I Feel Like It's Already Happened.

I'm sure it's a personal projection of some kind - at least I should be. But it doesn't feel that way.

It feels as though someone has made a very important phone call - one of those ones where you feel like you're filled with ice water and you're shaking, but you sound normal. What came out of their mouths came out as something smart and strategic, but it was really a plaintive wail and a desperate plea. The person on the other end didn't hear it cry. They didn't make much of it - dispense with it quickly. They did think about it after they hung up, but they went back to work, then turned on the basketball game for a few minutes, had a glass of water and went to bed. In the morning there was just another full day.

But not on the other end. The night was easier than expected on that end. There was a feeling of relief, even a wry laugter. On that end they watched a good chunk of the basketball game and woke up feeling pretty good. Felt a little odd at breakfast, but had some orange juice - very refreshing. A few butterflies, but they headed in bright and early. Certainly a priority list today!

Meetings were fast and precise - they were professionals energized by the task of high-speed problem-solving. The situation was bad, but the rhythm was good. Then around 10 somebody freaked. Whether it was that woman who cried or that guy you knew was going to be a problem really blowing his stack - I mean losing control - it's hard to remember. Suddenly nothing was happening properly. The call and response was way off. The rhythm was broken and knuckles got very white.

Then an hour or so later - hard to tell - there was that weird feeling of suddenly not knowing what to do - having nothing to do, really. You couldn't call X until Y called back. The numbers were going to take at least two hours. The lawyers hadn't arrived yet.

You never knew what "it's over" was going to feel like - certainly you didn't imagine this. Then you realized that "over" meant having so much to do and no way to do it or get it done. "Over" meant that the many things you needed to do were now going to find you, instead of the other way around.

And then all of us found out.

The End Of Money

Getting to know the wild, Austrian-school, Libertarian culture of goldbugs has been really interesting for me. We disagree on so many things but see the same crisis - an existential threat to the world's money system. Goldbugs make government deficits to be the first-order threat because of absolute size and inflationary primacy. I join those who make the collapse of credit institutions to be the first-order problem. Some goldbug share this latter view, Mish Shedlock notably among them. Although I'm not a goldbug, Shedlock's writings are part of the reason I am a so-called “deflationist”.

Clearly the “short dollars on imminent hyperinflation” trade has fallen apart. The yen is getting crushed. Paper gold has been acting oddly. I'm sorry, but I happen to be one of those people who think ETFs can overwhelm futures markets a bit. Thought so with oil this summer. Many knowledgeable people disagree. But the real value of gold is something reasonable people can debate. In fact, it's debated every day in London, New York, Sydney and Hong Kong. Right now, the consensus is: “not so valuable as we thought last week”.

What is not being debated properly is the value of our financial system. On the NewsHour Secretary Geithner pre-announced that nobody will fail the “stress test”:

“These banks now have very substantial amounts of capital relative to what you would have seen in the U.S. economy going into previous recessions.”

The conventional view - Geithner's view - makes this economic crisis to be a crisis of “beta” - a “fat-tails” crisis which will revert to the mean. One problem with that assessment is collateral. In a sense, Bank of America is a huge CDO. CitiGroup is a huge CDO. AIG is a huge CDO. CDOs are fine, unless you very badly misrepresent the “C” - the collateral - and that's what's happened. So, I make it to be a crisis of “alpha” - a crisis of our financial system's intrinsic value and a crisis of collateral. The goldbug solution is simple – collateralize the system with gold. Goldbugs reason that if the problem is at the very core – the “fiat” or legal-accounting money system itself – then that system needs to be moved to solid collateral. I agree to this extent: If we don't deal with how our system is collateralized, we're finished

[I even reluctantly and partially agree that gold could be part of the answer, but that's for another piece.]

Jim Cramer sees the collateral problem. His mortgage plan is about spreading a huge hit to term collateral value over a very long time. If you look at this interview with Robert Shiller and take a gander at the chart below which shows percentages of negative equity homeowners as house prices fall, you get an idea just how huge a hit we could be talking about.


Despite all the talk about it, deleveraging probably has not happened in America. Collateralized leverage has likely skyrocketed. Fed Chairman Bernanke implicitly recognizes this. Markets were relieved to hear the Chairman didn't intend nationalization. An expert on providing liquidity, Bernanke now plans to create equity - balance sheet collateral, if you will. Preferred at first, “rolling” to common as loan collateral and quality deteriorate. The idea has balance sheet elegance and the more “we the people” find out management has screwed up their businesses, the more right we'd get to tell them what to do.

It's a great concept. The Diamond and Dybvig model of central banking says that in a crisis the government should trade immediate-term credit for long-term exposure. Big-government conservatism says in a crisis the government should intervene first with money (and guns), then take authority only as a last resort. It's wonkish and wonderful – an academic tour de force. So why am I hearing Jim Cramer in my mind's ear shouting “Bernanke's being an academic! It is no time to be an academic...!”?

It's because I'm not sure how cash helps these institutions. It didn't help AIG. The banks already have much more than enough cash. If they can't use what they have, how will more help? Banks need to get assets with longer-term value into their portfolios faster than their collateral is deteriorating (and risk is rising). Ben Bernanke apparently believe they can create or find those assets.

Those banks? With that management? In this economy? With their cost structure? Really?

I saw Dick Bove talking about how the banking system was very profitable. I nearly fell off my chair. $59 billion positive cash flow? So they can pay back the TARP in what, 10 years? 15? I got back on my chair and listened to his excellent point about franchise intangibles' being an important part of overall value. But has he read what Ken Lewis thinks are the most valuable parts of his franchise? The biggest, crookedest mortgage writer in history and a failed investment house? Those are the “stars”? When institutions issue thousands of “AAA” securities that turn out to be junk, their franchises suffer – badly and justly.

I've read the BAC bulls. I believe Geitner wants to bring in private investors. But these banks already have investors who are a big part of the problem. Bondholders represent a big portion of liabilities so, again, let's think of the banks as a bond – a huge, multi-maturity CDO. We know the collateralized leverage of this bond has soared and the credit quality has plummeted. The principal of many long-dated tranches has gotten killed, but the short-term tranches have been saved – so far.

Is the bond still paying the coupon? As Dick Bove points out, almost. But why do people focus on that? The structuring is destroyed and the collateral is crap. By taking the TARP money, Citigroup, AIG, BAC, etc. have declared an intention to pay the coupon out of the new, “free” government collateral. Unless the government intends to let banks and bondholders pretend the entire real estate bubble never happened, it won't be enough. To boot, I have very little faith the structuring of these CDOs will improve. When I look at BAC, I see a CDO that has gotten bigger, not better. And Citigroup? AIG?

The challenge is bad structure and bad collateral, which is why serious people are finally talking about capitalizing our financial system with full-faith-and-credit (FFC) instruments. I have no idea how it took so long. Laugh if you want, goldbugs, but it's a step forward. It's sure a lot more sensible than cash. It's not magic, but FFC bonds would immediately change institutions' capital profile. Of course the bondholders will still be pounding on the doors. Even if you don't think these bondholders are too big to fail, we certainly don't want them freaking out again, either. The stories are wild about the last time they freaked out, but the facts are bad enough.

I think we need to deal with the bondholders separately. But I don't know, maybe Bernanke, Geithner and the holdover crew (who missed the entire bubble in the first place) really do intend to re-collateralize the people who bought and sold all the bad debt. Why make people unhappy? Apparently, it wasn't the investors' fault. They were, after all, only professional financiers.

So how does “the end of money” come about? Option 1 is that the crew gets ahead of the process and creates hyperinflation. Yet, the dollar is a very, very big money system and “fortunately” the crew have shown no capacity to get ahead of the process. Option 2 is that as collateral collapses, they continually pay out slightly less than the deterioration. This is the Japanese “lost decade” prescription for deflation. And of course hidden costs can jump out and cause instability, as in the AIG catastrophe. This would also be deflationary. That's why I feel deflation is the more-likely outcome.

Finally, adding value to the money system is not a forlorn hope. It can happen. Actually, we know that it will happen - eventually. It's really just a question of how long we want it to take. Many smart people say the problem isn't so bad and I respect that. However, I humbly suggest that if large numbers of people refuse to admit they lost money in what might be the biggest bubble in human history, money as we know it will end – at least for a while.

When A Plan Is Not A Plan

Secretary Geithner's plan for bank recovery is not viable and - as described so far - not sound. However, its lack of detail is not only understandable but good. Implicit in this un-plan is the question: "How do we get private money back in the banks and the credit markets?" So long as Secretary Geithner keeps asking that question and allowing it to guide him, he will be okay as he goes through the process of realizing that we *can't* get private money into the markets because private money does not and cannot trust the banks.

The trouble is there is also another question looming: "How do we get money into the economy?" This is a separate and far more pressing question and if not handled carefully, it could lead to rash decisions made in panic, haste and with more money than anybody as ever imagined. A deflationary crisis gives governments LOTS of room to maneuver. They can create LOTS of money and fund LOTS of programs - and nothing will work quickly enough. This means the tendency to think things through starts to diminish and we have to fight that. 

And just to be clear, I believe the deflationary crisis cannot now be avoided if indeed it ever could have been. Everyone outside the government is acting exactly the way people act to create a deflationary disaster. Bankers (obviously), business leaders and even governors, mayors and county executives are doing exactly the wrong things and exactly the wrong time, as you would expect them to do. This is the initial stage of the deflation during which none of these people can see the collective result of his actions yet. Each institution looks to preserve itself without seeing that by doing the same thing at the same time they are bringing us all down. For example, by trying to "get ahead of the curve" and cut their costs with big initial layoffs, American businesses have assured that unemployment will rise above the level the financial system can withstand. 

The federal government is trying to get ahead of the curve in the other direction, pouring out money as fast as it can. The problem is that the government is pouring out money to, in effect, prevent things that have already happened. The government has to get to a place where it can pour out money on the economy that will exist 6-12 months from now, not the economy that exists today or two months ago. The problem is that it is very hard to tell the voters that in a very short time, there will be fewer banks to rescue and in a very short time, there may be no point trying to prop up the market for consumer debt such as credit cards. Careless, reckless, "never, never" planning by the consumer credit industry means that around 10-12% unemployment, the backbone companies in that industry will start to fold. At that time the the federal government will run into a huge question: "Who in the world can we even lend money to?"

Right-wing ideology has blinded people to the obvious answer. In any economic crisis, you first lend to institutions that have the legal authority of taxation - the power to compel people to pay the money back. You lend to the states, cities and counties. You demand the highest standards of accounting, demand reform and then give them the money. It's just the wise thing to do. Then you lend to the institutions that have the best *ability* to pay the money back and can create the most economic benefit. You also do as much direct aid to individuals as possible, keeping in mind this unifying principle: ultimately, you are lending money to the people to put the life of the nation back together and they must do that through the bedrock institutions and through their own creativity and sense of purpose. You must give the people the capacity to build. 

One of the great things that World War II did for America - in fact, the only great thing it did for anyone in the world - was that it gave the American people a task that was too huge for anyone to tell them how to do it. Everybody became an "entrepreneur" in the mission to beat the Axis, from the fellow with a rifle, to the lady with a riveter, to the folks with the slide rules, pencils and heads to scratch with them. The War made America realize that this was their fight - all of them. So we invested in soldiers who had only weeks before been unemployed young men nobody cared about. Business executives got off their high horses, popped the bubble reputation and asked "how can I help?". American women said: "give us the job" and this time, we gave it to them. 

In more ways than one, the War was a war against the Depression. It was a horrifying way to solve a bad problem - the worst possible solution. Hopefully, we can look at that war, look at what was good in our nation's reaction and re-create that without the horror. 

The Econolypse, The Dollar, And Gold

I think we need a name for all this. "Credit Crisis" is lame. "Great Depression 2" is not only lame, but it misrepresents what is happening. It keeps us in the mindset of fighting the last war. For me, we are in "The Econolypse" (must credit my good friend V.R. on that one).

The Econolypse will twist our heads off. It is the The End of an era, and therefore a massive disillusionment is in store. No, it's not the disillusionment you thought was coming because that wouldn't be a disillusionment, would it? Unless you are already insane, the Econolypse will make you doubt what you know, who you thought you knew and why you ever believed you knew either of them. People who read economics are always modelling everything. This is that thing you can't model. Look, you're smart. If you could have modelled it, so could other smart people. And if they could have modelled it, it wouldn't have happened.

Nobody consciously chooses an Econolypse. Believe me, if anyone were to choose an Econolypse, it would be socialists. I know socialists - real, actual socialists, not liberals or Progressives - and they are very, very unhappy with what is going on. Oh, and if you think this was all caused by Greenspan and that the government is acting outrageously by bailing out all these firms - so do they. That's right. You probably agree with socialists.

I agree with...almost nobody, I guess...but such an attitude can help one pick one's way forward in this kind of darkness. It's a pretty simple algorithm: you go completely contrarian. Look at the pervading beliefs. List them. Now list their opposites. Now try to stitch together a world where all those things are true at the same time. Looks weird, huh?

Fortunately for you (and unfortunately for me) I have already been living in this dark world for some time. I've been waiting for you. Others of you think you have a good idea what this dark world looks like. No, you haven't. I dare say this because vast majority - or even all - of the people who are as least as smart as you are and who predicted the downturn also predicted something else - something big - that not only did not come true, the opposite came true. And that was the "Fall of the Dollar". This summer, they thought they were seeing it unfold before their eyes. Finally the imbalances had become too great. Finally it was all coming apart. The new Weimar Republic was here. Hyperinflation was just days away.

They thought this as the dollar (here I use the Dollar Index) went from 88 in 2006 to 78 in 2008. They were sure of it when the dollar went from 78 to a miserable 72 in just a few months. They still thought it when the dollar went from 72 to 80 (just a blip). They were sure of it when the dollar went from 80 to 76 (that's more like it) and they were still pretty sure of it as the dollar went from 76 to 88, although they were starting to put together some caveats like "flight to safety". Now that the dollar has fallen from 88 to 84 (and may head down even more), they are sure once again that they know what's going on.

If only it was true.

Because even a rip-roaring dollar inflation would be welcome right now. It would ease a lot of minds and show that we were in just the kind of plain, old stagflation we're used to. It's probably not going to happen and that is pretty frightening. The Fed and Treasury are doing literally everything they can think of to re-inflate the dollar and it is just not working. The fundamentals are just too strong and the dollar shortage is just too acute.

It's simple supply and demand. The market needs dollars, the world's credit system is no longer producing them and even the U.S. government cannot supply enough right now. The huge Fails To Deliver in the Treasuries market are no accident. The demand is enormous. The market has spoken. Treasuries are where the large players want to hold their money. So after this pause, it pains me to predict that the dollar will head much higher - like to 97-100.

Along with this breakout, we should expect panic and disorientation. Actually, the cause for the breakout - the bankruptcy of yet another huge firm (I'm worried about Banco Santander, personally) or some major collapse of yet another credit market - will cause the panic. Things will move from bad to incomprehensible. That should help gold. You have to respect the fact that gold is a highly emotional market that can move 10% in any given day. Gold could easily go through $850 and even spike to $900 intraday. Or, maybe, gold is done here at $820. Either way, gold is a commodity and in a deflation, it will deflate. The deflation of gold is long overdue. Gold is radically overpriced in terms of silver, oil, the dollar and even the gold lease rate. Basically people across the world will be given a choice among three things: U.S. dollars that can buy anything, their own currency that buys less and less, or gold that might hold value but can't really buy anything on its own. Once gold stops holding value, there is no investment thesis for it.

I hope I'm wrong. I really do. As scared as people are now, they are going to be even more scared when they find they have to sell a commodity they do understand - gold - and buy a currency they know, but don't understand - the dollar.

Will it happen tomorrow? Probably not. Will it happen in the next few months? Look, we are only at the beginning of this thing. It will happen and, much sooner than we would like,...

...We will all live in very interesting times

The New "Four Horsemen" of the Econolypse

Citigroup

Berkshire Hathaway

Unemployment

Gold


To quote Jim Rogers from an October 31 interview on Bloomberg:

" I wouldn't lend money to a guy with phony bookkeeping and you wouldn't either."

I disagree with a lot of what Jim Rogers says (his call to buy agricultural commodities in that interview was an absolute tragedy), but this is a simple, accurate analysis of the problem. Citigroup is a three-headed monstrosity of phony bookkeeping - call it "The Three C's." Commercial Real Estate + Credit Cards = Citigroup. The bank is a black hole about to get on its black horse and ride out into the world on Monday.

The next "black hole" is unemployment. It's not black because we don't have the information. It's black because we're all ignoring it. You keep hearing that unemployment will "possibly go as high as 8% by the end of 2009." Ridiculous. Add up just the announced layoffs (if you can) and you will see that we'll be lucky if unemployment isn't 8% by the end of January (although the number may have to be revised upwards in February or March). There is 8% unemployment in California already and California has led the nation in economic trends - good and bad.

The Horseman of Unemployment has Citigroup is on its horse and when those two are mounted, Berkshire Hathaway is next to ride. Unemployment will insure that the companies behind Berkshire's "investment" in junk bond CDS suffer devastating losses and default. Citigroup's debacle will kill worldwide averages and insure our insane levels of volatlity stay nice and high. Buffett bet long the averages and short volatility in 2007. Nice trade, Oracle.

Therefore will the Banshee of Berkshire ride, causing terror across the land.

With all the panic, gold should do nicely - maybe $850/ounce, maybe a bit higher. But as she mounts that next rise, beware, the Golden Goddess also mounts her horse and prepares to ride - fast - down Mt. Econolypse into the tiny and ever-shrinking town of Deflationville in the valley below - and then on to the valley below that and then the valley below that.

That will not be a nice time. People will be a little confused then.

But I predict this is an economy which will require total capitulation in all the financial markets before it turns. We must all be terrified and frustrated before the Econolypse will pass.

...And then things will start to turn around.



May you live in interesting times.

The Smoking Gun

By 2004, the FICO system was gamed.

It was the final step in the destruction of Wall Street, a destruction engineered by the rapacity and dishonesty of American mortgage and fixed-income firms. Here, on Portfolio.com, Michael Lewis reveals the mechanism of that destruction in the best article I have yet read on the origins of the Credit Crisis. Mr. Lewis hasn't hipped to the FICO story yet, but he'll get it. He covers all the rest. The article is absolutely a must-read for anyone who wants to understand what really happened.

I first realized FICO got gamed while reading a paper by the American Enterprise Institute's Peter J. Wallison. Mr. Wallison is the principal author of the Republican talking points on Fannie and Freddie. Wallison has been carrying Wall Street's water for many years in their jihad against the GSEs. If you think Fannie and Freddie are to blame for it all, Peter J. Wallison earned his money. Like all good con men, Mr. Wallison sticks to the truth as closely as possible for as long as possible, but he slipped up with one simple sentence:

There are many definitions of a subprime loan, but the definition used by U.S. bank regulators is any loan to a borrower with damaged credit, including such objective criteria as a FICO credit score lower than 660.

Emphasis mine, but those words "objective criteria" jumped out at me.

Obviously the most objective criterion of credit risk is the actual default rate. Wallison talks about the default rates in the GSE portfolio coming largely from private-lable RMBS, but he does not cite the default rates for the actual borrowers to whom he objects most. I wondered why. If you read the paper and then look at the data (as best you can), I think you'll find something surprising.

First, it turns out that Mr. Wallison is correct that Fannie and Freddie DID take on borrowers with FICO scores lower than they should have - although not in the way he implies. But I found that the borrowers to which Mr. Wallison attributes so much damage actually defaulted at LOWER rates than that same FICO cohort defaulted for private banks. Moreover, because Fannie and Freddie bought Alt-A mortgage paper, Alt-A mortgages and even guaranteed a few Alt-A borrowers (but a very few), one can glean from the data that the farther away a borrower of a given FICO score was from the GSE's full due diligence process, the more likely that borrower was to default. Relative to the private sector, the GSEs were better judges of default risk and their default rates prove it. Even the private-label Alt-A paper bought by the GSEs has a markedly lower rate of default than the industry average.

Still, it was strange. Relative to how it worked in the private-sector data, FICO significantly OVER-predicted defaults in the GSE portfolios (when taken as a whole). If FICO is an "objective" measure, this should not have happened.

And then there is the question of the vintages.

That question became very intriguing to me when I read a much-quoted working paper published by the St. Louis Fed entitled: "Where’s the Smoking Gun? - A Study of Underwriting Standards for US Subprime Mortgages." I've long ago learned that people who have something to hide generally hide it in the title and the appendices. So, I went looking for the smoking gun the authors said was not there and quickly found it.

The authors boldly claim that:

Our results indicate that there is no evidence of a dramatic change in underwriting standards in the subprime market, particularly for originations after 2004. Given the multidimensional nature of ex ante credit risk, it is difficult to emphasize weakening in terms of some attributes as a decline in overall underwriting standards. The results show that while underwriting may have weakened along some dimensions (e.g. lower documentation), it also strengthened in others (e.g. higher FICO scores).

So, I immediately looked at their FICO data. It was shocking. To make the claim they make, you have to completely ignore the performance of the FICO cohorts and the fact that people in the business know that data. If you look at Table 12 (which divides FICO cohorts very suspiciously, but, that's another question) you will find that for the FICO cohort 660-720, first-year mortgage default rates went up a bit in 2004, doubled in 2005, quintupled in 2006 and were about eight times higher than normal in 2007. The numbers were terrible for all FICO cohorts, but that big one with SO many borrowers was just appalling.

So in 2004, bankers had suspect data and kept lending. In 2005, they had alarming data and kept lending. In 2006 they had shocking data and just kept right on lending faster than ever. In 2007, it was a travesty and they still kept lending until the whole thing blew up. Now these Bozos writing for the St. Louis Fed have the nerve to claim that underwriting standards didn't fall? Lenders knew that FICO has already failed. They knew it was gamed. Their data showed it conclusively. As if the data weren't enough, they could see the sudden profusion of new "Credit Reporting Agencies" and all the "score borrowing" and "rapid readjust" nonsense going on.

They didn't want to see it. The FICO cohort that was falling apart represented the bulk of their profitable borrowers. This was not the sub-620 extreme or the low-profit Prime book. This was the thick part of their bell curve. FICO was gamed. FICO was junk. But question FICO and you yanked the emergency brake on the Gravy Train. So not only did they not question it, they started to rely on FICO almost exclusively. They started to insist on having as little OTHER data on borrowers as possible. When they asked for the Equifax reports, they stopped asking for the employment and income data. They started pushing "low-doc" and "no-doc" paper out the door as fast as they could. See no evil, hear no evil and make a buttload of money.

You'll find that all lenders - including the GSEs - raised their FICO score standards in the later years of the crisis - to no avail. FICO was no longer "objective". It had become the foundation of a scam. As Michael Lews writes of one of the people who saw through the scam:

[He] knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism.

A crisis like this is not an "'or' crisis". It's not a question of looking back and deciding whether this happened "or" that happened. It's an "'and' crisis". This happened "and" that happened but the "this" - the malplactice and fraud - predominated. Yes, there were stupid borrowers and stupid buyers of these securities (including the GSEs) at both ends of the line. But the cause of this crisis was pervasive malfeasance by the people in the private-sector, non-GSE business of selling American mortgage debt to borrowers and customers. Starting with the FICO, there was fraud at every step of the way up to and including the derivatives on the stuctured products. The willful ignorance and stupidity of borrowers and customers were just the whipped cream and cherry on top. We are living through the results what is the largest case of financial malpractice in human history - "malpractice" at best.

I'd call it "fraud".

This is why Paulson's plan's won't work: You can try every excuse in the world, but you can't fix this problem until you admit what it was and is.

Fraud.


May you live in interesting times

The End of The Era Of The Martingale

What do Barack Obama's election and the credit crisis have in common? They are both signals of the end of an era. They called it the "End Of History", and they were just as wrong as the phrase alone would lead you to expect they would be. But that didn't stop them. They were so sure of themselves that in the face of adversity, they just kept doubling their bets.

Didn't work out so well.

It was not just the now-central follies of ignoring the Kurdish Question, having too much confidence in Musharraff or the total blind faith put into the insane notion that somehow bankers would always tell the truth and be responsible that led us to the state we're in. It was a Culture War against doubt and intellectual skepticism itself. It was an iron-clad belief that what worked yesterday would always work. And in the waning year it became the nothing more than a Ponzi scheme depending on the emotional camouflage of the martingale.

The conservative business and political elite gave the world the message that they would back down to nothing short of total repudiation and that is very nearly what they've gotten. That is how martingale's always end: bankruptcy.

Does Socialism Make Smarter Capitalists?

I think that to understand the present crisis - I mean even to wrap your mind around it - you have to have been schooled in Marxism for at least some time. I really do. It's not that Marxism itself is so informative here, although highly selected and re-interpreted portions can be. It's that to understand what is happening now, you have to have learned - at some time - to look at the capitalist system from outside of it. You have to have wondered "what's next?" and tried to come up with something positive, rather than just catastrophe.

And it really helps if you have had the experience of rejecting doctrinaire Marxism and thus developing a deeper appreciation for capitalism. I theorize that this is why Jim Cramer has had such good instincts about this crisis. He was a red for a while back in his college days, I understand. And of course George Soros - another devout capitalist schooled, if unwillingly, in Marxism - has done really, really well.

Meanwhile his old partner Jim Rogers is floundering. High-powered investment bankers - like Henry Paulson - are confused. America's greatest living expert on deflationary crises - Ben Bernanke - has been slow to react after making an entire academic career around the observation that people in government - in his very position - were too slow to react in the 1930's. But European leaders - schooled in socialism, whether right wing or left - are acting with increasing clarity. Meanwhile high-powered people who have gotten so many things right - like Brad Setser, Nouriel Roubini and even Warren Buffett - seem increasingly baffled.

What they seem almost unable to really understand is simply this:



...and why it's happening.

That is a chart of the Dollar Index - a measure of the value of the U.S. dollar against major currencies. During this period, the U.S. government and now other governments have been pouring an supply of dollars and dollar credit onto the market that is not just unprecedented, but previously unimaginable. And these governments are doing nothing but announcing plans to keep on providing dollars as fast as they can for the foreseeable future. And during this period, the value of the dollar is going up - fast.

The law of supply and demand seems broken when it comes to the U.S. dollar. They supply and the world just keeps demanding.

I think the misunderstanding is based on some fundamental misconceptions, but who am I to explain things to the smart set? Let them figure it out for themselves, the big show-offs. I'm just going to predict that it's going to keep happening for a while and that is going to be really scary and bad. At the same time, the dynamic is forcing us to re-think the structure of our financial system and put some solid government backing behind it, which is a good thing. I think most of the major traded commodities and currencies are probably going to fall versus the dollar for quite a little while. Maybe even the renminbi will fall, although that is a currency highly subject to government intervention. Maybe even the yen will fall, although that is the currency of arguably the most-productive nation - person for person - in the history of the world. And, yes, maybe even gold will fall, although panic-buying gives gold the potential for incredible volatility, as we've seen. If you're not looking at the system from outside the system - questioning some of the common assumptions - I just don't think you could even be expected to see this coming.

Brad Setser has a wonderfully informative article about the "End Of Bretton Woods 2." on his blog. It's very good, although I'm not sure it explains why we've seen the reverse of some of his most important predictions. But in economics the same dynamic can have effects that seem the opposite of each other, particularly if they involve foreign exchange. He did get the timing of his crisis call very right. Nouriel Roubini did also and Roubini doesn't really need to get mechanisms quite right. He observes so many things about the world that he's incredibly informative and flexible. And Warren Buffett? I dunno, maybe his call on stocks isn't so bad, although I'm not sure his predictions of record profits in 5 years for some American corporations is necessarily all that meaningful if the majority are in the soup. Certainly unprecedented volatility looks like something we're going to have to get used to and people don't usually like having so much of their principal at risk.The point is that even people who saw a lot of risk in the American economy have consistently misidentified the likely results or come to make predictions that seem to ignore obvious risk.

To me, what looks clear about the world looks very clear and it's a strange experience. Every morning I wake up expecting everything to reverse course, but it doesn't. I'm usually terrible at making specific calls on markets and now even my call on gold doesn't seem so bad. Even the yen looks like it might be turning. That's pretty wild.

I hope I'm not right. I hope I'm really not seeing something important. Although the future does ultimately look bright to me, it's going to be pretty scary and people will be hurt. What can you do, other than...

...live in interesting times

The Panic of '08

Well, that's it. This is one of those "history book" moments. The weird part is that it will all be blogged

I almost wasn't going to write this story until I read a piece from Bloomberg that made it clear to me we were truly in the soup. The relevant paragraph is here:

Banks and investors who are losing money on the record $1.7 trillion of high-yield, high-risk loans made in 2006 and 2007 are charging borrowers an average of 1.64 percentage points more in interest to amend borrowing agreements and avoid default, according to Standard & Poor's. That's the highest since 1997 and almost eight times more than the first half of last year.

On the face of it, it doesn't seem like much. But if you know the history of this crisis, it's very disturbing indeed.

The break in the credit markets came first in the market for leveraged loans. These are loans made to companies that already have a lot of debt so there is very little capital backing them up - hence the leverage. The secondary market for leveraged loans was actually a pretty quiet place until July-August of 2007 when it just blew up. It was, Wall Street later told us, the financial equivalent of a 500-year flood. The first levee-breaks at the end of July 2007 was taken to be the first sign that subprime mortgage loans were destabilizing the credit markets.

But hang on, what's the connection between loans to companies and mortgages to people with poor credit? Well, the explanation that came out of Wall Street - very quickly - was that losses in the subprime market were forcing banks to reign in their lending and so they started this reigning-in in the leveraged loan market. The economy was doing well. The companies were sound. It was a credit crisis in another place that was causing the trouble in these loans. We didn't know that could happen. Interesting

First, Wall Street told us of a global market for debt. Then they admitted that the labyrinth of mutual bets the banks all made with each other in the derivatives market - particularly the Credit Default Swap market - made it so that trouble in one area of credit could quickly go to another. Then the story got wonkier. It was all about "mark to market accounting" which had been a very good thing the industry was pushing governments to adopt but was now a very bad thing the government was forcing on them. Wonkier still, they admitted that "actively-managed balance sheets" were moving credit losses from one area of business to another. In retrospect, they came up with all of it a little too fast. It should have struck me how quickly came the explanations, all supporting the story about how German banks were being sunk by California mortgages because we have all been made one big, happy family, by - yes, over-exuberant and certainly geeky, but business-sound - financiers....except that American mortgage borrowers are a bunch of deadbeats and ruined everything. I should have been even more skeptical and - given the people telling the story - even more cynical

Now it turns out that these maniacs in the financial industry were not only setting records in mortgage lending and derivatives, they were also setting records in risky loans to businesses. It's now becoming clear that the crash in the leveraged loan market has had quite a little bit more to do with the underlying soundness of those businesses than their banks first admitted. It looks like leveraged loans were the Business Class version of subprime.

If so, that's that. We're screwed. And I think it's so.

The only saving grace is that because these loans were made to businesses with plenty of lawyers and accountants, there was probably a lot less outright fraud than there was in the mortgage market. At the end of the boom, I'm not sure there were always even existing houses underneath some of the mortgages people wrote. We know for a fact they lent to dead people in some instances. It's harder to do that with a leveraged loan - but I'll bet they came as close as they could.

And I say we're screwed because it looks like - on top of all the other insanity - the genius-idiots of The City and Wall Street loaded up our most economically-sensitive businesses with piggy-back debt they were at pains to repay in good times. This assures us that as soon as the real economy turns down significantly, a wave of defaults from that supposed "500-year flood" will crash onto the financial sector. I had heard something about corporate loans having hurt one of the large banks recently in the news, but I thought it was a smokescreen for their mortgage losses. Now it looks likely they were getting killed by both mortgages and corporate loans.

And now so are we all.

May you live in interesting times

From Bloomberg:

"There's a dollar shortage globally,'' said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. ``Demand for liquidity trumps the fundamentals. Fundamentally, the U.S. is awful, and Europe is awful. Fundamentals are irrelevant today.''


May you live

Inconvenient Truth

Haven’t you heard? The United States dollar is toast. That sucker is going DOWN.

Short interest rates are incredibly low and no rational person thinks longer-term U.S. interest rates are headed anywhere but lower, given a looming, if not already-loomed recession. The American government is planning to borrow 5% of GDP on a single bailout package and that’s just one program added to an orgy of spending. The amount of dollar credit flowing out of central banks into the system worldwide is unprecedented. Gold is through the roof and the U.S. trade balance? Forget about it. It’s huge.

And we have been doing all this incredible stuff for at least a year now. So naturally, unquestionably, the U.S. dollar is finished - D to the O to the A. Cataclysmic inflation is moments away. Ron Paul’s face will be the only one we see on currency commonly used inside our borders within months. So long Kingsford, hickory chips and clean-burning propane. Hello dead, smoldering Presidents. Next summer, it’s “Grillin’ With Greenbacks”. Welcome to Weimar America. Enjoy the tangy, smoky, Fiat Flavor.

If you follow the financial pages, you have read this a minimum of a hundred times already, so surely you should have gotten the message by now. Everybody knows it.

Except, of course, that with all this unprecedented madness the dollar index is flat on the year, up 7% off its July lows.

But don’t get me wrong, here. Other than that one little inconvenient truth, the theory is ironclad. I mean it is bedrock solid. After all, the euro – the world’s next great reserve currency – okay the euro is down 8% off its highs but that’s not important. The point is that ours is now a multipolar world. Earth, she is a BRIC house. Mohamed El-Erian says it and he works for PIMCO.

PIMCO.

‘Nuff said.

And, again, other than the fact that three of the four BRIC currencies have fallen off the table (those being the ones that are actually traded in the marketplace), the theory is as beautiful as the Taj Mahal, as strong as a Russian oligarch and arguments against as scant as a Brazilian bikini.

It’s all about industrial production, you see. Note that the Japanese yen is up against the dollar about 4% this year. That may not seem like much, given the trade deficit between the two countries, and it is also 6-7% down from the highs,…making it seem like even less, come to think of it. But the point is that the yen has been the strong currency of a massive industrial powerhouse for decades and in that time the people of the world have been using it…okay, mainly to buy investments denominated in other currencies, but that is not germane because of...um…hang on, I’ll get it…

China! That’s it! The dollar is down decidedly against the Chinese yuan, no counter-trend, end of story. We all know it. China will dominate the world and soon we will all be using Chinese yuan to buy everything from alphabet soup to bicycles to…well…china. Of course because of currency and capital controls, we will not only have to use our yuan to buy from China but also in China, since that’s the only place on the globe you can actually spend Chinese yuan.

Wow, the lines are going to be murder.

But the important thing, Ron Paul reminds us, is that saving in a strong currency protects the value of your assets from inflation. Now, it’s true that Chinese wholesale inflation is at ten percent, but I’m sure that’s an anomaly. And by “anomaly” obviously I mean: “decade-long, upward trend.” But Chinese consumer inflation is at 5% and the Chinese Communist Party would never manipulate consumer prices to keep the Chinese people from getting upset or intervene in the stock market or anything like that. And by “would never” obviously I mean, “definitely would,” but...

Gold! Today’s gold coins come in convenient denominations between $900 and $900 and are accepted at all Sharia-compliant financial institutions, third-world bazaars and survivalist training camps. Gold has been money for 5000 years. Yes, the trend has been towards the acceptance of book-entry debits and credits over the last 700 of those years, but why be trendy?

The point is that the U.S. dollar is finished. You can read it in all the papers.

May you live in interesting times

Citizen Cramer

I’m watching the debates, listening to two smart guys try to pretend that a $700 billion intervention in the financial markets and a coming economic crisis doesn’t make all talk of “spending cuts” into a lot of hooey.

“Will somebody come on TV and tell the truth about how bad it is?” - Jim Cramer famously asked this about the fixed-income market crisis on August 6, 2007. If the Feds had listened - at least about the severity of the crisis - hundreds of billions could have been saved.

Since then, Cramer’s been stunningly right. But he started out stunningly wrong. And lately Cramer has been saying that there’s no time for hearings on the Paulson Plan.

Hmm.

Fortunately, in a surprise (imaginary) move, Congress has unanimously appointed me Chairman of the Joint Committee to Fix This Crazy Mess. Here’s a transcript of today’s proceedings, so tap the gavel and steamroll the witnesses along with me, won’t you?:

begin transcript

Chairman Bailey (I - WA) : The committee will come to order…(taps gavel)…order please…thank you…will someone get my good friend from the state of Washington, Mr. McDermott an oxygen mask or something? Calm down, Jim. Thank you.

I want to thank my good friends for reaching across the aisle and between the houses of the Congress and making it possible to convene this hearing in a spirit of bipartisanship and service to the nation. I am honored and even a little surprised to be your Chairman here today.

I want to thank the witnesses for coming on such short notice.

One scheduling note: the presentation by Representative Ron Paul, the Goldkopf Group and the Supreme Islamic Juridical Council of the Ulema on “Why Gold is God’s Chosen Currency and All Fiat Money is ‘Haraam’” has been moved to tomorrow. “Haraam” – did I pronounce that right Congressman Paul? Good. I’m sure it will be a fascinating.

With us now, we are honored to have our first witnesses, Secretary of the Treasury Henry Paulson and Federal Reserve Chairman Ben Bernanke. Thank you, gentlemen, for coming.

P & B: (inaudible)

Chairman Bailey: Be sure and move the microphones quite close to you, gentlemen.

I want to thank the Secretary and the Chairman for their opening statements and in the interest of time I move that these be submitted into the record so that we can proceed with questions.

Without objection?...so ordered.

Mr. Secretary, if I may start with you, it is the committee’s understanding that you are coming to the Congress of the United States, telling us you need seven hundred billion dollars to save the financial system. I assume you would prefer that in cash?

Paulson: (laughs) Um, well…-

Chairman Bailey: “Um, well,” what?

Paulson: (uncomfortable pause) …Well, Mr. Chairman -

Chairman Bailey: Your opening statement and previous testimony also indicate that you purport to require these moneys by….let’s see here…the end of the month. Is that right?

Paulson: The situation is-

Chairman Bailey: Secretary Paulson, approximately what percentage of the President’s fiscal 2007 budget would $700 billion represent – ex supplementals?

Paulson: Um, I guess…*shuffles papers** that would be about 25%.

Chairman Bailey: 25%, that’s right. And Mr. Secretary what percentage of the gross domestic product of the United States of America does $700 billion represent – in round figures?

Paulson: I think it would be about 5%, Mr. Chairman.

Chairman Bailey: Indeed it would. So is it fair to say, then, that you have come to the Congress of the United States telling us that you need an amount equal to 25% of the President’s official FY 2007 budget and FIVE PERCENT OF GDP, so that you, Henry Paulson, can personally save the financial system? Do I have those figures right?

Paulson: Well, the numbers…I mean, our staff will determine-

Chairman Bailey: -Get out.

Paulson: I beg your pardon, Mr. Chairman, I -

Chairman Bailey: Thank you for your testimony, Mr. Secretary. You’ve certainly given us a sense of the magnitude of this problem. Now you may leave.

Paulson: Um-

Chairman Bailey: Busy day, Mr. Secretary, let’s go. The door is over there. Don’t let it hit you on the way out….you lunatic.

(turns to staff)

Guy comes in here, with a straight face: “Can I have 5% of GDP please?” Oh, sure. Maybe you’d like an aircraft carrier with that? Would gray be okay?

Paulson: Ahem -

Chairman Bailey: Can't find the door, or just having trouble fitting your colossal nerve through it? There ya go, Mr. Secretary. Buh-bye.

[Paulson exits]

Now, Chairman Bernanke?

Bernanke: Yes, Mr. Chairman?

Chairman Bailey: Chairman Bernanke, can you draw up a list of the firms that claim to be threatened with bankruptcy unless we give Henry Paulson 5% of our nation’s gross domestic product?

Bernanke: Well, the situation is-

Chairman Bailey: I didn’t ask you about the situation. I asked you about a list. Can you draw up a list of these institutions – the ones that trouble you most?

Bernanke: Yes, I think I can put together-

Chairman Bailey: -Good. Now call those firms and tell them that I want their Chief Financial Officers in my office at nine o’clock Monday morning or they get nothing.

Bernanke: Monday, but these are busy people, and…

Chairman Bailey: -And we’re the American people. Monday at nine. Buh-bye.

(taps gavel)

The committee will stand in recess for thirty minutes.

(taps gavel again, 30 minutes later)

Chairman Bailey: The committee will come to order. Thank you.

I would like to thank our next witness, Mr. James Cramer.

Cramer: THANK YOU MR.-

Chairman Bailey: Whoa! Easy there, tiger. In your case, I think we want to push the microphone a bit farther away. Mr. Cramer, I’m going to ask that your opening statement also be added to the record.

Without objection?...so ordered.

Now Mr. Cramer. You have been very clever and very right about this financial crisis from the time of your – shall we say “passionate exhortation”, of August 6, 2007.

(all laugh)

Cramer: Thank you Mr. Chairman.

Chairman Bailey: But my staff has brought to my attention a broadcast of July 16th that same year – a webcast. In it you said and I quote “if every loan in 2006 that was subprime blew up - $500 billion - if they all blew up – you would still not notice…it has no relevance whatsoever…the tranching is the reason why there’s no impact….this is an issue that people want to really, really, really make a just a gigantic hill out of a molehill.”

Is it fair to say, Mr. Cramer, that you changed your mind about that?

Cramer: (laughs) Yes, Mr. Chairman. Very much so.

Chairman Bailey: In that July broadcast, you mentioned documents pertaining to the Accredited Home Lenders takeover. Do you remember doing that? Short answers here, Mr. Cramer.

Cramer: Yes I do.

Chairman Bailey: As I understand it, you used Accredited Home Lenders as an example of why the subprime issue was NOT going to be a huge problem. You suggested that one of the worst lenders in the country had a single-digit default rate and had issued a fairly small amount of debt relative to the marketplace. Is that a fair restatement?

Cramer: Of my words in July? Yes, Mr. Chairman.

Chairman Bailey: Now in your more famous August 6, 2007 broadcast you mentioned that Accredited Home Lenders document again, did you not?

Cramer: In terms of Fed President Poole, Mr. Chairman?

Chairman Bailey: Exactly, in terms of Fed President Poole. Only three weeks later, talking about the same documents you suggested – very loudly – that Mr. Poole should have more knowledge about this crisis - that he was “a shame” and “shameful” and that “he ought to go and read the Accredited Home Lenders document, at least I read the darn thing!”. I’m sure you remember that. So is it fair to say that in July of 2007 you had one attitude about the facts and figures revealed in the Accredited Home Lenders document and in August of 2007 you had another attitude about these same facts and figures?

Cramer: Well, yes the market-

Chairman Bailey: Did you say “yes”? Your attitude did change? You learned new information that changed your attitude?

Cramer: Yes, the Bear Stearns-

Chairman Bailey: So the answer is “yes”.

Now we are going to look at what changed your attitude, because what you have demonstrated, Mr. Cramer, has not only been rising concern, but an increasing disgust with the conduct of America’s financial community. I feel certain this may have some direct bearing on what kind of bailout will work and what won’t.

Mr. Cramer, in an article appearing on your web site July 29th of this year - again referring to Accredited Home Lenders as well as AIG and others - you wrote:

“The amazing thing about these CDOs is how different they are from the actual mortgage market.…These pieces of paper were simply set up to have tremendous losses if we get even 20% to 30% defaults….ultimately for the worst 2006 vintages, we could reach that because of the massive fraud and overvaluation that took place.”


In that same article, you wrote about: “bogus insurance” and you also wrote:

“Who the heck created stuff that could lose that much on mortgages that aren't defaulting anywhere near that?

The creators are a disgrace.

And they are probably making millions, because Wall Street can be an abject cesspool of ridiculously overpaid talent that has destroyed billions.”


Now you’ve been supportive of Mr. Paulson’s plan, Mr. Cramer. You have disparaged the need for hearings. But Mr. Cramer, when you write about a “disgrace”,
an “abject cesspool” producing “massive fraud,” “overvaluation,” and “bogus insurance,” that suggests to me there is something very rotten at the heart of this financial mess – something we need to have out if we are going to fix this - and that you, Mr. Cramer, have a pretty good idea what that something is.

Mr. Cramer, here is how nations solve these problems: somebody stops trying to be smarter than everyone else; stops worrying about reputation; stops doing his job, playing his role, acting out his part and starts being a citizen. Somebody just tells the truth about how bad it is out there.

Mr. Cramer in July of 1973 a smart lawyer kind of like you appeared before a committee kind of like this and started telling the truth about one of our nation’s greatest national crises. I am going to ask you a question kind of like the one he was famously asked:

Mr. Cramer, what do you know and when did you know it?

Cramer: (inaudible)

end transcript

May you live in interesting times

Why The Paulson Plan Won't Work

Make no mistake, something must be done quickly. WaMu, for example, may be just days away from bankruptcy. The Paulson Plan might possibly succeed in saving WaMu for another couple months. But I believe it will fail to save the financial system. I have been in favor of all the bailout efforts up until now, but the plan put forward by Secretary Paulson might be the worst approach possible. I can actually explain why with a single Wikipedia page. Honestly.

As you may know, the largest financial market in the world has crashed. No, you didn't read it in a headline when it happened. No, nobody in the government told you that it happened. The level of denial and disbelief has been astounding. But I am telling you, that it is 1929 and the market has already crashed. Forget the stock market, we're talking here about a market that is deeper in the heart of our financial system. You can see the crash start August 9th, 2007 in a chart of the LIBOR interest rate many know all too well:

The market was the market for American mortgages, mortgage-backed securities and contracts derivative of this market. Contrary to the irresponsible reporting that prevails in all but the financial press, selling mortgages is NOT a new practice, of course. It is many decades old. It helped get us out of the Depression. It is completely essential to our financial system. But right now, banks cannot sell their mortgages into a crashed market.

Thus the Paulson Plan's simple premise is for the government to start buying these mortgages, putting - they hope - a rational price on them when a crashed market has failed to. It seems reasonable. It would even work and I would support it wholeheartedly and shout down the critics if the problem in the secondary mortgage market was simply a lack of "liquidity" or money. But I fear the problem is different and must be addressed with different means.

As for Secretary Paulson himself, a cynical person might suggest that investment banker Henry Paulson, was previously treating America as his client - getting us equity when we extended credit - but is now treating the banks as his client and America as a "customer" - the lowest form of life for an investment banker. A cynical person might suggest that Paulson is simply "jamming bonds" down our throats. Actually a non-cynical person might suggest that also, because it's true. But let's get to the real problem.

The the real problem in the mortgage market is this guy:

Banks were inviting people into their used car lot of mortgages and saying things like:

"This one? Oh, this one's a beauty. It's a $500K mortgage on a house assessed at $510K, which we made to a guy with a 700 FICO score who makes $125K a year . Oh, and I will throw in an insurance policy on it that's worth $400K. Wanna buy it?"

And people bought.

But it turned out that the loan above was actually a $500K mortgage on a (then) $400K house with its assessment inflated by $110K made to a guy whose credit score had been inflated and who made...well, we really have no idea what he makes, but it's probably more like $45K. And that insurance policy? Yeah, turns out that was actually worth $0K - nothing. Hence, we the citizens now own 80% of AIG. Oh, and that house isn't even worth $400K any more, it's worth more like $300K and dropping.

So the market for these loans quite naturally dried up.

The banks were selling were Lemon Loans. And if you don't think "Lemon Loan" is strong enough and think something like "felony fraud" would be more appropriate, so do I. However, I choose "Lemon Loan" because of a theory for which some guys got the 2001 Nobel prize in economics, but about which Henry Paulson seems to have forgotten.

The Nobel-prize-winning theory is called "The Market For Lemons" and if you follow the link to that single Wikipedia page I promised you, you will see that the Nobel was for a paper which revealed why markets crash when they become filled with bad merchandise passed off as good merchandise. Of course we all know this through common sense, but you don't get Nobel prizes for common sense.

For comparison, let's use another little no-regulation nightmare and yet another market predictably destroyed by fraud: How many of you would buy powdered milk from China right now?

I'm sure China produces many tons of perfectly good powdered milk that would be healthful for anyone to drink. However, it has been revealed in the last few months that they have also been producing fraudulent powdered milk that has proven toxic to some children who drank it. If you are in the market for powdered milk you are not, I predict, going to spend the valuable money in your wallet on something with very uncertain value - Chinese powdered milk - something that might even be toxic. Likewise, America produces and can produce trillions of dollars in sound mortgages that would be wise investments for anyone to buy and own. However, it has been revealed in the last few months that we have also been producing fraudulent mortgages that have proven toxic to the balance sheets of some institutions who bought them.

Would you buy Chinese powdered milk simply because you read that Chinese government had started to buy it? I think not. Therefore, it is my belief that people in the secondary mortgage market are probably not going to start buying American mortgages simply because the American government is buying them. I think people are going to wait for proof that these mortgages are not toxic to their balance sheets before they put down cold cash. If we give buyers good information and sound guarantees, they may come back and buy. If we don't, I fear they will not.

To be technical for a moment, I think the information in the market for American mortgages became too "asymmetric" and thus the market reached a "no-trade equilibrium." This has caused a glut in the supply of high-risk assets so huge that portfolios simply cannot absorb them and maintain a normal risk-weight, let alone the more-conservative risk-weight they desire right now. I think this is also affecting other liquid, high-beta equities and credits. Here's the MSCI Emerging Markets ETF:

By the technical talk I mean that nobody will buy our mortgages until we turn ourselves from this guy:

into this guy:

I believe that the world desperately wants and needs safe American investments. If we are straight and honest with the world; if we reassure them with a next-generation financial information system; if we give them quality government guarantees; they will buy our bonds and mortgages. It will take a huge effort. Ultimately we may have to tell the truth about, and guarantee to the maximum extent possible, every non-fraudulent home mortgage in America. It sounds daunting, but only is such a project possible, it would bring monetizable value and innovation to our economy. It would allow us to survive a disaster which might otherwise destroy whole communities.

To those who would say "let the destruction happen" - you're simply being childish and foolish. We can't afford to lose an entire market every time some fraudsters get together and try to cheat people. We can't let the sleaziest capitalists in our system define the value of our markets. That's not a free market. That's anarchy ruled by villains.

If we the citizens act to bring honesty, information and government-guaranteed quality to our financial system, we can survive this. The choice is ours.

May you live in interesting times

Tidy Anti-Bubbles All Broken?

A trillion or so dollars in dollar-based credit = some promised, some delivered - will do that.

Ah well, back to fundamentals and maybe some brand-new bubbles. Nobody ever said this would be easy. Needless to say, the dollar short-term dollar shortage has been ameliorated.

Wow.

Long-term.

Doubt it.

But because the anti-bubble trends are threatened, while I still believe in the dollar-led deflation scenario, obviously it's a wait-and-see thing. Dollar index has been hit, through the 50-day MA, but still above the 100-day and nowhere near even July levels.



So maybe everything is still in place - except gold - but it's a shame. The trends were so nice and neat.


May you live in interesting times

Why I Got Gold Wrong

There should now be no question that America is in a deflationary crisis. Therefore, holding gold - a commodity - is fundamental financial insanity. And yet gold is skyrocketing. I missed the fact that, psychologically, people have little choice.

One always needs to look at one's ideas from different perspectives, especially when one feels surest about them and certainly when developments call them into question. So, I know a guy who does branding and I thought about it from his perspective.

I went through the asset classes, thinking in terms of a simple phrase that might characterize people's opinion of them:

Commodities: See "deflation" above.

Real estate/REITs: Are you kidding?

Mortgage-Backed Securities: Full of Lemon Loans, the whole problem. Next.

Corporate Bonds: Spreads too high, too much risk.

Municipal Bonds: No bond insurance, hurt by falling tax revenues.

Treasury Bonds: Yields INCREDIBLY low.

Foreign bonds: Nobody even knows how to buy them.

American Stocks: Cramer says "1987".

Emerging market stocks: 1987 or 1929, take your pick.

Even Money Market accounts are in trouble as the Reserve Fund "broke the buck".

That doesn't leave much. I come up with MAYBE European/Japanese stocks...and gold.

Gold is the only asset with - if you'll allow me - an untarnished brand.

Therefore, tragically, gold will go up and fast as people lose faith in other assets. It will also go up on the false, chimerical belief that somehow gold is money.

Here's how wrong is the idea that gold is money: Islamic law more-or-less mandates that gold be used as money and yet Islamic states issue fiat currency.

In the modern world, gold operates as a vehicle for currency arbitrage - a place to temporarily park your assets until you decide what currency you want them in. But it is a creature OF the currency system, not a backing for it and certainly not a substitute. For this reason the dollar index - despite unprecedented turmoil and low short-term rates - does little:



Once people decide they need that currency - to buy things - they sell their gold. And that's what people will do - en masse - when they start to need the money they have "saved" by buying gold.

In the meantime, goldbugs, have fun and, as ever...


May you live in interesting times

Here's A Headline You Don't See Every Day

Treasury 3-Month Bill Rates Drop to Lowest Since World War II

U.S. Treasury three-month bill rates dropped to the lowest since World War II as a loss of confidence in credit markets worldwide prompted investors to abandon higher-yielding assets for the safety of the shortest- term government securities.

Investors pushed down the rate to 0.0203 percent on concern that credit market losses will widen after the bankruptcy of Lehman Brothers Holdings Inc. and the federal takeover of American International Group Inc. In a sign of banks' reluctance to lend, the rates charged for short-term loans relative to U.S. bill rates rose to the highest on record.

Short-term rates basically MAKE the value of money in the foreign exchange markets. And yet with short-term rates at almost ZERO, here's the effect on the dollar:



Yes, it is back to the Monday morning opening price.

Lowest short-term rates since WW2, and the value of the dollar goes down to where it was all of Monday morning.

That's basically BANKERS saying: "we are so scared right now that we will give you all the dollars you want as long as you simply promise to pay us back what we gave you - no interest."

That is a statement that right now the ONLY thing serious people trust in the developed world is the United States Treasury bond.

I was so cheerful this morning. With AIG was bailed out and I thought maybe crisis was averted. I want change in this country and the world. I KNOW the changes we need and, interestingly, we are heading there - fast.

But I never expected - or wanted - for it to happen like this.

I think we cannot but surmise that The Crash has already happened and we are just sitting here, waiting for the tsunami.

May you live in times of great interest - or at least more than 0.3%

GOLDEN MADNESS!!!!!

GOOOOOOOOOOOLLLLLLDDD!!!

Okay, when I said trends would "pause" here, I might have thought a little deeper about gold, but then again I wasn't really expecting the existential threat to Western finance to come, you know, yesterday. That was a little sudden.

And although I had read the lunacy , that was starting go come out of the gold-crazy goldbugs, I didn't count on panic buying of gold to strike quite so hard.

Here is the chart of value of the dollar in that past couple days, showing DOLLAR SHORTAGE maintaining the price even in the face of total turmoil in the American financial system, and some Treasury bonds at rates not seen since World War 2:

: And here is the gold chart over the same period showing the GOLDEN MADNESS striking the markets today.

And here is the sequence as it is now becoming clear:

1) Lehman Brothers cracked open the stinking crypt of its books over the weekend and a horde of financial zombies leapt out and ATE WALL STREET'S BRAINS:

2) The WORLD saw that the Western Capital Markets were held in place by a rotten spiderweb called AIG and that AIG was failing.


3) They panic and Money-Market Rates Double Amid Global Credit Seizure (Bloomberg):

"I have never seen anything remotely like this. The money market was typically the one thing that always worked,'' said Luca Jellinek, head of interest-rate strategy in London at Royal Bank of Scotland Group Plc. ``It's the cardiovascular system of the financial body. When this happens, it's like a heart attack.''

4) AIG was rescued by the US government, giving markets a reprieve...aahhhh. Note the cool, refresing dollar-green of this text.

5) Banks, particularly in Europe looked at their books and realized that their very solvency was now - in a very real and immediate way - under the control of the BUSH ADMINISTRATION...(note here the alarming redness signifying possible shortage of dollars at the hands of laissez-faire idiots).

6) People went insane with panic and started to buy gold. [text color self-explanatory]

7) Goldbugs (and the venal, fiat-money-loving commodity traders who prey on their ignorance) went insane with happiness because it was the end of the world they had been predicting for so long had finally come and decided to buy, buy, buy.

I'm not a trader, but my thesis on these pages relies on their psychology. They will never try to "fight the tape" when it comes to madness like this - for good reason. If gold breaks out of the anti-bubble that major traded futures are in versus the dollar - or indeed any major commodities do - there is just as much of a possibility of another bubble as anything else. I doubt that it's happened yet, but it's possible.

If I sound dubious of my own words, see my post "It Begins" as an insight to bubble-market psychology. Bubble markets are an incredibly persuasive force, by definition. It's amazing. I know what I believe and yet the power of all this social energy works on my mind just as it works on everyone involved - although I'm not really involved.

May you live in interesting times

Gold Vs. Fiat Money - The Battle Begins

I had another one of those restless nights. I knew something was wrong, but I didn't know what. It was Gold. Of course it has always followed commodities. It's a commodity. In fact, it is the historical "master commodity". So my prediction that gold should go down was completely reasonable. But it troubled me.

Today, I turned on the computer and I saw it: GOLDEN MADNESS.

I was glib the other day when crossing foils with some goldbugs and I didn't feel good about it afterwards. I knew my thesis was holding up - better than ever - but there was something in their weird, anti-intellectual conspiiracy-theory enthusiasm that got to me. Something in their lunacy was echoing something sensible - however far away from their madness it might be. Even in lunatic conspiracy theory and nuttiness there is often value. The article is a weird, entertaining conspiracy theory about U.S. banks and commodities, but it had something in it that I noted with interest:

In July, India bought 22 tonnes of gold. In August, according to Reuters, India increased its gold purchases by more than 350%, buying more than 100 tonnes of gold.

This figure also represented a 56% increase in purchases when compared to purchases during the same month from a year prior. In Dubai, demand surged as well.

“We are definitely witnessing a surge in demand for gold in Dubai and physical shortages have been reported by many dealers,” said Ian MacDonald, the Dubai Multi Commodity Center’s executive director for gold and precious metals. “We are also seeing demand being driven by currency concerns in the region as many investors perceive the precious metal as one of the few strong currencies.”

Gold jewelry sales in Abu Dhabi soared 300 percent in volume and almost 250 percent in value in August from a year earlier after the metal dropped to nine-month lows, the emirate’s industry group said on Monday.

“It was the best month the market has seen in almost 30 years and it compensated for any drops we have seen earlier this year,” Abu Dhabi Gold and Jewelry Group Chairman Tushar Patni told Reuters.

There are big holes even in this data, but it reminds us of something very disturbing.

But first, a definition: Goldbug : A "goldbug" is a person who not only believes that gold is a good buy for market reasons, but believes that gold not only plays a huge part in the world financial system, but should and will inevitably play a larger part.

In the 1970's America on other developed countries cut any formal relationship between their currencies and gold in an agreement called "Bretton Woods". You'll find "Bretton Woods" listed under "Global Conspiracies To Undermine Rightness and Freedom" in the goldbug/loony-right-wing dictionary.

Ron Paul is the present day's most famous goldbug.

Karl Marx was a great goldbug of the past. Quoth Comrade Karl:

"Only in so far as paper money represents gold, which like all other commodities has value, is it a symbol of value."

Modern capitalist society is based on fiat money, so goldbugs are, naturally, those who do not believe that modern capitalism can survive. They inhabit a surprisingly big portion of the Right wing - all the way from Survivalists through Millenialists to serving Congressman and Presidential Candidate Ron Paul. On the Left, there is a very small fringe of anarchists and Old-Time Leninist/Maoist/Marxists.

I'm sure the Ron Paul fans and the Hard-Line Marxists and Anarchists would get on famously if we put them all in the same room. Let's try that someday.

But what does this gold madness mean?

It means that the situation is far worse than I thought. The disturbing thing we have to remember is that while in the developed world currency crises can cause a lot of displacement, in the developing world people die from them. I'm sure people in India and even Abu Dhabi have a cultural memory of times when the value of the little boxes of notes and coins representing people's life savings evaporated, the next harvest went bad, and they simply died.

Hence, the invention of the credit system, in about the 15th century.

In the modern credit system, even in the face of the kind of financial turmoil that comes once in a century and the prospect of future U.S. government borrowing the like of which we can't even imagine (especially if McCain somehow gets elected), the U.S. dollar is holding steady or going up. The euro is spiking up, the yen is spiking down, so there is no persuasive major-currency trend away from the dollar.

Gold, however, is going mental.

When reason leaves us and no answers come, all we have is fear. This is why we have to fix and EXPAND the modern fiat money system as fast as possible. People cannot be dependent on the value of notes and coins in a little jar. The metal they are made of doesn't matter.

Think of it this way: gold is very pretty and even useful sometimes, but it's also very weak. You can't build anything out of it.

What holds the world together is the labor and trust of people - human beings - Homo sapiens - US.

May you live in goldenly interesting times, goldbugs

Oh, THANK Goodness!!!

Jim Cramer made this shocking point today about and existential threat to the "world capital markets" if AIG was allowed to fail.



Amazingly, against all their principles and in a singularly-rare show of rationality by this Administration, the Feds saw the light!!!

Federal takeover of AIG planned

Federal officials reportedly may take 80% stake in the nation's largest insurer in an $85 billion rescue plan to prevent financial chaos worldwide.

NEW YORK (CNNMoney.com) -- The federal government is reportedly on the verge of taking over crumbling insurer American International Group in an $85 billion deal that could leave the company in the Federal Reserve's hands.

Probably up to a trillion dollars of AIG's obligations will be backed up by the American government and the world's financial system can go on another day.

Thank goodness!!!

May you LIVE in interesting times

You Stupid Bastards

How could you let this happen?

All night a question kept eating at me: "Why are these mortgage-backed securities and derivatives not worth more?"

There are real HOUSES underneath them, right?

I couldn't figure it out.

I couldn't make the numbers work.

They HAD to be worth more than the mark-down price. It just made no sense. The securities are trading for less than the underlying collateral. They had to be worth more.

Had to.

And then it hit me.

Folks, it's not that we should be anticipating The Crash, our worry should be that The Crash Has Already Happened.

After the crash of '29, people had the same question: "Why aren't these stocks worth more?" And the answer was that they were, in fact, trading well below their "intrinsic" value, but there was nobody there to buy them. The modern stock market was a relatively new institution. People simply lost faith in it.

While the more-or-less modern market for mortgage securities is at least 40 years old, most people don't understand it - just like stocks in '29. While the 20's roared for the smart set, most people lived out in the countryside. By the time they heard about the stock market, it was crashing or just about to. I daresay there are a great many VERY smart and well-informed people who cannot tell you what MBS, RMBS, CMBS, CDO, CMO and CDS mean, although these terms are not even thought to be exotic any more. Relative to these huge, modern, international mortgage securities' market, most people just plain live out in the countryside.

The market for American mortgage-backed securities WAS the most-liquid market in the world - even more liquid than treasury bonds. But most people - even very smart people - poo-poo this "securitization" as something new and somehow false. It's not. We all depend on it, actually. We have big government agencies that make sure that at least half of it is guaranteed and keeps running - Fannie and Freddie.

But I really am beginning to come to the conclusion that the private side of the mortgage-backed securities market has crashed completely. By that I mean, it is in a deflationary spiral where nobody will buy, even though there is "intrinsic" worth there. Why do I keep putting "intrinsic" in quotes? Because something is only worth something if somebody is there to buy it. The assumption is that because these securities represent real flows of cash payments, of course people will buy them. But those cash payments have to flow through financial institutions and those institutions over-leveraged themselves and now.....?

Well, you can think of it this way:

Banks must loan money to keep functioning, ideally safe loans.

At today's cut-rate prices, mortgage-backed securities should be, in effect, among the safest possible loans there are.

So what does it mean when banks WON'T make even the safest possible loans?

It means they must be, in effect, out of money.

And that's really bad.

And these stupid bastards have a small window left to save it - and I'll just bet you they won't because they have this weird belief that an "Invisible Hand" is going to fix it all for them.

May you live in SIGNIFICANTLY less interesting times than these