The Weekend Economist--August 30-September 1, 2008

[Demeter]

And welcome to the Labor Day Weekend Economist, a compendium of posts, observations and humor (usually dark) about the state of the US and world economies.

I'll be posting intermittently, between jobs (no holiday for Demeter), so stop in frequently as the thread grows. You can help by adding your own posts to keep the conversation rolling.

Follow up on Tuesday with the venerable Stock Market Watch thread, in the higher-class Latest Breaking News section.

[Demeter]

1. GDP Release Signals Further Decline into Banana Republic Status

http://www.nakedcapitalism.com/2008/08/gdp-release-signals-further-decline.html


Last year, we put America on Banana Republic watch, and sadly, things appear to be playing out as we feared:

I'm certain you're familiar with the expression "death wish." I am beginning to wonder whether America has a banana republic wish. The country has been taking steps towards being a small-minded, elite-dominated, sham democracy.

Mind you, I am pointing to a tendency, not an established fact. The US isn't Haiti, or even Argentina. But we are moving in that direction on a variety of fronts, and the devolution seems so concerted that I wonder if there is some unconscious mass desire to give up on the messiness and ambiguity of an open society and surrender to the certainty of one with institutionalized inequality, more authoritarianism, but more predictability, and perhaps an illusion of greater security.

What triggered this line of thought? Something surprisingly minor: the April employment report,...But even this disappointing figure may have been the product of manipulation, as we will discuss in due course. And we've now had so many instances of what charitably may be called artful reporting that it's beginning to undermine my faith in government statistics. Unreliable government statistics are a Banana Republic Indicator..... the integrity of that data is becoming compromised on enough fronts so as to render them suspect. And inaccurate data leads to bad business and bad policy decisions. Bad policy decisions are particularly likely since the information is massaged so as to minimize unpleasant news.

What is remarkable is that today's 2Q GDP revision. from a 1.9% that most observers regard as likely to be revised downward (and initial releases are often revised by significant increments), has now been revised to a simply not credible 3.3%. We'll discuss in a bit how this artwork was achieved.

Yet what is more remarkable is that a quick read of the MSM (Bloomberg, Financial Times, the Wall Street Journal, and the New York Times) reveals that no source seems willing to challenge this practice and call it for what it is, manipulation for political purposes. Some economists quoted by the MSM instead politely chose to ignore the dead body in the room and argue, essentially, that this supposed data point was irrelevant as far as the outlook was concerned. Here we see some tiptoeing around the tulips quotes:

Bloomberg: ``Outside of trade, the economy is considerably weaker,'' said Carl Riccadonna, an economist at Deutsche Bank Securities Inc. in New York. ``When you look at the spending, it looks terrible for the second half of the year.''

Reuters: "This number seems to overstate the underlying strength even though exports are obviously strong," said James O'Sullivan, an economist at UBS Securities in Stamford, Connecticut.

Now of course, there is good reason for less than a full-bore assault. One is that by the time someone made all the Freedom of Information Act filings to get enough of the supporting work to prove this number was massaged, we'll be not just into the next Adminstration, but into the recovery. Second, economists are supposed to be sober and analytical. Stirring controversy is not part of their job description.

Nevertheless, there were quarters in which doubts were expressed more strongly. Zubin Jelveh at Portfolio provided this quote:

RDQ Economics: "The strength of the economy in the second quarter suggested by the expenditure estimate of real GDP growth seems truly bizarre and is a product of a declining real trade gap."

Bloggers, needless to say, were less inhibited, with Barry Ritholtz, long on the bogus statistics beat, leading the charge:

GDP is out, ticking higher to 3.3% rather than 2.7%

And if you believe that data, I also have a bridge for sale in Brooklyn.

Why the beat on the headline figure? Aside from the usual inflation nonsense, there were two other factors: Exports, which rose to 13.2% (versus earlier reported 9.2%) and Inventories, which also played a part in the apparent strength.

My fishing buddy John Silvia of Wachovia put it into context:

"The overwhelming story is that the export numbers have offset this domestic weakness in consumer spending and business investment. We have a domestic recession.''

Also worth noting: larger than earlier reported gains in every single government expenditure category. If you are wondering why the government does not know what it is actually spending in near real time, welcome to the club.

That boldface was mine. If that isn't sus, I don't know what is.

Barry in a later post, with the help of a chart provided by Michael Panzner, found the real smoking gun: a laughable assumption for inflation. The lower the inflation assumption, the higher the GDP figure. Not only was the 1.2% chosen lower than CPI, which has been adjusted over time to underreport inflation so to reduce payouts on CPI-indexed programs, most notably Social Security, but as a commentor on Econompics noted, constituted the biggest gap between the GDP deflator and CPI since 1980 (squinting at the chart, that seems to be accurate):



Mind you, this massaging is taking place on top of long-running adjustments that make both GDP and inflation stats questionable. Is it time to revive the 1960s expression "credibility gap"?

Refreshingly, some in the MSM are coming close to doing so. This story in Bloomberg, "Lagging Incomes Signal U.S. Economy Weaker Than GDP Suggests," which came out within hours of the release, discusses the disparity between incomes data and GDP without taking on the GDP report frontally. That's a step in the right direction.

From Bloomberg:

The meager gains in earnings over the last year signal the U.S. economy is in much deeper trouble than the growth estimates indicate, economists said.

Gross domestic income, or the money earned by the people, businesses and government agencies whose purchases go into calculating gross domestic product, rose 0.3 percent in the 12 months ended in June after adjusting for inflation, according to Bloomberg calculations based on today's Commerce Department growth report. GDP expanded 2.2 percent.

``The income side of the economy, with profits down for four straight quarters and employment falling, looks like a recession,'' said John Ryding, chief economist at RDQ Economics in New York.

Incomes last quarter grew 1.9 percent at an annual rate after adjusting for inflation, a little more than half the 3.3 percent gain posted by GDP, according to Bloomberg calculations. The figures showed incomes dropped in each of the prior two quarters.

``What you are seeing is more legitimate economic weakness in the income numbers,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. ``The GDI numbers raise the potential that GDP is overstating growth.''

The 1.9 percentage-point difference between the GDI and GDP over the last 12 months is the biggest in the post World War II era.....

The income numbers are more in line with other figures that indicate the economy struggled from April through June. The jobless rate was 5.5 percent in June, up from 5.1 percent at the end of the first quarter, and employers cut 165,000 workers from payrolls, according to the Labor Department.

``I'm looking at the labor market, and the GDP income numbers make more sense,'' said Ryding. ``It certainly did not feel like 3.3 percent growth.''

The earnings data may more accurately predict the start of economic contractions, according to researchers at the Federal Reserve.

Income adjusted for inflation ``has done a better job recognizing the start of recessions than has the growth rate of real GDP,'' Jeremy J. Nalewaik, a Fed economist wrote in a December 2006 report. ``Placing an increased focus on GDI may be useful in assessing the current state of the economy.''

While the income and growth figures should theoretically match, the different methods used in calculating the numbers prevent them from converging fully.

[phrigndumass]

16. Wow, "let's assume inflation will only go up 1.2%"

What nutjob would predict that while the Fed keeps lowering interest rates?! The disconnect is unimaginable. It's more like 5%. Stagflation, anyone?

(K/R for this terrific thread, btw, one of my favs)

:hi:

[Demeter]

26. Thanks P-Man! This One's for You and The Daily Widget!

[truedelphi]

31. I would say that we are indeed Haiti - it depends which portion of the population you look at

And it depends on how the "white collar transfer of wealth" is seen differently than the wealth taken in a country like Haiti

No, George Bush's limo and his people will not pull up in from of my small business and take out the fixtures and small Oriental rug, as would happen in Haiti.

But the lobbyists managed over the last twelve months to give the small business owner a REAL nightmare in terms of sending things through the mail, while Time Warner got a very good deal on mail rates.

The oil profiteers have robbed us at the pump, while the nightmare in Iraq costs the middle income person 10 billion a month - our grandchildren will be paying for THAT particular transfer of wealth, and maybe their grandchildren, as well.

The tax rates continnue to take ALL expendable monies from the average household, while the people at Halliburton and their share holders look forward in delight to the end of the month fiscal report.

It is not like Argentina or Haiti - it is the SAME thing ONLY different.

[Ghost Dog]

78. Economists look to expand GDP to count 'quality of life'

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=103x380403

[Demeter]

2. Accounting for Quality: the Quality of Accounting

http://alephblog.com/2008/08/29/accounting-for-quality-the-quality-of-accounting/


Accounting is esoteric. :( I say this as one who has never taken an accounting course in his life, but has written papers on accounting standards, and has had to implement them in the life insurance industry, which is possibly the industry with the most complex accounting of any industry. (Okay, if we did the investment banks properly, they would be more complex.)... I have known for a while, and commented here that the SEC is planning on abandoning GAAP for IFRS. Why are they suggesting this?

IFRS is not that much different from GAAP.
They want to have every company in the developed world on a similar accounting basis, even if the basis is slightly worse than the existing standards.
Then perhaps, foreign companies will once again list their equities in the US.
You can get the same information in different ways from:

The Wall Street Journal
The New York Times
FEI financial reporting
The Accounting Observer
The Accounting Onion
(links in original article)


My short take is this:

IFRS is a more liberal accounting standard. Not by a lot, but significantly.
There will be a ton of retraining for accountants in the US, and financial analysts (ouch).
Earnings will rise, but P/E multiples will fall. The intial net effect should be small.
Value investors will fare relatively better, as they spend more time on the balance sheet, income statement, and other earnings quality issues.
Exchanges in the US might get more foreign listings, if Sarbox were repealed. Moving to IFRS is not enough.
If I were on the SEC, I would not care about global comparability, I would stick with GAAP, and stand alone if necessary, among the nations of the world. Why move to a less informative, and more rubbery standard? I don’t see a good reason.
IFRS is more flexible, which means that companies under it are less comparable. I don’t see the advantage in our moving away from GAAP, which has its problems, but less than IFRS. When I get the web address to post complaints, I will post it here, and I will be writing the SEC to stop this foolishness.

[Demeter]

3. EIA Revises Down June Oil Demand by "Stunning" Amount

http://www.alaron.com/energy_report.aspx?blogid=80

It seems like Mother Nature is the only thing supporting this market as demand destruction might have more long term impact on the market than anything Gustav can throw at us. Even after Katrina oil demand dropped and so too did prices....

Take for example the news from the Energy Information Agency that revised downward its June oil demand by a stunning number. The EIA said that US oil demand in June was 793,000 barrels a day less than previously reported. That is down a whopping 1.17 million barrels a day from the same period a year ago and the lowest level for any June since 1998. That comes out to be 5.6% less than a year ago....

What is becoming clear to the market is the demand pullback in the US is rising to the level of historic proportions. Even the EIA is now saying that the drop in demand should send oil below $100 a barrel. The Chief of the EIA, Guy Caruso, said that prices could fall below $100 a barrel on slowing global demand and rising production in the US, Brazil and Canada, and from OPEC states such as Saudi Arabia and Angola. While Caruso said "most of the risk is on the upside," and that it was not the official EIA prediction but added that a scenario of falling oil prices is "now closer to 50-50" if worldwide spare production capacity continues to increase from the current 1.5 million barrels per day (b/d) to 3-4 million b/d while global oil demand softens. Caruso then says that that scenario is now more realistic than any time in the past five years.

[Robbien]

22. Finally! That number they've been throwing about previously

just didn't seem right. People only cut back their gas use by 3%? Not any where close to the actual reduction from what I have seen.

This number is more like it.

[Demeter]

4. The Great Gold, Silver Conspiracy Explained

http://globaleconomicanalysis.blogspot.com/2008/08/great-gold-silver-conspiracy-explained.html

Gold and silver prices have crashed. Ted Butler, Rob Kirby, James Conrad and others are all blaming manipulation.


SEE LINK FOR INCREDIBLY LONG ARTICLE

[Ghost Dog]

15. I'll add this one from Bloomberg Thursday by way of evidence:

World's Largest Gold Refiner Runs Out of Krugerrands
http://www.bloomberg.com/apps/news?pid=20601012&sid=acH4WhPh1WJ0&refer=commodities
By Claudia Carpenter

Aug. 28 (Bloomberg) -- Rand Refinery Ltd., the world's largest gold refinery, ran out of South African Krugerrands after an ``unusually large'' order from a buyer in Switzerland.

The order was for 5,000 ounces and it will take until Sept. 3 for inventories to be replenished, said Johan Botha, a spokesman for Rand Refinery in Germiston, east of Johannesburg. He declined to identify the buyer.

Coins and bars of precious metals are attracting investors as a haven against a sliding dollar and conflict between Russia and its neighbor Georgia. The U.S. Mint suspended sales of one- ounce ``American Eagle'' gold coins, Johnson Matthey Plc stopped taking orders for 100-ounce silver bars at its Salt Lake City refinery and Heraeus Holding GmbH has a delivery waiting list of as long as two weeks for orders of gold bars in Europe.

``A lot of people are worried about the dollar, they're worried about inflation and now we have geopolitical risk with what's happening in Russia,'' said Mark O'Byrne, managing director of brokerage Gold and Silver Investments Ltd. in Dublin. O'Byrne said his company's sales are up fourfold this year, heading for a record since its founding in 2003.

/... http://www.bloomberg.com/apps/news?pid=20601012&sid=acH4WhPh1WJ0&refer=commodities

[Demeter]

5. Mortgage Applications Increase — or Did They?

http://www.housingwire.com/2008/08/27/mortgage-applications-increase-or-did-they/
By: PAUL JACKSON

Most media sources will report that mortgage applications posted their first increase in three weeks, according to data released by the Mortgage Bankers Association on Wednesday, as mortgage rates fell slightly. The group’s weekly application survey found that applications rose 0.5 percent from one week earlier, with a composite index rising to 421.6 for the week ended Aug. 22. Applications are off 31.2 percent from year-ago levels, however, the MBA said.

But — as has been the case throughout the current cycle — the MBA data may be overstating forward demand for mortgages, given that the index data doesn’t correct for multiple applications. A separate application index, known as the MAX, found that applications fell sharply last week; the MAX corrects for multiple applications, and tends to be relied upon by prepayment modelers more often, as a result.

The MAX national application index fell 6.4 percent last week, while a California sub-index fell an amazing 7.5 percent; the sharp decline in the MAX indices suggests that an overall increase in applications is likely tied to borrowers scrambling to get approved for a loan program.

Of course, hard evidence of this trend is difficult to come by. But anecdotally, it’s easy to see how this could take place: underwriting standards are tighter than ever, and lenders often suggest that borrowers shop programs to ensure they can qualify for a loan. And, of course, troubled borrowers may be putting in application after application in the hope they can stave off a foreclosure.

“As the credit crunch begins to slam into Main Street both psychologically and in actual funding, mortgage originations may set new historical lows for the balance of the year,” said Paul Descloux, publisher at Mortgage Maxx LLC, which publishes the MAX index.

Heading back to the MBA’s data, the group said both refinance and purchase applications posted small increases last week; the refinance share of mortgage activity increased to 35.2 percent of total applications from 34.8 percent the previous week.

But in terms of attempting to forecast future prepayment activity — a critical task in valuing mortgage bonds — doing so accurately is becoming more difficult as the market dislocation has continued unabated; sources tell HW that existing prepayment models are having trouble with current market conditions.

“It’s definitely become more art than science in recent weeks,” one ABS analyst suggested to HW Wednesday morning, “which is sort of strange. Prepayment modeling isn’t usually something that requires so much leeway in interpretation.

“It’s usually much more boring than that. But not in this market. Those that can get it right have a definite advantage.”

For more information, visit http://www.mortgagebankers.com and http://www.mortgagemaxx.us.

[Demeter]

6. Lehman To Be Acquired by Tooth Fairy

http://benbittrolff.blogspot.com/2008/08/lehman-to-be-acquired-by-tooth-fairy.html


Breaking News: Lehman To Be Acquired by Tooth Fairy

The market responded with enthusiasm to reports that the Tooth Fairy has agreed to acquire Lehman. The purchase price has not yet been determined and will be set by Dick Fuld wishing upon a star, clicking his heels three times, and being transported back to that magical place where Lehman still sells for over $70 per share.

In related news, Lehman has agreed to sell all of its level III capital, including CDOs, ABSs, pet rocks, baseball cards, slightly used condoms, and credit default swaps written by MBIA and Ambac. Lehman’s level III capital will be acquired for 150% of its face value by Tinkerbell, who will carry it off to Neverland to be fed to a crocodile. Lehman is financing 90% of the acquisition at an interest rate that has not been announced; Tinkerbell’s up-front payment consists of a handful of pixie dust, three crickets, and a bullfrog. Analyst Dick Bove estimates that the bullfrog could eventually be transformed into three princes and a pumpkin coach. The deal gives Lehman no recourse to any of Tinkerbell’s assets other than the Level III capital. If Tinkerbell defaults, Lehman’s successor entity will stick its hand down the crocodile’s throat and attempt to get it to regurgitate. The firm’s historical value-at-risk analysis shows that sticking your hand down a crocodile’s throat is completely safe.

Treasury Secretary Hank Paulson issued a statement: “I am delighted that SWFs (Sovereign Wealth Fairies) continue to express confidence in the terrific values represented by American financial institutions. As I have been saying since August of 2007, this shows that the crisis is now over.”

Meanwhile, the SEC has announced an investigation of mean, evil, bad short-seller David Einhorn. While out for a beer with a friend, Einhorn reportedly suggested that the Tooth Fairy does not exist and that wishing upon a star is not a wholly reliable price discovery mechanism. Christopher Cox, chairman of the SEC, said, “Vicious rumors attacking the Tooth Fairy will not be tolerated. Our entire financial system and indeed the American way of life depend on the Tooth Fairy and wishing upon a star. How else could one value level III capital appropriately?” The SEC is reportedly planning to set up re-education camps for short-sellers.

IT'S SUPPOSED TO BE FUNNY, FOLKS SO LAUGH

[DemReadingDU]

7. Christopher Laird: A world financial Armageddon?

8/25/08
Credit crisis II
A world financial Armageddon?
by Christopher Laird

Where are we now in the credit crisis, and why isn’t the massive Fed and ECB weekly lending working to loosen interbank lending? Why is the credit crisis not really improving? Where is this going next? We describe what may happen next as Credit Crisis II in this article.

Now that the credit crisis that started in 2007 is a year old, there has been a debate about whether the financial system will recover, or will the Western/world financial system end up like the Japanese financial system after the stock and real estate crashes in the 1990’s. In that case, the Japanese banks more or less carried their tremendous losses for ten years, and Japan entered a mild but painful decade of deflation. To this day, Japan is battling some of the deflationary forces from that time.

The question now becomes, will the Western financial system recover some normalcy, or are things merely going to get worse and the world end up with a financial malaise lasting ten years like Japan’s?

If the second alternative is the case, then the central banks which are merely propping up the financial institutions with their ‘temporary’ lending will find they are taking the losses off the banks hands, taking them on to their balance sheets, and effectively monetizing the losses.
The ECB and the Fed are both hoping to find a way out of having to keep the bad assets they took as collateral. They have lent hugely to financial institutions, taking their bad mortgage bonds, securities, derivatives as collateral. And at the same time, the financial institutions in question are carrying a sum total of $500 billion of losses on their books, the losses they admit so far, while estimates of ongoing losses from these bad assets runs well over $1 trillion. In effect, the Western credit industry is still crippled. Why is it so crippled still?

Either the financial industry earns its way out (will take ten or more years) and drastically pull back credit, or they find enough new investors to pony up new capital infusions, perhaps through stock sales. And new such investors are becoming increasingly hard to find. Hence, the central banks are the only alternative.

A theme now arises where it is becoming apparent that it is impossible to actually purge the escalating losses from the financial system, and that even big public bailouts don’t purge the losses because of interlinkages between stocks, bonds and derivatives. If one class or institution is bailed out, the losses of capital merely move to the other class. And the losses are clearly so huge as of now, that they weigh on the currencies themselves and cause a fall in their exchange rates.

It is estimated that the USTreasury/Fed/FHLB has infused a total of $2 trillion and counting since Aug 07 to the various credit infusions to the US financial system, and that the ECB is in at similar levels. And even after $ 4 trillion worth of infusions over the last year has been thrown out by the Fed and ECB, the world credit/financial system is actually getting worse. What will be the outcomes into 09?

Bankrupt en masse

In effect, this means the Western banks, etc are bankrupt en masse. The only thing propping up the entire Western financial system, and its respective stock markets has been massive ‘temporary’ lending, on an ongoing basis, by the Fed and ECB. Both central banks are beginning to balk at this situation. Even as they are starting to have second thoughts, the Western financial institutions continue to borrow more money than ever on a weekly basis. Why aren’t things loosening up?

Can’t stop or else

And, if the ECB or the Fed stops the emergency infusions, or even admit who the borrowers are, another round of collapsing banks/bank runs ensues as investors flee and pull their money out. In other words, the central banks have no choice but to continue the weekly $30-50 billion or so of infusions each for the Fed and the ECB, or else face a cascade of bank runs around the world.
…And each week the Fed and the ECB are effectively taking on another $30 or $50 billion of the bad assets from the various and sundry financial institutions scattered across the EU and the US. So, week after grueling week, the Fed and the ECB keep adding another $50 to $100 billion of bad assets to their balance sheets, as ‘collateral’ and making ‘temporary’ loans they keep having to roll over and extend the repayment on. Ie, the junk stuff is becoming a permanent resident on the central bank’s balance sheets. If either the Fed or the ECB stop the weekly infusions, quite possibly the entire Western financial system stops dead. And we get a massive world stock crash.

The question now becomes, what happens when these two central banks finally decide they have to let go? You are not going to tell me they are going to keep infusing a combined $50 to $100 billion worth of financial bailouts each week forever? This massive temporary lending certainly has to end at some point.

lots more...
http://www.financialsense.com/fsu/editorials/laird/2008/0825.html

[Joe Chi Minh]

47. A total madhouse! No wonder Adam Smith, like Keynes after him, designated

the business community, particularly its leading cabals, as a den of thieves. Why, he all but accused them of being neo-liberals - endemic felons, criminals, atavistic recidivists, lying "con" men of the worst sort, i.e who operated at a high level, and consequently caused greater harm than the ordinary run of robbers and swindlers by an order of magnitude.

"Capitalism is the astounding belief that the wickedest of men will do the wicked of things for the greatest good of everyone," was how Keynes put it.

and, "All for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind," was Smith's version.

Here's hoping. Thanks to the criminal lunatics of the far right, it's long overdue.

And the moral is:

"Property is not the sacred right. When a rich man becomes poor it is a misfortune, it is not a moral evil. When a poor man becomes destitute, it is a moral evil, teeming with consequences and injurious to society and morality," Lord Acton's topical words.

Wide-spread destitution and homelessness have become the "elephant in the living-room" to our respective, insentient, degenerate societies on either side of the pond. While the criminal, bare-faced, Thatcherite lunatics, in the UK, at least, having continued to decimate our industrial base, raved about how brilliantly we'd performed economically over the past 11 years.

Keynes also observed, "The day is not far off when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems - the problems of life and of human relations, of creation and behavior and religion." Maybe, the hapless, demented neo-liberals have unwittingly hastened the day.

[DemReadingDU]

48. Thanks for the quotes

Everyone's worst nightmare is about to come true

[Joe Chi Minh]

54. Looks like it.

[Demeter]

8. Sean O'Grady: Credit crunch: 'It's just the end of the beginning'

http://www.independent.co.uk/news/business/comment/sean-ogrady-credit-crunch-its-just-the-end-of-the-beginning-910778.html

Here's some "big picture" numbers on the state of the world's financial system. According to ING, the total value of assets written down by Planet Earth's big banks is $502bn. The total value of capital raised by the same: $351bn. That deficit, of $151bn could easily get much much bigger. No wonder the Deputy Governor of the Bank of England, Charlie Bean, said the other day that the slowdown may "drag on for some considerable time", while the IMF has called it "the largest financial shock since the Great Depression".


Now, shortly after the unhappy first birthday of the credit crunch we are at what we might call "the end of the beginning". Even though Ken Rogoff, a former chief economist at the IMF, has chillingly warned that a "whopper" major bank will go under in the next few months, at least we know the rough parameters of the sub-prime problem – usually neatly and memorably rounded to about $1 trillion ($1,000bn). It may even be a little better than that: house prices are still falling in the United States, but mostly at a gentler pace. So some of the gloom may be lifting over there.

What's next? Well, there are two new looming threats to keep us awake at night. First, the certainty that what one might term the "normal" writedowns and losses associated with an economic downturn will add to the strains on banks' balance sheets just when they are at their weakest.

In the UK, we know these are on the rise because some banks have already declared such difficulties; because of the rising trend of redundancies, arrears and repossessions; because of the collapse in sentiment in the housing market and because the first-round effects of the credit crunch are now creating their own second-round effects, through the "mortgage famine" for first-time buyers, the main source of new funding to the residential property market.

That, by the way, is now being exacerbated by a fall in demand for new mortgages from those same first-time buyers, who judge that a falling market is one where they can afford to rent, wait and see. No matter, though; the picture is one where more people will find it more difficult to service their debts, from credit cards to car loans and mortgages, the banks will have to wait longer for their money and may see some of it lost for good.

Which brings us to the second nightmare. Will the banks be able to raise the capital required for them to regain their strength as losses mount? Now for the banks what we've seen is rather like suffering from a bad case of flu (sub-prime) and then catching a cold (normal downturn losses) on top. Result: financial pneumonia. For which the well-known cure is plenty of liquidity fed to the system by assiduous central banks (see the Bank of England's patent Special Liquidity Scheme among other miracle cures) and a strong course of capital injections.

The latter is proving steadily more tricky to administer, as we see from those big numbers I quoted at the beginning and from the rights issue flops at HBOS and Bradford & Bingley, among others. It has been a laborious task even to raise the £20bn the British banks have now garnered for their balance sheets. The team at Capital Economics calculates that £65bn more is needed in the way of fresh capital, that is if the banks are to carry on functioning at their current rates of lending and to sort out the remaining damage from the credit crunch.

Alternatively, the banks could simply reduce their lending. But that would mean an even bigger brake on growth than we have seen so far. Capital Economics says that for the banks to correct their balance sheets in this manner would imply a reduction in lending of £440bn (17 per cent of the balance sheet), a truly terrifying sum. Some mixture of the two seems more likely, but even that has some nasty consequences.

If the banks manage to raise another £20bn from disposals, conventional rights issues, Sovereign Wealth Funds in China and the Gulf subscribing for equity, and stake building and takeovers by foreign banks relatively unscathed from the mess (e.g., Banco Santander/Alliance & Leicester), this would still mean a contraction in balance sheets of £180bn, or 7 per cent – equivalent to 13 per cent of the UK's GDP. I mention that just to illustrate the scale of the phenomenon, and is not meant to be a read off for the wider economic effects. Much of the contraction in lending will hit foreign entities, and bank credit is not the only source of spending in the economy. That is, despite appearances in recent years; some rebalancing away from our reliance on debt to fund growth is overdue and welcome, though it will be painful.

However, if UK bank lending drops by just 5 per cent, that will easily be enough to tip the economy into recession. Capital Economics says that it would mean business investment also down by 7 per cent, that housing market activity would "grind to a halt" with a 50 per cent drop in prices, and consumer spending down by 1.4 per cent, shaving 0.6 per cent off growth per annum, where it is already expected to be stagnant. We last saw real terms lending by the banks go negative in the mid 1970s – not a happy precedent. So recession here we come.

Is there a way out? Well, things may not turn out to be as bad as the pessimists anticipate. But a third option, not up to the banks but available to the regulators, internationally, would be to ease the banks' capital requirements, altering the ratios to allow them to lend more on thinner capital, so-called "counter cyclical" regulatory action. Risky, perhaps, but maybe more welcome than their fourth option, of direct state intervention to support lending. That, we can confidently say might well be the beginning of the end.

[Demeter]

9. Bell Labs Kills Fundamental Physics Research By Priya Ganapati

http://blog.wired.com/gadgets/2008/08/bell-labs-kills.html

After six Nobel Prizes, the invention of the transistor, laser and countless contributions to computer science and technology, it is the end of the road for Bell Labs' fundamental physics research lab.

Alcatel-Lucent, the parent company of Bell Labs, is pulling out of basic science, material physics and semiconductor research and will instead be focusing on more immediately marketable areas such as networking, high-speed electronics, wireless, nanotechnology and software.

The idea is to align the research work in the Lab closer to areas that the parent company is focusing on, says Peter Benedict, spokesperson for Bell Labs and Alcatel-Lucent Ventures.

"In the new innovation model, research needs to keep addressing the need of the mother company," he says.

That view is shortsighted and may drastically curtail the Labs' ability to come up with truly innovative discoveries, respond critics...

Bell Labs was one of the last bastions of basic research within the corporate world, which over the past several decades has largely focused its R&D efforts on applied research -- areas of study with more immediate prospects of paying off.

Without internally funded basic research, fundamental research has instead come to rely on academic and government-funded laboratories to do kind of long-term projects without immediate and obvious payback that Bell Labs used to historically do, says Lubell...

[Hugin]

13. They've decided to focus on...

Erectile Dysfunction and Hair Replacement.


I'm telling you, 'Idiocracy' is a documentary. :o


So much so, that I'm going to declare it the un-official Labor Day Weekend Economist 2008 theme movie.


:popcorn:

http://www.imdb.com/title/tt0387808/quotes


Oh, and P.S. "We're DOOMED!"

[Dr.Phool]

42. It's coming on one of the HBO channels right now.

I guess they saw it coming.

[antigop]

17. Maybe it's a good thing I didn't accept their job offer.... n/t

[Ghost Dog]

79. "government-funded laboratories" usually having military and "security" goals

in mind.

[Hugin]

10. Good Weekend to you too!

:hippie:

It's sure to turn out as a rich and nougaty Labor Day Weekend.

[Demeter]

12. Lots of Nuts, For Sure

Have a great time!

[Hugin]

14. In a fashion which has become typical of my life...

Last week I found what in normal times would be my dream home. Small... at only around 1,000 sq feet. It has
a VIEW!

*sigh* I took lots of pictures to post in my appliance box.

[Demeter]

23. Define Normal

Well, now you have a tangible goal, Prag.

[Demeter]

11. Ripping off two charts – Moodys mid year residential mortgage backed security performance update

http://brontecapital.blogspot.com/2008/08/ripping-off-two-charts-moodys-mid-year.html

Moodys has published a short report entitled U.S. RMBS Mid-Year Performance Update: H1 2008. This post will shamelessly rip off a two charts from it. The entire report is absolutely consistent with the data summary that I have been giving on this blog. Its really annoying to do all this work eyeballing hundreds of MBS pools and then find a really neat 8 page paper that does it all for you…

I would quote the report more broadly except that I do believe that they have some copyright issues. You might find someone to kindly send you it. Or you can buy it on the web here at an outrageous price.

But given that I do not own the research I will limit myself to a review.

The review goes through different types of collateral and different loss curves. I will not go through all of them for copyright reasons.

The first picture I will extract is cumulative losses on Subprime RMBS by year of origination. This is one of those “no hope” charts because losses are trending upwards fast with no obvious signs of stopping.





The picture makes it look like 2005 looked nasty and stabilised (something I have been saying for a while) but that the 2006 and 2007 pools have no hope. The 2007 pool is worse than the 2006 pool.

The second chart I think makes the story a little clearer:




The 2005 pool had a delinquency hiccup – but is now back in the fold. I think we can safely estimate losses on 2005 subprime pools now and they are not that bad. The 2006 pools looked like they were stabilizing – and I blogged to that effect. The data in the last month however has given me some pause – hence my depressing thoughts post. Any light at the end of the tunnel in the 2007 pool looks like an oncoming train.

The same trends exist for Alt-A generally – but I am not going to extract all the data from the Moody’s report as I respect their copyright. I should say with Alt A the 2007 pools are not modestly worse then 2006 pools they are immodestly worse.

This is consistent with my rolling loans thesis. The loans could never be repaid but they could be refinanced. They kept getting refinanced to later pools and the last pool contained the detritus.

The 2006 Alt A delinquencies also looked to be stabilising but with a hiccup in the last month. The hiccup in the last month was worse than the subprime pools. 2005 is right back in the fold as with subprime.

Moodys then break the Alt-A into conventional adjustable rate mortgages (ARMs) and Option Arms. It seems there is almost no last-month kick up in delinquency for conventional arms but a big kick-up for option ARMS. This suggests the problem is Option ARM resets and confirms the analysis of many of the people who have commented on my blog.

They then do cumulative losses on jumbos. Similar trends – but there is a kick down in last month delinquency. Does anyone know why jumbo credit looks to have got better very quickly. I have no idea.

They then do subprime Closed End Seconds and HELOCs (something I have studied at great detail). There is MUCH more stabilisation in CES – even the 2007 pools appear to be stabilising, however HELOCs, which are generally more prime than CES are not showing the same stabilisation.

Also with PRIME CES the 2005 pools look awful, with subprime CES the 2005 pools look good. In general 2005 mortgages are only bad if they are prime.

I would go further than the Moodys report and note that more generally the better the credit the worse the trend, or the worse the credit the better the trend. But nonetheless the Moody’s report is accurate, neat, short and should be got by anyone with decent access. The expensive source I link to is probably too expensive – but that is your choice.

If you are really maniac you can take this data and recalibrate Bill Ackman's open-source model of the bond insurers. I have done that - but my estimates are probably not much better than anyone else who does it with some integrity.

[antigop]

18. BBC News: Darling warns of economic crisis

http://news.bbc.co.uk/2/hi/business/7589291.stm

The UK is facing its worst economic crisis in 60 years, Chancellor Alistair Darling has admitted.

He told the Guardian newspaper that the economic downturn would be more "profound and long-lasting" than most people had feared.

Using strong language, Mr Darling acknowledged voters were angry with Labour's handling of the economy.

Shadow chancellor George Osborne said Mr Darling had "let the cat out of the bag" about the state of the economy.

The chancellor admitted the government had "patently" failed to get its message across that it understood people's concerns about rising living costs and growing job insecurity.

[Joe Chi Minh]

49. Don't laugh. He's backtracked. He apparently stressed that the "fundamentals"

of the UK economy remained strong!

I wonder if the "poisoned chalice" of Chancellorship of the Exchequer will soon be passed to Brown's aspiring rival for the keys of no 10, "Scourge of the Russian Hordes", David Miliband. One female NuLab politico said of him, "I find it difficult to take David seriously. I used to change his nappies, you see." It doesn't look as if it could have been that long ago, either.

[Ghost Dog]

77. Worth keeping an eye on UK weirdo politics and voodoo economics

from here on in...

[Joe Chi Minh]

82. Beyond all parody.

[antigop]

19. Thanks for the thread, Demeter.... n/t

[Demeter]

24. My Pleasure! Stop in Any Time!

I'm back from today's labor, ready to party on. ZZZZZzzzzzz.....

[antigop]

20. Bloomberg: Vanguard managers invested in web gambling, suit says

http://www.bloomberg.com/apps/news?pid=20601087&sid=arTJfW09d524&refer=home

Executives of Vanguard Group Inc., the second-biggest U.S. manager of stock and bond mutual funds, illegally invested client assets in companies running Internet gambling businesses banned in the U.S., according to a lawsuit.

Chief Investment Officer George Sauter, portfolio manager Duane Kelly and eight trustees violated U.S. racketeering laws and breached their fiduciary duties to investors by acquiring stock in the Web-based businesses, investors in two Vanguard- managed funds said in a complaint filed today in U.S. District Court in New York.

``Defendants caused the funds to become owners of illegal gambling businesses,'' according to the complaint. The plaintiffs seek class-action, or group, status on behalf of all similarly situated investors, plus unspecified compensatory and punitive damages.

Vanguard, based in Valley Forge, Pennsylvania, has more than $1.25 trillion in assets. Vanguard itself is a nominal defendant in the suit that plaintiff investors Deanna McBrearty and Marylynn Hartsel styled as an action brought on the company's behalf.

Rebecca Cohen, a Vanguard spokeswoman, said the company hasn't been served with the complaint and declined to comment.

[Demeter]

25. Okay--Stop the World, I'm Getting Off Right HERE!

Shakes head sadly. "If their mothers only knew, they wouldn't be able to sit down for a month!"

[cosmicdot]

41. Vanguard flashback

from sourcewatch:

Conflict of Interest

"Three years ago Alito drew conflict-of-interest accusations after he
upheld a lower court's dismissal of a lawsuit against the Vanguard
Group. Alito had hundreds of thousands of dollars invested with the
mutual fund company at the time. He denied doing anything improper but
recused himself from further involvement in the case." --Christopher
Lee, Washington Post, October 28, 2005.

When Alito "appeared before the Senate Judiciary Committee 15 years
ago as a nominee for the appellate bench, he promised in writing to
disqualify himself from 'any cases involving the Vanguard companies,'
a stock and mutual fund firm in which he had substantial personal
investments.

"That is why several Senate aides said they were wondering yesterday
why Alito agreed to participate in 2002 with two other judges in an
appellate case in which he ruled in Vanguard's favor, dismissing a
complaint that the company had improperly seized some private accounts
and blocked the owner's widow from obtaining the funds they contained.

"Alito's ruling, issued on April 12, 2002, was withdrawn the following
year by Anthony Joseph Scirica, the chief administrative judge for the
3rd Circuit where Alito worked. Scirica acted after the widow
complained in a court motion that Alito's participation was 'unlawful'
under judicial ethics rules." --R. Jeffrey Smith, Washington Post,
November 1, 2005.

http://www.sourcewatch.org/index.php?title=Samuel_A._Alito%2C_Jr.

Democrats seek answers from Alito on Vanguard case

http://www.boston.com/news/nation/washington/articles/2005/11/09/democrats_seek_answers_from_alito_on_vanguard_case/

[Demeter]

46. Good Research, C-Dot!

Know thy enemies, and keep them closer than thy friends...and keep an eye on them!

[Ghost Dog]

21. How the Chicago Boys Wrecked the Economy

An Interview with Michael Hudson
by Mike Whitney

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=103x379884

[Demeter]

27. And the Last Shall be First

http://www.dailyreckoning.com/Issues/2008/DR082908.html

Gold seems to have bottomed out at $784. That might have been the best buying opportunity we will have for many years. Time will tell. We’re not bothering to guess. To us, gold is a good thing to have when things go bad. And after such a long period when so many things went so well, we suspect it’s time for them to go bad – and in a big way. Badness in economic terms means either inflation or deflation – or both. And both is what we’re seeing.

“This is the first business cycle ever in which the middle class had less income at the end than the beginning,” says a report at CNN. The report refers to figures put out by the Census Bureau, showing that median real incomes for U.S. families dropped in the period 2000-2007 – from around $58,500 to $56,000. (EXCUSE ME, DOESN'T THAT DEFINE A RECESSION?--DEMETER)

“Real” is the important word. Most families have more dollars. The trouble is, consumer price inflation has made those dollars worth less.

An interesting nuance came to light as well – one much discussed by Democratic politicians. While the median family got poorer over the period, the people at the top got richer. The wealthiest 1% of the population now has the highest percent of national income in 80 years.

But what are we to make of these latest GDP numbers? The numbers have been lying to us for years; what story are they telling now?

Readers will recall that except for a 6-month period in 2001-2002 the U.S. economy grew during the entire 7 years – usually at very impressive rates. In fact, it was common for American economists to boast about it. They thought they had discovered some magic formula and actually taunted the Europeans for not following their model.

What they had actually discovered was not the miracle of eternal growth, but the mirage of episodic credit expansion. And it was a special kind of super-powered credit, courtesy of the dollar-based monetary system. In effect, Americans could borrow without ever having to pay the money back. They sent IOUs – dollars – all over the world. Since ’71, they couldn’t exchange their dollars for gold. And, besides, the grateful foreigners were so happy with the strong dollar, they were glad to keep them. They used them to stuff their mattresses, build up central bank reserves, and capitalize Sovereign Wealth Funds.

Of course, you can’t really get rich by spending money you don’t have on things you don’t need. So, we – often alone...often mocked and always unappreciated – pointed out that the GDP figures were a fraud. In a consumer economy in the late stages of a credit bubble, GDP growth measured the rate at which people impoverished themselves – not the rate at which they built wealth.

Hardly anyone believed us. (Usually a good instinct...) But now we have the figures to show we were right. GDP grew substantially during the last 8 years. But people actually got poorer.

And now we have more GDP numbers; and again, they’re claiming that the economy is growing. In the second quarter, U.S. GDP grew at a surprising 3.3% annual rate. Economists applauded. Investors celebrated. Politicians and central bankers slapped each other’s back. And many analysts take these GDP numbers to mean that the crisis is over; the economy is growing again – and healthily.

Not so. Most of the GDP growth in the 2nd quarter came from exports. But most of the exports were higher priced agricultural products. Grains went up in price. And U.S. farmers sold a lot of them on the world market.

Nothing wrong with that. But not many people are going to get much out of it. Consumers are still squeezed...and spending less money. Officially, consumer spending went up at a 1.7% rate in the second quarter. If you take into account the rising population, this is barely any increase at all, per capita. And retail sales actually fell in July.

Bankruptcy filings are rising at nearly 30% per year. And even Tiffany’s says it’s hard to make a sale.

So, before coming to a verdict on the economy, we’d like an opportunity to cross examine those GDP numbers...in order to get out the truth. And water-board them too...just for fun.

[Demeter]

28. Same Old Mistakes, Different Day

http://www.dailyreckoning.com/Issues/2008/DR082808.html

From the LA TIMES comes a report that prices in the Golden State have fallen 40% since the bear market in housing began. A year ago, the typical house cost $587,000, says the Times report. Now, you can buy it for $350,000.

A blogger on the Times ’ website said that he had found a house marked down 77% – and still no buyer. We looked at the photo of the house. No wonder it had found no buyer. It is a shack, not a real house. Unfortunately, many of the houses on sale in California are shacks. At least, now they’re selling for less money.

“We’re going to have to cut prices,” said our developer friend, “or just put the project on ice until this situation turns around.”

Then came the obvious question: “When do you think things will return to normal?”

Our answer slipped out as easily as a silk handkerchief: “Things ARE normal now,” we replied.

As we explained yesterday, the eagerness of lenders to lend and the value of their collateral tend to rise or fall together. When mortgage lenders compete to give out money so people can buy houses, you have to expect prices for housing to go up. Eventually, houses become so expensive that even though people can still afford to buy them, they can’t afford to pay for them. This is when the lenders begin to have second thoughts. And once the lenders get scared, prices fall. All perfectly normal.

So far, everything is working just as it should. Boom follows bust, which follows boom. Over and over again, the same mistakes are made – but by new people.

But people don’t like to admit they’ve made a mistake. So, when markets begin to turn against them, they imagine that the turn is just a fluke. They expect things to return to ‘normal’ quickly, not realizing that it is normal for them to make mistakes and lose their money.

When housing first began to go down, at first people didn’t believe it. They’d learned that “property always goes up,” or that “you can’t go wrong with real estate.” Naturally, they took the first signs of a downturn as a buying opportunity. Later, they realized that it was a selling opportunity – the last chance to get out before the roof collapsed.

Likewise, when banks, hedge funds and mortgage lenders began to send out alarums, the problems were thought to be temporary and modest. “Containable,” is how Hank Paulson described the first little cracks in the sub-prime debt market. But the cracks widened. And now, some of the biggest financial edifices in the country – Bear Stearns, Lehman Bros., Fannie Mae and Freddie Mac – have either already fallen down or are leaning dangerously.

One in four junk bonds is in distress, says CFO.com. And the credit crisis is far from over. It has continued for more than a year, but with the value of the collateral still dropping, there are probably hundreds of billions in losses that have not yet been discovered, acknowledged and written off.

But maybe the collateral will stop falling in price...? And maybe, then, lenders will be more willing to extend credit...? And maybe the good times will roll again...?

“US home sales show signs of recovery as price declines ease,” is a headline in yesterday’s International Herald Tribune . The gist of the good news is that house prices fell less in June than they did in May (though the 12 months through June showed the biggest drop in housing in US history) and in July, sales of new and used houses actually went up!

At least 3 or 4 times over the past year, stock markets have rallied on news that “it’s over.” Eventually, of course, it will be over...but probably not before people have stopped looking for the end.

*** When will housing stop falling in price? Remember, housing is a consumer item, not an investment. It needs to be affordable. That is, the average fellow has to be able to buy the average house – and pay for it. Otherwise, prices must come down. How much must housing come down now so that the average person can buy a house? We saw estimates of about 30%-40%. And generally, there’s a little over-shooting. Nationwide, prices are down about 18% from their peak. We’d expect about as much more.

*** But while things are happening in a perfectly normal way in the housing market, in the broader world economy we are in the realm of the extraordinary. Never before have so many people in so many places had so much money. The Chinese are earning billions. The Arabs too. And Russians...

“This story coming out of Ossetia is very revealing,” said a fellow diner last night. “The region is much more complex than I realized. These people have been at each others’ throats for centuries. You know, they have about 50 different languages – and none of them related to any of the others. It is only when there is a strong imperial power in place that they settle down and behave themselves. The Tsar pacified the region in the 19th century. Then, the different cultures lived side by side. There were Catholic churches next to Orthodox churches next to mosques. And people mostly got along. And then, Stalin took over. He tried to erase a lot of the ethnic divisions...making them all communists...and forcing them all to learn Russian. But the Russians – either from the time of the Tsars or the time of the Soviets always had trouble along the southern periphery of the empire. They could never very easily bring the Muslims under control. That’s what the Crimean war was all about...and then, in Afghanistan, the Muslims kicked them out.

“But what I think is most interesting about this story is the way Russia is asserting itself. I don’t know what was going through the Georgian president’s head. You don’t attack Russia with just 17 tanks. He must have thought he had support from the U.S. and Europe. But what could the U.S. or Europe do? We know that the Russians can cut off natural gas to Europe anytime they want. They have the energy; we don’t. If they cut off the gas, it will be a long, cold winter for us. And the United States? Putin knows that the U.S. is bogged down in Iraq. And he knows too that the U.S. doesn’t have any money. In geopolitics, the country with the energy and the money wins. And right now, that’s Russia.”

Yes, dear reader, Russia looks like a winner. And China. And India. And all the countries that seem to be on the way up. Who knows which will succeed...or when? But it looks to us as though these countries are catching up – first in economic terms...later in military terms – to the United States.

What does this mean for investors? It probably means that, over the long run, shares in growing, developing countries are a better bet than those in the United States. And it probably means that the dollar is a bad way to store wealth – since it is tied to an economy in (relative) decline.

It probably also means that limited resources – gold, copper, land, water – will become (relatively) more expensive, because there are more and more people who want them and have the purchasing power to buy them.

[Demeter]

29. WELCOME TO A TRILLION-DOLLAR DEFICIT, MR. PRESIDENT

http://www.dailyreckoning.com/Issues/2008/DR082808.html#essay

The Daily Reckoning PRESENTS: Most people like deflation: falling prices and rising purchasing power helps us out. But central bankers aren’t most people, and they will fight deflation to the bitter end. Dan Amoss explains...

WELCOME TO A TRILLION-DOLLAR DEFICIT, MR. PRESIDENT
by Dan Amoss, CFA

If you are a typical citizen, you like deflation. You want your wages and investment income to stretch as far as possible. Falling prices, or rising purchasing power, are a sign of economic progress – the progress resulting from productivity gains and competition.

If you are a modern central banker, anxious to implement your ivory-tower theories, deflation is enemy No. 1. (For the sake of clarity, by “inflation,” I mean rising prices, and by “deflation,” I mean falling prices).

Central bankers must be the only people who celebrate a 3 or 4% annual reduction in purchasing power.

Why is this? Because “moderate” inflation tends to be good for bankers. Too much inflation and debtors will repay loans in increasingly worthless money. With too much deflation, debtors will be more likely to default. The Federal Reserve wants to stay in that sweet spot.

If you were Bill Gross, you also would not like too much deflation. As chief investment officer at PIMCO, Gross manages $130 billion in fixed income investments. Gross thinks like a banker. After all, he’s essentially loaning his clients’ money to governments, corporations, and households (via mortgage securities). Spiraling deflation could push his bonds into default.

Gross’s good long-term track record owes a lot to the “great moderation” in inflation since the early 1980s.

You can generate very high returns by buying high-yielding long-maturity bonds when inflation is high and holding them while inflation cools off. This was the best strategy for bond investors from the early 1980s until today.

Rather than deflation, Gross should worry about a decade-long resurgence in inflation. But surprisingly, he fears that deflating house prices will drag the U.S. economy into a Japanese-style slump. His solution? He wants the government to print money and Treasury bills to prevent it.

In his July 2008 investment outlook, available on PIMCO’s Web site, Gross writes an open letter to Democratic presidential nominee Barack Obama. Presuming Obama will be the next president, Gross urges him to dramatically expand the federal budget deficit until it reaches a trillion dollars. I quote:

“While the Republicans will blame you for years and label you “Trillion-Dollar Obama” in future campaigns, there is, in fact, not much that you or any other president can do. You’ve inherited an asset-based economy whose well has been pumped nearly dry with lower and lower interest rates and lender-of-last-resort liquidity provisions that have managed to support Ponzi-style prosperity in recent years.”

The U.S. economy “will need an additional jolt of $500 billion or so of government spending real quick,” pleads Gross. His comically simple formula for GDP, this $500 billion “jolt” to the slowing real economy, is as follows:

“Some quick math for you, sir: Gross private domestic investment (machines, houses, inventories) has declined by $200 billion since its peak in late 2006. Due to higher unemployment and energy costs, domestic consumption will soon be $300 billion less than it should be if we are to return to historical economic growth rates. According to that old C + I + G formula (scratch the trade deficit for now), when C + I is reduced by $500 billion, then G should increase by that amount in order to fill the gap. The G, sir, is you – the government deficit, the fiscal stabilizer popularized by Keynes following the Depression. And since the fiscal deficit for 2008 is likely to press $500 billion even before you take the oath of office, well, there you have it: $500 billion + $500 billion = $1 trillion big ones, probably by sometime in 2011 or so.”

Only a Keynesian could argue that such an extraordinary waste of capital is a good thing. And only a Keynesian would believe that the simple GDP equation could summarize a vastly complex, adaptive economy.

I’ve always been skeptical of GDP as a measure of economic progress. It treats dollars spent and dollars invested equally (a dollar invested adds to capital formation, while a dollar spent subtracts from it). The GDP equation also treats government spending as a good thing. It is not. Aside from spending on the occasional “public good,” it just sucks capital out of the efficient, adaptive private sector and doles it out to politically powerful voting blocks.

Gross’ prescription to “save” the economy through wasteful spending would do much more harm than good. He aptly notes that the U.S. depends on foreigners to continually reinvest U.S. dollars back into the U.S economy and government.

As OPEC knows, many of the dollars recycled back into the U.S. were originally exchanged for oil imports. Gross acknowledges that the U.S. economy has an “energy cost” problem. But what does he think oil exporters’ reaction to an extra $500 billion spending “jolt” will be?

It won’t be pretty. Major oil exporters will demand higher oil prices and higher interest rates to offset what they know will be an ever-growing supply of U.S. dollar assets. Would you invest in an asset if you knew the future supply of that asset were guaranteed to increase at a rapid rate?

I have a more constructive suggestion for the next president:

DON’T dream up creative new ways to suck $500 billion in capital out of the private economy and redirect it into vote-buying programs. DO take a crash course on how the energy supply chain works, and invite Congress. Energy ignorance is the biggest immediate obstacle to the government being part of any sort of solution.

Inflation is here to stay, albeit with occasional “deflation” scares. Adjust your portfolio accordingly.

Regards,

Dan Amoss, CFA
for The Daily Reckoning

Editor’s Note: The above essay was pulled from the most recent issue of Strategic Investment . For more, see LINK AT ORIGINAL ARTICLE .

[Dr.Phool]

43. I used to subscribe to Strategic Investment back in the early-mid- '90s.

I took advantage of the money back guarantee on their very pricey newsletter, because they were always wrong.

[Demeter]

30. Don't Think About White Elephants

http://www.dailyreckoning.com/Issues/2008/DR082708.html

After the biggest spending and borrowing binge in history, Americans need time and money. They need to pay their debts. They need to build savings for their retirements. They need time and money to recover from their mistakes.

What kind of mistakes?

Well, down near the bottom of the ladder, people bought houses they couldn’t really afford to own in places they couldn’t afford to live. And cars they couldn’t afford to run. Those mistakes need to be undone. Which is why there are so many foreclosed houses on the market...and why house prices generally are falling.

S&P/Case-Shiller reports that house prices took their biggest hit ever in the second quarter of this year. They were down 15.4% from the year before.

Further up on the ladder, the rich are now embarrassed by their own housing mistakes. New Yorker magazine reports that it is the ‘season of white elephants’ in Greenwich, Connecticut. Speculators began huge mansions – in the “Georgian Stockbroker” style, for example, complete with indoor swimming pools, wine cellars, movie theatres, dozens of bathrooms, even ice-skating rinks – and now find the buyers have disappeared. Want to buy a $28 million spec house? Go to Greenwich.

At the investment level there were plenty of mistakes too. Subprime mortgage lending dominated the headlines for the last 12 months, but the same reckless spirit found its way into transactions all over the economy. Private equity, IPOs, student loans, shopping malls, fast-food joints – while the going was good, everyone wanted to go along.

And now, they all need time and money to pay for their errors.

The baby boomers say they are postponing retirement. Some are going back to the office.

A county in Alabama says it will have to declare bankruptcy.

The FDIC says its “problem list” of banks lengthened by 30% during the second quarter.

Bank earnings fell to their second lowest level in 19 years, says Bloomberg .

In London, tens of thousands of jobs have already been lost in the financial sector, says the Financial Times . IPOs, where the City (equivalent to Wall Street in New York) made much of its money, have “fallen off a cliff.”

We have lived through the biggest credit expansion ever. Ahead is perhaps the biggest credit contraction ever. Why? Because it takes time and money to correct mistakes. The bigger the mistakes; the longer and more expensive the correction.

Corrections can be tough on the economy – and on the individual consumer. Most have no idea what lies ahead...but our friends at Strategic Investment have made some interesting forecasts. Read their latest report, which outlines not only the next 5 supershocks the U.S. economy should brace itself for, but how you can protect your portfolio – and even turn a nice profit. See the report here .

When money and credit flow, they tend to raise prices. You get inflation – first of asset prices...later, of consumer prices. When money stops flowing, prices come down. As George Soros puts it, the willingness to lend is directly related to the value of the collateral. Both tend to rise and fall together.

Currently, lenders are wary and the value of the collateral is falling. Everyone knows house prices are going down. But U.S. stock prices are going down too. Adjusted for consumer price inflation, they’ve been going down since the end of 1999. That is, a $50 stock is still worth about $50...but the 50 bucks ain’t what it used to be. It buys only 1/5th as much oil, for example.

This trend, towards lower asset prices, is likely to last a long time. To protect ourselves, we began buying gold in 2000. So far...so good.

*** “Gold hasn’t done too well lately, maybe it’s time to get out...”

The thought comes up from time to time, most recently from a visitor from Maryland.

“If the world economy is slowing down, commodities aren’t the place to be,” he went on. “Gold either. People buy gold to protect themselves from inflation. But inflation isn’t going to increase in a recession. You’d be better off in cash until this thing turns around.”

Our guest voiced what is probably the dominant opinion of the summer – that a worldwide slowdown means price increases will slow down too. Without the hot breath of the inflation hounds chasing it, gold will go back to sleep and the Fed can continue to rescue speculators from their mistakes.

That’s why the U.S. 10-year Treasury note yields all of 3.78%. Yes, investors know they will lose money if inflation remains above 4%. But that risk – they believe – is worth taking for the safety of the dollar and the full faith and credit of the U.S. Federal Government. Besides, inflation is almost sure to go down.

This view may turn out to be right. But when we think of moving to cash we pose the question: what cash? And there’s the problem. The planet’s alpha cash is the dollar. And while the dollar may have some limited upside in a punk market (it’s already gone up about 7% against the euro), the potential downside is enormous.

What if the bond market is wrong about inflation? What if the increase in producer prices – now running at nearly 10% – works its way into consumer prices? What if demand from the developing world doesn’t slack off as expected? What if there is war? What if the U.S. economy worsens...and the feds need to cut rates and offer further $100 billion bailouts? What if Asian, Arab and Russian creditors lose faith in the dollar and switch to euros?

Any of these things could be catastrophic for holders of U.S. Treasury bonds. At 3.78% yields – it hardly seems worth the risk. Shorter-term Treasury bills barely pay anything at all.

So what cash do you hold? We choose gold because it is cash that no central bank manages. No one prints. No government backs. And no one ever threw away a gold coin. Gold will always hold an intrinsic value – so we’ll keep holding gold. And perhaps you’ll want to take out a golden insurance policy for your portfolio as well. See here:

Zero-Downside Gold

*** Colleague Joel Bowman of The Rude Awakening lives in Dubai. We wondered whether the place was the bubble we had heard, so we posed the question to him. His reply:

“My short stay here in Dubai has led me to believe that Dubai & Co. is a largely unsustainable enterprise.

“Dubai’s lifestyle makes the average American look like a prudent, energy-conscious, environmentally-friendly health nut! I read the other day that 60% of the average Emirates’ total income is spent on consumer goods – Gucci totes, designer abayas and million-dollar number plates.

“The big difference I can see is that, save for the last few years, the vast majority of America’s wealth accumulated over time and from the productive, honest toil of citizens who forged metal, cracked bullwhips and invented light bulbs. Dubai’s wealth has come on fast and strong...and is not really the product of its own honest toil. Were it not for American, British and French companies – among others – who told them what all that black stuff underfoot was and what the rest of the world was prepared to pay for it, Dubai might still be a pearl diving port of a few thousand itinerant workers.

“If the American economy is drunk on its own home brew of ‘irrational exuberance,’ Dubai is sucking down straight tequila shots and desperately trying to catch up. We see it here everyday as the government squanders its unearned wealth on extravagant welfare programs and ‘National Identify Preservation’ boards and committees dedicated to ‘cultural heritage association’ this and ‘watchdog for immoral behaviour’ that. Then there’s the over-reaching controls on the economy – price fixing, wage manipulation, rent caps...the list goes on.

“I read with interest the ‘Frapp On Ice’ story just the other day – about how Starbucks will close 600 stores over the next year as discretionary consumer spending shrinks. That story was all the more amusing for me as I actually read it on my laptop... in the Starbucks that just opened in the lobby of my building last week. There are now six Starbucks within walking distance from my front door (and I don’t walk far – it was 125 degrees on Monday). We also have numerous Seattle’s Best, Krispy Kreme’s and the rest of the strip mall junk to go along with them. It’s like anytown USA...super-supersized. Which brings me to my next point...

“Jumeirah Beach Residence (or JBR for the cool kids) is a 36-building project that opened a year or so ago. Each building is around 40 stories and there is said to be space for 25,000 people to live here. But where are the people, I ask myself? So few apartments are occupied that I still notice when a conspicuous new light comes on at night in the surrounding buildings...yet, apparently, most are sold. I can’t see the newbies rushing to cut more keys as rent prices have, get this, risen by over 50% since we moved in in December. We took a relatively comfortable two-bedroom with a decent view, but if I walked in off the street today I couldn’t get a studio on the first floor for the same price.

“The story is similar elsewhere in the city too. Projects are developed, pumped through the massive Dubai & Co. media arm and, voila! the joint is 50, 60, or 70% taken! ‘It’s another success story,’ ring the papers ‘Dubai’s world-beating ingenuity triumphs again!’ chorus the king and his merry band of sycophants. But, best as I can make out, the biggest developments – including JBR, touted as the ‘largest single-phase residential project in the world’ – are still ghost towns.

“A friend of mine was out the other day to inspect a house he saw for sale in one of these new developments (Arabian Ranches, in this case). The price was at the top-end of his budget and he was ‘umming and ahhing’ about it until the estate agent casually threw in, ‘now, this property is only available in lots of 10.’ In other words, the development is being sold off in 10-house chunks to middle-men who then flip ‘em and burn onto the next ‘world beating’ development.

“So who’s buying all these vacant houses, streets and islands? Some – and not just the conspiracy theorists either – say Dubai is a massive funnel for dirty Russian money. Others, including myself, reckon speculators buy into the hype...hoping a bigger idiot will buy into it a year later and hand them a handsome return.

“The trouble is, sooner or later you’re going to run out of idiots. Even here in Dububble the supply of them is not without limit.”

[Demeter]

32. Those Are Some Swell Articles, Guys! Thanks to Antigop, etc!

Now I have to swim the kid...carry on in my absence!

[antigop]

33. Banks seek preferential treatment for their Fannie, Freddie preferred

http://financialweek.com/apps/pbcs.dll/article?AID=/20080829/REG/808299983/1036

Bankers have started to lobby the Treasury Department to go easy on their Fannie Mae and Freddie Mac preferred stock.

But do they have a prayer?

Both the Financial Services Roundtable and the American Bankers Association today confirmed that they have asked the Treasury to consider the damage to banks’ preferred shares in the government-sponsored enterprises if Fannie and Freddie are nationalized.

By some estimates, banking companies own up to half of the roughly $36 billion in Fannie and Freddie preferred equity outstanding.

Christopher Whalen, co-founder of Institutional Risk Analytics, a unit of Lord Whalen, said on Friday that it’s unlikely the government will take pity on banks. He added that officials at Treasury should just get it over with.

[Pale Blue Dot]

34. I've got one of my patented very bad feelings

Gustav is approaching New Orleans. Hannah will likely hit the US as well. McCain seems to have made an absolutely insane VP selection. Banks continue to fail in dribs and drabs.

I would be willing to make a small bet on total economic collapse by the end of the week and a larger one on total economic collapse by the election.

Take it with a large grain of salt.

[Dr.Phool]

35. I usually tell people, "Smile, it's not that bad".

Not anymore.

I have a feeling, I'm not gonna like Hannah very much.

[DemReadingDU]

50. An economic collapse is coming

I had thought the collapse would wait until next year because Paulson keeps pulling more rabbits of the hat. But I think he's run out of tricks.

My post #7 describes how quickly the collapse will occur once it is put into motion, see - Christopher Laird: A world financial Armageddon?

edit: It's a long 7-page article. I printed it out so my spouse could also read it.

[Karenina]

36. BIG SHOUT OUT and Thank You to Demeter!!

:yourock::yourock::yourock:

[Demeter]

37. Thank You! You're Too Kind!

[Demeter]

38. ‘Why Middle Class Mothers and Fathers Are Going Broke’

http://www.msnbc.msn.com/id/3079221/

New book looks at how the ferocious bidding war for housing and education has quietly engulfed America’s suburbs



There were over 1.6 million bankruptcy filings last year, up 7.4 percent from the previous year. And according to a new book, more people will end up in bankruptcy this year than will suffer a heart attack, than will be diagnosed with cancer or graduate from college, and it’s not who you would think. Elizabeth Warren is a Harvard law professor and bankruptcy expert and discusses these findings in her new book “The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke.”

... Over the past generation, the number of American families who have found themselves in serious financial trouble has grown shockingly large. In a world in which our neighbors seem to be doing fine and the families on television never worry about money, it is hard to grasp the breadth or depth of financial distress sweeping through ordinary suburbs, small towns, and nice city neighborhoods... typical American families who are doing their best to make a good life for their children — working hard, paying their bills, and playing by the rules — lose it all when disaster strikes.

... my attention was suddenly drawn back to a single line on the page: the number of women in the sample. In 1981, about 69,000 women had filed for bankruptcy. The data on my printout indicated that by 1999 that figure had jumped to nearly 500,000 — an unimaginable leap. I guessed that the data had been entered wrong — maybe someone had added a couple of zeroes somewhere — or, worse still, our research team had somehow pulled way too many women into their sample, inadvertently producing a huge distortion in the numbers. Frustrated, I tossed the printout in the trash, assuming we would be forced to throw out months of work.

The research team went back into the field for more data, initiating the 2001 Consumer Bankruptcy Project, which would evolve into the largest study ever conducted about families that had failed financially. I soon learned that there was something wrong, but it wasn’t the data sampling. In just twenty years, the number of women filing petitions for bankruptcy had, in reality, increased by 662 percent. As I soon discovered, divorced and single women weren’t the only ones in trouble; several hundred thousand married women filed for bankruptcy along with their husbands.

Our research eventually unearthed one stunning fact. The families in the worst financial trouble are not the usual suspects. They are not the very young, tempted by the freedom of their first credit cards. They are not the elderly, trapped by failing bodies and declining savings accounts. And they are not a random assortment of Americans who lack the self-control to keep their spending in check. Rather, the people who consistently rank in the worst financial trouble are united by one surprising characteristic. They are parents with children at home. Having a child is now the single best predictor that a woman will end up in financial collapse.

Consider a few facts. Our study showed that married couples with children are more than twice as likely to file for bankruptcy as their childless counterparts. A divorced woman raising a youngster is nearly three times more likely to file for bankruptcy than her single friend who never had children.

Over the past generation, the signs of middle-class distress have continued to grow, in good times and in bad, in recession and in boom. If those trends persist, more than 5 million families with children will file for bankruptcy by the end of this decade. That would mean that across the country nearly one of every seven families with children would have declared itself flat broke, losers in the great American economic game.

Bankruptcy has become deeply entrenched in American life. This year, more people will end up bankrupt than will suffer a heart attack. More adults will file for bankruptcy than will be diagnosed with cancer. More people will file for bankruptcy than will graduate from college. And, in an era when traditionalists decry the demise of the institution of marriage, Americans will file more petitions for bankruptcy than for divorce...And the lines at the bankruptcy courts are not the only signs of financial distress. A family with children is now 75 percent more likely to be late on credit card payments than a family with no children. The number of car repossessions has doubled in just five years. Home foreclosures have more than tripled in less than 25 years, and families with children are now more likely than anyone else to lose the roof over their heads. Economists estimate that for every family that officially declares bankruptcy, there are seven more whose debt loads suggest that they should file for bankruptcy — if only they were more savvy about financial matters.

MUCH MORE AT LINK

[Demeter]

39. Taleb's Harsh Assessment of Bankers, Economists, and the Fed

http://www.nakedcapitalism.com/2008/06/talebs-harsh-assessment-of-bankers.html


...a wide-ranging interview with Nassim Nicholas Taleb, author of the Black Swan and professional iconoclast, in the Times of London. Exerpts:




To explain: black swans were discovered in Australia. Before that, any reasonable person could assume the all-swans-are-white theory was unassailable. But the sight of just one black swan detonated that theory. Every theory we have about the human world and about the future is vulnerable to the black swan, the unexpected event. We sail in fragile vessels across a raging sea of uncertainty. “The world we live in is vastly different from the world we think we live in.”

Last May, Taleb published The Black Swan: The Impact of the Highly Improbable. It said, among many other things, that most economists, and almost all bankers, are subhuman and very, very dangerous. They live in a fantasy world in which the future can be controlled by sophisticated mathematical models and elaborate risk-management systems. Bankers and economists scorned and raged at Taleb. He didn’t understand, they said. A few months later, the full global implications of the sub-prime-driven credit crunch became clear. The world banking system still teeters on the edge of meltdown. Taleb had been vindicated. “It was my greatest vindication. But to me that wasn’t a black swan; it was a white swan. I knew it would happen and I said so. It was a black swan to Ben Bernanke . I wouldn’t use him to drive my car. These guys are dangerous. They’re not qualified in their own field.”

In December he lectured bankers at Société Générale, France’s second biggest bank. He told them they were sitting on a mountain of risks – a menagerie of black swans. They didn’t believe him. Six weeks later the rogue trader and black swan Jérôme Kerviel landed them with $7.2 billion of losses.

As a result, Taleb is now the hottest thinker in the world. He has a $4m advance on his next book. He gives about 30 presentations a year to bankers, economists, traders, even to Nasa, the US Fire Administration and the Department of Homeland Security. But he doesn’t tell them what to do – he doesn’t know. He just tells them how the world is. “I’m not a guru. I’m just describing a problem and saying, ‘You deal with it.’”...



... he also learnt from a very early age that grown-ups have a dodgy grasp of probability...For the non-mathematician, probability is an indecipherably complex field. But Taleb makes it easy by proving all the mathematics wrong. Let me introduce you to Brooklyn-born Fat Tony and academically inclined Dr John, two of Taleb’s creations. You toss a coin 40 times and it comes up heads every time. What is the chance of it coming up heads the 41st time? Dr John gives the answer drummed into the heads of every statistic student: 50/50. Fat Tony shakes his head and says the chances are no more than 1%. “You are either full of crap,” he says, “or a pure sucker to buy that 50% business. The coin gotta be loaded.”

The chances of a coin coming up heads 41 times are so small as to be effectively impossible in this universe. It is far, far more likely that somebody is cheating. Fat Tony wins. Dr John is the sucker. And the one thing that drives Taleb more than anything else is the determination not to be a sucker. Dr John is the economist or banker who thinks he can manage risk through mathematics. Fat Tony relies only on what happens in the real world.

In 1985, Taleb discovered how he could play Fat Tony in the markets. France, Germany, Japan, Britain and America signed an agreement to push down the value of the dollar. Taleb was working as an options trader at a French bank. He held options that had cost him almost nothing and that bet on the dollar’s decline. Suddenly they were worth a fortune. He became obsessed with buying “out of the money” options. He had realised that when markets rise they tend to rise by small amounts, but when they fall – usually hit by a black swan – they fall a long way.

The big payoff came on October 19, 1987 – Black Monday. It was the biggest market drop in modern history. “That had vastly more influence on my thought than any other event in history.”

It was a huge black swan – nobody had expected it, not even Taleb. But the point was, he was ready. He was sitting on a pile of out-of-the-money eurodollar options. So, while others were considering suicide, Taleb was sitting on profits of $35m to $40m. He had what he calls his “f***-off money”, money that would allow him to walk away from any job and support him in his long-term desire to be a writer and philosopher.

He stayed on Wall Street until he got bored and moved to Chicago to become a trader in the pit, the open-outcry market run by the world’s most sceptical people, all Fat Tonys. This he understood.....

In the midst of this came his purest vindication prior to sub-prime. Long-Term Capital Management was a hedge fund set up in 1994 by, among others, Myron Scholes and Robert C Merton, joint winners of the 1997 Nobel prize in economics. It had the grandest of all possible credentials and used the most sophisticated academic theories of portfolio management. It went bust in 1998 and, because it had positions worth $1.25 trillion outstanding, it almost took the financial system down with it. Modern portfolio theory had not accounted for the black swan, the Russian financial crisis of that year. Taleb regards the Nobel prize in economics as a disgrace, a laughable endorsement of the worst kind of Dr John economics. Fat Tony should get the Nobel, but he’s too smart. “People say to me, ‘If economists are so incompetent, why do people listen to them?’ I say, ‘They don’t listen, they’re just teaching birds how to fly.’ ”....

And what he knows does not sound good. The sub-prime crisis is not over and could get worse. Even if the US economy survives this one, it will remain a mountain of risk and delusion. “America is the greatest financial risk you can think of.”

Its primary problem is that both banks and government are staffed by academic economists running their deluded models. Britain and Europe have better prospects because our economists tend to be more pragmatic, adapting to conditions rather than following models. But still we are dependent on American folly.

The central point is that we have created a world we don’t understand. There’s a place he calls Mediocristan. This was where early humans lived. Most events happened within a narrow range of probabilities – within the bell-curve distribution still taught to statistics students. But we don’t live there any more. We live in Extremistan, where black swans proliferate, winners tend to take all and the rest get nothing – there’s Bill Gates, Steve Jobs and a lot of software writers living in a garage, there’s Domingo and a thousand opera singers working in Starbucks. Our systems are complex but over-efficient. They have no redundancy, so a black swan strikes everybody at once. The banking system is the worst of all.

“Complex systems don’t allow for slack and everybody protects that system. The banking system doesn’t have that slack. In a normal ecology, banks go bankrupt every day. But in a complex system there is a tendency to cluster around powerful units. Every bank becomes the same bank so they can all go bust together.”

He points out, chillingly, that banks make money from two sources. They take interest on our current accounts and charge us for services. This is easy, safe money. But they also take risks, big risks, with the whole panoply of loans, mortgages, derivatives and any other weird scam they can dream up. “Banks have never made a penny out of this, not a penny. They do well for a while and then lose it all in a big crash.”

On top of that, Taleb has shown that increased economic concentration has raised our vulnerability to natural disasters. The Kobe earthquake of 1995 cost a lot more than the Tokyo earthquake of 1923. And there are countless other ways in which we have built a world ruled by black swans – some good but mostly bad. So what do we do as individuals and the world? In the case of the world, Taleb doesn’t know. He doesn’t make predictions, he insults people paid to do so by telling them to get another job. All forecasts about the oil price, for example, are always wrong, though people keep doing it. But he knows how the world will end.

“Governments and policy makers don’t understand the world in which we live, so if somebody is going to destroy the world, it is the Bank of England saving Northern Rock. The biggest danger to human society comes from civil servants in an environment like this. In their attempt to control the ecology, they don’t understand that the link between action and consequences can be more vicious. Civil servants say they need to make forecasts, but it’s totally irresponsible to make people rely on you without telling them you’re incompetent.”

Bear Stearns – the US Northern Rock – was another vindication for Taleb. He’s always said that whatever deal you do, you always end up dealing with J P Morgan. It was JPM that picked up Bear at a bargain-basement price. Banks should be more like New York restaurants. They come and go but the restaurant business as a whole survives and thrives and the food gets better. Banks fail but bankers still get millions in bonuses for applying their useless models. Restaurants tinker, they work by trial and error and watch real results in the real world. Taleb believes in tinkering – it was to be the title of his next book. Trial and error will save us from ourselves because they capture benign black swans. Look at the three big inventions of our time: lasers, computers and the internet. They were all produced by tinkering and none of them ended up doing what their inventors intended them to do. All were black swans. The big hope for the world is that, as we tinker, we have a capacity for choosing the best outcomes...

And you and me? Well, the good investment strategy is to put 90% of your money in the safest possible government securities and the remaining 10% in a large number of high-risk ventures. This insulates you from bad black swans and exposes you to the possibility of good ones. Your smallest investment could go “convex” – explode – and make you rich. High-tech companies are the best. The downside risk is low if you get in at the start and the upside very high. Banks are the worst – all the risk is downside. Don’t be tempted to play the stock market – “If people knew the risks they’d never invest.”

There’s much more to Taleb’s view of the world than that. He is reluctant to talk about matters of human nature, ethics or any of the traditional concerns of philosophy because he says he hasn’t read enough. But, when pressed, he comes alive. “You have to worry about things you can do something about. I worry about people not being there and I want to make them aware.” We should be mistrustful of knowledge. It is bad for us. Give a bookie 10 pieces of information about a race and he’ll pick his horses. Give him 50 and his picks will be no better, but he will, fatally, be more confident.

We should be ecologically conservative – global warming may or may not be happening but why pollute the planet? – and probablistically conservative. The latter, however, has its limits. Nobody, not even Taleb, can live the sceptical life all the time – “It’s an art, it’s hard work.” So he doesn’t worry about crossing the road and doesn’t lock his front door – “I can’t start getting paranoid about that stuff.” His wife locks it, however.

[Joe Chi Minh]

55. Wow! Thanks a million Demeter. That must be, at least, one of the most fascinating and absolutely

hilarious articles I've ever read. He reminds me a lot of Yossarian in Catch 22. The scenarios he describes are just as farcical as Milo Minderbender's wildest capers, and his analyses just as incisively correct.

With his Fat Tony and Dr John, I think Taleb's captured the primacy of first principles reasoning over deductive reasoning most graphically and very wittily (just don't tell a journeyman scientist though). Like old Blackjack Kennedy's fabled rationale for selling his stock before the Wall Street Crash of old. Well, on reflection, that is an over-simplification. Trial and error is hardly inductive reasoning!

I'm not sure Taleb has recognised the voluntary intellectual "blinkers" that a ticket on the gravy-trains of professional establishments invariably involves, particularly where money is concerned most directly. Voluntarism - knowing what we want to know, works on many levels, not all conscious, in the way that we understand the term at least. But so what? It's not germane to the practicalities, other, perhaps, than indicating that it is most unwise to ever expect the players concerned to accept regulation, unless coerced.

[Joe Chi Minh]

75. "Trial and error is hardly inductive reasoning!" On FURTHER reflection,

this time, not in haste, I have to go back again on that assertion, and point out that Taleb's main thrust, of course, is a fundamental principle, substantially on the lines I pursued in a post the other day, namely, that Economics CANNOT be a science, nor can it be virtually reduced to mathematical models.

The very term, "social science" is misconceived pretentiousness. Mechanistic science's mesmeric effect on the naive is still very to slow to dissipate, and thus we retain this laughably servile deference to empirical science as the ultimate paradigm of knowledge. The world and his wife want a piece of it.

On the contrary, economics is surely properly the study of human behaviour in the context of their trading - with statistics, etc, playing only a very minor role, where helpful. Human beings in the round are immeasurably too subtle and complex for predictions of their behaviour to be reduced to mathematical analyses. Not even essential psychopaths are machines.

The recognition of the primacy of a particular first principle invariably leads to hilarity, because it goes straight to the heart of a matter in a single, laughably simple step. Another example of it is Sean Connery' comment - I think he attributed to a friend, though he was probably quoting someone else - that the difference between a rich man and a very rich man is a good lawyer. Judging from some of the legal saws I've encountered here and elsewhere, it seems to be a particularly fecund mine of such mordantly witty axioms.

[Demeter]

40. Frick and Frack (Fannie and Freddie) By Bill Sharon

http://www.opednews.com/articles/Frick-and-Frack-by-Bill-Sharon-080828-731.html



...There is much conflicting data about the financial health of these two companies. An analyst from Barclays Bank estimates that Freddie has a negative value of at least $20 billion and Fannie is at negative $3 billion. Collectively they need to raise $30 billion before the end of September. The likelihood of this happening from the usual sources is slim to none. The Asian banks have slowed their investment in Freddie and Fannie debt to a minimum (they currently hold 35-40% of the outstanding debt) and while US investors are picking up the slack many of them are employing something called a "switch"-. A "switch"- is where an investor agrees to buy a new debt issue only if the issuing bank will take back on older debt issue of equal value. So it looks like the new debt issues is well received but in actuality Freddie and Fannie are not really raising the funds that it would seem that they are raising.


This sleight of hand is being employed is a fairly transparent attempt to maintain confidence; the emotional underpinning that sustains the markets. It is the same device that the Federal Reserve has been using in extending loans of greater and greater amounts to banks. The Fed, a consortium of private banks has in essence been lending money to its own members. The problem with all of this is that the system and Freddie and Fannie in particular is more and more resembling the scrambling legs of Frick and Frack; although the ice is a lot thinner and the likelihood that they will fall on their faces a near certainty.


The next step in this drama increasingly appears to be nationalization of both of these troubled companies. On the surface nationalization has the appeal of the taxpayers owning the assets of these failed companies (that would be the mortgages that have been securitized into mortgage backed securities). Shareholders would loose what is left of their equity position and although that is still not a trivial amount and would no doubt result in a serious impact to the markets it is the normal result of the bankruptcy of a publically held company "" just ask the shareholders who held Enron stock.


But there is an ugly problem that has the potential to have an even greater impact than the loss of shareholder value. Fannie Mae and Freddie Mac have $19 billion outstanding in subordinated debt. Subordinated debt is essentially the class of bonds that are at the bottom of the food chain. Should a default or "credit event"- (the latter sounds so much nicer) occur it is likely that the interest on this debt could be deferred up to five years. Again, that is an expected event but the problem is that deferring the interest on those bonds could trigger the payout of the insurance policies that investors bought to hedge against a default. These policies are called credit default swaps and can be issued to investors who don't even hold any of the subordinated debt. You can bet on a bond that you don't own defaulting by buying a CDS. How much of this insurance is out there and can the companies who wrote the policies pay off? Nobody knows. As with the great majority of securities in the US and around the world these swaps are bought and sold in an unregulated auction market.


It is possible that a deal could be structured so that the credit default swaps would not be triggered by a bailout but you can be sure that there will be a lot of angry investors if that happens. It might make betting on failure less attractive but in the near term we can expect a good deal of outrage about constraints on the free market. The real question in all of this however is what is going to happen to the human beings "" people like you and me.


The best case scenario is that we influence our government to keep people in their homes. This is a practical solution based on fundamental economics. People who are still in their homes spend money in the businesses in their communities which keeps the economic engine running. People in their homes would throttle down the continuing negative spiral in housing values. People in their homes would form the firewall in the current economic meltdown. No doubt that there would be cries of "socialism"- and dire warnings that we need to let the market work but we are well past that now. A bailout of Fannie and Freddie will occur...







Authors Website: www.sorms.com

Authors Bio: Bill Sharon has been conducting seminars, workshops and consulting assignments in the area of risk management for the past 15 years. His clients include: American Express ICEA JP Morgan Chase PricewaterhouseCoopers Interpublic McCann Worldgroup DuPont DuPont Merck CIBC Corning EBS Regulus Watson Wyatt The Partnership Strathmore University Hyperwave Bill has 25 years experience in the Financial Services and Marketing/Communications industry in a variety of "C" level positions and consultancies. He has a history of managing projects that result in significant change in organizational culture. This operational experience has a strong influence on the design of his workshops, seminars and consultancies-they are results oriented. At JP Morgan as the COO of Corporate Real Estate, he was a key player in the transformation from a commercial bank to an investment bank through the development and construction of high tech offices in 23 markets around the world that reflected the new organizational culture. He went on to develop cross functional risk management processes for penetrating new markets and establishing new products. He also created the first proactive operational risk management process designed as a vehicle to communicate opportunities as well as hazards. At Price Waterhouse, Bill established the North American Operational Risk Management practice which focused on the "upside" of risk – the choices an organization needs to make to stay competitive. He developed a groundbreaking approach to converge differing perceptions of risk as well as corporate level scorecards that communicated risk profiles across a portfolio of business units. He expanded his practice to the marketing services industry, initially as a consultant to McCann Erickson in professionalizing the wholly owned subsidiary that provided IT services and then as a consultant to Interpublic as they began to centralize operational services. At the request of Interpublic he assumed the position of CIO of McCann Worldgroup for a period of 18 months to facilitate the transition to a more centralized organization for operational services. While at the agency, Bill developed a global collaborative system as the foundation for supporting the cross-discipline business strategy of Demand Creation. He is featured in numerous industry magazines (CIO Magazine, Business Finance Magazine, Business Credit Magazine) has authored an executive briefing on managing risk in marketing services published by the Cutter Consortium and has published a series of articles that are widely distributed on the Internet (i.e. www.bettermanagement.com , www.continuity central .com) and is a significant contributor to Q Financial, an encyclopedia of risk management strategies that will be published by Bloomsbury Press in October 2008. Over the past three years Bill has conducted workshops in Bangkok, Thailand, Singapore and Nairobi, Kenya. Through his relationship with Strathmore University in Kenya he provides consulting services for a variety of financial and health care companies and maintains an active correspondence and consultation with business leaders throughout Africa, Asia and Europe. Bill holds a clinical degree and, for the first ten years of his professional life worked with adolescents in the South Bronx and East Harlem, an experience that taught him the very difficult skill of how to listen.

[DemReadingDU]

44. morning kick

:donut:

[Hugin]

45. Morning DemReadingDU...

I'm guessing I'll have to add the link to Integrity Bank from Friday.

[Demeter]

51. Lehman: Following Good Bank/Bad Bank to Redemption

http://www.informationarbitrage.com/2008/08/lehman-followin.html


Lehman Brothers recently announced that they are taking a Good Bank/Bad Bank approach to tens of billions of dollars of illiquid real estate assets, hiving them off from the rest of the firm. Nice to see someone is listening. As previously discussed, I firmly believe that segregating toxic, hard-to-value assets from the rest of bank balance sheets is the only way true healing can take place and additional investment can be secured. Here is what I said about the benefits of such an approach a month ago:

The good bank is a bank we can understand, analyze and readily price. The bad bank, well, is bad for a reason. It contains a large number of very complex, hard-to-value instruments. Mortgages. Illiquid derivatives. Leveraged loans and loan commitments. So an investor in such a combined good bank/bad bank entity is likely to pay a sharply discounted value for the good bank because the bad bank is so bad, or at least it's potential losses are so unclear.

What I believe we really need is a good bank/bad bank approach to the current banking sector woes, causing all banks to shrink by offloading their bad bank instruments into either a bank-specific vehicle (like Citi taking its bad assets and selling them into a "Citi Bad Bank") or a series of pools organized by asset type (similar to the Super SIV idea, except separate vehicles for mortgages, derivatives, leveraged loans and unfunded commitments). The instruments to be marked-to-market upon transfer and funded by private capital, which will now demand a return in line with the risk without placing unnecessary downward pressure on the valuation of the good banks that remain. And if private capital wishes to fund the good banks who now have clean balance sheets and are ready to expand but are short on capital, they will receive a return commensurate with healthy, good bank growth capital.

Otherwise, investors will continue to be surprised and disappointed, much like those SWFs that have spent billions by investing in the equity of Citigroup, Merrill, Lehman and others, well before their balance sheets had the transparency and simplicity necessary for making an investment with a Graham & Dodd "margin of safety." Who knows what cheap really is in the absence of objective, verifiable data? This is the basis on which many purportedly "smart" investors have been deploying capital, much to curiousity of people like me. Sure, they say "We take a long-term view." Well, I'd rather take a long-term view by establishing a basis 50% lower than those at which they invested. But that's water under the bridge at this point.


...Lehman, according to one person close to the deal, is expected to provide at least some financing. Lehman was sitting on $40 billion in commercial real estate at the end of the last fiscal quarter and another $24.9 billion in residential assets.

If Lehman goes with this plan, it will differ from the one Merrill Lynch & Co. opted for in August when it sold more than $30 billion in toxic mortgage-related assets at just 22 cents a dollar. That deal was done with just one buyer: private-equity firm Lone Star Funds but Merrill provided financing.

The WSJ piece does a god job highlighting the differences between the Lehman plan and the Merrill deal, one for which I had much less enthusiasm than I do the Lehman structure. The degree to which Merrill retains recourse due to the seller financing it provided to the single buyer, Lone Star Funds, together with the uncertainty around how much of its distressed real estate assets were actually represented by the assets "sold" makes its strategy akin to putting a band-aid on a deep wound. Is the Merrill transaction a "true sale," either in substance or in form? They are definitely walking a fine line, but analysts must sharply discount how much risk has truly been transferred when arriving at the true economic effect of the transaction. The Lehman deal seemingly has far less ambiguity. Theirs might become the true bellwether of how banks should deal with troubled asset portfolios. If Lehman is able to sell a meaningful percentage of its asset management business, and is successfully able to raise capital in order to jettison its $60 billion+ real estate portfolio, it will be well on its way to surviving what many felt has been a losing battle. Say what you may about Dick Fuld and his aggressive expansion into some dicey asset classes late in the game, but his toughness and focus in dealing with Lehman's problems lays in stark contrast to the denial and delay of Bear Stearn's management in handling their brush (and eventual capitulation) with death.

Lehman may just make it, and if they do it will be because of a smart, aggressive approach to risk reduction, the centerpiece of which is the Good Bank/Bad Bank asset transfer. I would posit that their approach to balance sheet repair (read: survival) will be replicated many times by many firms over the next 24 months, unlike the finger-in-the-dike strategy favored by their friends over at Merrill Lynch. It is hard to do the right thing, to take drastic measures in the face of crisis. But sometimes, it is the only path to survival.

[Demeter]

52. Lehman in "Urgent" Talks to Close Deal Before Expected $4 Billion Writedown

http://www.nakedcapitalism.com/2008/08/lehman-in-urgent-talks-to-close-deal.html

TODAY'S UPDATE!

When the Korea Development Bank had signaled that buying a stake in an investment bank might be premature at this juncture, it had appeared the bureaucrats had beaten back KDB's chairman and former head of Lehman's Seoul branch, Min-Euoo-song, who was pushing the deal. But the Telegraph tells us not only that negotiations are back on, but that Lehman appears desperate to cinch a deal before its earnings are announced in roughly two weeks.

And no wonder. The Telegraph indicates the earnings release will include $4 billion of writedowns. Note that this is consistent with, even lower than some of the estimates out on the Street now. For instance, Merrill's Guy Moszkowski forecasts that Lehman will lose $2.6 billion in its third quarter, showing $4.5 billion in losses, with a 35% reduction due to gains on hedges.

So if these numbers are already reflected in the stock price, why the scramble to get a deal done? Is this simply adherence to the recent practice of having capital-raisings in hand that are equal to or in excess of the hit to capital? Is it that, as with the second quarter, the losses that will be announced are vastly worse than expected? Or is it that the details in the financials will suggest that further deterioration is likely?

From the Telegraph:

The Sunday Telegraph has learned that Lehman has intensified talks in recent days with Korea Development Bank, the South Korean government-backed lender, about a capital injection of as much as $6bn (£3.3bn). KDB has drafted in bankers from the heavyweight advisory boutique Perella Weinberg to provide counsel on the talks, which could be concluded this week.

The acceleration of the negotiations, which Lehman wants to have wrapped up before it reports third-quarter earnings in mid-September, underlines the urgency with which one of the US banking industry's most venerable names is seeking capital.

If the talks with the Koreans fall through, Lehman is lining up alternative investment from other sources, including Citic Securities, a Chinese brokerage which was on the verge of investing in Bear Stearns before its implosion earlier this year, which resulted in a cut-price takeover by JP Morgan, another Wall Street banking group.

Lehman is also holding talks with a number of sovereign funds from the Middle East, which have been invited to participate in a capital-raising. These are understood to include investors from Abu Dhabi and Qatar.

Under the structures being discussed by Lehman executives, including Richard Fuld, the bank's chairman and chief executive, KDB could buy up to 25 per cent of Lehman, which has a market value of just $11.2bn following a slump in its share price this year.

Alternatively, if it proceeds with a deal with Citic or the Gulf investors, Lehman is likely to sell no more than 10 per cent of itself to each of those funds, but could combine it with a broader equity-raising in the open market. Fuld, who is determined to avoid a sale of the bank's prized assets at distressed prices, is understood to have assigned several of his key executives to look at different fundraising scenarios.

Other options open to the Lehman board, whose members include Sir Christopher Gent, the former chief executive of Vodafone and current chairman of GlaxoSmithKline, include the sale of part or all of its asset management arm.Lehman's so-called "crown jewel", it includes Neuberger Berman, a highly rated fund management business. Analysts have valued the division at up to $10bn.

"The preferred option is not to sell any of it unless they cannot raise enough from external investors," said a person involved in the talks. Dozens of parties, including JC Flowers and Kohlberg Kravis Roberts, have expressed an interest in the business.

Fuld is also keeping Lehman's board appraised of plans to spin off the bank's troubled $40bn commercial real estate portfolio, which may result in the creation of a separately quoted company in which Lehman Brothers shareholders would be given equity. The demerger of the real estate assets would leave the investment bank with a cleaner risk profile and remove one of the main drags on its share price...

At its earnings announcement next month, Lehman is expected to disclose further writedowns of about $4bn, to add to the $8bn in writedowns and losses already declared.

[Demeter]

53. Bank of England to show no mercy as firms go under By John Lawless and Simon Evans

http://www.independent.co.uk/news/business/news/bank-of-england-to-show-no-mercy-as-firms-go-under-913615.html

Base rate is set to remain at 5 per cent this week, while official figures reveal corporate failures could reach a staggering 17,000 this year...The Bank of England is expected to ignore pleas for a cut in rates this week, despite warnings that the number of companies set to go under in Britain this year could reach 17,000.


The cost of borrowing should remain at 5 per cent even though figures – collated from official statistics for the first six months of 2008 – show that failures among companies could rise by a staggering third over last year's total of 12,507.

There's worse to come, insolvency experts warn. Figures for the 1990s show that company failures do not seriously escalate until the second and third year of a recession. Britain has yet to officially lurch into recession, defined as two quarters of negative economic growth.

Ian Jones, a partner in the Manchester-based insolvency practice JLD, said: "The number of failing businesses we have been asked to deal with has tripled from July last year to this. Few business owners throw in the towel straight away but companies reach a point where they simply can't carry on. Our recent three-fold increase could easily go to four- or five-fold."

InsolvencyInfo, which analyses administrations and receiverships, said that insolvent liquidations would hit 17,000 this year, should the trend of the first six months continue.

Insolvency practitioners have privately accused some of Britain's biggest firms of using strong-arm tactics on their smaller suppliers and ditching long-term suppliers to gain the slenderest increase in their own profit margins.

Receiverships in the UK soared from 77 in the second quarter of 2007 to 177 in the same three months this year. But total failures are masked by the numerous companies opting for administration: the figure stands at 938 in the quarter to end June, up 62 per cent over the same three months a year ago.

Despite the growing list of business failures, economists warn that the Bank will keep rates on hold when it meets later this week. Michael Taylor, senior economist at Lombard Street Research, said: "I don't think there should be a cut in rates in the near term. Inflation is heading towards 5 per cent, far ahead of target and rising. Ultimately, the Bank of England's job is to control inflation."

Graeme Leach, chief economist at the Institute of Directors, said: "The most they could possibly do is make a quarter-point cut and that is not going to make any difference to growth."

[Demeter]

56. QUESTION FOR THE READERS!

Shall we continue this thread on Labor Day, or start a new one?

[Dr.Phool]

57. I'd keep it going, but, either way is fine with me.

I've been in and out all day, taking my time reading the articles and posts.

[Demeter]

58. So Noted!

I just wasn't sure if anybody was still interested. I'm in and out all weekend myself.

My inbox is down to 30, finally. I've been trying to catch up on economic-political newsletters since the computer died May 5th!

[Dr.Phool]

62. That's a lot of catching up to do.

My wife's been sick all week-end, and whenever she dozes off, I check the Weather Channel and the computer.

[Demeter]

64. My Best Wishes for Her Speedy Recovery!

[DemReadingDU]

68. Keep it going! I'm wondering if Paulson

Does anyone think Paulson is using his bazooka during this long holiday weekend where lots of people are tuned to hurricane Gustav to sneak in and bail out Fannie and Freddie?

[Demeter]

71. I Think He's Buying Back the Fannie and Freddie Bonds from China

I can't imagine who else the Chinese might be selling to.

[Dr.Phool]

72. Bingo!

[Ghost Dog]

80. China Goes The Big Squeeze; Fix Freddie And Fannie … Or Else

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=389x3893564

[Hugin]

69. The Labor Day Weekend was made for Weekend Economists.

It's about the only time we get to think about this in any depth. :D

[Demeter]

59. This Week's Bank Failure Surprisingly Costly (Integrity? The Plot Sickens!)

http://www.nakedcapitalism.com/2008/08/this-weeks-bank-failure-surprisingly.html


Some of the usual suspects have dutifully noted the closure of $1.1 billion in assets Integrity Bank of Alpharetta, Georgia (weirdly, the links at the Wall Street Journal to two stories lead only to "Page Not Available").

The plot is already familiar: the Friday night, FDIC prepack, in this case, with Birmingham, Alabama-based Regions bank assuming all $974 million of deposits and $34 million of assets. The New York Times reported that the bank focused on real estate lending and had a "faith based culture". The results suggest that they might have relied overmuch on divine intervention at the expense of due diligence.

Now let's get to the juicy bit. As Bloomberg noted:

Banks are being closed at the fastest pace in 14 years as financial companies report more than $505 billion in writedowns and credit losses since 2007.....

Regions will buy about $34.4 million in assets and will pay the FDIC a premium of 1.01 percent to assume the failed bank's deposits, the FDIC said. The FDIC estimates the cost of the Integrity failure to its deposit-insurance fund will be $250 million to $300 million.

$250 to $300 million of losses for a mere $1.1 billion in assets bank? As reader Steve A noted:

Today's failure of the amusingly named Integrity Bank of Alpharetta, GA, confirms two very ugly trends: once again, FDIC was only able to pass cash and cash-equivalents to the assuming bank, and the FDIC's loss estimate is extremely high ($250M - $350M on $1.1B of assets). I don't have hard numbers handy but I seem to recall that receivership losses in the range of 25% - 35% were unusual in the commercial bank failures of the late 80's. I could be wrong, but the numbers this year are extremely high. FDIC's expected losses certainly make me wonder what on earth the bank examiners were doing for the last year besides critiquing the bank's coffee and color scheme.

Now given that the bank was only eight years old and may have have used its religious positioning to hide some less-than-upstanding practices, the magnitude of the bust may reflect fraud, and well executed fraud harder to detect than good old fashioned recklessness or shoddy controls.

I'd love to learn more about what went awry here, but his story will probably slip beneath the radar as failures continue apace.

[Dr.Phool]

60. Slim Pickings- US Vulture Funds head for Europe.

SLIM PICKINGS
US Vulture Funds Head to Europe

By Emily Thornton

As the Continent's economy slows, American distressed-debt and workout funds go on a hunt for wounded businesses.


An aerial view of the "City," London's business disctrict. American vulture investors are turning their attention toward Europe.
American vulture investors are swooping down on Europe. Attracted by the scent of rotting valuations, such high-profile players as Wilbur L. Ross Jr. in New York and Lone Star Funds in Dallas are starting to do deals across the Continent. On Aug. 18, Ross spent $70 million to acquire an 86 percent stake in struggling British auto supplier Wagon. Days later, Lone Star took over IKB Deutsche Industriebank, a troubled German bank, for $150 million. And such heavyweights as Oaktree Capital Management and Avenue Capital Group are raising billions to invest in European assets in coming months.

As an arena for distressed-debt investing, in fact, Europe is rising to the top of the list. Having largely ignored the region until recently, investors are raising $7 billion worldwide this year to buy distressed European debt, estimates London research firm Preqin (Private Equity Intelligence). Of that, U.S. players are raising $5 billion.



Several factors are making the region more attractive to U.S. investors. Europe's slowing economy and bursting real estate bubbles in Britain and Spain are raising the specter of a deep debt crisis. About 65 percent of corporate credit rating actions in Europe through July were downgrades, the highest ratio since 2003, according to Standard & Poor's (like BusinessWeek, a unit of The McGraw-Hill Companies). Moreover, European companies that have gone private generally have received loans with less favorable terms than those in the U.S. Another draw: a surprising lack of competition from Europeans. "There's a less developed distressed-debt market in Europe, with very few distressed-fund players," says Oaktree Chairman Howard Marks.

Bargains Galore

Already, some junk-rated bonds are starting to trade at deep discounts. Europe's market for junk bonds and so-called leveraged loans (to companies with high debt) has almost quadrupled since 2003, to a total of $616 billion issued last year, according to researcher Dealogic. Bonds of such companies as Greek dairy producer Fage and Germany's IKB are trading at 55¢ and 10¢, respectively, on the dollar. Weakened European banks -- like UBS and the Royal Bank of Scotland Group, which were exposed to the U.S. mortgage meltdown -- may be forced to shed billions of dollars more in assets if a slowdown spreads through Europe. "Banks and investment banks are having to sell things they wouldn't have sold in previous cycles," says Julian Nichols, head of European distressed products at Deutsche Bank.

(snip)
http://www.spiegel.de/international/business/0,1518,575142,00.html

Good ole Wilbur Ross.
Bought Eastern Airlines after Frank Lorenzo destroyed it, and had all of it's assets, right down to the ticket counters sold within a week.

Bought LTV Steel (my former parent company) after the moran management looted it, fucked all the creditors, and sold it for a huge profit.

Bought several distressed coal mines in Pennsylvania and West Virginia, and killed a lot of coal miners before he took home his killing.

Sweet guy.

[Demeter]

65. How To Win Friends and Influence People--The Ugly American Way

sigh

[Demeter]

61. UK home sales boosted by desperate vendors

http://www.nakedcapitalism.com/2008/08/uk-home-sales-boosted-by-desperate.html

Today's Financial Times describes a new sign of how bad things are in the real estate market in London. People are so desperate to keep their deals alive that they are buying houses they do not want (yes, that sounds completely barmy, but the piece explains how it works). The net effect is that not only are sellers having difficulty exiting the real estate market even with a nominally successful sale, but as the example shows, some are increasing their exposure.

From the Financial Times:

The London property market, once one of the most buoyant in the world, is now so stagnant that desperate vendors are spending hundreds of thousands of pounds buying houses they don’t want in order to sell their homes.

The extreme measure arises from the growth of the so-called property chains that often frustrate home sales in the UK, where houses are normally sold by one party to another, rather than by auction.

The chains occur when a line of buyers and sellers all rely on each other’s transaction to go through. If one deal falls through, because someone pulls out or cannot get a mortgage, for instance, the rest are delayed or fail.

In the increasingly difficult London market, where estate agents say prices have been falling or weak for most of the year, there are fewer cash buyers so vendors are facing longer chains that break down more often as buyers fail to obtain mortgages or try to negotiate discounts.

Rather than waiting for chains to clear, agents say vendors have begun to buy the properties of people further down the chain to clear the way for their own home to be sold.

One homeowner engaged in such a process told the Financial Times she had only been able to sell her house for £450,000 – in order to upgrade to a £700,000 home – by buying an apartment at the bottom of her chain for £200,000...

Hamptons International, one of London’s biggest agents, says it has a number of clients who have sold properties worth between £2m and £3m after buying homes in the region of £300,000 further down the chain. These properties are then being rented out or given to children.

[Demeter]

63. Big Misconceptions about Small Business and Taxes

http://economistsview.typepad.com/economistsview/2008/08/big-misconcepti.html


Would allowing the Bush tax cuts to expire harm small businesses?:

Big Misconceptions about Small Business and Taxes, by Chye-Ching Huang and James R. Horney, CBPP: Supporters of various tax benefits for high-income households often claim that failure to maintain them would have an undue effect on many small businesses. ...

This paper analyzes these claims. It likely overestimates the number of small businesses adversely affected by changes to the top two marginal tax rates, the estate tax, and loopholes available to hedge-fund managers because it: (1) adopts an extremely generous definition of “small business” ... and (2) does not consider many valuable tax breaks that small businesses and small-business owners enjoy... Yet it still finds that the claims typically made about small businesses and taxes are highly exaggerated, misleading, or false.


THE SMALL BUSINESSES, THE STARTUPS, ARE ALL GONE ALREADY. NOW THE RETAILERS: CLOTHES, FURNITURE, AND BANKS ARE GOING. AND DON'T FORGET THE BIG 3!

[Demeter]

66. "The swelling tide of toxic home loans is proving to be even more worrisome than initially feared"

http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=08&year=2008&base_name=the_swelling_tide_of_toxic_hom


It would be nice if some of the people who get paid big dollars because they supposedly have high skills could acknowledge that they messed up. It would also be nice if the national media did not consider it part of their job to cover up for powerful people who messed up on their job.

Yes, that headline is a a direct quote. It also is the sort of statement that has no place in a serious news article. The swelling tide of toxic loans is not proving to be more worrisome than feared. The problem is that the people who were supposed to be regulating the financial system did not know what they were doling.

The people who did understand the economy knew that an unprecedented run-up in house prices, with no remotely plausible explanation based on fundamentals, with no corresponding increase in rents, was a bubble. We also knew that bubbles burst. And, we knew that when bubbles in a highly leveraged asset like housing burst, that lots of debts go bad and that banks then take really big hits.

The NYT should be exposing the incompetence of people who were paid big dollars to know the housing and financial markets (this includes both bankers at place like Citigroup, Merill Lynch, Bear Stearns, Fannie Mae and Freddie Mac, as well as the top regulators) and completely failed in their responsibilities.

It should not try to tell readers that the housing crash was somehow an unforeseeable event that came out of the blue. It was an entirely predictable event and it was only incompetence that prevented these people from seeing it. Unfortunately, unlike dishwashers and custodians, bank executives and regulators are not held accountable for their performance. Instead, the media covers it up for them.

--Dean Baker

VITRIOL--IT GOES WITH EVERYTHING!

[Demeter]

67. Fannie, Freddie Mortgage Profit Rises With Debt Costs (Update2) By Jody Shenn

http://www.bloomberg.com/apps/news?pid=20601087&sid=a17G1.vWMkuU&refer=home



Aug. 27 (Bloomberg) -- The crisis of confidence that sent Fannie Mae and Freddie Mac debt costs to record highs above U.S. Treasuries is also providing the mortgage-finance companies with the biggest profits on new investments since at least 1998.

The current-coupon mortgage bonds Fannie and Freddie buy yield about 40 basis points, or 0.40 percentage point, more than what they pay to borrow by selling benchmark bonds, according to Citigroup Inc. The difference exceeded 20 basis points only twice in the 10 years through 2007 -- in 1998 and 2003.

The gap enables the government-chartered companies to offset some of the credit losses on mortgages they own or guarantee and eases pressure on U.S. Treasury Secretary Henry Paulson to step in with a bailout. The companies, which profit from their $1.6 trillion of mortgage investments, have tumbled more than 85 percent this year in New York Stock Exchange trading as mortgage delinquencies grow and the cost of debt rises.

``From Fannie and Freddie's perspective, there's actually better investments now,'' said Moshe Orenbuch, an analyst at Credit Suisse Group in New York, adding that their interest margin is likely to continue to widen. ``It's ironic.''



Interest Income

Washington-based Fannie said last month net interest income rose to $2.1 billion in the second quarter, from $1.7 billion in the first quarter. The company's profit on its investments expanded to 100 basis points from 82 basis points, according to Credit Suisse.

Freddie's net interest income jumped 92 percent to $1.5 billion. The annualized profit per dollar of investments rose to 80 basis points from 48 basis points.

``They, at the increment, are very, very profitable,'' said Dan Fuss, vice chairman of Loomis Sayles & Co. in Boston and co- manager of the $17 billion Loomis Sayles Bond Fund. ``If they can continue to do anything close to business as usual, they are immensely profitable.''

``Our funding costs remain attractive, particularly based on the opportunities to purchase mortgage assets at attractive spreads,'' Freddie spokesman Michael Cosgrove said. A Fannie spokesman, Jason Lobo, declined to comment.

Fannie and Freddie shares fell this year and their borrowing costs rose amid concern they don't have enough capital to weather the biggest housing downturn since the Great Depression. The companies had $14.9 billion of losses in the past four quarters as late payments on mortgages rose to the highest on record.

Most in 10 Years

Freddie on Aug. 19 sold $3 billion of five-year reference notes to yield 113 basis points more than similar-maturity Treasuries, the most in at least 10 years. Fannie sold $3.5 billion of three-year notes at a record spread of 122.5 basis points on Aug. 13.

The crisis of confidence prompted Paulson to draw up a rescue plan last month giving him authority to inject unlimited amounts of capital into the companies.


Depleting Capital

While the difference between Fannie and Freddie's cost to borrow and the returns they get on new investments has widened, losses are depleting capital and causing the companies to rein in their purchases of securities.

Both said they plan to limit growth to preserve capital, after boosting holdings by $115 billion in the first seven months of this year. Their reluctance to purchase is contributing to higher yields on mortgage assets. If they were expected to buy more, ``yields on mortgage-backed securities would decline, reducing their spread opportunity,'' said Rick Redmond, a portfolio manager in New York at Caspian Capital Management LLC, which oversees $5.8 billion.

Fewer purchases by Fannie and Freddie means the companies' debt costs are having little influence on mortgage bond prices and home-loan rates, according to some analysts. Yields in the $4.5 trillion market for agency mortgage bonds, those issued by Fannie, Freddie and Ginnie Mae, guide rates on new home loans.

`Make a Difference'

``It would make a difference if they were increasing their portfolios,'' said UBS AG mortgage analyst Laurie Goodman in New York, whose team was ranked No. 1 in a 2007 poll by Institutional Investor magazine for ``pass-through'' agency mortgage bonds.

Fannie and Freddie's holdings are shrinking at a monthly rate of about $20 billion because of refinancings, home sales and borrower defaults, according to an Aug. 21 report from New York- based Citigroup analysts Scott Peng, Brad Henis, and Brett Rose. That money can be reinvested into higher yielding securities.

That is one reason ``there is no pressing need'' for a bailout, they wrote in the report, titled ``All That Sound and Fury, Signifying Nothing New.''

The companies are also boosting fees to guarantee home-loan securities, off-balance-sheet obligations for which they don't need to borrow. Fannie plans on Oct. 1 it will double to 50 basis points an upfront ``adverse market delivery charge,'' introduced this year for every mortgage the company buys or guarantees.

To contact the reporter on this story: Jody Shenn in New York at [e-mail].

[mykolas]

70. Times of London Covers Palin's Questionable Fifth Child

http://www.timesonline.co.uk/tol/news/world/us_and_americas/us_elections/article4647965.ece

[Dr.Phool]

73. If it's name isn't Fannie or Freddie, nobody here cares.

[Dr.Phool]

74. Kick for Monday morning.

Have some coffee folks.

Time to take the Fudd to the park.

[Ghost Dog]

76. Posted this morning's Global Markets reports here:

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=102x3463999

[Pale Blue Dot]

81. FACTBOX: Deepest job cuts at major financial firms

(Reuters) - Commerzbank plans to cut almost 2 billion euros ($3 billion) in costs by slashing 9,000 jobs and shrinking investment bank Dresdner Kleinwort after buying Dresdner Bank, but investors appeared unconvinced by the deal.

Following is a summary of some of the deepest job losses at major banks:

* BANK OF AMERICA CORP

The second-largest U.S. bank by assets expects to eliminate about 7,500 jobs over the next two years after it completes its acquisition of Countrywide Financial Corp , the largest U.S. mortgage lender.

Separately, Bank of America is cutting about 3,000 jobs, mainly in corporate and investment banking.

* CITIGROUP INC

The U.S. bank said in May it could cut almost a quarter of jobs in its British consumer business, or about 750 positions, as it focuses on its Citi and Egg brands.

The reduction is in addition to the 13,200 job cuts Citigroup has announced this year to date.

http://www.reuters.com/article/rbssFinancialServicesAndRealEstateNews/idUSL139548920080901

The article also covers Credit Suisse, Deutche Bank, Goldman Sachs, HSCB, JP Morgan, Lehmann Bros, Merrill Lynch, Morgan Stanley, National City, UBS, Unicredit, and Wachovia. Bottom line? Almost 100,000 jobs lost at the major financial firms since the beginning of the year.