Monday, August 27, 2007

Signs of the Economic Apocalypse, 8-27-07

From Signs of the Times:

Gold closed 677.50 dollars an ounce Friday, up 1.6% from $666.80 at the close of the previous Friday. The dollar closed at 0.7312 euros Friday, down 1.5% from 0.7420 at the previous week’s close. That put the euro at 1.3676 dollars compared to 1.3477 the Friday before. Gold in euros would be 495.39 euros an ounce, up 0.1% from 494.77 for the week. Oil closed at 71.09 dollars an ounce Friday, down 1.3% from $71.98 at the close of the week before. Oil in euros would be 51.98, down 2.8% from 53.41 for the week. The gold/oil ratio closed at 9.53 Friday, up 2.9% from 9.26 at the end of the previous week. In U.S. stocks, the Dow Jones Industrial Average closed at 13,378.87, up 2.3% from 13,079.08 for the week. The NASDAQ closed at 2,576.69 Friday, up 2.9% from 2,505.03 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.62% Friday, down four basis points from 4.66 for the week.

Stock prices recovered last week, buoyed by news of a rise in housing starts and durable goods orders in July in the U.S. and also by the infusion of unimaginable amounts of newly created money. The problem is that the numbers were for July—before the recent market turbulence. August numbers certainly won’t look so good. Despite some short term optmism, the falling U.S. dollar (1.5% against the euro last week) has many people worried behind the scenes. Investors who feel more confident now that the U.S. Federal Reserve Board has decided to lower interest rates also should know that that policy can only go on so long: lowering interest rates on the dollar could easily push the value of the dollar over the edge. All things being equal, lowering interest rates on the dollar makes the dollar less attractive to hold, thereby lowering its value.
Dollar May Fall to Record Within Six Months, Goldman Sachs Says

Ye Xie

Aug. 24 (Bloomberg) -- The dollar may decline to a record low against the euro in the next six months because U.S. economic growth will slow, forcing the Federal Reserve to cut interest rates, according to Goldman Sachs Group Inc.

From the current level of $1.3568 per euro, the U.S. currency will weaken to $1.43 per euro in the next three to six months, Goldman Sachs said in a research note yesterday. New York-based Goldman, the world's biggest securities firm by market value, lowered its dollar forecast from a prior estimate of $1.35. The dollar set a record low of $1.3852 per euro on July 24.

Concern about losses in investments related to mortgage securities has bolstered expectations the Fed will cut its benchmark interest rate from 5.25 percent at its Sept. 18 policy meeting. Traders are certain the Fed will cut its key rate to at least 5 percent by Sept. 18, futures show.

“Financial conditions are tightening at a time when clearly there's some downside risk to the growth,” said Jens Nordvig, a senior currency strategist at Goldman Sachs in New York. Fed rate cuts “will drag the dollar lower.”

The Fed will lower its benchmark interest rate by 0.75 percentage point to 4.5 percent by year-end, according to Goldman Sachs.

The dollar will fall also because foreign investors will reduce purchases of higher-yielding corporate bonds, said Nordvig.

Goldman also said the dollar will decline to 110 yen in the next three to six months, from 116 yen at present, compared with a previous forecast of 118 yen.

Adding to fears of a slowdown was news announced last week about layoffs in the mortgage industry. News like that, coming from one of many segments of the overall housing industry, reminds us just how much of the U.S. economy has been based on the housing bubble:

Mortgage Job Losses Surpass 40,000

Ieva M. Augstums, AP Business Writer

August 22, 2007

CHARLOTTE, N.C. (AP) -- At the North Carolina offices of mortgage lender HomeBanc Corp., Archie Clark is the only employee left. But in a few days, he'll be gone, too. When Clark finishes helping movers from the company's Atlanta headquarters collect computers and other property, he'll join the more than 25,000 workers nationwide who have lost jobs in the financial services industry since the beginning of the month -- with more than half coming since last Friday.

With few exceptions, the cuts are the direct result of woes in the nation's housing market.

More layoffs are announced daily. On Wednesday, Lehman Brothers Holdings Inc. closed its "subprime" mortgage business, laying off 1,200 workers at 23 offices; Scottsdale, Ariz.-based 1st National Bank Holding Co. closed its wholesale mortgage unit and cut 541 jobs, and Accredited Home Lenders Holding Co. added 1,600 positions to the heap. The night before, banking giant HSBC said it would close a main financing office and cut 600 jobs.

Since the start of the year, more than 40,000 workers have lost their jobs at mortgage lending institutions, according to recent company layoff announcements and data complied by global outplacement firm Challenger, Gray & Christmas Inc. Meanwhile, construction companies have announced nearly 20,000 job cuts this year, while the National Association of Realtors expects membership rolls to decline this year for the first time in a decade.

It's an employment collapse that threatens to rival the massive layoffs in the airline industry that followed the Sept. 11, 2001, terrorist attacks, when some 100,000 employees lost their jobs.

"It's far from over," said Bart Narter, a senior analyst with Celent, a Boston-based financial research and consulting firm. "The subprime lending collapse will continue to ripple through the financial sector."

For five years, the nation's housing market was booming and mortgage companies grew quickly, at times offering lucrative jobs to people with little experience. But as home values declined and interest rates rose in the past year, rising delinquencies and defaults -- especially in subprime mortgages targeted at borrowers with risky credit -- have pounded lenders who couldn't keep pace.

"These kind of mortgage lenders just sprung up like mushrooms and grew like men," said John A. Challenger, chief executive at Challenger, Gray & Christmas. "They staffed up and now you have a bust."

America's largest mortgage lender, Countrywide Financial Corp., began an undisclosed number of layoffs this week. Last week, Arizona mortgage lender First Magnus Financial Corp. shut down its operations and laid off nearly 6,000 workers. On Monday, Capital One Financial Corp. said it would shutter Greenpoint Mortgage, its wholesale mortgage banking business, and lay off 1,900 employees.

"It's only been weeks," Challenger said. "These companies are acting remarkably quickly, stopping on a dime."

Andy Roach didn't foresee the turmoil when he joined Greenpoint in March. As late as June, the 25-year industry veteran thought the business of making "Alternative A" mortgage loans -- geared for those with slightly better credit than subprime borrowers -- was on a solid track.

But in July, he said, spooked investors stopped buying the securities the company sold by repackaging the loans. A little more than a month later, Capital One announced that Roach and about 1,900 of his colleagues across the country were out of a job.

"It was evident that it was serious," said Roach, 46, a regional manager in the Chicago suburb of Downers Grove. "When you can't sell the loans, when there's no market for those loans, it put us in a bad, bad situation."

Clark, 33, headed information technology operations for three HomeBanc offices in the Raleigh area. He had a feeling earlier this month that trouble was lurking, as the company began cutting back on perks and made some initial layoffs. On Aug. 9, HomeBanc filed for bankruptcy protection. They kept him on through the end of the month to collect equipment and "just go in and check on things."

"It was pretty much a free for all in the office, people taking paper, stuff HomeBanc wouldn't need," he said. "I don't feel like HomeBanc did anything. It was a perfect storm of a bad housing market."

Two of Clark's friends have already landed jobs with Countrywide. Another found work with an affiliate of First Magnus, and was almost immediately laid off again. Roach plans to open his own lending business, focusing on commercial business loans and originating home loans himself.

"The mortgage business isn't dead -- there's just going to be less people in it," Roach said.

Dean Baker writes that if one goes by the official estimate that housing contributes 5% of GDP, then the deflation of the bubble could be catastrophic:
The correction of the housing bubble is likely to throw the economy into a recession and quite possibly a very severe recession. Residential construction directly accounts for almost 5.0 percent of GDP presently. Based on past patterns, this can be reduced by between 0.9 and 1.7 percentage points of GDP (between $120 and $230 billion in 2007) as the market corrects. The end of the bubble will eliminate between $4 and $8 trillion of housing bubble wealth. Given conventional estimates of the housing wealth effect, this will lead to a reduction in annual consumption of between $160 and $540 billion. Finally, the end of the housing bubble is likely to put an end to the recent wave of speculation that drove the stock market above trend levels. The loss of $4.5 trillion in stock bubble wealth will lead to a reduction in annual consumption of $135 to $180 billion, due to the wealth effect.

The total effect from the end of the housing and stock bubbles will be to reduce annual demand by between $415 and $950 billion. If this correction happens quickly, it is virtually certain to lead to a recession and quite possibly a very severe recession. The end of these bubbles is also likely to impose serious hardships on state and local governments that lose property tax revenue. It may also lead to larger shortfalls in pension funds and public employee retiree health care funds.

The feeling that something bad is in store for September, either a market crash, another conveniently-timed “incident” in the United States followed by a U.S. attack against Iran, or some kind of large natural disaster, seems to be shared by many this summer. The following story, from the week before last making the rounds lately, adds fuel to the fire:
Mystery trader bets market will crash by a third

Renée Schultes

16 Aug 2007

Carry trade unwinds as yen hits one-year high

An anonymous investor has placed a bet on an index of Europe's top 50 stocks falling by a third by the end of September, as world equity markets plunged for a third day and volatility hit a three-year high.

The mystery investor has bought put option contracts on the DJ Eurostoxx 50 index that will result in a profit if it plunges to 2,800 or below by the end of September. Based on the 2,800 strike price, the position covers a notional €6.9bn, and potentially even more using a market price of about 4,100 when the trades were done on Tuesday and Wednesday.

The identity of the investor is unknown but market sources speculated it was either a large hedge fund hedging itself against deepening losses, or a long-only fund manager pressing the panic button to protect its gains.

The investor has bought a total of 245,000 put options on the index. The September put option with a 2,800 strike was the most popular DJ Eurostoxx 50 contract yesterday, according to data from Bloomberg

In times of crisis, where a long-established equilibrium seems to be on the verge of transition to something else entirely, it may be a good time to step back a bit from our fears of collapse and see the existing order for what it really is. Henry See published an essay last week called Insiders and Outsiders in Everyday Life where he addresses basic questions of where we are, how we got here, and who is pushing us there. According to See, the fear and uncertainty we feel are more than byproducts of a dynamic, changing society. They may actually be the result of conscious planning by pathocrats, people who are fundamentally different from normal humanity, and may be designed to create the type of psychic shock that can put the public in a state of dissociation and breakdown. Such a state lends itself to dependency, the Stockholm Syndrome and other sinister reprogrammings:
We all know stories of qualified and skilled people who can't find work or who are passed over for promotion when someone who specializes in office politics gets the nod. This situation is another example of the insider/outsider dichotomy I discussed in my last article. It not only applies to Washington, it also applies to the facts and events of our daily lives. How many Americans are working for companies that are "offshoring" jobs to India and China? Ordinary people are on tenterhooks with the announcement of each round of layoffs while management have that glassy-eyed glare of bigger stock options and pay-offs when the year's profit margins improve and stock prices soar.

One of the consequences of such policies is that society loses the input and skills of its most gifted members. Positions that could be filled with people capable of bringing creative and thoughtful solutions to problems are instead filled with individuals whose only skill is the ability to play the game. They are often mediocre or incompetent and get others to do their work for them, while they, of course, claim the credit. Society as a whole loses as this great wealth of creativity is wasted.

But the losses are not only seen on the larger scale; they hit home more directly in the lives of those laid off or who live in a permanent state of fear.

Here are some quotes from email I have received recently describing just this.

One correspondent wrote:

Some life, being on the treadmill constantly trying to outrun 'redundancy'. I do not like where the 'new world order' has been herding us. A century ago I would have lived my entire life doing what I spent years training for in the first place.

Think about that. Think about what an important shift such a change is in our lives and how it affects all of us, how it puts us in a permanent state of anxiety over the future. We can spend thousands of dollars on an education and have no assurance whatsoever that we will even be able to find employment in our chosen field. Think about your fathers or grandfathers who may have had a job doing the same work throughout their careers and who believed that their children would have the same choice.

If the shift just described isn't enough to leave us anxious and insecure, what about the nefarious policy called by that whitewashed label "outsourcing" and "offshoring" of jobs?

…You have to wonder whether or not this permanent state of anxiety is one of the goals of these policies and these announcements. Read through this explanation of
Transmarginal Inhibition and see if it doesn't describe what is happening to the work force in the United States and elsewhere. Pavlovian shock methods are being used to soften us up and prepare us for the next blow. The regular "terrorist" alerts issued following 911 serve the same purpose.

…The problem is, these kinds of schemes are inherent in the logic of a system that values economic results over the lives of those doing the work. The faulty premise is that the good of the people is taken care of by the "invisible hand" of the marketplace, which boils down to, somehow, things will just take care of themselves, with the caveat: as long as you are industrious and are willing to work. You all know the great American myth that anyone can be a success, that anyone can be president.(1) This great American myth about individual success puts the burden of failure squarely on the individual. Failure is never the fault of the system or the people who benefit from the system. It is always your fault.
Convenient, isn't it? Do you think it is only a coincidence?

So how does one learn to benefit from the system, or, in other words, to succeed? By mimicking those who have already attained some success. And how does one do that? By becoming ruthless, back-stabbing, and only looking out for one's own interests. In other words, one must become sick to survive. One must encourage the propagation of the virus of pathological thought processes within oneself by killing any manifestation of consideration of others that might prevent you from getting what you want or what you have convinced yourself you deserve. Once the values of the insiders become the values of society as a whole, once their distorted and inhuman way of seeing the world becomes the accepted way of seeing and understanding the world, the only way to succeed is to become like them. You could call it the Stockholm Syndrome on a societal level.

An important element in this pathological way of viewing the world that one must internalize in order to succeed is the acceptance of the various false divisions that the insiders promote in order to hide the fundamental insider/outsider divide. Think of how race, nationality, language, and religion are all used to sow dissension and discord among outsiders. Do you think this process just happens by chance? An example that is prominent now is the question of illegal immigration and what to do with the long border joining the United States and Mexico. We see a vehement discussion on the need to close off America's borders.

But, really, what group is the problem here? Is it the Mexican workers who come to the United States, or is it the insiders who claim the vast majority of the wealth and resources for themselves? And to what extent are the insiders responsible for the large migration of workers into the US through decades of injustice and exploitation of Mexico by US corporations in collaboration with corrupt Mexican politicians and officials? And that holds for other countries in Latin America and the world. Do you think that these people would leave their homes and families if they could make a living where they were? Would you?

Which raises another question: What do you want out of life?

Probably security, as in having a home and enough money to get by, is high on the list. A safe place to raise your kids and a satisfying job that leaves you time to do other things than work and pay the bills would likely also have a place. Those are the needs and desires of normal people everywhere. Someone with a healthy psychological profile doesn't need large sums of money that he or she will never spend. He or she doesn't need multiple houses. He or she wants a job that is rewarding and satisfying and that provides enough income to pay his or her way and provide for his or her family. He or she wants to live in peace and security and not see a son or daughter go off to fight in a war overseas. He or she doesn't want to see a home-grown, para-military police force patrol the streets of their hometown, such as we saw used against the people of New Orleans after Hurricane Katrina, much less the thousands of foreign troops.

The Mexicans that come to the US want the same thing. Their goals are the goals of normal Americans. They share the goals of ordinary people everywhere. The ordinary Muslims, who we are told are the source of all of the problems in the Middle East, also want the same thing. So if this world of peace and security is what we want, why are we so far from achieving it?

We are told that it is because we all have a dark side, the animal part of our nature that breaks out every so often and wreaks havoc and destruction. In response to that, I would ask each of you, do you not see a difference between a violent act that comes out of the heat of emotion and a violent act that is coldly planned in advance? Would you be capable of planning the destruction of another country, including the deaths of over 1 million people, in a cold and rational manner, with the same emotional detachment that you would draw up the plans for the construction of a house? If you were running a profitable company, would you be capable of eliminating the jobs of thousands of workers, creating anxiety, suffering, and distress, simply to increase your profit margin by a few percentage points?

The insiders can and do make their plans in this way. They have no qualms about it. Their violence, be it physical or psychological, is not born of stress or overworked emotions. It is emotionless and calculated. They then invent slogans, theories, and excuses to justify their deviant plans, convincing us that it is done in the name of freedom and democracy or because there is a threat to our security.

The real threat to our security comes from those who can calmly make plans for war.

If normal people, ordinary people, were able to get beyond the divisions sown by the insiders and unite to claim what is rightfully ours, power and control over our own lives, the insiders would be where they belong: on the outside. Why should a small percentage of the population control the vast majority of the wealth? Why should they have the control over life and death decisions that concern the majority? Why should they impose their cold and calculated view of the world on those of us who value human contact, experience, and intimacy over money and power?

Whatever justification or rationalization springs to mind as you read these words has been implanted within you by people who do not have your best interests at heart. It is not their sons and daughters who are in Iraq. It is not their future that is put into jeopardy through downsizing, offshoring, and outsourcing. Using the media, these justifications and rationalizations are repeated over and over again until we accept them at face value, until we begin to think like them.

Certainly, groups subjected to injustice have tried to unite in the past. The problem was they were uniting over the wrong rallying point. Class, religion, nationality, none of these strike at the root of the problem, and therefore they can only go so far in achieving a working unity. The one issue that touches the root is that of conscience. How do you treat your neighbor? How do you treat your family? Moreover, without an understanding of psychopathy and other pathologies, it was easy for these types to join such movements and eventually turn them away from their original aims. People who are incapable of putting themselves in another's shoes, of genuinely feeling what it is like to be in another's position, are incapable of forming any lasting unity because they can never place the interests of someone else before their own. They are never capable of true compromise, that is, compromise that doesn't come with the baggage of self-righteous sacrifice or deep-seated and hidden resentment and their subsequent plans for revenge or retribution.

The fact of the matter is that our lives are controlled in almost every aspect by decisions over which we have no say, be it political decisions by the insiders in Washington or other centers of power, economic decisions by our bosses whose goal is to maximize profits at the expense of providing secure working environments for their employees, or decisions over what it is permissible to think and what ideas will be drummed into our heads through the media, to name but a few. Normal people, ordinary people, people of conscience live in an environment that does not express our inner nature, that is not the manifestation of our ability to empathize and care for others, and until we become aware of this fact, we, too, are infected. How will we ever be able to create a different world if we do not root out the insider virus that has taken root in us?

A blogger wrote the following that illustrates Henry See’s point that our society does not make maximum use of the creativity of it’s members. Rather it subordinates the many to maximize the power of a few:
Like Mexico

August 16, 2007

When folks ask me, "what kind of nation do the Republicans want us to be?", I point towards the Mexican border. You have the places like Acapulco where the rich and wealthy play in fabulously expensive resorts. The workers in those resorts are paid a pittance and go home to one-room dirt-floored tar-paper hovels with no electricity or running water. That is the Republican vision of the future of America -- an America with winners and losers, where the winners are filthy, filthy rich and the losers... meh. Losers.

I live down the road from Shallow Alto oops Palo Alto, where Stanford University is located. The upper-middle-class parents who live there know this future in their bones. Children there are under tremendous pressure from an early age to excel academically, play the "right" sports, do the "right" extracurriculars, that will get them into the "right" college. Some of them crack and commit suicide under the pressure -- Palo Alto has more kids committing suicide than any other community its size that I've ever heard of -- but most of them buckle down and obediently put nose to grindstone. Palo Alto has been rocked by cheating scandals also, because if it is a choice between being that peasant in the one-room dirt-floored hovel and a winner, anything is justifiable, including cheating or in some cases false accusation thereof. And while pretty much every student in Palo Alto will graduate and qualify for a decent four-year college, going to San Jose State is not good enough. You have to be accepted by the "right" institution, the institution that is number one in the field you're going into, because as the cabbies with four-year degrees will tell you having a degree nowdays isn't good enough to ensure you become one of the winners. It has to be the "right" degree.

The sad thing is that it doesn't have to be that way. There is no fundamental law of nature that says that America must invariably slide into being just another third world nation with super-rich rich and super-poor poor and nobody inbetween. There is not a scientific law that says that a poor kid cannot graduate from a middle-tier state university in a poor state and become a well-paid engineer with a six figure salary. Indeed, for a brief moment in the late 60's and 1970's it seemed that real progress was going to be made in insuring that all Americans, regardless of whether they were lucky enough to have upper-middle-class parents in Palo Alto, would have a chance to maximize the talents with which they were born. I know. I am one of the last generation of poor kids who had the total cost of his college tuition and textbooks paid for via federal grants. So where I once would have been just another construction worker adding no more value than a nailed 2x4, nowdays folks appreciate my talents enough to pay big money for it. As one of my bosses told me, "you are critical to the success of this company and the new product we are developing and we are going to pay you accordingly" (leaving unstated the "so you don't leave" bit :-).

Thing is, that's not true in America anymore. The elite figured out that they could get their technology workers cheaper by importing them from India and the rest of the world, and now poor kids can't go to college without running up gigantic debts which are not dischargable via bankruptcy if the kid can't pay it back. Who's going to go to college with that kind of burden hanging over them, unless they have a near-guarantee of a job at the end? Thus the emphasis upon the "right" college, the one whose entire graduating class of MBA's or whatever gets jobs on Wall Street or wherever. Meanwhile, millions of American kids with smarts and talent are saying "Will there be fries with that order, sir?" because they can't justify the risks of taking on enormous debt for an education when few recruiters visit the colleges that they can afford to attend, generally low-ranked state colleges. It's a tragic waste, and one that's not necessary. I know it's not necessary, because I was one of those kids, in a kinder gentler America that did not have the edge of cruelty and sadomasochism that today's America has, and America has more than made back the money it invested in my education, hell I pay more taxes in one single year than every dollar that America invested in my education, something that wouldn't be true if I were working multiple part-time odd jobs like most poor kids today have to do to keep body and soul together. But Mexico keeps sliding northward, and most Americans, it seems, have forgotten that it doesn't have to be that way -- and once wasn't.

The blogger who wrote the post above blames the Republican party, and they have spearheaded these policies, but so too, has the Democatic party, albeit more softly. The plans of the global economic plutocracy are not up for debate and are not to be decided upon in a democratic political process. Look what happened in Germany during the past ten years or so. The German voters consistently delivered left wing majorities or pluralities, and polls show strong public support for the traditional post-war social welfare state. Yet, the Social Democratic Party (SPD) has pushed through a series of “reforms” beginning during the Schroeder chancellorship when the party ruled in allicance with the Green party. Then in the last election where, once again, a majority voted left, the elites had the Social Democrats form an alliance, not with the Left Party, whose positions were closer to those of the SPD’s rank and file, but with the right-wing Christian Democrats, even making the Christian Democrats’ leader, Angela Merkel, the chancellor.

The widening gulf between official German politics and the electorate

Dietmar Henning

21 August 2007

“Wealth... for me means security. To be able to lose one’s job without falling into a bottomless pit.” Deutsche Bank chairman, Josef Ackermann

A survey of public opinion conducted by the Emnid agency on behalf of the newsweekly Die Zeit reveals broad opposition to Germany’s grand coalition government of the Christian Democrats (CDU/CSU) and Social Democratic Party (SPD). Only 16 percent of those questioned believed the government is doing enough in the area of social equality and social justice. In eastern Germany, this figure fell to less than ten percent. Discontent exists with all the parties and is very common among those voting for the government parties.

“Can it be that this country has moved imperceptibly to the left,” asks Die Zeit journalist Jörg Lau, commenting on the Emnid poll, “that today it stands much further to the left than it would care to admit?” Lau suggests this conclusion: “Large majorities in all political camps express support for more state intervention and against further privatisations, against nuclear power, against the deployment of German troops in Afghanistan and a halt to any further reforms. There are left-wing majorities for many issues—across all parties.”

At a time when all the leading political parties in Germany are moving to the right, poverty and inconceivable wealth are growing at opposite poles, the government is handing over state assets to the highest bidder and the German army is once again waging war throughout the world, the results of this opinion poll are striking in several respects.

Among other things, Emnid asked the question: “Left and right are much-used terms to mark a political position. Where would you situate yourself?”

In a poll conducted more than 25 years ago, in 1981, 17 percent of the German population described themselves as left-wing. Today, it is twice as many, i.e., 34 percent. The ratio between left and right has been reversed. In 1981, 38 percent considered themselves to be on the right, today it is just 11 percent. Even in the CDU/CSU and the Free Democratic Party (FDP), those regarding themselves on the left outweigh those who regard themselves as on the right.

This development is expressed particularly in response to social issues. Some 72 percent of all respondents think that the government is doing too little in the area of social equality. In eastern Germany the figure is 82 percent. Among those voting for the Left Party, the figure is 97 percent; for Green Party voters it is 93 percent. The figure stands at 76 percent among those supporting the SPD, and even among CDU/CSU voters, 60 percent think along these lines.

Similar trends are registered in response to questions about the social safety net. More than two-thirds of those asked support the introduction of a minimum wage. Seventy-six percent of SPD voters support such a move and more than half of CDU/CSU voters declare themselves in favour, even though the party leadership vehemently opposes a minimum wage.

The number of those rejecting the increase in the pension age to 67, championed by Labour Minister Franz Müntefering (SPD), is even clearer. Some 82 percent (in the east, 90 percent) believe the increase should be annulled, with 82 percent of SPD and 80 percent of CDU voters supporting the pension age returning to 65.

Two-thirds of those surveyed reject the privatisation of state assets. They believe that “enterprises such as the railways, telecommunications and the energy supply should remain in government hands.” This figure is over 70 percent among those voting for the government parties—CDU and SPD—i.e., the parties responsible for the privatisations of recent years.

The neo-liberal arguments, according to which privatisation increases competition and thus boosts the economy, are no longer believed. Instead day-to-day experience has led millions to draw their own conclusions. The banks and large shareholders have raked in fortunes through privatisations, whereas ordinary working people pick up the tab through job losses, lower wages, higher prices and deteriorating living standards.

A majority also believe the state has a major responsibility for the care of children. Nearly three-quarters of those polled—both men and women—think that the state should do more to support young children. This makes the demand from the ranks of the CDU/CSU for a “home-makers’ bonus” for mothers who look after their children at home seem especially desperate and retrograde. Far from being a response to ‘popular demand,’ the bonus idea is an attempt by ultra-right elements among Christian Democrats to suppress the widespread desire in the population for emancipation from oppressive conditions in the home…

Social questions move to the foreground

The Emnid poll confirms that the gulf is widening between official politics and the broad mass of the population. On questions of social equality and social justice, as noted above, the SPD and CDU/CSU, which like to call themselves “people’s parties,” receive the support of only 16 percent of the population.
Other polls confirm this result. In a recent study, the Mannheim Centre for European Social Research writes that satisfaction with the German health system has decreased from almost 64 percent in 1996 to barely 31 percent in 2002. The health “reforms” of the past five years have seen discontent continuing to grow.

The constant drumbeat from official political circles and the media about the “demographic time-bomb” and the need to “cut back bureaucracy,” the ideological assault on “sentimental social conservatism” and a “cradle-to-grave welfare state,” cannot hide the miserable reality. For years, the real wages and incomes of ordinary families have been sinking.

The number of working people with an income that guarantees a family’s survival is continuously falling. People can feel the effects of cuts in public spending where they live and work. In recent years, more than 500 railway stations were shut down, more than 10,000 jobs in youth work were destroyed and more than 1,500 public baths closed. Added to this comes the shutting of libraries, youth centres, information offices, post offices, etc.

Over a short period of time, 50,000 hospital beds were cut, while the number of patients increased in the same period by around one million.

Those are excluded from gainful employment are hit hardest. The so-called “Hartz laws,” introduced by the previous SPD-Green Party coalition led by Gerhard Schröder (SPD), cut unemployment and welfare benefits in a manner unknown since the days of the Weimar Republic in the 1920s. The measures put pressure on wages for those with jobs and created the basis for a massive expansion of cheap wage labour in Germany.

After one year, an unemployed person is now entitled to only €347 ($US 468) a month in benefits. For the long-term unemployed, whose number remains high despite an economic upturn, this is little more than a pittance. This benefit level was determined quite arbitrarily on the basis of the consumption patterns of the lowest fifth of single-parent incomes—in other words, on the basis of the consumption of the very poorest layer in society.

This benefit level is not adjusted for inflation or increases in average wages, but is pegged to pensions. These have not been increased for several years, and only this year have seen an increase of 0.54 percent. Thus the benefit level laid down by the “Hartz laws” was increased in the last three years by just €2 to €347 a month. At present, nearly 7 million people are dependent on such benefits, with 1.3 million also holding down a low-wage or “mini job.”

Die Zeit is conscious that the political vacuum opened up between working people and the political establishment can lead to intensified class struggle. Jörg Lau warns: “If confidence in society’s equality of opportunity is lost, it can become a problem for democracy.” “Democracy” here does not mean the determination of policy by the will of the people, but rather the preservation of the capitalist order.

Clearly, the solution is not with electoral politics. Something much more fundamental is required. If normal humanity arms itself with real knowledge of what it is up against, then acts together, all at once, the pathocrats would be out of a job in a moment. As an organizer of the International Workers of the World, the IWW or Wobblies, put it in the early 20th century,
If the workers of the world want to win, all they have to do is recognize their own solidarity. They have nothing to do but fold their arms and the world will stop. The workers are more powerful with their hands in their pockets than all the property of the capitalists. (quoted in Howard Zinn, A People’s History of the United States, p. 324)


Monday, August 20, 2007

Signs of the Economic Apocalypse, 8-20-07

From Signs of the Times:

Gold closed at 666.80 dollars an ounce Friday, down 2.2% from $681.60 at the close of the previous Friday. The dollar closed at 0.7420 euros Friday, up 1.6% from 0.7301 at the previous week’s close. That put the euro at 1.3477 dollars compared to 1.3696 the Friday before. Gold in euros would be 494.77 euros an ounce, down 0.6% from 497.66. Oil closed at 71.98 dollars a barrel Friday, up 0.7% from $71.47 at the close of the week before. Oil in euros would be 53.41, up 2.4% from 52.18 for the week. The gold/oil ratio closed at 9.26, down 3.0% from 9.54 at the end of the previous week. In U.S. stocks the Dow closed at 13,079.08, down 1.2% from 13,239.54 for the week. The NASDAQ closed at 2,505.03, down 1.6% from 2,544.89 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.66%, down 14 basis points from 4.80 for the week.

It was a wild week in world markets, as the words “panic” and “fear” were bandied about—never a good thing for financial markets that need to be faith and confidence for their functioning. World stock markets plunged for most of the week, leading the U.S. Federal Reserve Board to lower interest rates just a week after they said there was no reason to. That move raised stock prices at the end of Friday, allowing the markets to post a modest weekly drop of less than two percent. That removed the panic temporarily but not the fear and uncertainty.

What caused the Fed to reverse course was growing fear that turmoil in financial makets would affect the “real” economy. Several CEO’s of large consumer corporations sounded the warning, including Bob Lutz of General Motors.
Fed Cuts Discount Rate, Acknowledging Need for Action

By Scott Lanman

Aug. 17 (Bloomberg) -- The Federal Reserve lowered the interest rate it charges banks and acknowledged for the first time today that an extraordinary policy shift is needed to contain the subprime-mortgage collapse that began roiling the world’s financial markets two months ago.

The Fed, in a surprise announcement in Washington, cut the so-called discount rate by 0.5 percentage point, to 5.75 percent. Policy makers dropped language indicating their bias toward fighting inflation, and instead highlighted a rising threat to economic growth. That suggests officials will reduce their benchmark rate when they meet Sept. 18, economists said.

“This telegraphs their intention to cut rates at the next meeting,” said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “This discount rate cut calms the market and helps financing.”

This is the first reduction in borrowing costs between scheduled meetings since 2001, and Ben S. Bernanke’s first as Fed chairman. Officials kept the benchmark federal funds rate target for overnight loans between banks at 5.25 percent. Policy makers next meet to set the rate on Sept. 18. Futures indicate traders anticipate at least a quarter-point cut.

Stocks Rally

The Fed’s decision ignited a rally in stocks from Europe to the U.S. The Dow Jones Industrial Average rose 180.13 points to 13,025.91 at 2:53 p.m. in New York after advancing as much as 321.9 points earlier. The Dow Stoxx 600 Index of European shares added 2.1 percent to close at 359.65.

FOMC members held a 6 p.m. conference call yesterday, spokeswoman Michelle Smith said in Washington. The Board of Governors met after to accept requests by the New York and San Francisco Fed banks to cut the discount rate. St. Louis Fed President William Poole skipped the FOMC call to keep a dinner
appointment and avoid tipping the Fed’s hand, spokesman Joseph Elstner said.

Meanwhile, Treasury Secretary Henry Paulson spoke with President George W. Bush to update him on market developments, White House spokesman Gordon Johndroe told reporters in Crawford, Texas.

The Fed said while recent reports indicate economic growth continues at a “moderate pace,” risks to the expansion have risen “appreciably.” The statement is a marked change from just 10 days ago, when officials kept rates unchanged a ninth straight time and reiterated inflation was their “predominant” concern.

‘Prepared to Act’

“Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth,” the Federal Open Market Committee said today. “The committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects.”

Once a key barometer of Fed policy, the discount rate has faded in relevance since 1994, when the FOMC began discussing its federal funds rate stance. This is the first time since then that policy makers changed the discount rate alone. Four years ago, the Fed altered the structure so that the discount rate is now above, rather than below, the benchmark rate.

The discount window can still serve a major role. The day after the Sept. 11 terrorist attacks, the Fed lent banks $46 billion, more than 200 times the daily average over the prior month. It was like opening the “floodgates of a great dam,” then-Vice Chairman Roger Ferguson said.

Officials today also extended so-called discount window borrowing, allowing 30-day financing instead of a standard overnight loan. The Fed’s board sets the discount rate while the FOMC, which includes the governors and heads of five of the 12 district banks, determines the federal funds target rate.

Among the New York Fed’s directors are JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon, Lehman Brothers Inc. CEO Richard Fuld and General Electric Co. chief Jeffrey Immelt.

Strategy Failed

The Fed acted today after its injections of cash into the federal-funds market in the past week failed to ease companies’ access to capital. While there were enough funds to drive the effective federal funds rate below the 5.25 percent, credit in other markets was scarce.

The amount of commercial paper outstanding, a key financing tool, fell the most in the week to Aug. 15 since the 2001 terror attacks. Countrywide Financial Corp., the biggest U.S. mortgage lender, tapped an entire $11.5 billion bank line yesterday to get funds.

“This is an attempt to wake the world up,” said John Roberts, managing director and head of government bond trading at Barclays Capital Inc. “The system is flush in overnight money. Where the system is stacked up is in term funding.”

Housing Recession

The Fed’s action reflects alarm that more restrictive lending conditions and market volatility in will deepen the housing recession and weaken employment. As recently as the Aug. 7 meeting, the FOMC said inflation was still the biggest danger to the economy. Today’s statement, approved unanimously by 10 Fed governors and presidents, didn’t mention inflation.

Bernanke and his colleagues changed tack as losses mounted on subprime securities and concern spread that major lenders would be harmed.

Merrill Lynch & Co. analysts raised the risk in an Aug. 15 report that Countrywide could go bankrupt. JPMorgan, the biggest lender in the leveraged buyout market, may forfeit about $1.4 billion of second-half profit because of loans it can’t sell, according to Keith Horowitz, an analyst at Citigroup Inc.

At the same time, there are signs that inflation, the Fed’s preoccupation up to now, is receding. The Fed’s preferred gauge, which excludes food and energy costs, rose 1.9 percent in the 12 months to June, the lowest rate in three years.

Inflation Expectations

Investors’ expectations for inflation have also stayed contained. A measure derived from differences in yields on five- year Treasury inflation-protected securities and regular notes fell to 2.43 percent today, little changed from 2.37 percent at the start of the year.

Meanwhile, there are some signs consumers will suffer the impact of falling real-estate prices and dwindling ability to tap home equity. Consumer confidence fell to the lowest level in a year this month, a private report showed today. The Reuters/ University of Michigan preliminary index fell to 83.3 from 90.4.

“You’re getting a contagion effect on Main Street and any rational person would be downgrading their forecast” for growth, said Paul McCulley, a money manager in Newport Beach, California, at Pacific Investment Management Co., which runs the world’s biggest fixed-income fund. “All the pieces are coming into place for the beginning of an easing” in the Fed’s benchmark rate.

The subprime rout is the biggest challenge for Bernanke, 53, since he took office in February 2006. Under predecessor Alan Greenspan, the Fed in 1998 cut interest rates three times as currency crises in emerging markets roiled Wall Street.

Global Effort

In the past week, the Fed and central banks in Europe, Japan, Canada and Australia have been compelled to add money to the banking system. The collapse in demand for securities backed by subprime mortgages has forced at least 90 lenders out of business.

The European Central Bank began adding liquidity on Aug. 9 after BNP Paribas SA, France’s biggest bank, was forced to halt withdrawals from three of its investment funds. The Fed followed, along with counterparts from Sydney to Oslo.

Mortgage defaults by Americans with poor credit histories prompted the collapse in June of two hedge funds managed by Bear Stearns Cos. and triggered a worldwide rout in the debt markets. Companies such as London-based Cadbury Schweppes Plc have delayed asset sales, and banks including JPMorgan Chase & Co. and Deutsche Bank AG have been left on the hook for as much as $300 billion of debt they’ve agreed to provide.

Economists and policy makers anticipate a slower expansion in the second half. For the year, Fed governors and presidents expect growth, on average, of about 2.25 percent to 2.5 percent, Bernanke told Congress last month. The projections are about a quarter-point below the last round in February, mainly on weakness in homebuilding.

Why all the fear if the world’s central banks are willing to dump trillions of dollars into the system to keep it going? Because no one knows how deep the hole is into which they are throwing money. Andrew Leonard of Salon broke it down last week:
Panic on Wall Street

By Andrew Leonard

Aug. 17, 2007 -- From New York to Hong Kong and everywhere in between, alarm bells are ringing. Central bankers are on 24/7 alert, ready to perform life support on catatonic markets. Stock traders are panicking -- the Dow's wild ride on Wednesday, down 350 points and then almost all the way back, is just the latest declaration of confusion and fear.

If you had been paying only casual attention to the financial markets as summer rolled along, you could be excused for glancing at the headlines and wondering, what the hell is going on? By many measures the global economy is growing faster than it has for decades. But in our globalized world, anxiety is everywhere. Soon after the markets close in New York, Asia's traders start running for cover. By the time they're exhausted, Europe is picking up the relay. And then back to the United States it comes.

People who devote their entire lives to studying the intricacies of high finance are confused right now. But the basic storyline isn't that complicated once you break it down into simple building blocks. And that's what Salon is going to do. Here are some simple questions and, we hope, some simple answers.

How did this happen? How did we get here? What does it all mean?

There is a standard explanation included as a paragraph in almost every story attempting to explain the current turmoil. It goes like this: Anxious to goose the U.S. economy out of its dot-com-bust doldrums, Alan Greenspan and the Federal Reserve Bank lowered interest rates to rock bottom in 2001. The resulting flood of cheap money encouraged an orgy of borrowing at every level of the U.S. and world economies. Whether you wanted to buy a house or a multibillion-dollar conglomerate, lenders were your best friends, falling over themselves to offer you whatever amount of capital you desired -- and charging low, low rates of interest. Cheap money led to a growing complacency about risk. If you ran into trouble, you could just refinance your house, or borrow a few billion more dollars today to pay off the billions you might owe tomorrow.

Greenspan's policies are being blamed for inciting the greatest housing bubble in U.S. history. The collapse of that bubble set off a wave of defaults by homeowners no longer able to make the payments on their mortgages. Mortgage lenders were the next link of the chain to break, followed by the investors who were trading in bonds and securities whose value was tied to these loans. Suddenly, risk was back!

So that's that? It's Greenspan's fault?

Partially, but interest rate tinkering is not the whole story. It may not even be the most important part of the story. There's another reason so many homeowners are in trouble and stock markets are imploding: Wall Street rigged the system so something like this was inevitable.

One could make a case that the biggest economic story of the last 10 years -- bigger than the dot-com or housing booms, bigger than their busts, perhaps even bigger than the extraordinary growth of the Chinese and Indian economies -- has been the astonishing growth of what is obscurely referred to as "structured finance," a crazy quilt of arcane derivatives and other "financial instruments" that have become the lifeblood of markets everywhere.

Whoa. Stop right there. What is a derivative?

Strictly speaking, a derivative is a financial doohickey whose value derives from some underlying asset. A mortgage loan is an asset. A pool of mortgage loans grouped together into a security that can be traded on markets is a derivative.

We often hear about the "real economy," that place where real people buy and sell real things, or go to work at real jobs where they make real stuff or deliver real services. Derivatives belong to what should be called -- but never is -- the unreal economy, a place where speculators make bets about what will happen in the real economy. Derivatives are vehicles for making such bets. If you think the borrowers whose loans are pooled together are going to make their payments, then buying a share in a group of such investments might be a good idea. That would be your bet.

A metaphor might be useful here. The real economy is like the Super Bowl. Real men on a real field push each other around and play with a real ball for a set period of time, and the team with the most points at the end wins. But while all this is going on, millions of outsiders who are not physically involved in the game bet on its outcome. Only they don't bet just on the outcome. They also bet on the spread -- how badly one team might beat the other. Or they can get more creative and bet on what the combined score of the teams might be, or which team's quarterback will be the first to be injured. There's absolutely no limit to the things that you can bet on, as long as you can find someone to take your bet.

The betting economy is the unreal economy. All those sports bets, no matter how kooky, are financial exercises whose value and meaning are derived from what happens on the field. Theoretically speaking, the betting economy exists in a separate dimension from the actual game, but we all know that's not true. There's so much money involved in gambling that the temptation to fix the results becomes irresistible. Players and referees, for instance, can be bribed.

We can call a bribed NBA official an example of "spillover" from the betting economy into the sports economy. The very same thing happens in the real and unreal economies. So much money is riding on all the derivative bets connected to the housing sector that Wall Street speculators essentially rigged the housing sector to make their bets pay off.

To understand exactly what happened, we must take a closer look at a particular kind of derivative: the infamous "collateralized debt obligation," or CDO.

Say what? Collateralized who which how?

Don't worry about the name. Call it an extra-special funky doohickey if you like. It's not important. What is important is its function, which is to make things that should be considered risky take on the appearance of less riskiness.

After a mortgage lender makes a loan to a homebuyer, that loan is packaged up with a bunch of other loans into a security -- a financial instrument that can be traded. Securities are rated by rating agencies according to the chances that the underlying assets will be defaulted upon. U.S. Treasury bonds, for example, get stellar AAA+ ratings because the U.S. government is considered likely to meet its obligations.

A security based on a pool of subprime mortgage loans would normally not deserve an AAA+ rating. Subprime, by definition, means "not so good." Subprime loans are made to people who can't put together a down payment or have bad credit, or can't prove they have a job. Subprime loans are risky!

Many investors -- particularly in pension funds and municipalities -- are prohibited from investing in securities that are not high-rated. Let the hedge funds and the investment banks play around with the risky BBB stuff, the "junk." The rest of us should be more prudent.

But investment bankers are clever fellows. In cahoots with the ratings agencies, they came up with a way to magically transform a low-rated security to a high-rated security. (The culpability of the ratings agencies -- Fitch, Standard & Poor's, Moody's -- should be not underestimated. It might be helpful to think of them as the bribed referees in this game.)

Enter the collateralized debt obligation. The CDO takes a pool of risky mortgage loans and divides it into slices. (Wall Street calls these slices "tranches," but that seems to be a word that makes the brains of normal people freeze up, so we'll ignore it.) For simplicity's sake, let's say that a mortgage-backed security gets divided into two slices when it is transformed into a CDO -- a senior slice and a junior slice. Let's say that the senior slice gets rated AAA+ and the junior slice gets rated BBB-. But if anything goes wrong -- if the homeowners whose loans are part of this security start missing their payments -- the investors in the junior slice have to lose all of their money before the investors in the senior slice start feeling any pain. That's the beauty of the scheme. You take a bunch of bad loans and turn some of them into high-rated gold and some into lower-rated bronze. You sell the gold to the cautious and the bronze to the bold. If a few loans go kaput, the bronze investors suffer. If all the loans go kaput, everybody gets hurt. Unless there's a total financial meltdown, everyone is happily making money.

We keep hearing in the financial news about risk being "sliced and diced." Is that what you're talking about?

Yes. After the transformation, we now have an instrument that satisfies the desires of both conservative investors, who can just buy the AAA+ rated slice, and investors who have a taste for risk, who can buy the BBB- slice. It's a brilliant work of alchemy.

And very popular. CDOs tied to subprime mortgages became hot commodities, snapped up with gusto by traders all over the world -- even the riskiest, most likely to self-immolate, lowest-rated slices of those CDOs. Especially those slices.

Why? Why was there such an appetite for risk?

No risk, no reward. In the securities world, financial vehicles whose underlying assets are risky yield higher rates of return. Subprime loans ultimately charge higher rates of interest than prime loans. That means that as long as homeowners don't take advantage of introductory low rates and pay off their loans early, pools of such loans will throw off a higher stream of income than pools of less risky loans. Traders who want to get a piece of that higher stream of income will take the chance of default.

This is where we approach the crucial turning point. Many different parties have been blamed for the housing mess. Homeowners are told that they should have read the fine print on their loans and should have avoided taking on financial obligations that they couldn't meet. Mortgage lenders are blamed for pushing the risky loans in the first place. And of course, there's the maestro, Alan Greenspan. But these attributions of guilt all miss the mark. The incentive for everyone to behave this way came from Wall Street, where the demand for subprime CDOs simply couldn't be satisfied. Wall Street was begging the mortgage industry to reach out to the riskiest borrowers it could find, because it thought it had figured out a way to make any level of risk palatable

So Wall Street wanted mortgage lenders to make bad loans?

Let's return to our Super Bowl metaphor. The gamblers aren't satisfied with their odds of winning, so they bribe a player to fumble at the one-yard line and alter their bets accordingly. Wall Street traders, hungry for more risk, fixed the real economy to deliver more risk, by essentially bribing the mortgage originators and ratings agencies to fumble the ball or make bad loans on purpose. That supplied CDO speculators the raw material they needed for their bets, but as a consequence threw the integrity of the whole housing sector into question.

But hang on. Isn't the total amount of subprime loans outstanding just a fraction of the overall home-lending market? And isn't the U.S. economy still growing? Why has just one small sector of one country's economy caused so much trouble?

Two main reasons: a lack of transparency and an overabundance of leverage.

What's been described here so far is just the simplest possible model of how things work. The truth of what is really going is far more complex. So complex that no one has a good handle on exactly what will happen if things go awry. Not regulators, not traders, not even pessimistic journalists. Try reading an SEC filing from a New York investment bank -- it is one of the most difficult-to-comprehend documents ever created by the human mind.

It is not, in a word, transparent. It serves the opposite purpose: It is an instrument of obfuscation. Because of failures of regulatory oversight, we have very little idea who owns what, or what risks hedge funds and pension funds and municipalities and mutual funds are really exposed to. This is all fine and dandy if your goal is to prevent your competitors from understanding what kinds of bets you are making. But it becomes a much more severe problem when you're trying to figure what is going wrong when the trains start derailing.

(By the way, if you're looking for something that government could do that might address this problem, calling for greater transparency carries the double whammy of being both the right thing to do, and rhetorically speaking, something that free markets are supposed to depend on for their proper functioning.)

Next up: leverage. Archimedes told us that if he had a lever long enough and a place to put it, he could move the world. Speculators in the world's financial markets also like leverage; but they don't use crowbars to move objects -- they use borrowed money to make bigger bets. This is fine as long as your bets pay off. But when your bets go bad, the people whose money you borrowed want it back.

Right now, a great many people want their money back.

The people who say that subprime is just a small part of the economy are correct. What they fail to note, however, is that the same games that Wall Street played with subprime are likely being played in every sector of the economy. It's not just a Super Bowl whose results can be fixed. The NBA, and Major League Baseball, and the Tour de France and the Olympics are all under the same pressures.

Subprime ripped a window open into the way business as usual is being conducted.

Now everyone wonders, what's next?

Nouriel Roubini explains it in terms of the difference between risk and uncertainty.

Current Market Turmoil: Non-Priceable Knightian “Uncertainty” Rather Than Priceable Market “Risk”

Nouriel Roubini

Aug 15, 2007

Economists distinguish between “Risk” and “Uncertainty”: the former can be priced by financial markets while the latter cannot. The distinction between the two was made by the famous economist Frank H. Knight in his seminal book, Risk, Uncertainty, and Profit (1921). In brief, “Risk is present when future events occur with measurable probability” while “Uncertainty is present when the likelihood of future events is indefinite or incalculable”.

This distinction between risk and uncertainty helps to explain the recent market panic and turmoil. Today, the FT cites a market economist at Lehman who said: “We are in a minefield. No one knows where the mines are planted and we are just trying to stumble through it”. A few days ago another market participant put it this way: “It is not the corpses at the surface that are scary; it is the unknown corpses below the surface that may pop up unexpectedly”.

Unknown minefield; unexpected corpses: this is “uncertainty” rather than “risk”. Risk can be measured and priced because it depends on know distributions of events to which investors can assign probabilities. Uncertainty cannot be priced by markets because it relates to “fat tail” distributions and extreme events that cannot be easily predicted or measured. A few days ago the CFO of Goldman Sachs justified the massive – 30% plus - losses of the two Goldman Sachs hedge funds by arguing that these were unpredictable “25 standard deviation events” that should occur only once in a million years. The same thing was said by the LTCM “masters of the universe” when their highly leveraged hedge fund went belly up in 1998.

Too bad that these fat tail events do occur more often than once in a million years: the real estate bubble and bust and S&L crisis of the late 1980s; the boom and bust of the tech stocks in 2000-2001; the 1987 stock market crash; the 1998 LTCM debacle; the variety of asset bubbles that ended up into busts from Japan (1980s) to East Asia (1997-98).

Indeed, for many reasons the current market panic has to do with unpriceable uncertainty rather than measurable risk.

First, we have no idea of what the subprime and other mortgage losses will be: $50 billion, $100 billion, $200 billion? They could be as large as $500 billion if the US enters in a recession and we have a systemic banking and financial crisis. The uncertainty about these losses depends on the fact that we have no idea of how deep and protracted the housing recession will be and how much will home prices will fall. If home prices were to fall – as my research suggests as likely – more than 10% in the next year or so, the subprime carnage will massively expand to near prime mortgages and prime mortgages. There is already plenty of evidence that the delinquencies are not limited to subprime mortgages as a number of near prime and prime lenders are now bankrupt or in trouble (AHM, Countrywide just to cite two examples). The worse the housing recession will be the worse these now uncertain losses.

Second, we have no idea of where the mines and the corpses are. Every day the turmoil is popping out in unexpected institutions and places: by now hedge funds, banks and asset managers in US, France, Germany, UK, Asia, Australia have gone belly up. And every day a different financial market gets into a liquidity crunch and credit crunch: first subprime; then near prime, prime, CDOs, CLOs, LBOs, ABCPs, corporate credit spreads, overnite interbank loans, money market funds, mutual funds. Every day we get a different surprise that adds to the market’s uncertainty and investors’ nervousness.

This increased financial uncertainty is in part due to the increased opacity and lack of transparency in financial markets…

But it is not just credit derivatives that create market opacity. This increased lack of transparency in financial markets is much broader: thousands of hedge funds that not only are unregulated but whose activities are opaque and not measured by any supervisor; shift of the corporate system from a public to a private one via LBOs and private equity transactions; increased size of unregulated over-the-counter trading in derivative instruments rather than on regulated exchanges; development of complex financial instruments whose correct pricing and rating is increasingly difficult; mis-rating of these new instruments by credit rating agencies saddled with severe conflict of interest as a large part of their revenues come from rating these new structured finance instruments; a laissez faire attitude among US supervisors and regulators that allowed reckless lending to foster.

Here are two examples of how uncertainty and opacity has vastly increased in financial markets.

First, you take a bunch of shaky and risky subprime mortgages and repackage them into residential mortgage backed securities (RMBS); then you repackage these RMBS in different (equity, mezzanine, senior) tranches of cash CDOs that receive a misleading investment grade rating by the credit rating agencies; then you create synthetic CDOs out of the same underlying RMBS; then you create CDOs of CDOs (or squared CDOs) out of these CDOs; and then you create CDOs of CDOs of CDOs (or cubed CDOs) out of the same murky securities; then you stuff some of these RMBS and CDO tranches into SIV (structured investment vehicles) or into ABCP (Asset Backed Commercial Paper) or into money market funds. Then no wonder that eventually people panic and run - as they did yesterday – on an apparently “safe” money market fund such as Sentinel. That “toxic waste” of unpriceable and uncertain junk and zombie corpses is now emerging in the most unlikely places in the financial markets.

Second example: today any wealthy individual can take $1 million and go to a prime broker and leverage this amount three times; then the resulting $4 million ($1 equity and $3 debt) can be invested in a fund of funds that will in turn leverage these $4 millions three or four times and invest them in a hedge fund; then the hedge fund will take these funds and leverage them three or four times and buy some very junior tranche of a CDO that is itself levered nine or ten times. At the end of this credit chain, the initial $1 million of equity becomes a $100 million investment out of which $99 million is debt (leverage) and only $1 million is equity. So we got an overall leverage ratio of 100 to 1. Then, even a small 1% fall in the price of the final investment (CDO) wipes out the initial capital and creates a chain of margin calls that unravel this debt house of cards. This unraveling of a Minskian Ponzi credit scheme is exactly what is happening right now in financial markets.

So combine an opaque and unregulated global financial system where moderate levels of leverage by individual investors pile up into leverage ratios of 100 plus; and add to this toxic mix investments in the most uncertain, obscure, misrated, mispriced, complex, esoteric credit derivatives (CDOs of CDOs of CDOs and the entire other alphabet of credit instruments) that no investor can properly price; then you have created a financial monster that eventually leads to uncertainty, panic, market seizure, liquidity crunch, credit crunch, systemic risk and economic hard landing. The last two asset and credit bubbles in the US – the S&L real estate bubble and bust of the late 1980s and the tech stock bubble of the late 1990s – ended up in painful recessions. The latest credit and asset bubble was much bigger: housing, mortgages, credit, private equity and LBOs, credit derivatives, corporate re-leveraging. So, the current bust and de-leveraging of the financial system is likely to lead to another painful economic hard landing.

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Monday, August 13, 2007

Signs of the Economic Apocalypse, 8-13-07

From Signs of the Times:

Gold closed at 681.60 dollars an ounce Friday, down 0.4% from $684.40 at the close of the previous Friday. The dollar closed at 0.7301 euros Friday, up 0.6% from 0.7260 at the previous week’s close. That put the euro at 1.3696 dollars compared to 1.3774 the Friday before. Gold in euros would be 497.66 euros an ounce, up less than 0.2% from 496.88 for the week. Oil closed at 71.47, down 5.6% from $75.48 at the close of the week before. Oil in euros would be 52.18 euros a barrel, down 5.0% from 54.80 for the week. The gold/oil ratio closed at 9.54, up 5.2% from 9.07 at the end of the previous week. In U.S. stocks the Dow Jones Industrial Average closed at 13,239.54 Friday, up 0.4% from 13,181.91 for the week. The NASDAQ closed at 2,544.89 Friday, up 1.3% from 2,511.25 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.80%, up 11 basis points from 4.69 for the week.

Despite a small rise in the stock market last week, the volatility, including a sharp drop on Thursday, still has everyone on edge. There were several reasons for this. First, the maintenance of stock prices at anything resembling their recent levels required a staggering infusion of “liquidity” (in other words, newly created money) by the world’s central banks, $213.6 billion on Thursday and Friday by the European Central Bank, $62 billion by the U.S. Fed). Second, that infusion of liquidity included an unprecedented departure by the U.S. Federal Reserve. This time they actually bought CDO’s (collateralized debt obligations). Usually they buy short term Federal Reserve obligations. This implies that no one else would accept these CDO’s. Finally, there was talk both in the media and at the highest levels of both government of what would happen if China pulled the plug on the United States.

All in all a very interesting week. Let’s look more closely at each aspect. First, the plunge protection team going all out:
Treasuries Decline as Fed Acts to Ease Credit Crunch Concerns

Daniel Kruger and Elizabeth Stanton

Aug. 11 (Bloomberg) -- Treasuries posted their first weekly decline since early July after the Federal Reserve added $62 billion to the banking system to help avert a crisis of confidence in global credit markets.

Yields of two-year Treasury notes, more sensitive than longer-maturity debt to changes in the federal funds target, rebounded from an 18-month low touched yesterday as the Fed, the European Central Bank, and central banks in Japan and Australia provided relief to banks facing elevated money-market rates.

``They'll probably continue to pump in liquidity,'' said Thomas Girard who helps manage $110 billion in fixed income with New York Life Asset Management in New York. ``Overnight and short-dated rates are still firmer than they should be.''

Two-year note yields rose 6 basis points, or 0.06 percentage point, 4.47 percent, according to bond trader Cantor Fitzgerald LP. They touched 4.34 percent yesterday, the lowest since January 2006. The price of 4 5/8 percent notes maturing in July 2009 fell 3/32, or 94 cents, to 100 9/32. Prices and yields move inversely.

The Fed's $38 billion in temporary funds yesterday was the most since September 2001.

``The central banks of the U.S. and Europe are saying they're not going to have a liquidity crunch,'' said Theodore Ake, head of U.S. government bond trading in New York at Mizuho Securities USA Inc. ``They will let the chips fall where they may in terms of bad loans, but they will provide liquidity.''

`Another Shoe'

Trading on fed funds futures indicated traders are certain of a cut in the target rate for overnight lending between banks to 5 percent at the Fed's Sept. 18 meeting and see a 34 percent chance of a reduction to 4.75 percent by the Oct. 31 meeting. Fed policy makers met Aug. 7 and left the rate unchanged at 5.25 percent, where it's been since June 2006.

``The concern is we don't know where or when another shoe is going to drop,'' said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading in New York at Deutsche Bank AG's Private Wealth Management unit.

The yield advantage of 10- over two-year notes rose yesterday to 34 basis points, the biggest since July 2005. For most of December 2005 through May 2007, two-year yields were higher than 10-year yields, reflecting expectations for steady monetary policy that would contain economic growth and inflation.

The Fed's additions yesterday lowered the overnight lending rate between banks to as low as 0.75 percent, below the Fed's 5.25 percent target, according to ICAP Plc. It began the day trading at 6 percent, the highest opening rate since 2001.

`Provide Liquidity'

``The Fed and central banks generally are doing what they're supposed to do, which is provide liquidity in times of stress,'' said Woody Jay, a former head of Treasury trading at Lehman Brothers Inc. who now runs Rock Ridge Advisors LLC, a $255 million hedge fund in Greenwich, Connecticut.

The rise in money-market rates reflects investors' reluctance to provide financing to banks for securities backed by loans after losses in subprime mortgages called into question the value of other types of collateral.

The U.S. central bank conducted its so-called open market operations earlier than usual yesterday, shortly after 8 a.m. in New York, lending $19 billion to dealers and accepting all forms of collateral. It later lent $16 billion and $3 billion. The central bank added $24 billion on Aug. 9.

The central bank normally conducts so-called separate repurchase agreements in which it specifies Treasury, federal agency or mortgage-backed debt as the lowest-quality collateral acceptable, said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey.

Treasuries in Demand

Yesterday's agreements accepted all forms, meaning that dealers probably delivered only mortgage-backed securities, enabling them to retain their Treasuries at a time when those securities are in high demand.

The European Central Bank loaned the equivalent of $83.6 billion to banks yesterday after a record injection of $130 billion Aug. 9. The Bank of Japan added 1 trillion yen ($8.5 billion) to the financial system yesterday, the most since June 29, while the Reserve Bank of Australia lent A$4.95 billion ($4.2 billion).

Economists at JPMorgan Chase & Co., the third-biggest U.S. bank, said yesterday in a research note that an August rate cut is ``a genuine possibility.'' The firm last week changed its forecast for monetary policy from a fourth-quarter increase to 5.5 percent to an increase in June 2008.

U.S. Stocks Recover

The Standard & Poor's 500 Index closed little changed yesterday, recovering from a global sell-off, after falling almost 3 percent on Aug. 9. European shares fell yesterday the most in four years, and Asian stocks dropped the most in five months.

The U.S. government's auction of $13 billion of 10-year notes on Aug. 8 drew fewer indirect bidders than average. Indirect bidders, a class that includes foreign central banks, bought 32.1 percent of the auction. In the last eight new 10- year note auctions of the same amount, they bought 39.1 percent on average.

And, no surprise, stocks recovered:
U.S. Stocks Recover as Fed Assuages Lending Concern

Eric Martin and Lynn Thomasson

Aug. 11 (Bloomberg) -- U.S. stocks gained for the first time in four weeks on speculation the government will take steps to avert a lending crisis, helping the market overcome increasing home-loan and hedge fund losses.

The Standard & Poor's 500 Index began the week with the steepest two-day advance in four years, buoyed by a bullish economic outlook from the Federal Reserve. The benchmark was little changed yesterday after the Fed pumped the most money into the banking system since the September 2001 terror attacks and pledged more ``as necessary'' to bolster investor confidence.

``Someone needs to step in and create some stability, and we're seeing the Fed do that,'' said Jason Graybill, who helps manage $750 million at Abner Herrman & Brock Inc. in Jersey City, New Jersey.

The S&P 500 advanced 1.4 percent to 1453.64, recovering from the biggest three-week loss since February 2003. The Dow Jones Industrial Average rose 0.4 percent to 13,239.54. The Nasdaq Composite Index climbed 1.3 percent to 2544.89.

The yield on the benchmark 10-year U.S. Treasury note rose 0.11 percentage point to 4.80 percent this week as the Fed joined central banks in Europe, Japan, Australia and Canada in attempting to prevent a credit crunch.

Stocks tumbled on Aug. 9, with the S&P 500 slumping the most since February, as subprime mortgage contagion and hedge fund losses halted a three-day rally.

Manic, Depressive, Manic

Citigroup Inc., JPMorgan Chase & Co. and Goldman Sachs Group Inc. gained for the week, even after brokerage shares suffered the biggest one-day decline of the almost five-year bull market. Citigroup rose 2.8 percent to $47, JPMorgan climbed 1.4 percent to $44.25 and Goldman advanced 0.5 percent to $180.50.

After the close of trading yesterday, people familiar with Goldman's $8 billion Global Alpha hedge fund said it has lost 26 percent so far this year.

Quantitative hedge funds, including those run by Goldman, Highbridge Capital Management LLC and Tykhe Capital LLC, have lost money as credit spreads widen and volatility jumps, rendering useless their statistical investment models.

``Our market is rapidly swinging from manic to depressive and back to manic in nanosecond moves with each headline acting as a trigger,'' said Frederic Dickson, who manages $17 billion as chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon…

Investors will get clues next week on the health of the U.S. economy. Retail sales rose last month, signaling that a deepening real-estate slump and elevated food and fuel costs are slowing rather than stopping consumers, economists said before a government report.

Purchases rose 0.2 percent after dropping 0.9 percent in May, according to the median estimate in a Bloomberg News survey before a Commerce Department report on Aug. 13. Other reports may show prices increased in July, according to the survey.

The following piece by Floyd Norris of the New York Times offers some historical perspective on the current situation. The global financial system, how money is borrowed and how the risk is calculated, has changed into something new over the last decade or two:
A New Kind of Bank Run Tests Old Safeguards

Floyd Norris

August 10, 2007

A few generations ago, savers responded to financial panics with runs on banks, and even healthy institutions could fail if they could not raise enough cash quickly enough.

For a long time, that all seemed to be safely relegated to the past. But now the runs are back — and this time the targets are not banks but the securities that have replaced them as the prime generators of credit in the new financial system.

“Our current system of levered finance and its related structures may be critically flawed,” said William H. Gross, the chief investment officer of Pimco, a mutual fund company. “Nothing within it allows for the hedging of liquidity risk, and that is the problem at the moment.”

This problem has plagued the United States at regular intervals. The Panic of 1907 was halted only when the banker J. P. Morgan persuaded banks to stand together and halt the string of closings by lending money to threatened institutions. That led to the creation of the Federal Reserve, as Congress recoiled from the notion that the country’s financial health had relied on the wealth and wisdom of one private citizen.

Then the Depression, with a wave of bank failures, led to the establishment of deposit insurance. With that, savers became convinced that they need not worry about the health of their bank, and bank runs vanished.

But a new financial architecture emerged in the last decade — one that relied more on securities and less on banks as intermediaries. With the worth of those securities now being questioned — and no equivalent of deposit insurance — some who financed the securities want their money out, a fact that has created the 21st-century equivalent of a run on a bank.

Left to deal with the run are the institutions that were created to deal with the old system’s problems — notably the central banks like the Federal Reserve and the European Central Bank. But, in contrast to their close involvement with the banking system, these banks have little regulatory oversight of the securities that are in trouble and may not even know who is holding them.

At the heart of the new system was a decision to have loans financed directly by investors, rather than indirectly by bank depositors. Investors, ranging from hedge funds to wealthy individuals, had confidence in the arrangement because most of the securities were blessed as very safe by the bond rating agencies, like Moody’s and Standard & Poor’s.

The highly rated securities pay relatively low interest rates, but until now there were many willing to own them or to lend money to those who did own them. But there is no reason to hold them if there is any question about their safety — just as there was no reason to keep deposits in a bank that was facing a run amid rumors about its safety.

A result has been a freezing up of markets for many securities that, it turns out, were critical to the free flowing of credit. The problem first gained widespread attention when two hedge funds run by the brokerage firm Bear Stearns collapsed and a third Bear Stearns fund had to suspend redemptions as investors sought to get out even though there was no evidence that the fund was in trouble.

“The third Bear Stearns fund announcement was the key,” said Robert Barbera, the chief economist of ITG. “You have to believe that in the hedge fund and mutual fund complexes, there is a decision that is building that says, ‘I want to hold some Treasuries to have a cushion if I see redemptions.’ ”

The basis of the system was a belief that securities backed by bad credit could be very safe — so long as there were other securities that would suffer the first losses that came from defaults in pools of subprime mortgages or of loans to highly leveraged companies.

So far, none of those highly rated securities have failed to make their interest payments on time, but that fact is not enough to make anyone want to buy them. The rating agencies have downgraded some securities, and they are tightening their standards for new ratings.

Early this week, stock market investors around the world tried to reassure themselves that nothing was really wrong, and financial stocks bounced back after suffering sharp declines last week. Analysts argued that profits remained strong, as does world economic growth.

On Tuesday, the Fed declined to lower the federal funds rate, saying that despite financial market volatility and a decline in the housing market, “the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.”

But that comforting outlook did not help the credit markets recover, or persuade anyone to buy the newly questioned securities — at least at anything like the prices people had assumed. No one wants to sell the securities at very low prices — and in many cases they have borrowed heavily against them. So the markets have dried up.

Yesterday, BNP Paribas, a major French bank, said it could no longer value three investment funds that it managed, whose assets had been invested in highly rated securities that were backed by dubious mortgages.

“The complete evaporation of liquidity in certain market segments of the U.S. securitization market,” the French bank said, “has made it impossible to value certain assets fairly, regardless of their quality or credit rating.”

Adding to the problem is that the questionable securities are widely owned and sometimes have been repackaged to form the basis of other securities. European banks and funds own paper tied to subprime mortgages, and it is not clear who else does, or how investors will react.

Banks that are worried about their own liquidity decided this week to increase their reserves, which they can do by borrowing from other banks. Loans on such rates rose as a result of the added demand. Both the federal funds rate — the rate on loans of reserves between American banks — and the London Interbank Offered Rate leaped sharply yesterday.

The Fed — which conducts monetary policy by focusing on the fed funds rate — was forced to inject money into the system to bring the rate back down to its targeted level. And the E.C.B. lent almost 100 billion euros ($130 billion), to European banks.

If the current panic is just that — unreasoning fear — then such cash infusions may be able to let the new financial system weather the storm. Money can be lent to those owning the dubious securities, obviating the need to sell. As they eventually turn out to be good, the loans can be repaid and all will be happy.

On the other hand, if many of those securities turn out to be as bad as people now fear, some of those loans will not be good, and there may be more financial failures.

Yesterday, stock prices fell in Europe and kept declining in the United States, amid speculation over what other owners of the securities might surface as having problems. But American stock prices remain well above the levels they fell to in February, after a sudden drop in the Chinese stock market, and many stock investors still think all will work out acceptably.

The central banks, while clearly crucial to dealing with the loss of faith in the new financial system, lost influence under that system. Loans could be arranged by nonbanks, not subject to bank regulators, and the regulators were hesitant to impose rules that would not apply to all lenders. The lenders sold securities to finance mortgages that let people borrow at rates that — temporarily — were far lower than the Fed envisioned. That delayed the impact of the Fed’s attempts to raise interest rates in 2005 and 2006.

“That is important because it means the decline in the housing market is likely to continue,” Mr. Barbera said. If the American economy does continue to weaken, the Fed may feel forced to reduce interest rates sooner than it had expected, even if that move threatens to hurt the value of the dollar.

Prices in the futures market for federal funds show that just a few weeks ago investors thought there would be no Fed easing this year. Now they seem to think such a move is highly likely, and some expect it as early as next month.

But the Fed’s influence is limited when lenders are suddenly risk-averse. “The impetus of lowering interest rates may not help, if they don’t let you borrow in the first place,” said Kingman Penniman, the president of KDP Investment Advisors.

The new financial system is not the one the Fed was created to deal with, but it is the one it must try to handle.

The following comment (on that video of Jim Cramer on MSNBC) adds some more perspective:

Subprime is an issue, but it's not the issue. Of itself it's nowhere near enough to break the market. What is enough is a spread from subprime into a contagion of other credit / credit derivative markets, and that is what's proved so interesting / alarming about the past few months. Will it or won't it?

There have been multiple distress signals from credit markets, hedge funds and mortgage providers in recent times. All par for the course. However, this morning we saw the london interbank market effectively cease to function. This is the marketplace where banks source their daily funding requirements for ongoing operations.

Interbank liquidity is, absent a black swan every five years or so, a given. The sun rises and sets, the banks lend and borrow. But not today. What these banks were saying was, in effect, "I don't trust any of these other banks enough to give them any cash at 4%pa overnight, because I'm not sure I'll get it back".

Think about that for a minute. I'm pretty sure most of you have your cash sitting at those same banks earning a paltry rate of interest, and I'm pretty sure most of you think it's safe. Well, this morning, following bnp paribas' revelations, the banks weren't so sure. The ECB then had to step in and guarantee any and all funding requirements for the day. About US$120bn all up. They've never had to make this guarantee before.

As a contrast, on 9/11 (the last time a similar operation was engaged) they injected around US$95bn. Without Government intervention, the European banking system may have shut down this morning - or at least operated in a half-arsed illiquid take-it-or-leave-it fashion. In other words, the market 'failed' (to free-market capitalists, the market was doing what it should do, simply re-pricing credit to make it more expensive given all the prevailing uncertainty / risk).

Does all this mean the world's gonna end? Not necessarily. The US Fed, in contrast, added $24bn, net $10bn this morning. Maybe double normal. On 9/11 they added roughly $200bn. So today was no big deal Stateside. Of course the S&P500 may not have agreed, and tomorrow is another day ...

So: Right now there's a lot of apprehensive traders and prudent risk managers and an inappropriately large number of Rumsfeld's unknown unknowns out there. The central banks played failsafe / backstop exactly as the system intended. All we've got for sure is a market that's spooked and running on fear. The danger is that, absent a circuit-breaker - say the Fed lowering interest rates 50bp by end October - is that the fear will lead to a vapourlock and total absence of liquidity in the marketplace. What did Enron in - and LTCM - was not just their leverage, and not just their wrongheaded underwater positions. It was the refusal of their counterparties to allow them any further credit - in effect, asking them to pony up and cover their outstanding debts before they would do any further business with them. Given they were leveraged to the gills, this was of course impossible, and under they went. So what, you ask? Well, unfortunately for all of us the banks operate under a fractional reserve banking system. Just because Cramer's on the excitable side doesn't make him wrong. For the record, though, the central banks' actions to date have been commendable.

Most commentators are spot on in noting the IB's self-interest. The pressure that's being bought to bear on the Fed - and in particular Bernancke - is enormous. There's a concerted PR campaign being waged out there to ensure Bernancke understands that if this goes wrong, he will be hung out to dry by Wall Street. They're after reassurance that the 'Greenspan put' is still alive and kicking ... it's understandable that there's some anger at the 'too big to fail' notion for the financial system, but a word of caution to those above wanting to pull the financial system down around their ears: be careful what you wish for. You may just get ten-fifteen years of tough times in which to work through your schadenfreude.

I won't continue to bore you with detail, but for now all you need to know is:

(1) IB's and hedge funds are holding a pile of toxic / junk credit that no-one can sensibly value;

(2) No-one wants to have this credit sensibly valued, because doing so would lead to massive writedowns / losses across the board. If you don't value it, there are no losses. The wonders of mark-to-market, a la Enron;

(3) No-one, at present, aside from the occasional side deal (Citadel/Sowood) is willing to buy this credit at any price (meaning in effect its value is zero in the current marketplace). The holders of this credit are refusing to accept this as reasonable and believe that eventually 'normality' will return. This concerns me, because it may not.

(4) There is an extensive OTC market in credit derivatives (CDO's, CLO's etc etc) that are priced and traded based on the underlying debt. As the underlying debt cannot be valued, neither can the derivatives. Just how big the losses are in these instruments, and who bears the bulk of these losses, is the big guessing game for now. Its a tangled web that the IB's don't really want to unravel - mainly because they're not sure what they'll find. Sometimes pulling on a single thread can unravel the whole jumper ...

(5) The market could, in its current frame of mind, run to a place where the Fed is forced to bail them out (beyond supplying repo / discount window liquidity, they may have to cut the overnight rate. FYI, the Fed Funds and Eurodollar futures have already priced in the assumption that this will happen. As is typical with markets, they've priced in the endgame well before the whistle is blown.

How this ends up, no-one knows. I'm not a big fan of making sweeping public predictions about market direction, as there's little upside in doing so. We could be back in happyland in three months, or we could spiral into something far more sinister. But there's enough historical synchronies with the current environment to make me wanna pull out my beat-up ol' copy of The Grapes of Wrath and get to reading ...

Now we see why the Fed was buying CDO’s last week. No one else would.

The Fed Is Buying Mortgage-Backed Securities?

PSP: Hoisted from Comments

Fri morning's N.Y. Times online edition:

The E.C.B. injected another 61 billion euros ($84 billion) into the banking system, after providing 95 billion euros the day before. The Federal Reserve today added $19 billion to the system through the purchase of mortgage-backed securities, then $16 billion in three-day repurchase agreements. The Fed also added money on Thursday.

I thought the Fed only bought and sold Federal debt. This says it is intervening directly in the mortgage-backed securities market. Is this as unusual as I think it is?


And, as if all this wasn’t enough, last week China and the United States openly discussed in the media the question of if and when China will pull the plug on the whole Anglo-American empire and financial system.

China threatens 'nuclear option' of dollar sales

Ambrose Evans-Pritchard

August 8, 2007

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress. Shifts in Chinese policy are often announced through key think tanks and academies.

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels.

It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds over $900bn in a mix of US bonds.

Xia Bin, finance chief at the Development Research Centre (which has cabinet rank), kicked off what now appears to be government policy with a comment last week that Beijing's foreign reserves should be used as a "bargaining chip" in talks with the US.

"Of course, China doesn't want any undesirable phenomenon in the global financial order," he added.

He Fan, an official at the Chinese Academy of Social Sciences, went even further today, letting it be known that Beijing had the power to set off a dollar collapse if it choose to do so.

"China has accumulated a large sum of US dollars. Such a big sum, of which a considerable portion is in US treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency. Russia, Switzerland, and several other countries have reduced the their dollar holdings.

"China is unlikely to follow suit as long as the yuan's exchange rate is stable against the dollar. The Chinese central bank will be forced to sell dollars once the yuan appreciated dramatically, which might lead to a mass depreciation of the dollar," he told China Daily.

The threats play into the presidential electoral campaign of Hillary Clinton, who has called for restrictive legislation to prevent America being "held hostage to economic decicions being made in Beijing, Shanghai, or Tokyo".

She said foreign control over 44pc of the US national debt had left America acutely vulnerable.

Simon Derrick, a currency strategist at the Bank of New York Mellon, said the comments were a message to the US Senate as Capitol Hill prepares legislation for the Autumn session.

"The words are alarming and unambiguous. This carries a clear political threat and could have very serious consequences at a time when the credit markets are already afraid of contagion from the subprime troubles," he said.

A bill drafted by a group of US senators, and backed by the Senate Finance Committee, calls for trade tariffs against Chinese goods as retaliation for alleged currency manipulation.

The yuan has appreciated 9pc against the dollar over the last two years under a crawling peg but it has failed to halt the rise of China's trade surplus, which reached $26.9bn in June.

Henry Paulson, the US Tresury Secretary, said any such sanctions would undermine American authority and "could trigger a global cycle of protectionist legislation".

Mr Paulson is a China expert from his days as head of Goldman Sachs. He has opted for a softer form of diplomacy, but appeared to win few concession from Beijing on a unscheduled trip to China last week aimed at calming the waters.

Bush answered with this:

China dollar attack would be 'foolhardy' : Bush

August 8, 2007

AFP - President George W. Bush on Wednesday said China would be "foolhardy" to attempt to push down the dollar in retaliation for US pressure over Beijing's alleged currency manipulation.

Bush said he had not seen the report that Beijing was hinting at such a move, in Britain's Daily Telegraph newspaper, but warned against any attempt by China to hit back at Washington using vast foreign currency reserves.

"That would be foolhardy of them to do that," Bush said in an interview with Fox News, adding he doubted the report was based on sources from the office of Chinese President Hu Jintao.

"If that's the ... position of the government, it would be foolhardy for them to do this."

US Treasury Secretary Henry Paulson meanwhile said on CNBC that suggestions that China was considering selling off dollar denominated assets to hammer the already weakened US dollar were "absurd."

"We have tensions and we have to deal with tensions on both sides ... but overall, both of our countries are committed to a constructive economic relationships," said Paulson, who returned from talks with top leaders in China last week.
China said on Friday it would not be pressured into currency reform as Washington and the US Congress renewed calls for it to speed up changes to make the yuan more market-oriented.

The Telegraph reported that two officials at leading Communist Party bodies had given interviews in recent days warning that Beijing might use more than a trillion dollars in foreign reserves as a political weapon in the event of US sanctions designed to punish Beijing for yuan manipulation.

Described as China's "nuclear option" in the state media, such a move could trigger a crash of the already-falling greenback and a spike in the US bond yields, which could then dampen the beleaguered housing market and put the world's richest economy into a recession.

When asked whether such an option would hurt China more than the United States, Bush said, "Absolutely. I think so."

China reportedly holds some 900 billion dollars in a mix of US bonds.

Bush said the United States and China could resolve their differences "in a cordial way" as opposed to the reported option by Beijing of liquidating its vast holdings of US dollars or through legislation by the US Congress imposing sanctions on China.
He cited a high level "strategic economic dialogue" chaired by Paulson and Chinese Vice-Premier Wu Yi as an effective channel to discuss differences between the two powers.

Bush said the two powers had "a very complex trading relationship" and that it was "very important" for the US economy to have access to the vast Chinese market…

Or, as Paul Craig Roberts put it,

Uncle Sam, Your Banker Will See You Now

Paul Craig Roberts

08/08/07 "ICH" --- - Early this morning China let the idiots in Washington, and on Wall Street, know that it has them by the short hairs. Two senior spokesmen for the Chinese government observed that China’s considerable holdings of US dollars and Treasury bonds “contributes a great deal to maintaining the position of the dollar as a reserve currency.”

Should the US proceed with sanctions intended to cause the Chinese currency to appreciate, “the Chinese central bank will be forced to sell dollars, which might lead to a mass depreciation of the dollar.”

If Western financial markets are sufficiently intelligent to comprehend the message, US interest rates will rise regardless of any further action by China. At this point, China does not need to sell a single bond. In an instant, China has made it clear that US interest rates depend on China, not on the Federal Reserve.

The precarious position of the US dollar as reserve currency has been thoroughly ignored and denied. The delusion that the US is “the world’s sole superpower,” whose currency is desirable regardless of its excess supply, reflects American hubris, not reality. This hubris is so extreme that only 6 weeks ago McKinsey Global Institute published a study that concluded that even a doubling of the US current account deficit to $1.6 trillion would pose no problem.

Strategic thinkers, if any remain who have not been purged by neocons, will quickly conclude that China’s power over the value of the dollar and US interest rates also gives China power over US foreign policy. The US was able to attack Afghanistan and Iraq only because China provided the largest part of the financing for Bush’s wars.

If China ceased to buy US Treasuries, Bush’s wars would end. The savings rate of US consumers is essentially zero, and several million are afflicted with mortgages that they cannot afford. With Bush’s budget in deficit and with no room in the US consumer’s budget for a tax increase, Bush’s wars can only be financed by foreigners.

No country on earth, except for Israel, supports the Bush regimes’ desire to attack Iran. It is China’s decision whether it calls in the US ambassador, and delivers the message that there will be no attack on Iran or further war unless the US is prepared to buy back $900 billion in US Treasury bonds and other dollar assets.

The US, of course, has no foreign reserves with which to make the purchase. The impact of such a large sale on US interest rates would wreck the US economy and effectively end Bush’s war-making capability. Moreover, other governments would likely follow the Chinese lead, as the main support for the US dollar has been China’s willingness to accumulate them. If the largest holder dumped the dollar, other countries would dump dollars, too.

The value and purchasing power of the US dollar would fall. When hard-pressed Americans went to Wal-Mart to make their purchases, the new prices would make them think they had wandered into Nieman Marcus. Americans would not be able to maintain their current living standard.

Simultaneously, Americans would be hit either with tax increases in order to close a budget deficit that foreigners will no longer finance or with large cuts in income security programs. The only other source of budgetary finance would be for the government to print money to pay its bills. In this event, Americans would experience inflation in addition to higher prices from dollar devaluation.

This is a grim outlook. We got in this position because our leaders are ignorant fools. So are our economists, many of whom are paid shills for some interest group. So are our corporate leaders whose greed gave China power over the US by offshoring the US production of goods and services to China. It was the corporate fat cats who turned US Gross Domestic Product into Chinese imports, and it was the “free trade, free market economists” who egged it on.

How did a people as stupid as Americans get so full of hubris?

Roberts calls this a “grim outlook.” It is from a U.S. nationalist perspective. But is it really so grim if China’s economic power over the United States prevents the U.S. from attacking Iran? The following news was most likely not a coincidence:
‘Rival to Nato’ begins first military exercise

Tony Halpin in Moscow

August 6, 2007

Russian and Chinese troops are joining forces this week in the first military exercises by an international organisation that is regarded in some quarters as a potential rival to Nato.

Thousands of soldiers and 500 combat vehicles will take part in “Peace Mission 2007”, organised by the Shanghai Cooperation Organisation (SCO) in the Chelyabinsk region of Russia. Russian officials have also proposed an alliance between the SCO and a body representing most of the former Soviet republics.

Scores of Russian and Chinese aircraft begin joint exercises tomorrow before a week of military manoeuvres from Thursday that will include Tajikistan, Kyrgyzstan and Kazakhstan. At least 6,500 troops are involved in what is described as an antiterror exercise.

Colonel-General Vladimir Moltenskoi, the deputy commander of Russian ground forces, said: “The exercise will involve practically all SCO members for the first time in its history.”

Staff officers from Uzbekistan, the sixth SCO member, will also attend in what is being regarded as a major extension of the organisation’s capabilities. The SCO was founded as a nonmilitary alliance in 2001 to combat drugs and weapons smuggling as well as terrorism and separatism in the region. It has since developed a role in regional trade and is increasingly regarded by Moscow and Beijing as a counterweight to US global influence.

The secretary-general of the Collective Security Treaty Organisation (CSTO) called last week for joint military exercises with the SCO. Nikolai Bordyuzha said that the body representing Armenia, Belarus, Kazakhstan, Kyrgyzstan, Russia, Tajikistan and Uzbekistan should work with the SCO to guarantee security across the region. Mr Bordyuzha has already announced a CSTO plan to create a large military force capable of assisting a member state in the event of an attack. A rapid-reaction force is already based in Central Asia and there are plans for a common air defence system covering most of the former Soviet Union.

Leaders of SCO member states will meet in Bishkek, the Kyrgyz capital, next week for their annual summit. Turkmenistan will also attend for the first time, while Mongolia, Iran, India and Pakistan have observer status.

Igor Ivanov, the head of Russian security, played down concerns in May that the SCO was evolving into a military alliance to counter the expansion of Nato into Asia as part of the War on Terror. But MPs on the Foreign Affairs Select Committee expressed fears last year that the West could be on a collision course in the struggle for energy resources with “an authoritarian bloc opposed to democracy” that was based on an alliance between China and Russia.

A newly assertive Russia, flush with oil and gas revenues, is moving rapidly to increase its military capability amid tensions with the West over missile defence and Nato expansion. Almost £100 billion has been set aside for rearmament over the next eight years.