and invective fill the airways, McCain will let everyone know who is boss. hooray! I'm so glad you guys have such a sterling candidate to do battle with that looser Obama who only has been endorsed by self interested types like Carter, Volker these nonentities:

National political figures
Jeffrey Bader, former U.S. Ambassador to Namibia and Fmr. Assistant US Trade Representative for Asia[92]
Henri Barkey, former member of U.S. Department of State Policy Planning and Professor of Lehigh University[92]
David Birenbaum, former U.S. Ambassador to the U.N. for Management and Reform[92]
Esther Brimmer, former member of U.S. Department of State Policy Planning[92]
Art Brown, former National Intelligence Officer for East Asia and Chief of CIA's East Asian Operations Division[92]
Mark Brzezinski, former Director of European Affairs of National Security Council[92]
Joseph Cirincione, Vice President for National Security and International Policy at the Center for American Progress[92]
Bonnie Cohen, former Undersecretary of State for Management[92]
Ivo H. Daalder, former Director, European Affairs, National Security Council[92]
Alice Dear, former U.S. Executive Director of African Development Bank[92]
Michael Froman, Chief of Staff and Deputy Assistant Secretary at the Department of Treasury and National Security Council Staff Member[92]
Tony Gambino, former Mission Director, USAID, Democratic Republic of the Congo[92]
Tobi Gati, former Assistant Secretary of State for Intelligence and Research; Senior Director for Russia, Ukraine and Eurasian Affairs, National Security Council[92]
Robert S. Gelbard, former Presidential Envoy for the Balkans; Assistant Secretary of State for International Narcotics and Law Enforcement; Ambassador to Indonesia; and Ambassador to Bolivia[92]
John J. Gibbons, former federal appeals court judge[137]
Matthew Goodman, former Director for Asian Affairs, National Security Council[92]
Philip Gordon, former Director, European Affairs, National Security Council[92]
Scott Gould, former Assistant Secretary of Commerce for Management[92]
Scott Gration, former Director for Strategy, Policy and Planning, U.S. European Command[92]
John Holum, former Director of ACDA and Undersecretary State for Arms Control and International Security[92]
Vicki Huddleston, former Deputy Assistant Secretary of State and Ambassador to Mali and Madagascar, Chief of Mission to Cuba and Ethiopia[92]
Paul Igasaki, fmr. Vice Chair and Commissioner of the U.S. Equal Employment Opportunity Commission[129]
David Lipton, former Under Secretary of Treasury for International Affairs[92]
Frank Loy, former Undersecretary of State for Global Affairs[92]
Donald McHenry, former United States Ambassador to the United Nations[92]
Norman Mineta, former U.S. Rep. (D-CA), mayor of San Jose, United States Secretary of Transportation and United States Secretary of Commerce[87]
Newton N. Minow, former Chairman of the Federal Communications Commission[138]
Alfred H. Moses, former United States Ambassador to Romania[92]
Nick Rey, former United States Ambassador to Poland[92]
Witney Schneidman, former Deputy Assistant Secretary of State for African Affairs[92]
Dan Shapiro, former Director, National Security Council[92]
Mona Sutphen, former Special Assistant to the National Security Advisor[92]
Jim Vermillion, former Mission Director, USAID, Nicaragua[92]
Paul Volcker, former Chairman of the Federal Reserve[139]
Patricia Wald, former Chief Judge for the United States Court of Appeals for the District of Columbia Circuit[140]

McCain must win.

RE: Yes that was Brilliant TheWOlf NEW 4/7/2008 5:00:21 AM
Carter, last honest US president.

Ridiculed for preaching conservation by fredeed type sheeple.

Kevin McKern

Retail rumour from US Big Retail

I have worked retail for several years. I am in mid-level store management right now. I don't want to say exactly what company I work for, but it is in the top 3 largest. I work at a store in a major city.
There have been some crazy things going on recently. The changes that we are being asked me make per corporates direction makes me think that the people at the top think something VERY big is going to be happening to the economy soon. I don't think the media or the government is giving us the full details of what is actually going on, but I think the CEO's and others at the top are fully aware and are making plans.
For one thing I check sales every day. At the store level we usually compare what sales are today compared to sales for the same day, week, month, and year last year. Sales at our store, our district, and company wide have taken a HUGE drop compared to the same time last year. When I looked at them today my store and every store in our district was down over 30% for the same time last year. The company as a whole is also in the negative for the same time last year. (but not as much, but it gets lower every day).
Honestly at my store I could say that we have done everything in our power at the store level to increase sales, but it just isn't happening. Departments like electronics are literally almost completely empty the entire day. The only departments that actually are getting sales are consumables, health, and chemicals. Just walking the store these are the only departments I ever even see people in ever since christmas ended.
Sometimes I will cover the service desk so a team member can take a lunch/break. When I do I sometimes process peoples credit card payments which lets me see how much they owe and how much they are paying. There are tons of people with THOUSANDS of dollars on their card only making minimum payments. These balances are usually at interest rates over 20%. Then there are people bringing in checks for the full amount, but they are BALANCE TRANSFER checks.... they are just moving it to other cards.
But that isn't what really worries me. What worries me is the changes corporate is making. I have worked here for years, and in the last 4 months I have seen more changes than all that time combined.
We are getting emails all the time from corporate telling us to reduce costs anyway we can. We recently got one telling us to start pulling fluorescent light bulbs, that we don't need all of them in order to provide illumination.... and those bulbs barely use any power.
Corporate has instructed all stores to lower the AC. It has been lowered enough to the point we get complaints from team members and customers.
Corporate has sent us emails telling us to make sure we fill bags to the absolute possibly maximum. They are not even sending us large bags anymore to some stores.
Corporate has recently eliminated (what I would estimate based on how many positions we lost vs the thousands of stores we have) several thousand management positions at *all levels* of management at stores.
This NEVER APPEARED ON THE NEWS! I suspect because it was not a traditional lay off. What corporate basically told us was "Your position is eliminated, but you are not laid off. Once you quit/get your self fired/whatever your position just won't be filled again" So we are basically slowly losing jobs as people company wide quit, get fired, etc.... but the jobs are never filled again. So basically we are cutting jobs, but the way it is being done is preventing it from getting reported in the media or tracked by the government as job losses.
No non-management positions have been eliminated, instead hours have been cut for them.
Raises this year have also been lowered in amount compared to in previous years. They have been lowered enough that corporate is keeping it a secret until we have to tell team members.
The company is also buying less. Our distribution centers are sending us, for example, 3 of a certain item when normally we would get 50.... and they don't send us more until those sell. I have not been able to keep departments full of product despite contacting corporate and asking for more because we are being sent such small amounts of product.
We have had trucks cancelled all the time now simply because we sold so little that they can't justify sending so few items to a store.
People are simply NOT buying things. They are not buying anything that isn't a consumable basically. I asked our pricing team to do a store mark down and lower the price on almost all of our TVs by 30-50%. We still have not sold a single one in over a week after! Our TVs were not priced very high to begin with.
Our pricing team is also being sent price increase changes from corporate in huge numbers. I am talking entire aisles of product for them to raise the prices on. The other day we got a STACK of pages of product to increase prices on. We thought it HAD to be a mistake because that has simply never happened before. We have emailed corporate asking if it was a mistake... we have not heard back yet, but I suspect it was not.
Many stores are now changing to non-overnight stores. They will be closed overnight and ALL power except in office areas will be cut overnight to save on costs.
There have even been changes to job descriptions recently. Corporate is basically giving job dutys to people at lower levels which used to be reserved for people at higher levels. Even some management tasks are being given to people in non-management positions. Basically they are paying people less to do what people used to get paid more to do.
Things are NOT looking pretty right now. I can tell you from a consumer spending point of view something is definantely going on.... All these changes tell me the people at the top are trying to brace for something big that is going to be happening to the economy.

Saturday, April 05, 2008

Where is the Money? Let’s Get it Back!

Summary
Media revelations are unfolding daily regarding losses in the U.S. mortgage market. These losses are not a new phenomenon. Rather, they represent the latest phase in an ongoing tradition of institutionalized fraud in the U.S. mortgage system and the federal credit system that directly and indirectly guarantees it. An understanding of this history can mobilize public support for reforms that address root causes by reversing the profitability enjoyed by those responsible.

Where is the Money? Let’s Get it Back!
by Catherine Austin Fitts

Large banks now claim recent losses in the US mortgage market totaling over $100 billion. While amounting to only a small percentage of banking profits over the last decade, this is still a lot of money. It may pale by comparison, however, to the losses the banks’ customers, the communities drained by predatory lending and investment practices and the citizens who stand behind the federal credit may incur.

Municipalities from Australia to Montana are reporting losses on U.S. mortgage and structured investments sold to them by the banks. (1) (2) Just as small towns in the Norwegian Arctic Circle reported losses of $167 million on investments packaged by Citicorp, Citicorp’s departing CEO exited his job with a $100 million compensation package.


The City of Baltimore is suing Wells Fargo. The City of Cleveland is suing them as well, as part of the city’s suit against 21 Wall Street banks, a veritable who’s who of U.S. mortgage lending and securities, including JP Morgan Chase, Citicorp and Goldman Sachs, arguably the most prestigious member banks of the New York Federal Reserve Bank, the depository for the U.S. government.

According to the Baltimore lawsuit, nearly 450,000 properties were in some stage of foreclosure during the third quarter of 2007. The Baltimore lawsuit cites a recent study of Chicago communities in which it was estimated that each foreclosure is responsible for an average decline of approximately 1% in value of each single-family home within a quarter of a mile.

While the financial community holds its breath waiting for pension fund annual reports to disclose what may be the most significant losses, the stock market continues to drop, evaporating the wealth of millions of investors in America and around the world.

The state pension fund lawsuits over stock portfolio losses have begun. The Ohio Public Employees Retirement System is suing Freddie Mac, and Norfolk County Retirement and the New York City and State Pension Funds are suing Countrywide. Ultimately, pension stock portfolio losses will be insignificant compared to the fixed income portfolio losses expected to wipe out billions in retirement savings.

The last time the U.S. media exposed mortgage fraud of this magnitude was in 1989. In April of that year, I was appointed Assistant Secretary of Housing/FHA Commissioner at the U.S. Department of Housing and Urban Development (HUD) only to find that the FHA single family mortgage insurance fund, required by law to be financially sustainable, was losing $11 MM a day and that the combined FHA mortgage insurance funds had lost $2 billion in the Texas region alone over the prior year. The mortgage fraud at HUD, one of the largest issuers of mortgage securities in the world, was so bad that Secretary of Treasury Nicholas Brady privately tried to dissuade me from joining the agency, saying “You can’t go to HUD — HUD is a sewer.”

The HUD losses were a drop in the bucket compared to the losses on the savings and loan institutions, ultimately costing U.S. taxpayers an estimated $500 billion by the time the clean-up was through in the mid 90’s. This estimate did not include the subtle and more expensive inflation borne by ordinary citizens, resulting from allowing the large financial institutions to use the federal credit to borrow inexpensively in the short-term markets and reinvest in long-term U.S. Treasury and agency securities, helping some of them dig out of the losses and resulting in windfall profits to the industry across the board.

Policymakers encouraged those of us leading the last clean-up to fashion reforms such that mortgage fraud on this systemic scale “could never happen again.” And so significant financial reforms were legislated and instituted.

First and foremost, were laws requiring federal agencies and credit programs to produce audited financial statements. As a significant amount of the US mortgage market enjoys direct or indirect support of federal credit programs, such an audit requirement should ensure that any problems in the housing finance system are illuminated early on. Part of this reform, so-called “paygo,” (The equivalent of “loan loss reserves” required of private lenders) would make it prohibitively expensive for Congress to extend federal credit to support a new bubble.

Second, were administrative steps to ensure transparency of federal mortgage credit and spending by county and zip code. The most effective internal control is knowledgeable citizens, watching the use of government resources on their home turf. With easy access to data about government resources expended locally, communities could assess the performance of their tax-supported housing and mortgage resources contiguous to the areas in which they live, work and vote for political representation. Without access to such “place based” financial information, it is difficult to hold our legislative representatives accountable.

What happened? Beginning in 1995, numerous government agencies and the US Treasury began annual announcements declining to publish audited financial statements. In the process of explaining itself, HUD announced “undocumentable adjustments” to balance its books in 1998 and 1999 of $17 billion and $59 billion, declining to give a total for the undocumentable adjustments in 2000. In the process, the Office of Management and Budget solved the loan loss reserve problem by cooking the assumptions used to estimate costs, thus permitting issuance of greater amounts of mortgage credit with lax terms and conditions. Things got so bad that the chief of staff to the chair of the Senate Appropriations Subcommittee in 2000 confessed to me “HUD is being run as a criminal enterprise.” The myths that there was a budget surplus during the Clinton Administration or that the housing bubble began after the Clintons left office represent the partisan fantasies of Americans desperately searching for ways to avoid facing the real risks before us.

Even more money was missing at the Department of Defense (DOD). On September 10, 2001, Secretary of Defense Donald Rumsfeld conceded, “According to some estimates, we cannot track $2.3 trillion in transactions.”




By 2003, more than $4 trillion of “undocumentable adjustments” had been reported at HUD, DOD and NASA alone. Since then the federal government fails to account for additional billions each year as the U.S. commitment in Iraq leads to unprecedented spending with third party contractors, many under “no bid” contracts and without meaningful contracting supervision. Finally, after years of manipulation in the precious metals markets, serious concerns are growing about the status of the US gold stores. Has our gold gone missing as well?

In the 2007 Financial Report, the U.S. Comptroller General stated “Certain material weaknesses in financial reporting and other limitations on the scope of our work resulted in conditions that, for the 11th consecutive year, prevented us from expressing an opinion on the financial statements…”

Meantime, efforts to bring local transparency to government mortgage programs and credit have been stopped, destroyed or reduced to ineffective window dressing. (See articles: Where is the Collateral? and So, Where is the Collateral?.) The average American has little understanding of the government resources and credit programs around them.

So our earlier reforms failed to prevent billions in subsequent mortgage fraud losses and the disappearance of trillions from US government accounts. Why? What have we learned from this failure, which would suggest lasting reforms?

If your public company were operating outside its bylaws and U.S. Securities and Exchange Commission regulations requiring audited financial statements, at some point your bank would refuse to effect your banking transactions and stop selling your securities to their customers. This means if $4 trillion is missing from the U.S. government, the federal depository and its member banks are complicit, if not responsible.

We don’t need new laws for each new crisis. We need enforcement of existing laws. What we also don’t need are bank depositories and government payment and accounting contractors who will proceed with trillions of banking transactions and government securities sales while basic provisions of the U.S. constitution and laws governing federal financial management are blatantly ignored.

In 1989, we failed to identify what money, credit and assets had been stolen and to get them back. Billions of dollars in profits remained in the pockets of the conspirators and their co-conspirators - the investors, strategic partners and offshore backers to whom they funneled it. Rather than hold people and institutions accountable and achieve restitution, we plowed additional back door profits into the financial institutions and allowed them to continue in their role as member banks and shareholders of the New York Federal Reserve Bank, depository to the US Treasury.

These institutions continued to provide a wide number of important services to federal, state and local government and pension funds, ensuring their access to extraordinary amounts of revenues, assets and critical inside market information. We continued to accord them, their investors and the politicians they funded the prestige and power traditionally reserved for a society’s most trusted stewards and fiduciaries. By so doing, we legitimized and institutionalized mortgage and financial fraudsters on a global scale. (1) (2) (3)

Trillions of dollars are missing. Where did it go? Who has it? Let’s act on what we learned the last time around – “Crime that pays is crime that stays.” This time, let’s ask and answer the right question: “Where is the money and how do we get it back?”

Friday, April 04, 2008

Fear of a Black Swan

Risk guru Nassim Taleb talks about why Wall Street fails to anticipate disaster.
By Eric Gelman, assistant managing editor
(Fortune Magazine) --

In two bestselling books, "Fooled by Randomness" and "The Black Swan," Nassim Nicholas Taleb has explored the ways people misunderstand randomness and risk. At the heart of his thinking is the idea of a "Black Swan" - an unlikely but not impossible catastrophe that no one ever seems to plan for. In an e-mail and telephone exchange with Fortune's Eric Gelman that began with Taleb in the Yucatán for the equinox, the New York City-based former trader turned scholar and essayist expounds on the role of Black Swans in the current market crisis.

What is a Black Swan?

What I call a Black Swan is a surprise event - like the discovery of the black bird in Australia, which was unpredictable because swans in the Old World were all white. But unlike the bird, my Black Swan carries large consequences.

There are two types of businesses: those that are exposed to Black Swans and those that are relatively insulated from them - not because Black Swans cannot occur, but because their impact is not going to be monstrous. Your dentist's income will not disappear on a single day: No single event will carry big consequences for her. But trading profits can all be lost by a single transaction. So some businesses are insulated, some (like technology) are exposed to positive Black Swans, and others are exposed to negative ones.

Most people seem to have been caught off-guard by the subprime crisis, yet such an event was not only predictable but also inevitable. It was a Black Swan, yes?

The Black Swan is a matter of perspective. A turkey is fed for 1,000 days - every day lulling it more and more into the feeling that the human feeders are acting in its best interest. Except that on the 1,001st day, the butcher shows up and there is a surprise. The surprise is for the turkey, not the butcher. Anyone who knows anything about the history of banking (or remembers the 1982 Latin American debt crisis or the 1990s savings and loan collapse) will tell you that the subprime crisis was so bound to happen. Banks are exposed to such blowups. Bankers have been the turkey, historically.

So I call these crises "gray swans." I've been telling anyone willing to listen that banks have a tendency to sit on time bombs while convincing themselves that they are conservative and nonvolatile.

I gather you don't have a lot of respect for the effectiveness of Wall Street's "risk management."

It is the "science" of risk management that effectively turned everyone involved into a turkey. If the Food and Drug Administration monitored the business of risk management as rigorously as it monitored drugs, many of these "scientists" would be arrested for endangering us. We replaced so much experience and common sense with "models" that work worse than astrology, because they assume that the Black Swan does not exist.

Trying to model something that escapes modelization is the heart of the problem. We like models because they do not require experience and can be taught by a 33-year-old assistant professor. Sometimes you need to say, "No model is better than a faulty model" - like no medicine is better than the advice of an unqualified doctor, and no drug is better than any drug.

The idea that catastrophe can strike without warning does not seem particularly hard to understand. Why doesn't Wall Street ever seem to allow for that possibility? And why doesn't it learn from past catastrophes?

Let me blame business schools and the financial economics establishment - they have a vested interest in promoting models and devaluing common sense.

I worked on Wall Street for close to two decades in trading and risk management of derivatives. I noticed that while portfolio models got worse and worse in tracking reality, their use kept increasing as if nothing was happening. Why? Because in the past 15 years business schools accelerated their teaching of portfolio theory as a replacement for our experiences. It looks like science, and they have been brainwashing more than 100,000 students a year. There is no way my experiences can be transmitted to the next generation because of these schools. We've had fiascoes in finance that they need to neglect because they contradict their models. The problem may also be the Nobel in economics that gave a stamp to these junky theories. Someone needs to make the Nobel committee account for this, for the damage to society - and I hope to do so.

Banks thought they were hedging their bets in the mortgage market. Clearly they were wrong. Would there have been a way to participate in the mortgage bond market in a prudent way?

Of course, in a less leveraged manner. But greed pushes bankers to take the maximum amount of "hidden risks" - those risks that do not show on a regular basis because the models miss it, but end up causing blowups. Banking is a very treacherous business because you don't realize it is risky until it is too late. It is like calm waters that deliver huge storms.

You can tell that there will be another blow-up, another Black Swan, but you can't tell me where it will occur - or can you?

I don't know where it may occur. But if you look at balance sheets and contingent liabilities, it is easy to know who may be exposed to negative ones and who may be exposed to positive ones. Furthermore, some banks and hedge funds are more resistant than others to the Black Swan - we need to discriminate between them.

Is there any way to prevent drastic shocks to the financial system?

Occasional blowups are good if they are small and recurrent. When you live in Manhattan, you notice the quality of the food is high because restaurants are rapidly punished for their mistakes. But unfortunately we have been experiencing the opposite: rare but deep and systemic blowups.

Is there something fundamentally wrong with the structure of the U.S. financial system? What can be done to fix it?

In the past, the financial world had a very diversified ecology: banks going bust on a steady basis. They were not all homogeneous.

Today the entire banking system is dominated by a few monster banks, and almost all have the same exposures. So the system became less and less volatile while becoming riskier and riskier. So we moved from the more resilient ecology to a more concentrated architecture. I used to say, "You trade with a bank, you end up trading with J.P. Morgan (JPM, Fortune 500)." Well, it turned out to be true with the Bear Stearns (BSC, Fortune 500) rescue.

Did your personal portfolio benefit or suffer from the subprime crisis?

I prefer not to answer that, as I am trying to avoid talking about my nonintellectual activities.

Thursday, April 03, 2008

Soros Sees Additional Market Declines After Temporary Reprieve

By Katherine Burton

April 3 (Bloomberg) -- Billionaire George Soros called the current financial crisis the worst since the Great Depression and said markets will fall more this year after a brief rebound.

''We had a good bottom,'' Soros said yesterday in an interview in New York, referring to the rally in stocks and the dollar after JPMorgan Chase & Co. agreed to buy Bear Stearns Cos. on March 17. ''This will probably not prove to be the final bottom,'' he said, adding the rebound may last six weeks to three months as the U.S. moves closer to a recession.

Last summer, worried about market disruptions that started with rising subprime-mortgage defaults, Soros, 77, returned to a more active role in managing the $17 billion Quantum Endowment Fund, whose profits pay for his philanthropic projects. Quantum returned an average of 30 percent a year before Soros started using outside managers in 2000 for much of his money.

He also decided to write a book, his 10th, ''The New Paradigm for Financial Markets'' (Public Affairs, 2008). Released today online, the book explains the causes of the current meltdown, a crisis he says has been in the making since 1980, and the trades he put in place this year to protect his wealth, much of it in Quantum.

Soros has bet on declines in the dollar, 10-year Treasuries and U.S. and European stocks. He expected foreign currencies to rise, as well as Chinese and Indian equities. The latter bet helped Quantum return 32 percent in 2007. Quantum's returns this year have ranged from up 3 percent to down 3 percent.

'Heightened Uncertainty'

The euro has climbed 7.5 percent against the dollar this year and the Japanese yen has gained 9.1 percent. These and other currencies may continue to strengthen, he said.

''There is an increasing unwillingness to hold dollars, though there's a lack of suitable alternatives,'' he said. ''It's a period of heightened uncertainty.''

Federal Reserve officials dropped their benchmark interest rate 2 percentage points this year to 2.25 percent, and Soros doesn't see that they can lower the rate much further, given the weak dollar.

''We are close to the limit,'' he said.

As for his wagers on developing markets, Soros hasn't abandoned his holdings in India, even with the 22 percent drop in the benchmark Indian index this year.

''The fundamentals remain good,'' he said. He is less certain about what will happen to Chinese H shares, which trade in Hong Kong.

Credit-Default Swaps

Credit default swaps -- a way to bet on the creditworthiness of a company -- may be the next crisis area because the market is unregulated, and it's impossible to know whether counterparties can meet their obligations in the event of a bond default. The market has a notional value of about $45 trillion -- or about half the total wealth of U.S. households.

Soros recommends the creation of an exchange with a sound capital structure and strict margin requirements, where current and future contracts could be traded.

The cause of the current troubles dates back to 1980, when U.S. President Ronald Reagan and U.K. Prime Minister Margaret Thatcher came to power, Soros said. It was during this time that borrowing ballooned and regulation of banks and financial markets became less stringent. These leaders, Soros said, believed that markets are self-correcting, meaning that if prices get out of whack, they will eventually revert to historical norms. Instead, this laissez-faire attitude created the current housing bubble, which in turn led to the seizing up of credit markets and the demise of Bear Stearns, Soros said.

To avoid a super-bubble in the future, Soros said banks must control their own borrowing. They must also curtail lending to clients such as hedge funds by demanding greater collateral and margin requirements on loans.

Asked if such moves would make it impossible to achieve returns like those of his pre-2000 days, Soros laughed.

''Since I'm designing these regulations, they would not hurt me,'' he said. ''We made direction bets but we haven't used leverage'' like the $25-to-$1 borrowing that brought down John Meriwether's Long-Term Capital Management LLC in 1998.

Wednesday, April 02, 2008

The worst market crisis in 60 years

By George Soros

Published: January 23 2008 02:00 | Last updated: January 23 2008 02:00

T he current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years.

However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.

Boom-bust processes usually revolve around credit and always involve a bias or misconception. This is usually a failure to recognise a reflexive, circular connection between the willingness to lend and the value of the collateral. Ease of credit generates demand that pushes up the value of property, which in turn increases the amount of credit available. A bubble starts when people buy houses in the expectation that they can refinance their mortgages at a profit. The recent US housing boom is a case in point. The 60-year super-boom is a more complicated case.

Every time the credit expansion ran into trouble the financial authorities intervened, injecting liquidity and finding other ways to stimulate the economy. That created a system of asymmetric incentives also known as moral hazard, which encouraged ever greater credit expansion. The system was so successful that people came to believe in what former US president Ronald Reagan called the magic of the marketplace and I call market fundamentalism. Fundamentalists believe that markets tend towards equilibrium and the common interest is best served by allowing participants to pursue their self-interest. It is an obvious misconception, because it was the intervention of the authorities that prevented financial markets from breaking down, not the markets themselves. Nevertheless, market fundamentalism emerged as the dominant ideology in the 1980s, when financial markets started to become globalised and the US started to run a current account deficit.

Globalisation allowed the US to suck up the savings of the rest of the world and consume more than it produced. The US current account deficit reached 6.2 per cent of gross national product in 2006. The financial markets encouraged consumers to borrow by introducing ever more sophisticated instruments and more generous terms. The authorities aided and abetted the process by intervening whenever the global financial system was at risk. Since 1980, regulations have been progressively relaxed until they have practically disappeared.

The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility.

Everything that could go wrong did. What started with subprime mortgages spread to all collateralised debt obligations, endangered municipal and mortgage insurance and reinsurance companies and threatened to unravel the multi-trillion-dollar credit default swap market. Investment banks' commitments to leveraged buyouts became liabilities. Market-neutral hedge funds turned out not to be market-neutral and had to be unwound. The asset-backed commercial paper market came to a standstill and the special investment vehicles set up by banks to get mortgages off their balance sheets could no longer get outside financing. The final blow came when interbank lending, which is at the heart of the financial system, was disrupted because banks had to husband their resources and could not trust their counterparties. The central banks had to inject an unprecedented amount of money and extend credit on an unprecedented range of securities to a broader range of institutions than ever before. That made the crisis more severe than any since the second world war.

Credit expansion must now be followed by a period of contraction, because some of the new credit instruments and practices are unsound and unsustainable. The ability of the financial authorities to stimulate the economy is constrained by the unwillingness of the rest of the world to accumulate additional dollar reserves. Until recently, investors were hoping that the US Federal Reserve would do whatever it takes to avoid a recession, because that is what it did on previous occasions. Now they will have to realise that the Fed may no longer be in a position to do so. With oil, food and other commodities firm, and the renminbi appreciating somewhat faster, the Fed also has to worry about inflation. If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an end.

Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world.

The danger is that the resulting political tensions, including US protectionism, may disrupt the global economy and plunge the world into recession or worse.

The writer is chairman of Soros Fund Management

Agflation will change the course of history

BY MATEIN KHALID (At Home)

2 April 2008



WHILE consumers, savers and financiers in the Gulf fret about the current inflation surge and rightly attribute it to the dollar peg, offplan madness and the property speculation bubble, the prices of cement and steel, rent spirals, wage spikes, the money supply, 30 per cent bank credit growth and the tooth fairy, I am convinced that the Middle East’s next macroeconomic demon will be a spectacular rise in food prices.


Agflation will define the future of the region to a far greater degree than illusory hopes for a GCC monetary union, Arab League diplomatic platitudes or demographic time bombs everywhere from Iran to the Maghreb. Yet myriad forces define the supply and demand equations of agflation. As in crude oil, iron ore, nickel and steel, Chinese demand has surged for soyabeans, where the Middle Kingdom already accounts for 26 per cent of global consumption. The world’s inventories of grain, corn and edible oil are at historic lows and, just like gold and crude oil in 2003, spectacular bull markets in soft commodities have been ignited. Political chicanery has been the DNA of agflation in modern times. The Iraq war and $100 crude oil forced the Bush White House and the EU to anoint biofuels as the path to energy independence from Arab oil. As US corn, protected by price subsidies and mandation, monopolised arable land, soybean and cotton production will plunge.

Agflation will change international politics, redefine economic models and trigger regime changes across the emerging markets. Far more than crude oil or even bullion, price rises in the supermarket trigger mass consumer inflation psychology. So central bankers at the Fed, the ECB, the Bank of Japan, RBI, PBOC and SAMA will be powerless to prevent food prices from accelerating the embryonic global inflation nightmare. Global warming, the destruction of the rain forest, carbon emissions and black swan (rare high impact events with fat statistical tail) events like Mad cow’s disease, avian flu and Australian droughts will make agflation as compelling a global issue, at Davos or the UN, as climate change.

Inflation in Dubai is as visceral as “stickershock” in Spinneys and Carrefour as in the price surge in white hot developments like the DIFC or Business Bay. Inflation psychology aside, agflation hits the poor like a financial neutron bomb and encourages hoarding behaviour that make price spirals a self fulfilling prophecy. As agflation accelerates, countries with farmland like Russia, Argentina, Ukraine, Australia and Brazil will possess a new currency of geopolitical power. While soybean and corn are as supply elastic in the short run as black gold, making price rises inevitable. Chinese pork prices, half the CPI for a staple diet for more than a billion people, surged and sparked worker riots and wage rise demands even in the high growth coastal provinces. The surge in the price of beef and tofu in Indonesia led to protests and compelled a cabinet minister to warn of potential social unrest similar to 1965, the fabled year of living dangerously when General Suharto overthrew President Sukarno and the Indonesian military massacred 500,000 suspected communists. Australia’s drought, Brazil’s bad harvests, Russia and Ukraine’s export restrictions and soaring global demand has lead to epic rises in the price of wheat. The surging price of kerosene, cooking oil and flour were instrumental in bringing down Pakistani President Musharraf’s PML-Q, the ostensible king’s party now reduced to a pitiful toothless dictator party. Indonesia’s sovereign creditworthiness is at stake because of agflation since Jakarta spends a third of its budget on fuel/and electricity subsidies.

Egypt is most at risk in the Arab world by the nightmare of agflation. Bread has been subsidised by the rulers of Egypt for millennia from Pharonic times down to the government of President Mubarak. Basic food prices have surged on strikes, bringing factories and universities to a halt. After all, “IMF bread riots” preceded the violence and unrest in the early 1990’s that culminated in the assassination of Anwar Sadat at a military parade to commemorate the 1973 October War. Even though the Egyptian government subsidises sugar, rice, oil and bread, food price surges are more of a threat to regime stability than Dr Zawahiri’s Al Qaeda terrorists. Bread queues turn violent, a recurrent theme in Egyptian history from Ramses II to the Mamluk sultans, from the Ottoman pasha rule to Lord Cromer’s British viceroyalty, from King Farouk to Nasser, Sadat to Mubarak.

The price of rice is the most accurate gauge of social stability for almost three billion Asians. Since Egypt, India and Vietnam banned exports to bring down local prices, the global price of rice has skyrocketed. If India restricts Basmati rice exports, a worldwide panic is inevitable. I believe Thai rice will prove a far bigger money maker for investors than Saudi sour crude. As rice prices double, the poor of Southeast Asia will go ballistic, threatening the government of countries like the Philippines, Burma and Vietnam. With water scarce, low investment in agriculture and dependence on imported food is a disaster for the Arab world.

As hedge funds speculate in coffee, the incomes of Brazilian farmers and Coorgi yuppies surge and the price of a Starbucks cappuccino became an inflation indicator in Ibn Batuta Mall. Stock exchange rumours swirl that Nestle and Kraft Food (owners of the Maxwell House brand) have not hedged their wholesale prices for robusta and arabica beans. I grew up in a world where the CRB, the world’s commodities index, correlated perfectly with global economic growth. The correlation, unfortunately, has broken down as the world flirts with recession even as food prices skyrocket. This is the stagflation and supply shock scenario, as in the 1970’s.

Agflation concerns UAE economic policymakers. The UAE economy minister is considering food price reserves to combat inflation. This was also the message of the government’s decision to freeze 18 basic foodstuff prices on 2007 levels. Will the UAE government follow rent caps with price freezes at private supermarkets? Food subsidies could even compensate for the decision by GCC central banks not to revalue their currency or drop the dollar peg, the symbol of the Gulf’s Washington security and diplomatic umbrella. Agflation, I am convinced, will be world history’s next game changer, an ominous sword of Damocles over the poorest citizens of the global village.

Matein Khalid is a Dubai-based investment banker and economic analyst

Tuesday, April 01, 2008

How To Fix It

"This disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect, persons of poor and mean condition, though necessary both to establish and to maintain the distinction of ranks and the order of society, is, at the same time, the great and most universal cause of the corruption of our moral sentiments."

Adam Smith, The Theory of Moral Sentiments (1759)
Twelve Basis Points

One way of measuring how perilously close the U.S. financial system came to melting down in mid-March 2008 is to look at how low the rate on one-month Treasury bills fell at the depths of the crisis. That number is 12 basis points. 0.12%. The three-month Treasury bill rate, which our friend Jim Bianco of the highly respected Bianco Research points out is the "risk-free" rate for many models such as the capital asset pricing model, the arbitrage risk pricing model and the Black-Scholes pricing model, fell to a 50-year low of 56 basis points on Tuesday, March 25. 0.56%. As Mr. Bianco pointed out, these bills were yielding less than Japanese 3-month financial bills for the first time since July 14, 1993.

And it's not as though the Japanese economy is flourishing. In fact, quite the opposite is occurring as Japan continues to struggle with the aftermath of its lost decade (which is stretching into lost decades). Hilary Clinton, who looks increasingly unlikely to lead her party in the upcoming Presidential election, is definitely onto something when she warns that "[w ]e may be drifting into a Japanese-like situation. I don't think we can work our way out of the problems we're in for the broad-based economy through monetary policy alone. Japan tried that and tried and tried that."1 The structural problems ailing the U.S. economy are severe. They derive from bad economic policies and bad political values.
American Capitalism In Need of Repair2

We all know Adam Smith as the author of the bible of capitalism, The Wealth of Nations (1776). But he first wrote what is arguably a far more important book, The Theory of Moral Sentiments, from which the quote that heads this month's newsletter is drawn. America is rushing headlong into the 21st century without a proper understanding of what economic policies and financial tools are going to be required to prosper in a changing world. For more than two decades, the United States economy has favored financial speculation over production. Over the past century, our legal system had developed an increasingly outmoded concept of fiduciary duty that privileges short-term, single-firm interests over the kind of long-term, society-wide interests that could lead to prolonged prosperity. The current meltdown in the financial markets is a symptom of a serious disease that is eating away at the stability of our most important institutions. What we are witnessing might well be the end of American financial hegemony, which is the result of a burgeoning global economy. The current crisis in financial markets gives us an opportunity to evaluate how we can better prepare ourselves to deal with a borderless world.

In spite of claims to the contrary, the American economy has become increasingly unstable in recent decades. This phenomenon picked up momentum in recent years as financial markets focused on trading derivative financial instruments rather than cash stocks and bonds. Paradoxically, the very financial instruments designed to manage risk increase mark volatility. As the distance separating lenders and borrowers as well managers and stockholders increased, debacles such as the Enron and WorldCom frauds earlier this decade and, more recently, the subprime mortgage and structured credit meltdown of today became more common. By effectively reducing all financial instruments and measures of financial value to "one's and zero's" - by digitalizing value - Wall Street removed crucial checks and balances on financial behavior, which ultimately remains a human activity. The growing use of quantitative trading models led to a market dominated by traders directing money into companies about which they know little or nothing. This leveling of all economic values to indistinguishable signs did untold damage to economic actors' ability to distinguish valuable assets from worthless ones.

In addition, unstoppable economic and historical trends such as globalization caused a shift of jobs and factories to geographic locations with lower labor and materials costs, resulting in a transformation of the U.S. economy from one that manufactures goods to one that traffics in intangible items. The result has been a shift from investing in activities that add to the productive capacity of the country to transactions and activities that are merely speculative in nature, i.e., that merely spawn more money but not more physical or capital assets. This shift from a tangible to an intangible economic base was accompanied by a change in the way in which businesses are financed. At the same time as the business base became increasingly intangible, so did the financial base. Equity was replaced by debt, and cash securities were replaced by derivatives. Much of the new financial architecture is now constructed outside the purview of the Federal Reserve and other regulators, allowing economic actors to avoid margin requirements and other limits on leverage that can prevent systemic threats. The new foundations of corporate finance can vaporize in the blink of a trader's eye. These trends have enormous policy consequences for the United States and our future standard of living.

The fiduciary law that governs our business culture reaches back to the 15th century and requires those who are entrusted with managing our largest corporations or pools of money to act in the best interests of their shareholders or clients. But the evolution of fiduciary law has developed into a mode of thinking that privileges short-term, single-company results over long- term, society-wide results. Consequently, fiduciaries are driven by a logic that dictates a focus on the short-term, which can be more accurately predicted than the long-term. But there is something deeper at work in this mindset. Fiduciary thought privileges form over substance, procedure over justice. Decisions that serve a single corporation's shareholders may cause significant harm to a wider array of interests. The entire concept of fiduciary duty must be rethought if capitalism is going to flourish in a borderless, digitalized world. Instead of a narrow focus on the interests of a single firm's shareholders, the fiduciaries of our large business enterprises are going to have to widen their arc of concern to a wider group of constituencies. Without such a broadening of focus, narrow interests will continue to place the entire system in jeopardy because of the networked nature of today's financial markets.

Some Specific Recommendations for Financial Reform

Nano-scopic interest rates are a sign of just how corrupted our financial system has grown from the twin diseases of leverage and greed. The collapse of Bear Stearns was an all-too predictable byproduct of a system that refuses to look itself in the mirror. The bailout of Bear was an obnoxious necessity in view of the fact that the firm was too interconnected as a Wall Street counterparty and prime broker to be permitted to fail. Its collapse would have placed many hedge funds and other financial firms at risk.3 So instead of being able to allow the firm to enter bankruptcy as a just dessert for its failure to properly manage the risks inherent in its business, the Federal Reserve and Treasury Department had to place the interests of the financial system first. The time to ask about moral hazard is not when the system is about the implode - the appropriate time for such questions is much earlier, when the seeds of destruction that lead to the necessity to bail out players that act in ways that threaten long-term systemic stability are being sown. Such questioning, and the requisite action to avoid future problems, requires degrees of forethought and forthrightness for which the power players on Wall Street and in Washington have little tolerance. Even when we skirt complete systemic collapse - and make no mistake about it, we have come as close to such an event as anyone should dare imagine - those with a stake in the game continuing are working behind the scenes to protect their interests.

The Bush Administration, under the intellectual leadership of Treasury Secretary Henry Paulson, has proposed a broad reorganization of financial industry regulation. Unfortunately, this plan merely addresses form over substance and does little or nothing to address the underlying problems that are eating away at the system like a cancer. If reform ultimately follows the path proposed by Mr. Paulson and goes no farther to outlaw the reckless practices that place the system at risk in order to line the pockets of a privileged few, we will have sadly learned nothing from the current crisis. The system is infected by deep, inbred flaws that are rendering it increasingly unstable. Free-market capitalism as practiced on Wall Street and in The City has run amok. If the current crisis, and the recurring crises of the last twenty years, tell us anything, it is that market solutions are insufficient to protect the system from the greed and fear that drive markets. If the deep structural cracks in the system are not addressed and corrected, the markets may not survive the next near-death experience.

This is not a time to mince words. As the poet William Blake wrote, "Opposition is true friendship." At the risk of offending many of our readers, here are HCM's thoughts on how to reform the financial system.
Financial Industry Regulation: There is too little, not too much, financial industry regulation. The problem with our current regulatory regime is that too many of our current regulations serve little or no purpose (for example, the pages of meaningless disclosure in Wall Street research reports that nobody reads and are often longer than the research reports themselves) or are enforced in a capricious and arbitrary manner by unqualified regulators and overzealous prosecutors. This breeds disrespect for the law and resentment among the regulated. As a result, we have a system of laws, not values, a system that privileges form over substance, process over justice. We are never going to have a sound regulatory system until we raise the compensation levels for those who are charged with insuring that millionaires are following the rules.

HCM often hears the argument that too much regulation will force business offshore and render the U.S. financial industry less competitive. Our response to that argument is that institutions and fiduciaries in the end will gravitate to the system with the strongest and wisest regulatory protections. Moreover, we should be pushing the most reckless practices out of our markets and into other markets. We should be creating global competition over best regulatory practices, not worst ones.

Wall Street Compensation: The financial incentive system that governs Wall Street - and by "Wall Street," we mean the investment and commercial banks, private equity firms and hedge funds - requires dramatic rethinking. As compensation is meted out today on Wall Street, too much is paid to too few for doing too little of value for society. Too much capital is allowed to exit investment banks in the form of annual cash compensation. Executive compensation should be calculated based on multiple years of performance and subject to high water marks and claw backs in the event one year's profits from a transaction or a specific activity are lost in later years when that activity turns out to have been fraudulent or flawed. The subprime mortgage business is a case in point. Why should bankers be permitted to retain bonuses earned with respect to the closing of subprime mortgage CDOs that subsequently led to losses for their firms and investors? Compensation should be based on a longer-term view of value-added. Furthermore, regulators should permit firms to maintain reserve accounts and make other arrangements to facilitate a more nuanced compensation structure with adequate disclosure to keep investors fully informed.

Private equity managers and hedge fund managers should not be compensated based on returns attributable to inflation or the market. Their performance fees should be subject to a hurdle rate that is based on annual inflation rates and the applicable asset class performance (equity market performance in the case of private equity firms, for instance) to insure that investors are really paying fees for performance, not for fortuity.

Private Equity: The private equity business has resulted in the overleveraging of American business. One result is that many businesses are short-changing capital expenditures and research and development in order to service debt. Despite the statistics promulgated by self-serving, private equity-financed industry groups, it is irrefutable that companies would have more money to contribute to the productive stock of the economy if they were devoting less money to servicing their enormous debts. We will look back at the private equity boom as a phenomenon that damaged the American economy and impaired America's competitive position in the world.

The private equity boom is the quintessential example of what the economist Hyman Minsky termed "speculative finance" and, in its most extreme form, "Ponzi finance."4 Private equity deals add little or nothing to the productive capacity or capital base of the economy. Instead, they merely create debts that have to be serviced and divert cash to the activity of servicing debt rather than creating jobs or funding new projects or research. In 50 years, it is going to be clear that the U.S. economy has paid a terrible price for this.

Private equity managers' (and hedge fund managers') "carried interests" should be taxed at ordinary tax rates, not at the capital gains rate. Such earnings are nothing other than compensation, not earnings on risk capital.5 The arguments that private equity firms have tried to promote on Capitol Hill that such a taxation regime would reduce risk-taking are completely unsupportable from a factual standpoint. Henry Kravis and Stephen Schwarzman are not going to stop doing deals because they have to pay taxes at the same rate as their chauffeurs. These arguments are also the most cynical kind of politicking that insults the intelligence of every American. If politicians want to be held in even lower regard than they already are, supporting these arguments is a good way to go.

Finally, private equity firms should not be permitted to go public. The discipline of the markets - i.e. 50 percent or more declines in the price of private equity firms' stocks such as The Blackstone Group (BX) and Fortress Investment Group (FIG) - is inadequate to police the abuses of such transactions. These firms are hopelessly and terminally conflicted between their fiduciary obligations to their limited partners and their fiduciary obligations to their shareholders. The fact that investors are willing to ignore the mind-boggling hypocrisy of IPOs of businesses that are built on the premise that public ownership is economically inefficient is a tribute to the insatiable greed that has consumed investors. That greed has not only corrupted investors' moral sentiments, as Adam Smith wrote more than two centuries ago, it has crippled their common sense.

Financial Institution Leverage: Allowing investment banks to be leveraged to the tune of 30 to 1 is the equivalent of playing Russian roulette with 5 of the 6 chambers of the gun loaded. If one adds the off-balance sheet liabilities to this leverage, you might as well fill the 6th chamber with a bullet and pull the trigger. If this continues, the odds of a systemic crisis more severe than the one we are experiencing are near 100%. An absolute leverage limit should be imposed on investment banks and other financial institutions.6 Some will argue that limiting financial institution leverage will render these businesses less profitable and less competitive with non-U.S. companies. HCM's response is - "so what?" Perhaps less profitable investment banks will result in more of America's talented students becoming scientists, engineers, doctors and teachers instead of investment bankers and mortgage traders. What would be so terrible about that?

Off balance sheet entities should be outlawed immediately, plain and simple. If first Enron and now the SIVs haven't taught us the necessary lessons about hidden liabilities, the system probably doesn't deserve to survive. Speaking as someone with extensive knowledge of these off-balance sheet entities, it would not be difficult to render them extinct relatively easily. It would be doing the world a favor.

Tying this issue to the compensation question in the financial industry, if investment banks want to leverage themselves 30 to 1, their executives should be required to retain 97 percent of their compensation in their firms in the form of equity capital. The way it stands now, the ratio between capital retained and cash out is much lower (perhaps 1:1) and effectively creates a "heads-I-win, tails-you-lose" culture. For institutions that play a central role as financial counterparties and lenders, this is an unacceptable risk-sharing arrangement for society to bear. These institutions need to understand that they have responsibilities to the system, not just to their own shareholders and employees. Sure, Jimmy Cayne sold stock once worth $1.2 billion for only $61 million, but he also took out hundreds of millions of dollars in cash compensation over the years. Nobody can argue that his incentives were anything but grossly asymmetric, which may explain his ability to keep his job while demonstrating a much greater understanding of the strategies of the game of bridge than of the balance sheet risks his firm was undertaking.

Hedge Fund Leverage: Allowing unregulated entities such as hedge funds to be leveraged 10 to 1 or 15 to 1 would be laughable if it wasn't so dangerous. Prime brokers continue to be suckers for big names and big clients (and especially for big name clients). As a result, they often extend credit to parties who are not qualified to employ it prudently. HCM has expressed its view on more than one occasion that fixed income strategies that require excessive amounts of leverage do not make sense and have never made sense. We would refer anybody who disagrees with us to the recent collapses of Sowood Capital Management, LP, Peloton Partners LLP and Carlyle Capital Corp. Each of these firms reportedly employed high amounts of leverage (reportedly more than 15x) in their strategies. An absolute leverage limitation should be placed on hedge funds immediately. Since the prime brokers don't seem to want to impose such a limitation, the Federal Reserve should do so with its new powers. If investors can't generate decent returns without employing grotesque amounts of leverage, they should find another profession.

We recently read7 that John Meriwether of Long Term Capital Management infamy is at risk of blowing up a hedge fund that was leveraged 14.9 to 1 as of the end of February (and is reportedly down 28 percent year-to-date). The fund in question, Mr. Meriwether's Relative Value Opportunity Fund, reportedly has earned about 7 percent per annum since inception in 1999 through February 2008 (according to The Wall Street Journal) despite the use of generous amounts of leverage. According to the Journal article, Mr. Meriwether, like many hedge funds, charges a 2 percent management fee and 20 percent performance fee for managing his fund. We really don't mean to pick on Mr. Meriwether. Everybody is entitled to a second chance. But one would hope that an individual whose firm almost cratered the entire financial system in 1998 would have learned from his mistakes. Any way you slice it, 15x leverage is imprudent. It may look prudent compared to the 100x leverage employed at Long Term Capital Management a decade ago, but that is like saying 2 degrees below zero isn't cold because it isn't 30 degrees below zero.

Of course, the real question is why hedge fund investors are still willing to risk their money in such highly leveraged strategies. HCM has been asking that question for years but has yet to hear a satisfactory explanation. But since the market won't impose the type of discipline that is necessary to protect the system from boom and bust cycles, it is time for the regulators to step in.

Quantitative Strategies: Quantitative investing has not only introduced an unhealthy amount of volatility into the markets, but has contributed to a larger trend in the financial markets that divorces the investment process from the concept of fundamental value. HCM would defy the quants to explain in any degree of detail what the companies in their portfolios do. This is another type of investing activity, like private equity, that does little or nothing to provide capital to increase the productive capacity or physical stock of the economy. In fact, quantitative investment strategies are the quintessential "hot money." Enslaved by their computer models, they trade in and out of positions at the blink of an eye. When things go wrong, they blame everybody but themselves. Being a quant means never having to say you're sorry.

At some point, society has to figure out that the way an investor earns his money is even more important than the amount of money he makes. This is why human beings were vested with moral sentiments, so they could distinguish the quality of human conduct from the quantity of its results. Until that happens, we will continue to extol the types of investment activity that contribute little to our world. HCM would respectfully propose that a new school of "ethical investing" be adopted that takes into account how particular kinds of investments contribute to the economy. On this basis, quantitative strategies would be eliminated from consideration.

Short Selling: Short selling is an absolutely legitimate way to invest or hedge a portfolio. The SEC made a major error when it repealed the downtick rule last year. The repeal of this rule increased downside volatility exponentially and contributed to the ability of quantitative and other computer-driven selling to push the market lower based on technical rather than fundamental investment considerations. The SEC should reinstitute the downtick rule immediately.



Financial Triage

The magnitude of the unprecedented steps that the Federal Reserve and U.S. Treasury have had to take to bail out the U.S. financial system speaks to the depth of the problems we are facing. We may have left some steps out, but by our account the following is a list of the extraordinary actions that the U.S. central bank has been required to take to address the current crisis.
Since last summer, the Fed has cut interest rates by 300 basis points. The result? Mortgage rates have barely budged, but they are finally starting to move lower. Unfortunately, this comes too late for many homeowners who are losing their homes.

On December 12, 2007, the Federal Reserve created the Term Auction Facility (TAF) whereby the Fed will auction term funds to depository institutions against a wide variety of collateral that can be used to secure loans at the discount window. On March 7, 2008, the Federal Reserve increased the size of the TAF to $100 billion and initiated a series of term repurchase transactions that were expected to cumulate to $100 billion. As with the TAF auction sizes, the Fed said it would increase the size of these term repo operations if necessary. No doubt these facilities will need to be increased.

On March 11, 2008, the Federal Reserve created a $200 billion Term Securities Lending Facility (TSLF) whereby primary dealers could borrow Treasury securities for a period of up to 28 days using as collateral federal agency debt, federal agency residential mortgage backed securities (MBS) and non-agency AAA/Aaa-rated private-label residential MBS.

On March 17, 2008, the Federal Reserve opened up the discount window to the investment banks, which are not subject to the same regulatory limitations as the commercial banks that have traditionally had access to the window.

The Federal Reserve made a $29 billion line of credit available to JP Morgan Chase in connection with its takeover of Bear Stearns.

The Office of Federal Housing Enterprise Oversight (OFHEO) announced on March 19 that it would reduce excess capital requirements for Fannie Mae and Freddie Mac by one-third, from 30 percent to 20 percent. This is calculated to permit these two entities to add another $200 billion of mortgages to their existing $1.4 trillion portfolios (on an equity base of less than $70 billion). The two agencies shortly thereafter announced that they were authorized to raise an additional $5-10 billion of equity capital each, which would still leave them grossly leveraged by HCM's count.

The Federal Housing Finance Board announced that it would increase the limit on Federal Home Loan Banks' MBS (mortgage backed securities) investment authority from 300 percent of capital to 600 percent of capital for two years. This is estimated to enable these institutions to purchase another $200 billion of this paper.

While these moves were probably necessary to save the system from complete collapse, it is abundantly clear that these drastic steps are going to have enormous negative long-term effects on the U.S. economy. Among those effects will be higher future inflation and an extension of the high levels of leverage in the system that pushed the economy to the precipice this time. Does anybody really think it's a good idea to have Federal Home Loan Banks buy more MBS paper? Or for Fannie and Freddie to leverage their balance sheets further? All of these actions are going to have to be unwound at some point, which means that the day of reckoning is simply being delayed.8 It is clear that the authorities are engaged in a desperate attempt at economic triage that bodes poorly for the future economic health and stability of the United States. Looked at in this context, it is difficult to argue against those who believe in long-term U.S. dollar weakness. If you want to look at the end of American economic hegemony, just look at the list of desperate actions taken by U.S. financial authorities above. It is a sad commentary on how the greed and short-sighted actions and policies of U.S. politicians and businessmen have inflicted permanent damage on our economy.

There is a way out, but it will not be easy. The way out is to accompany the drastic steps taken by the Federal Reserve and Treasury with a comprehensive regulatory revolution that addresses the flaws embedded in the system. HCM does not use the word "revolution" loosely, but nothing less than a drastic rethinking of our current system accompanies by action to change it is going to be required if we are to strengthen the global economic system for the challenges to come.

Michael E. Lewitt

Footnotes:

1 The Wall Street Journal, March 27, 2003, p. A3.

2 I want to thank Professor Mark C. Taylor of Columbia University for helping to edit this section of the newsletter. I urge all readers to pick up a copy of Professor Taylor's incredibly insightful and brilliant book, Confidence Games Money and Markets In A World Without Redemption (Chicago: The University of Chicago Press, 2004). This wonderful book is not available in paperback.

3 Make no mistake, however, that by avoiding bankruptcy, Bear Stearns' executives benefitted greatly. In a bankruptcy, their 2007 bonuses would have been subject to repayment as "preferences" under the bankruptcy laws. Some will argue that Bear Stearns stock may have been worth a great deal more than $10 per share in a bankruptcy, but after time value, aggravation and illiquidity are factored in, HCM would argue that the JP Morgan Chase deal was still preferable to a bankruptcy ordeal.

4 See Hyman Minsky, Stabilizing an Unstable Economy (New Haven: Yale University Press, 1996), p. 70. ("A unit that expects its cash receipts to exceed its cash payments in each time period is engaged in what we will call hedge finance. On the other hand, an organization from which the contractual cash flow out over a time period exceeds its expected cash flow in is engaged in either speculative or Ponzi finance. A unit in a speculative or Ponzi financing posture obtains the cash to satisfy the debtors by selling some assets, rolling over maturing debt, or new borrowing; such units are dependent upon financial market conditions in a more serious way than units whose liability structures can be characterized as hedge financing." (emphasis in original)

5 To the extent private equity investors invest their own capital in their deals, earnings on those investments should be treated as capital gains.

6 The obvious question is what this leverage level should be, a question that requires a great deal of study. HCM would suggest that over a period of years, these firms should be required to bring their leverage down below a certain level in an orderly manner that is not disruptive to markets. HCM has no illusions about the anti-growth effects this could have on the economy, but we also have no illusions about the dangers of allowing the current regime to continue.

7 The following is based on an article in The Wall Street Journal, March 27, 2008, "A Decade Later, Meriwether Must Scramble Again," p. C1.

8 After rereading that sentence, HCM has to ask whether we are the only ones who think that it is really the case that these moves will have to be unwound or that they can be unwound. It may be more realistic to believe that these moves, such as the releveraging of Freddie and Fannie and Federal Home Loan Banks' increased purchases of MBS will remain permanent until the system can either work through its problems or collapses under its own weight once and for all. The only thing we know for sure is that pain delayed is pain increased. Failure to accompany these triage moves with substantive financial reforms will guarantee that the future pain will make the current crisis feel like a walk in the park.




Conclusion


Your still meditating on what the next paradigm will be analyst,

Global Systemic crisis continues

ccording to LEAP/E2020, the end of the third quarter of 2008 will be marked by a new tipping point in the unfolding of the global systemic crisis. At that time indeed, the cumulated impact of the various sequences of the crisis (see table below) will reach its maximum strength and affect decisively the very heart of the systems concerned, on the frontline of which the United States, epicentre of the current crisis. In the United States, this new tipping point will translate into a collapse of the real economy, final socio-economic stage of the serial bursting of the housing and financial bubbles (1) and of the pursuance of the US dollar fall. The collapse of US real economy means the virtual freeze of the American economic machinery: private and public bankruptcies in large numbers, companies and public services closing down massively (2),...

A revealing harbinger: from March 2008 onward, the US government will stop a service publishing its economic indicators due to budget restrictions (3). Those who read the GEAB N°2 (02/2006) and included Alert certainly keep in mind our anticipation which connected the upcoming fall of the US dollar with the US Fed's decision to cease publishing the M3 indicator. This new decision is another clear sign that US leaders are now anticipating a very bleak economic outlook for their country.


Time perspective of the seven sequences of the impact phase of the global systemic crisis as anticipated since mid-2007 - Source LEAP/E2020, GEAB N°18 (10/2007)
In this 22nd issue of the GEAB, LEAP/E2020's experts try in particular to anticipate very specifically what will come out of the collapse of the US real economy for the United States themselves and for the other regions of the world. Meanwhile our team presents five sets of strategic and operational recommendations helping to protect oneself from the upcoming deterioration of the global systemic crisis.

On the occasion of the second anniversary of the publication of our famous “Global systemic crisis Alert” which toured the world in February 2006 (4), LEAP/E2020 wishes to remind that we are now resolutely stepping into an era with no historical precedent. Our researchers insisted on that many times in the last two years: any comparison with the previous crises of our modern economy would be fallacious. It is neither a “remake” of the 1929 crisis nor a repetition of the 1970s oil crises or 1987 stock market crisis. It is truly a global systemic crisis, that is to say a crisis affecting the entire planet and questioning the very foundations of the international system upon which the world was organised in the last decades.

According to LEAP/E2020, it is also instructive to observe that, two years after the release of this « Alert » which at the time generated both the interest of millions of readers worldwide and the condescending irony of most « experts » and « managers » of the economic and financial spheres, everyone is now convinced that a crisis is truly happening, that it is really global, and for most people already that it could indeed be systemic. However, it is always a repeated astonishment for our team to see the degree of incapacity of these same experts and managers in understanding the specific nature of the phenomenon currently unfolding. According to them, this crisis would only be a usual crisis but bigger. As a matter of fact that's how the financial media reflect the dominant interpretations of the ongoing crisis. According to our team, this approach is not only intellectually lazy (5), it is also morally guilty, because it has for a main consequence to prevent their readers (whether they are simple citizens, private investors or public or private organisation managers) from preparing for the upcoming shocks (6).

For this reason, in opposition to all what can be read in the mainstream media always eager to conceal the truth and serve the interests of those who rule them, LEAP/E2020 wishes to remind that it is first and foremost in the United States that the systemic crisis is taking an unprecedented shape (the « Very Great US Depression » as our team decided to call it in January 2007 (7)) because it is around this country, and this country alone, that the world got progressively organised after the second World War. The various issues of the GEAB extensively described this situation. In short, it appears to be useful to make clear that neither Europe nor Asia have a negative saving rate, a full-scale housing crisis throwing millions of citizens out of their homes, a free-falling currency, abysmal public and trade deficits, an economic recession and, on top of all this, a number of costly wars to finance.

Neither Asia nor Europe (or more precisely ‘nor the Eurozone') will suffer the roughest, the most sustainable and the most negative impact of the ongoing crisis; but the United States will, as well as all the countries/economies strongly linked to the US (what our experts have decided to call “the American risk”) (8). A “decoupling” is indeed taking place between the US economy and the other large regions of the world. But “decoupling” does not mean “independence” and it is clear that, as anticipated by LEAP/E2020 for many months, Asia and Europe will be affected by the crisis. But « decoupling » entails that the evolution of the US economy and of the other large regions of the world are no longer synchronised, that Asia and Europe are now moving along courses no longer determined by the US economy.

The global systemic crisis is in fact the beginning of an economic « decoupling » between the US and the rest of the world, knowing that the non « decoupled » economies will be dragged down the US negative spiral.


US Self-Employment in a Steep Downturn - Source Bureau of Labor Statistics / Merril Lynch (shaded region represents period of US recession)
The cases of the housing (2006) and financial (2007) bubble-bursting are eloquent. Indeed, the large majority of operators (non-specialised in the concerned sector) discovered that « the party was over » a long time after the trend had reversed. During the entire reversal period (which usually lasts between 6 to 12 months at most), dominant stances kept repeating them that nothing was changing and that emerging worries had no reason to be; and later, that the problems would remain confined to the sector concerned and to the US only. All those who, in the US and elsewhere, listened to these arguments are bitterly regretful now that they are stuck with unmarketable houses (or about to be foreclosed) or now that they see the value of their assets crumble day after day (9).

Concerning stock markets, our team has anticipated since October 2007 that international stocks would plummet by 20 to 60 percent according to the region in the course of the year 2008. Today, we must re-evaluate our anticipations as we estimate that losses will be even greater than that. Indeed, on the one hand, stock markets have already lost between 10 and 20 percent since the beginning of the year (10), and, on the other hand, the collapse of the real economy in the US by the end of Summer 2008 will drag down all stock markets. According to LEAP/E2020, international stock markets will probably drop by 50 percent in average compared to 2007 (including in the emerging countries) (11).

This sort of re-evaluation is typical of the work of anticipation carried by LEAP/E2020. Month after month we try to distinguish which trends are growing and which are relenting in order to improve the accuracy of our evaluations. We do not strive to “be right” (12), not to “sell” or “promote” anything. We seek simply and without prejudice to describe in advance the consequences of the heavy trends at play in this 21st-century world, and to share with our readers what we think are the proper means to protect oneself from the most negative effects.

In this 22nd issue of the Global Europe Anticipation Bulletin, with the alert we sound about a collapse of US real economy from September 2008 onward, we are trying again to warn those concerned that this major event will generate many very severe socio-political troubles in the United States (13) whose economy is truly on a tumbling course (14), a situation extremely likely to entail very heavy consequences for the financial and monetary markets, and for the world's economy. We have not yet reached the heart of the crisis. According to LEAP/E2020, we will be there in the second semester of 2008.

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Notes:

(1) A very instructive film was recently nominated at the Sundance Film Festival: I.O.U.S.A., directed by Patrick Creadon. As it follows the journey of David Walker, US Comptroller General (and therefore responsible for controlling federal public spending), during a series of conferences on the state of public expenditures throughout the country, this film shows the very direct impact of the current crisis on American citizens and the United States. The release of this film illustrates the fact that, in just a few months time, this crisis left the mere circles of experts and boardrooms of financial institutions to enter into the daily life of the US citizens.

(2) In the past few days, the complete collapse of Municipal bonds (or « Munis ») illustrates the fact that the crisis is spreading to all the sectors of the US society. This collapse will freeze all public investment projects scheduled by local authorities in the US. It is one of the first big victims of the implosion of « bonds insurers » announced by LEAP/E2020 in the GEAB N°19. It also demonstrates the fact that large banks are now incapable of playing their role of financers of the country's economic activity. Sources: Financial Times, 02/13/2008 & Bloomberg, 02/14/2008

(3) Source: EconomicIndicators.Gov, Economics & Statistics Administration, US Department of Commerce

(4) See GEAB N°2, 02/15/2006

(5) The first reason that may prevent those « experts » to conceive the « unconceivable », is not a matter of intelligence but a « commercial » problem. Indeed it would compel them to review most of their intellectual principles (their work hypotheses) and their business base (their « clients » would not appreciate to learn that they were on the wrong track all these years).

(6) On this subject, it is worth noticing the very straightforward speech made by the head of the Bank of England, Mervyn King, who recently warned his fellow citizens that the current crisis would downgrade significantly their living standards. Unfortunately, no US leader, including among the Democrats, is able to produce such a speech, knowing that their fellow citizens are hit even harder than the British. Source: The Telegraph, 02/14/2008.

(7) See GEAB N°11, 01/15/2007.

(8) In this 22nd issue of the GEAB, the LEAP/E2020 team gives a set of recommendations helping investors to assess themselves the « American risk » of a country, sector or investment.

(9) The same goes for all those who chose to listen to similar arguments telling them, along the years 2006 and 2007, that it was impossible for the EURUSD exchange rate to go above 1.30, then 1.40, and now 1.50… while waiting 1.70 at the end of the year 2008.

(10) Only « dream merchants » can still imagine that stock markets could improve by the end of the year, while the crisis is speeding up.

(11) It is worth reminding that in January 2008, in just a month, global stock markets saw USD 5,200 billion-worth go up in smoke. Source: China Daily News, 02/10/2008

(12) Even if our anticipations undeniably proved to be right in the past two years concerning the global systemic crisis.

(13) See ‘Sequence 6 : 2nd quarter 2007 – 4th quarter 2009 : « Very Great Depression » in the US, social unrest and growing influence of the army on public management, GEAB N°18, 10/15/2007

(14) Predictions about the failure of dozens of US banks in the coming two years illustrate the scope of upcoming difficulties. Source: Reuters, 02/01/2008