Signs of the Economic Apocalypse, 9-8-08

From SOTT.net:

Gold closed at 802.80 dollars an ounce Friday, down 4.1% from $835.20 for the week. The dollar closed at 0.7009 euros Friday, up 2.8% from 0.6815 at the close of the previous week. That put the euro at 1.4267 dollars compared to 1.4674 the week before. Gold in euros would be 562.70 euros an ounce, down 1.1% from 569.17 at the close of the previous Friday. Oil closed at 106.23 dollars a barrel Friday, down 8.7% from $115.46 at the end of the week before. Oil in euros would be 74.46 euros a barrel, down 5.7% from 78.68 for the week. The gold/oil ratio closed at 7.56, up 4.6% from 7.23 at the end of the week before. In U.S. stocks, the Dow closed at 11,220.96 Friday, down 2.9% from 11,543.55 at the close of the previous Friday. The NASDAQ closed at 2,255.88 Friday, down 4.9% from 2,367.52 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.70%, down 11 basis points from 3.81 for the week.

Signs of an economic collapse began to pile up again last week, leading to further drops in commodity prices. Oil fell almost 9% and gold fell 4%. The dollar continued to rise against the euro. Job losses continued in the United States and now 9% of houses in the U.S. are behind in payments or in foreclosure. Finally, the U.S. government seized Fannie Mae and Freddie Mac.

US jobless rate soars as foreclosures break new record

Bill Van Auken

6 September 2008

In a stark indication that the crises gripping the US housing market and the financial sector are spreading throughout the economy, unemployment figures for August rose far more sharply than expected, hitting a five-year high.

The official unemployment rate rose to 6.1 percent last month, according to a report released Friday by the Bureau of Labor Statistics. In addition to the net loss of 84,000 jobs last month, the agency revised its figures for June and July, reporting the destruction of an additional 58,000 jobs, pointing to an entire summer dominated by layoffs and economic slump.

Meanwhile the so-called misery index, which adds the unemployment and inflation rates, hit 11.7 percent, the worst figure recorded since mid-1991, as high gas, food and utility prices continue to gouge workers’ paychecks even as layoffs mount.

Also on Friday, the Mortgage Bankers Association issued a report showing that the new foreclosure rate has risen to its highest point in nearly three decades, as falling home prices and tighter credit is forcing more and more people out of their homes. The total number of homes in foreclosure hit 2.75 percent, triple the rate recorded three years ago. Meanwhile, 6.41 percent of all home mortgages were one or more payments overdue, a record high since these figures were first recorded in 1979.

At the same time, existing home sales fell to a 10-year low in the second quarter, while the median price of a single-family house plummeted by another 7.6 percent, the National Association of Realtors reported.

The increase in unemployment and the rising number of foreclosures are clearly trends that are feeding into one another in a vicious downward spiral. Workers having lost their jobs are finding it impossible to meet monthly mortgage payments, and the collapse of home values has wiped out credit for many, leading to falling consumption and new layoffs.

The loss of jobs was spread throughout the economy, with health care, education and government employment virtually alone in resisting the surge of layoffs. Manufacturing companies cut 61,000 workers from their payrolls; business and professional companies eliminated 53,000 jobs, temporary employment—which generally is a leading indicator of future job trends—fell by 36,000 and the retail trade sector cut 19,900 jobs. Construction employment was down just 8,000, reflecting in part the massive bloodletting that has already taken place—558,000 jobs wiped out since the beginning of 2007.

Massive new layoffs are on the horizon. The Air Transport Association reported Friday that US airlines plan to cut at least 36,000 jobs by the end of the year.
Job cuts will continue throughout the auto industry as new vehicle sales slump. The DMAX engine plant in Dayton, Ohio announced this week that it is laying off another 330 workers, on top of 290 jobs cut in July. The plant makes engines for GM trucks. Daimler Trucks North America, meanwhile, has announced plans to cut one of the two shifts at its Mount Holly, North Carolina Freightliner plant, putting 675 workers on the unemployment lines.

The financial sector is also shedding large numbers of jobs. GMAC Financial Services announced this week it will lay off 5,000 workers, while Wachovia Corp. has indicated that it intends to eliminate the jobs of some 7,000 of its employees.

The official figures released Friday were substantially higher than those predicted by economists, who had projected only a 0.1 percent increase over July’s rate of 5.7 percent, with the loss of 75,000 jobs, rather than a 0.4 jump to 6.1 percent and the loss of 84,000 jobs.

The decisive issue in the unemployment figures is the sustained character of the assault on jobs, with unemployment rising for eight months straight—the most protracted such trend in the last 25 years. The result is that 2.2 million more workers have joined the unemployment lines over the past year, for a total of 9.4 million officially counted as out of work.

These figures drastically underestimate the real crisis confronting working people in the US. An alternative measure provided by the Bureau of Labor Statistics, which includes so-called “discouraged workers”—those who have given up actively looking for work—as well as those forced to eke out a living with part-time jobs because they are unable to get full-time work, rose by a tenth of a percentage point to account for fully 10.7 percent of the US workforce.

The latest report on the growth in unemployment elicited widespread acknowledgment that the US economy is gripped by recession.

“The economy has clearly slipped into a jobs recession because the housing meltdown and credit market turmoil has spread to the broader economy,” Steven Wood, chief economist at Insight Economics, wrote after the new figures were released.

Bank of America economist Peter Kretzmer, in a note to investors, wrote, “The rapid rise in the unemployment rate points to a US recession, as such an increase has never occurred outside of one.” The economist said that household surveys have produced data indicating that 1.75 million jobs have been wiped out since April alone.

William Poole, former president of the Federal Reserve Bank of St. Louis, told Bloomberg Television, “It certainly increases the probability that we really are in a recession. It is a weak number, including the [June, July] revisions.”

Friday’s dismal unemployment and foreclosure figures came at the end of the worst week for the world financial markets since the aftermath of the terrorist attacks on New York City and Washington seven years ago.

The Dow Jones Industrial average eked out a 32-point advance Friday after falling nearly 350 points, or 3 percent, the day before—the worst losses in two months. The sell-off was attributed to the release of the initial projection of a 5.7 percent unemployment rate, combined with dismal retail sales figures and rampant rumors that a major hedge fund, Atticus Capital, with $14 billion in investments, was on the brink of collapse.

While the Atticus executives insisted that the rumors were false and that the fund had substantial cash reserves, the fears that major hedge funds will go under are well founded. Many of them had invested heavily in the commodity bubble, which has been rapidly deflating with the recent fall in oil and food prices.
Asian stock markets, which fell every day this week, suffered sharp losses Friday, with the Hang Seng index in Hong Kong falling 2.2 percent, Tokyo’s Nikei down 2.75 percent, the Shanghai A-share market dropping 3.3 percent and Australia’s market down 2.1 percent. Similar percentage losses were recorded on all of the major European markets.

Meanwhile, the manager of the world’s largest bond fund warned Friday that the US economy faced a “financial tsunami” unless the government intervenes to buy up assets being dumped by banks and finance houses.

“Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,” Bill Gross of California-based Pacific Investment Management Co. wrote in a statement on the company’s web site. “If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the US Treasury.” Specifically, he called for the federal government to stem the foreclosure tide by issuing subsidized loans and buying up properties.

Gross’s statement reflects growing fears within financial circles that the worst of the credit crisis is still to come and could produce a catastrophic global collapse.

In the face of the rapidly deepening economic crisis, the White House issued a sanguine statement that simply ignored the job losses and rise in foreclosures, pointing instead to earlier figures showing an increase in the gross domestic product. “The level of growth demonstrates the resilience of the economy in the face of high energy prices, a weak housing market and difficulties in the financial markets,” the White House said.

While this is obviously cold comfort to the millions forced onto the unemployment lines or facing the loss of their homes, the attempt by the candidates of the two major parties to turn the latest figures into political hay offered little more.

Republican candidate John McCain acknowledged that “Americans are hurting and we must act to create jobs.” He vowed to enact a “Jobs for America” program, which appeared to involve little more than job training schemes, tax cuts for business and advocacy of free trade.

Democratic candidate Barack Obama issued a predictable statement accusing his rival McCain of preparing “more of the same” and continuing the Bush administration’s tax cuts for the rich. He pledged instead to institute an exceedingly modest tax cut for “middle-class families” plus a $50 billion fund to aid state budgets.

There is no reason to believe such paltry promises will be realized. Even they were, they would prove entirely inadequate to stem the tide of layoffs or stabilize the crisis-ridden financial system. The Democratic Party is incapable of advancing any serious alternative to the policies of the Bush administration, tied as it is to the interests of Wall Street and corporate America.

The continuing housing crisis led the U.S. government to take over the two Government Sponsored Enterprises, Fannie Mae and Freddie Mac in order to prevent a collapse of the world financial system.

Officials announce takeover of mortgage giants

September 7, 2008

Alan Zibel and Martin Crutsinger

WASHINGTON (AP) -- The Bush administration, acting to avert the potential for major financial turmoil, announced Sunday that the federal government was taking control of mortgage giants Fannie Mae and Freddie Mac.

Officials announced that the executives and board of directors of both institutions had been replaced. Herb Allison, a former vice chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac.

Treasury Secretary Henry Paulson says the historic actions were being taken because "Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe."

The huge potential liabilities facing each company, as a result of soaring mortgage defaults, could cost taxpayers tens of billions of dollars, but Paulson stressed that the financial impacts if the two companies had been allowed to fail would be far more serious.

"A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance," Paulson said.

Both companies were placed into a government conservatorship that will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie.

The Federal Reserve and other federal banking regulators said in a joint statement Sunday that "a limited number of smaller institutions" have significant holdings of common or preferred stock shares in Fannie and Freddie, and that regulators were "prepared to work with these institutions to develop capital-restoration plans."

The two companies had nearly $36 billion in preferred shares outstanding as of June 30, according to filings with the Securities and Exchange Commission.
Paulson said that it would be up to Congress and the next president to figure out the two companies' ultimate structure.

"There is a consensus today ... that they cannot continue in their current form," he said.

Paulson and James Lockhart, director of the Federal Housing Finance Agency, stressed that their actions were designed to strengthen the role of the two mortgage giants in supporting the nation's housing market. Both companies do that by buying mortgage loans from banks and packaging those loans into securities that they either hold or sell to U.S. and foreign investors.

The companies own or guarantee about $5 trillion in home loans, about half the nation's total.

Lockhart said that both Fannie and Freddie would be allowed to increase the size of their holdings of mortgage-backed securities to bolster the housing industry as it undergoes its worst downturn in decades.

Lockhart said in order to conserve about $2 billion in capital the dividend payments on both common and preferred stock would be eliminated. He said that all lobbying activities of both companies would stop immediately. Both companies over the years made extensive efforts to lobby members of Congress in an effort to keep the benefits they enjoyed as government-sponsored enterprises.

Both Paulson and Lockhart were careful not to blame Daniel Mudd, the CEO of Fannie Mae, or Freddie Mac CEO Richard Syron for the companies' current problems. While both men are being removed as the top executives, they have been asked to remain for an unspecified period to help with the transition.

The problem is that each time they do something like this, the obligations of the already vastly overstretched U.S. government increase. In this takeover plan the U.S. Treasury will purchase mortgage securities.

U.S. Rescue Seen at Hand for 2 Mortgage Giants

Stephen Labaton and Andrew Ross Sorkin

September 6, 2008

WASHINGTON — Senior officials from the Bush administration and the Federal Reserve on Friday called in top executives of Fannie Mae and Freddie Mac, the mortgage finance giants, and told them that the government was preparing to place the two companies under federal control, officials and company executives briefed on the discussions said.

The plan, which would place the companies into a conservatorship, was outlined in separate meetings with the chief executives at the office of the companies’ new regulator. The executives were told that, under the plan, they and their boards would be replaced and shareholders would be virtually wiped out, but that the companies would be able to continue functioning with the government generally standing behind their debt, people briefed on the discussions said.

It is not possible to calculate the cost of any government bailout, but the huge potential liabilities of the companies could cost taxpayers tens of billions of dollars and make any rescue among the largest in the nation’s history.

The drastic effort follows the bailout this year of Bear Stearns, the investment bank, as government officials continue to grapple with how to stem the credit crisis and housing crisis that have hobbled the economy. With Bear Stearns, the government provided guarantees, and the bulk of its assets were transferred to JPMorgan Chase, leaving shareholders with a nominal amount.

Under a conservatorship, the common and preferred shares of Fannie and Freddie would be reduced to little or nothing, and any losses on mortgages they own or guarantee could be paid by taxpayers. Shareholders have already lost billions of dollars as the stocks have plunged more than 80 percent this year.

…The declines in the housing and financial markets apparently forced the administration’s hand. With foreign governments increasingly skittish about holding billions of dollars in securities issued by the companies, no sign that their losses will abate any time soon, and the inability of the companies to raise new capital, the administration apparently decided it would be better to act now rather than closer to the presidential election in two months.

Just five weeks ago, President Bush signed a law to give the administration the authority to inject billions of dollars into the companies through investments or loans. In proposing the legislation, Treasury Secretary Henry M. Paulson Jr. said that he had no plan to provide loans or investments, and that merely giving the government the authority to backstop the companies would provide a strong shot of confidence to the markets. But the thin capital reserves that have kept the two companies afloat have continued to erode as the housing market has steadily declined and the number of foreclosures has soared.

As their problems have deepened — and the marketplace has come to expect some sort of government rescue — both companies have found it difficult to raise new capital to absorb future losses. In recent weeks, Mr. Paulson has been reaching out to foreign governments that hold billions of dollars of Fannie and Freddie securities to reassure them that the United States stands behind the companies.

In issuing their quarterly financial statements last month, the two companies reported huge losses and predicted that home prices would fall more than previously projected.

The debt securities the companies issue to finance their operations are widely owned by mutual funds, pension funds, foreign governments and big companies…

The meetings reflected the reality that senior administration officials did not believe they could wait for some kind of financial tipping point, as happened with Bear Stearns, which was saved from insolvency in March by government intervention after its stock plummeted and lenders withheld their capital.

Instead, Mr. Paulson has struggled to navigate through potentially conflicting goals — stabilizing the financial markets, making mortgages more widely available in a tightening credit environment, and protecting taxpayers from possibly enormous losses…

It appears likely that Paulson’s ship will hit all three rocks. He can only stabilize the financial markets for so long. Who will to buy houses when values plummet and jobs are cut? And, the costs of all the bailouts will paid by taxpayers.

Signs of the Economic Apocalypse, 9-1-08

From SOTT.net:

Gold closed at 835.20 dollars an ounce Friday, up 0.9% from $828.10 for the week. The dollar closed at 0.6815 euros Friday, up 0.7% from 0.6769 at the close of the previous week. That put the euro at 1.4674 dollars compared to 1.4774 the week before. Gold in euros would be 569.17 euros an ounce, up 1.5% from 560.51 at the close of the previous Friday. Oil closed at 115.46 dollars a barrel Friday, up 0.8% from $114.57 at the end of the week before. Oil in euros would be 78.68, up 1.5% from 77.55 for the week. The gold/oil ratio closed at 7.23 Friday, unchanged. In U.S. stocks, the Dow closed at 11,543.55 Friday, down 0.7% from 11,628.06 at the close of the previous Friday. The NASDAQ closed at 2,367.52 Friday, down 2.0% from 2414.71 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.81%, down six basis points from 3.87 for the week.

Gold continued its steady rise from the recent lows below $800 an ounce. The dollar also resumed its rise against the euro. The recent rise of the dollar has been attributed to evidence that the rest of the world is entering a recession and that the downturn will not be limited to the United States. It has also been fueled by an export-based mini-recovery in the United States. A recent revision of U.S. GDP (Gross Domestic Product) number showing a 3.5% annualized growth rate in the second quarter of 2008 shows the results of both the growth in exports from the United States and the effects of the tax rebate checks being spent in the economy. Both, however, cannot last, as the checks has already been spent and the dollar is now rising (it was the low dollar that fueled exports).

Eyes Off the Target

Max Wolff

August 29, 2008

On August 28, 2008 the Bureau of Economic Analysis [BEA] released two very widely followed and important reports. Both are backward looking and detail national macro conditions and corporate profits. Gross Domestic Product and Corporate Profits Second Quarter 2008 (Preliminary) are the reports in question. Markets have surged on the good headline news regarding 2Q2008 GDP growth. Indeed the 3.3% reported growth was well ahead of expectations- mine included. The upward revision from the advance estimate was also huge, going from 1.9% to 3.3%. This is an increase of 73%- not too shabby. Of course there was that second report as well, you know corporate profits. There are even a few folks who believe that corporate profits have some relation to where share prices ought to be.

On that first report on GDP, the sources of the quarter over quarter growth are a little troubling. About 90% of the quarterly growth came from falling imports and rising exports. All measures are in falling dollars and rising foreign currencies converted to the dollar. Thus, a very large share of the good news boils down to our declining greenbacks- during the second quarter- and the newfound poverty of American consumers. What do I mean? Our smashed dollar makes our goods cheaper- more exports- and theirs more expensive-fewer imports. Our smashed consumers are buying less- falling imports. More than a little of yesterday's celebration is excitement over our weak currency- which has been strengthening- and our broke consumers- 70% of the US GDP. Export driven GDP gain is ominous given increasing fear of a Euro Zone slowdown and further difficulties in Japan. Import reduction and export growth may not be helped by the recent strengthening of the dollar?

Real exports of goods and services increased 13.2 percent in the second quarter, compared with an increase of 5.1 percent in the first. Real imports of goods and services decreased 7.6 percent, compared with a decrease of 0.8 percent.

· GDP and Corporate Release 28, August 2008- BEA
Beyond celebrating tax rebate checks, local and state government spending, our tanking currency and the poverty of our citizens, there is little to be happy about in the GDP number other than the great headline. The other report from yesterday sheds more and different light on the present situation for assets. Why? Well the corporate profits report speaks to the earnings, growth, dividends and health of the firms who issue and report numbers. Humor me as I assume this is of some passing import to asset valuation and trajectory.

Corporate Profits

Profits from current production (corporate profits with inventory valuation and capital consumption adjustments) decreased $37.8 billion in the second quarter, compared with a decrease of $17.6 billion in the first quarter. Current-production cash flow (net cash flow with inventory valuation and capital consumption adjustments) -- the internal funds available to corporations for investment -- decreased $41.3 billion in the second quarter, in contrast to an increase of $10.1 billion in the first.

· 28 August 2008- BEA
Thus, the BEA measure of corporate profits was less robust than the surging GDP headlines might suggest. The relatively weak performance of broadly measured corporate profits indicates the economic weakness many fear. Ironically, the same report banishing recession concerns across trading floors and around water coolers contains warning level indicators about corporate profit and cash flow.

While the GDP revisions are positive, the corporate profit news is not. In addition, the large role for falling dollars has reversed - at least over recent weeks. The pain in consumer wallets looks likely to increase- now that the tax rebates are behind us. Thus, we must conclude that the sources of the growth are fleeting or disturbing. Meanwhile, the last quarter showed accelerating weakness in corporate earnings- particularly non-financials.

It is hard not to think that yesterday's rally has its eyes off the target?

So, while a little good news is always welcome, we’re not out of danger, by any means. The drop in the price of gold this summer has made all currencies seem stronger, but what is really behind it? Market manipulation? Of course! All markets are always manipulated. Only a naïve believer in market fundamentalism should be shocked by that. The question is how effective the manipulations will be, for how long and for whom.

The Building Storm: Gold, the Dollar and Inflation

David Galland

August 24, 2008

One could hardly fail to notice that gold investors have suffered a little more than a “bit of pain” over the past month. More like a good kicking as gold moved down by about 20% from its recent high of $986 on July 15.

Making assumptions is often a bad idea, but I am going to go out on a limb here and make the assumption that those of you with an interest in gold are concerned over the latest setback, the depth of which has surprised even us.

Don’t be.

The evidence to support that statement would fill a telephone book at this point. Starting with the latest U.S. inflation numbers which, even using the government’s own crooked calculations, rang in the last reporting period at 5.6%. Quoting John Williams of ShadowStats.com from a recent email I received from that organization…

Reported consumer inflation continued to surge on both a monthly and annual basis, once again topping consensus expectations. The July CPI-U jumped to a 17-year high of 5.6% in July, while annual inflation for the narrower CPI-W — targeted at the wage-earners category where gasoline takes a bigger proportionate bite out of spending — annual inflation jumped to 6.2%. The CPI-W is used for making the annual cost of living adjustments to Social Security payments. The 2009 adjustment — based on the July to September 2008 period — remains a good bet to top 5%, more than double last year’s 2.3% adjustment for 2008. Such is not good news for federal budget deficit projections.

Based on William’s calculations, which use the same CPI formula used by the Fed prior to the jiggering of the Clinton years, the actual inflation rate is now running at 13.64%.

And on August 19, we learned that the U.S. Producer Price Index rang in at a month-over-month increase of 1.2%, the third month in a row where that leading indicator has topped the 1% mark. Meanwhile, in Europe, the latest numbers put inflation at a 16 year high. And these are not anomalies, but the norm as the inflation tide continues to rise literally around the world.

Dark Clouds

A good analogy to the global currency devaluation is a slow-moving hurricane that, once over warm water, gains energy.

Right now the global inflation is a huge storm, slowly circling off the proverbial coast where it is gathering strength from the hundreds of billions of dollars being fed into it by governments desperate to avoid economic collapse… and from pricing decisions being made by everyone from manufacturers to local shopkeepers looking to cover rising costs.

At this point the skies are dark, the wind is rising, and the torrential rains are beginning to sweep in. The radio is broadcasting warnings to move to higher ground, but the hurricane has yet to hit the shore.

But when it does, it will be a Category 5 and maybe worse.

That’s because, in addition to the straight-up consequences of the government monetary prolificacy and businesses raising prices to try and stay afloat, there is something else feeding power to the storm… something we have been warning about for years now: the rising odds that the global fiat currency system will fail.

Let me add some nuance to that remark.

In recent years, the global financial community, reflexively looking for an alternative to the obviously damaged U.S. dollar, has settled on the euro. But the euro is equally flawed, and maybe even more so, than the U.S. dollar. Now that the trading herd has also come to that conclusion, they are rushing back toward the dollar.

They are doing so not because the U.S. dollar is healthy, but rather because that is all that they know… a heads-or-tails continuum running something along the lines of “If the ‘it’s-not-the-dollar’ play is over, then it must be time to go back into the dollar.”

The euro sinks, the dollar goes up.

And so gold, viewed by these same traders only in terms of its inverse relationship to the dollar, gets hammered.

What they are missing, but not for much longer, is that rushing back into the dollar is akin to heading for the vulnerable coast, and not to the higher ground now proscribed. They are also missing the point that gold’s monetary value is not limited to protecting only against a failure in the U.S. dollar, but against any faltering fiat currency… a moniker that the euro deserves in spades. Not only is it backed by nothing, but it is also backed by no one…

The long-term weakening of currencies won’t end, because the financial crisis hasn’t ended. The only way for governments to prevent the financial crisis from becoming a complete collapse is by pumping money into the system. It now looks like it’s commercial banks’ turn to be bailed out.

When sorrows come

The Economist

Aug 28th 2008

Commercial banks prepare, reluctantly, to take centre stage

Every episode in the credit crunch has had its dramatic flourish. There were the defenestrations at Citigroup and Merrill Lynch late last year; then, in March, the Bear Stearns fiasco; the humbling of UBS; and now Fannie Mae and Freddie Mac, a tale of hubris that might impress Shakespeare himself. What next?

With the tragedy of the mortgage giants still unfolding, another dark drama is entering its second act, and it has rather a lot of players. It concerns America’s commercial banks. “Pretty dismal” was the frank description of their recent performance offered on August 26th by Sheila Bair, head of the Federal Deposit Insurance Corporation (FDIC). That was just after announcing a rise in the number of banks on its danger list, from 90 to 117.

Nine banks have failed so far this year, felled by shoddy lending to homeowners and developers—six more than in the previous three years combined. The trajectory is steep: Institutional Risk Analytics, which monitors the health of banks, expects more than 100 lenders—most, but by no means all, tiddlers—to fold over the next year alone. Alarmingly, the ratio of loan-loss provisions to duff credit is at its lowest level in 15 years.

The FDIC will soon have to replenish its deposit-insurance fund, which collects premiums from banks and stood at around $53 billion before the downturn. One of this year’s failures, IndyMac, has alone depleted the fund’s coffers by one-sixth—and it was no giant. This has pushed the fund’s holdings below a trigger point that requires the FDIC to craft a “restoration” plan within 90 days.

Ms Bair has indicated that banks with risky profiles—which already pay up to ten times more than the typical five cents per $100 insured—will be asked to “step up to the plate” with even higher premiums. This would ensure that safer banks are not unfairly burdened. But it will heap yet more financial pressure on strugglers. Bankers’ groups have already started to protest loudly.

How much will be needed? Possibly far more than the FDIC is letting on, reckons Joseph Mason of Louisiana State University. Extrapolating from the savings and loan crisis of the early 1990s, and allowing for the growth in bank assets, he puts the possible cost at $143 billion.

That would force the FDIC to go cap-in-hand to the Treasury. The need to do so could become even more pressing if nervous savers began to move even insured deposits (those under $100,000) away from banks they perceived to be at risk—which no longer looks fanciful given the squeeze on the fund. Ms Bair’s admission, in an interview with the Wall Street Journal, that the FDIC might have to tap the public purse, albeit only for “short-term liquidity purposes”, will have done little to calm nerves.

It is also sure to reinforce a growing sense that the financial-market crisis has a lot further to run. Risk-aversion, measured by spreads on corporate debt, fell sharply after the sale of Bear Stearns in March but has leapt back in recent weeks as the spectre of systemic meltdown resurfaced. Sentiment towards spicier assets is astonishingly grim: prices of junk bonds and home-equity loans imply a default rate consistent with unemployment of around 20%, points out Torsten Slok, an economist at Deutsche Bank.

Measure for measure

Banks continue to tighten credit, and their own belts—Citigroup has even restricted colour photocopying. What liquidity they have is being jealously hoarded, partly out of distrust of one another, but mostly in anticipation of refinancing requirements on bonds that they issued with abandon in the credit boom. The spread over expected central-bank rates that they charge one another for short-term cash has risen to three times the level that it was in January. Worse, derivatives markets point to a further increase. Another measure of trust, or lack of it, the index of the “counterparty” risk that derivatives dealers pose, is creeping back towards its March peak.

Nor have investors grown any more confident about their ability to price the banks’ toxic mortgage-backed assets: Merrill Lynch’s cut-price sale of collateralised-debt obligations in July has had few imitators. Lehman Brothers has tried unsuccessfully to sell a pile of iffy securities backed by commercial mortgages all summer.

The woes of Fannie Mae and Freddie Mac weigh on these efforts. Bankers feel obliged to advise clients against snapping up distressed securitised assets until the mortgage giants are put on a firmer footing, says one. And banks themselves are exposed: paper issued by the mortgage agencies accounts for roughly half of their total securities portfolios, estimates CreditSights, a research firm. American banks own much of the preferred stock (a hybrid of debt and equity) that the two firms issued. They were attracted by the preference shares’ combination of a low risk weighting and decent yield, says Ira Jersey of Credit Suisse, but have seen their prices tumble on fears that they will be wiped out if the government moves to prop the agencies up. Although only a few regional lenders would be seriously hurt by this, it would add to the pain of many. JPMorgan Chase has just become the first bank to write down its holdings, saying it may lose $600m, or half the value it had put on them. That may start a trend.

Worse, banks have come to rely on issuing their own preference shares to raise capital, and will find that harder if holders of Fannie’s and Freddie’s paper suffer losses. Banks have raised a total of $265 billion of capital since last summer, says UBS. With much of that issuance underwater, investors are understandably wary of throwing good money after bad.

Contagion also spreads through the market for credit-default swaps. Banks have busily written such insurance contracts on Fannie’s and Freddie’s $20 billion of subordinated debt, which sits below senior debt in their capital structures. If the debt’s holders suffer losses in a bail-out, triggering a “credit event”, banks that had sold the swaps would face huge payouts. The amounts involved are “impossible to calculate but far from trivial”, says one sombre analyst. As the bard wrote: “When sorrows come, they come not single spies, but in battalions.”

Fannie Mae and Freddie Mac seem to be the linchpins. A bailout of them would destroy lots of commercial banks, according to The Economist. Max Fraad Wolf has an easy to understand description of what they are and why they are important:

Foreign spigot off for US consumers

Max Fraad Wolff

28/08/08 "ICH" -- - As US public attention shifts from the Olympics to running mates and the celebrity "news" de jour, the infrastructure beneath your house is termite-infested. Just beneath the nicely painted exterior and behind all the new appliances, doubt is boring through the beams, gnawing at the studs.

Alongside falling prices, rising mortgage rates, stricter credit conditions and general malaise, the structure that supports American home ownership is being condemned by market valuation. Fannie Mae and Freddie Mac have nose dived and been downgraded toward a smaller future - and these are more important names for your future than Joe, Sam, Kathy, Mitt, Meg ...

Fannie Mae was created in the depths of the Great Depression to decrease foreclosure and increase home ownership. In 1968, it was re-chartered as a public company, removed from within official government agency status. Freddie Mac, since its inception in 1970, has financed 50 million homes.

Fannie and Freddie mission statements make clear, they exist to facilitate, ease and cheapen home ownership. They do this by acting as liaisons between international capital markets and mortgage seekers. They borrow at preferential rates - based on the implicit/explicit - assurance of the US government. Borrowed funds are used to buy mortgages and bundles of mortgages. They provide credit guidelines and purchase mortgage issued by banks. This reduces banks' risk and provides banks with more cash, more quickly to make more loans at lower costs. These firms, then, exist to facilitate, ease and accelerate bank lending for home purchase.

Fannie and Freddie form a central hub between lenders and investors. After they buy American mortgages, they bundle sell and guarantee repayment. This transforms mortgages into investments for banks, corporations and governments all over the world. Your home mortgage, bundled with many other folks' mortgages, is sold, repackaged and assured by Fannie and Freddie. This reduces risk and assures global savings flow in to support American purchases of homes. International investment is the foundation on which our home ownership was built.

Well over US$1 trillion of our mortgages have been sold to foreign investors this way in the recent past. As you sit down and read this, your mortgage may well be "owned" by a firm, individual or central bank thousands of miles away. This relationship is neither healthy nor sustainable in its present form. Rising defaults, falling dollars and the sheer size of past borrowing are turning people off to American mortgages. The foundation below our houses is shifting.

What we are witnessing is the breakdown of the link between middle-class America and the global financial markets it has over-tapped across the last several decades. Fannie and Freddie were the support infrastructure connecting houses to capital market access. They have been caught with weak financials, swollen balance sheets and escalating default, just like the home owners they assist. The size of their retained mortgage portfolios is truly gigantic.

The extent of the firms' guarantee commitments is global in scope. Sixty-six global central banks buy loans bundled and or backed with Freddie Mac and Fannie Mae involvement. As of June 30, 2007 foreign entities and individuals held over $1.4 trillion in securities of US agencies such as Freddie and Fannie.

Fannie Mae's June 2008 statement declares a gross mortgage portfolio of $750 billion and guarantees of mortgage backed securities and loans of $2.6 trillion. Freddie Mac's June statement details a retained portfolio balance of $792 billion and a total mortgage portfolio balance of $2.2 trillion. These two giants have retained interest in over $1.5 trillion and guaranteed over $4.5 trillion in mortgages, mortgage backed securities and loans. There are $11 trillion in outstanding mortgage liabilities in the US.

The US housing market continues to melt down with dire consequence. In the seven years from 2001 through late 2007, household real estate value increased by $8.873 trillion to $22.495 trillion. It has since fallen by $426 billion. Many claim we are at or a near a bottom. These claims should be viewed with extreme weariness. The housing downturn is not over and it will take a while after it is over to judge the damage.

The search for parallels with today yields little. The closest one finds is the interesting decline in home ownership across the period 1905-1920 followed by a surging rise across the '20s and then collapse across the 1930s. Fannie was born of this collapse, the ideology of The New Deal and sense that government-driven market interventions could broaden home ownership in America. This was a success. Home ownership did grow spectacularly across the period from 1938-2007. It is falling now as Fannie and Freddie flounder.

In 1940, US home ownership stood just below 44%. At the start of 2008 68% of Americans owned their home. Over the decades, Fannie and Freddie changed, middle-class America changed and the global financial realm underwent several revolutions. The last and most transformative revolution involved the rise of securitization and integration of global financial markets.

Securitization involves transforming assets and promises of future payment into financial products for sale to investors. International financial integration tears down the walls between national banking systems and allows savings, loans and payments to be gathered and transferred across international boundaries.

A world of wealth poured into US real estate through securitization and deregulation. This flow was channeled and molded by the actions of Fannie Mae and Freddie Mac. The decline of these firms will have dramatic and long-lasting implications for home mortgage finance. This will impact the price of American homes, the cost and ease of borrowing for home ownership.

Housing prices have further to fall and global savings will likely never be lent to American consumers at recent percentage levels. Across the past few years America has been borrowing over 50% of the world's internationally available savings. The diminishing role of Fannie and Freddie will impact more people, for far longer than presidential running-mate selections. Policy makers and managements in Fannie and Freddie are stuck. Today's consumer strength, their missions and international financial realities no longer align.

We face a housing finance future different from the recent past. Fannie and Freddie will not be able to function in the same way, or to the same extent. The debates about and plans for these firms will touch millions of families through housing prices, finance terms and cost. Fannie and Freddie are much more important than Joe, Sam, Kathy, Mitt, Meg ...

Average people will see the economic troubles as a failure of the system. Not everyone shares that view. For some, things are going right according to plan.

The Ranks of the Ultrawealthy Grow

Tom Herman

Thursday, August 28, 2008

One of the most exclusive clubs in the U.S. has picked up more members.
About 47,000 people had a net worth of $20 million or more in 2004, the latest available year, according to new estimates by the Internal Revenue Service. While that was up only slightly from 46,000 in 2001, it was up 62% from 29,000 in 1998.

The IRS also reported increases in the number of people with a net worth between $10 million and $20 million: 79,000 people qualified for this group in 2004, up from 77,000 in 2001 and 51,000 in 1998.

California had the largest number of residents with a net worth of $1.5 million or more, with 428,000 in 2004. Florida came in second, with 199,000, followed by New York (168,000), Texas (108,000), Illinois (101,000), Pennsylvania (86,000) and Massachusetts (83,000).

This new peek inside the nation's upper crust comes from IRS data posted recently on the agency's Web site. While nobody knows precisely how many millionaires or multimillionaires there are, the IRS figures are considered an important indicator since they're based on federal estate-tax returns, which include extensive details on assets and debts of wealthy people who have died. IRS analysts use data on these returns to estimate the wealth of the living.

The IRS numbers also provide additional insights into wealth in the U.S. beyond what has already been reported in several other studies. Among them was a Federal Reserve Board survey of consumer finances, which focuses on households and was published in 2006. The Fed and IRS data are helpful when read together, says James Poterba, professor of economics at Massachusetts Institute of Technology and president of the National Bureau of Economic Research, the nonprofit research organization best known for tracking the U.S. business cycle. Both sets of data "provide important information," Mr. Poterba says. "They appear to track broadly similar trends in wealth distribution -- but they provide somewhat different perspectives."

Separate IRS data, released earlier this year, showed the nation's top 400 taxpayers by income reported total income of $85.6 billion on their federal income-tax returns for 2005 -- an average of nearly $214 million apiece. Just to make the cutoff to be eligible for this group of 400 required income of at least $100.3 million, up from $74.5 million for 2004. Joel Slemrod, professor of economics at the Ross School of Business of the University of Michigan, dubbed this group "the Fortunate 400."

Some of the IRS's new personal-wealth numbers aren't directly comparable with those in its previous studies because analysts used different net-worth ranges at the lower end. But the top three groups -- starting with a net worth of $5 million -- are the same in these and several previous IRS reports by the Statistics of Income Division. Among the findings in the latest report, which isn't adjusted for inflation:

The total net worth of the 47,000 people in the $20 million-or-more category totaled $2.591 trillion in 2004. That was down from $2.756 trillion held by the top group in 2001 but up sharply from the approximately $1.5 trillion held by those in the top group in 1998.

About 231,000 people had a net worth between $5 million and $10 million in 2004. That was down slightly from 243,000 in 2001.

Of the total income for the $20 million or more group, the biggest single asset category by far was publicly traded stock ($719.28 billion). In second place was closely held stock.

The IRS figures underscore the importance of stock and other business assets for those in the highest echelons of the super rich, says Mr. Poterba of MIT and the National Bureau of Economic Research.

Michael Hudson, in a recent interview by Mike Whitney, agrees that for the super-rich, recent economic policies have not been disastrous at all:

…MW: The housing market is freefalling, setting new records every day for foreclosures, inventory, and declining prices. The banking system is in even worse shape; undercapitalized and buried under a mountain of downgraded assets. There seems to be growing consensus that these problems are not just part of a normal economic downturn, but the direct result of the Fed's monetary policies. Are we seeing the collapse of the Central banking model as a way of regulating the markets? Do you think the present crisis will strengthen the existing system or make it easier for the American people to assert greater control over monetary policy?

Michael Hudson: What do you mean “failure”? Your perspective is from the bottom looking up. But the financial model has been a great success from the vantage point of the top of the economic pyramid looking down? The economy has polarized to the point where the wealthiest 10% now own 85% of the nation’s wealth. Never before have the bottom 90% been so highly indebted, so dependent on the wealthy. From their point of view, their power has exceeded that of any time in which economic statistics have been kept.

You have to realize that what they’re trying to do is to roll back the Enlightenment, roll back the moral philosophy and social values of classical political economy and its culmination in Progressive Era legislation, as well as the New Deal institutions. They’re not trying to make the economy more equal, and they’re not trying to share power. Their greed is (as Aristotle noted) infinite. So what you find to be a violation of traditional values is a re-assertion of pre-industrial, feudal values. The economy is being set back on the road to debt peonage. The Road to Serfdom is not government sponsorship of economic progress and rising living standards; it’s the dismantling of government, the dissolution of regulatory agencies, to create a new feudal-type elite.

The former Soviet Union provides a model of what the neoliberals would like to create. Not only in Russia but also in the Baltic States and other former Soviet republics, they created local kleptocracies, Pinochet-style. In Russia, the kleptocrats founded an explicitly Pinochetista party, the Party of Right Forces (“Right” as in right-wing).

In order for the American people or any other people to assert greater control over monetary policy, they need to have a doctrine of just what a good monetary policy would be. Early in the 19th century the followers of St. Simon in France began to develop such a policy. By the end of that century, Central Europe implemented this policy, mobilizing the banking and financial system to promote industrialization, in consultation with the government (and catalyzed by military and naval spending, to be sure). But all this has disappeared from the history of economic thought, which no longer is even taught to economics students. The Chicago Boys have succeeded in censoring any alternative to their free-market rationalization of asset stripping and economic polarization.

My own model would be to make central banks part of the Treasury, not simply the board of directors of the rapacious commercial banking system. You mentioned Henry Liu’s writings earlier, and I think he has come to the same conclusion in his Asia Times articles.

MW:Do you see the Federal Reserve as an economic organization designed primarily to maintain order in the markets via interest rates and regulation or a political institution whose objectives are to impose an American-dominated model of capitalism on the rest of the world?

Michael Hudson: Surely, you jest! The Fed has turned “maintaining order” into a euphemism for consolidating power by the financial sector and the FIRE sector generally (Finance, Insurance and Real Estate) over the “real” economy of production and consumption. Its leaders see their job as being to act on behalf of the commercial banking system to enable it to make money off the rest of the economy. It acts as the Board of Directors to fight regulation, to support Wall Street, to block any revival of anti-usury laws, to promote “free markets” almost indistinguishable from outright financial fraud, to decriminalize bad behavior – and most of all to inflate the price of property relative to the wages of labor and even relative to the profits of industry.

The Fed’s job is not really to impose the Washington Consensus on the rest of the world. That’s the job of the World Bank and IMF, coordinated via the Treasury (viz. Robert Rubin under Clinton most notoriously) and AID, along with the covert actions of the CIA and the National Endowment for Democracy. You don’t need monetary policy to do this – only massive bribery. Only call it “lobbying” and the promotion of democratic values – values to fight government power to regulate or control finance across the world. Financial power is inherently cosmopolitan and, as such, antagonistic to the power of national governments.

The Fed and other government agencies, Wall Street and the rest of the economy form part of an overall system. Each agency must be viewed in the context of this system and its dynamics – and these dynamics are polarizing, above all from financial causes. So we are back to the “magic of compound interest,” now expanded to include “free” credit creation and arbitraging.

The problem is that none of this appears in the academic curriculum. And the silence of the major media to address it or even to acknowledge it means that it is invisible except to the beneficiaries who are running the system.

Signs of the Economic Apocalypse, 8-25-08

From SOTT.nethttp://www.sott.net/

Gold closed at 828.10 dollars an ounce Friday, up 4.6% from $791.70 for the week. The dollar closed at 0.6769 euros Friday, down 0.7% from 0.6813 at the close of the previous week. That put the euro at 1.4774 dollars compared to 1.4677 the week before. Gold in euros would be 560.51 euros an ounce, up 3.9% from 539.42 at the close of the previous Friday. Oil closed at 114.57 dollars a barrel Friday, up 0.8% from $113.71 the week before. Oil in euros would be 77.55 euros a barrel, up 0.1% from 77.47 for the week. The gold/oil ratio closed at 7.23 Friday, up 3.9% from 6.96 at the end of the week before. In U.S. stocks, the Dow closed at 11,628.06 Friday, down 0.3% from 11,659.90 at the close of the previous Friday. The NASDAQ closed at 2,414.71 Friday, down 1.6% from 2,452.52 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.87% Friday, up three basis points from 3.84 for the week.

Gold recovered last week, rising almost 5% against the dollar, but it’s still a long way off its peak of $1000 an ounce. The euro stabilized as well, gaining a bit against the dollar after losing ground over the last few weeks. Movements in the price of gold have been hard to explain lately. Some of that is due to gold’s dual role as both a commodity and a currency. There also seems to be a divergence between real gold and paper gold lately. As gold prices dipped below $800 an ounce, it suddenly became hard to find real gold coins at near that price.

George Ure suggests that that is due to the bifurcation between real gold and paper gold:

Metals Markets Splitting?

Monday August 18, 2008

Gold and silver are up a little bit today, but not enough to explain some reader reports. Readers have been sending in all kinds of notes about the "odd behavior" of the precious metals. Here's one..

"George,

Unexpected consequences?

It's very interesting to witness supply-demand dueling with market price in the metals complex. Friday, I decided enough was enough, and went to the local dealer, intending to buy some bullion. Where in past I'd buy silver bars, now, I generally buy rounds, thinking it'd be easier to exchange for value when the spam hits the air-circulation device.

As I walked in the door, the fella was literally pulling boxes of silver out of his display cases. The place was otherwise pretty empty. We made some small talk about how clever he must have been to reduce stock at the recent high. Later it came out he, and other dealers in his network, just weren't going to sell at the depressed levels!

I have been trying to buy 2008 silver eagles (for gifts) since spot was at $18. He, the dealer, further explained if someone wanted to buy so the dealer was "right side up" trades might happen, otherwise no. I reminded about wanting the eagles for gifts, and would pay what was needed to get them. No joy.

Out of curiosity I checked eBay, same-same, no eagles. Non numismatics are also being pulled. When I saw the red announcement on Kitco the scene cleared. No one is selling. Sure, Kitco needs to keep taking orders, but metals dealers, like a gas station owner who filled tanks when oil was 147, won't sell at prices that lose money.

So, what's an ounce of silver worth? Is it $12? $13? Or, is it whatever it takes to get someone to sell? Might metals markets freeze up like credit markets? In past I'd have said no. Right now, evidence says yes.

What do you make of it ... and might this apply equally to other commodities?

A click over to the Kitco website this morning brings up this curious note at the top of their page:

"IMPORTANT NEW NOTICE: Due to market volatility and higher demand in the entire industry, we are anticipating delays in supply of all bullion products. Please note that you can continue to place orders and prices will be guaranteed; however, cancellation fees will still be applicable regardless of the length of the delay. Consequently once inventory is received there may also be delays in processing and shipping by our vaults. "

But wait! How can this all be?

Here's what I think is going on.

You know those gold and silver ETF's? What if - and this is only an if - they really don't have all the hard physical assets that their pieces of paper might attest to? What if they just have some actual physical and the rest is paper promising future deliveries? And further supposed this market is hedged six ways to Sunday.

Would that account for a momentary distortion where supply is heading toward unavailable and yet at the same time, price has also be collapsing? This flies right in the fact of economic reality. Something is truly amiss here.

And then there's the report last week that the US Mint was suspending sales of Gold American Eagles.

Now here's the curious thing: I went to the US Mint site this morning and wanted to see if they would sell a one ounce Gold Eagle. Yup, they will. But the price for an uncirculated 2008 Gold Eagle is not anywhere near spot ($790). They are asking $1,119.95 for a one ounce coin.

A few other savvy financial writers are onto this - and I would draw your attention to Jason Hommel's piece posted over at Gold Eagle titled "Why Paper Silver is not as good as Physical Silver" as a fine example.

My "best guess" is that we are seeing a bifurcated market develop where on the one hand we're seeing a physical market develop and the almost separate paper market for silver & gold related instruments. The predictive linguistics team doesn't think it will pop for a while yet, but what happens when the public realizes that the gold and silver ETF's are shown to be paper-trading exercises and not backed by physical? And investors figure that what they thought was actually backed by physical is just another paper abstraction and like so many others, is being hedged/disconnected from reality of the marketplace?

…I called my friend who manages a whole pile of money expecting him to have some keen insight - the kind that comes from pushing 9-places left of the decimal point around. His answer - which I'll paraphrase loosely - went something like this:

"What's happening is that the price of the metal at retail has little to do with the exchange prices of silver because the physical is such a small part of the market.

In other words, the physical price is being swamped by the financial price. Sure, you can see shortages of physical, but that's such a tiny piece of the LEVERAGE game that it's almost insignificant."

Oh, oh. I'm starting to 'get it'. As long as there's enough paper in play, we can have a complete disconnect from physical prices.

Now that I think about it, I can see why. If a tracking fund has no convertibility for the small players, it becomes almost like walking up to a craps game in progress on the sidewalk where the stakes are physical silver, and then starting to trade shares based on valuation of the stakes in the craps game, and then to top it off, you convince yourself that you own silver, even though in order to get into the convertibility part of the game, you need 50,000 shares, to be authorized by the players, be a registered broker-dealer, participate in DTC and be able to deliver or accept silver in a London vault.

If you think that's crazy, perhaps you haven't been watching metals prices.

Mike Whitney weighed in on both the drop in gold prices and the rise of the dollar.

The Incredibly Shrinking Dollar? Think Again ... Greenback Surges, Euro Shrivels

Mike Whitney

August 20, 2008

The greenback has surged 6 per cent in the last month alone. The euro, on the other hand, has been caught in the same recessionary downdraft that is buffeting a number of other currencies, all of which are unwinding at the same time although unevenly. Currency markets don't move in straight lines, but don't be fooled, most paper money is steadily losing value due to the unprecedented expansion of credit. Investors are moving to cash and hunkering down; the stock and bond markets are just too risky and real estate is in a shambles. As the equity bubble continues to lose gas, balance sheets will have to be mended and lending will slow to a crawl. At present, Germany's slowdown and Spain's housing crash are drawing most of the attention but, the spotlight is shifting fast. Next week it could be shining down on the America's failing banking system or poor corporate-earnings reports in the US. Then it will be the dollar marching off to the gallows.

Europe's troubles have put to rest to idea that other countries can "decouple" from the US and prosper without the help of the US consumer. That might be true in the long-term, but falling demand is already visible everywhere. Retail and auto sales are taking a thumping and 2009 is shaping up to be even tougher. It's looking more and more like the Europeon Central Bank was faked-out by the early signs of inflation and missed the deflationary sledgehammer that was about to come crashing down. It was a catastrophic blunder by European Central Bank (ECB) chief Jean Claude Trichet and it could cost him his job. Raising interest rates while sliding into the jaws of recession is madness. Now all of Europe is headed for a hard landing and there's no way to soften the blow. The ECB doesn't have the same tools as the Fed; Trichet can't simply backstop the whole system with green paper and T-Bills like Bernanke. He can either slash rates or sit on his hands and hope for the best.

Deficits are expected to soar in the European south (particularly Spain, Greece and Italy) while growth in the industrial north, e.g., Germany, will continue to shrink. Also, Spain, Ireland and England are undergoing the biggest housing meltdown in history after indulging in the same mortgage hanky-panky that took place in the US. Billions of dollars of low interest loans, that were issued to unqualified mortgage applicants, are gumming up the whole system and sending foreclosures skyrocketing.

Now the losses have to be written down and thousands of unoccupied houses sold at auction. The perception that the dollar is getting stronger is mostly an illusion. Deflation is "dollar positive" because investors who flee from toxic assets naturally move into cash. But that doesn't mean they have faith in the dollar; far from it. The fundamentals for the greenback get worse by the day. Fiscal and trade deficits are out of control, the national debt is tipping $10 trillion, foreign investment is drying up, and confidence in US leadership has never been lower. Paper currency is a country's IOU; and foreign central banks are wary of taking checks from a country that no longer wins wars or has the capacity to pay off its debts. That's why, for the first time, there's serious talk about the US losing its triple A rating on government debt. And it could happen sooner than anyone thinks. Every time the Fed uses the dollar to prop up the faltering banking system or provide limitless capital for defunct GSEs like Fannie Mae and Freddie Mac, the dollar comes under greater and greater pressure.

As the US housing market continues to collapse, trillions of dollars in equity and credit are disappearing in a deflationary bonfire. When a $400,000 home--with no down payment and negative equity--goes into foreclosure; $400,000 vanishes from the digital-pool of credit and has to be written down as a loss. So far, much of the losses have not yet been accounted for because the banks are using their own internal models for determining the value of their downgraded assets. Two weeks ago, Merrill Lynch sold $30 billion of mortgage-backed junk for 20 cents on the dollar. But they also financed the deal, which means that they really only got 5 cents on the dollar! This reflects the true "market value" of these assets. They are virtually worthless. Naturally, Merrill's sale sent tremors through Wall Street where banks and other financial institutions are sitting on trillions of dollars of this garbage marking it down at a few percentage points every reporting period rather than doing what Merrill did and putting it all behind them. As a result, the banks have less capital to lend, which means economic activity will continue to slow and the country will go into a deep recession. The point is, that the Federal Reserve now holds about $400 billion of this junk-paper on their balance sheets and the US Treasury is planning to take on hundreds of billions more (perhaps as mush as $800 billion more under the new legislation!) to prop up Fannie Mae and Freddie Mac. The Bush administration is using the credibility of the dollar as collateral in its plan to bail out the most reckless, high-stakes Wall Street gamblers.

So, how does this affect the dollar?

The nation's debts are entirely balanced atop its currency. The greenback is like a circus strongman holding a barbell precariously over his head; as the weight is increased, the sweat begins to appear on his brow while the veins in his neck and forehead begin to bulge. Finally, the knees buckle and the and the over-matched weightlifter crashes to the canvas in a heap. That's the future of the dollar in a nutshell.

But how does that explain the sudden fall in gold prices; after all, gold is the logical alternative to paper money, right?

Wrong. Gold is "real money" alright, but it's also a commodity. And when commodities are smashed by a deflationary tidal wave--as they have been the last few weeks-- gold will follow them into the basement. In truth, gold has taken an even worse pasting than the euro; free-falling from $980 per ounce in mid-July to $786 at Friday's market close. $194 in a month.

When the economy is in the grips of deflation; all asset-classes get dragged down, gold included. Many of the hedge funds and other big market players are selling their gold positions recognizing that the commodities boom is over and it's time to move on. That doesn't mean that gold won't rebound sharply when Bernanke slashes rates or if Bush blows up some new part of the globe. It simply means that in the short term, "cash is king". Pension funds and hedge funds will continue to deleverage to reduce their credit exposure to put themselves in a better position to roll over their debt. That means that gold's slide could last a while. This doesn't look like a conspiracy to me, but I have my tin-foil hat in hand just in case.

No one knows where the bottom is for gold, but one thing is certain; its future prospects are a lot brighter than the dollar's. The Bush administration has yet to demonstrate that it can enforce Dollar Hegemony via military intervention. That is a very big deal indeed. If the dollar isn't backed by Middle East oil, then the $6 trillion stockpile of dollars and dollar-denominated assets that are languishing in foreign central banks and sovereign wealth funds, will continue to dwindle until the dollar's position as "reserve currency" comes to an end.

That's one doomsday scenario, but there is another one, too. If Bernanke and Paulson continue to pile all of the nation's credit problems (bad paper) on top of the greenback; foreign capital will head for the exits and the dollar will crash. Either way, the dollar's troubles are mounting and something's got to give.

Meanwhile, the troubles of Fannie Mae and Freddie Mac, the two government-sponsored mortgage companies, continued last week as their bond ratings were lowered.

Moody's ratings cut latest blow to Fannie, Freddie

Lynn Adler

NEW YORK (Reuters) - A major credit rating agency cut the preferred share rating on Fannie Mae and Freddie Mac amid mounting concern about the ability of the two largest U.S. home funding providers to access capital, in the latest blow before a widely expected government bailout.

Early in the day, influential stock market investor Warren Buffett told CNBC there is a "reasonable chance" that Fannie Mae and Freddie Mac stock will get wiped out in a government rescue, reflecting market sentiment that has slammed the companies' shares toward 20-year lows this week. The shares closed mixed on Friday.

In the ratings cut, Moody's Investors Service cited concern that market turmoil has hurt the mortgage finance giants' ability to get fresh capital. Moody's made a ratings adjustment that suggests a greater likelihood the government sponsored enterprises, called GSEs, will need "extraordinary financial assistance" from the government or shareholders.

"Given recent market movement, Moody's believes these firms currently have limited access to common and preferred equity capital at economically attractive terms," Moody's analysts said.

Many analysts expect the government will have to exercise new abilities to recapitalize the companies, effectively nationalizing them. Those worries yanked their stock closer to zero this week from more than $65 a year ago.

Fannie Mae shares rose 2 percent to $4.98 while Freddie Mac stock dropped 4 percent to $3.03. Freddie's shares had fallen about 20 percent at one point on Friday.

A source familiar with Treasury's thinking said on Friday that any backstop would aim to keep the shareholder-owned status of these GSEs, erasing sharper earlier losses.

The debt these companies issue to fund their mortgage purchases benefited, in contrast, from the view that a federal rescue assures repayment for bonds even if not for shareholders. Fannie and Freddie own or back nearly half of all outstanding U.S. mortgages.

"The institutions are too big to fail and the government needs them operating," said Jeff Given, portfolio manager at MFC Global Investment Management in Boston. "It's the only part of the mortgage market that's even remotely working right now.

"At the end of the day probably the U.S. government's going to come in," he added. "I wouldn't want to be a preferred share owner or a common stock owner, but if you own the debt or the MBS you're going to be okay…"

Fannie Mae and Freddie Mac were set up to serve the public interest by making mortgages more available to those wanting to buy houses. In a process of corruption followed in many areas, they ended up being little more than a way for insiders to steal money. The financial press won’t put things so bluntly, so we will have to turn to the pro football columnist for the sports news site ESPN (and Brookings Fellow), Gregg Easterbrook:

Government Policy Rewards CEO Lying, So We Get More of It

Increasingly Fannie Mae and Freddie Mac are looking like little more than devices to transfer money from the pockets of taxpayers to the pockets of Fannie and Freddie senior executives. Former Fannie Mae boss Franklin Raines paid himself about $50 million for years in which, we now know, the company lied about its earnings in order to inflate executive bonuses, while management was playing fast and loose with other people's money. Beginning in 2007, Fannie Mae and Freddie Mac went off the cliff, their stocks plummeting to less than 20 percent of their previous values, and taxpayers were put on the hook as guarantors of the firms' bad management decisions. The Congressional Budget Office estimates the Mae-Mac debacle will cost taxpayers $100 billion or more. Yet Freddie Mac CEO Richard Syron was paid $14.5 million for 2007, including a $2.2 million "performance bonus." Syron has taken home $38 million total from Freddie in the past five years. Fannie Mae CEO Daniel Mudd got $14.2 million for 2007, plus a substantial prepaid life insurance policy and other perks including "financial counseling, an executive health program and dining services," the Washington Post reported. Hey, $49,000-a-year median U.S. households, you are being taxed for millionaire Mudd's "dining services." Bon appetite.

Executives receiving very high pay justify their deals on two grounds: that they are risk-takers in high-pressure situations, and that they have valuable expertise. Now we know that no one at the top of Fannie Mae and Freddie Mac took any personal risks -- everything was federally guaranteed, and all mistakes billed to the taxpayer. Here, the New York Times reports that Syron was repeatedly warned in 2004 that the organization was taking on bad loans, and did nothing. Syron justified his inaction by complaining to the Times that he was under pressure from various Fannie constituents. That's why he was paid so much, to take the heat! Yet he took no heat, rather, devoted himself to avoiding responsibility. If things go well, executives are lavished with money and praised as risk-takers. If things go poorly, executives are lavished with money and blame others.

And just what incredible expertise do Syron and Mudd possess? They made billion-dollar blunder after billion-dollar blunder; they failed to realize things as basic as buyers borrowing without documentation of income may not be able to repay loans. People chosen at random from the phone book could hardly have performed worse. Yet the federal bail-out legislation just signed by George W. Bush does not require them to give back any of their ill-gotten gains.

This is the core lesson of CEO overpay scandals: The corrupt or incompetent executive always keeps the money. He may be caught and embarrassed by bad press, but he keeps the money while someone else -- shareholders, taxpayers, workers -- is punished. Raines recently settled a federal legal complaint by agreeing to return about $3 million of his $50 million, but kept the rest; his employment contract was worded such that even if he was malfeasant, whatever he took from company coffers was his. Hilariously, federal prosecutors claimed victory because Raines "surrendered" to the government a large block of stock options -- options now worthless, owing to the Fannie Mae decline Raines helped set in motion by lying about Fannie numbers. Until Congress enacts a law that allows money taken by corrupt or incompetent executives to be recovered, the lying will continue. Lying by CEOs is what society rewards!

Why does Congress tolerate the swindle aspect of Fannie and Freddie? For the standard reason: Congress is on the take. Here, Lisa Lerer of Politico reports that in the past decade, Fannie and Freddie spent almost $200 million on campaign donations to Congress and on lobbying members of Congress, some of the lobbying money going to former members. This year, for instance, Fannie gave the legal max of $10,000 to Speaker of the House Nancy Pelosi and to Republican House Whip Roy Blunt, neither of whom face meaningful re-election challenge. As for costly lobbying, the implied deal is: Don't rock the boat while in office and someday you too will be a former member getting easy money to lobby former colleagues. During Senate debate on the Mae-Mac bailout, Majority Leader Harry Reid refused to permit a vote on an amendment that would have barred Fannie and Freddie from giving money to members of Congress. Reid did not merely oppose the measure, he refused to allow the Senate to vote on it -- so that members of Congress could remain on the take, without having to go on record about the matter.

Now that taxpayers are covering Fannie and Freddie's cooked books, the $200 million diverted to Congress in effect came from average Americans, forcibly removed from their pockets -- and thanks to Senator Reid, more will be forcibly taken from your pocket and placed into the accounts of senators and representatives. This is what TMQ calls a Sliver Strategy. The Sliver Strategy is a means to disguise embezzlement. Congress looked the other way while Fannie and Freddie approved vast amounts of bad debt, in order to shave off a sliver for itself -- in this case, the $200 million in lobbying and donations. Had Congress simply awarded itself $200 million, editorialists would have been outraged. Because the money was slipped in to a larger fiasco of much greater sums wasted, Congress got away with it.

The problem is that when such corruption becomes the norm, when it seems normal, it becomes hard to even imagine a state of affairs where such things are not tolerated. The will of the public to oppose these practices then becomes enfeebled, allowing more corruption which further weakens any healthy opposition, and so on.

Signs of the Economic Apocalypse, 7-14-08

From SOTT.net:

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, GoldMoney.com

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.