Free Market Capitalism - Morally and Financially Bankrupt

By Simon Davies and Donald Hunt
SOTT.net

While the world slithers into the black hole of economic collapse, those that head the institutions that sit astride its nations and peoples met in Davos, Switzerland last week for the World Economic Forum. Attendance was, as always, by invitation only and that included the press so we can be sure that whatever came out of Davos 'on-the-record' was intended to. In case you doubt the ability of conference organizers to manage the information flow consider two things; there are numerous "off-the-record" briefings throughout the conference the details of which we never hear, and all those attending, including journalists, want to be invited back for they are members of the Inner Circle and rely on their membership for their place in life.

We were not invited which is somewhat galling given that in October 2005 (The Economic Collapse: An Insider's View) and then again in August 2006 (Signs of the Economic Apocalypse - Update) sott.net (or signs-of-the-times.org as it was then) was hosting podcasts in which the forthcoming collapse of the free market capitalist system was discussed in detail as well as our consistent warnings over the last five years. It is even more galling to find that Nouriel Roubini is being treated as some sort of god for saying exactly the same thing as sott.net after we said it. The upside of not being invited is that you, dear reader, can rest assured of our continued independence of both mind and spirit.

In a conference brimming with talking points the quote of the week award, bestowed for demonstrating a total disconnect from reality so striking that his psycho-pathology shines through, has to go to David Rubenstein co-founder and managing director the Carlyle Group, one of the most powerful and financially aggressive companies on earth who said in an interview:-

"There are six billion people on the face of the earth, and probably about five billion participated in what went on," Rubenstein said in an interview. "Everybody participated in some way or shape or form."

This is the same David Rubenstein whose private equity company grew due to his extraordinary political and financial connections through the use of every aggressive financing tool that Wall Street could invent, tools that relied on the availability of limitless amounts of cheap debt and the financial engineering made possible only by derivatives. He is not a stupid man but he is clearly psychotic and delusional having a complete inability to empathise or see the reality of the lives of billions on this poor planet; the very notion that any more than a very small handful of already wealthy people and perhaps a few who gathered the crumbs from their table benefited from the debt driven private equity bubble is beyond comprehension. Rubenstein was ranked by Forbes magazine as the 165th richest person in America in 2007.

The Carlyle Group has over $90 billion of funds under management (with many times that amount of debt at its disposal), is notorious for being the company with which both Bushes and bin Ladens are affiliated in various ways and boasts current and former employees ranging from Nicholas Sarkozy's brother Olivier to James Baker, former US Secretary of State, and Karl Otto Pohl, former President of the Bundesbank (the German central bank). These are the men who run our world, the men who have created the financial 'crisis' and who plan to profit from it as Rubenstein himself said recently to the Wall Street Journal :-

In a keynote speech at the 15th annual venture capital and private equity conference at Harvard Business School, Rubenstein laid some of the blame for the private equity industry's troubles on investment banks, who competed with each other to see who could offer the cheapest debt with the loosest terms. But he admitted that the buyout industry got carried away, too.

"I analogize it to sex," Rubenstein said. "You realize there were certain things you shouldn't do, but the urge is there and you can't resist."

The top priority now is "to make sure deals from 2004 to 2007 don't go bankrupt," he said. To that end, buyout firms will focus on cutting costs, including through layoffs, buying back the debt on their portfolio companies and holding the companies longer, "So, when the world comes back, you'll have an asset that you can use."

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"Ultimately, the best private-equity deals of all time will be done [during] this time," Rubenstein said.

While the IMF's chief economist declares that, "We now expect the global economy to come to a virtual halt." we have Rubenstein and his ilk licking their lips at the cheap pickings that are soon to be available to those who created this 'crisis'.

The sage words of Warren Buffett are worth remembering when he referred to Rubenstein and private equity firms of his genre as "porn shop operators", "You can sell it to Berkshire [Buffett's fund], and we'll put it in the Metropolitan Museum; it'll have a wing all by itself; it'll be there forever. Or you can sell it to some porn shop operator, and he'll take the painting and he'll make the boobs a little bigger and he'll stick it up in the window, and some other guy will come along in a raincoat, and he'll buy it."

Talking of crisis, the truly global extent of the current collapse is striking:-

IMF expects global economy to come to "virtual halt" in 2009.

The International Monetary Fund (IMF) said yesterday that it expects world economic growth this year to be the lowest since World War II. The Fund's latest update to its 2009 World Economic Outlook forecasts global gross domestic product (GDP) growth of just 0.5 percent - sharply lower than the 2.2 percent annual growth it expected last November.

IMF chief economist Olivier Blanchard declared: "We now expect the global economy to come to a virtual halt."

The global slump is being led by the advanced economies, almost all of which will experience major economic contractions. The US economy is expected to decline by 1.6 percent, the eurozone by 2 percent, Japan by 2.6 percent and Britain by 2.8 percent. On average, output in the advanced economies will fall by 2 percent - the first such collective contraction since the 1930s.

Economies classified as "emerging and developing" will grow by an average of 3.3 percent this year, down from 6.3 percent in 2008. Countries in Eastern Europe, Latin America and Asia are expected to experience the sharpest slowdowns. China and India remain the fastest growing, with expected 2009 growth of 6.7 and 5.1 percent respectively. In neither case, however, is the projected growth rate sufficient to generate enough jobs for the rapidly growing Chinese and Indian urban populations.

The IMF's extraordinary world forecast underscores the inability of world governments to mitigate the economic crisis.

The Fund's revised outlook takes into account the various stimulus packages enacted internationally. It warns: "Given that the current projections are predicated on strong and coordinated policy actions, any delays will likely worsen growth prospects... Downside risks continue to dominate, as the scale and scope of the current financial crisis have taken the global economy into uncharted waters. The main risk is that unless stronger financial strains and uncertainties are forcefully addressed, the pernicious feedback loop between real activity and financial markets will intensify, leading to even more toxic effects on global growth."

While advocating aggressive monetary and fiscal policies to try to stimulate global demand, the IMF warned that stimulus spending threatened to blow out governments' budget deficits. In advanced economies, these deficits are forecast to reach 7 percent of GDP this year, nearly double the 2008 level.

"The sharp increase in the issuance of public debt could prompt an adverse market reaction, unless governments clarify their strategy to ensure long-term sustainability," the IMF report stated. In other words, while stimulus packages are now required to prevent a deflationary spiral of declining economic activity, in the longer term pressure will build for austerity programs involving deep cuts to social programs to cover government debts.

The world crisis is plunging hundreds of millions of working people deeper into poverty.

The International Labor Organization (ILO) released its annual Global Employment Trends report yesterday. It forecast that as many as 51 million workers could be laid off this year, potentially pushing the global unemployment rate to 7.1 percent (up from 5.7 percent in 2007).

...Mass unemployment is but one aspect of the growing social hardship being experienced internationally.

The ILO forecast that the number of "working poor" - or more accurately, the working destitute, given that the category's criteria is earnings of less than $2 a day - may rise to a total of 1.4 billion people, or 45 percent of the world's employed. Up to 20 percent of those now living marginally above the poverty line may fall back into extreme poverty.

"The ILO message is realistic, not alarmist," Director-General Juan Somavia said. "We are now facing a global jobs crisis. Many governments are aware and acting, but more decisive and coordinated international action is needed to avert a global social recession. Progress in poverty reduction is unraveling and middle classes worldwide are weakening. The political and security implications are daunting."

At the risk of actually being invited to Davos next year, we think that the IMF's forecasts are too optimistic. If the statistics are not manipulated we expect the US, Japanese, Eurozone and British economies to all contact by over 5% and possibly significantly more in the next year. That assumes no external event such as cometary impact, Israel's initiation of a nuclear holocaust in the Middle East or the complete collapse of the free market capitalist system all of which are more than possible in which case all bets, including the next World Economic Forum, may well be off.

What is clear is that while the production of "goods" will be down, the escalation and expansion of suffering will be up this year.

The economic system is psychopathic in nature, pushing suffering downwards through society and profits upwards. Two very telling incidents last week in the United States, one of the wealthiest countries in the world, illustrate the problem and the extent to which the capitalist system has degraded human bonds and humanity in general.

In Bay City, Michigan, Marvin Schur froze to death sometime between 13th and 17th January, the local municipal electricity company having installed a device on his house to limit (to nil?) his electricity because of unpaid energy bills. This "limiter" cut power to his house, and Marvin eventually died from hypothermia amidst a bitter cold front that descended on Michigan that week. Nobody made any effort to tell Marvin that the 'limiter' has been installed much less how to restore electrical power to his home. Marvin was 93.

Following his death city officials, the police, the electricity company and the local newspaper seem to have done their best to bury the story; it only being due to the leg work of the a World Socialist Web Site reporter that the story eventually surfaced:-

The director of the local state welfare agency in Bay County, Bernell Wiggins, refused to be interviewed for this article. Wiggins would not answer questions about services the state of Michigan provides to the elderly in Bay County. His employees are prevented by a state gag order from communicating with the press.

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The callousness of the city, which is dominated by the Democratic Party, is indicative of a social system that regards the market principle - defense of the profit system at the expense of social need - as the holiest of the holies. In fact, even in the wake of Schur's death city officials continue to operate dozens of "limiters" across the city, and have shut off power to scores of households this winter, many of which are doubtless inhabited by the elderly and small children.

Similar suspensions are taking place across the country and regularly result in house fires, asphyxiations, and freezing deaths. These deaths result directly from the policies of the US political and economic elite, which regard heat, water and electricity not as basic human rights, but as lucrative sources of profit for the financial aristocracy.

In another tragic incident, by no means isolated, a Southern California man who lost his job killed his wife and five children and then himself. Ervin and Ana Lupoe both worked for a health company, Kaiser Permanente West Los Angeles which had sought to take action against them following representations they made to "an outside agency" regarding their employment in relation to obtaining some benefit related to childcare. Ervin was told by his administrator at Kaiser Permanente on December 23, "You should not even had bothered to come to work today, you should have blown your brains out."

Both Ervin and Ana were eventually fired by Kaiser Permanente in a manner such that they wouldn't be eligible for unemployment benefits and the company withheld their licenses thereby preventing them obtaining other similar employment. With five children under 8 Ervin clearly felt he had no other options; he faxed a suicide note to a local media office then shot his wife and children before turning his gun on himself.

The San Jose Mercury News quotes Carmen Adame, who said, "Their employer led them to this." She said Lupoe and others in their community were being forced to work under unreasonable conditions. "Employers are abusing this economy because people don't want to lose their jobs," she said.

Another Wilmington resident, Xavier Hermosillo, told city officials, "People are frustrated with their government. This is a societal decline."

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Wilmington, a working class neighborhood located between the ports of Los Angeles and Long Beach, has a population of about 55,000. The annual income of more than half of its households is less than $30,000. Home prices are collapsing, and more than 1,000 homes went into foreclosure from January 2007 to September of last year. Foreclosures are expected to increase significantly when the full impact of the crisis begins to be felt.

Many Wilmington residents who previously worked at the nearby docks have lost their jobs as dock traffic has plummeted in recent months. Longshoremen working on a casual basis have not found work since the end of November. The official unemployment rate for Los Angeles as a whole stands at 9.5 percent, a 14-year high.

Following the Lupoe murder-suicide, investigations into Ervin Lupoe's personal finances showed how this economic climate, combined with the loss of his and his wife's job, was plunging him into debt and increasing desperation. He was at least a month behind on his mortgage, owing $2,500 and a late fee, and owed thousands more on a home equity line of credit.

He also owed the Internal Revenue Service at least $15,000 for back taxes, and a check he written to the agency for that amount had recently bounced. On Monday, Lupoe had called his attorney to check on money he was owed in an auto accident settlement.

[ ]

Within hours of the shootings, Los Angeles Mayor Antonio Villaraigosa set up a news conference outside the Lupoe home, offering his take on the devastating situation. "A man who recently lost his job allowed the despair to put him over the edge," he said. "Unfortunately this has been an all-too-common story in the last few months. But that does not and should not lead people to resort to desperate measures."

The mayor was alluding to the fact that there have been five cases of murder-suicide in Southern California in the last year. The majority of the shooters in these incidents were facing work-related or financial crises.

The mayor also advised people to reach out for financial advice and mental health counseling. Again, there was no mention of concrete measures to provide jobs, or to counteract the housing crisis.

Ironically, the very agencies that provide such counseling are threatened with drastic cuts due to the California budget crisis. Ken Kondo, press spokesman for the LA Department of Mental Health, said that calls to the department's hotline have more than doubled since last year, with 22,000 calls specifically related to economic stress received in the last six months alone.

"Since the rise of foreclosures and unemployment we have seen a huge increase in calls," Kondo told Deutsche Press-Agentur. He said the cuts "would have a terrible impact, especially with the amount of traumatic incidents we are having."

Some of the most brutal incidents in the region over the last year:

- On Christmas eve, a man dressed as Santa Claus arrived at the home of his former mother and father-in-law in Covina, Calif. He killed his ex-wife and eight of her relatives and later killed himself.

- Last October, an unemployed and financially distraught financial manager shot his wife, three children, his mother in-law and then himself in the Porter Ranch area of the San Fernando Valley.

- In February 2007, an apparent murder-suicide claimed the lives of five family members in Yorba Linda. A 14-year-old son survived.

These truly tragic events which are being repeated the world over even as you read this column contrast with the attitudes reported by Bloomberg in Davos this week.

Davos Delegates in 'Denial' as $25 Trillion of Wealth Vanishes

Regret is cheap for some delegates at the World Economic Forum in Davos, Switzerland. Redemption for their role in the worst economic wreck since the Great Depression comes at a steeper cost.

"Nobody in Davos wants to get near a negative like redemption," said Robert Dilenschneider, chief executive officer of the Dilenschneider Group, a public relations firm in New York. "But the truth is that everyone here is part of the problem, and the public will soon begin demanding a pound of flesh."

"No banker or businessman wants to take responsibility," said Dilenschneider, who counts 40 Davos delegates as clients, their identities shielded by confidentiality agreements. "It's their view that everybody else did something wrong."

Questions about responsibility, blame and contrition hang in the cold mountain air at the glitzy Alpine resort this week like so much exhaled breath. With $1 trillion of bank losses and $25 trillion of market value gone missing since the start of the financial crisis, there's much to account for.

"There's a 'Great Gatsby' quality to Davos," said Niall Ferguson, a professor of history at Harvard University in Cambridge, Massachusetts, referring to the novel by F. Scott Fitzgerald. "When people look back at this gilded age, I'm sure there will be images of the investment bank parties at Davos, just as people looked back at flappers after the 1920s. People are still in denial."

Ferguson, author of "The Ascent of Money: A Financial History of the World," and a first-time Davos delegate, said "There's a sense of 'let's have the party anyway,' and 'let's talk about the post-crisis world,' as though that could be soon."

'Stupid Things'

At a panel on leadership yesterday morning before hosting a reception with champagne and canap s at the Hotel Europe Piano Bar, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon expressed frustration at those who seek to pin all the blame on bankers.

"I take full blame for all the American banks and all the things they did," said Dimon, 52, the only CEO of a major U.S. financial institution to attend the conference this year, adding that he knows that's what people want to hear. Regulators, he said, should share some of the blame.

"God knows, some really stupid things were done by American banks," Dimon said. "To policy makers, I say where were they? They approved all these banks."

Stephen Green, chairman of London-based HSBC Holdings Plc, also criticized regulators at a panel about capitalism on Wednesday. Green, 60, a Church of England lay minister who has written a book about reconciling a life in banking with his belief in God, called for "an overhaul of the regulatory environment." He also talked about the need for self-regulation, saying that "no amount of rules is going to enforce good behavior."

'Everybody Participated'

At a press conference on Jan. 28, he dodged the question of personal responsibility, saying only that "the banking industry" has "something to apologize for."

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No Innocents

Ruben Vardanian, CEO of Russian investment bank Troika Dialog Group, said just saying sorry is not enough. "Our values became miserable," Vardanian said. "We are all guilty, and the scope of attrition is large."

Suzanne Nora Johnson, a former vice chairman at Goldman Sachs Group Inc. and a director of American International Group Inc., took a similar view: She said there are no innocents walking Davos's icy streets.

"There's no immunity in any sector," says Johnson, who heads the World Economic Forum's Global Agenda Council on Finance and Business. "No one did a good job."
Spreading the blame around is one thing; whether bankers are ready to atone for their actions is another.

Abu Eesa Niamatullah, executive director of the Cheadle Mosque in Manchester, England, who is in Davos to tend the spiritual needs of global business leaders, says Islam calls its cleansing process "expiation" and that he doesn't expect any takers.

Redemption

"Bankers don't want redemption for the moral wrongs they've committed against humanity," said Niamatullah. "Redemption is a heavy word for Davos Man because remorse must come with sincerity and the desire to atone for the transgression. There are no sincere acts of sorrow in Davos."

That may be because Davos has no time for redemption, says Barry Gosin, CEO of Miami-based global real estate firm Newmark Knight Frank. "If a shark bites your leg off while swimming in the ocean, can you condemn the shark? This was not an intentioned plan to destroy the world. Wall Street was designed to make money."

If atonement is difficult, retribution may prove "brutally difficult," Starwood Capital Group CEO Barry Sternlicht said in an interview in Davos. As Sternlicht sees it, "everyone wants a head, and that's not reasonable. To do that, you'd need to take out the top 20 executives at the 300 biggest financial firms."

Humility, Transparency

The forum's chief redemption officer, John DeGioia, hasn't figured out how to make the moral component a useful part of any economic stimulus package. "This moment requires a real humility about the fact that we built these systems and are responsible for them," says DeGioia, president of Georgetown University in Washington and head of the forum's Global Agenda Council on Society and Values. "None of us has demonstrated the leadership required and humility necessary to respond to the depths of this crisis."

John Studzinski, a 52-year-old senior managing director of Blackstone Group Inc., the New York-based private equity firm, says Davos delegates need more than humility. "People can't be transparent until they start being transparent with themselves," Studzinski said.

It takes a certain mindset to be able to talk with such contrition yet avoid the obvious, a mindset that Walter Bromberg, noted psychiatrist and criminologist, summarised in Crime and the Mind (1965):-

In the area of business crimes, ethics are not so neatly applicable: here the zone of gray, lying between the black and white of right and wrong, becomes significant. Sharp business practices, chiefly by large corporations or cartels, once considered ethical in the larger frame of private enterprise began, on scrutiny, to appear suspiciously like criminal actions. Manipulations arising out of cartels, subsidiaries and monopolies, overemphasis or omissions of vital facts in economic competition, short cuts, circumventions and skimpiness in complying with laws and regulations, self-assigned indulgencies in the matter of exploitation, connivance with governmental officials - all touched on criminal categories.

This mindset is underpinned by one of the greatest slights of hand ever perpetrated upon society; corporations have the legal rights and protections of 'natural persons' but are not held to the same responsibilities. The US Supreme Court even ruling that "business practices and callings are above the law", as Walter Bromberg commented, "The notion that a corporation could be immoral seemed an idea foreign to American thinking". This was summarise by E.A. Ross in Sin & Society (1907), a corporation is "an entity that transmits the greed of investors, but not their conscience".

With the viral spread of just this "American thinking", we see today the results upon the outlook of those at the pinnacle of world power; a thinking that can only be described as "without conscience" and therefore by definition, psychopathic.

All those in attendance at Davos and all the commentators in the mainstream media are imprisoned in their self interest such that they cannot venture to conceive the obvious; that what is at fault is the entire system not the actions or inactions of any one group or groups of players. Whichever stone one turns in examining this 'crisis' one ultimately has to face the fact that the capitalist system as practiced today is morally, ethically, socially and financially bankrupt. It is bankrupt because that is it's nature.

We have been researching the history of the ethics of business and in particular the role of religion in the rise of capitalism. This research is ongoing but one thing is becoming abundantly clear - whatever system of morals and laws that has been conceived at whatever time in history, there has always been a yawning chasm between the purported morals and laws and the daily practices of the time. The medieval ban on usury was easily bypassed by clever framing of contracts and business arrangements and was totally ignored by the Church, Kings and Princes when they needed funding for their pet enterprises and especially in the financing of wars.

In our own time, we have a plethora of morals and laws which stand in stark contrast to the daily actions we see around us and in complete isolation when compared to the actions or those at the forefront of free market capitalism. We should not be surprised for the god of love has been replaced for many centuries by the god of money and power.

Markets

The markets this week (to Feb 2nd)

	Previous week's close	This week's close	Change	% change
Gold (USD)	901.90	928.90	27.00	2.99%
Gold (EUR)	695.43	725.02	29.60	4.26%
Oil (USD)	45.90	41.66	4.24	9.24%
Oil (EUR)	35.39	32.52	2.88	8.13%
Gold:Oil	19.65	22.30	2.65	13.48%
USD / EUR	0.7711 / 1.2969	0.7805 / 1.2812	0.0094 / 0.0157	1.22% / 1.21%
USD / GBP	0.7249 / 1.3795	0.6878 / 1.4539	0.0371 / 0.0744	5.12% / 5.39%
USD / JPY	88.779 / 0.0113	89.920 / 0.0111	1.141 / 0.0002	1.29% / 1.77%
DOW	8,078	8,001	77	0.95%
FTSE	4,052	4,150	97	2.40%
DAX	4,179	4,338	159	3.81%
NIKKEI	7,745	7,994	249	3.21%
BOVESPA	38,132	39,301	1,168	3.06%
HANG SENG	12,579	13,278	700	5.56%
US Fed Funds	0.19%	0.19%	0.00	0.00%
$ 3month	0.10%	0.23%	0.13	130%
$ 10 year	2.62%	2.85%	0.23	8.78%

Africa

The World Bank is projecting lower growth this year (around 3.5%) due to falling commodity prices. The way the free market system works, 3.5% growth would be regarded as fine for developed countries, but for the poorest and most under developed, where all the benefits of growth go to a minute percentage of the poulation much higher growth and much more equitable income distribution would be needed to avoid suffering. Because African countries mostly export raw materials, the sharp drop in commodity prices is hitting them hard. Since most African countries cannot afford large stimulus packages, the World Bank official in charge of African programs called for developed countries to chip in some of their stimulus money:

Obiageli Ezekwesili, the World Bank's vice president for Africa, told reporters today at an African Union summit in Addis Ababa, Ethiopia. "Africa did not create this problem. Africa should not be left to suffer the impact of this alone."

Many governments on the continent don't have the flexibility for stimulus plans that would add to deficits, the official said. Industrialized nations should divert 0.7 percent of their measures to Africa to soften effects of the crisis and improve roads, electric lines and infrastructure, she said.

There's not much chance of the wealthy countries diverting any of their stimulus money to Africa. South Africa, with one of the strongest economies on the continent, plans to implement a $69 billion infrastructure program in hopes of restarting growth, few other African countries can afford to do the same.

Asia

Chinese stocks are holding up well, leading to some optimism about China weathering the storm. Speaking to people we know in China it does seem that aside from the low end manufacturing, there is still reasonable activity within China. Companies which have previously relied on foreign banks for as much as 60% of their funding are finding that as these foreign banks pull back from lending, so far the Chinese banks are stepping into the gap. One company we talked to reported that this year it expects Chinese banks to provide up to 80% of their funding needs.

China's World-Beating Stocks Keep BlackRock Bullish on Economy

The world's largest money managers say China's steepest monthly stock gain in more than a year shows the fastest-growing major economy will avert a
recession.

The Shanghai Composite Index, the broadest measure of shares traded on the mainland, opens after a weeklong celebration of the Lunar New Year and a 9.3 percent gain in January, the best among the world's 10 biggest markets. Last year, the index fell 65 percent, the worst since at least 1996, according to data compiled by Bloomberg.

Chinese shares rebounded after the central bank lowered interest rates five times since September and the government announced a $585 billion stimulus plan. China's economy is expected to grow near 8 percent this year even after expanding 6.8 percent in the fourth quarter, the slowest pace since December 2001, according to fund managers Richard Urwin at BlackRock Inc. and Barclays Plc's Russ Koesterich, who together help manage more than $3 trillion in assets.

"China is going to do what it has to do to keep the economy humming," Koesterich, the San Francisco-based head of investment strategy at Barclays Global Investors, said in a Bloomberg Television interview Jan. 26. "They can enjoy faster growth than the rest of the world in 2009 and in 2010 as well."

In Korea, the Hyundai and Kia auto manufacturers are increasingly targeting China to make up for weaker sales in the U.S.

Western Europe and the U.K.

European stocks rose last week led by gains in bank stocks, of all things.

French workers staged a one-day general strike last week as millions took to the streets to protest Nicholas Sarkozy's policies of bailing out banks while cutting spending for people.

Sarkozy Response Sought by Unions After French Strike, Protests

French President Nicolas Sarkozy is under pressure to review his response to the economic crisis after more than a million people took to the streets yesterday in the biggest protest since he was elected in May 2007.

"The president said 'I hear you,'" Jean-Claude Mailly, general secretary of the Force Ouvriere union, said today on La Chaine Info. "I'd rather have 'I understand you.' With 2.5 million people in the streets, the president should be careful."

Sarkozy, whose €26 billion ($33.5 billion) economic stimulus package to support banks and spur investment was passed by parliament last night, needs to do more to counter rising unemployment and falling purchasing power as the French economy enters its first recession in 16 years, the unions said.

Yesterday's one day general strike disrupted transport, closed schools in large swathes of the country and, according to the police, brought 1.1 million people to the streets in cities and towns across France. Unions Confederation Generale du Travail and FO put the number closer to 2.5 million.

While France has a history of street protests, the global financial crisis has sparked similar demonstrations and unrest in countries from China and Greece to Iceland.

Sarkozy responded in an emailed statement after the demonstrations, saying the "concern is legitimate" and that he is ready for "dialogue." Today, his aides say he won't change his policies.

"No change in direction," Raymond Soubie, the president's social affairs adviser, told RTL radio. Sarkozy "will maintain" his economic and social policies, he said.

Popular Backing

The government will, however, respond, Labor Minister Brice Hortefeux said. "We will respond, but not in an immediate, inarticulate way," he told reporters today.

The strike had widespread backing. About 69 percent of the French people supported the strike, a poll by CSA-Opinion for newspaper Le Parisien showed on Jan. 25.

"French people have turned to their president to say 'this crisis is serious and we need more protection,'" Stephane Rozes, head of CSA-Opinion, said in an interview today. "Missing that point may bring more social protest."

Eastern Europe

Russia raised interest rates last week to curb inflation and support the ruble.

Poland announced it will delay long-term spending plans in response to anticipated loss of revenue. Poland is planning on adopting the euro in 2012 and needs to avoid large deficits.

Latin America

Mexico's economy probably shrank 1% in the fourth quarter of 2008, spurring talk of stimulus plans.

In Brazil, President Lula announced a 12% rise in the minimum wage.

United States

Shocking fourth quarter 2008 Gross Domestic Product (GDP) numbers for the United States came out last week : a 3.8% drop even including inventory sitting in warehouses or on store shelves. Equally shocking was the announcement by Exxon-Mobil of profits of $45.2 billion, the largest ever in US corporate history.

Gold Bubble?

We conclude this week with the thoughts of Naufal Sanaullah on the possibilities of a Gold Bubble in the near and medium term:-

With an insolvent public and no foreign demand for Treasuries, the Federal Reserve will monetize debt [ie. print money] to finance its continued bailouts and economic stimulus. This is purely created capital pumped right into the system. This is not anything new for the Fed, for the past two decades, it has kept interest rates artificially low and created massive artificial wealth in the form of malinvestment and debt-financing. In the past, the Fed has been able to funnel the inflationary effects of its expansionary monetary policy into equity values with its low rates, which discourage saving, causing bubble after bubble, in the form of techs, real estate, and commodities. The excess liquidity (the artificial capital lent and spent because of low interest rates and debt financing) was soaked up by the stock market, which gave the appearance of economic growth and production. With inflation being funneled into equity and real estate over the last two decades, illusionary wealth was created and the public remained oblivious to the inflationary risk and the much lower real returns than nominal.

Now that the "artificial wealth bubble" being inflated for the past two decades is finally collapsing, one of two scenarios can occur: capital destruction or purchasing power destruction. Capital destruction occurs when the monetary supply decreases as individuals and institutions sell assets to pay off debts and defaults and savings starts growing at the expense of consumption. This is deflation and the public immediately sees and feels its effect, as checking accounts, equity funds, and wages start declining. Deflation serves no benefit to the Federal Reserve, as declining prices spur positive-feedback panic selling and bank runs, and debt repayments in nominal terms under deflation cause real losses.

Purchasing power destruction is much more desirable by the Fed. Its effects are "hidden" to a certain extent, as the public doesn't see any nominal losses and only feels wealth destruction in unmanageable price inflation. It breeds perceptions of illusionary strength rather than deflation's exaggerated weakness. The typical taxpayer will panic when his or her mutual fund goes down 20% but will probably not react to an expansion of monetary supply unless it reaches 1970s price inflationary levels. In addition, the government can pay back its public debt with devalued nominal dollars, which transfers wealth from the taxpayers to the government to pay its debt. Inflation is essentially a regressive consumption tax, which the government wants and the Fed attempts to "hide". Not only is the Treasury's debt burden reduced, but the government's tax revenues inherently increase.

The Fed, in an effort to minimize inflationary perception, has for the last two decades supported naked COMEX gold shorts to keep gold prices artificially low. The Fed, as well as European central banks, unconditionally supported these naked shorts to deflate prices and stave off inflationary perception, as gold prices stay artificially low. This caused gold shorts to be "guaranteed" eventual profit, by Western central banks offering huge artificial supply whenever necessary, causing long positions in gold to be wiped out by margin calls and losses.

[The liquidity generated by such quantitative easing (printing of money) will have a similar effect to the excess credit and liquidity boom of the last twenty years - it will seek a home and generate inflation - estimated at 300% at today's liability level before Obama gets to spend a single dollar.]

In order to funnel the excess liquidity into a less harmful asset, the Fed appears to be abandoning its support for gold naked shorts, causing shorts to suffer their own margin calls and cause rapid price expansion in gold. On December 2, for the first time in history, gold reached backwardation. Gold is not an asset that is consumed but rather it is stored, so it is traditionally in what is called a contango market. Contango means the price for future delivery is higher than the spot price (which is for immediate settlement). This is sensible because gold has a carrying cost, in the form of storage, insurance, and financing, which is reflected in the time premium for its futures. Backwardation is the opposite of contango, representing a situation in which the spot price is higher than the price for future delivery.

On December 2, COMEX spot prices for gold were 1.99% higher than December gold futures, which are for December 31 delivery. This is highly unusual and it provides strong evidence to the theory that the Fed is abandoning its support for gold shorts. Backwardation represents a perceived lack of supply (in this case, the artificial supply the Fed would always issue at strategic times no longer existed), causing investors to pay a premium for guaranteed delivery. On May 21, when crude oil futures reached contango, I started waiting patiently for the charts to offer a short sell trigger because the contango represented a supply glut relative to perception and current pricing. Oil was priced at $133/barrel at that time and six weeks later, on July 11, oil topped at $147, and six days later crude broke its 50DMA on volume and triggered a large bearish position against commodities that resulted in some of my most profitable trades last year.

I consider gold's backwardation as a similar leading indicator to the opposite effect - a dramatic increase in prices. Crude began its most recent backwardation in August 2007 at around $75/barrel and increased dramatically over the next nine months to $133/barrel at contango levels. Backwardation, especially in the case of gold prices, reflects a lack of supply at current prices and is very bullish.

But why would the Fed abandon its support for naked COMEX shorts? What makes gold such a desirable asset to attempt to direct excess liquidity into? The unique nature of gold and precious metals provides its desirability in this Fed operation. Gold has little utility outside of store of value, unlike most commodities (like oil, which is consumed as quickly as it's extracted and refined), so its supply/demand schedule has unusual traits. Most commodities and assets go down in price as the public loses capital, because the public has less to consume with and that is reflected in demand destruction that leads to price deflation. Gold is not directly consumed and its industrial use and consumer demand (jewelry) is at a lower ratio to its financial/investment demand than almost any other asset in the world.

As a result, gold is relatively "recession-proof," as evidenced by its relative strength in 2008. Gold prices rose 1.7% last year, which is quite spectacular considering equity values went down 39.3%, real estate values went down 21.8%, and commodity prices went down 45.0% in the same period (as determined by the S&P 500, Case-Shiller Composite, and S&P Goldman Sachs Commodity Indices, respectively). Because gold is not easily influenced by consumer spending, highly inflationary gold prices don't do any direct damage to the public and are a good way to funnel excess liquidity without economic destruction.

Federal Reserve Chairman Ben Bernanke is a staunch proponent of dollar devaluation against gold and is very supportive of President Franklin D. Roosevelt's decision to do so in 1934. In the past, manipulating gold prices to artificially low levels was beneficial because it prevented capital flight into a non-productive asset like gold and kept production, investment, and consumption high (even if it were malinvestment and unfunded consumption).

Bernanke's continued active support of gold price suppression would lead to widespread deflation that would collapse equity values and cause pervasive insolvencies and bankruptcies. Insolvency in insurers removes all emergency "backups" to irresponsible lending and spending, which would surely ruin the economy. Bernanke's plan seems to be to devalue the dollar against gold with huge monetary expansion, causing equity values to rise and economic stabilization. I've heard estimates of 7500 and 8000 in the Dow Jones Industrial Average as being minimum support levels that would cause insurers and banks to realize massive losses, causing widespread insolvencies in them and other weak sectors like commercial real estate that would irreversibly collapse the economy.

This gold price expansion, set off by the massive short squeeze, will continue until gold prices reflect gold supply and Federal Reserve liabilities in circulation. The "intrinsic" value of gold today (called the Shadow Gold Price), calculated dividing total Fed liabilities by official gold holdings, is about $9600/oz, compared to around $865/oz today. This gold price calculation essentially assumes dollar-gold convertibility, as is mandated by the US Constitution and was utilized at various periods of American history. The near-term price expansion in gold, mainly led by abandonment of gold shorts and the first traces of inflationary risk, should show $2000/oz by the end of this year. As the leveraged deals from the pre-crash credit craze mature, with the majority of them maturing in 2011-2014, there will be more monetary expansion for debt repayment, which will structurally weaken the US Dollar (which is inherently bullish for gold) and will also provide new excess liquidity to be funneled into precious metals. This leads me to believe gold will be worth $10,000/oz by 2012.

The US Dollar's strength as the equity and commodity markets collapsed was due to deleveraging and an effect of the Fed's temporary sequestration of dollars, taking dollars out of supply. That is over. Oil seems to be putting in a bottom on strong volume, no one is left to buy any more negative real yield securities the Treasury is issuing, and gold has started looking very bullish.

But a good speculator always considers all situations. Even if deflation is to occur, which I see as next to impossible, gold prices should still rise to $1500/oz levels next year, because it has shown relative strength as one of the most viable assets left to invest in. In addition, the short squeeze occurring in gold will provide substantial technical price expansion, even in the absence of dollar devaluation. Because of this, I suggest gold as an investment cornerstone for the foreseeable future.

...Literally the only thing that I find suspicious in all of this is the fact that I see so many inflationists out there and I even see commercials on TV about precious metals. I usually like to stay contrarian to the public, which I consider irrational and wholly incompetent. But this enormous debt and monetary expansion is a structural problem that common sense may provide better insight for than the most complex of models and theories.

I leave you with this, a quote from Fed Chairman Ben Bernanke about President Franklin D. Roosevelt's 1934 Gold Reserve Act, which was the greatest theft of wealth I've aware of in American history:

"The finding that leaving the gold standard was the key to recovery from the Great Depression was certainly confirmed by the U.S. experience. One of the first actions of President Roosevelt was to eliminate the constraint on U.S. monetary policy created by the gold standard, first by allowing the dollar to float and then by resetting its value at a significantly lower level ... With the gold standard constraint removed and the banking system stabilized, the money supply and the price level began to rise. Between Roosevelt's coming to power in 1933 and the recession of 1937-38, the economy grew strongly."

My predictions: gold at $2000/oz by the end of the year and $10,000/oz by 2012 and silver at $30/oz by the end of the year and $130/oz by 2012.

Signs of the Economic Apocalypse, 9-1-08

From SOTT.net:

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

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

Eyes Off the Target

Max Wolff

August 29, 2008

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

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

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

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

Corporate Profits

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

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

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

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

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

The Building Storm: Gold, the Dollar and Inflation

David Galland

August 24, 2008

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

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

Don’t be.

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

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

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

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

Dark Clouds

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

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

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

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

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

Let me add some nuance to that remark.

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

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

The euro sinks, the dollar goes up.

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

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

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

When sorrows come

The Economist

Aug 28th 2008

Commercial banks prepare, reluctantly, to take centre stage

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

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

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

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

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

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

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

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

Measure for measure

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

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

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

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

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

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

Foreign spigot off for US consumers

Max Fraad Wolff

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Ranks of the Ultrawealthy Grow

Tom Herman

Thursday, August 28, 2008

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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