Monday, July 28, 2008

Signs of the Economic Apocalypse, 7-28-08


Gold closed at 926.80 dollars an ounce Friday, down 3.4% from $958.00 for the week. The dollar closed at 0.6371 euros Friday, up 0.9% from 0.6312 at the close of the previous week. That put the euro at 1.5697 dollars compared to 1.5842 the week before. Gold in euros would be 590.43 euros an ounce, down 2.4% from 604.72 at the close of the previous week. Oil closed at 123.41 dollars a barrel Friday, down 4.4% from $128.82 for the week. Oil in euros would be 78.62 euros a barrel, down 3.4% from 81.32 at the close of the Friday before. The gold/oil ratio closed at 7.51 Friday, up 0.9% from 7.44 for the week. In U.S. stocks, the Dow closed at 11,371.92 Friday, down 1.1% from 11,496.57 at the close of the previous Friday. The NASDAQ closed at 2,310.79 Friday, up 1.2% from 2,282.78 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.09%, unchanged for the week.

Gold and oil were down sharply last week. Over the last two weeks, oil fell 17.5% on lower probability of war in Iran and growing evidence of a serious global economic downturn. It may be that the commodities bubble will be short-lived and that we are shifting back to risk of deflation due to collapse in demand.

Bad news in the U.S. housing sector continued to pile up. Foreclosures have doubled from a year ago and existing housing sales hit a ten-year low:

U.S. Economy: Sales of Existing Homes Decline to 10-Year Low

Bob Willis

July 24 (Bloomberg) -- Sales of previously owned U.S. homes fell in June to the lowest level in a decade as tumbling real- estate prices and consumer confidence signal no end in sight to a housing recession now in its third year.

Resales dropped 2.6 percent to a lower-than-forecast 4.86 million annual rate from a 4.99 million pace the prior month, the National Association of Realtors said today in Washington. The median home price dropped 6.1 percent from June of last year.

The housing slump may deepen further after mortgage rates climbed to the highest in a year this month and turmoil engulfed Fannie Mae and Freddie Mac, which account for more than two- thirds of new home-loan financing. A record 18.6 million homes stood empty in the last three months as the industry's recession reverberated through communities, separate figures showed today.

The NAR report “is, unfortunately, not telling us about an end” to the slide, said David Resler, chief economist at Nomura Securities International Inc. in New York. “Housing is going to be a non-contributor, if not a drag, on the overall economy.”

The Standard & Poor's Supercomposite Homebuilding Index dropped 4.9 percent to 480.61 at 10:33 a.m. in New York. By comparison, the Standard & Poor's 500 Stock Index lost 0.6 percent, to 1,274.06.

Economists forecast home resales would fall to a 4.94 million pace, according to the median of 77 projections in a Bloomberg News survey. Estimates ranged from a 4.79 million pace to 5.1 million rate.

Jobless Claims

The Labor Department earlier today reported that first-time claims for unemployment benefits rose last week to the highest in almost four months, a sign the slowing economy is weakening the labor market. Applications increased by 34,000 to 406,000 in the week ended July 19.

Compared with a year earlier, existing home sales were down 16 percent in June. Purchases are down by about a third from a record of 7.25 million reached in September 2005.

The number of previously owned unsold homes on the market at the end of June rose to 4.49 million from 4.482 million in May. The total represented 11.1 months' supply at the current sales pace. The agents' group has said that a five-to-six month's supply reflects a balanced market.

“The biggest problem is that we've not yet seen inventories come down,” Paul Puryear, managing director of Raymond James & Associates Inc. in St. Petersburg, Florida, said in an interview with Bloomberg Radio yesterday. The housing market isn't likely to recover until at least 2009 or 2010, he said.

Property Types

Sales of existing single-family homes declined 3.2 percent to an annual rate of 4.27 million. Purchases of condos and co-ops increased 1.7 percent to a 590,000 pace.

The median sales price fell to $215,100 from $229,000 in June 2007. The median cost of a single-family home decreased 6.7 percent to $213,800, while that of condominiums and co-ops fell 2.2 percent to $224,200.

Purchases decreased in three of four regions, led by a 6.6 percent decline in the Northeast. Sales rose 1 percent in the West, which also showed a 17 percent drop in the median price, the biggest of any region.

The glut of homes may be even greater because not all foreclosed properties are counted by the Realtors group. The group only includes foreclosures that have been listed on the multiple listings service…

Since the U.S. economy has been propped up this decade by war and housing, the pain from the collapse of the housing bubble and the rise in energy prices is spreading to any sector affected by consumer spending:
Commercial bankruptcies soar, reflecting widening economic woes

Tony Pugh McClatchy Newspapers

Sat, Jul. 19, 2008

WASHINGTON — Driven by a sour economy and skittish consumers, U.S. business bankruptcies saw their sharpest quarterly rise in two years, jumping 17 percent in the second quarter of 2008, according to an analysis by McClatchy.

Commercial filings for the first half of 2008 are up 45 percent from last year, as the national climate for commerce continues to deteriorate amid rising energy and food costs, mounting job losses, tighter credit and a reticence among consumers to part with discretionary income.

From April through June, 15,471 U.S. businesses called it quits, according to data from Automated Access to Court Electronic Records, an Oklahoma City bankruptcy management and data company.

States that saw the biggest increase in filings were Delaware, Montana, Oregon, Maryland and Connecticut, suggesting that the economic gloom is spreading beyond large population centers.

It was the 10th straight quarter that business bankruptcy filings have increased. Nearly 29,000 companies filed in the first half of 2008.

Another 60,000 to 90,000 others probably have closed, because roughly two to three businesses fold for every one that files for bankruptcy, said Jack Williams, resident scholar at the American Bankruptcy Institute.

The vast majority of these failed companies are among the nation's 23 million small businesses, with fewer than 100 employees. Their fortunes have tumbled as the national economic downturn has deepened.

"The climate is turning desperate for small businesses," said George Cloutier, founder of American Management Services, a consulting firm that helps small companies increase profits. "They are in crisis, and, as these numbers show, it's getting worse and worse."

Larger enterprises typically have more capital to weather downturns, but many of them also are reeling from the sputtering economy.

"I've been doing this for 36 years, and this is clearly the worst I've ever seen," said Harding Dawahare, the president of the Lexington, Ky.-based Dawahare's clothing store chain, which employs more than 400 people.

It was 1907 when Dawahare's Syrian immigrant grandfather, Serur Dawahare, began packing his mules with bags of fabric and linens and peddling his goods door to door to coal miners in Eastern Kentucky.

From those modest beginnings, Dawahare's grew to a 32-store clothing chain with outlets throughout Kentucky and a few stores in Tennessee and West Virginia.

However, Harding Dawahare did the unthinkable recently and filed for bankruptcy after amassing more than $9 million in debts. He said his problems began after a tough year in 2006, but it was the 2007 holiday season that did him in.

"We had a great third quarter, but if you don't have a good fourth quarter, you're not gonna make it. And that's essentially what happened. The economy tanked in late November and it never came back, and we just couldn't overcome it."

More than 20 percent of the newly shuttered businesses were in California, which logged 3,141 bankruptcies in the second quarter.

Texas fielded the next highest number of bankruptcies with 1,168, followed by Michigan with 702 and Florida with 635. New York was next, with 618 petitions, and Colorado had 547.

Commercial bankruptcy filings reported by Automated Access to Court Electronic Records are typically higher than official government figures due to a more thorough reading of the petitions.

Robert Lawless, a law professor at the University of Illinois and a bankruptcy expert, has researched and written about the federal government's underreporting of business bankruptcies. He estimates that roughly one in seven people who file for consumer bankruptcy do so in connection with their businesses.

Tom Clements' pet shop in Tampa, Fla., started seeing steep declines in business in April of last year.

"We didn't know what it was at the time, so we were trying to work through it," Clements said.

But as sales stayed flat for the next 15 months, Clements, 62, realized that the economy was forcing customers to make tough choices. "Obviously a puppy isn't something that everybody has to have."

With listed assets of about $2,605, Clements filed for Chapter 7 bankruptcy in June, owing more than $260,000 for back taxes, a property lease, auto leases, unpaid inventory, dog food, phone service, advertising, pest control, waste removal and other services.

"I absolutely loved that business," Clements said wistfully. "It's the kind of business where people were happy. You come, get a puppy or a dog, you go home happy. Unfortunately, I'm not a philanthropist."

Clements said the lingering debt and the money he invested had jeopardized his and his wife's retirement.

"That's why I wouldn't ever consider going back into something like that again," he said.

Williams of the bankruptcy institute said that because bankruptcies were lagging economic indicators, they probably would "continue to increase at least for the next year to 18 months at the rate that we're seeing right now."

Cloutier wants the federal government to create a $10 billion emergency-loan fund to help struggling small businesses avoid bankruptcy. Williams is skeptical.

"I think most of the business problems are not simply market-driven, they're operational. So there's a mix. Throwing more money at a poor operation means you just spent more money, but the operation is still poor."

Jodi and Steven Carbaugh of Waynesboro, Pa., ended up in bankruptcy court after they tried to expand their Cupo' Joe coffee shop in Greencastle, Pa.

In 2006, the couple used their home as collateral to buy a nearby Amish-owned bakery. "Big mistake," Jodi Carbaugh said.

As their debt increased, the couple tried to juggle four business-related loans and their home mortgage as well as pay vendors, employees, utilities and insurance. At the same time, business at the coffee shop began to slow.

Some 70 miles outside Washington, the Cupo' Joe was a favorite morning launching pad for residents who drive to work in the nation's capital. But as gas prices increased, Jodi Carbaugh noticed that business began to wane, falling 40 percent since last year.

"People had to spend more money to buy gas to get to D.C. instead of buying lattes and specialty breads," Carbaugh said. At the same time, food prices spiked. A case of eggs tripled to $60 and a 50-pound bag of flour went from about $20 to more than $50.

"The price of goods increased so drastically that we couldn't ask folks to pay what it cost to make the products," Carbaugh said.

Their fortunes bottomed out in June, when they filed for Chapter 13 bankruptcy protection.

"We worked as hard as we could for as long as we could," Carbaugh said of their failed ventures. " . . . Some of life's lessons aren't so easily learned, but we learned our lesson."

The result is a lot of personal pain and shattered lives. In the Boston area last week a woman committed suicide before her house was going to be reposessed.

US housing slump “without precedent”: foreclosures up 121 percent over 2007

David Walsh

26 July 2008

Foreclosures in the US continued to climb in the second quarter of 2008, experts acknowledge that the current housing slump is “without precedent” in the modern era, and the resulting stress is taking both an economic and emotional toll: a 53-year-old Massachusetts woman committed suicide July 22 only hours before her family’s home was to be put up for auction.

In the three-month period April through June, some 740,000 foreclosure filings were recorded in the US, an increase of 14 percent over the first quarter and 121 percent over the same period in 2007. According to RealtyTrac, one in every 171 US households received a filing, which includes notices of default, auction sale notices and bank repossessions.

The banks took back some 220,000 homes in the second quarter (and 370,000 in the first six months of the year) and there are presently 18.6 million homes in the country standing empty, the highest number in history. The number of vacant houses has jumped nearly 7 percent in the last year.

California’s Central Valley “remains ground zero” for foreclosure filings, as CNNMoney notes, with one in every 25 houses in Stockton affected, for example. Riverside-San Bernardino, east of Los Angeles, had the second highest rate with one filing for every 32 households. Las Vegas, Nevada and Bakersfield and Sacramento, California were the others among the top five regions.

California as a whole witnessed another 203,000 foreclosures; Nevada had the highest rate, one in every 43 households. Phoenix, Arizona saw a 534 percent increase in foreclosures in the first half of 2008. Its west and southwest sides had increases of 700 percent or more.

Outside the Sun Belt, Detroit is suffering the most of any major center, with one filing for every 66 homes in the second quarter. In Ohio, Toledo (one in 92), Akron (one in 93) and Cleveland (one in 108) have also been hit very hard.

RealtyTrac, the Irvine, California-based data company, reported that 48 of the 50 states and 95 of 100 major city regions witnessed year-over-year increases in foreclosure activity.

The firm has doubled the projected number of foreclosures in 2008 to about 2.5 million.

Previously foreclosed homes are now making up a growing percentage of existing home sales in some areas. In San Joaquin and Merced counties in California, seven in ten existing-home sales in the second quarter involved properties that had experienced foreclosure in the previous year. Foreclosed houses and condominiums made up 41 percent of existing-home sales in California in April, May and June.

The National Association of Realtors reported Thursday that sales of existing homes in June were lower than expected and had hit their lowest level in a decade. Sales by homeowners declined last month to a yearly rate of 4.86 million, down 2.6 percent from the 4.99 million annual rate in May. This is slowest pace since the first three months of 1998.

The existing home sales rate is down 15.5 percent from June 2007. Economists had predicted sales at an annual rate of 4.95 million.

The median price for a house sold in June 2008 was down 6.1 percent from one year earlier.

Despite lower house prices, mortgages rates are increasing, so that “the total mortgage price is under upward pressure,” notes CNNMoney, further discouraging sales. The 30-year fixed rate mortgage rose to 6.63 percent in the week ending July 24, up from 6.26 percent the week before.

Bill Gross, manager of the world’s largest bond fund at Pacific Investment Management, estimates that as many as 25 million US homeowners risk owing more than the values of their homes, a condition known as “negative equity.” This will lead to further foreclosures and widespread financial hardship. The bill currently being passed in Congress may assist at most 400,000 homeowners, according to the claims of its own advocates. In any event, Brian Bethune, an economist at Global Insight, points out that while the bill “has some very positive elements ... it would be very easy to negate those elements if mortgage rates keep rising.”

Gross of Pacific Investment estimates that financial firms have already suffered $467 billion in credit losses and asset writedowns. He argues that a total of $5 trillion worth of mortgage loans are in “risky asset” categories, and that “nearly [$1 trillion] of cumulative losses will finally mark the gravestone of this housing bubble.” If financial firms write down this massive amount, it will result in sharply reduced bank lending and produce a fire sale of assets.

A special commentary prepared by the Wachovia Bank’s Economics Group, “How Far Will Housing Prices Fall?” released July 14, revealed the current perplexity of the banking and financial experts. The report noted: “We are repeatedly asked how far housing prices will fall and when home prices will bottom out. The answers to these questions are complicated. The current housing slump is without precedent, both in terms of breadth and magnitude.”

According to the National Association of Realtors, the authors explain, the median price for an existing home “has fallen 6.8 percent over the past year and has been down on a year-to-year basis for the past 22 months. Prior to the recent string of declines, the median price of an existing home had never declined for more than two months in a row, except once back in 1990.”

Wachovia’s analysts tentatively estimate that housing prices will ultimately have dropped anywhere from 22 to 29 percent from their peak in 2005, a massive decline in the value of the only significant asset most American families own.

Impending foreclosure led to suicide

Knight Ridder’s Washington bureau noted July 20, “For many homeowners, the deep housing slump feels like a drop off a skyscraper. Every time another 15 floors have passed, there seems to be more room to fall.”

It seems to safe to predict that the suicide of Carlene Balderrama in Taunton, Massachusetts, southwest of Boston, will not be the last such tragedy produced by the housing slump.

The distraught woman, mother of one son, shot herself Tuesday afternoon after sending a fax to her mortgage company alerting them of her intention. The company was planning to sell her foreclosed home at 5 pm.

Taunton Police Chief Raymond O’Berg read a portion of the fax to the media: “By the time you foreclose on my house I’ll be dead.” In a suicide note, she asked her family to use the life insurance money to pay off the debt.

Horribly, Balderrama’s husband, a plumber, arrived home from work to discover police with his wife’s corpse, unaware of the impending auction. “He told us she handled all the finances,” Police Chief O’Berg said. “He had no idea the house was being foreclosed on.” Potential buyers also arrived while the dead woman’s body was still inside the home.

The media reports that since John Balderrama bought the $232,000 three-bedroom house in Taunton in 2002, he had attempted to file for bankruptcy three times, and the mortgage company had twice launched foreclosure proceedings. Balderrama was earning about $95,000 a year as a plumber. He said that in her suicide note his wife explained “that it got overwhelming for her.”

O’Berg told the media, “It is a tragedy ... There’s victims all around in this ... Something’s wrong with the system when you have working people being foreclosed on.” The housing crunch, the police chief said, “is inflicting real pain on middle-class America. Put yourself in her shoes. You handle the finances, and you’re hiding everything from family. It’s a lot of pressure.”

WHSM television reported, “Neighbors said it is a sign of the times.”

Bruce Marks, chief executive of the Neighborhood Assistance Corporation of America, told the Boston Globe that it was not uncommon for homeowners to contemplate suicide when they were not able to keep up their mortgage payments.

“What gets us so angry is that people blame themselves,” Marks observed to the newspaper. “They can’t see past their sense of responsibility to see the responsibility and the predatory nature of these lenders. The fact of the matter is, unless something dramatic happens, there’s going to be more and more people like her taking their lives.”

Emails from readers posted by the Taunton Call about the episode provide some indication of popular sentiment.

Wrote one reader: “My heart goes out to this family. How tragic that she felt that she needed to take her life. Mortgage companies are so heartless that I am sure they still care more about auctioning off this house than the family of this poor woman. I am sure buyers will be lined up tomorrow. What a very sad sign of the times!”

Another commented: “I have pleaded in the past with my mortgage company to work with me on my rates because I was stupid not to read the whole 10 thousand pages when I bought my house and now I’m stuck with a mortgage that will go up every 6 months. I’m on my way to foreclosure and I don’t know where to go as a single parent with 3 kids. A mortgage company shouldn’t feel sorry for people, but have a heart if someone is trying the hardest to pay the mortgage—then give them a little time.”

A third wrote: “Most people who read this article will probably say to themselves ‘of course they foreclosed the house, it’s the law, they had too.’ The sad truth is that they are right because that is how the world works. This article should be an eye-opener to anyone who reads it. It clearly shows how disgusting and ridiculous the system of government we live under is. Just the fact that people are driven to suicide simply because of ‘financial pressure’ is horrible. In America people are supposed to have a right to life, liberty and the pursuit of happiness, but this story revokes all those rights. Situations like these disgrace the good intentions that the fathers of this country once fought for. I see this as banks (and other money collecting companies) having the right to take from clients even when it may result in death.”

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Monday, July 21, 2008

Signs of the Economic Apocalypse, 7-21-08


Gold closed at 958.00 dollars an ounce Friday, down 0.3% from $960.60 for the week. The dollar closed at 0.6312 euros Friday, up 0.6% from 0.6276 at the close of the previous week. That put the euro at 1.5842 dollars compared to 1.5934 the week before. Gold in euros would be 604.72 euros an ounce, up 0.3% from 602.86 at the close of the previous week. Oil closed at 128.82 dollars a barrel Friday, down 12.5% from $144.98 for the week. Oil in euros would be 81.32 euros a barrel, down 11.9% from 90.99 at the close of the Friday before. The gold/oil ratio closed at 7.44, up 12.2% from 6.63 for the week. In U.S. stocks, the Dow closed at 11,496.57 Friday, up 3.6% from 11,100.54 at the close of the previous Friday. The NASDAQ closed at 2,282.78 Friday, up 1.7% from 2,245.38 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.09% Friday, up 14 basis points from 3.95 for the week.

Oil prices fell sharply last week on fears of serious recession as well as signs that the U.S. is prepared to cut a deal with Iran. The media gave lots of coverage to the former and very little to the latter. After years of saber rattling, the Bush administration sent its third-ranking diplomat to Geneva to meet with the Iranian diplomat in charge of the nuclear program negotiations. It was also revealed that the U.S. is setting up an “interest section” in Teheran for the first time since 1979. That is an office that represents a country’s interests when that country doesn’t officially recognize the other.

What seems to be happening is that the old U.S. establishment has decided to cut its losses in Iraq by arranging a face-saving force reduction with help from Iran so that it can shift military resources to the war in Afghanistan. The war against the Taliban is going badly. Note also that the Taliban is an enemy of Iran. The fact that the establishment has forced Bush to do this will provide cover for Obama who has been attacked by Neocons and Zionists for advocating talking with Iran. Now he can say that the process was started by Bush, the best friend the Ziocons ever had.

The good news for the economy in all this is that we have a chance of having only a severe recession/depression instead of a complete collapse. If the United States can behave itself a bit more internationally and the banks and consumers ease up on some of the more obscene excesses, they might let Americans keep eating. As the International Herald Tribune put it, the U.S. may be too big to fail:

Is America too big to fail?

Peter S. Goodman

Sunday, July 20, 2008

NEW YORK: In the narrative that has governed American commercial life for the last quarter-century, saving companies from their own mistakes was not supposed to be part of the government's job description. Economic policymakers in the United States took swaggering pride in the cutthroat but lucrative form of capitalism that was supposedly indigenous to their frontier nation.

Through this uniquely American lens, saving businesses from collapse was the sort of thing that happened on other shores, where sentimental commitments to social welfare trumped sharp-edged competition. Weak-kneed European and Asian leaders were too frightened to endure the animal instincts of a real market, the story went. So they intervened time and again, using government largess to lift inefficient firms to safety, sparing jobs and limiting pain but keeping their economies from reaching full potential.

There have been recent interventions in America, of course - the taxpayer-backed bailout of Chrysler in 1979, and the savings and loan rescue of 1989. But the first happened under Jimmy Carter, a year before Americans embraced Ronald Reagan and his passion for unfettered markets. And the second was under George H.W. Bush, who did not share that passion.

So it made for a strange spectacle last weekend as the current Bush administration, which does cast itself in the Reagan mold, hastily prepared a bailout package to offer the government-sponsored mortgage companies, Fannie Mae and Freddie Mac. The reasoning behind this rescue effort - like the reasoning behind the government-induced takeover of Bear Stearns by JPMorgan Chase just a month before - sounded no different from that offered in defense of many a bailout in Japan and Europe:

The mortgage giants were too big to be allowed to fail.

Big indeed. Together, Fannie and Freddie own or guarantee nearly half of the nation's $12 trillion worth of home mortgages. If they collapse, so may the whole system of finance for American housing, threatening a most unfortunate string of events: First, an already plummeting real estate market might crater. Then the banks that have sunk capital into American homes would slip deeper into trouble. And the virus might spread globally.

The central banks of China and Japan are on the hook for hundreds of billions of dollars worth of Fannie's and Freddie's bonds - debts they took on assuming that the two companies enjoyed the backing of the American government, argues Brad Setser, an economist at the Council on Foreign Relations.

Commercial banks from South Korea to Sweden hold investments linked to American mortgages. Their losses would mount if American homeowners suddenly couldn't borrow. The global financial system could find itself short of capital and paralyzed by fear, hobbling economic growth in many lands.

Nobody with a meaningful office in Washington was in the mood for any of that, so the rescue nets were readied. The U.S. Treasury secretary, Henry Paulson Jr., announced that the government was willing to use taxpayer funds to buy shares in Fannie and Freddie. The chairman of the Federal Reserve, Ben Bernanke, said the central bank would lend them money.

The details were up in the air as the week ended, but some sort of bailout offer was on the table - one that could ultimately cost hundreds of billions of dollars. Whatever the dent to national bravado, or to the free-enterprise ideology, the phrase "too big to fail" suddenly carried an American accent.

"Some institutions really are too big to fail, and that's the way it is," said Douglas Elmendorf, a former Treasury and Federal Reserve economist who is now at the Brookings Institution in Washington. "There are no good options."

Still, there are ironies. Since World War II, the United States has been the center of global finance, and it has used that position to virtually dictate the conditions under which many other nations - particularly developing countries - can get access to capital. Letting weak companies fail has been high on the list.

Paulson, who announced the bailout, made his name as chief executive of Goldman Sachs, the Wall Street investment giant, where he pried open new markets to foreign investment. As Treasury secretary, he has served as chief proselytizer for American-style capitalism, counseling the tough love of laissez-faire. In particular, he has leaned on China to let the value of its currency float freely, and has criticized its banks for shoveling money to companies favored by the Communist Party in order to limit joblessness and social instability.

…Today, among strict adherents of laissez-faire economics, the offer to bail out Fannie and Freddie is already being criticized as a trip down the Japanese path of putting off immediate pain while loading up the costs further along.

For one thing, this argument goes, taxpayers - who now confront plunging house prices, a drop on Wall Street and soaring costs for food and fuel - will ultimately pay the costs. To finance a bailout, the government can either pull more money from citizens directly, or the Fed can print more money - a step that encourages further inflation.

"They are going to raise the cost of living for every American," said Peter Schiff, president of Euro Pacific Capital, a Connecticut-based brokerage house that focuses on international investments. "The government is debasing the value of our money. Freddie and Fannie need to fail. They are too big to save."

Using public money to spare Fannie and Freddie would increase the public debt, which now exceeds $9.4 trillion. The United States has been financing itself by leaning heavily on foreigners, particularly China, Japan and the oil-rich nations of the Persian Gulf. Were they to become worried that the United States might not be able to pay up, that would force the Treasury to offer higher rates of interest for its next tranche of bonds. And that would increase the interest rates that Americans must pay for houses and cars, putting a drag on economic growth.

Meanwhile, as American debts swell and foreigners hold more of it, nervousness grows that, someday, this arrangement will end badly. The dollar has been declining in value against other currencies. Some foreigners have begun to hedge their bets by buying more euros.

"Obviously, this is going to come to an end," Schiff said. "Foreigners are not charitable organizations, and they're going to demand that we pay them back."

No single country owning large amounts of dollar-based investments is inclined to dump them abruptly; nobody aims to start a panic. But fears have begun to grow that one day a country may get spooked that another is about to dump its dollars - and that could trigger pre-emptive panic selling.

"Foreigners could decide it's just not worth the risk and sell," says Andrew Tilton, an economist at Goldman Sachs. "The really dire scenarios have become a lot more likely than they were a year or two ago."

Still, as Tilton and others are aware, one fundamental reality continues to offer assurances that foreigners will still buy American debt: In the global economy of the moment, the United States itself is too big to fail.

The logic for that assurance goes like this: The American consumer has for decades served as the engine of world commerce, using borrowed cash to snap up the accouterments of modern living - clothes and computers and cars now manufactured, in whole or in part, in factories from Asia to Latin America. Eliminate the American wherewithal to shop, and the pain would ripple out to multiple shores.

Globalization, in other words, allowed China and Japan to amass the fortunes they have been lending to the United States.

But globalization also emboldened American capitalists to take huge risks they might have otherwise avoided - like borrowing to erect forests of unsold homes from California to Florida, delivering the speculative disaster of the day. They were operating with bedrock confidence that money would never run out. Someone would always buy American debt, delivering more cash for the next go.

And this same interconnectedness appears to have reassured regulators in Washington about the health of the American financial system, as they declined to intervene against highly speculative lending during the real estate boom. Mortgages were being distributed to investors around the globe, and so were the risks, the regulators reasoned. Anyone who bought into that risk would have a strong interest in seeing that the American financial system stayed upright.

In other words, in the estimation of people in control of money, the United States cannot be allowed to collapse, just as Fannie and Freddie cannot be allowed to fail. Too much is riding on their survival.

The central truth of that logic still seems to be apparent as the Treasury keeps finding takers for American debt.

So the government offers its rescue of the mortgage companies, and foreigners keep stocking the government's coffers. "They don't want the U.S. to go into the worst downturn since the Depression," Tilton says.

But all the while, the debt mounts along with the costs of an ultimate day of reckoning. Debate grows about the wisdom of leaning on foreign credit, and about how much longer Americans will retain the privilege of spending and investing money that isn't really theirs.

Bailouts amount to mortgaging the future to stave off the wolf howling at the door. The likelihood of a painful reckoning is diminished, while the costs of a reckoning - should one come - are increased.

The costs are getting big.

So while world money has an interest in keeping the United States’ financial system afloat with just enough consumer spending to keep global production from completely collapsing, hard times are still ahead for people in the United States. The New York Times tells us so:

Uncomfortable Answers to Questions on the Economy

Peter S. Goodman

July 19, 2008

You have heard that Fannie and Freddie, their gentle names notwithstanding, may cripple the financial system without a large infusion of taxpayer money. You have gleaned that jobs are disappearing, housing prices are plummeting, and paychecks are effectively shrinking as food and energy prices soar. You have noted the disturbing talk of crisis hovering over Wall Street.

Something has clearly gone wrong with the economy. But how bad are things, really? And how bad might they get before better days return? Even to many economists who recently thought the gloom was overblown, the situation looks grim. The economy is in the midst of a very rough patch. The worst is probably still ahead.

Job losses will probably accelerate through this year and into 2009, and the job market will probably stay weak even longer. Home prices will probably keep falling, shrinking household wealth and eroding spending power.

“The open question is whether we’re in for a bad couple of years, or a bad decade,” said Kenneth S. Rogoff, a former chief economist at the International Monetary Fund, now a professor at Harvard.

Is this a recession?

Officially, no. The economy is not in recession until a panel at a private institution called the National Bureau of Economic Research says so. Unofficially, many economists think a recession started six or seven months ago, even as the economy has continued to expand — albeit at a tepid pace.

Many assume that if the economy expands at all, then it isn’t a recession, but that’s not true. The bureau defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months.” If enough people lose their jobs, factories stop making things, stores stop selling things, and less money lands in people’s pockets, it is probably a recession.

Whatever it is called, it is a painful time for tens of millions of people. Indeed, this may turn out to be the most wrenching downturn since the two recessions in the early 1980s; almost surely worse than the recession that ended the technology bubble at the beginning of this decade; perhaps worse than the downturn of the early 1990s that followed the last dip in real estate prices.

But, despite what some doomsayers now proclaim, this is not the Great Depression, when unemployment spiked to 25 percent and millions of previously working people woke up in shantytowns. Not by any measure, even as your neighbors make cryptic remarks above dusting off lessons passed down from grandparents about how to turn a can of beans into a family meal.

How bad is housing?

Bad in many markets, awful in some, and still O.K. in a few.

The downturn has its roots in the real estate frenzy that turned lonely Nevada ranches into suburban ranch homes and swampland in Florida into condominiums. Speculators drove home prices beyond any historical connection to incomes. Gravity did the rest. After roughly doubling in value from 2000 to 2005, home prices have fallen about 17 percent — and more like 25 percent in inflation-adjusted terms — according to the widely watched Case-Shiller index.

Even so, most economists think house prices must fall an additional 10 to 15 percent to get back to reality. One useful measure is the relationship between the costs of buying and renting a home. From 1985 to 2002, the average American home sold for about 14 times the annual rent for a similar home, according to Moody’s By early 2006, home prices ballooned to 25 times rental prices. Since then, the ratio has dipped back to about 20 — still far above the historical norm.

With mortgages now hard to obtain and speculation no longer attractive, arithmetic has replaced momentum as the guiding force for housing prices. The fundamental equation points down: Even as construction grinds down, there are still many more houses on the market than there are people to buy them, and more on the way as more homeowners slip into foreclosure.

By the reckoning of, enough houses are on the market to satisfy demand for the next two-and-a-half years without building a single new one.

The time it takes to sell a newly completed house has expanded from an average of four months in 2005 to about nine months, according to analysis by Dean Baker, co-director of the Center for Economic and Policy Research.

And many sales are falling through — more than 30 percent in some parts of California and Florida — as buyers fail to secure financing, exacerbating the glut of homes, Mr. Baker said.

No wonder that in Los Angeles, San Francisco, Phoenix and Las Vegas, house prices have in recent months declined at annual rates of more than 33 percent.

When will banks revive?

So far, they have written off more than $300 billion in loans. Many experts now predict the toll will rise to $1 trillion or more — a staggering sum that could cripple many institutions for years.

Back when home prices were multiplying, banks poured oceans of borrowed money into real estate loans. Unlike the dot-com companies at the heart of the last speculative investment bubble, the new gold rush was centered on something that seemed unimpeachably solid — the American home.

But the whole thing worked only as long as housing prices rose. Falling prices landed like a bomb. Homeowners fell behind on their loans and could not qualify for new ones: There was no value left in their house to borrow against. As millions of people defaulted, the banks confronted enormous losses in a bloody period of reckoning.

In March, the Federal Reserve helped engineer a deal for JPMorgan Chase to buy troubled investment bank Bear Stearns. Many assumed the worst was over. But, this month, the open distress of Fannie Mae and Freddie Mac — two huge, government sponsored institutions that together own or guarantee nearly half of the nation’s $12 trillion in outstanding mortgages — sent a signal that more ugly surprises may lie in wait.

To calm markets, the government last weekend hurriedly put together a rescue package for Fannie and Freddie that, if used, could cost as much as $300 billion. The urgent need for a rescue — together with another round of billion-dollar write-offs on Wall Street — has unnerved economists and investors.

“I was a relative optimist, but I’ve certainly become more pessimistic,” said Alan S. Blinder, an economist at Princeton, and a former vice chairman of the board of governors at the Federal Reserve. “The financial system looks substantially worse now than it did a month ago. If the Freddie and Fannie bailout were to fail, it could get a hell of a lot worse. If we get more bank failures, we have the possibility of seeing more of these pictures of people standing in line to pull their money out. That could really scare consumers.”

In one respect, Mr. Blinder added, this is like the Great Depression. “We haven’t seen this kind of travail in the financial markets since the 1930s,” he said.

More than two years ago, Nouriel Roubini, an economist at the Stern School of Business at New York University, said that the housing bubble would give way to a financial crisis and a recession. He was widely dismissed as an attention-seeking Chicken Little. Now, Mr. Roubini says the worst is yet to come, because the account-squaring has so far been confined mostly to bad mortgages, leaving other areas remaining — credit cards, auto loans, corporate and municipal debt.

Mr. Roubini says the cost of the financial system’s losses could reach $2 trillion. Even if it’s closer to $1 trillion, he adds, “we’re not even a third of the way there.”

Where will the banks raise the huge sums needed to replenish the capital they have apparently lost? And what will happen if they cannot?

The answers to these questions are unknown, an unsettling void that holds much of the economy at a standstill.

“We’re in a dangerous spot,” said Andrew Tilton, an economist at Goldman Sachs. “The big threat is more capital losses.”

Banks are a crucial piece of the economy’s arterial system, steering capital where it is needed to fuel spending and power growth. Now, they are holding tight to their dollars, starving businesses of loans they might use to expand, and depriving families of money they might use to buy houses and fill them with furniture and appliances.

From last June to this June, commercial bank lending declined more than 9 percent, according to an analysis of Federal Reserve data by Goldman Sachs.

“You have another wave of anxiety, another tightening of credit,” said Robert Barbera, chief economist at the research and trading firm ITG. “The idea that we’ll have a second half of the year recovery has gone by the boards.”

Is my job safe?

Economic slowdowns always mean job losses. Unemployment already has risen, and almost certainly will increase more.

The first signs of distress emerged in housing. Construction companies, real estate agencies, mortgage brokers and banks began laying people off. Next, jobs started being cut at factories making products linked to housing, from carpets and furniture to lighting and flooring.

But as the real estate bust spilled over into the broader economy, depleting household wealth, the impacts rippled out to retailers, beauty parlors, law offices and trucking companies, inflicting cutbacks throughout the economy, save for health care, farming and energy. Over the last six months, the economy has shed 485,000 private sector jobs, according to the Labor Department. Many people have seen hours reduced.

The unemployment rate still remains low by historical standards, at 5.5 percent. And so far, the job losses — about 65,000 a month this year — do not approach the magnitude of those seen in past downturns, particularly the twin recessions at the beginning of the 1980s, when the economy shed upward of 140,000 jobs a month and the unemployment rate exceeded 10 percent.

But Goldman Sachs assumes unemployment will reach 6.5 percent by the end of 2009, which translates into several hundred thousand more Americans out of work.

These losses are landing on top of what was, for most Americans, a remarkably weak period of expansion. From 1992 to 2000 — as the technology boom catalyzed spending and hiring — the economy added more than 22 million private sector jobs. Over the last eight years, only 5 million new jobs have been added.

The loss of work is hitting Americans along with an assortment of troubles — gasoline prices in excess of $4 a gallon, over all inflation of about 5 percent, and declining wages.

“In every dimension, people are worse off than they were,” said Mr. Roubini, the New York University economist.

Are consumers done?

That is a major worry.

The fate of the economy now rests on the shoulders of the American consumer, whose spending amounts to 70 percent of all economic activity.

When people go to the mall and buy televisions and eat out, their money circulates through the economy. When they tighten their belts, austerity ripples out and chokes growth.

Through the years of the housing boom, many Americans came to treat their homes like automated teller machines that never required a deposit. They harvested cash through sales, second mortgages and home equity lines of credit — an artery of finance that reached $840 billion a year from 2004 to 2006, according to work by the economists James Kennedy and Alan Greenspan, the former Federal Reserve chairman. That allowed Americans to live far in excess of what they brought home from work.

But by the first three months of this year, that flow had constricted to an annual rate of about $200 billion.

Average household debt has swelled to 120 percent of annual income, up from 60 percent in 1984, according to the Federal Reserve.

And now the banks are turning off the credit taps.

“Credit is going to remain tight for a time potentially measured in years,” said Mr. Tilton, the Goldman Sachs economist.

This is the landscape that has so many economists convinced that consumer spending must dip, putting the squeeze on the economy for several years.

“The question is, will it get as bad as the 1970s?” asked Mr. Rogoff, recalling an era of spiking gas prices and double-digit inflation.

Long term, Americans may have no choice but to spend less, save more and reduce debts — in short, to live within their means.

“We’re getting a lot of the adjustment and it hurts,” said Kristin Forbes, a former member of the Council of Economic Advisers under President George W. Bush, and now a scholar at M.I.T.’s Sloan School of Management. “But it’s an adjustment we’re going to have to make.”

Who’s to blame?

There is plenty to go around.

In the estimation of many economists, it starts with the Federal Reserve. The central bank lowered interest rates following the calamitous end of the technology bubble in 2000, lowered them more after the terrorist attacks of Sept. 11, 2001, and then kept them low, even as speculators began to trade homes like dot-com stocks.

Meanwhile, the Fed sat back and watched as Wall Street’s financial wizards engineered diabolically complicated investments linked to mortgages, generating huge amounts of speculative capital that turned real estate into a conflagration.

“At the end of this movie, it’s clear that the Fed will have to care about excesses,” Mr. Barbera said.

Prices multiplied as many homeowners took on more property than they could afford, lured by low introductory interest rates that eventually reset higher, sending many people into foreclosure.

Mortgage brokers netted commissions as they lent almost indiscriminately, offering exotically lenient terms — no money down, no income or job required. Wall Street banks earned billions selling risky mortgage-linked securities around the world, aided by ratings agencies that branded them solid.

Through it all, a lot of ordinary Americans borrowed a lot more money then they could afford to pay back, running up enormous credit card bills and borrowing against the value of their homes. Now comes the day of reckoning.

So I guess it’s the fault of “ordinary Americans” and Alan Greenspan. And the “painful adjustments” will have to be made by “us” says Kristin Forbes of Bush’s Council of Economic Advisors and MIT’s Sloan School. Somehow, I don’t think people named Forbes will find it as painful as us ordinary types.

People want to know what to do. Where to put their money, how to arrange their lives, etc. There are many websites with plans for how you can “profit from the coming collapse.” Nice. Similarly, the survivalist method, while containing some good suggestions, always seemed a bit unrealistic, not to mention selfish. In contrast, Charles Hugh Smith outlines the Taoist method, one that actually takes into account real human nature and social bonds:

The Art of Survival, Taoism and the Warring States

Charles Hugh Smith

June 27, 2008

I'm not trying to be difficult, but I can't help cutting against the grain on topics like surviving the coming bad times when my experience runs counter to the standard received wisdom.

A common thread within most discussions of surviving bad times--especially really bad times--runs more or less like this: stockpile a bunch of canned/dried food and other valuable accoutrements of civilized life (generators, tools, canned goods, firearms, etc.) in a remote area far from urban centers, and then wait out the bad times, all the while protecting your stash with an array of weaponry and technology (night vision binocs, etc.)

Now while I respect and admire the goal, I must respectfully disagree with just about every assumption behind this strategy. Once again, this isn't because I enjoy being ornery (please don't check on that with my wife) but because everything in this strategy runs counter to my own experience in rural, remote settings.

You see, when I was a young teen my family lived in the mountains. To the urban sophisticates who came up as tourists, we were "hicks" (or worse), and to us they were "flatlanders" (derisive snort).

Now the first thing you have to realize is that we know the flatlanders, but they don't know us. They come up to their cabin, and since we live here year round, we soon recognize their vehicles and know about how often they come up, what they look like, if they own a boat, how many in their family, and just about everything else which can be learned by simple observation.

The second thing you have to consider is that after school and chores (remember there are lots of kids who are too young to have a legal job, and many older teens with no jobs, which are scarce), boys and girls have a lot of time on their hands. We're not taking piano lessons and all that urban busywork. And while there are plenty of pudgy kids spending all afternoon or summer in front of the TV or videogame console, not every kid is like that.

So we're out riding around. On a scooter or motorcycle if we have one, (and if there's gasoline, of course), but if not then on bicycles, or we're hoofing it. Since we have time, and we're wandering all over this valley or mountain or plain, one way or another, then somebody will spot that trail of dust rising behind your pickup when you go to your remote hideaway. Or we'll run across the new road or driveway you cut, and wander up to see what's going on. Not when you're around, of course, but after you've gone back down to wherever you live. There's plenty of time; since you picked a remote spot, nobody's around.

Your hideaway isn't remote to us; this is our valley, mountain, desert, etc., all 20 miles of it, or what have you. We've hiked around all the peaks, because there's no reason not to and we have a lot of energy. Fences and gates are no big deal, (if you triple-padlock your gate, then we'll just climb over it) and any dirt road, no matter how rough, is just an open invitation to see what's up there. Remember, if you can drive to your hideaway, so can we. Even a small pickup truck can easily drive right through most gates (don't ask how, but I can assure you this is true). If nobody's around, we have all the time in the world to lift up or snip your barbed wire and sneak into your haven. Its remoteness makes it easy for us to poke around and explore without fear of being seen.

What flatlanders think of as remote, we think of as home. If you packed in everything on your back, and there was no road, then you'd have a very small hideaway--more a tent than a cabin. You'd think it was safely hidden, but we'd eventually find it anyway, because we wander all over this area, maybe hunting rabbits, or climbing rocks, or doing a little fishing if there are any creeks or lakes in the area. Or we'd spot the wisp of smoke rising from your fire one crisp morning, or hear your generator, and wonder who's up there. We don't need much of a reason to walk miles over rough country, or ride miles on our bikes.

…All of which is to say that the locals will know where your hideaway is because they have lots of time to poke around. Any road, no matter how rough, might as well be lit with neon lights which read, "Come on up and check this out!" If a teen doesn't spot your road, then somebody will: a county or utility employee out doing his/her job, a hunter, somebody. As I said, the only slim chance you have of being undetected is if you hump every item in your stash on your pack through trailess, roadless wilderness. But if you ever start a fire, or make much noise, then you're sending a beacon somebody will eventually notice.

The Taoists developed their philosophy during an extended era of turmoil known as the Warring States period of Chinese history. One of their main principles runs something like this: if you're tall and stout and strong, then you'll call attention to yourself. And because you're rigid--that is, what looks like strength at first glance--then when the wind rises, it snaps you right in half.

If you're thin and ordinary and flexible, like a willow reed, then you'll bend in the wind, and nobody will notice you. You'll survive while the "strong" will be broken, either by unwanted attention or by being brittle.

…The flatlander protecting his valuable depot is on the defensive, and anyone seeking to take it away (by negotiation, threat or force) is on the offensive. The defense can select the site for proximity to water, clear fields of fire, or what have you, but one or two defenders have numerous disadvantages. Perhaps most importantly, they need to sleep. Secondly, just about anyone who's plinked cans with a rifle and who's done a little hunting can sneak up and put away an unwary human. Unless you remain in an underground bunker 24/7, at some point you'll be vulnerable. And that's really not much of a life--especially when your food supplies finally run out, which they eventually will. Or you run out of water, or your sewage system overflows, or some other situation requires you to emerge.

So let's line it all up. Isn't a flatlander who piles up a high-value stash in a remote area with no neighbors within earshort or line of sight kind of like a big, tall brittle tree? All those chains and locks and barbed-wire fencing and bolted doors just shout out that the flatlander has something valuable inside that cabin/bunker/RV etc.

Now if he doesn't know any better, then the flatlander reckons his stash is safe. But what he's not realizing if that we know about his stash and his vehicle and whatever else can be observed. If some locals want that stash, then they'll wait for the flatlander to leave and then they'll tow the RV off or break into the cabin, or if it's small enough, disassemble it and haul it clean off. There's plenty of time, and nobody's around. That's pretty much the ideal setting for leisurely thieving: a high-value stash of goodies in a remote area accessible by road is just about perfect.

Let's say things have gotten bad, and the flatlander is burrowed into his cabin. Eventually some locals will come up to visit; in a truck if there's gas, on foot if there isn't. We won't be armed; we're not interested in taking the flatlander's life or goodies. We just want to know what kind of person he is. So maybe we'll ask to borrow his generator for a town dance, or tell him about the church food drive, or maybe ask if he's seen so-and-so around.

Now what's the flatlander going to do when several unarmed men approach? Gun them down? Once he's faced with regular unarmed guys, he can't very well conclude they're a threat and warn them off. But if he does, then we'll know he's just another selfish flatlander. He won't get any help later when he needs it; or it will be minimal and grudging. He just counted himself out.

…So creating a high-value horde in a remote setting is looking like just about the worst possible strategy in the sense that the flatlander has provided a huge incentive to theft/robbery and also provided a setting advantageous to the thief or hunter.

If someone were to ask this "hick" for a less risky survival strategy, I would suggest moving into town and start showing a little generosity rather than a lot of hoarding. If not in town, then on the edge of town, where you can be seen and heard.

I'd suggest attending church, if you've a mind to, even if your faith isn't as strong as others. Or join the Lions Club, Kiwanis or Rotary International, if you can get an invitation. I'd volunteer to help with the pancake breakfast fundraiser, and buy a couple tickets to other fundraisers in town. I'd mow the old lady's lawn next door for free, and pony up a dollar if the elderly gentleman in line ahead of me at the grocery store finds himself a dollar light on his purchase.

If I had a parcel outside town that was suitable for an orchard or other crop, I'd plant it, and spend plenty of time in the local hardware store and farm supply, asking questions and spreading a little money around the local merchants. I'd invite my neighbors into my little plain house so they could see I don't own diddly-squat except some second-hand furniture and a crappy old TV. And I'd leave my door open so anyone could see for themselves I've got very little worth taking.

I'd have my tools, of course; but they're scattered around and old and battered by use; they're not shiny and new and expensive-looking, and they're not stored all nice and clean in a box some thief could lift. They're hung on old nails, or in the closet, and in the shed; a thief would have to spend a lot of time searching the entire place, and with my neighbors looking out for me, the thief is short of the most important advantage he has, which is time.

If somebody's desperate enough or dumb enough to steal my old handsaw, I'll buy another old one at a local swap meet. (Since I own three anyway, it's unlikely anyone would steal all three because they're not kept together.)

My valuable things, like the water filter, are kept hidden amidst all the low-value junk I keep around to send the message there's nothing worth looking at. The safest things to own are those which are visibly low-value, surrounded by lots of other mostly worthless stuff.

I'd claim a spot in the community garden, or hire a neighbor to till up my back yard, and I'd plant chard and beans and whatever else my neighbors suggested grew well locally. I'd give away most of what I grew, or barter it, or maybe sell some at the farmer's market. It wouldn't matter how little I had to sell, or how much I sold; what mattered was meeting other like-minded souls and swapping tips and edibles.

If I didn't have a practical skill, I'd devote myself to learning one. If anyone asked me, I'd suggest saw sharpening and beer-making. You're legally entitled to make quite a bit of beer for yourself, and a decent homebrew is always welcome by those who drink beer. It's tricky, and your first batches may blow up or go flat, but when you finally get a good batch you'll be very popular and well-appreciated if you're of the mind to share.

Saw-sharpening just takes patience and a simple jig; you don't need to learn a lot, like a craftsman, but you'll have a skill you can swap with craftsmen/women. As a carpenter, I need sharp saws, and while I can do it myself, I find it tedious and would rather rebuild your front porch handrail or a chicken coop in exchange for the saw-sharpening.

Pickles are always welcome in winter, or when rations get boring; the Germans and Japanese of old lived on black bread or brown rice and pickled vegetables, with an occasional piece of dried meat or fish. Learning how to pickle is a useful and easy-to-learn craft. There are many others. If you're a techie, then volunteer to keep the network up at the local school; do it for free, and do a good job. Show you care.

Because the best protection isn't owning 30 guns; it's having 30 people who care about you. Since those 30 have other people who care about them, you actually have 300 people who are looking out for each other, including you. The second best protection isn't a big stash of stuff others want to steal; it's sharing what you have and owning little of value. That's being flexible, and common, the very opposite of creating a big fat highly visible, high-value target and trying to defend it yourself in a remote setting.

I know this runs counter to just about everything that's being recommended by others, but if you're a "hick" like me, then you know it rings true. The flatlanders are scared because they're alone and isolated; we're not scared. We've endured bad times before, and we don't need much to get by. We're not saints, but we will reciprocate to those who extend their good spirit and generosity to the community in which they live and in which they produce something of value.

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Monday, July 14, 2008

Signs of the Economic Apocalypse, 7-14-08


Gold closed at 960.60 dollars an ounce Friday, up 2.7% from $935.50 for the week. The dollar closed at 0.6276 euros Friday, down 1.4% from 0.6367 at the close of the previous week. That put the euro at 1.5934 dollars compared to 1.5706 the week before. Gold in euros would be 602.86 euros an ounce, up 1.2% from 595.63 at the close of the previous week. Oil closed at 144.98 dollars a barrel Friday, up 0.6% from $144.18 for the week. Oil in euros would be 90.99 euros a barrel, down 0.9% from 91.80 at the close of the Friday before. The gold/oil ratio closed at 6.63, up 2.2% from 6.49 for the week. In U.S. stocks, the Dow Jones Industrial Average closed at 11,100.54 Friday, down 1.7% from 11,288.54 at the close of the previous Friday. The NASDAQ closed at 2,239.08 Friday, down 0.3% from 2,245.38 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.95%, down three basis points from 3.98 for the week.

Except for the 3% rise in gold against the dollar, market movements weren’t drastic last week. But that doesn’t capture the fear in the markets and in the media that things are close to getting much worse. The collapse of “IndyMac”, the near collapse of Fannie Mae and Freddie Mac (such cute nicknames!) stoked that fear at the end of the past week.

It began on Thursday when the stocks of Fannie Mae and Freddie Mac plummeted. Fannie Mae stands for FNMA or the Federal National Mortgage Association and Freddie Mac stands for FHLMC or the Federal Home Loan Mortgage Corporation. They are both so-called GSE or “Government Sponsored Enterprises.” What does that mean? Well much of the market power of these companies stems from the very ambiguity of those terms. They are publicly traded corporations that are not government owned or run, but their market value has always been propped up by the perception that when push comes to shove the government will bail them out in some way. Push seems to have come to shove over the last several days.

What do they do? In a nutshell they guarantee mortgage debt. $5 trillion of it. Half of all the outstanding mortgage debt in the United States. They also help securitize mortgage debt (bundling thousands of mortgages and selling shares in the bundles, basically). The reason there are two of them is that when the government made Fannie Mae go public in 1968 (it used to be government-run) they also launched Freddie Mac so there would be some competition. According to Wikipedia,
FNMA's primary method for making money is by charging a guarantee fee on loans that it has securitized into mortgage-backed security bonds. Investors, or purchasers of Fannie Mae MBSs, are willing to let Fannie Mae keep this fee in exchange for assuming the credit risk, that is, Fannie Mae's guarantee that the principal and interest on the underlying loan will be paid regardless of whether the borrower actually repays.

There’s the problem. As long as most mortgage holders are paying their mortgages off, the system works fine and Fannie Mae and Freddie Mac help free up lots more money for new mortgages, making house purchasing available and more affordable for people. But they are publicly traded companies. Their stock price in times like these, where it is not at all certain that people will be able to keep paying on their mortgages, can drop fast. If they are guaranteeing what cannot be guaranteed who will guarantee them? The U.S. taxpayers, of course!

But if things get worse, how can even the government guarantee $5 trillion dollars in bad debt?

But we’re getting ahead of ourselves here. On Thursday, stock prices for both companies went into a free-fall:

Fannie, Freddie stocks and bonds plummet

Thursday July 10, 10:18 am ET

Al Yoon

NEW YORK (Reuters) - A firestorm of anxiety over the ability of U.S. mortgage giants Fannie Mae and Freddie Mac to get the capital they need to survive sent their debt and stocks plummeting on Thursday.

Stoking concerns, former St. Louis Federal Reserve President William Poole said the two major U.S. mortgage finance companies were "insolvent" and may need a U.S. government bailout, according to Bloomberg News.

The outlook was so dire that Bush administration officials were meeting with regulators to discuss contingency plans should they be unable to raise funds and support the worst housing market since the Great Depression, according to a report in the Wall Street Journal.

Yield spread premiums for the larger Fannie Mae rose to the highest since the days before the Federal Reserve's orchestrated bailout of Bear Stearns Cos in March.
Shares in both companies plunged to their lowest since 1991.

The government-sponsored enterprises, or GSEs, are expected to need billions of dollars in capital to support their balance sheets to try to stabilize the mortgage market. They found strong demand as they raised some $20 billion since last fall, but the instability in share prices since raises doubts about new investor support.

"This is not an opportune time to have to increase liquidity with the stocks down so much," said Alan Lancz, president of investment advisory firm Alan B. Lancz & Associates in Toledo, Ohio. "These dilutive deals these companies are putting together are just increasing that downward spiral within the financials, not even to mention the confidence in the whole system."

Mounting doubts over the ability of the companies led Deutsche Bank analyst Mustafa Chowdhury, a former Freddie Mac executive, on a Wednesday conference call to float the possibility that share prices could go below $5…

By Friday there was talk of a government bailout. The problem is that in strong bailout scenarios, the stock wouldn’t be worth much (as in the Bear Stearns bailout). So then policymakers had to cool the bailout talk:

Treasuries Fall as Fannie, Freddie Bailout Speculation Eases

Sandra Hernandez and Daniel Kruger

July 11 (Bloomberg) -- Treasuries fell on speculation the government won't have to bail out Fannie Mae and Freddie Mac, easing demand for government debt as a haven from credit-market turmoil.

Government securities extended losses, pushing up the 10- year note's yield the most in almost four months, after President George W. Bush, Treasury Secretary Henry Paulson and Senate Banking Committee Chairman Christopher Dodd damped talk of a government takeover of the mortgage-finance companies.

“We're talking about a near-cataclysmic end-of-the-earth type situation,” said Glen Capelo, a Treasury trader at RBS Greenwich Capital in Greenwich, Connecticut, one of 20 primary dealers that trade with the Federal Reserve. “Now that's been relieved, at least in the short run.”

The two-year note's yield rose 21 basis points, or 0.21 percentage point, to 2.61 percent at 5:14 p.m. in New York, according to BGCantor Market Data. The price of the 2.875 percent security due June 2010 fell 13/32, or $4.06 per $1,000 face amount, to 100 1/2. The 10-year note's yield increased 17 basis points, the most since March 24, to 3.96 percent.

Treasuries extended losses after Reuters reported Fed Chairman Ben S. Bernanke told the mortgage-finance companies they can borrow money from the central bank's discount window. Fed spokeswoman Michelle Smith said there are no discussions about access to direct loans.

Dodd said Fannie Mae and Freddie Mac may have several options for capital and liquidity.

‘A Number of Things’

“There are a number of things, including things like the discount window, that they’re, I know, considering,” Dodd said at a Washington news conference today. “They are certainly examining what other means might be taken in order to shore up a situation should it become necessary.”

Government debt rose earlier this week, pushing yields on two-year notes to a one-month low, on concern Fannie and Freddie will need an infusion of capital to weather the worst housing slump since the Great Depression. The two companies own or guarantee about half of the $12 trillion of U.S. mortgages.

Two-year notes’ yields posted a weekly gain of 7 basis points, with their price falling 1/8, or $1.25 per $1,000 face amount. Yields on 10-year notes declined 1 basis point for the week.

Treasuries began falling today on speculation the government won’t allow the pair of mortgage-finance companies to fail, and on concern a bailout would require the U.S. to sell more debt.

‘Explicit Guarantee’

“The market’s starting to believe the government will make an explicit guarantee on” Fannie Mae and Freddie Mac’s debt, said James Caron, head of U.S. interest-rate strategy at primary dealer Morgan Stanley in New York. “If the government were to make Fannie and Freddie’s guarantee an explicit AAA rating, then that would cause the Treasury to need to raise capital by increasing Treasury supply,” he added.

U.S. government debt is “well within” the guidelines for an AAA rating even if the government is forced to rescue Fannie and Freddie, Moody’s Investors Service said.

“The amount of money required would not be so large that it would make us worry about the U.S. credit rating,” said Steven Hess, vice president and senior credit officer at Moody’s in New York.

Government debt also fell as the extra premium investors demand to own debt issued by Fannie Mae and Freddie Mac decreased, indicating declining perceptions of risk.

Ten-year debt issued by Fannie Mae yielded 0.69 percentage point more than Treasuries of comparable maturity, narrowing the yield gap by 0.19 percentage point from yesterday. The yield difference between Freddie Mac’s 10-year debt and U.S. 10-year notes was 0.75 percentage point, down 0.19 percentage point.

Bets on Fed

Traders increased bets Fed policy makers will keep the target for overnight loans between banks at 2 percent on Aug. 5, futures contracts on the Chicago Board of Trade showed. The chance of no cut in the rate rose to 91 percent from 86 percent yesterday. The rest of the bets are that the Fed will raise the rate a quarter-percentage point to curb inflation.

It’s nice to know that “near-cataclysmic end-of-the-earth type situation” has been avoided, as the bond trader quoted above put it, “at least in the short run.” So what did the government decide to do? On Sunday it was announced that the Federal Reserve will lend Fannie Mae and Freddie Mac as much money as they will need.
US spells out Fannie-Freddie backstop plan

Jeannine Aversa, AP Economics Writer

Sunday, July 13, 2008

WASHINGTON - The Federal Reserve and the U.S. Treasury announced steps Sunday to shore up mortgage giants Fannie Mae and Freddie Mac, whose shares have plunged as losses from their mortgage holdings threatened their financial survival.

The Federal Reserve said it granted the Federal Reserve Bank of New York authority to lend to the two companies "should such lending prove necessary." If the companies did borrow directly from the Fed, they would pay 2.25 percent — the same rate given to commercial banks and Big Wall Street firms.

Secretary Henry Paulson said the Treasury is seeking authority to expand its current line of credit to the two companies should they need to tap it and to make an equity investment in the companies — if needed. Such moves will require congressional approval.

"Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owner companies," Paulson said Sunday. "Their support for the housing market is particularly important as we work through the current housing correction."

The Treasury's plan also seek a "consultative role" for the Federal Reserve in any new regulatory framework eventually decided by Congress for Fannie and Freddie. The Fed's role would be to weigh in on setting capital requirements for the companies.

Fannie Mae and Freddie Mac either hold or back $5.3 trillion of mortgage debt. That's about half the outstanding mortgages in the United States.

The department, the Fed and other regulators worked in close consultation throughout the weekend after investor fears about the companies' finances sent their shares plummeting in trading last week. Paulson is working closely with congressional leaders to advance his plan as soon as possible as one complete package.

The announcement marked the latest move by the government to bolster confidence in the mortgage companies. A critical test of confidence will come Monday morning, when Freddie Mac is slated to auction a combined $3 billion in three- and six-month securities.

Fannie and Freddie were created by the government to provide more Americans the chance to own a home by adding to the available cash banks can loans customers.

A senior Treasury official said any increase in the line of credit — now at $2.25 billion for each company_ would be at the Treasury secretary's discretion. The same would apply to any equity investment made by the government.

The official, who spoke on condition of animosity, also sought to send a calming message about Fannie's and Freddie's financial shape, saying: "There's been no deterioration of the situation since Friday."

If one or both of the companies were to fail, it would wreak havoc on the already fragile financial system and the crippled housing market. The problems would spill over in the national economy, too.

Paulson on Friday said the government's focus was to support the pair "in their current form" without a takeover.

Hoping to bolster confidence, Senate Banking Committee Chairman Chris Dodd, D-Conn., told CNN on Sunday that Fannie and Freddie are financially sound.

"What's important here are facts," Dodd said. "And the facts are that Fannie and Freddie are in sound situation. They have more than adequate capital — in fact, more than the law requires. They have access to capital markets. They're in good shape. The chairman of the Federal Reserve has said as much. The secretary of the Treasury as said as much."

Last week Fed Chairman Ben Bernanke and Paulson, appearing before the House Financial Services Committee, made a point of saying that the regulator of Fannie and Freddie, the Office of Federal Housing Enterprise Oversight, has found both companies adequately capitalized.

While technically correct, the reassuring statements of Bernanke and others shouldn’t overshadow the real problem. Even if the companies don’t fail and require a complete bailout, mortgages could get more costly and harder to obtain—at a time when the housing market is already collapsing.
The $5 trillion mess

Fannie Mae and Freddie Mac were created by Congress to help more Americans buy homes. Now their shaky condition threatens the entire housing market.

Katie Benner

July 13, 2008

NEW YORK (Fortune) -- They own or guarantee $5 trillion worth of mortgages­ - nearly half of all the country's outstanding home loan debt - and they're crashing. But not everybody is convinced they should be.

Fannie Mae and Freddie Mac are struggling with an investor loss of confidence so great that, while they're unlikely to go under, they could conceivably see their ability to function impaired. That would wreak yet more havoc on an already wrecked housing market - making loans tougher to come by and possibly pushing hundreds of billions of dollars in cost onto U.S. taxpayers.

The extent of their troubles is in debate. Several analysts and a former Federal Reserve governor have said the two companies desperately need to raise money to continue their business of buying and guaranteeing home mortgages.

Others, including Fannie and Freddie, their regulators, some Wall Street analysts, and Sen. Christopher Dodd, D - Conn., the chairman of the Senate Banking Committee, have defended the strength of the two companies.

"What's important are facts - and the facts are that Fannie and Freddie are in sound situation," Dodd said on CNN's Late Edition on Sunday. "They have more than adequate capital. They're in good shape. The chairman of the Federal Reserve has said as much. The Secretary of the Treasury has said as much."

The Treasury Dept. and the Federal Reserve on Sunday outlined plans that would provide capital to Fannie and Freddie if it were needed.

Still, inherent problems

How could the companies end up in such awful straits? Given the way they were created and run, a better question might be: how could they not?

The two companies are so-called government-sponsored enterprises, created by Congress in 1938 (Fannie) and 1970 (Freddie) to help more Americans buy houses.

Their mandate is to maintain a market for mortgages - buying loans from banks, repackaging them as bonds, and selling those securities to investors with a guarantee that they will be paid.

This makes lending more tempting for banks because Fannie and Freddie take on risks like missed payments, defaults and swings in interest rates.

But the companies are also publicly traded, with the usual mandate of trying to maximize profits for shareholders.

That effort, of course, involves risk, but as quasi-government programs, they've long carried an implicit guarantee that the feds wouldn't let them fail.

Their hybrid nature created both the opportunity and the temptation for the enterprises to take on more risk and to make themselves ever larger, more important and thus more profitable players in the mortgage market.

Very special treatment

The market and ratings agencies have treated Fannie and Freddie as bulletproof, even though the actual business of dealing with interest sensitive loans is very risky. This is in large part because of the very special perks granted to the mortgage giants, but to no one else.

Each may borrow up to $2.25 billion direct from the Treasury. They are exempt from state and local income taxes and from Securities and Exchange Commission registration requirements and fees. And they can use the Federal Reserve as their bank.

One result of all this special treatment was AAA credit ratings. That means Fannie and Freddie could borrow at super-low rates, a benefit they used to purchase - and hold -high-yielding mortgage loans. The spread between the two provided an irresistible earnings stream and the companies just kept getting bigger.

The mortgages they hold on their books alone total about $1.4 trillion, said Mike Stathis, managing Principal of Apex Venture Advisors, a research and advisory firm.

In the meantime, the companies were allowed to operate in this manner, piling on risk after risk, with virtually no capital cushion (Wall Street speak for the rainy-day piggybank financial companies keep should one of their investments blow up.) As the company's loan portfolio loses value and the mortgage market continues to crumble, it's easy to see why this was a fatal misstep.

Some saw the crisis coming before this week. For example, Alan Greenspan famously warned in 2004 that Fannie and Freddie's rapid growth needed to be curbed because their expansion threatened the financial markets.

Still, the cocktail of high credit ratings, domination of the mortgage securities market, and preferential government treatment led to the sort of shenanigans that go hand in hand with excessive privilege.

Fannie overstated its earnings by $10.6 billion from 1998 through 2004, and its chief executive Franklin Raines lost his job. Freddie Mac had understated its profit by nearly $5 billion from 2000 through 2002. Both companies missed earnings filings while their overhauled their books.

"If Fannie and Freddie had been created in the private sector, they wouldn't look like this," says Christopher Whalen, head of research firm Institutional Risk Analytics. "They have a public sector mission to expand housing and run what is essentially an insurance company. But they also have a conduit to securitize and sell loans, which is what broker-dealers like Lehman do; and they have an interest arbitrage piece (making money on the spread between interest rates) that looks like a hedge fund."

Robert Rodriguez, the founder of First Pacific Advisors, hasn't bought Fannie for Freddie bonds for over two years. "With the recent issuance of their financials, we were still uncomfortable with their leverage," Rodriguez says. "We believed there was considerable balance sheet risk in both of these companies.

Now the dwindling pool of mortgages, higher foreclosure risk, and a shaky interest rate environment have the companies on the ropes; and investors are beginning to lose faith in Fannie and Freddie.

Both firms told Fortune that they have enough capital to weather the storm and continue to support the nation's housing market.

And yet, Fannie has fallen 32% this week and 65% since the beginning of the year. Freddie plunged 47% so far this week and is down 75% since January.
Investors have lost faith that the companies can operate in their current incarnation without running into major problems.

If investors abandon these companies, what do we learn from this odd Frankenstein of a business model?

"Nobody every believed that Fannie and Freddie were truly private and they never should have been," says Whalen. "Now we will all have to pay for a company that has gone astray."

Now about the other cutely-nicknamed failing financial institution. IndyMac was a California-based mortgage lender that failed Friday.

IndyMac seized as financial troubles spread

John Poirier and Rachelle Younglai

July 12, 8:20 PM ET

WASHINGTON (Reuters) - U.S. banking regulators swooped in to seize mortgage lender IndyMac Bancorp Inc on Friday after withdrawals by panicked depositors led to the third-largest banking failure in U.S. history.

California-based IndyMac, which specialized in a type of mortgage that often required minimal documents from borrowers, became the fifth U.S. bank to fail this year as a housing bust and credit crunch strain financial institutions.

The federal takeover of IndyMac capped a tumultuous day for U.S. markets that saw stocks slide on a surging oil price and renewed fears about the stability of the top two home financing providers, Fannie Mae and Freddie Mac.

IndyMac will reopen fully on Monday as IndyMac Federal Bank under Federal Deposit Insurance Corp supervision, but tensions ran high as customers at a branch at its Los Angeles-area headquarters read a notice in the window saying it was closed.

At another branch down the road, a man who said he had more than $200,000 in an account -- twice what is normally FDIC guaranteed -- argued with a security guard who was closing up.

The FDIC, which will seek a buyer for IndyMac, estimated the cost of the bank's failure to its $53 billion insurance fund at between $4 billion and $8 billion.

"IndyMac is a company that was pretty much 100 percent invested in mortgage assets, and we're in a bad mortgage market, and it had no capital. It's not complicated," said Adam Compton, co-head of global financial stock research at RCM in San Francisco, which manages about $150 billion.

IndyMac joins top bank failures headed by the 1984 collapse of Continental Illinois National Bank & Trust Co.

The Office of Thrift Supervision (OTS) insisted IndyMac's failure was the second-largest bank failure based on FDIC figures. But the FDIC said its data showed it was third behind the collapse of First RepublicBank Corp in 1988.

Run On The Bank

The OTS, IndyMac's primary regulator, blamed comments by New York Democratic Sen. Charles Schumer for causing a run on deposits at the largest independent publicly traded U.S. mortgage lender.

Schumer responded quickly on Friday, blaming the OTS for not doing its job and allowing IndyMac's loose lending practices. "OTS should start doing its job to prevent future IndyMacs," he said in a statement.

Schumer questioned IndyMac's ability to survive the housing crisis in late June, and over the next 11 business days, depositors withdrew more than $1.3 billion, the OTS said.

"This institution failed today due to a liquidity crisis," OTS Director John Reich said. "Although this institution was already in distress, I am troubled by any interference in the regulatory process."

IndyMac was founded in 1985 by David Loeb and Angelo Mozilo, who also founded Countrywide, another big mortgage lender whose loans helped fuel the housing boom. Countrywide was taken over last week by Bank of America Corp.

FDIC spokesman David Barr said agency officials arrived at IndyMac's headquarters in Pasadena at 3 p.m. (2200 GMT).

The successor FDIC-run bank opens for business on Monday. Over the weekend, depositors will have access to their funds by ATM, other debit card transactions, or by writing checks, but no access via online banking and phone services until Monday.

Yet many customers were in the dark as branches shut on Friday. "I'm pissed. They should have let me know," said Elizabeth Ortega, a 29-year-old hairdresser who has a checking account with IndyMac.

IndyMac had said earlier in the week it was unable to raise new capital, would slash staff by 60 percent and had stopped making home loans. Its stock then tumbled, last trading at 28 cents on the New York Stock Exchange, down 95 percent in 2008.

The FDIC insures up to $100,000 per deposit and up to $250,000 per retirement account at insured banks.

At the time of closing, IndyMac had about $1 billion of potentially uninsured deposits held by about 10,000 depositors. The FDIC said it would pay those depositors an advance dividend equal to 50 percent of the uninsured amount.

The OTS told a conference call with reporters that it did not expect significant market impact from IndyMac's closure as the firm is not a systemic institution and does not have numerous counterparties. Reich also said he did not expect a larger thrift to fail.

If there won’t be “significant market impact” from the failure than why worry? According to James Turk the worry is that the failure may be multiplied and that the true value of many institutions’ assets may be less that half of “book value”

America's Second Biggest Bank Failure

James Turk,

July 12, 2008

Late Friday afternoon (July 11th) federal regulators swooped in on California-based IndyMac Bank and closed its doors. With $32 billion in assets, it is according to The Los Angeles Times the second largest bank failure in US history. IndyMac will re-open its doors on Monday morning as a ward of the FDIC.

Some background will be helpful to put this bank failure into perspective. IndyMac is ground-zero of the sub-prime crisis and the poster-child of imprudent lending. Founded in 1985 by Countrywide Bank, whose own recent failure was masked by its acquisition by Bank of America, IndyMac pioneered the issuance of so-called Alt-A mortgages to borrowers who do not fully document their income or assets, which typically means borrowers with blemished credit histories or real estate speculators looking to 'flip' houses during the bubble years. Alt-A mortgages were considered to be less risky than the subprime loans which started the current financial crisis last year, so IndyMac's plight may cause everyone to re-think that credit quality fairy tale.

IndyMac sold most of the loans it originated, but it also drank its own poison by holding some of these loans on its books, which is the important point. The liquidation value of IndyMac's assets may be instructive to help us understand what lies ahead for the unfolding financial crisis. By applying IndyMac's experience to the value of the questionable mortgage assets still within the global banking system, we can begin to understand the scope and magnitude of the problem.

IndyMac's $32 billion in assets are funded by $19 billion of deposits, with funding for the $13 billion balance having been provided primarily by debt and a little equity. About $1 billion of deposits are above the insured limit, so the FDIC is insuring about $18 billion of deposits, but here is the interesting - and scary - stuff. The FDIC press release states: "Based on preliminary analysis, the estimated cost of the resolution to the Deposit Insurance Fund is between $4 and $8 billion."

Think about this statement for a moment. After liquidating the bank's assets, not only will IndyMac shareholders and holders of IndyMac debt be wiped out, the FDIC's insurance fund will still take a "$4 and $8 billion" hit so that the $18 billion of insured deposits in IndyMac are made whole. So let's do a little math here.

After liquidating $32 billion in assets, the FDIC still has to add some $4 billion to $8 billion more to make sure $18 billion of deposits are made whole. So in the worst case scenario, the liquidation value of IndyMac's $32 billion of assets is $10 billion, or in other words, the true market value of IndyMac's assets is only 31% of their stated book value. In the FDIC's best case scenario, the liquidation value of IndyMac's $32 billion of assets is $14 billion, which is still only 44% of their stated book value.

So here is the all-important question. Can we infer from this liquidation analysis of IndyMac that the true value of sub-prime and Alt-A mortgage debt still in the banking system is something less than 50% of stated book value?

I don't have the answer to that question. If anybody does, it is the bankers themselves, and they aren't talking. They do not want to disclose how bad off they remain, even after already writing off more than $300 billion of assets globally (as reported by London's Financial Times). They no doubt must be panicked about what's yet to come.

So how big is the potential problem? My guess is that even bankers really don't know the answer to that question, but there are some estimates worth considering.

Investment guru John Paulson had his hedge-fund correctly positioned to benefit from the sub-prime meltdown, so given this record, his estimates of the problem are probably better than most. According to the Bloomberg he says that "global writedowns and losses from the credit crisis may reach US$1.3 trillion." That estimate seems reasonable in view of the IndyMac experience, given that at least $3 trillion of inferior loans probably remain on bank books at present. Keep in mind too that the amount of inferior loans will grow as economic conditions continue to weaken.

All of this does not bode well for the dollar. The federal government is readying the printing press to create even more dollars to plug the black-hole on bank balance sheets, but there is another black-hole that they need to begin worrying about.

The FDIC deposit fund only has $53 billion of assets, and around 10% or perhaps more of that is now going to be used to bail-out IndyMac. So how safe is the FDIC? How safe is the dollar, or more to the point, how safe is your wealth held in dollars? Not very…

The bigger picture is that we are entering a phase of re-regulation and increasing government takeovers of financial institutions. The problem is that the U.S. government is also broke thanks to tax cuts for the rich and disastrous, illegal wars.
Fannie Mae: The credit crunch meets the F-word

Paul Mason

12 July 08, 2008

The panic on Friday about the two US mortgage giants, Fannie Mae and Freddie Mac, is followed by the collapse of California's IndyMac, a regional mortgage lender. Customers at Indy have been told their money (up to a $100k limit) has been transferred to something called "IndyMac Federal Bank". The crucial letter in the acronyms that Freddie and Fannie are short for is F, as now also with Indy: the two giants are Federal institutions, as is - now - the busted Californian bank. Slowly but surely the state - not just in America but here too - is having to bail out the financial system, and I think this could have a big impact, eventually, on politics too....

Fannie Mae was founded in 1938 as the monopoly provider of mortgage loans. It was privatised in 1968, Freddie set up to expand the operation in 1970: they don't issue mortgages - they underwrite them for other institutions. Together they have underwritten $5 trillion of mortgages - half of all US mortgages.

On privatisation they received a bailout guarantee from the government and a direct line of credit from the US treasury; but they were listed companies - their shares traded on the stock exchange and they made a healthy profit. So healthy in fact that pure private capitalist banks had been baying for them to be unshackled from this part-private, half-life existence.

Thus Fannie and Freddie were sustained by one of those necessary fictions that underpin finance capitalism: that this $5 trillion was not really guaranteed by the US government at all. Now that fiction is collapsing (every step of the financial crisis has destroyed a necessary financial fiction) we are confronted with the emergence of something very strange: a state backed financial capitalism.

Consider this: right now the US legislature is about to pass a separate bill allowing the government to underwrite $300bn of mortgages for those whose homes are about to be repossessed; the US Treasury has already doled out in excess of $100bn cheap loans to banks to keep them afloat and "reinvented" a rule allowing it to underwrite the rescue of Bear Stearns by JP Morgan. Now it is faced with at the very least having to shoulder $40bn of Fannie and Freddie's debts (the two companies have insisted they are solvent and their is nothing wrong, but many analysts disagree, as does the market which has wiped 78% off their share value since January).
And one option being discussed is to take the whole of Fannie/Freddie's mortgage book into public ownership, Northern Rock style. It is an option that, as with Northern Rock, they will surely try to avoid - because $5 trillion is the size of the US national debt!

(Put another way, the annual GDP of the United Kingdom is about $2.5 trillion and the entire GDP of the world, nominally, just under $50 trillion!)

All over the word, slowly but surely, the state is becoming exposed to the debts and liabilities of the finance system. We've seen it here with Northern Rock - and with the Bank of England's special liquidity scheme, and with the expanded deposit guarantee. The words "too big to fail" - once uttered as a joke, about a theoretical situation in the dining rooms of the investment banking world - have now been elevated into a philosophy.

The strange thing is it's being done on the watch of governments committed to removing the state from the economy. It is being done, in other words, in defiance of the official ideology of governments, regulators, banks, business schools, accountancy firms, TV pundits, Nobel prizewinners and nearly every think tank on earth…

What does “state-backed financial capitalism” mean? Socialism for the banks and the rich and cut-throat capitalism for the rest of us. And we pay. Looking at it that way, it may not contradict the real ideology of neoliberalism, transferring wealth up the pyramid:

Bernanke, Paulson outline strategy to make working class pay for Wall Street crisis

Andre Damon and Barry Grey
10 July 2008

In speeches delivered Tuesday, Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Henry Paulson outlined the ruthless class policy being carried out to place the burden for the financial and housing crisis on the backs of working people.

Bernanke indicated that the Fed would extend its policy of offering unlimited loans to major Wall Street investment banks. The provision of Fed funds to non-commercial banks and brokerage firms, a departure from the Fed’s legal mandate without precedent since the Great Depression, is part of a policy of bailing out the banking system to the tune of hundreds of billions of dollars.
The Fed announced its loan program for investment banks last March when it dispensed $29 billion to JPMorgan Chase as part of a rescue operation to prevent the collapse of Bear Stearns.

In his speech, Treasury Secretary Paulson acknowledged that home foreclosures in 2007 reached 1.5 million and predicted another 2.5 million homes would be foreclosed in 2008. But he made clear that nothing would be done to save the vast majority of distressed homeowners from being thrown onto the street.

Paulson, the former CEO of Goldman Sachs, said that “many of today’s unusually high number of foreclosures are not preventable.” With a callous indifference reminiscent of Marie Antoinette’s “Let them eat cake,” he went on to say that “some people took out mortgages they can’t possibly afford and they will lose their homes. There is little public policymakers can, or should, do to compensate for untenable financial decisions.”

In other words, low-income home owners who were lured into high-interest mortgages by predatory mortgage companies and banks are getting their just deserts! Of course, the Wall Street CEOs and big investors who made billions of dollars by speculating on these loans, creating a vast edifice of fictitious capital that was bound to collapse, are not to be held accountable for any “untenable financial decisions.” On the contrary, they are to be subsidized with hundreds of billions of dollars of credit, ultimately to be paid for by public funds.

The two speeches, presented at a Federal Deposit Insurance Corporation forum on the housing crisis held in Virginia, underscore the real social interests—those of the financial aristocracy—that are being protected by the policies of the Fed, the Bush administration, and the Democratic Congress.

Bernanke made clear that his call for an extension of loans to big investment banks is part of a more comprehensive proposal to systemize and regularize federal subsidies and bailouts for troubled banking giants. Particularly significant was the following remark: “Because the resolution of a failing securities firm might have fiscal implications, it would be appropriate for the Treasury to take a leading role in any such process, in consultation with the firm’s regulator and other authorities.” The implication is that the US Treasury should be ready to fund bank bail-outs with whatever taxpayer funds are necessary.

In neither speech was there even a hint that the government has any responsibility to protect home owners, or that the people responsible for the “lax credit and underwriting standards” that led to the current crisis might be called to account by regulators, Congress, or the courts.

Essentially the same principles underlie the Democratic-sponsored housing bill currently under debate in Congress. The bill, which President Bush has threatened to veto, includes provisions to provide government insurance on mortgages in exchange for lenders writing down the principal by 15 percent. The main purpose of the bill is not to assist homeowners, but to prevent foreclosures from harming the balance sheets of financial firms by transferring risky mortgages to the government.

The bill is tailored to marginally reduce the flood of home loan defaults and foreclosures, at a minimal cost to the government, so as to stabilize the housing market and stem the losses suffered by banks and financial institutions from the collapse of subprime mortgage-backed securities. Home owners with subprime and adjustable-rate mortgages, who demonstrated their ability to pay off a refinanced loan, would have the debt converted to a thirty-year, fixed-rate mortgage, resulting in lower monthly payments.

The plan is entirely voluntary. No bank or mortgage lender would be required to participate, and the financial firms would decide which, if any, loans they refinanced in return for a government guarantee against losses. As a result, mortgage companies and banks that decide to participate will “cherry pick” the loans they refinance, choosing from among the loans which qualify under the terms of the bill only those they believe most likely to default.

The Congressional Budget Office (CBO) estimates that the measure would help a maximum of 500,000 home owners—that is, only 20 percent of the 2.5 million who, according to Paulson, will face foreclosure this year. It does nothing to help those who have already had their homes foreclosed, or block banks and mortgage lenders from carrying out new foreclosures. Lenders are currently filing foreclosure proceedings against more than 7,000 home owners a day.

The CBO estimates that the actual cost of the program—resulting from defaults of Federal Housing Administration-backed refinanced loans—would amount only to $2.7 billion over the next five years. This is less than the amount spent on the Iraq war every 15 days, and a billion dollars less than the 2007 earnings of the top hedge fund manager in the US. It is a tiny fraction of the nearly $1 trillion that the Fed has pumped into the financial markets since the credit crisis erupted last August.

The moves to further subsidize the banks coincide with the Fed’s announced policy of halting interest rate cuts and preparing to raise rates later this year. As Bernanke has made clear, the major consideration behind this policy shift is a desire to stem “inflationary expectations”—a euphemism for wage increases. The aim is to utilize the economic contraction to drive up unemployment and undercut any struggle by workers for wage hikes to compensate for soaring prices and ruinous levels of household and personal debt.

The eruption of the credit crunch last August was not anticipated by the Fed or government policy-makers, whose easy credit policies had fueled the housing bubble. They initially badly underestimated the seriousness and depth of the crisis, but soon responded with a series of interest rate cuts and massive injections of liquidity to bolster the banking system. This was bound to ignite inflationary pressures and further weaken the dollar.

By the time of the Bear Stearns rescue last March—carried out with the support of both parties and all of their presidential candidates—it had become clear to the Fed that the credit and housing crisis would have a protracted impact on economic growth and that the financial system would remain highly fragile for an extended period. A consensus emerged within the ruling elite in support of a brutal class policy to continue the bailout of Wall Street, while seeking to manage an orderly unwinding of the trillions of dollars in fictitious capital built up during the speculative boom—at the expense of the working class.

Now the strategy is to exploit the economic contraction to further depress wages. There is no support in either political party to allocate any significant resources to relieve the economic and social distress of working class families being hammered by job cuts, sharply rising gas and food prices, and the collapse of their home values.

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