British economy in bad shape, at “60-year low”

The UK is facing the worst economic conditions for 60 years and the current crisis will be "more profound and long-lasting" than expected, British finance minister Alistair Darling warned Saturday.

Darling's comments are the Government's grimmest assessment yet of the situation, and come after a Bank of England policymaker warned that unemployment could hit two million by Christmas, the UK's Press Association reported.

Darling said that the economic conditions faced by the UK and the rest of the world "are arguably the worst they've been in 60 years," adding: "I think it's going to be more profound and long-lasting than people thought."

[CNN]

Foreign spigot being turned off to the U.S.

Fannie and Freddie have always borrowed at preferential rates. Mortgages are borrowed and bundled, which transformed mortgages into investments for banks, corporations and governments all over the world.

International investment is the foundation on which our home ownership was built. Well over US $1 trillion of our mortgages have been sold to foreign investors this way in the recent past. Over the past few years America has been borrowing over 50% of the world's internationally available savings.

Today we learn that the Bank of China has cut its portfolio of securities issued or guaranteed by troubled US mortgage financiers Fannie Mae and Freddie Mac by a quarter since the end of June. The sale by China’s fourth largest commercial bank is a sign of nervousness among foreign buyers of Fannie and Freddie’s bonds and guaranteed securities. Asian investors in particular have become net sellers of agency debt, said analysts.

This weekend, the Group of Twenty developed and advanced developing countries will be holding a preparatory meeting in Brazil. Although the crisis at Fannie Mae and Freddie Mac is not on the agenda, there is speculation that Treasury officials could informally encourage big holders of agency debt and mortgage-backed securities not to scale back their investments.

Treasury may have to bail out FDIC

The Federal Deposit Insurance Corp (FDIC) might have to borrow money from the Treasury Department to see it through an expected wave of bank failures. The borrowing could be needed to cover reimbursing depositors immediately after the failure of a bank.

"I would not rule out the possibility that at some point we may need to tap into (short-term) lines of credit with the Treasury for working capital, not to cover our losses," Chairman Sheila Bair said in an interview with the Wall Street Journal.

In a bid to replenish the $45.2 billion fund, Bair had said that the FDIC will consider a plan in October to raise the premium rates banks pay into the fund, a move that will further squeeze the industry.

The last time the FDIC borrowed funds from the Treasury was at nearly the tail end of the savings-and-loan crisis in the early 1990s after thousands of banks were shuttered.

The fact that the agency is considering the option again, after the collapse of just nine banks this year, illustrates the concern among Washington regulators about the weakness of the U.S. banking system in the wake of the credit crisis.

[Reuters]

Freddie and Fannie Failure World Catastrophe, Yu Says

U.S. mortgage finance companies Fannie Mae’s shares closed on Friday at $5, down from almost $70 a year ago. Freddie Mac fell to $2.61, which is down from about $65.

A failure of Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank. “If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said. “If it is not the end of the world, it is the end of the current international financial system.''

“The seriousness of such failures could be beyond the stretch of people's imagination,'' said Yu, a professor at the Institute of World Economics & Politics at the Chinese Academy of Social Sciences in Beijing.

China's $376 billion of long-term U.S. agency debt is mostly in Fannie and Freddie assets. The Chinese government probably holds the bulk of that amount.

[Bloomberg.com]

A Tectonic Shift in the Global Economy

As of today, there should be no remaining doubts as to the tectonic shift in the global economy -- the world's largest and most profitable bank is Chinese.

While banks in North America and Europe are still counting massive credit crunch losses, Industrial and Commercial Bank of China (ICBC) has surged ahead of its international competitors thanks to a booming domestic economy that has dramatically boosted profits. ICBC’s half yearly earnings jumped an astonishing 57% to US$9.4-billion, up from US$5.9-billion last year. Lending, investment banking and wealth management all saw significant increases as the Chinese economy continued to outpace much of the rest of the world.

The results catapult ICBC ahead of international global powerhouse HSBC PLC -- the most profitable bank in the world last year -- where earnings fell 29% in the first six months of 2008.

The rise of ICBC is matched by China's other leading banks. (Among them China Citic Bank Corp, China Merchants Bank, and China Construction Bank)

The fortunes of the Chinese banking industry, which has been relatively insulated from the global credit crunch, contrasts sharply with slashed profits at banks on Wall Street and [Canada’s] Bay Street and across Europe.

"China may still grow significantly faster than developed economies for at least another one or two decades," said JP Morgan's Hong Kong-based bank analyst Samuel Chen in a recent report.

[Excerpt of an article by Duncan Mavin, The Financial Post]

Large U.S. Bank Collapse Seen Ahead

The worst of the global financial crisis is yet to come and a large U.S. bank will fail in the next few months as the world's biggest economy hits further troubles, former IMF chief economist Kenneth Rogoff said on Tuesday.

"The U.S. is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say 'the worst is to come'," he told a financial conference.

"We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks," said Rogoff, who is an economics professor at Harvard University and was the International Monetary Fund's chief economist from 2001 to 2004.

"Probably Fannie Mae and Freddie Mac -- despite what U.S. Treasury Secretary Hank Paulson said -- these giant mortgage guarantee agencies are not going to exist in their present form in a few years."

[Reuters]

The perfect storm leading to a global recession

Recent developments suggest that all G7 economies are already in recession or close to tipping into one.

When they reach it, there will be a sharp slowdown in Brazil, Russia, India, and China and other emerging markets.

Elsewhere, Japan is contracting, too.

This G7 recession will lead to a sharp growth slowdown in emerging markets and likely tip the overall global economy into a recession

[Excerpt of an article by Nouriel Roubini, Professor of Economics at the Stern School of Business, New York University]

European economies crumbling

The economies of Germany, France and Italy all contracted in the first quarter and may now be in full recession, shattering assumptions that Europe would prove able to shrug off the effects of the credit crunch.

The picture is darkening so fast in Spain that Prime Minister Jose Luis Zapatero cancelled holidays and called his cabinet back to Madrid for the first emergency session of its kind since the Franco dictatorship.

Growth has turned negative in Ireland, Denmark, Latvia, and Estonia, while grinding to a halt in Sweden and The Netherlands.

The oil shock over the early summer appears to have had a dramatic effect on the heavy industries of Japan and Germany.

Spain’s finance minister Pedro Solbes says “The economic situation is worse than we all predicted.”

[The Telegraph]

If OPEC Dumps the U.S. Dollar

Iranian President Mahmoud Ahmadinejad dropped a bombshell. He stated on the record at a rare gathering of the heads of the Organization of Petroleum Exporting Countries [OPEC] that member nations have expressed a real interest in converting their cash reserves from the beleaguered U.S. greenback to the European euro. More specifically, Ahmadinejad referred to the U.S. dollar as "a worthless piece of paper."

What makes their posturing so troublesome, however, is that for the first time there was no rebuttal, or reassuring commentary from Saudi Arabia and other key U.S. petrodollar supporters, in response.

Instead, OPEC members formed a working group to study the dollar’s effect on oil prices and to "investigate the possibility of a currency basket" as a means of offsetting declining dollar-based reserves.

Many OPEC countries presently peg their own currencies to the dollar. Should that change, this could result in dramatically higher oil prices as the bigger players squeeze the smaller producers out and the dollar falls even further in response. How high will crude oil soar? $197 a barrel is possible.

[Seeking Alpha]

Top Budget Committee Republican: U.S. Headed Toward Bankruptcy

The ranking Republican on the House Budget Committee, Rep. Paul Ryan (R-Wis.), said the U.S. government is headed toward bankruptcy if it stays on its current fiscal course.

To back up this claim, Ryan cited an estimate by the non-partisan Government Accountability Office that says the government faces a $53 Trillion shortfall to cover the costs of promised benefits in its entitlement programs: Medicare, Medicaid and Social Security.

Ryan said that to deal with this situation the government must either reform the entitlement programs or eventually impose massive tax increases on American workers. “By the time my three children – who are three, five and six years old—are my age, the federal government will have to tax 40 cents out of every dollar made in America just to pay the bills for the federal government at that time,” he said.

“What [the Congressional Budget Office] told me was really startling,” said Ryan. “They said that the current low rate, the 10-percent bracket for low-income Americans, would have to go up to 25 percent. The middle-income tax rate for middle-income Americans would have to go up to 66 percent, and the top rate, which is what small businesses pay, would have to go to 88 percent.

“And if you did that, all experts conclude, you would literally crash the American economy.”

[CNSnews]

Britain's second largest bank posts largest six-month loss in British banking history

Britain's second largest bank, Royal Bank of Scotland, reported the largest six-month loss in British banking history. (802 million pounds or $1.5 billion after taxes.)

The Edinburgh-based bank was forced into the red largely by 5.9 billion pounds ($11.4 billion) worth of write-downs arising from its exposure to the international credit crisis.

[AP]

A second, far larger wave of U.S. mortgage defaults is building

The first wave of Americans to default on their home mortgages appears to be cresting, but a second, far larger one is building with alarming speed. With the U.S. economy struggling, homeowners with better credit are now falling behind on their payments in growing numbers. The problems in the broader market may not peak for another year or two, analysts said.

"Subprime was the tip of the iceberg," said Thomas Atteberry, president of First Pacific Advisors, a investment firm in Los Angeles that trades mortgage securities. "Prime will be far bigger in its impact."

Delinquencies in prime and alt-A loans are particularly challenging for banks because they hold more such loans on their books than they do subprime mortgages.

[International Herald Tribune]

U.S. job losses at hit four-year high

The nation's employers continue to put jobs on the chopping block at a steep rate as the economy struggles, according to latest reports.

The unemployment rate in the US has climbed to a four-year high of 5.7 per cent in July after employers shed 51,000 jobs.

So far, the US economy has lost a total of 463,000 jobs this year.

An outplacement consultancy firm says that planned job cuts announced by employers in July jumped 26% from the figure announced in June. That's up 141% from a year ago.

This news comes as car-manufacturing company General Motors posted losses of $15.5 Billion, filing a report showing its third-worst quarterly loss in its history in the second quarter.

Additionally, Federal regulators closed Florida's First Priority Bank, marking the eighth bank failure of the year.

Vicious Economic Cycle

Wall Street's titans face huge losses ahead, and informed insiders assume a far larger federal bailout will be needed--after the election. No one wants to upset voters by talking about it now.

The bailouts are rewarding the very people and institutions whose reckless behavior caused this financial mess. Yet government demands nothing from them in return--like new rules for prudent behavior and explicit obligations to serve the national interest.

The largest banks and brokerages have already lost enormously, but lending portfolios must shrink a lot more--at least $1 trillion, some estimate.

The gravest danger is that the national economy will weaken further and spiral downward into a negative cycle that feeds on itself: consumers stop buying, banks stop lending, producing companies cut their workforces. That feeds more defaulted loan losses back into the banking system's balance sheets. This vicious cycle is essentially what led to the Great Depression after the stock market crash of 1929.

[Excerpt of an article by William Greider, The Nation]

IMF predicts no end in sight to credit crisis

The International Monetary Fund (IMF) says there's no end in sight to the credit crisis gripping world financial markets.

The IMF has a particularly gloomy assessment of the US economy, and it came on the same day as the Bush administration revealed America's budget deficit will climb to a record high of more than half-a-Trillion dollars.

[Australian Broadcasting Corporation]

The Dodgy Asset behind the U.S. Dollar

Last Friday, after the market had closed, the FDIC shut down two more banks, First Heritage Bank and First National Bank. (The FDIC now operates like a stealth paramilitary unit, deploying its shock troops on the weekends.)

The new Fannie Mae and Freddie Mac bailout package that was passed into law on Saturday provides Paulson with $300 billion of taxpayer dollars to shore up the faltering mortgage behemoths.

In order to accomplish this, Congress increased the national debt by a whopping $800 billion sending it over the $10 trillion mark for the first time in history! (Naturally, Congress buried this little tidbit of information deep in the 600 pages of legislation.)

The Fed has already spent more than $300 billion to prop up the teetering banking system in the last year alone, plus buying the toxic bonds from Bear Stearns in the JP Morgan acquisition.

Now, the Treasury has been authorized by Congress to buy an "unlimited amount" of Fannie and Freddie shares at their own discretion. They are presently exchanging Fannie and Freddie securities for US Treasury's, which means that the dollar is now backed by dodgy mortgage-backed sludge (MBS) for which there is no market. According to Rep Ron Paul, "This is the asset (MBS) which now backs up our currency. An asset that no one else wants. If they were to dump these securities on the market today, the value of these stocks would go straight to 0. But that is literally the asset that is behind our currency. It is a very serious situation."

[Excerpts of an article by Mike Whitney]

Ross Perot: “We are running out of time”

Ross Perot is jumping back into the political fray, this time with a stern warning that the country better start paying attention to the national debt.

"Not since the Great Depression have we seen an economic crisis of the magnitude that we are facing today," he says.

The former presidential candidate has reemerged with a Web site spotlighting the soaring budget deficit: more than $9.3 trillion and growing.

He says the purpose of the site, which is not affiliated with any political party, is "to provide accurate information to every citizen about the serious economic problems facing our country."

[CNN]

Note: Mr. Perot points out that 9.3 trillion dollar bills placed end-to-end would reach the moon and back 1,900 times.

So How Bad is the Damage?

The demise of Indymac is expected to cost the FDIC around $8 billion of its meager $53 billion of reserves.

Four or five bank failures of equal size and the FDIC will be underwater, which is a serious problem since even conservative estimates expect bank failures to run into the hundreds.

But Indymac is small potatoes compared to the liabilities of the two mortgage behemoths, Fannie Mae and Freddie Mac. As the housing bubble continues to fizzle; Fannie and Freddie could face losses of $500 billion or more.

Investors are not charitable organizations

The United States has been financing itself by leaning heavily on foreigners, particularly China, Japan and the oil-rich nations of the Persian Gulf.

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

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

The U.S. government offers its rescue of the Fannie Mae and Freddie Mac mortgage companies, and foreigners keep stocking the government's coffers. But all the while, the debt mounts along with the costs of an ultimate day of reckoning. Debate grows about the wisdom of leaning on foreign credit, and about how much longer Americans will retain the privilege of spending and investing money that isn't really theirs.

[Excerpt of an article by Peter S. Goodman, NY Times]

The unsettling void of the U.S. economy

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

"I was a relative optimist, but I've certainly become more pessimistic," said Alan S. Blinder, an economist at Princeton, and a former vice chairman of the board of governors at the Federal Reserve. "The financial system looks substantially worse now than it did a month ago."

Mr. Blinder added, this is like the Great Depression. "We haven't seen this kind of travail in the financial markets since the 1930s," he said.

More than two years ago, Nouriel Roubini, an economist at the Stern School of Business at New York University, said that the housing bubble would give way to a financial crisis and a recession. He was widely dismissed as an attention-seeking Chicken Little. Now, Mr. Roubini says the worst is yet to come, because the account-squaring has so far been confined mostly to bad mortgages, leaving other areas remaining--credit cards, auto loans, corporate and municipal debt. “We're not even a third of the way there."

Where will the banks raise the huge sums needed to replenish the capital they have apparently lost? And what will happen if they cannot? The answers to these questions are unknown, an unsettling void that holds much of the economy at a standstill.

[Excerpt of an article by Peter S. Goodman, NY Times]

US faces global funding crisis

Merrill Lynch has warned that the United States could face a foreign "financing crisis" within months as the full consequences of the Fannie Mae and Freddie Mac mortgage debacle spread through the world. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.

Merrill Lynch said foreign governments had added $241 billion of US agency debt over the past year alone. China holds around $400bn, Russia $150bn and Saudi Arabia and other Gulf states at least $200bn.

Brian Bethune, chief financial economist at Global Insight, said the US Treasury had two or three days to put real money behind its rescue plan for Fannie and Freddie or face a dangerous crisis that could spiral out of control.

Fannie and Freddie - the world's two biggest financial institutions - make up almost half the $12 trillion US mortgage industry. But that understates their vital importance at this juncture. They are now serving as lender of last resort to the housing market, providing 80pc of all new home loans.

Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt - as well as other US "government-sponsored enterprises" - is now in foreign hands. The great unknown is whether foreign patience will snap as losses mount and the dollar slides.

[The Telegraph]

US inflation rate at 17-year high

This past month, US inflation accelerated at its fastest pace in 17 years, official figures have shown, driven higher by surging energy prices

In his second day of congressional testimony on Wednesday, Fed boss Ben Bernanke said inflation was too high and it was a key objective for the central bank to bring it down. Many analysts now believe that the central bank may have to leave borrowing costs on hold, or even increase them, as it tries to steer a faltering economy through turbulent times.

Gary Thayer, from Wachovia Securities, says that the Fed is facing a tricky balancing act. "This increases concern that the Fed is not going to be able to lower interest rates if the economy remains weak."

But he added: "And as long as the economy remains weak, it will be hard for the Fed to raise rates to fight inflation."

[BBC News]

Financial Collapse Edging Closer?

The financial crisis in the United States and worldwide entered a new phase this week, as Fannie Mae and Freddie Mac, the two huge US home-loan institutions, began what appears to be a "death spiral" similar to that which claimed Bear Stearns four months ago.

In 1933, about a quarter of US banks failed, [but things were more solid] because US banks in the 1920s had been relatively conservative in their lending, with many banks requiring a 50% down payment for home mortgage loans, for example. The main problem in 1932-33 was quite simply liquidity; the Fed failed to supply adequate reserves to the banking system, so crises of confidence in individual banks led to panic withdrawals of deposits that caused the banks themselves to fail.

This time around, the problem is the opposite.

Fannie and Freddie are probably toast. Federal Reserve Board chairman Ben Bernanke's statement that the two companies can discount paper with the Fed may prolong the inevitable, but also increases its likely huge cost to taxpayers.

A total collapse of the US financial system, while not inevitable, is a contingency which should now be planned for.

[Excerpt of an article by Martin Hutchinson, a retired international merchant banker, writing in the Asia Times]

IndyMac bank second largest bank failure in US history

The Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift Supervision (OTS) “took control of Pasadena-based IndyMac Bank on Friday in what regulators called the second-largest bank failure in U.S. history.” The bank has succumbed to “huge losses from defaulted mortgages made at the height of the housing boom”:

As the bank was shuttering offices and laying off employees nervous … depositors were pulling out $100 million a day. The bank’s stock price had plummeted to less than $1 as analysts predicted the company’s imminent demise.

The takeover of IndyMac came amid rampant speculation that the federal government would also have to take over lenders Fannie Mae and Freddie Mac, which together stand behind almost half of the nation’s mortgage debt.

Meanwhile Forbes reports that the FDIC is monitoring 90 institutions with assets of $26 billion that it has identified as troubled.

Greenspan confirms U.S. economy on brink of extended recession

Former U.S. Federal Reserve Chairman Alan Greenspan, when asked if the U.S. economy was in recession, said: "We are on the brink".

"A rebound at this stage is not something I think is in the immediate outlook," he added.

[Reuters]

The Recession is only just beginning

This will be a different kind of recession -- a recession with an overlay of inflation. That combo puts the Federal Reserve in a Catch-22 -- whatever it does to solve one problem only makes the other worse.

[For the past year] we've seen a fairly consistent pattern to the economic mood swings. Every three months or so, there's a round of bad news about housing, followed by warnings of more bank write-offs and then a string of disappointing corporate earnings reports. Eventually, things stabilize and there are hints that the worst may be behind us. Stocks regain some of their lost ground, bonds fall and then -- bam -- the whole cycle starts again.

The last hope for a second-half rebound began to fade earlier this month when Lehman Brothers reported that it wasn't as immune to the credit-market downturn as it had led everyone to believe. It could be the next Bear Stearns. Since then, there has been a steady drumbeat of worrisome news from nearly every sector of the economy.

Like the rain-swollen waters of the Mississippi River, this sudden surge of downbeat news has now overflowed the banks of economic policy and broken through the levees of consumer and investor confidence. At this point, there's not much to do but flee to safety, rescue those in trouble and let nature take its course. And don't let anyone fool you: It will be a while before things return to normal.

[Excerpt of an article by Steven Pearlstein, Washington Post]

The Weakened State of the Dollar

Who Insures the Insurers?

The Federal Deposit Insurance Corporation (FDIC) insures bank accounts up to $100,000. The FDIC holds about a penny in reserve (in T-bills) for every dollar worth of insured deposits.

Who insures the T-bills? The Federal Reserve System. Who insures the Federal Reserve System? No one. It doesn't need insurance. It can create money.

Then who insures the purchasing power of the dollar? The central banks of the world, which hold dollars as legal reserves for their own currencies.

What happens if they decide not to add to their holdings of dollars?

[What we can look forward to includes:] rising prices for imported goods, rising domestic interest rates because foreign central banks are not buying Treasury debt any longer, unemployment, bankruptcies, defaults.

And when the checks from Washington no longer buy much of anything, the great political transformation will begin.

[Excerpt of an article by Gary North]

Soros: “Worst financial crisis since the 1930s”

George Soros, the legendary financier and philanthropist, has written a new book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means.

Mr. Soros’ opening sentence summarizes his sense of urgency about the turmoil in the financial world, where he is one of the most successful and enduring of investors:

“We are in the midst of the worst financial crisis since the 1930s.”

Wall Street Investment Banks Now Borrowing $38.1 billion Daily

As an update on my March 29th posting, Wall Street investment companies are stepping up their borrowing a bit from the Federal Reserve’s unprecedented emergency lending program.

The Federal Reserve reports Thursday that those firms averaged $38.1 billion in daily borrowing over the past week from the new lending program!

That compared with $32.9 billion in the previous week and $13.4 billion in the first week the lending facility opened.

On Abolishing the Federal Reserve

As discussion is underway to give further, sweeping financial oversight to the Federal Reserve, reflect for a moment on this excerpt of a speech by Congressman Ron Paul to the U.S. House of Representatives (September 10, 2002)

Since the creation of the Federal Reserve, middle and working-class Americans have been victimized by a boom-and-bust monetary policy.

From the Great Depression, to the stagflation of the seventies, to the burst of the dotcom bubble, every economic downturn suffered by the country over the last 80 years can be traced to Federal Reserve policy. The Fed has followed a consistent policy of flooding the economy with easy money, leading to a misallocation of resources and an artificial "boom" followed by a recession or depression when the Fed-created bubble bursts.

Though the Federal Reserve policy harms the average American, it benefits those in a position to take advantage of the cycles in monetary policy. Federal Reserve policies also benefit big spending politicians who use the inflated currency created by the Fed to hide the true costs of the welfare-warfare state.

Abolishing the Federal Reserve will allow Congress to reassert its constitutional authority over monetary policy.

I urge my colleagues to stand up for working Americans by putting an end to the manipulation of the money supply which erodes Americans' standard of living, enlarges big government, and enriches well-connected elites, by cosponsoring my legislation to abolish the Federal Reserve.

Investment Banks Borrowing Billions

Big Wall Street investment companies are taking advantage of the Federal Reserve's unprecedented offer to secure emergency loans, the central bank reported. Investment houses can put up a range of collateral, including investment-grade mortgage backed securities.

The Fed debuted a separate lending facility where Wall Street firms can borrow Treasury securities and put up risky home-loan packages as collateral.

Those firms averaged $32.9 billion in daily borrowing over the past week from the new lending facility, compared with $13.4 billion the previous week. The program, which began last Monday, is part of the Fed's effort to aid the financial system, and the broadest use of the Fed's lending authority since the 1930s.

The Fed also said it would make as much as $200 billion worth of Treasuries available through weekly auctions that started Thursday.

[Excerpt of an article by Jeannine Aversa, AP]

Note: A “billion” is a difficult number to comprehend. The next time you hear of loans or debts in the “billions”, or consider how much a billion is.

Derivatives, the ticking bomb

“Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." –Warren Buffet, 2002

A Derivative is an investment that derives its value from another more fundamental investment, as a commitment to buy a bond for a certain sum on a certain date. In recent years, there was a five-fold growth of derivatives, from $100 to $516 trillion. The new derivatives bubble was fueled by five key economic and political trends:

1. Sarbanes-Oxley increased corporate disclosures and government oversight

2. Federal Reserve's cheap money policies created the subprime-housing boom

3. War budgets burdened the U.S. Treasury and future entitlements programs

4. Trade deficits with China and others destroyed the value of the U.S. dollar

5. Oil and commodity rich nations demanding equity payments rather than debt

To grasp how significant this five-fold bubble increase is, let's put that $516 Trillion in the context of some other domestic and international monetary data:

• U.S. annual gross domestic product is about $15 trillion
• Current proposed U.S. federal budget is $3 trillion
• U.S. government's legal debt is $9 trillion
• World's GDPs for all nations is approximately $50 trillion
• Total value of the world's real estate is estimated at about $75 trillion
• Total value of world's stock and bond markets is more than $100 trillion

[By Paul B. Farrel, MarketWatch]

Derivatives and the Shadow Banking System

The Federal Reserve has not only taken action unprecedented since the Great Depression--by lending money directly to major investment banks--but also has put taxpayers on the hook for billions of dollars in questionable trades these same bankers made when the good times were rolling.

Over the last decade, the biggest Wall Street banks and brokerage firms created a dizzying array of innovative products that experts now acknowledge are hard to understand and even harder to value.

One of the fastest-growing and most lucrative businesses on Wall Street in the past decade has been in derivatives. It is a stealth market that relies on trades conducted by phone between Wall Street dealer desks, away from open securities exchanges. How much changes hands or who holds what is ultimately unknown to analysts, investors and regulators.

Used unwisely --when greed and the urge to gamble with borrowed money overtake sensible risk-taking --derivatives can become Wall Street's version of nitroglycerin.

Even the people running Wall Street firms didn't really understand what they were buying and selling, says Byron Wien, a 40-year veteran of the stock market who is now the chief investment strategist of Pequot Capital, a hedge fund.

[Excerpt of an article by Nelson D. Schwartz and Julie Creswell, NY Times News Service]

Federal Reserve's boldest action since Great Depression

The Federal Reserve is the only U.S. institution with the authority and ability to create money out of thin air. And the FED has taken its boldest action since the Great Depression, invoking rarely used powers in an effort to contain a panic threatening to undermine the economy.

Because of the Fed's direct influence over interest rates, the money supply, and the larger economy, some have called the Fed chairman the second most powerful job in Washington after the president.

But the Fed's moves are raising questions about its regulatory powers. In one remarkable week, the Fed:
--engineered the fire sale of bankruptcy-headed Bear Stearns Cos. to J.P. Morgan Chase & Co. with a $30 billion loan.
--offered emergency loans to other securities dealers under terms normally reserved for regulated banks.
--slashed a key short-term interest rate by three quarters of a percentage point, to 2.25 percent. The cut was sixth since September.

These steps followed moves to lend $100 billion in cash to banks, and $200 billion in Treasury bonds to cash-strapped investment banks.

"I spent 35 years on Wall Street, have been a Fed watcher for a long time and I have never seen the potential for a more severe credit crisis than this one," said David Jones, chief economist at DMJ Advisors and a former Wall Street economist.

[AP]

When the Bear Stearns fantasy turned into a nightmare

We had a conversation yesterday with a source who is very close to the Bear Stearns situation.

"What went wrong?" we wanted to know. "How could this group of very smart accountants, lawyers, and investment pros have been so wrong about what they had in their own portfolios?"

One day, they think they have a stock worth $30...a few hours later, they sell it for $2--making the whole company worth less than a quarter of the value of their headquarters building. If they had thought it wasn't worth $30, they would have unloaded it then. Instead, they held until forced to turn it over for practically nothing.

"Well" said our source, "They have no reliable way of knowing what their 'assets' are worth. They're not marked to market; they're marked to whatever fantasy they have in their heads at the moment. When the fantasy was positive, the assets were worth something. When the fantasy turned into a nightmare, they panicked and wanted to get rid of them in the worst possible way.

"And the really scary thing is that the other financial institutions are in much the same situation. They don't really know what they have...or what it is worth. There are almost certainly some more horror stories that will be coming out.”

[Excerpt of an article by Bill Bonner, The Daily Reckoning]

Stiglitz: U.S. Financial Crisis Worst since the 30’s

The current financial crisis is the worst the world has seen since the Great Depression of the 1930s and the US Federal Reserve move to cut interest rates will not make much difference, the Nobel Prize winning economist Joseph Stiglitz said on Wednesday.

Stiglitz, who won the Nobel Prize in economics in 2001, is a former chief of the World Bank and chaired former US president Bill Clinton's council of economic advisers.

He said the main problem is the fact that an estimated 2 million Americans are going to lose their homes because they could not repay mortgages which exceed the value of their property, as house prices fell dramatically. "As people walk away from their mortgages there will be more and more defaults - that undermines the whole financial system," he said.

Stiglitz said the Bush administration was bailing out banks, but accused it of refusing to do anything to help poor people stay in their homes which would stabilise the housing market. "It's very easy to do something about it," he said, suggesting the administration could give assistance to write down mortgages to about 90 per cent of the value of a house which would enable people to stay in their properties.

[Of the Iraqi War, Stiglitz said:] "They didn't want Americans to know exactly how bad the war was for the economy so they flooded it with liquidity, they looked the other way with regulations and they deliberately, I think, postponed the problem into the future and now we're paying the price."

[The Economic Times]

Wall Street fears next Great Depression

Wall Street is bracing itself for another week of roller-coaster trading after more than $300bn was wiped off the US equity markets on Friday following the emergency funding package put together by the Federal Reserve and JPMorgan Chase to rescue Bear Stearns.

One UK economist warned that the world is now close to a 1930s-like Great Depression, while New York traders said they had never experienced such fear. The Fed's emergency funding procedure was first used in the Depression and has rarely been used since.

A Goldman Sachs trader in New York said: "Everyone is in a total state of shock, aghast at what is happening. No one wants to talk, let alone deal; we're just standing by waiting. Everyone is nervous about what is going to emerge."

In the UK, Michael Taylor, a senior market strategist at Lombard, the economics consultancy, said on Friday night: "We have all been talking about a 1970s-style crisis but as each day goes by this looks more like the 1930s. No one has any clue as to where this is going to end; it's a self-feeding disaster."

Mr Taylor added that the problems unravelling at Bear Stearns are just the beginning: "There will be more banks and hedge funds heading for collapse."

[By Margareta Pagano, The Independent]

Who's Next After Bear Stearns?

The Bush Administration and FED engineered a deal to at least temporarily save Bear Stearns from bankruptcy, but investors began turning a critical eye to other investment banks amid worries about how far the credit contagion could spread.

The fact that a major investment bank could reach the verge of buckling -- and be sold at such a discount -- sent dismay through Wall Street and beyond.

"One reaction is shock that a company that reaffirmed its book value at around $84 on Wednesday can be worth $2 per share four days later on Sunday," said Deutsche Bank analyst Mike Mayo.

The price represents roughly 1 percent of what the investment bank was worth just 16 days ago.

The financial industry wants to know exactly how badly Bear Stearns bet on mortgage-backed investments. Unwinding the nation's fifth-biggest investment houses should provide some insight into what other financial institutions might have on their books.

Wall Street analysts say the rescue bid was more than just saving one of the world's largest investments banks -- it was a prop for the U.S. economy and the global financial system.

[AP]

The Dollar has been shoved off a cliff

The dollar has been shoved off a cliff and no one knows where it will land.

Recently, the Wall Street Journal broke down the relationship between the dollar and oil and revealed the ugly truth; that consumers are getting gouged at the pump because of the Bush Administration's policies, not Saudi greed:

“Since 2001 the dollar price of oil and gold have run almost in tandem. The price of gold has risen 240% since 2001, while the price of oil has risen 270%. That means that if the dollar had remained “as good as gold” since 2001, oil today would be selling at about $30 a barrel, not $100. Gold has traditionally been a rough proxy for the price level, so the decline of the dollar against gold and oil suggests a US monetary that is supplying too many dollars”.” (“Oil and the Dollar” Wall Street Journal)

There it is in black and white. Bush's dollar policy has taken us where Bin Laden never could; the edge of ruin. The consumer is getting clobbered, the country is slipping into recession, and the greenback is hanging by a thread.

There's another reason to believe the dollar won't rebound, too, that is, that Fed chairman Bernanke is deliberately undercutting the dollar to stimulate the economy. … Unfortunately, there are roughly $6 trillion in US dollar-backed assets around the world which could be quickly dumped on US shores if Bernanke goofs up and foreign holders of USDs start selling their paper on the open market. That would trigger a round of Wiemar-like hyperinflation in the homeland that would terminate the dollar's position as the world's reserve currency as well as America's role as the global superpower.

[Excerpt of an article by Mike Whitney, ICH]

So what caused the Mortgage Banking Scandal?

So what caused the Mortgage Banking Scandal? In one word --GREED!

"It became commonplace for banks to outsource their mortgage lending to free-lance brokers. Instead of doing their own credit checks they relied, often exclusively, on various online credit questionnaires … where no follow-up was done.

"It became common practice for mortgage lenders to offer brokers bonus incentives to bring in more signed mortgage loan volume, another opportunity for massive fraud. The banks got more gain from making high volumes of loans than selling for securitization.

"The world of traditional banking was being turned on its head. Many US banks, simply to churn loan volume and returns, gave what they cynically called "Liars’ Loans." They knew the person was lying about his credit and income to get that dream home. They simply didn’t care. And they sold the risk once the ink was dry on the mortgage.

"A new terminology arose after 2002 for such loans, such as "NINA" mortgages—No Income, No Assets. "No problem, Mister Jones. Here’s $400,000 for your new home, enjoy."

[Excerpt of an article by F. William Engdahl, Global Research]

International experts foresee collapse of U.S. economy

Harry Koza in the Globe and Mail quotes Bernard Connelly, the global strategist at Banque AIG in London, who claims that the likelihood of a Great Depression is growing by the day.

Martin Wolf, celebrated columnist of the U.K.-based Financial Times, cites Dr. Nouriel Roubini of the New York University's Stern School of Business, who, in 12 steps, outlines how the losses of the American financial system will grow to more than $1 trillion - that's one million times $1 million. That amount is equal to all the assets of all American banks.

Every day now, thousands of people all over the U.S. and Great Britain are walking away from their homes - simply mailing their house keys to the banks - as housing bailout plans fail. With unemployment growing, the next phase will hit commercial real estate making the financial institutions the unwilling owners not only of quickly depreciating houses, but also of empty strip malls and even larger shopping centers.

The next domino to fall will be credit card defaults, and after that... who knows?

The most frightening forecast so far comes from the Global Europe Anticipation Bulletin: "The end of the third quarter of 2008 (thus late September, a mere seven months from now) will be marked by a new tipping point in the unfolding of the global systemic crisis.

The report goes on to say that we are entering a period for which there is no historic precedent. What we will have, instead, is truly a global momentous threat - a true turning point affecting the entire planet and questioning the very foundations of the international system upon which the world was organized in the last decades.

The report emphasizes that it is, first and foremost, in the United States where this historic happening is taking an unprecedented shape (the authors call it "Very Great U.S. Depression").

Concerning stock markets, the GEAB anticipates that international stocks would plummet by 40 to 80 per cent depending where in the world they are located, all affected in the course of the year 2008 by the collapse of the real economy in the U.S. by the end of summer.

The European authors of this report - it appears simultaneously in French, German and English - state that they simply and without prejudice try to describe in advance the consequences of the ominous trends at play, so readers can … take the proper means to protect themselves from the most negative effects.

[Excerpt of an article by Bert Hielema, Belleville Intelligencer]

Why the Gold Boom, Dollar Bust

Forget the fact that over the last 6 months gold has skyrocketed from $670 an ounce to now-approaching $990 an ounce, and yet it’s hardly even been mentioned in the mainstream media.

Michael Byrd, of the Austin Report offers some background:

Many of today's currency problems began in World War I when the gold standard was first abandoned.

On August 15, 1971, President Nixon severed the link between the U.S. dollar and gold. Since 1973, flexible exchange rates were introduced and chaos has prevailed in the global financial system. Jacques Rueff, an advisor to President Charles de Gaulle, described the situation in his book The Monetary Sin of the West: “Since the abandonment of the gold standard, i.e. the only system that ever worked, the world has been moving from one crisis to the next, from deflation to inflation, from economic boom to bust."

The sudden jump in the price of gold after central banks gave up on control was confirmation of a loss of confidence in the U.S. dollar. In the absence of a gold-market-valued U.S. dollar, investors chose to put their faith in gold alone. Consequently, the price of gold rose from $35 per troy ounce in 1969 to almost $850 in 1980. As a result, the value of the U.S. dollar fell against gold and has never recovered since 1971.

Note the similarities in the 1970's and today—rising commodity prices, record oil prices, an unpopular War while the government refuses to cut back other expenses, and a massive trade deficit. These factors combined with a trade deficit to create a situation in which the dollar was worth less than the gold used to back it.

Playing musical chairs on the deck of the Titanic

I once heard the expression used, “playing musical chairs on the deck of the Titanic", and feel it fairly accurately describes the various attempts to avoid a shipwreck of the economy!

Are the Fed’s attempts to help going to do that much good? Since the FED is what has caused much of the financial mess, isn’t this kind of like asking the Mafia to donate drug money toward research for curing addiction?

The Federal Reserve IS the problem. Greenspan and the FED knowingly caused this mess.

The probability is that nothing effective will be done by the Fed or the Government. We are going to have to ride out the recession-depression, during which time all elements of the population will have plenty of time to contemplate the level of greed at all levels, that contributed to this mess.

The principal shareholders of the Fed

What most American citizens don't realize is that the Federal Reserve, which controls the U.S. currency, inflation, and deflation at the cost of the American people, is a private corporation.

While the name “Federal Reserve” might suggest otherwise, it is simply a private company set up by big bankers in 1913, a company that makes decisions based on profits, as required by stockholders.

The principal shareholders of the Fed are: the Rothschilds, Lazard Freres, Israel Schiff, Kuhn-Loeb Co., Warburg Co., Lehman Brothers, Goldman-Sachs, the Rockefeller family, and the J.P. Morgan interests.

The fact that Americans hold a great deal of private debt isn't troublesome to them, merely profitable.

Who’s responsible for the meltdown? The Federal Reserve

Gold has spiked over $950, a new high, while oil futures passed the $100 per barrel mark. The battered greenback has taken a beating, and yet, Fed chairman Bernanke is signaling that there are more rate cuts to come. The prospect of a global run on the dollar has never been greater.

The problem far exceeds the Federal Reserve's paltry increases to the money supply or Bush's projected $168 billion “surplus package”. Capital is being sucked out of the system faster than it can be replaced which is apparent by the sudden cramping in the financial system and a more generalized slowdown in consumer spending.

An article which appeared on the front page of The Financial Times [but not in the US media] illustrates how hard-pressed the banks really are: “US banks have been quietly borrowing massive amounts of money from the Federal Reserve...$50 billion in one month”.

The present troubles originated at the Federal Reserve and, ultimately, they are the ones who are responsible for the meltdown. The Fed refused to perform its oversight duties because its friends in the banking industry were raking in obscene profits selling sketchy, subprime junk to gullible investors around the world. They knew about the “massive off balance-sheet positions” which allowed the banks' to create mortgage-backed securities and CDOs without sufficient capital reserves. They knew it all; every last bit of it, which simply proves that the Federal Reserve is an organization which serves the exclusive interests of the banking establishment and their corporate brethren in the financial industry.

[Excerpt of an article by Mike Whitney, Counterpunch]

300 Days to Create a Trillion Dollars

Last August, the near meltdown of the Sub-Prime Mortgage Markets led to a panic sell-off of stocks which quickly became a worldwide liquidity crisis. In response, an unprecedented $400 billion dollars was created at the press of a few computer keys to save the entire financial system from a wipe-out, followed by the Federal Reserve lowering interest rates by one-half a percent.

What is the root cause of the dollar crisis? The single leading factor destroying the value of the U.S. dollar is the law of supply and demand. The world has become flooded with paper dollars.

It took the U.S. government 354 years (1620 – 1974) to create the first $1 trillion dollars in circulation. It only took 300 days to create the last trillion dollars of paper money.

Somewhere there's a point of equilibrium where the demand for dollars by foreigners can no longer absorb the flood of the money supply. On that day, our country will no longer be able to pay its bills.

At the same time, everyone holding U.S. Treasury bonds, U.S. debt, or U.S. stocks may create a mad rush for the exits. In a panic sell-off, every single dollar outstanding could fall in value suddenly and dramatically. If you believe the U.S. dollar cannot fail, you'll be very surprised to learn that currency failures are not rare events. In fact, history is loaded with failed currencies around the world.

[Excerpt of an article by Michael Byrd, Austin Report]

The Decline of the American Empire

The notion that Washington had entered a "New American Century" -- a phrase used by the nationalist and neo-conservative unilateralists who championed the Iraq war -- seems largely to have gone the way of the dodo bird.

Yale Professor Paul Kennedy argued that the U.S. was falling into a familiar historical pattern where the combination of huge military budgets and ever-larger deficits led inevitably to the kind of "imperial overstretch" that transformed once-mighty empires into shadows of their former selves.

Washington Post neo-conservative columnist Charles Krauthammer exulted on [the American empire], "The fact is no country has been as dominant culturally, economically, technologically, and militarily in the history of the world since the Roman Empire."

What a difference five years and an invasion and bungled occupation of Iraq make! References to the Roman Empire at this point are more likely to refer to its decline than to its power.

"I’ve argued that not since the Roman Empire has anyone had such extraordinary power as the United States after the Cold War," says Donald Kagan, a dean of neo-conservatism. "But all of the elements of our strength are now being challenged, and it’s perfectly possible that we are seeing a relative decline in U.S. power that will prove lasting."

[Inter Press Services]

Iran forcing more Dollar Doldrums

Japanese investors are selling their dollars on the Tokyo Financial Exchange with worries about a recession in the U.S. economy.

The dollar also recently had its biggest weekly loss this year against the euro after Federal Reserve Chairman Ben S. Bernanke signaled he may cut interest rates further amid mounting concern that the economy is headed for a recession.

Iran, OPEC's second largest exporter, has already cut all of its ties with the greenback with respect to oil transactions.

And on Sunday, Iran established its first oil products bourse in a free trade zone on the Persian Gulf Island of Kish. Oil and petrochemical products will be traded in Iranian Rials, as well as all other hard currencies, the statement quoted Iranian Oil Minister Gholam Hossein Nozari as saying. About 20 brokers are already active in the market, it added.

As the fourth-largest oil producer in the world, Iran has a measure of influence over international oil markets. The country ranks second for output among OPEC Countries, and controls about 5 percent of the global oil supply. Tehran also partially controls the Persian Gulf's Strait of Hormuz, through which much of the world's oil supply must pass.

Now, the Organization of Petroleum Exporting Countries (OPEC), which supplies 40 percent of the global crude demand, plans to discuss a proposal by Iran and Venezuela to price oil in non-dollar currencies.

US subprime crisis costs global 7.7 trillion dollars

The meltdown in the US subprime real-estate market has led to a global loss of 7.7 trillion dollars in stock-market value [over the last 4+ months], a report by Bank of America showed Thursday.

The crisis, which has spread beyond US shores to banks and other sectors worldwide, is "one of the most vicious in financial history," according to Bank of America chief market strategist Joseph Quinlan.

Quinlan said in the report that the losses are worse than any in the past few decades, including Wall Street's Black Monday of 1987, the 1999 Brazilian real currency crisis and the collapse of hedge fund Long Term Capital Management in 1998.

"The current financial crisis is one for the record books and one, more ominously, not over yet."

[AFP]

Expensive Oil is far from being the Only Problem

"The greatest challenge to the world is not US$100/barrel oil. It's getting enough food so that the new middle class can eat the way our middle class does," says Donald Coxe, global portfolio strategist at BMO Financial Group, at the Empire Club's 14th annual investment outlook in Toronto.

The credit crunch and the reverberations of soaring oil prices around the world will pale in comparison to what is about to transpire. "It's not a matter of if, but when," he warned investors. "It's going to hit … hard."

The impact of tighter food supply is already evident in raw food prices, which have risen 22% in the past year. Wheat prices alone have risen 92% in the past year.

Mr. Coxe said the sharp rise in raw food prices in the past year will intensify in the next few years amid increased demand for meat and dairy products from the growing middle classes of countries such as China and India, as well as heavy demand from the biofuels industry.

With 54% of the world's corn supply grown in America's mid-west, the U.S. is one of those countries with an edge. But Mr. Coxe warned U.S. corn exports were in danger of seizing up in about three years if the country continues to subsidize ethanol production. Biofuels are expected to eat up about a third of America's grain harvest in 2007.

[Excerpt of article by Alia McMullen, Financial Post]