Signs of the Economic Apocalypse, 10-13-08

From SOTT.net:

Gold closed at 859.00 dollars an ounce Friday, up 2.2% from $840.80 for the week. The dollar closed at 0.7458 euros Friday, up 2.8% from 0.7255 at the close of the previous week. That put the euro at 1.3408 dollars compared to 1.3783 at the end of the week before. Gold in euros would be 640.66 euros an ounce, up 5.0% from 610.03 at the close of the previous week. Oil closed at 77.70 dollars a barrel Friday, down 19.82% from $93.10 at the close of the week before. Oil in euros would be 57.95 euros a barrel, down 16.6% from 67.55 for the week. The gold/oil ratio closed at 11.06 Friday, up 22.5% from 9.03 at the close of the previous week. In U.S. stocks, the Dow Jones Industrial Average closed at 8,451.19 Friday, down 22.2% from 10,325.38 at the close of the previous Friday. The NASDAQ closed at 1,649.51 Friday, down 18.1% from 1,947.39 for the week. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.87%, up 17 basis points from 3.60 at the close of the week before.

The crash we have been expecting finally happened last week and it was global in scope. The resulting recession/depression will be severe, since recent recessions have been staggered, meaning they never occurred all at once everywhere. While some national economies fell into recession, others were healthy and could pull the weak ones back up with their demand. When all economies crash at once, only governments can stimulate demand by massive deficit spending. But the United States, home to the world’s reserve currency, has been engaging in massive deficit spending throughout the last expansion, leaving it in a very weak position to do more. But do more it must, as we have seen with bailout after bailout in recent weeks, all of which will be added to the deficit and the public debt. That will increase interest rates, thereby plunging the U.S. economy further into full-scale depression. The result will most likely be a collapse in the value of the dollar and the end of the United States as a military hegemonic superpower.

Last week world stock markets finally reacted to the financial crisis:

Worst week for global markets since 1929

Barry Grey

11 October 2008

World stock markets plummeted Friday, ending a week that saw the biggest collapse in share values since 1929. The looming threat of a world depression provided the backdrop for a meeting of finance ministers from the G7 industrialized countries, who gathered in Washington for emergency talks with US Treasury Secretary Henry Paulson and Federal Reserve Board Chairman Ben Bernanke.

After a day of panic selling on markets from Asia to Europe and Latin America, and wild swings on the US stock market, the G7 issued a statement that pledged to place the resources of their respective countries at the disposal of the most powerful banks, but failed to outline any specific coordinated actions to stem the slide to economic disaster.

Paulson issued a statement and held a press conference following the meeting to announce that the US government would use the virtually unlimited authority granted it under the $700 billion Wall Street bailout passed one week before by the Democratic Congress to begin directly buying stock in banks and financial firms, an expansion of the government transfer of taxpayer funds to the most powerful sections of the financial aristocracy.

Major stock exchanges in Asia and Europe registered losses on Friday even greater than the 7.3 percent drop in Wall Street’s Dow Jones Industrial Average on Thursday. Japan’s Nikkei index fell 9.6 percent to its lowest level in five years. Since the start of the week, it has lost 24 percent of its value. Toyota shares dropped by 6.2 percent and a major Japanese insurance firm filed for bankruptcy.

Hong Kong’s Hang Seng Index plunged 7.2 percent. Australia’s S&P/ASX 200 index fell 8.3 percent and the broader All Ordinaries was down 8.2 percent. The Shanghai Composite Index declined 3.6 percent, leaving it 12.8 percent lower than it was a week earlier. The Indonesian stock exchange, which closed earlier in the week because of panic selling, remained suspended.

In Europe, the pan-European Dow Jones Stoxx 600 index fell 7.5 percent, which ranks among the worst one-day performances on record for the index.

London’s FTSE finished Friday down 8.9 percent. Since its last peak in June 2007, it has declined 43 percent. Friday marked the British index’s fifth consecutive losing day, during which it lost 20 percent of its value.

France’s CAC-40 index fell 6.8 percent and Germany’s DAX 30 plunged 7 percent. Trading in Italy, Russia and Austria was halted. The last of Iceland’s major banks collapsed and was taken over by the government, and all stock trading remained suspended.

Markets across Latin American were lower. The Mexican central bank was forced to auction off $6.4 billion in foreign reserves to prop up the peso.

The MSCI World Index—a measure of international share prices—was down 19 percent for the week, its worst performance since records began in 1970.
An indication that the financial crisis is now plunging the world economy into a major recession is the fact that, alongside bank stocks, shares in oil, metal and other basic resource firms fell sharply.

“What we are witnessing is mass selling on a global scale due to a combination of sheer panic and fear, combined with complete uncertainty over the future of the world’s major economies,” said Martin Slaney, head of derivatives at GFT.
In the US, most stocks ended lower after the wildest intra-day swing in history. For the first time in its 112-year existence, the Dow Jones Industrial Average gyrated in a range of more than 1,000 points.

The Dow fell 696 points in the first 15 minutes, falling below the 8,000 mark. Later in the day it was up by more than 320 points, but closed with a loss of 128 points, or 1.5 percent, ending at 8,451.

That marked the eighth straight losing session for the index, which gave up more than 1,870 points, or 18.2 percent, in the course of the week. The weekly loss outstripped the week that ended July 22, 1933, in the depths of the Great Depression, which registered a 17 percent drop—at a time when there were six trading days in a week.

Since its record high a year ago, the Dow has lost 40.3 percent, wiping out $8.4 trillion in stock values.

The Standard & Poor’s 500 Index sank by 10.7 points, falling below the 900 mark to 899. The S&P 500 is down 42.5 percent from its 2007 peak. The Nasdaq Composite Index finished the day with a slight gain of 4.4 points, but was down 15 percent for the week.

It was the worst week ever for Wall Street, with both the Dow and the S&P 500 recording their biggest weekly losses in point as well as percentage terms.

Most financial stocks rose, in the expectation that the G7 and Paulson would announce new bailout measures. However, Morgan Stanley, which is widely seen as the next likely bank failure, fell 22 percent, and Goldman Sachs lost 12 percent.

Ford Motor Company stock fell another 4.33 percent and ExxonMobil ended down 8.29 percent.

The Toronto stock exchange fell 535 points.

“There is a downward spiral of fear,” said Richard Sparks, senior equities analyst at Schaeffer’s Investment Research.

The seize-up of credit markets showed no signs of lifting. Banks are hoarding their cash and refusing to lend to other banks, or charging usurious interest rates, because they have no confidence in the other banks’ solvency.

The three-month Libor rate, a key lending benchmark for inter-bank loans of US dollars, climbed to 4.82 percent, the highest in nearly ten months. The flight of capital to what is deemed the safe haven of US government debt deepened, resulting in a decline in the yields on one-month and three-month Treasury bills to nearly zero.

Hedge funds, whose previous outsized profits have turned to losses, are contributing to the panic sell-off of stocks. Many of these firms are facing redemption demands from clients as well as demands from their bank creditors for more collateral and larger margins on their borrowings, and are dumping stocks to raise cash.

Amid the market turmoil, the reality of the decay of American capitalism was summed up by the fact that General Motors felt compelled to announce that it was not contemplating filing for bankruptcy. After decades of plant closures, wage cuts and attacks on the benefits and pensions of auto workers, justified by the claim that they were necessary to restore the biggest US auto maker to profitability and enhance its competitive position, this one-time icon of American capitalism is teetering on the edge of collapse.

GM’s announcement underscores the new stage that has been reached in the economic crisis, which has moved far beyond the situation that existed even three weeks ago, when the Bush administration announced its bailout plan for the banks and insisted it was the only way to avert a market meltdown and severe recession. That supposed panacea—designed to cover the losses of the biggest banks and facilitate a further consolidation of financial power in their hands—has done nothing to stem the crisis. Nor could it, since it did not address the underlying rot in the industrial base of American capitalism.

Now, the crisis is rapidly engulfing the broader economy, heralding a wave of plant closures and cutbacks in every branch of economic life.

The Wall Street Journal reported Friday that the consensus of economists it surveyed was that the US gross domestic product would contract in the third and fourth quarters of this year, as well as in the first quarter of 2009. “This is the first time that survey forecasts for those periods have turned negative,” the newspaper wrote. “If those predictions bear out, it would mark the first time US GDP has contracted for three consecutive quarters in more than half a century.”

President Bush made another White House appearance Friday morning in a futile attempt to revive confidence in the financial markets. Aside from making clear that his administration had decided to begin buying equity stakes in order to inject more capital into US banks, he had nothing to add to his previous remarks on the crisis.

He declared that the “federal government has a comprehensive strategy” to resolve the crisis, without explaining the abject failure of his previous “strategy”—the $700 billion bailout package—to stem the financial panic.

Bush has come to symbolize the disarray not only in the financial markets, but also at the highest levels of government. Even as he spoke the Dow began falling, and was down more than 300 points minutes after he finished speaking.

Summing up the prevailing attitude toward Bush and other political leaders, Howard Silverblatt, senior index analyst at Standard & Poor’s, said, “People are scared. Nobody believes what is coming out of the mouths of politicians or chief executives.”

There is mounting evidence that more costly measures to prop up the banks are under consideration, including a government guarantee for hundreds of billions in bank debt and inter-bank loans and government insurance for all bank deposits.

All of the proposals to deal with the worst economic crisis since the Great Depression, whether from the Bush administration and the Democrats and Republicans in the US, or the governments of Europe and Asia, have one thing in common: They all proceed from the need to maintain and defend the interests of the financial aristocracy.

None of the measures address the social tsunami that is about to engulf the working class.

As for the multi-millionaires and billionaires who monopolize the economy and dominate the US government, they will remain as ruthlessly preoccupied with their personal enrichment as ever. As the New York Times reported on Friday, a sticking point in the government plan to purchase stock from the banks with taxpayer money is the existence of token provisions in the bailout bill imposing certain limitations on the pay of top executives. The Times wrote: “It is not clear, administration officials said, that the largest American banks would agree to this, particularly given the restrictions on executive pay.”

The events of Friday, culminating two weeks of mounting financial crisis and a flurry of measures by governments to prop up their banking systems at public expense, confront the working people of the world with the prospect of rapidly rising unemployment, poverty and social misery. They raise urgently the need for a coordinated international socialist strategy to defend the interests of the world’s people against the financial elites who are responsible for the unfolding catastrophe and are seeking to impose the burden of the crisis on the working class.

Again, past budget excesses of the United States government make any response to the financial and economic crisis that much harder:

Cost of U.S. Crisis Action Grows, Along With Debt

Matthew Benjamin

Oct. 10 (Bloomberg) -- The global financial crisis is turning into a bigger drain on the U.S. federal budget than experts estimated two weeks ago, ballooning the deficit toward $2 trillion.

Bailouts of American International Group, Fannie Mae and Freddie Mac likely will be more expensive than expected. States are turning to Washington for fiscal help. The Federal Reserve said this week it will begin buying commercial paper, the short- term loans companies used to conduct day-to-day business, further increasing costs. And analysts now say the $700 billion bank- rescue plan passed by Congress last week may have to be significantly larger.

“I always assumed they would be asking for more money along the way if it was necessary, and it looks like it's going to be necessary,” said Stan Collender, a former analyst for the House and Senate budget committees, now at Qorvis Communications in Washington. “At the moment, there's nothing happening here that's positive for the budget. Nothing.”

The 2009 budget deficit could be close to $2 trillion, or 12.5 percent of gross domestic product, more than twice the record of 6 percent set in 1983, according to David Greenlaw, Morgan Stanley's chief economist. Two weeks ago, budget analysts said the measures might push deficit to as much as $1.5 trillion.

Yields to Rise

That means a lot more borrowing by Treasury, which will push up interest rates, said Greenlaw. “The Treasury's going to be ramping up supply dramatically over the course of coming months to meet this enormous federal budget obligation,” Greenlaw told Bloomberg this week. “The supply will trigger some elevation in yields.”

Treasuries have fallen the past four days even as stocks sank, a sign investors are preparing for bigger U.S. government borrowing. Benchmark 10-year note yields rose to 3.82 percent at 7:49 a.m. in New York, from a close of 3.45 percent Oct. 6.
Payments the government allocated to keep vital companies solvent are beginning to look insufficient.

AIG, the giant insurance company that was taken over by the government in mid-September, said this week it may access $37.8 billion from the Federal Reserve Bank of New York, in addition to the $85 billion the government already loaned it to stave off bankruptcy.

“You're in for a dime, you're in for a dollar on this one,” said David Havens, a credit analyst at UBS AG.

The financial health and earnings prospects of Fannie Mae and Freddie Mac -- seized by the government on Sept. 7 to prevent them from failing -- worsened in the second and third quarters, the companies' government regulator said this week.

Price Declines

The companies and regulators are recalculating the value of all of their assets to factor in price erosion. That may mean the government will have to spend more to keep the firms solvent.

Earlier this week the Fed announced it will create a special fund to buy commercial paper, the credit that businesses use to finance payrolls and other ongoing expenses. The Treasury will deposit money into the Fed's New York district bank to help set up the new unit. A Fed official said Treasury funding for the program could be “substantial.”

California, Alabama and Massachusetts are urging the Fed and Treasury to include their securities in rescue plans designed for banks and businesses. The $2.66 trillion U.S. market for state and city bonds has been all but frozen since Lehman Brothers Holdings Inc., weighed down by losses in mortgage-backed bonds, declared history's largest bankruptcy on Sept. 15.

California has said it needs to sell as much as $7 billion in notes to maintain its schools, health system and other public services. The Bush administration said it is reviewing the states' financial positions.

Plan for Banks

Meanwhile, Treasury Secretary Henry Paulson indicated two days ago that he is considering buying stakes in a wide range of banks in coming weeks to help recapitalize them.

Such a move is allowed under the $700 billion bailout package Congress passed last week. Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University, said such action is necessary -- and will likely turn out to increase the measure's cost. Spending beyond the amount set in last week's bill would require further Congressional approval.

“We have to recapitalize the banks,” Phelps told Bloomberg Television this week. “I don't imagine that there's enough money in the first Paulson plan to be able to do all that needs to be done in that direction.”

The additional borrowing could push the national debt well past 70 percent of GDP, the highest since the immediate aftermath of World War II, when the U.S. was still paying off war debt.

Debt Limit

Gross U.S. debt, which includes debt held by the public and by government agencies, this year reached about $9.6 trillion, or about 68 percent of gross domestic product. The rescue legislation increased the government's debt limit to more than $11.3 trillion from $10.6 trillion.

On top of all that, budget watchdogs say the sheer size of the interventions is making Washington more profligate than usual. To attract votes in Congress, leaders added several costly items to the $700 billion rescue, including extensions of some tax credits and tax breaks for makers of wooden arrows and stock- car racetrack owners.

Under normal circumstances, there would have been more resistance to such expenses, said Robert Bixby, executive director of the Concord Coalition, a non-partisan budget watchdog.

The rescue legislation “creates a mask for all sorts of fiscal irresponsibility,” said Bixby. “It covers up a multitude of sins.”

How did we get here? There are various answers to that question, depending on how far back and how deep you want to go.

Going far back, lending money at interest, usury, or fractional reserve lending, would seem to lead inexorably to where we’re at now. Ran Prieur explains:

You might have heard the thought experiment where we're all on an island using a fixed number of coconuts for money, and if we start lending coconuts at interest, we create imaginary coconuts so it's impossible for all the debts to be repaid. To make the simplest possible example, if there's only one coconut, and I lend it to you on the condition that you pay me back two, we now have two imaginary coconuts and only one real coconut. You can't pay me back two, so instead you pay me back one and become my slave. Now, I could give you the coconut as wages and you could give it back to me, but it's much better for me if I loan it to you again and create more debt, and that's what happens in the real world.Multiply that by billions, and it's still not as bad as the real situation, because once we have a system where someone can make money merely by lending, we get predatory institutions that don't just lend the money they have, but money they don't have. The really big fake money is not created as interest, but as fake principal to enable the creation of more debt/slavery. Inevitably, the lending institutions grow like cancers to consume the whole economy, and the supply of real stuff cannot match the exponential growth of money/debt, and the system collapses. And the foundation of the whole nightmare is the rule that if you loan someone money, they have to pay you back more…

I came up with another island-coconut story that makes the point better: Imagine an island with three people, Morgan, Chase, and you. Each of you has ten coconuts. Morgan and Chase agree to hold each other's coconuts and pay interest to each other, and you think that's silly and just keep your coconuts under your bed. Eventually, through compound interest, they have accounts worth hundreds of coconuts, while you still have only ten. Of course, if they try to withdraw their coconuts, the system collapses, so to make it more stable, they use pieces of paper that represent coconuts, and later they don't even use paper, but just keep a ledger of how many coconuts everyone supposedly owns. They agree to rules where they can lend each other even more coconuts than they have in paper money, so they can grow their money faster, until there are tens of thousands of symbolic coconuts. Meanwhile you still have only ten, and now if you want to buy stuff, it's going to cost more than it did before. Probably you will have to sell your actual coconuts to Morgan and Chase to afford to eat.

Certainly the last thirty years of deregulation spearheaded by the United States and Great Britain can be blamed. Here is the blogger “Badtux” on the Reagan “revolution”:

The toxic legacy of Ronald Reagan

Twenty-eight years. That is how long ago it was when Ronald Reagan burst upon the scene and changed American politics forever. Twenty-eight years. Reagan, like FDR, was a giant who changed politics for long after he departed from the political scene. His influence over the nation for these past twenty-eight years has been almost incalculable. Whether you are Democrat or Republican, liberal or conservative, you must admit that the shadow of Ronald Reagan has loomed over every man who has held office from the smallest town to the Presidency ever since then.

And what has happened in those twenty-eight years?

Well, a lot of things. Okay. Manufacturing employment: Down from 24% of the population to under 14% of the population. Ship construction: Down by 83% since 1980. There are now only six shipyards in the entire United States capable of building large vessels and all of them are naval shipyards. Personal debt: The size of the total consumer debt grew from $355 billion in 1980 to $2.6 trillion in 2008. Gross federal debt: In 1980, the federal debt was 33.3% of GDP. In 2007, the federal debt was 65.5% of GDP, or twice as much debt. Trade deficit: In 1980, the trade deficit was $19,407 and in 2007 $700,258. Debtor/creditor nation status: In 1980, the United States was a net creditor nation, owning 7% of the world GDP abroad. In 2007 the United States was a net debtor nation, with more than 21% of US GDP in hock to overseas.

Note that none of this has to do with how much cheap Chinese cr*p you can buy, the size of your television screen, or anything like that. I am talking about the fundamental underpinnings of a modern economy. These past 28 years have ripped the guts out of our economy until we're a nation of real estate salesmen selling each other the same overpriced homes over and over again. Well, at least that was the case until this year. BOOM. The whole house is falling down. Well, that's what happens when you rip the guts out of an economy. A hollow economy simply can't continue standing forever, it's like when they go back into a mine and pull out the pillars to get the last of the gold or silver or etc. out of it, pretty soon the whole mountain comes crunching down kaboom!

The problem is that the whole point of Reaganism was something for nothing. Reagan told us that we could have tax cuts *AND* a bigger military. The result was gigantic deficits -- bigger as a percentage of GDP than the Bush deficits (until this year). But Reagan had no problem with spending money he didn't have on fancy toys for the military. He just ran up the government's credit card bill! And no matter what Reagan might have said, that was the role model he set for the entire country. Reagan said, via his actions, "hey, don't worry about tomorrow, borrow, borrow, borrow, and live it up today!". And we did. Until now we're the world's biggest debtor nation. And the bill is coming due...

In 1980, we didn't know any of this. After the dismal Carter years, Reaganism seemed like a good idea. And maybe it was a good idea if Reagan himself had lived by the conservative values that he espoused. He didn't. He was like a middle class couple who run up a gigantic debt buying a house and junk to put in it that they don't need. He proved to America that "hey, you don't need to live within your means, you can always just borrow, borrow, borrow!" to the point where Dick Cheney said about the Bush deficits, "Ronald Reagan proved that deficits don't matter." But here's a secret Reagan did not tell you: there is no free lunch. He lied to you. He told you that we could have the greatest nation on the planet, and not have to pay for it.

A smaller less intrusive government would be nice. But Reaganism, by saying "hey, you don't have to live within your means!" inherently makes government bloat up because hey, if you don't have to pay for it, why not have big government? And Reaganism, by saying "hey, you don't have to work hard and wait for the good stuff in life, you can just charge it to your credit card!" inherently urges people to not do the constructive stuff that makes an economy strong but, rather, to spend their money on cheap Chinese crap from Wal-Mart and big-screen TV's and other junk like that which adds nothing to the economy, it's just like FDR paying one group of people to dig holes and paying another group of people to fill the holes back in all over again. Except with a Republican twist.

In short, Reagan sold us a bill of goods, and we thought it was golden. Until the hollowed-out shell left by decades of borrow, borrow, spend, spend started collapsing. The only good thing about this -- the only good thing -- is that perhaps Reaganism as a political philosophy is going to finally fall out of favor. Everybody over the past 25+ years has had that five thousand pound wrecking ball hanging over their heads. Now that it's fallen to earth, maybe folks will notice that hey, maybe Reaganism (the philosophy as practiced, not the soothing words) wasn't such a great idea after all.

Or maybe not. After all, few people want to admit it when they've been conned. And it was a con -- Reagan told us that everything had a simple answer that we wanted to believe, Reagan told us we could get something for nothing, and that's the hallmark of any good con, it's so good that you want it to be true. Yet even after twenty-eight years have shown that Reaganism is a hollow fraud that has destroyed our nation, people still want to believe. There is none so blind as the man who refuses to see. And there are an awful lot of blind men out there today...

Wishful thinking will get you every time! As will willful ignoring of reality. “Badtux” again:

The crown princess of the Ignorati

Ah yes, the ignorati. The great unwashed of American politics. Dim-witted, proudly ignorant, suspicious of anything they view as being dismissive or disdainful of their dim selves, eager to accept any politician who, in their view, is just as stupid as they are. Commonly associated with the term "I want a President that I can have a beer with."

In recent years the ignorati have been quite influential, having elected the President for six of the last seven elections. And I will say this: Ignore the polls saying that Obama is ahead. Because 50% of Americans are below average. And "average" ain't so smart, given the dumbing down of education over the past thirty years. Any rational, reasoning man could see that Barack Obama is a clearly the superior candidate compared to Cranky McDepends and his sidekick Caribou "Dinosaurs walked the earth with Man 6,000 years ago" Barbie. But if we had a rational, reasoning electorate... (shrug).

The fact that the world is billions of years old and that the dinosaurs died roughly 60 million years before the first human being walked the world are matters of science, verifiable via experiments and observation. Palin may have faith that the world is only 6,000 years old and that dinosaurs co-existed with man. But the only way she can maintain that faith is by rejecting science and all of its benefits, such as this computer that you and I are communicating with. Frankly, that is a scary thought to me, because we have already experimented with having a President who believes in faith rather than observable objective reality as the mechanism for organizing government, and it hasn't worked out very well...

So now we have the clear chance of having a President within the next four years who rejects modern science, who rejects objective reality in favor of superstition. Forty years ago, scientists and engineers and people who dealt with observable reality were respected here in the United States. Today, they are reviled as "atheistic" and "elitist", made fun of as "nerds" and "geeks", and our young people flock to become mortgage bankers and real estate salesmen rather than scientists and engineers. This also corresponds with the decline of the United States as the leader of the free world and an economic superpower, to the point where the US can't even build ocean liners and cargo vessels any more. Coincidence? Nope. That's what happens to a nation that rejects observable objective reality and decides to base itself on faith instead. When our nation was led by practical pragmatic reality-oriented people, it thrived. Now, dominated by the ignorati who view those practical pragmatic reality-oriented people as heretics and "elitists", it declines. Coincidence? Nope.

Personally, I am not too eager to meet my new Chinese overlords, but meet them I shall. Did you know that China's president is an engineer? Maybe that explains why China is growing and thriving while the United States is declining. The U.S. elects people who reject science and objective reality. China selects people who do not. I don't think I'll like living under Chinese rule, it is a harsh and unforgiving rule, but that's what is going to happen if the U.S. keeps electing people who reject science and objective reality. I'll laugh and laugh and laugh, but it'll be more of a gallows laugh because it will be the end of a once-promising dream, the dream of a nation built upon freedom and liberty... but what can I say. Democracy is the theory that the common people know what they want and deserve to get it good and hard. This situation is, apparently, what the common people want. Getting it good and hard yet?

That commentator puts his finger on two aspects of the ponerization of the United States: what Andrew Lobaczewski, in Political Ponerology calls hysteria, or the “hysteroidal cycle” and what he identifies as the downfall of the psychopaths who take control of a society with insufficient defenses: their lack of basic competence and view of objective reality.

During good times, people progressively lose sight of the need for profound reflection, introspection, knowledge of others, and an understanding of life’s complicated laws…

Perception of the truth about the real environment, especially an understanding of the human personality and its values ceases to be a virture during the so-called “happy” times; thoughthful doubters are decried as meddlers who cannot leave well enough alone. This, in turn, leads to an impoverishment of psychological knowledge, the capacity of differentiating the properties of human nature and personality, and the ability to mold minds creatively. The cult of power thus supplants those mental values so essential for maintaining law and order by peaceful means. A nation’s enrichment or involution regarding its psychological world view could be considered an indicator or whether its future will be good or bad.

During “good” times, the search for truth becomes uncomfortable because it reveals inconvenient facts. It is better to think about easier and more pleasant things…

Catastrophe waits in the wings. In such times, the capacity for logical and disciplined thought, born of necessity during difficult times, begins to fade. When communities lose the capacity for psychological reason and moral criticism, the processes of the generation of evil are intensified at every social scale, whether individual or macrosocial, until everything reverts to “bad” times. (Political Ponerology, pp. 85-6)

Since the bad times are now here, Lobaczewski points the way to hope.

When bad times arrive and people are overwhelmed by an excess of evil, they must gather all their physical and mental strength to fight for existence and protect human reason. The search for some way out of the difficulties and dangers rekindles long-buried powers of discretion…

Slowly and laboriously… they discover the advantages conferred by mental effort; improved understanding of the psychological situation in particular, better differentiation of human characters and personalities, and, finally, comprehension of one’s adversaries. During such times, virtues which former generations relegated to literary motifs regain their real and useful substance and become prized for their value. A wise person capable of furnishing sound advice is highly respected…

Difficult and laborious times give rise to values which finally conquer evil and produce better times. The succinct and accurate analysis of phenomena, made possible thanks to the conquest of the expendable emotions and egotism characterizing self-satisfied people, opens the door to causative behavior…(Ibid., p. 88)

William Pfaff says the same thing in a different way, that the seeming lack of any constraint on American power after the Cold War, led to a hysterical cut-off from reality-based reasoning and will lead to the end of U.S. hyperpower:

The Threat of a Pentagon Crash

William Pfaff

October 2, 2008

Paris - The nuclear physicist Leo Szilard once remarked that the fall of the Soviet system would eventually lead to the fall of the American system. He said that in a two-element structure the interrelationship and interdependence are such that the one cannot survive without the other.

This comment has been relayed by a friend, and as Szilard has passed to his reward I am in no position to explain his meaning, but it is possible to restate it in political terms, and we are seeing the result in finance and in war. I think that Szilard was implying what a very intelligent opponent of the United States also said when the cold war ended. Georgi Arbatov, former head of the U.S.A. and Canada Institute of the Soviet Union, said to an American interlocutor: we are about to do something truly terrible to you. We are going to deprive you of your enemy.

Without the enemy, the machinery of power begins to race, with nothing to resist it; megalomania sets in. The end of the cold war coincided with the beginning in the United States of globalized finance, launched under the Clinton administration. It operated with ever more dazzling and daring gambles in which the constraints and tension of the cold war were replaced by the psychology of greed and excess.

The economic crisis that has now overtaken the United States can be interpreted as the logical result of a financial system that had reached the point where there was no limit to what you could take out of it even when you were incapable of understanding the transactions taking place.

Less apparent to most people but just as real are the signs of an impending crash of an American military system in which, since the end of the cold war, Pentagon dysfunction has metastasized so uncontrollably as to scandalize both the man who was Defense Secretary when the so-called war on terror began, and the current Secretary, Robert M. Gates, the man now in charge as that war mutates into the "Long War…"

I think that what Leo Szilard was saying is that a system cut free from the opposition that kept it honest, passes into hubris, otherwise known as irrational exuberance, and after hubris, comes the fall.

Kevin Depew, like Lobaczewski, says bad times can be healthy when they burn away illusion:

Secular Forces of Deflation... Explosion of Simulacra... The Crisis of the Real... The Precession of the Simulacra... What Next?

The long-term secular forces of debt revulsion and deflation continue to build and are showing up in social mood with increasing frequency. The question is what do these forces mean for our everyday lives, how will they manifest in popular culture and lifestyle?

In Tuesday's New York Times, in the Science section of all places, was an intriguing story asking the question, "Are Bad Times Healthy?"

Most people are worried about the health of the economy. But does the economy also affect your health?

On the one hand, economic growth can lead to both advances in medicine and treatment of disease as well as to improvement in a population's overall economic health. But what about long-term economic stagnation or economic declines? Do people get sicker if the economy fails? The conclusions the article reaches about these questions may seem surprising, but they fit squarely within the hypothesis that social mood drives social change, not vice versa, and underscore the psychological shift a darkening social mood brings in attitudes toward consumption, money and time.

“The value of time is higher during good economic times,” said Grant Miller, an assistant professor of medicine at Stanford. “So people work more and do less of the things that are good for them, like cooking at home and exercising; and people experience more stress due to the rigors of hard work during booms.”

“When coffee prices suddenly rise, people work harder on their coffee plots and spend less time doing things around the home, including things that are good for their children,” he said.

This is a rather straightforward manifestation of how society copes with more challenging economic times; by seeking a positive outcome from less work and less consumption, and by challenging the boom hypothesis that hard work is both critical to economic success and something worth valuing above time spent at home with family and children.

Yet another social manifestation of debt revulsion and anti-consumption preceding the breakdown of a debt bubble is the conscious attempt to revolt against the explosion of simulacra that the fiat currency-based debt bubble inevitably produces; simulacra in finance, food, fashion, art and culture.

Explosion of Simulacra

Plato, in his dialogue, The Sophist, portrayed the distinction between two types of images; those that try to faithfully reproduce the original, and another, more insidious image that is intentionally distorted in a manner to make the reproduction itself appear real to those who see it.

Theaetus: Stranger, can I describe an image except assomething fashioned in the likeness of the true?

Plato presented two types of images; a faithful one, and a simulacra, or a distortion that was asserted to be reality. Later, Jean Baudrillard expanded upon the Platonic duality of images to assert four stages of imagery.

To understand where we are at this historic juncture in finance, it is helpful to see our currency system in terms of Baudrillard's imagery and precession of simulacra.

After all, currency is nothing but a representation of value, a paper dollar simply an image that is intended to mean something between two parties in order to execute a transaction.

The Crisis of the Real

A significant consequence of the massive debt bubble we have experienced is the inevitable explosion in simulacra, of which derivatives are a prime example; the dissection of financial assets into increasingly discrete objects, or instruments, that ultimately displace the reality of the underlying asset and assume their own reality that exists separate and apart from the very thing upon which they were based. Thanks, in part, to extreme leverage, this new reality supersedes the original in both importance, and also fragility, attaining the ability to actually destroy the very asset upon which the derivative was based.

We have reached the tipping point where that ability to destroy the original is now at hand. This tipping point is what I call "The Crisis of the Real."

To understand what this crisis entails, it is useful to look at what this precession of the simulacra entails as it was outlined by Jean Baudrillard in his prescient work, Simulacra and Simulation, published in 1981.

Simulacrum, for Baudrillard, is a copy of an original that displaces the original as a sign and becomes real in its own right.

The Precession of the Simulacra

The precession of simulacra that Baudrillard outlined is as follows:

1) Era of the Original

2) Era of the Counterfeit

3) Era of the Produced, Mechanical Copy

4) Era of the Third Order of Simulacra, where the reproduction displaces the original

In September 2006 I looked at how this precession of simulacra applies to pricing structure in securities markets.

At that time, I argued for the view that we are seeing the culmination phase in securities markets where pricing structure breaks, literally: "From the standpoint of the final phase of the image (price), we now witness securities markets that have no relation whatsoever to anything - they are solely existent as a pure simulacrum from which higher and lower are relations to something without meaning; in other words a hyperreal market."

We can see this progression in what Baudrillard formulated as the Successive Phases of the Image. After all, securities prices begin as nothing if not representations, images, signifiers of some "thing."

Successive Phases of the Image (with price relation in parentheses)
- the image is the reflection of a profound reality (price "means" something profound with respect to the security)
- the image masks and denatures a profound reality (price disguises a profound reality - the value investor's dream)
- it image masks the absence of a profound reality (2000 Dotcom Bubble. for example)
- it has no relation to any reality whatsoever; it is its own pure simulacrum, a copy without a model (the continuous supply of credit to market participants with no underlying attachment to any "thing" real, pure transaction that supersedes the act of exchange itself).

What Next?

This debt revulsion and structural deflation demands a readjustment that has profound consequences for society. What does a revolt against the displacement of the "real" entail?

First, from a consumption standpoint, it entails a shift in focus, a change in patterns of accumulation and the valuation of material objects. Going back to the New York Times article on "Are Bad Times Healthy?", it means the revaluation of time spent at home, or among friends, and an overall attitude involving less "doing" and more "being."

The proliferation of images, reproductions, the sheer volume and excess of signs, of choices, is itself deflationary, and this secular pattern is evident in everything from clothing and textiles to automobiles, home furnishings, technology and media.

This is the structural deflationary paradox where the excess of signs and choices, an inflation of everything, literally, actually creates the conditions for imposing limitations and regulations upon the chaos of apparent freedom.

Deflation is simply the market's attempt to unwind and dismantle the confiscatory dominance of the inflationary regime. Inflation, in the purest sense, confiscates money, purchasing power, control. In the philosophical and social sense, however, inflation confiscates something else that will increasingly be revalued among all other concepts and materials: Time away from production.

I understand there are those who disagree with structural deflation and who believe that central banks worldwide, in coordination with fiscal policy, will be able to intervene and resurrect banking and production. The outcome, it is asserted, will be inflation, or hyperinflation.

But again, if we see that "The Crisis of the Real" is really a crisis of reproduction, then we can also see that the very mechanisms of reproduction - fiat currency, fractional reserve banking, leverage - are broken, perhaps permanently so. In order for inflation or hyperinflation to displace this ongoing debt deflation, the mechanisms that facilitate reproduction and currency velocity must be intact. The last vestige of bull market hope is the hope, too, that the monetary velocity triggers are functional. They are not, and there is a significant probability that we may never again return to that place where they were.

Ultimately, the question of where we are going is less an economic question than a philosophical one. If you could ask the aggregate what this change might mean, the answer would probably be something along the lines of an "impossible to conceive" fear and dread. Indeed, it is very difficult to imagine such a profound change in the aggregate. However, I suspect that if you ask one individual at a time what it means, the answer would be filled with the certainty of purpose, dedication to survival and even optimism that something good will eventually emerge from this transition…

So here is hope, real hope, not the false hope of hysteria and wishful thinking

Signs of the Economic Apocalypse, 12-17-07

From Sott.net:



Gold closed at 798.00 dollars an ounce Friday, down 0.3% from $800.20 at the close of the previous week. The dollar closed at 0.6930 euros Friday, up 1.6% from 0.6822 at the close of the previous Friday. That put the euro at 1.4430 dollars compared to 1.4658 the Friday before. Gold in euros would be 553.01 euros an ounce, up 1.3% from 545.91 for the week. Oil closed at 91.41 dollars a barrel Friday, up 3.5% from $88.28 at the close of the week before. Oil in euros would be 63.35 euros a barrel, up 5.2% from 60.23 for the week. The gold/oil ratio closed at 8.73 Friday, down 3.8% from 9.06 at the end of the week before. In U.S. stocks, the Dow closed at 13,339.85 Friday, down 2.1% from 13,625.58 for the week. The NASDAQ closed at 2,635.74 Friday, down 2.7% from 2,706.16 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.23%, up 12 basis points from 4.11 for the week.

Last week was an eventful one for financial markets. The U.S. Federal Reserve Board cut interest rates by a quarter point, sending stocks down (traders wanted a half point cut). According to insiders, banks are in a state of panic. Analysts increasingly predict that the United States will fall into recession in 2008, and, to make it worse, inflation is rising, leading to fears of stagflation, fears that were voiced by none other than Alan Greenspan. Greenspan, formerly a hero, now haunts the world economy like the ghost of an unwelcome houseguest.

First the rate cut:

US stocks plunge on Federal Reserve rate cut announcement

Barry Grey

12 December 2007

US stocks plummeted Tuesday after the Federal Reserve Board announced a quarter-point cut in short-term interest rates and indicated in an accompanying statement that it remained concerned over the potential for an inflationary surge.

The sharply negative reaction on Wall Street, which was looking for a half-point cut in interest rates and a statement clearly giving primacy to the risks of recession and a meltdown on financial markets above inflation concerns, is a measure of the near-panic gripping big investors and some of the largest banks in the US and Europe over the implosion of the US housing market and resulting crisis on credit markets.

Immediately after the Federal Reserve Board’s Federal Open Market Committee announced its decision, at 2:15 PM Eastern Standard Time, all of the major New York stock indexes began to plunge. By the end of trading, the Dow Jones Industrial Average had fallen 294.26 points, a drop of 2.1 percent. The Nasdaq Composite Index declined by 66.60 points, down 2.5 percent, and the Standard & Poor’s 500 Index fell 38.31 points, a 2.5 percent decline.

The sharp fall on the markets came despite the fact that Tuesday’s rate cuts marked the third consecutive reduction in interest rates by the Fed since the credit crisis erupted last August. Since then, the US central bank has slashed rates by a full point, the greatest easing of borrowing costs since the recession of 2001.

The Fed cut its target federal funds rate, the overnight rate at which banks lend money to one another, from 4.5 percent to 4.25 percent. At the same time, it reduced the so-called discount rate, at which the Fed directly lends money to banks, from 4.75 percent to 4.5 percent.

These moves are aimed at cheapening the cost of loans and pumping liquidity into the credit markets. They come at a time when major banks and investment houses in both the US and Europe are reeling from massive losses resulting from the collapse of assets linked to US subprime home loans.

The depression in US home sales and prices and soaring mortgage delinquencies and foreclosures of homes purchased with high-interest subprime loans have undermined the stability of banking giants that leveraged such loans into a multi-trillion-dollar edifice of highly profitable securities that were sold to banks and other investors around the world.

According to an article in Monday’s Wall Street Journal, “Over the past decade, Wall Street built a market for more than $2 trillion in securities sold globally and backed by loans to US homeowners.” That market has come crashing down—as it was destined to do, since it was built on the most speculative and unstable of foundations.

Facing huge losses from the collapse of these investments, and unable to determine the real value of exotic securities derived from dividing up, bundling, repackaging and reselling loans—many to subprime borrowers with shaky credit, to other investors and financial institutions—the banks have sharply cut back their lending to consumers and businesses. Lending is down, its cost is rising and the result is a credit crunch that is driving the US economy into recession, with dire consequences for the global economy.

This crisis is an expression of the increasingly parasitic and speculative character of American and world capitalism. It effects are rapidly spreading throughout the US economy, with job growth slowing, consumer spending falling off, US corporate profits tending downward and rising delinquencies on all forms of consumer credit—from home loans to auto loans and credit card payments.

Most analysts are now forecasting minimal or negative economic growth in the US for the current quarter, and some are predicting the economy will fall into recession in 2008. On Monday, Morgan Stanley became the first major Wall Street bank to predict a US recession next year.

Last week, the Bush administration announced a scheme for mortgage lenders, servicers and investors to voluntarily agree to freeze interest rates for a small minority of the estimated 2 million subprime borrowers whose adjustable-rate loans are scheduled to reset sharply higher over the next 18 months.

The plan, which will do little to relieve the suffering of millions of Americans who fell victim to predatory lending practices during the housing boom, is above all aimed at buying time for the big banks and mortgage companies and reassuring financial markets that a full-scale collapse will be averted. There is, however, little likelihood that it will prevent a deepening of the credit crunch and stave off an economic downturn that could prove severe and protracted.

The Wall Street Journal carried a front-page article Monday headlined “US Mortgage Crisis Rivals S&L Meltdown,” referring to the US savings and loans collapse of the late 1980s and early 1990s that ended with a multi-billion-dollar government bailout of Wall Street. The article had a sub-headline that read: “Toll of Economic Shocks May Linger for Years; A Global Credit Crunch.”

The Journal wrote that an examination of the current crisis “shows that it is comparable to some of the biggest financial disasters of the past half-century.”

Developments this week appear to vindicate that prognosis. The Zurich-based banking giant UBS, the world’s largest provider of banking services to the wealthy, announced Monday that it was writing down the value of its subprime assets by an additional $10 billion. The bank had already taken a $4.4 billion third-quarter write-down. It issued a statement that the “ultimate value of our subprime holdings... remains unknowable.”

UBS said it would post a loss for the fourth quarter and possibly for the year as a whole. It further said it had received an $11.5 billion investment from a fund owned by Singapore and an unnamed Middle Eastern investor, equivalent to selling as much as 12.4 percent of the company in return for a cash bailout.

With the announcement, UBS became the biggest casualty outside of the US of the American housing slump, but banks in other countries, such as Britain and Germany, have also been hit by the fallout from the US housing and credit crisis.

“That UBS, long known as a conservative lender, could take such a financial hit suggests that the wave of industry write-downs, which so far total about $50 billion, may be far from over,” wrote the Wall Street Journal.

Just two weeks ago, Citigroup, the largest US bank, agreed to sell a $7.5 billion stake, 4.9 percent of the company, to the Abu Dhabi Investment Authority in order to shore up its capital base, after announcing write-downs of $8 billion to $11 billion related to bad subprime investments. The bank had already disclosed $5.9 billion in write-downs.

Merrill Lynch, which has $20.9 billion in remaining exposure to subprime-linked investments, may also need to take a further write-down, as could Morgan Stanley, according to analysts. Merrill already disclosed a third quarter write-down of $7.9 billion. Morgan Stanley has announced subprime-linked losses of $3.7 billion in the first two months of the fourth quarter, which could increase, based on its $6 billion in remaining subprime exposure.

Washington Mutual, the largest US savings and loan bank, this week widened its expected fourth quarter loss to $1.5-$1.6 billion due to deteriorating credit and mortgage markets. The S&L said it would abandon subprime lending entirely, close 190 of its 336 home loan center and sales offices as well as 9 loan and processing call centers, and cut 3,150 jobs. It also announced it would cut its dividend 73 percent to 15 cents a share.

Bank of America announced it was liquidating a money market fund for institutional investors that was worth $40 billion only a few months ago but now has only some $12 billion in assets. The bank said the losses were related to the subprime mortgage crisis.
Meanwhile, Fannie Mae, the US government-sponsored mortgage company, predicted house prices would continue to fall for two or three more years, with no normalization until 2010.

Wall Street is clamoring for a bailout by the Fed, in the form of drastic interest rate cuts, with scant concern for the medium- and longer-term implications for the status of the dollar and the position of American capitalism in the global economy. The Fed is attempting to balance the threat of a US banking collapse with the dangers arising from soaring energy, food and commodity prices and the relentless fall of the dollar on world currency markets.

The dollar has already lost a quarter of its value against all other currencies since 2002 and 40 percent against the euro, and further interest rate cuts can only push the US currency lower. The position of the dollar, which has been further undermined by the current US housing and credit crisis, is a barometer of the declining relative strength of American capitalism on the world market.

Gerard Lyons, chief economist at Standard Chartered in London, published a column in the December 7 Financial Times entitled “The Middle East Must Loosen its Ties to the Dollar.” In the article, he recommended that the oil-rich Persian Gulf regimes sharply revalue their currencies and cease pegging them to the dollar. He wrote: “The region should shift from the dollar peg to managing exchange rates against a basket of currencies of the countries with which they trade. The dollar would form a big part of this basket, but so too would the euro and Asian currencies. Over time, the dollar’s weight would fall.”

Commenting Tuesday on the bailout of UBS by Singapore and a Middle East investor, he said it was a “reflection of the current fragile state of the financial sector in the West” and “a further sign of how the balance of the world economy is changing.”

Greenspan urges policymakers to stand firm on inflation and let the chips fall where they may, even if it means an economic depression (he doesn’t use that word, of course).

Greenspan sees early signs of U.S. stagflation

December 16, 2007

WASHINGTON (Reuters) - The U.S. economy is showing early signs of stagflation as growth threatens to stall while food and energy prices soar, former U.S. Federal Reserve Chairman Alan Greenspan said on Sunday.

In an interview on ABC's "This Week with George Stephanopoulos," Greenspan said low inflation was a major contributor to economic growth and prices must be held in check.

"We are beginning to get not stagflation, but the early symptoms of it," Greenspan said.

"Fundamentally, inflation must be suppressed," he added. "It's critically important that the Federal Reserve is allowed politically to do what it has to do to suppress the inflation rates that I see emerging, not immediately, but clearly over the intermediate and longer-term period."

The U.S. central bank has lowered its benchmark interest rate three times since mid-September as a housing downturn, tightening credit conditions, and steep food and energy prices threaten to push the U.S. economy into recession.

But cutting rates can have the unwanted side effect of pushing up prices, so the Fed finds itself in a tricky position of trying to revive growth without spurring inflation.

Last week, U.S. data showed that wholesale inflation rose at the highest rate in 34 years, while consumer prices rose the most in more than two years.

Greenspan repeated his assessment that the probability of a U.S. recession had moved up toward 50 percent but noted that corporate America's debt levels were in good shape, which should help cushion the blow from tightening credit terms.

"The real story is, with the extraordinary credit problems we're confronting, why the probabilities (of recession) are not 60 percent or 70 percent," he said.

"Because of the decline in long-term interest rates for a protracted period of time, American business was able to fund a significant part of its short-term liabilities and take out low-cost, long-term debt, so the credit needs have not been all that large," he said.

Greenspan has drawn some criticism for keeping the trendsetting federal funds rate at a low 1 percent from June 2003 through June 2004, which some argue contributed to a housing bubble that is now bursting spectacularly.

Greenspan said real estate prices will stabilize only when the overhang of unsold new-construction homes begins to ease, and estimated that financial losses could be in the range of $200 billion to $400 billion as securities tied to failing subprime mortgages lose value.

He warned against any sort of government bailout plan for homeowners that interfered with the normal functioning of markets for home prices or interest rates, saying it would "drag this process out indefinitely." Offering cash to stricken homeowners instead would cause less long-term damage, he said.

"It's only when the markets are perceived to have exhausted themselves on the downside that they turn," he said. "Trying to prevent them from going down just merely prolongs the agony."

So the man who more than anyone else caused all this pain, the man who announced as Federal Reserve Chair that variable rate mortgages were a sensible option, now says that nothing should be done to help the victims. Not surprising, I guess, coming from one whose hero is the philosopher of psychopathic individualism, Ayn Rand. While Greenspan abhors any bailing out of average people facing eviction from their homes, he and other central bankers are always ready to bail out their fellow bankers. Only they don’t call it bailing out, they call it “providing liquidity.” The problem we face now is that, as Paul Krugman put it, this is not a liquidity crisis it is a solvency crisis.

After the money's gone

Paul Krugman

December 14, 2007

Princeton, New Jersey -- On Wednesday, the U.S. Federal Reserve announced plans to lend $40 billion to banks. By my count, it's the fourth high-profile attempt to rescue the financial system since things started falling apart about five months ago. Maybe this one will do the trick, but I wouldn't count on it.

In past financial crises - the stock market crash of 1987, the aftermath of Russia's default in 1998 - the Fed has been able to wave its magic wand and make market turmoil disappear. But this time the magic isn't working.

Why not? Because the problem with the markets isn't just a lack of liquidity - there's also a fundamental problem of solvency.

Let me explain the difference with a hypothetical example.
Suppose that there's a nasty rumor about the First Bank of Pottersville: People say that the bank made a huge loan to the president's brother-in-law, who squandered the money on a failed business venture.

Even if the rumor is false, it can break the bank. If everyone, believing that the bank is about to go bust, demands their money out at the same time, the bank would have to raise cash by selling off assets at fire-sale prices - and it may indeed go bust even though it didn't really make that bum loan.
And because loss of confidence can be a self-fulfilling prophecy, even depositors who don't believe the rumor would join in the bank run, trying to get their money out while they can.

But the Fed can come to the rescue. If the rumor is false, the bank has enough assets to cover its debts; all it lacks is liquidity - the ability to raise cash on short notice. And the Fed can solve that problem by giving the bank a temporary loan, tiding it over until things calm down.

Matters are very different, however, if the rumor is true: The bank really did make a big bad loan. Then the problem isn't how to restore confidence; it's how to deal with the fact that the bank is really, truly insolvent, that is, busted.

My story about a basically sound bank beset by a crisis of confidence, which can be rescued with a temporary loan from the Fed, is more or less what happened to the financial system as a whole in 1998. Russia's default led to the collapse of the giant hedge fund Long Term Capital Management, and for a few weeks there was panic in the markets.

But when all was said and done, not that much money had been lost; a temporary expansion of credit by the Fed gave everyone time to regain their nerve, and the crisis soon passed.

In August, the Fed tried again to do what it did in 1998, and at first it seemed to work. But then the crisis of confidence came back, worse than ever. And the reason is that this time the financial system - both banks and, probably even more important, nonbank financial institutions - made a lot of loans that are likely to go very, very bad.

It's easy to get lost in the details of subprime mortgages, resets, collateralized debt obligations, and so on. But there are two important facts that may give you a sense of just how big the problem is.

First, the United States had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.

Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.

As home prices come back down to earth, many of these borrowers will find themselves with negative equity - owing more than their houses are worth. Negative equity, in turn, often leads to foreclosures and big losses for lenders.
And the numbers are huge. The financial blog Calculated Risk, using data from First American CoreLogic, estimates that if home prices fall 20 percent there will be 13.7 million homeowners with negative equity.

If prices fall 30 percent, that number would rise to more than 20 million.

That translates into a lot of losses, and explains why liquidity has dried up. What's going on in the markets isn't an irrational panic. It's a wholly rational panic, because there's a lot of bad debt out there, and you don't know how much of that bad debt is held by the guy who wants to borrow your money.

How will it all end? Markets won't start functioning normally until investors are reasonably sure that they know where the bodies - I mean, the bad debts - are buried. And that probably won't happen until house prices have finished falling and financial institutions have come clean about all their losses. All of this will probably take years.

Meanwhile, anyone who expects the Fed or anyone else to come up with a plan that makes this financial crisis just go away will be sorely disappointed.

Meanwhile, the housing crisis shows no signs of ending.

U.S. Housing Crash Deepens in 2008 After Record Drop

Daniel Taub

Dec. 14 (Bloomberg) -- For U.S. homeowners, builders, bankers and realtors, the crash of 2007 will only get worse in 2008.

Everyone from mortgage-finance company Fannie Mae to Lehman Brothers Holdings Inc. expects declines next year. Existing home sales will drop 12 percent and existing home prices will fall 4.5 percent, Washington-based Fannie Mae says. Lehman analysts estimate almost 1 million mortgage loans will default in 2008, up from about 300,000 this year.

“We’re only halfway through the housing shock,” said Ethan Harris, chief U.S. economist at New York-based Lehman, the fourth- biggest U.S. securities firm by market value. “It’s just a matter of time before the weakness spreads to the rest of the economy.”

The housing market collapse has been anything but the “soft landing” that Federal Reserve Bank of San Francisco President Janet Yellen and David Lereah, former chief economist at the National Association of Realtors in Chicago, predicted for real estate at the start of 2007.

Median home prices declined in the U.S. this year, the first annual drop since the Great Depression, according to forecasts from the National Association of Realtors.

“I’m not going to sit here and tell you it’s going to turn real strong next year,” said Jim Gillespie, chief executive officer of Coldwell Banker Real Estate LLC, the largest U.S. residential brokerage, according to Franchise Times. “It’s not going to turn real strong next year.”

‘Let the House Go’

Analysts at New York-based CreditSights Inc. predict housing won’t rebound until “2009, at best.” Moody’s Economy.com Inc., the economic forecasting unit of Moody’s Corp. in New York, says home sales will hit bottom next year, declining 40 percent from their peak. And U.S. Treasury Secretary Henry Paulson’s plan to slow foreclosures won’t help those who already are facing the loss of their homes, like C.W. and Sandy Hicks of Las Vegas.

The Hickses refinanced the mortgage on their four-bedroom, 1,300-square foot home two years ago. Their $237,000 adjustable- rate loan resets every month, and now their monthly payment has jumped 50 percent to $2,700. The couple can’t afford it.

“It looks like we’re going to have to let the house go,” said C.W. Hicks, 65, a long-haul truck driver who has kept working past retirement age to help pay medical bills for his wife Sandy, 59, who has heart problems. “I guess we’ll try to rent a house or something.”

The Hickses aren’t the only ones grappling with the consequences of this year’s housing market. The number of Americans behind on their mortgage payments rose to a 20-year high in the third quarter, the Washington-based Mortgage Bankers Association said earlier this month.

Lender, Homebuilder Woes

“The whole thing has deteriorated faster and further than we or anyone else had anticipated,” said Ron Muhlenkamp, president of Wexford, Pennsylvania-based Muhlenkamp & Co., which has about $2.5 billion under management and holds shares of mortgage lender Countrywide Financial Corp. and homebuilder Ryland Group Inc.

Not true, Mr. Muhlenkamp. Many of us saw this coming a mile away.

The five biggest U.S. homebuilders by revenue, led by Miami- based Lennar Corp., recorded writedowns and charges totaling about $7.5 billion this year for land that plunged in value.

Mortgage companies, including Irvine, California-based New Century Financial Corp., the second-largest subprime lender in 2006, have filed for bankruptcy protection after borrowers unable to repay their loans defaulted.

H&R Block Inc. of Kansas City, Missouri, shut Option One this month after plans to sell the subprime home-lending unit fell apart, and U.S. regulators ordered Santa Monica, California-based Fremont General Corp. to stop selling subprime mortgages, loans given to people with poor or limited credit histories or high debt levels.

O’Neal, Prince Fall

Bank and brokerage writedowns and losses related to subprime loans totaled more than $80 billion. Citigroup Inc., the biggest U.S. bank by assets, last month said it would write down the value of subprime mortgages and collateralized debt obligations -- securities backed by bonds and loans -- by $8 billion to $11 billion. At Merrill Lynch & Co., writedowns on mortgage-related investments and corporate loans have cost the world’s biggest brokerage $8.4 billion. Both companies are based in New York.

The losses led to the ouster of Merrill Chief Executive Officer Stan O’Neal and the resignation of Citigroup CEO Charles O. “Chuck” Prince III. O’Neal’s exit came after he said as late as July that “not even a sharp downturn in one market today necessarily portends financial disaster in another, and we’re seeing this play out today in the subprime market…”

“I know we weren’t predicting things would get this bad,” said Frank Liantonio, executive vice president for global capital markets at New York-based Cushman & Wakefield Inc., the largest closely held real estate services provider. “There were some signs there, but I don’t think anyone anticipated the level of dislocation that was actually created.”

They need to stop saying that no one anticipated this! Maybe no one living in whatever bubble these people live in saw it coming, but this crisis was the easiest thing to predict.

Now, however, the mainstream media is jumping on the bearish bandwagon with pieces like the following from the Los Angeles Times on the attractiveness of gold as an investment:

Buy yourself gold for portfolio protection?

Tom Petruno, Los Angeles Times

December 16, 2007

Financial advisors often try to discourage clients from such investments, but some individuals consider the metal to be insurance against the U.S. dollar. Learn four common ways to invest, and the pros and cons of each.

Gold is one holiday gift that has kept on giving for the last seven years.

The metal's market price, which last month surged above $800 an ounce for the first time in nearly three decades, has risen every year since 2000.

It has trounced the U.S. stock market in that period, rocketing 190%, compared with a 26% total return for the Standard & Poor's 500 index. After mostly being out of favor in the 1980s and 1990s, gold has found a new, and global, investor audience -- including the emerging rich in booming Asian economies.

Fresh interest in gold also has spawned an array of gold-related securities, providing more options for people who want to own the metal without having to take physical possession of it. Yet professional financial advisors often try to discourage their clients from gold investing in any form. Many say they don't believe it has a place in a modern portfolio. In part, gold and other precious metals -- platinum and silver -- suffer from their long-standing image as havens for survivalists, conspiracy theorists and flakes."

That's for the guys we don't want as clients," said Michael Glowacki, head of financial planning firm Glowacki Group in West Los Angeles.

Some fans of gold, however, say the bad rap is outdated and ignores the metal's powerful performance in this decade.

Martine Pham, a 45-year-old Bay Area investor, says she likes gold as a way to protect her purchasing power if the U.S. dollar continues to lose value, deepening its slide of the last six years.

But she also says she was drawn to the commodity in recent years by basic investment analysis."

If you just look at it based on supply and demand, I could make a good fundamental case for the price to go up," Pham said.

Some individual investors say they simply consider gold to be a modest bit of insurance for their portfolios of stocks and bonds."

In a worst-case scenario, you might be glad you had it," said Orvis Adams, an 82-year-old Los Alamitos investor who said his gold holdings amounted to less than 2% of his total investment mix.

If you're thinking about adding gold to your portfolio, how best to do it?

Here's a primer on the pros and cons of four common ways to invest in gold:

Gold bullion

Coins and bars from government or private mints are the classic way to own the metal itself -- and also the most cumbersome.

Coin dealers like to say that nothing compares to the weighty feel of real gold, one of the heaviest of the elements.

There's a "warm, fuzzy feeling" people get when they hold a gold coin in their hand, said Ken Edwards, a partner at California Numismatic Investments in Inglewood.

That's part of the marketing, of course. And government mints have tried to outdo one another in the last two decades in designing coins to catch the public's eye -- and bring in revenue from mint sales.

Thirty years ago the South African Krugerrand had the global gold coin market largely to itself. Now, the Krugerrand competes with the American Eagle, the Chinese Panda, the Canadian Maple Leaf and other government-minted coins.

One current favorite of some coin dealers is the Austrian Philharmonic, which on one side is adorned with the images of musical instruments including the harp and the violin.

Ultimately, gold is gold: The value of a minted coin depends mostly on its weight and the market price of the metal, plus the dealer commission (the markup or markdown, depending on whether you're buying or selling).

Dealer commissions typically range from 2% to 4.5%, depending on the coin. So it's worth shopping around.

The benchmark price of gold in New York futures markets Friday was $793.30 an ounce.

For 1-ounce coins, California Numismatics on Friday quoted a selling price of $826 for the American Eagle, $821 for the Canadian Maple Leaf and $816 for the Krugerrand.

All of the coins contain 1 ounce of gold. But some, including the Krugerrand, contain small amounts of alloys, such as copper, to add strength (because gold is relatively soft). Others, including the Maple Leaf and the relatively new American Buffalo, are virtually pure gold.

It's a matter of personal preference, Edwards says. "Some people just prefer solid gold."

Some investors also prefer gold bars to coins. The bars, in sizes as small as 1 gram, also are produced by government and private mints.

Michael Carabini, who manages gold dealer Monex Precious Metals in Newport Beach, sells bars and coins. But he recommends coins for most investors because they are easier to sell, he says."

The liquidity is better with coins," he said, in part because they're easily recognizable around the world.

Besides 1-ounce gold coins, some mints produce smaller sizes, down to one-tenth of an ounce.

But you may pay a bigger percentage premium to buy smaller coins, and dealers may charge a bigger markdown when you sell, compared with 1-ounce coins. The reason: Smaller coins trade less frequently.

"On a typical day, I'll trade 100 times more 1-ounce coins than smaller coins," Edwards said.

Even so, smaller coins may make sense for some investors, Carabini said. For example, if your plan is to eventually split the coins among heirs, smaller sizes could make that easier.

Thinking about your exit strategy is important for another reason: The tax man isn't friendly to bullion. Hard assets like gold coins are subject to a higher long-term federal capital gains tax rate when you sell -- 28% versus a top rate of 15% for securities such as stocks.

For some investors, the biggest potential drawback to owning coins or bars is the need to store them somewhere secure. Under the mattress isn't recommended -- not at about $800 an ounce for something so easily fenced.

Storage will cost you money, whether you use a bank safe deposit box, a home safe or a safekeeping program offered by some gold dealers.

Monex, for example, charges $5.50 a month to store 20 ounces of gold, Carabini said.

Gold certificates

These programs allow an investor to hold gold in certificate form. The certificate represents ownership either in gold held specifically for you or a stake in a pool of gold with other investors.

The firm that issues the certificate handles the safekeeping and typically is obligated to produce the gold upon demand or redeem it for cash.

When investor Martine Pham decided she wanted to own physical gold two years ago, she said, she considered buying coins but didn't want to deal with storing them herself.

She bought into the certificate program of GoldMoney, a Britain-based gold certificate company. The company stores its gold in vaults in London and Zurich, Switzerland.

She chose the program over others, Pham said, because of the ease of transferring funds. GoldMoney promises 24-hour access to its program.

Other companies offering certificate programs include EverBank in Jacksonville, Fla., and the Perth Mint in Australia.

It's worth shopping around to compare minimums and fees for the programs. GoldMoney says that it has no minimum investment and that its storage and insurance fee is a flat one-tenth of a gram of gold per month (about $2.60), regardless of the amount of gold owned.

EverBank has a $5,000 minimum for pooled accounts but doesn't charge a storage fee on them.Also compare purchase and sales fees. The Perth Mint charges a commission of 1.75% on purchases. EverBank charges 0.75%.

Exchange-traded funds

These funds provide a simple way for investors to ride a rally in gold's price -- or bet on a price decline.

Shares of the funds, the streetTracks Gold Trust (ticker symbol: GLD) and its rival, the Ishares Comex Gold Trust (IAU), trade on the New York and American stock exchanges, respectively.

A central idea behind the funds is that their daily price changes closely track changes in the price of bullion. That's because the funds' shares are backed by the metal itself, held in storage.

StreetTracks Gold Trust, created in 2004, has a market capitalization of nearly $16 billion. Ishares Comex Gold Trust, created in 2005, has a market cap of $1.4 billion.

Both stocks trade for about one-tenth the market price of bullion. On Friday, for example, the streetTracks Gold Trust closed at $78.50 a share. It's up 24% this year, compared with a 25% rise in the New York futures price for bullion.

The funds also can be used to bet on a falling gold price, because they can be "shorted" -- meaning, the shares can be borrowed from a brokerage and sold, with the expectation that the price will drop and the borrowed stock can be repaid later with shares bought at a lower price.

One potential drawback of the funds: You'll have to pay a trading commission each time you buy or sell.

And the stocks pay no cash dividends because gold itself doesn't generate any income.

Also, the Internal Revenue Service considers these a direct investment in gold, which means they're subject to the 28% hard-asset long-term capital gains tax instead of the 15% maximum on most stocks.

Some investors who prefer owning physical gold point to another potential negative with gold securities: When the stock market was closed for four days in 2001 after the terrorist attacks, owners of gold securities had no way to sell what they owned, or buy more.

Larry Heim, who operates a business in Portland, Ore., that buys gold bullion for clients, said he didn't recommend gold securities for that reason. "I don't want to take that risk," he said.

Mining stocks and fundsShares of gold mining companies and mutual funds that invest in them offer a way to buy into the business of gold as opposed to just the metal itself.

The performance of a gold mining stock may be tied in part to the metal's price performance, but in the long run the stock's rise or fall may well depend more on how well the business is managed.

Consider: The price of gold is up 25% this year. Shares of Barrick Gold Corp., one of the industry's titans, are up 24%. Shares of the much smaller Yamana Gold Inc. are down 5%.

In general, gold mining stocks are "notoriously volatile," warns Katherine Yang, an analyst at investment research firm Morningstar Inc. in Chicago.

The point being, if you're going to buy a gold stock, you ought to be prepared to do some homework -- and cross your fingers.

Overall, a Philadelphia Stock Exchange index of 16 major gold mining stocks is up nearly 17% this year after rising 11% last year and 29% in 2005.

Some mining-stock experts worry that a broad slide on Wall Street could drag mining stocks down as well for a while, even if the price of gold holds up.

"We could be coming up on a time when mining stocks could decouple from the price of the metal," said Frank Barbera, who writes the Gold Stock Technician newsletter in Los Angeles.

Decoupling could occur, he said, if a stock market plunge drives investors to sell their winners as well as their losers. In sharp market declines, "you sell what you can," Barbera said.

But longer term, he said, he favors smaller mining companies that could be takeover targets if the industry continues to consolidate and the metal's price continues to rise.

Investors who want to own a basket of mining stocks can pick from more than a dozen mutual funds that focus on gold stocks."

For people who aren't that interested but want some exposure, that's probably the way to go," Barbera said.

But as with any mutual funds, shop around. Some gold funds charge high management fees that will dent your returns.Morningstar's two favorite fund picks are American Century Global Gold and the Vanguard Precious Metals and Mining fund.

Signs of the Economic Apocalypse, 3-5-07

From Signs of the Times:

Gold closed at 645.90 dollars an ounce Friday, down 6.2% from $685.70 at the close of the previous Friday. The dollar closed at 0.7580 euros Friday, down 0.2% from 0.7595 at the previous week’s close. That put the euro at 1.3193 dollars compared to 1.3167 at the end of the week before. Gold in euros would be 489.58 euros an ounce, down 6.4% from 520.77 for the week. Oil closed at 61.47 dollars a barrel, up 0.5% from $61.14 at the close of the previous week. Oil in euros would be 46.59 euros a barrel, up 0.3% from 46.43 euros at the end of the week before. The gold/oil ratio closed at 10.51 Friday, down 6.8% from 11.22 for the week. In U.S. stocks, the Dow Jones Industrial Average closed at 12,138.77, down 4.2% from 12,647.48 at the close of the previous Friday’s trading. The NASDAQ closed at 2,374.12 Friday, down 5.9% from 2,515.10 at the close of the Friday before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.51% down 16 basis points from 4.67 for the week.

The big story last week was the fall in stock markets across the world on Tuesday. In the United States the Dow had it’s biggest one-day drop since September 2001 while the housing market continued its slide and signs of recession mounted.

U.S. Economy: Home Sales Tumble, Growth Revised Lower

By Courtney Schlisserman and Joe Richter

Feb. 28 (Bloomberg) -- New-home sales in the U.S. tumbled last month by the most in 13 years and fourth-quarter economic growth was less than previously estimated, dousing speculation that the worst of the slowdown is over.

January new-home purchases fell 16.6 percent, the most since 1994, the Commerce Department said today in Washington. The department in a separate report said gross domestic product, the sum of all goods and services produced, grew at an annual rate of 2.2 percent, compared with the 3.5 percent reported on Jan. 31, and the 2 percent the previous quarter.

Federal Reserve Chairman Ben S. Bernanke played down the figures, saying the growth revision is in line with his estimates and predicting a rebound later this year. His remarks helped lift stocks after the biggest slide in four years.

“One by one, various growth indicators for the U.S. economy are tipping to the downside,” said Avery Shenfeld, a senior economist at CIBC World Markets Inc. in Toronto. “The housing market still looks decidedly in a downtrend. The Fed appears to be somewhat late in adjusting its views.”

A separate report showed a national business activity index unexpectedly dropped this month. The National Association of Purchasing Management-Chicago said its business barometer fell to 47.9 this month, the lowest since October 2002, from 48.8 in January. A reading lower than 50 signals contraction.

For all of last year, the economy grew 3.3 percent, compared with 3.2 percent in 2005…

Gold prices fell sharply as well last week, even more sharply than stocks did, dropping 6.2%. The drop in gold prices seemed to follow the logic of the stock market drop, a correction after a period of steady price increases.

Gold battered by stock market worries

By Daniel Magnowski
Fri Mar 2, 10:52 AM ET

LONDON (Reuters) - The global flight from risk knocked precious metals again on Friday, with gold falling below $650 an ounce for the first time in three weeks as shaky global stock markets prompted investors to reduce positions in commodities.

Investors often buy gold as a safe bet when financial markets look unstable, but investors are keen to unload the metal after plunges in global equity markets this week, analysts said.

Many investment funds were seen to have bought commodities, including gold, over the past month with the proceeds from stocks as Wall Street reached record highs last month.

"Gold is not glittering any longer as a safe haven," Dresdner Kleinwort analysts said in a market report.

"Commodities in general are perceived as risky assets...This asset class is just sold to reduce portfolio risk and to take profits in order to compensate losses suffered in other assets like equities," the bank said.

"Thus, as long as unwinding of yen carry trades continues and equity prices head south, gold and silver remain in the wake of bear markets."

As of 1537 GMT spot gold was at $651.50/651.95 per ounce, down sharply from $662.60/663.30 in New York on Thursday. It fell as low as $649.25 on Friday, the lowest since February 8 and down almost 6 percent from the nine-month high touched on Monday.

The pan-European FTSEurofirst 300 index was down 0.35 percent by 1536 GMT after losing 5 percent in the past three sessions, while in the United States the Dow Jones industrial average was down 0.22 percent.

A 9 percent fall in the Shanghai stock market on Tuesday triggered a global flight away from stocks into less risky assets.

Technical sentiment in gold deteriorated after the price went below several near- and medium-term moving averages.

Cash gold broke below its seven-day moving average of $674 and its 30-day average around $660.

However, traders said gold might receive support from firm energy prices.
U.S. crude oil futures hit a 2007 high on Thursday on tightening fuel supplies in the United States.

On Friday, U.S. crude traded firmly above $62. It was quoted at $62.15 at 1540 GMT, up 15 cents from Thursday’s close. On Thursday it hit $62.40, its highest since December 26.

Gold hit a nine-month high of $689 on Monday as firm crude oil and tensions between Iran and the United States raised the metal’s appeal as a haven and a hedge against inflation.

Traders were watching whether gold could hold above $655.40 -- a low reached on February 20.

The so-called flight to safety was a flight to bonds (bond prices increased sending yields down sharply) not a flight to precious metals. As the above article put it, “Many investment funds were seen to have bought commodities, including gold, over the past month with the proceeds from stocks as Wall Street reached record highs last month.” Meaning that, as George Ure observed, the drop in gold came from investors selling gold to cover other positions. Like Ure, I can’t help but think that the storm clouds hanging over the stock market and the larger economy will be good for gold.

As for the continuing problems in housing, these will have more effects on stock prices than some might think, due to the massive amounts of bad paper being held (usually as funds holding securitized debt and derivatives connected to those markets) as assets by most all of the top financial institutions:

General Motors and the housing bust

Back at the dawn of the automobile era, banks generally refused to loan money for such things as buying a car. It wasn’t considered prudent. This was frustrating to companies such as General Motors, which naturally wanted as many people as possible to have the wherewithal to purchase Cadillacs and Oldsmobiles and Pontiacs and Chevrolets. So GM decided to solve the problem by, in effect, becoming its own bank. In 1919 GM created the General Motors Acceptance Corp., a financial arm of GM that specialized in offering credit to car buyers and allowing them to buy on installment plans.

GMAC was a huge success. So much so that, over the years, it gradually expanded its operations, becoming a significant bottom-line contributor to GM’s profits. In 1985, GM’s execs decided, hey, if we’re loaning money to our customers to buy cars, why not go ahead and loan them money to buy homes as well? GM promptly purchased two large mortgage lenders and instantly became the second largest mortgage bank in the U.S.

Along the way GMAC also became an early player in the world of "structured finance" or derivatives, by taking the income streams generated by all those car and mortgage payments and turning them into bonds, through the process known as "securitization," which it then sold off to investors. All very state-of-the-art, all very emblematic of the career arc of the modern American corporation.

Why should we care about all this history? Well, with the Dow just finishing its worst week in four years, down another 120 points on Friday, it would behoove us to look for explanations as to what is continuing to spook investors. To wit: On Thursday, GM shook up Wall Street by announced that it was delaying filing its 2006 Annual Report by a couple of weeks. The reason, said analysts, had to do with GMAC’s significant exposure to the ever-popular subprime lending debacle. Like so many other players in the mortgage business in the last few years, GMAC’s home lending subsidiary, ResCap, apparently got pretty deep into making risky loans to homeowners with bad credit, and now is paying the price.

How bad is it? According to the Houston Chronicle, "At the end of the third quarter, ResCap, long viewed as the crown jewel in GMAC’s businesses, held $57 billion of subprime mortgages for investment, or 77 percent of its total loans held for investment. Its exposure to ‘residual interest’ in mortgage securities -- the high-yielding slices that suffer some of the first losses if loan defaults are higher than expected -- was $1.4 billion as of Sept. 30."

There are two primary schools of thought on how the subprime lending saga will play out. One side says that financial woes are limited to just that segment of the mortgage industry that dealt with the riskiest loans, and the problems will spread no further. But the other side contends that we’re only at the beginning of a chain reaction that could end up causing serious damage to some of Wall Street’s biggest players.

GM, the largest car maker in the world, is a pretty big institution, and GMAC is a pretty big financial player. But due to the opaque nature of the derivatives trading business, no one, not even, apparently, GM itself, is clear on exactly what ResCap’s subprime woes might mean for the larger picture. But it can’t be good.

From the Chronicle:

ResCap said in January it will eliminate 1,000 positions by October to reduce costs as the mortgage lender grapples with the continued deterioration in the subprime mortgage sector. The company now has 14,000 employees worldwide. In a filing with the SEC, ResCap estimated that it would incur about $10 million in severance and related costs associated with the work-force reduction.

"We continue to believe GM equity is complacent about the potential impact of such subprime exposure," Bear Stearns auto analyst Peter Nesvold wrote in a note. He said the weakness at GMAC due to subprime problems is one of the key risks facing GM.

Last fall, GM sold 51 percent of GMAC to Cerberus Capital Management, in a cash-raising effort aimed at bolstering the company’s shaky finances. But the two parties have since been squabbling over the fine print. There now appear to be some questions as to whether GMAC was properly valued at the time of the deal.

All in all, not a good week for Wall Street. Monday morning should be interesting.

Indeed, the exposure to severe risk is unprecendented throughout the top levels of the corporate system:

Goldman, Merrill Almost ‘Junk,’ Their Own Traders Say

By Shannon D. Harrington

March 2 (Bloomberg) -- Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.

Prices for credit-default swaps linked to the bonds of the New York investment banks this week traded at levels that equate to debt ratings of Baa2, according to Moody’s Investors Service. For Goldman, Morgan Stanley and Merrill that’s five levels below the actual Aa3 rating on their senior unsecured notes and two steps above non-investment grade, or junk.

Traders of credit derivatives are more alarmed than stock and bond investors that a slowdown in housing and the global equity market rout have hurt the firms. Merrill since 2005 has financed two mortgage lenders that subsequently failed and bought a third, First Franklin Financial Corp., for $1.3 billion.

“These guys have made a lot of money securitizing mortgages over the years in a mortgage boom time,” said Richard Hofmann, an analyst at bond research firm CreditSights Inc. in New York. “The question now is what is the exposure to credit risk and what are the potential revenue headwinds if they’re not able to keep that securitization machine humming along.”

Credit-default swaps on the debt of Goldman, the world’s biggest securities firm, have risen to $32,775 per $10 million in bonds, up from $21,500 at the start of the year, according to prices compiled by London-based CMA Datavision. The price touched $35,000 on Feb. 28, the highest since June 2005.

Spokesmen and spokeswomen for Goldman, Lehman, Merrill and Morgan Stanley declined to comment. A spokeswoman for Bear Stearns didn’t immediately return calls for comment.

Conceived to Protect

Morgan Stanley and Goldman were among the top five traders of credit-default swaps in 2005, a group that represented 86 percent of the market, according to a September Fitch Ratings report. Lehman, Merrill and Bear Stearns were among the top 12.

Credit-default swaps that trade at such wide gaps below actual ratings tend to rally, said David Munves, director of Moody’s credit strategy research group.

The contracts were conceived by Wall Street to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should the company fail to adhere to debt agreements. An increase in price indicates a decline in the perception of creditworthiness; a drop means the opposite.

Contracts tied to Morgan Stanley, Merrill, Lehman Brothers Holdings Inc. and Bear Stearns Cos. also are at 19-month highs.

Rising Prices

Morgan Stanley credit swaps have risen $10,000 to $32,775 this year, CMA data show. Contracts on Merrill jumped $16,500 to $33,000. For Lehman, they are up $12,440 to $34,440, and the swaps on Bear Stearns have climbed $12,080 to $33,830.

By contrast, Deutsche Bank AG in Frankfurt, Germany, is trading near a record low at 9,800 euros, according to data compiled by Bloomberg. And, a Standard & Poor’s index of investment bank stocks has fallen 6.29 percent this year.

The increases were larger than an index that measures credit risk for investment-grade companies in North America. The cost of protecting $10 million in debt included in the Dow Jones CDX North America Investment Grade Index has risen $1,250 to $34,750 this year, according to Deutsche Bank prices.

Lehman and Bear Stearns credit swaps traded as if their debt were rated four levels lower than their A1 rankings. High-yield, high-risk notes, or junk bonds, are rated below Baa3 at Moody’s and lower than BBB- at S&P.

More Bearish

Credit-default swap investors are more bearish than bondholders, data from Moody’s Market Implied Ratings service shows. As of Feb. 28, the bonds of Goldman and Morgan Stanley were trading as if the debt were rated a step below Moody’s official rating. Goldman has $171.6 billion in bonds outstanding, according to data compiled by Bloomberg. Morgan Stanley has $168.5 billion.

Last year was the best ever for the five biggest Wall Street firms, whose combined profit rose 33 percent to $132.5 billion.

Subprime mortgages, loans taken out by homebuyers with poor or limited credit histories, typically charge rates at least two or three percentage points above safer, so-called prime loans. They made up about a fifth of all new mortgages last year, according to the Washington-based Mortgage Bankers Association.

Subprime Turmoil

At least 20 lenders have shut down, scaled back or been sold this year. Countrywide Financial Corp., the biggest U.S. mortgage lender, yesterday said borrowers were at least 30 days past due at the end of last year on almost a fifth of the subprime loans that it serviced for others.

“There’s been a little bit of a reappraisal of the financial sector, with a strong desire to get away from subprime exposure,” said Scott MacDonald, director of research at Aladdin Capital Management LLC in Stamford, Connecticut, which manages $16.5 billion in assets.

What they are telling us here is that the signal has been given to start a severe recession. If the “financial sector” stops lending massive amounts of money to everyone (that’s what they mean by ‘getting away from subprime exposure’), the whole system will crash.

The web bot linguistic analysis folks at http://www.halfpasthuman.com/ deserve credit for predicting the exact date of the correction, February 27th. I also like their “rolling iceberg” metaphor:

Markets - Iceberg Rolls Over, Gold Floats on Debt

The [illusion] of (prosperity) that has propped up the Bush administration these last 6/six years is breaking up. Unlike previous market situations, our data suggests that no mere correction is underway, rather what is happening is akin to the [economic] and [financial] iceberg of the USofA rolling over. The vastly disparate ratio of wealth transfer these last few decades, which accelerated to gigantic proportions under the Bush decider-ship, and which has resulted in the top 1/one percentile of the populace controlling 99/ninety-nine percent of the wealth, is about to [flip] or roll over. As with real icebergs, the process is observable only at the point rolling begins, and by then it is way too late to react. As with real icebergs, it is entirely unequal distribution of ‘mass’ which results in the flip. As with really big icebergs, the actual flipping can take minutes.

The data suggests that the economy of the USofA based markets, and specifically all forms of [usofa dollar] associated debts are rolling over, and the actual visible signs of the roll will be apparent on February 27, 2007… The coming period of 8/eight days leading up to the Ides of March release period will also be presenting more [visible] (manifestations) of financial crumbling, but by that time, it is far too late to react to stem the process. In fact, as of this interpretation, ...alea jacta est/the die is cast. Start running now, just guess correctly as to which way the iceberg will roll.

As part of the [economic] degradation, soon to be exacerbated by political degradation, the populace of the USofA is going to have to endure a Spring of [employment] (crashes). The data sets are quite clear about the projection, and it is very dire. The data being interpreted has been showing up for over the last 6/six months and has been posted in previous ALTA report series.

The fundamental core of our modelspace is the replacement of words. These words are showing up in basically the same sorts of conversations about the same kinds of things, but the nature of the words used to discuss all this same-old at the same-old, is different. So as an instance, since early July (2006) the Markets entity has been moved through modelspace by the replacement values associated with words used to describe 2/two very large {linguistically, that is lots of verbiage’s on the internet} general areas. The dominant of these has been [housing], with the subordinate element being [instruments, paper/debt]. In this last area there are all the references to such things as stocks, bonds, derivatives, notes, et al. Further the lexicon for this group naturally contains references back to the other element [housing] just as within the [housing] lexical structure are supporting aspect/attributes which include [paper debt] and [note] references. This brief description is to provide a certain sense of the muddy nature of our interpretations. That is to say, the data sets are not usually very cleanly separated, and thus a certain amount of bleed-through on the interpretation will occur.

At this time the Markets entity is exhibiting what we have termed in the past "splitting behavior". We have seen this most frequently within the Bushista entity as the various layers of support feel away from the BushCo entity and subsequently the linguistic descriptor set was split or pared down to its current shape. Within the Markets entity, and specifically within the [usofa] sub set, a split of direction is becoming visible as the [housing] lexical element is now dropping below the neutral line. This occurs as a result of the summation of the emotional values associated with the words now linked to this [housing] aspect. As the summation drops past 0/zero and into the negative range, it has a tendency to drag down the entity as a whole by lowering the many related summations which compose an entities movement through modelspace. All that just as clear as crystal at the bottom of a lake on a cloudy day?

Well, here is the developing issue within the Markets entity. The [housing] sub set, a large sub set, is now dropping into negative territory, and this is JUST as the [paper debt] sub set is roaring along on a [stressed] (run up/climb). Further, the [housing] section of the data set is larger than the total [paper debt] sub set in several key ways within our modelspace. The data sets and processing that we use tend to put humans first over information. So the emotional component of [housing] in the real world will be several orders of magnitude more impacting than that of [stocks/bonds/et al] since more humans have houses than ‘own’ paper debt…

None of what’s happening should come as any surprise. Now we at least have a date for when it all happened.