Weekend Economists--The Blue Light Special November 28-30, 2008

[Demeter]

Welcome shoppers! With Thanksgiving under our belts (that's a joke, son) it's time to pump up the economy! After all, there are only 52 shopping days left until the Inauguration! Browse both sides the aisles for a wide selection of appointees. Check out our Indictments! Everything from Stoops to Nuts in the Bargain Basement, on Clearance now. Everything must go by January 20th so come in before it's all gone!

Ahem. Too much alcohol in that punch. Or maybe it was the cough syrup.

Anyway, see if you can make heads or tails of the events this week. Post them if you've got them.


U.S. FUTURES &
MARKETS INDICATORS>
NASDAQ FUTURES-----------------------------S&P FUTURES

[Hugin]

1. Excellent thread so far!

Keep up the good work. :)

[Demeter]

3. You Are Such a Card, Prag!

Or is it cad, that I meant? Happy Weekend!

[Demeter]

2. Sudden Debt: Can the US Do An IMF On Itself?

http://suddendebt.blogspot.com/2008/11/can-us-do-imf-on-itself.html

In previous years and decades whenever a third world country would get into financial difficulty it would turn to the IMF for a bailout. Because of the way the global financial system was structured in the post-Bretton Woods era (World Bank, IMF, WTO, etc.), the US was always in the forefront of such efforts. The bailout examples are numerous and well known: Latin America, Mexico, Asia, Russia. By and large the process worked pretty well, based on the premise that in an interconnected world if your neighbor's house is on fire you don't haggle about the garden hose.


Let's explore this fire simile a bit further.

Picture the US as the Global Fire Department (GFD). In the last ten years or so the GFD became extremely irresponsible. It ignored the fire safety of its own firehouse, which became choked with highly flammable material (i.e. debt and derivatives), and relaxed the rules about the health and fitness of its firemen (i.e. oversight and regulation were weakened).

Seeing this, the good citizens in the neighborhood (i.e. other western nations) also adopted the same attitude. And why not? If the fire department itself didn't care about all that dead wood and turpentine piling up in its own back yard, why should they? A whole raft of nations from the UK and Australia, to Bulgaria, Poland, Iceland and Romania bought the same highly flammable "growth" model. Borrow - spend - inflate assets - borrow.

It was only a matter of time until a fire started somewhere. Unfortunately, it started in the worst possible place: the GFD firehouse itself. Predictably, the unfit firemen could not contain it and the fire quickly spread to the rest of the town. So, who's going to put it out now and how?

The current plan is to take all that dry firewood and turpentine and stow it someplace else: to replace and guarantee private debt, plus issue additional government debt. But with the entire town now threatened by the blaze, that's just a delaying tactic. What we need is less wood and less turpentine, plus more, better and smarter firemen. And even that's not enough. The entire town should get together to fight this fire before it scorches everything in its path.

Previous IMF bailouts transferred some of the risk from, say, Mexico or Argentina to the IMF (essentially, the US) by providing fresh loans and guarantees. By current standards, the sums involved were tiny: $20-50 billion.

But the US cannot perform a similar IMF bailout on itself, as it is currently attempting to do. The United States IS the IMF. Astronomical guarantees and bad-asset purchases merely transfer and spread out the problem internally, instead of solving it. There is simply way too much debt; too much dead wood, too much turpentine and, naturally, no one else wants it in his back yard. Just think of China, Japan, the Gulf States or Russia and how much US debt they have already piled up. How much more "firehouse debt" are they willing to accept, particularly when the flames are already licking their own houses?

What we need right now is water: a.k.a. debt liquidation. And the longer we fail to recognise this simple fact, the longer we fail to provide it, the worst it's going to get later on.


Can Old Dogs Learn New Tricks?


President-elect Obama is currently hiring firemen, his economic policy team; and it doesn't look good. They are the exact same bunch that let the firehouse get full of tinder in the past, if they didn't necessarily also strike the match. I sincerely hope they can teach new tricks to old dogs - but does Larry (Summers) look trainable to you? Woof.

Final thought (and Happy Thanksgiving to all): Turkeys destined to become roasters think they live in gobble heaven, right up to the point they turn into Butterballs. We got to change the way we look at things folks, and the past isn't necessarily the best guide to the future.

[Demeter]

10. I Think I'll Give This One to Ozy!

He is the man in charge of putting out fires around here. He should appreciate it.

[Demeter]

4. Analysis of the Citibank Scheme:Scurvon Investing: C Bailout

http://scurvon.blogspot.com/2008/11/c-bailout.html

A bunch of notes on Citi and its bailout (FT, WSJ1, WSJ2, Bloomberg, NYTimes, a research report from Guy Moszkowski of Merrill Lynch titled "Cutting PO to $6, Retain Underperform rating").

* The government and Citi are creating a pool of $306 bln of problem assets. The pool will include any reserves Citi has taken against those assets. Once the reserves are exhausted, Citi will be on the hook for the first $29 bln of losses. Thereafter, the government will take 90% of any losses with Citi picking up 10%. The mechanics of the government's guarantee are a mess - Treasury will take the first $5 bln of losses, then FDIC will take $10 bln, and then then Fed will provide a 'loan' for the remaining assets. If the assets are worth nothing (and the reserves are zero), C's maximum loss is $56.7 bln and the government's is $249.3 bln. Which assets exactly will be in the pool is one of the details that has yet to be worked out (though it is expected to include residential and commercial mortgage backed securities). Without knowing what assets are in the pool or how much C has reserved against these assets, it is impossible to guess at what actual losses might be. It is obviously in C's interest to pick assets facing significant losses with minimal reserves.
* The Treasury will purchase $20 bln of preferred shares and the FDIC will get another $7 bln of preferred. The shares will be pari passu with other preferreds. The dividend on these shares will be 8%.
* The government will receive warrants with a strike price of $10.60 representing 4% of diluted shares. The government will own 7.8% of C after the capital injection. It isn't clear whether this number includes the warrants.
* The company's Tier 1 capital ratio will be 14.8% after this deal, up from 8.2% at the end of Q3.
* C has now raised $50 bln from the private markets and $25 bln from the TARP. Common equity has declined by $28 bln, while total equity (including preferreds) is down by only $1 bln.
* C has $2 trln of assets on its balance sheet. In addition, the company has $122 bln of off-balance sheet exposure even after consolidating $17 bln last week.
* Total deposits peaked in Q1 at $831 bln, and fell to $780 mln at the end of Q3 (given the large international exposure, one wonders about the effect of exchange rates on those numbers).
* Ratings agencies aren't yet convinced this bailout will fix C's problems and have threatened to downgrade the company. Losing its credit rating could affect the company's ability to conduct business with counterparties and could immobilize the business.
* C's dividend is restricted to 1 cent per quarter for the next three years.
* This deal is similar to the deal C had struck with the FDIC to acquire assets from Wachovia. That plan was upended when Wells Fargo bid for the company. It appears a lot of the thinking applied to the original deal was used in structuring this one.

So what is wrong with this deal?

* There is no program or rationale guiding the government's actions.
* It doesn't guarantee that C won't need more money, and there is no plan for if (when?) it does.
* It doesn't address the concerns of the ratings agencies.
* Taxpayers are almost sure to suffer losses under this scheme. The equity in C owned by the government is clearly inadequate compensation for these losses. It seems indefensible that existing shareholders benefit from the government's losses.
* Many of C's problems are of its own making. The absence of a request for changes in management appears to condone the practices that have led to this bailout.
* If C can obtain aid on such preferential terms, it is likely that other banks will want the same.
* There is nothing to guarantee depositors will stay with C. In the case of Washington Mutual and Indymac, it was a run by depositors that finally did the firms in.

[Demeter]

14. Familiar Trio at Heart of Citi Bailout: Rubin, Paulson, Geithner's Shared History Paved Way

http://www.washingtonpost.com/wp-dyn/content/article/2008/11/24/AR2008112401118_pf.html




By David Cho and Neil irwin
Washington Post Staff Writers
Tuesday, November 25, 2008; A01



The bailout of Citigroup, which put the government at risk of hundreds of billions of dollars of losses, was set in motion by three men whose professional lives have long been intertwined.

Treasury Secretary Henry M. Paulson Jr.; Citigroup board member Robert E. Rubin; and Timothy F. Geithner, the president of the Federal Reserve Bank of New York, have for years followed one another in and out of jobs in government and industry. Their close relationships helped pave the way for one of the largest and most dramatic government interventions to date in the financial crisis.

The bailout, announced late Sunday night, was designed to make a statement, officials said. In agreeing to protect Citigroup against potential losses on a $306 billion pool of troubled assets, the government made clear that it was not going to allow one of the nation's largest financial firms to collapse.

Yesterday, the markets cheered the rescue, sending Citigroup's shares soaring 58 percent while the Dow Jones industrial average climbed 4.9 percent, or 396.97 points.

The bailout came only days after Paulson made comments that many in the financial markets took to mean that he would leave any future bailouts to the Obama administration. But once Citigroup's stock price plunged 60 percent last week, Rubin, an old colleague from Goldman Sachs, told Paulson in phone calls that the government had to act, according to industry sources familiar with their discussions.

MUCH MORE AT LINK!

[Demeter]

25. Mirabile Dictu! Rubin Takedown by the Wall Street Journal!

Yves does a reaction at her blog:

http://www.nakedcapitalism.com/2008/11/mirabile-dictu-rubin-takedown-by-wall.html

on the original article in WSJ:

http://online.wsj.com/article/SB122791795940965645.html

[Demeter]

5. Too many cooks in Obama’s economics kitchen

http://blogs.ft.com/maverecon/2008/11/too-many-cooks-in-obamas-economics-kitchen/

President-elect Barack Obama will not be short of economic advice. Little of that advice will be unanimous. The Byzantine complexity of the White House economic policy-making machine means that a range of institutions and individuals will be pushing, pulling and shoving in different directions. With a new President who knows little if anything about economic matters, the adviser who comes out on top in the internecine struggle to be the Alpha-Adviser will effectively be running US economic policy. What are the institutions and who are the people in this play? Will it be drama, tragedy, comedy or farce?

1. The US Department of the Treasury. Here Obama has nominated Timothy Geithner, the current President of the New York Fed (a position he has held since 2003), to be the next Treasury Secretary. He was Under Secretary of the Treasury for International Affairs (1998–2001) under Treasury Secretaries Robert Rubin and Larry Summers. He spent the years 2001-2003 at the IMF as Director of the Policy Development and Review Department (aka the Pain Department).With Paul Volcker he is the only one of the inner circle of economic advisers without a Ph.D. in economics. I leave it to the reader to decide whether this is an advantage, a disadvantage or an irrelevance. One crisis-related development that will strengthen the hand of the Treasury Secretary in the war for Obama’s ear is the fact that the Treasury and the Fed have, unavoidably, become a seamless web. With rate cuts all but exhausted as an instrument of monetary policy in the US, quantitative easing is the main monetary policy instrument. This means the Fed increasing the size of its balance sheet by purchasing private securities, and financing these purchases by expanding the monetary base (bank reserves with the central bank). The scale on which the Fed is now acting as direct purchaser of private securities is massive. It also results in a large and growing exposure of the Fed to credit risk (default risk). The Fed is of course also exposed to private sector default risk through the private securities it accepts as collateral in its repos, at the discount window and in the ever-expanding number of special facilities it has created. Should the risk taken on by the Fed materialise, it is essential that the Treasury stand behind the Fed to recapitalise it. Without such tax payer support, the Fed can only repair a hole in its capital base by monetary issuance. Under current conditions, with liquidity preference just about unbounded, this would not present a problem. But when normalcy returns, in two or three years, such forced liquidity injections could become excessively inflationary. The Treasury must therefore stand behind the Fed, ready to indemnify it for losses it incurs as part of its lender of last resort and market maker of last resort roles. This symbiosis strengthens the position of the Treasury and the Treasury Secretary.


2. The National Economic Council (NEC). The NEC was created in 1993 by president Bill Clinton as part of the Executive Office of the President. The Director of the NEC is also Assistant to the President for Economic Policy. According to its website “It was created for the purpose of advising the President on matters related to U.S. and global economic policy. … the NEC has four principal functions: to coordinate policy-making for domestic and international economic issues, to coordinate economic policy advice for the President, to ensure that policy decisions and programs are consistent with the President’s economic goals, and to monitor implementation of the President’s economic policy agenda.” The NEC has become what the Council of Economic Advisers used to be. It was indeed, as far as I can tell, created because the CEA was increasingly perceived by the White House as to independent – a bit of a rogue elephant. The significance of the office depends on the interest of the president in economic issues and on the personality of the Director. Until I did the background research for this post, I had never heard of the current incumbent, Keith Hennessey. On the other hand, the Director could take on the role taken by Henry Kissinger when he Assistant to the President for National Security from 1969 till 1975. Before he become Secretary of State (a position he held from 1973 till 1977), he completely overshadowed the Secretary of State William P. Rogers. The NEC will be headed by Larry Summers. Adding Larry to a team is like putting a whale in an aquarium. There won’t be much room for independent movement for the other creatures supposedly sharing the same space. There must be a real concern that Summers will (try to) do a Kissinger to Geithner’s Rogers.


3. The Council of Economic Advisers (CEA). This is the academic wing of the President’s advisory councils edifice. The Chair and the two other members tend to serve short terms (typically 2 years) after which they return to academe. They tend to operate with one eye fixed on their past and future academic hunting grounds. Not losing academic cred is important to most CEA members. This occasionally leads to manifestations of independent thinking, and even to independent statements to the public or the press that embarrass the administration. Martin Feldstein made himself deeply unpopular with elements of the Reagan Whitehouse during his tenure as Chairman of the CEA and Chief Economic Adviser to president Reagan (1982 through 1984), when he kept objecting privately and in public to government deficits. The CEA has become steadily less influential since then. Christina Romer, a professor of economics at the university of Berkeley and a monetary historian has been nominated by Obama to Chair the CEA. She has no previous economic policy experience. Austan Goolsbee, a Chicago professor of economics who is close to Obama, will be a member of the CEA as well as Chief Economist to the Economic Recovery Advisory Board.


4. The Economic Recovery Advisory Board (ERAB). This is a new creature, modelled on the President’s Foreign Intelligence Advisory Board, established by President Eisenhower in 1956. It is a collection of the great and the good from outside government, and is supposed to provide the President with independent advice (whenever you hear the word ‘independent’, always ask: independent of whom and of what?). Paul Volcker has been appointed to head the ERAB.


5. The Office of Management and Budget (OMB). This is a Cabinet-level office, within the Executive Office of the President of the United States. Through it the White House oversees the activities of federal agencies. The OMB also gives expert advice to senior White House officials on federal policy, management, legislative, regulatory, and budgetary issues. Obama has nominated Peter Orszag, currently Director of the Congressional Budget Office to be Director of the OMB. Orszag’s self-confidence is in the Summers league. It will be interesting to hear them clash, even from a distance.


As far as I can tell, Jason Furman, who played an important role in Obama’s campaign, has not yet been given an official slot in the White House political economy edifice, but he is unlikely to disappear from the scene. Also, the identity of the new US Trade Representative, a key appointment for a Democratic party that reeks of protectionism, is not yet known.

So much for the president-elect’s own economics team. He can also count on counsel from the Chairman of the Federal Reserve Board, Ben Bernanke and the other Federal Reserve Board members. My first impression is that, with Geithner, Summers, Romer, Goolsbee, Volcker, Orszag and Furman, we have too high a ratio of ego to team spirit. I foresee a significant diversion of effort and time from the design and implementation of policy to fighting over turf. I hope to be proven wrong.

Even if the President’s team come up with a common recommendation, getting it through the Congress will not be trivial. Although the Democrats will control both houses and may have a filibuster-proof majority in the Senate, party discipline tends to be dreadful when there is a large majority. And the interests of the House and the Senate are not necessarily aligned with those of the White House. Reaching agreement on any economic policy will not be easy (never mind reaching agreement on the right economic policy).

Some may call the organisation of economic advice and competencies in the White House ‘checks and balances’, or ‘letting a hundred flowers bloom’. Others will call it institutional balkanisation and a recipe for organisational chaos and incoherent policy making. We shall see.

[Demeter]

6. I've Found the Perfect Gift for Tansy Gold!

ATLAS SHRUGGED
UPDATED FOR THE CURRENT
FINANCIAL CRISIS.

BY JEREMIAH TUCKER (an ebook)

http://mcsweeneys.net/2008/11/20tucker.html


Shh! Don't let her know!

[Hugin]

13. Oh, I agree!

The perfect stocking stuffer!

:bounce:

Mums the word!

[Tansy_Gold]

16. too late!

I'll take a look when I finish my paying work. . . . .


Tansy Gold, who should be doing that work now and not reading WE.

[Hugin]

17. Oops!

Happy Holidays Tansy_Gold!

:)

It's funny and over-the-top, but, also carries the pathos of being true. (I still liked your sequel better.)



Edit: Geeze, I've still got Needtoeditosis.

[Tansy_Gold]

20. Hi, Prag! (Hi, Demeter!)

:hi:

Well, it's cold enough here in AJ that my fingers are stiff and not cooperating very well so I have a great deal of sympathy with the needtoeditosis.

Of course it's over the top. Good satire is. But it's also sooooooooooo true to the original!

Mine was dull and serious. :-(

I see, however, that MANY are raising questions about the construction of Obama's economics team as a bunch of recycled -- or should I say trickled down? -- Greenspan students/proteges. Hmmm, maybe the old TG ain't so stupid after all? :evilgrin:

Okay, back to the grindstone....


Tansy Gold, for whom DU is like a trip to the water cooler

[Demeter]

7. AIG Plans to Pay Retention Bonuses to Executives

http://www.nakedcapitalism.com/2008/11/aig-plans-to-pay-retention-bonuses-to.html


How can you give cash compensation to an executive, yet claim it is not a salary or bonus? You call it a "retention bonus," No, I am not making this up.

Note that AIG chose to make this disclosure the day before Thanksgiving, clearly choosing a time when it would attract the least notice. Not that it really matters. The talk about restricting executive compensation to bailout recipients has been just that, talk.

From the Financial Times:

One day after announcing strict limits on salaries and bonuses for its top tier of executives, AIG revealed that some of those executives will receive millions in “retention bonuses” next year...

The retention bonuses for 130 key executives were disclosed by AIG in September, after the US government rescued the firm from bankruptcy by purchasing 79.9 per cent of the company for $85bn. After the government takeover, Edward Liddy, the former Allstate chairman, was named chief executive and AIG offered retention bonuses to Mr Wintrob, head of AIG’s retirement services division, among others....

The company announced on Tuesday that Mr Liddy would be paid a salary of $1 for 2008 and 2009, and that Paula Rosput Reynolds, who joined AIG as chief restructuring officer in October, would receive no salary or bonus for 2008.

The company said the other five members of AIG’s seven-member leadership group would not receive annual bonuses for 2008 or salary increases through 2009.

AIG also said that the company’s senior partners, about 60 executives, would not earn long-term performance awards in 2008, not earn salary increases in 2009, and that the group’s annual bonuses would be limited.

An AIG spokesman said on Wednesday that retention bonuses were different from the annual bonuses included in Tuesday’s statement. In September, Mr Liddy pledged to sell off significant portions of AIG’s international operations in order to pay back the government loan. The company said at the time that retention bonuses would be necessary to maintain continuity and value at various AIG units.

“Retention bonuses are a better alternative for the repricing of option awards so long as they are reasonable, fully disclosed and truly needed to retain talent,” said Richard Ferlauto, director of corporate governance and pension investment at the American Federation of State, County and Municipal Employees union.

“But in this market we don’t see much clamour for executives who made big bets, cannot make risk and were paid more than they are worth,” he added.

Do you really believe, with massive deleveraging and all sorts of big financial firms, including insurers, teetering, that AIG executives have great employment prospects these days? But the bigger issue, as far as I am concerned, is the misrepresentation, trying to claim that AIG was forgoing significant senior level comp, only to learn that they define terms a bit differently than the rest of the world does

[Dr.Phool]

28. I think it's time for those severence packages.

You know the ones I'm talking about.

Of all the fricking nerve!

[Demeter]

38. You Won't Get an Argument From Me!

After you, Gaston!

[Tansy_Gold]

44. And I have knitting needles and yarn to spare!

Allons, mes amis!

(Uh, for Ghost Dog's benefit, that's ¡Vamos, amigos!) :evilgrin:

[Demeter]

8. The Parable of the Troubled Assets Relief Program (Putting the X in Xmas)

http://www.creditbubblestocks.com/2008/11/parable-of-troubled-assets-relief.html

Then went the CNBC executive producers, and took counsel how they might entangle him in his talk.

And they sent out unto him the Money Honey saying, Master, we know that thou art true, and teachest the way of God in truth, neither carest thou for any man: for thou regardest not the person of men.

Tell us therefore, What thinkest thou? Should Congress extend the Troubled Assets Relief Program to Paulson?

But Jesus perceived their wickedness, and said, Why tempt ye me, Maria Bartiromo?

Shew me a dollar bill. And a CNBC network intern brought unto him a dollar bill.

And he saith unto them, Whose signature is this on the bill?

She said unto him, The Secretary of the Treasury, Henry Paulson's.

Then saith he unto them, Render therefore unto Paulson the things which are Paulson's; and unto God the things that are God's.

When they had heard these words, they marvelled, and left him for a commercial break.

[Demeter]

9. Insight: US debt puts strain on dollar By Chris Watling

http://www.ft.com/cms/s/0/9790f1ba-bbe0-11dd-80e9-0000779fd18c.html



The outlook for the dollar is poor.

In the short term an expected equity market rally, quite plausibly the beginning of a cyclical, although not secular, bull market should bring an end to the dollar’s recent “repatriation rally”. The inverse correlation of the dollar and the S&P 500 is well established and not expected to break any time soon, given the global macroeconomic backdrop. The short term trend should be further reinforced by the broken financial system which impairs the US economy’s ability to releverage and mutes the strength of its cyclical recovery. The inability to releverage precludes the US from leading the global economy out of this recession. That also reinforces the dollar’s short term unattractiveness.

In the medium term, the US economy faces significant, albeit not insurmountable, structural problems. In particular the interaction of a heavily indebted economy with a broken financial system suggests a decade of poor domestic economic growth as savings are rebuilt and trust in the system restored. The US is a debtor nation and owes the rest of the world more than $2,000bn (up from $750bn as recently as 2000). Indeed both the household and the government sectors have been dis-saving in recent years – a trend that now needs to reverse. All of which suggests an extended period of sub-par domestic economic growth.

There are two distinctive policy choices for an overly indebted economy when confronted by a breakdown in the financial system. Which is chosen can have a significant impact on the long term outlook for the currency.

Policy choice 1 – do nothing and allow the economy to work itself out with a severe recession or even depression, with a cleaning out of the system as weak companies fall into bankruptcy, leaving strong companies and a base from which to build recovery.

Policy choice 2 – use all policy tools available to attempt to stem the downturn.

Choice 1, not surprisingly, is considered politically unpalatable as millions of people lose their jobs and many companies go bust. Choice 2, while seemingly more palatable, carries far greater risk. If it doesn’t work it sows the seeds for a decade or more of disappointing growth as savings are rebuilt slowly and the pain of the adjustment prolonged. If it does work it sows the seeds for significant inflation.

MORE AT LINK

[Demeter]

11. Stocking Stuffer For the Men of WE and SMW:

We have no longer just a crisis in the financial system....The western (north-Atlantic) financial system we knew has collapsed. If I may paraphrase that great ensemble of Nobel-prize winning financial wizards, Monty Python’s Flying Circus:

“This financial system is no more! It has ceased to be! ‘It’s expired and gone to meet its maker! ‘It’s a stiff! Bereft of life, it rests in peace! If you hadn’t nailed ‘it to the tax payer’s perch it’d be pushing up the daisies! ‘Its metabolic processes are now ‘istory! ‘It’s off the twig! It’s kicked the bucket, it’s shuffled off its mortal coil, run down the curtain and joined the bleedin’ choir indivisible!! THIS IS AN EX-FINANCIAL SYSTEM!!”


http://www.nakedcapitalism.com/2008/11/western-financial-system-we-knew-has.html

MORE SERIOUS COMMENTARY AT LINK. ENJOY, GUYS!

[Demeter]

12. Here's A Little Something for AnneD: Income Elasticity of Mistress Demand

http://gregmankiw.blogspot.com/2008/11/income-elasticity-of-mistress-demand.html


From the Wealth Report:

You know times are tough when the rich start cutting costs on their mistresses. According to a new survey by Prince & Assoc., more than 80% of multimillionaires who had extra-marital lovers planned to cut back on their gifts and allowances. Still, only 12% of the multimillionaire cheaters said they plan to give up on their lovers altogether for financial reasons.


(CAN YOU IMAGINE WHAT KIND OF INTERROGATOR IT TAKES TO ASK THESE KINDS OF QUESTIONS OF THAT CLASS OF MAN? MAYBE WE COULD GET THEM TO MOONLIGHT FOR OBAMA'S JUSTICE DEPARTMENT. FITZGERALD CAN'T DO IT ALL HIMSELF!)

[AnneD]

32. Gee, and I haven't had the chance to pick you anything yet.......

Roland and I can share this......we are always fighting over who owns the street corners. I guess things are tough all over-but believe you me-that info was easy to pry from those guys. Lubricate their tongues with a few strong drinks.

I have been to a few high roller gatherings and watched more than a few get shit face drunk. They know wifey won't leave their meal ticket nor will their mistress, who sees them as a gravy train. But before I sound too cynical-the same thing it takes to be successful in business can be applied to a marriage. Most of the really well to do that I know are very married and seldom stray (unless they have prenups.)

[Demeter]

15. Steve Waldman on Good and Bad Financial Innovation

http://www.nakedcapitalism.com/2008/10/steve-waldman-on-good-and-bad-financial.html


Steve Waldman has a longish and very useful post "I sing the praises of financial innovation" in which he seeks to identify some good and bad financial innovation
http://interfluidity.powerblogs.com/posts/1224388192.shtml

(I very much support Martin Meyer's observation that, for the most part, what is called financial innovation is finding new technology that makes legal what was illegal under the old technology).

You must read his entire post, but I wanted to focus on the key bits. Here is the list of innovations he likes:

Exchange-traded funds
The growth of venture capital and angel investing
The democratization of access to financial information (e.g. Yahoo! finance)
The democratization of participation in financial markets (e.g. the growth of internet and discount brokerages that offer easy access to a wide variety of stocks, bonds, and exchange-traded derivatives, both domestic and international).


I can add one to his list:

Electronic order placement

Frankly, it is a luxury to be able to place a limit order at 3:00 AM anywhere in the world.


And his section on bad innovations:

Obviously at the top of the list go CDOs, CPDOs, OTC credit-default swaps, the general alphabet soup of the structured finance revolution. (I would not, however, put all mortgage or asset-backed securities on the list. Well-constructed asset-backed securities, those that are transparent and not overdiversified, are very much like ETFs, and if they were more widely accessible I'd place them directly in the "good" column.) But there are many, many more bad innovations that we have yet to come to terms with:

401-K plans with limited investment menus
The conventional wisdom that long-term savings ought by default be placed in passive stock funds
The conflation of ordinary saving and financial return seeking
The tolerance, advocacy, and subsidy of financial leverage throughout the economy
The move towards large-scale, delegated, and professionalized of money management
The growth of investment vehicles accessible primarily or solely to professional and institutional investors

Waldman discusses these issues at greater length in the post. His discussion about how badly we treat savers is particularly useful

With 401 (k)s, it isn't just the lousy menus, but also the limited ability and long lead times for changing allocations. And some funds also take a heinous amount of time to credit annual contributions. I don't have a full overview, but I have heard enough bad stories to be convinced that this product is heavily slanted towards the administrator, with too many having "gotcha" features, compared to very user friendly IRAs.

With supposed professional management has come a lot of faux science. For instance, the academic literature has repeatedly found that investors benefit from being diversified by asset class (stocks, bonds, foreign stocks, foreign bonds, cash, real estate, perhaps commodities, although some research has found that CTAs fail all tests of being an asset class; the term of art is that it puts you on the efficient investment frontier). The notion of asset class is broad categories. Yet the industry has gotten investors to confuse styles with asset classes and produces all sorts of cute analyses over pretty short (by historical standards) periods of time which show low covariance of X fund versus, say, the S&P 500. Since I used to work for firms that were adept at cutting the numbers in ways to prove their points, I have little confidence in anything not produced by someone who has no skin in the game (and the pension fund consultants have every reason to promulgate this methodology, since it is how they justify their fees).

Warren Buffett put it more colloquially:

To understand how this toll has ballooned, imagine for a moment that all American corporations are, and always will be, owned by a single family. We’ll call them the Gotrocks. After paying taxes on dividends, this family – generation after generation – becomes richer by the aggregate amount earned by its companies. Today that amount is about $700 billion annually. Naturally, the family spends some of these dollars. But the portion it saves steadily compounds for its benefit. In the Gotrocks household everyone grows wealthier at the same pace, and all is harmonious.

But let’s now assume that a few fast-talking Helpers approach the family and persuade each of its members to try to outsmart his relatives by buying certain of their holdings and selling them certain others.

The Helpers – for a fee, of course – obligingly agree to handle these transactions. The Gotrocks still own all of corporate America; the trades just rearrange who owns what. So the family’s annual gain in wealth diminishes, equaling the earnings of American business minus commissions paid. The more that family members trade, the smaller their share of the pie and the larger the slice received by the Helpers. This fact is not lost upon these broker-Helpers: Activity is their friend and, in a wide variety of ways, they urge it on.

After a while, most of the family members realize that they are not doing so well at this new “beat my- brother” game. Enter another set of Helpers. These newcomers explain to each member of the Gotrocks clan that by himself he’ll never outsmart the rest of the family. The suggested cure: “Hire a manager – yes, us – and get the job done professionally.” These manager-Helpers continue to use the broker-Helpers to execute trades; the managers may even increase their activity so as to permit the brokers to prosper still more. Overall, a bigger slice of the pie now goes to the two classes of Helpers.

The family’s disappointment grows. Each of its members is now employing professionals. Yet overall, the group’s finances have taken a turn for the worse. The solution? More help, of course. It arrives in the form of financial planners and institutional consultants, who weigh in to advise the Gotrocks on selecting manager-Helpers. The befuddled family welcomes this assistance. By now its members know they can pick neither the right stocks nor the right stock-pickers. Why, one might ask, should they expect success in picking the right consultant? But this question does not occur to the Gotrocks, and the consultant-Helpers certainly don’t suggest it to them.

The Gotrocks, now supporting three classes of expensive Helpers, find that their results get worse, and they sink into despair. But just as hope seems lost, a fourth group – we’ll call them the hyper-Helpers – appears. These friendly folk explain to the Gotrocks that their unsatisfactory results are occurring because the existing Helpers – brokers, managers, consultants – are not sufficiently motivated and are simply going through the motions. “What,” the new Helpers ask, “can you expect from such a bunch of zombies?”

The new arrivals offer a breathtakingly simple solution: Pay more money. Brimming with self-confidence, the hyper-Helpers assert that huge contingent payments – in addition to stiff fixed fees – are what each family member must fork over in order to really outmaneuver his relatives.

The more observant members of the family see that some of the hyper-Helpers are really just manager-Helpers wearing new uniforms, bearing sewn-on sexy names like HEDGE FUND or PRIVATE EQUITY. The new Helpers, however, assure the Gotrocks that this change of clothing is all-important, bestowing on its wearers magical powers similar to those acquired by mild-mannered Clark Kent when he changed into his Superman costume. Calmed by this explanation, the family decides to pay up.

And that’s where we are today: A record portion of the earnings that would go in their entirety to owners – if they all just stayed in their rocking chairs – is now going to a swelling army of Helpers. Particularly expensive is the recent pandemic of profit arrangements under which Helpers receive large portions of the winnings when they are smart or lucky, and leave family members with all of the losses – and large fixed fees to boot – when the Helpers are dumb or unlucky (or occasionally crooked). A sufficient number of arrangements like this – heads, the Helper takes much of the winnings; tails, the Gotrocks lose and pay dearly for the privilege of doing so – may make it more accurate to call the family the Hadrocks.

Today, in fact, the family’s frictional costs of all sorts may well amount to 20% of the earnings of American business. In other words, the burden of paying Helpers may cause American equity investors, overall, to earn only 80% or so of what they would earn if they just sat still and listened to no one.

[DemReadingDU]

18. Rec #5

Good morning everyone!

[Demeter]

23. Good Morning! Made It 3 Minutes Before Noon!

I hate these emergency board meetings on Saturday morning.....

[DemReadingDU]

19. Debt Rattle, November 26 2008: From the Top of the Great Pyramid

Ilargi is taking some time off, and while he is absent, there are some guest writers. If your read the DailyKos, you might be familiar with author Stranded Wind, aka Iowa Boy, who wrote intros for TAE dated 11/24/08 & 11/25/08.

The 11/26/08 intro is written by Stoneleigh, co-editor with Ilargi at http://theautomaticearth.blogspot.com/

Stoneleigh: Everyone has heard of pyramid, or Ponzi, schemes. In their simplest form they are short-lived deliberate frauds where a small number of existing members are paid from the buy-in of a larger number of newer members until the supply of newer members is exhausted, whereupon they collapse. Typically, the founders, and perhaps a few others who got in early and out before it was too late, end up making a lot of money at the expense of later entrants, who end up holding the empty bag. There are always many more losers than winners. What most do not realize, however, is that Ponzi dynamics are far more pervasive than people think. There are many human systems that ultimately rest on the buy-in of new entrants, and every one of them will ultimately meet the same fate, although it can take far longer for complex constructions than for simple pyramid frauds.

What allows a more complex pyramid to last for longer than a simple one is a supplementary source of funds to pay members, besides merely the buy-in of newer members. The more such sources there are, legitimate and otherwise, the more complex the pyramid can become and the longer it will last, as the apparent on-going success of early entrants will attract many more new ones. There's nothing like seeing one's friends and neighbours seemingly making a lot of easy money for a long time to eventually overcome the mental defenses of even the most skeptical.

Following the collapse of communism in Eastern Europe, there was a spate of such schemes - notably MMM in Russia, Caritas in Romania, Jugoskandic and Dafiment Bank in Serbia, TAT in Macedonia, and VEFA Holdings, Xhafferi, Populli, Gjallica and several others in Albania. They were the topic of my academic research at the time. All of these lasted for quite a long time, and some paid out spectacular returns for much of that time. For instance, the Albanian funds , or quasi-banks, began by paying out 3-5% per month over a 6 month term and were eventually paying out 10% per month (and briefly much more as an interest rate war ensued very late in the game).

They were able to do this temporarily because the income from the buy-in of new entrants was supplemented by revenue from drug smuggling, oil sanctions busting, money laundering, gun running, human trafficking and a thriving trade in car theft from across Europe. There was some revenue from legitimate business interests, but not much in a country that survived mainly on a combination of remittances and politically supported criminal activity. Ironically, Albania was the darling of the IMF at the time.

Over time, approximately 80% of the Albanian population was drawn into the pyramids, often selling their only real property in order to invest and then depending on the pyramids for all their income. When the inevitable happened, the vast majority of the population was completely dispossessed. Although many had realized that there was something too-good-to-be-true about their 'investments' they had succumbed to greed "in the belief that they were in the hands of properly structured criminality", as The Guardian newspaper put it in February 1997. The population believed, erroneously, that there was an implicit guarantee from the government, which was conspicuously and intimately entwined with the activities of the various funds.

In the developed world, there are many examples of pyramid dynamics where there is no intent to defraud at all - where even the founders really don't understand the underlying logic of their business model taken to its logical conclusion. Direct marketing, for instance, is essentially pyramid-based - depending on an ever-increasing network of sales people, each of whom receives a percentage of their income from those they can attract into the business. If these businesses can no longer grow by attracting new salespeople, then they are ultimately finished, but as they cannot grow perpetually (or eventually everyone in the country would end up making a living selling these products to each other), they are inherently self-limiting. They can last for many years thanks to legitimate business revenues, but not forever. Early entrants will always do very well, at the expense of later ones, and the last tiers will certainly lose their stake.

Large economic bubbles, typically formed in dominant economies during periods of manic optimism (see McKay's Extraordinary Public Delusions and the Madness of Crowds), have the same underlying dynamic. Without continual buy-in from new money - new investors or more money from existing investors - they cannot grow, and when they can no longer grow, they will collapse. Although grounded initially in legitimate business activity, they morph into structures where one has to question the motives and understanding of key individuals. In some cases there may be intent to defraud, but what is far more common is a characteristic recklessness as to the risks those in control are prepared to take with other people's money.

In their latter stages, such structures hollow out, feeding on their own internal substance as they lose the ability to attract new investment. In the terminal phase, there is the appearance of great wealth, but it is virtual, and therefore extremely ephemeral. The next step is implosion, as the virtual wealth disappears - where the claims to wealth generated through leverage that exceed the amount of underlying real wealth are extinguished en masse. Enron was a prime example, and on a much larger scale, so is the derivatives market. Bubbles, like all Ponzi structures, are inherently self-limiting and will always collapse in the end.

At the largest scale, empires are also grounded in pyramid dynamics, which is why they too have a limited lifespan. They grow by assuming control, either politically or economically, of new territories, positioning themselves to cream off surpluses from an ever-expanding geographical area in a form of involuntary buy-in. In the past political control through invasion or physical colonization was more common, but latterly globalization has enabled the development of a sophisticated system of economic control based on international debt slavery, supplemented with economic colonization for the purpose of resource extraction. Both resources and financial surpluses, in the form of perpetual interest payments, could be efficiently extracted from the periphery and accumulated at the centre, where they led to the development of an unprecedented level of socioeconomic complexity.

Such wealth conveyors in favour of the economic centre, at the expense of the hinterland, are the very heart of empire, but without continual expansion to feed rapidly developing central complexity, they eventually fail, leaving the centre unable to sustain its existing complexity level. As with economic bubbles, empires hollow out in the latter stages, consuming their own substance in a catabolic manner in order to compensate for the inability to strengthen wealth conveyors sufficiently quickly to keep pace with the expanding requirements of the centre.

As the hinterland is increasingly stripped of wealth and resources, and burdened with the increasing environmental impact of its own exploitation, an increasing fraction of it is left too impoverished to sustain a minimum level of internal order. In modern times we speak of failed states without realizing why many of these states are failing, or the impact that an increasing number of failed states will ultimately have on our own standard of living.

Wealth conveyors are breaking down, and no amount of financially squeezing the population in the central economies can compensate for the loss of that ability to accumulate wealth from virtually the whole world. The vast majority of the central population will be brutally squeezed as the elites try to hang on to their own privileged position, but this can only sustain a very small, and rapidly shrinking, fraction of the population, and at great cost.

We are living through the collapse of the final - and all-consuming - economic bubble at the end of the American empire.

click for related articles and comments
http://theautomaticearth.blogspot.com/2008/11/debt-rattle-november-26-2008-from-top.html

[Tansy_Gold]

21. I.T.Y.S.

[DemReadingDU]

34. and you did...

Tansy_Gold: There is no there there. And there is no money there, either
http://www.democraticunderground.com/discuss/duboard.php?az=show_topic&forum=103&topic_id=405228


:)

[Tansy_Gold]

35. Thanks, and you know what? I wasn't even thinking of that thread

It was more a collective ITYS. all of us here on WE and SMW have been saying the same thing.

But thanks for the nod. It reminded me to update my journal!

:hi:


Tansy Gold, seriously workin' the payin' gig and hatin' every second of it.

[Joe Chi Minh]

56. "Ironically, Albania was the darling of the IMF at the time." "Ironically", DemReading? I think

you must be being ironical.

[DemReadingDU]

22. Naomi Klein and Joseph Stiglitz on Economic Power

10/20/08 This is an hour discussion panel.
http://fora.tv/2008/10/20/Naomi_Klein_and_Joseph_Stiglitz_on_Economic_Power

[KoKo]

40. This is such an EXCELLENT site! I've been on it for three hours...

Many Thanks for this! What a great resource!

:kick:

[DemReadingDU]

43. Yes it is!

I just recently discovered this site myself. Just browsing around,

What does FORA.tv do?
We deliver discourse, discussions and debates on the world’s most interesting political, social and cultural issues and enable our viewers to join the conversation. We provide deep unfiltered content, tools for self expression and the place for the interactive community to gather. There are brilliant ideas, expressed everyday, in public discussions and events, all over the world. Don’t miss them.

more...
http://fora.tv/fora/faq.php?faq=new_faq_item#faq_new_faq_item_1

[KoKo]

46. It beats trying to watch C-Span's Booknotes on Weekends where one has to

see 3 for 1 "Heritage Foundation, AIPAC, AEI, BROOKINGS interspersed with a few Neo Lib Foundations or an occasional CAP or Blog discussion. Sometimes it's hard to stay with it all. This way one can link to the discussions that are interesting and not waste time with the others that are just RW Talking Points that we've heard for years.

[Hugin]

48. I bookmarked it.

Thanks. :)

[DemReadingDU]

49. FORA.tv

I think this is a more right-leaning site, but there are videos all over the spectrum
http://fora.tv/daily_highlights


watch this short video, and read staff bios
http://fora.tv/aboutfora

[Demeter]

24. A Mark Fiore Video on Capitalism!

I'll give this one to Prag. He'll love it!

http://www.markfiore.com/clapper_0

[DemReadingDU]

26. That's a good one!

[Hugin]

27. Aw, and here's a little something for you this Holiday Season...

The WE Movie of the Weekend....

"Tucker: The Man and His Dream" (1988)

Plot:

"The film is initially presented as a kitschy promotional movie/documentary made in the 1940s, complete with a eccentric narrator and flashy titles that decorate the screen. The story concerns Preston Tucker's (Jeff Bridges) dream of making a safe and reliable family automobile - with technological innovations that were rather radical at the time. As a result, the established car manufacturers considered his car a threat to their products. Tucker's car could be built for a fraction of the money it took the mainstream car-makers to construct one. His car also featured a wide array of extras like disk brakes, seat belts, a fuel-injected engine in the rear, a padded dashboard, and a front windshield that popped out in a severe collision. These ideas were considered revolutionary at the time, and as Tucker began to make his car a reality, the Big Three and the authorities in Washington, D.C. worked together to ruin him."

Some Background:

"Coppola had a certain amount of personal affiliation with the material. His father had been one of the original investors in Tucker stock and since Coppola was a young boy he had always admired the inventor's short-lived legacy. Coppola stated in an interview that, 'It was that beautiful, gleaming car that caught my imagination, but it was also something else: the whole notion of what our country was going to be like in twenty or thirty years, based on our new position in the world...our technological inventiveness.'"

Oddly enough, George Lucas guaranteed the $25 Million to start the film project. I didn't know that until reading the
wiki entry.

There's also this...

"Following the initial release of the film, original stock certificates for Tucker Corporation common stock surged in value. (Source: Cataloged with an estimated value of between $2,000-$3,000 by W.M. Smythe & Co. in New York City in 2003.)"



Read more: http://en.wikipedia.org/wiki/index.html?curid=1367498

[Dr.Phool]

29. Or, tonight if you have HBO.

Charlie Wilson's War.

I read the book a few years ago. It was much better, but the movie did it some justice, although it couldn't provide the details the bood did.

[Hugin]

30. Good suggestion.

I haven't seen that yet, but, I've heard many people recommend it.

[KoKo]

47. I put off watching it...but rented it and LOVED it! It's better than I thought

reading the RW Reviews that the MSMEDIA put out about it. Good Watching! Not depressing...just very interesting.

[Demeter]

39. Thanks! I'll Look For It

[KoKo]

31. Eight Annual Mutual Fund Turkey Awards (for those of us with scraps in our 401-K/IRA)

Eight Annual Mutual Fund Turkey Awards

Submitted by Jonas Ferris on Fri, 11/28/2008 - 07:07.

It's Not an Honor Just to be Nominated. Not exactly a rare breed even in the best of times, the Fund Turkey multiplies exponentially when the market turns south.

A bear market is a high-powered headlight bar across the top of your fund research pickup truck, shining a spotlight on bull market excess. Tis the season to hunt Fund Turkeys (squawking all the way about investing abroad or in commodities), and thin this breed.

So without further ado, it's high time for our 8th annual Fund Turkey Awards!

The "Audacity of Hope" Award
Winner: Bear Stearns

At the top of the list of suckers for the real estate bubble is was Bear Stearns, the century-old Wall Street investment bank that collapsed well before the other leveraged "Masters of the Universe” suffered similar fates. What started innocuously enough with leveraged mortgage debt hedge funds didn’t end until the entire firm lay in ruins.

But failure's no reason to give up! You have to give Bear props for launching the first actively managed ETF, Bear Stearns Current Yield ETF (YYY). So what did this innovative new fund invest in? Mortgage securities. Naturally.

Bear's final hurrah didn’t last long. In September , the fund's Board of Trustees unanimously approved its liquidation "in the best interests of the Fund and its shareholders.”

The “Oops, I Did It Again” Award
Winner: Van Wagoner Emerging Growth (VWEGX)
Runner-up: Firsthand Technology Value (TVFQX) and other tech funds

Former Fund Turkey winner/loser Garrett Van Wagoner proves that a broken clock can be wrong all the time. Van Wagoner Emerging Growth (VWEGX) is down more than 50% this year – its third 50%+ calendar year drop in the past eight years.

The fund recently got a new subadvisor (Husic) and name (Embarcadero Small Cap Growth). Now the fund can embark on a new Van Wagoner-free era.

Bubble 1.0 wonderfund Firsthand Technology Value (TVFQX) doesn't look much better, having also fallen over 50% this year. The fund plummeted more than 56% in 2002, but a mere 44% drop in 2001 keeps this fund off the three-time-50%-plus-loser list.

The “Value Bubble” Award
Winner: Too many to list

Our current bear market has proven that focusing on fundamentals and valuations – dividends, book value, price-to-earnings ratios, and other Benjamin Graham good stuff – doesn’t work so well when earnings themselves are enclosed in a bubble.

The 2000 market was one of only 50 P/E ratios in which stocks traded on optimistic expectations for future earnings growth. This time around, the P/E ratios were sensible; it was the earnings that were in a bubble.

Many bank, natural resource, energy, real estate, and other old-economy stocks (those that don’t go belly up) won't see their (inflation-adjusted) future earnings return to their recent highs for another decade or so. Unfortunately for many Dodge & Cox, Legg Mason, and T. Rowe Price funds, as well as giant value funds like Vanguard Windsor (VWNDX), falling farther than many growth funds in a down market is indeed a reality. Did we mention Vanguard Capital Value Fund (VCVLX) was down 55% this year?


More Funnies :-( at.........................
http://www.maxfunds.com/?q=node/319

[DemReadingDU]

33. Debt Rattle, November 29 2008: "Inflation" deflated

11/29/08 As mentioned above in an earlier posting, Ilargi is taking some time off from http://theautomaticearth.blogspot.com / .While he is absent, there are some guest writers. Stoneleigh writes another intro today for TAE (The Automatic Earth).

Stoneleigh: There are many things we have discussed here frequently that come up as questions in the comments because we are attracting new readers all the time. I thought it would be a good time to answer those questions en masse, so that there would be a URL to point to if the same questions should come up again.

The basic point is that we here at TAE are expecting deflation. Although inflation and deflation are commonly thought of as descriptions of rising or falling prices, this is not the case. Inflation and deflation are monetary phenomena. The terms represent either an increase or a decrease, respectively, in the supply of money and credit relative to available goods and services. Rising prices are often a lagging indicator of an increase in the effective money supply, as falling prices are of a decrease. There is an important distinction to be made between nominal prices and real prices, however. Nominal prices can be misleading as they are not adjusted for changes in the money supply and so do not reflect affordability. Real prices, which are so adjusted, are a far more important measure.

Nominal prices typically rise during inflationary times as there is more money available to support higher prices, but prices need not rise evenly, and some prices may fall, depending on other factors. In real terms the picture would be quite different, as increases would be smaller and decreases would larger. When nominal prices fall despite inflation, it means that the price in real terms is plummeting. For instance, global wage arbitrage allowed the price of imported goods to fall drastically in real terms. In deflationary times, nominal prices typically fall across the board, but prices need not fall in real terms, and, in cases of scarcity, may well rise.

The easy availability of cheap credit has conveyed a considerable amount of price support - price support that will be progressively withdrawn as credit tightens. Prices will fall, but the collapse of credit will cause purchasing power to fall faster than price, leading to the apparent paradox of nominally cheaper goods being less affordable in the future than nominally more expensive goods are today. Moreover, there are likely to be substantial changes in relative prices between essentials and non-essentials. As a much larger percentage of a much smaller money supply will be chasing essentials such as food and energy, there will be relative price support for those items. In other words, while everything is becoming less affordable due to the collapse of purchasing power, essentials such a food and energy will be the least affordable of all, whatever the nominal price. People commonly speak of unaffordable prices as a result of inflation, but do not realize that deflation can have the same effect, only much more abruptly.

Thanks to a credit boom that dates back to at least the early 1980s, and which accelerated rapidly after the millennium, the vast majority of the effective money supply is credit. A credit boom can mimic currency inflation in important ways, as credit acts as a money equivalent during the expansion phase. There are, however, important differences. Whereas currency inflation divides the real wealth pie into smaller and smaller pieces, devaluing each one in a form of forced loss sharing, credit expansion creates multiple and mutually exclusive claims to the same pieces of pie. This generates the appearance of a substantial increase in real wealth through leverage, but is an illusion. The apparent wealth is virtual, and once expansion morphs into contraction, the excess claims are rapidly extinguished in a chaotic real wealth grab. It is this prospect that we are currently facing today, as credit destruction is already well underway, and the destruction of credit is hugely deflationary. As money is the lubricant in the economic engine, a shortage will cause that engine to seize up, as happened in the 1930s. An important point to remember is that demand is not what people want, it is what they are ready, willing and able to pay for. The fall in aggregate demand that characterizes a depression reflects a lack of purchasing power, not a lack of want. With very little money and no access to credit, people can starve amid plenty.

Attempts by governments and central bankers to reinflate the money supply are doomed to fail as debt monetization cannot keep pace with credit destruction, and liquidity injected into the system is being hoarded by nervous banks rather than being used to initiate new lending, as was the stated intent of the various bailout schemes. Bailouts only ever benefit a few insiders. Available credit is already being squeezed across the board, although we are still far closer to the beginning of the contraction than the end of it. Further attempts at reinflation may eventually cause a crisis of confidence among international lenders, which could lead to a serious dislocation in the treasury bond market at some point. If a debt-junkie economy can no longer easily raise funds, then interest rates would rise substantially and spending at home would be drastically cut. This would be the financial equivalent of hitting the 'emergency stop' button on the economy, as it would cause a far larger rash of defaults than anything we have seen so far. We are not there yet though. Currently the dollar is benefiting from an international flight to safety, and it will probably continue to do so for some time, despite temporary counter-trend pullbacks from time to time.

We have seen a pattern of ebb and flow of market liquidity since February 2007, when the credit crisis arguably began. A constellation of market trends has largely moved in synch with liquidity. As liquidity falls, equities fall, bond yields fall (and prices rise), commodities fall, precious metals fall, real estate falls and the dollar rises, as cash becomes king. When we see market rallies, in contrast, rallies in bond yields, commodities, and metals are also common, and the dollar experiences a pullback. We appear to be beginning a market rally at the moment, which should lead to precisely this set of trend reversals. Such a rally is only temporary relief however. It may last for a couple of months, but then the decline should resume with a vengeance.

We have a very long way to fall, and the deleveraging process is likely to play out over several years. During this time we can expect to be mired in a worse depression than the 1930s, as the excesses that led to our current situation are far worse by every measure than were those of the Roaring Twenties. Unfortunately, we are much less prepared to face such an occurrence than were our grandparents. Our expectations are far higher, our knowledge and skill base is much less appropriate, we are far less self-sufficient and we have a structural dependency on cheap energy. This will be a very painful time. Deflation and depression are mutually reinforcing, leading to a vicious circle of decline that is very difficult to escape. It will be over when the (small amount of) remaining debt is acceptably collateralized to the (few) remaining creditors. At that point trust will begin to rebuild.

For a longer and more detailed explanation of the credit bubble and deflation see The Resurgence of Risk - A Primer on the Develop(ed) Credit Crunch. This an article I wrote in August 2007 that was recently rerun on The Oil Drum, where I used to be an editor.

Click for related articles and comments
http://theautomaticearth.blogspot.com/2008/11/debt-rattle-november-29-2008-inflation.html


Here is the direct link to Stoneleigh's article: The Resurgence of Risk - A Primer on the Develop(ed) Credit Crunch
http://www.theoildrum.com/node/4629

[Demeter]

37. Proving Once Again Why Economics Is Called "The Dismal Science"

thanks for the post.

[Demeter]

36. For Dr. Phool: Wall Street drowns its sorrows

http://www.ft.com/cms/s/0/693de752-bdaa-11dd-bba1-0000779fd18c.html


By Greg Farrell in New York

Published: November 29 2008 00:16 | Last updated: November 29 2008 00:16

The titans of Wall Street have taken a battering in the financial markets recently, but they are eating well and drinking more, according to the people who run Manhattan’s “power” dining spots.

At the 21 Club, a longtime redoubt of corporate chieftains and big names, alcohol sales are up 9 per cent from last year, and businessmen can be seen drinking $14-a-glass cocktails as early as 3pm on a weekday.

“Where people used to have one vodka on the rocks, now it’s a second one or maybe a third,” says Roger Rice, the floor manager. “I don’t know what to attribute it to. Maybe it’s the last year of the expense account.”

Others say their customers are drinking more to drown their sorrows. “People want to feel a little numb because it’s numbing out there,” says Steve Millington, general manager at Michael’s, the restaurant of choice for publishing and media executives.

He reports that alcohol sales are up a fifth from last year. “At dinner, hard liquor sales are up, cocktails and martinis. It’s less so at lunch. People are drinking wine at lunch, less the high-end wines and more medium-priced wines.”

The increase in alcohol sales is clear, says Mr Millington, because overall customer levels are on a par with last year. “There’s a scent of fear,” he says.

Times are good at Delmonico’s, the 181-year-old fine dining restaurant, says Dennis Turcinovic, managing partner.

“It’s scary to say, but our business is up 6 to 7 per cent,” he says. “Alcohol sales . . . help a lot, they’re about 15 per cent up this year. The bar’s busy all day. I’ve had to hire extra barmaids.”

There are few signs that people are saving money on food either. At San Pietro, an upmarket Italian restaurant, business remains brisk. Gerardo Bruno, president, says overall business is up 12 per cent from last year.

In spite of the turmoil in the markets, one rule has held firm at San Pietro. “Americans, they never drink at lunch,” Mr Bruno says. As for dinner, hard liquor sales are down, but after-dinner drinks, particularly grappa and cognac, are up, he adds.

Wine sales remain strong, especially at dinner, except for one noticeable change. “When times are fantastic, the host does not lead, he lets his guests lead in choosing the wine,” says Mr Bruno. However, in the current climate, dinner hosts are turning to him to ask for wine recommendations, a clear sign that restraint is in order, according to Mr Bruno.

Yet not everyone has suffered in the economic downturn. Mr Bruno produced two empty bottles of 1947 Petrus, consumed recently by a Chinese customer who called ahead to order the wines. The price? A mere $12,000 each.

[Dr.Phool]

41. $14 cocktails? Did they build an airport on Wall Street?

Things are so tough around here, I can't afford to buy a mistress a present, much less have one. And after setting up my online bill-pay for Monday, I may be switching to cheaper vodka before X-mas. And the Fudd will have to settle for cheaper beer.

I still have to hold back some extra cash, for holiday tips for my favorite bar-keeps. They taught me the true meaning of "Black Friday". Because I don't remember anything about it.:evilgrin:

[Dr.Phool]

42. Growth won't pay the bills in Florida

We've got some major, major economic problems in this state. We're out of money, and we have a Republican legislature here that's ideologically opposed to ANY taxes. The Governor puts a smiley face on everything. The CFO, Alex Sink, the only Dem elected to statewide office, is warning them about a catastrophe, and the need for a special session to address the problems, but so far her pleas are falling on deaf ears.

http://www.tampabay.com/news/politics/state/article919617.ece

Growth won't pay the bills in Florida

By Mary Ellen Klas and Steve Bousquet, Times/Herald Tallahassee Bureau
In print: Sunday, November 30, 2008

TALLAHASSEE — For the dozen state economists huddled around a table this month to fine-tune Florida's annual revenue forecast, something was different and disturbing.

Their projections from just a year ago were way off. Their new math: In the next four years, the state will collect $31.4-billion less in taxes than expected. That's more than six times the Pinellas and Hillsborough county budgets combined, the cost of more than 60 waterfront stadiums for the Tampa Bay Rays, and almost half of this year's state budget.

The free fall in revenues the economists saw Nov. 21 was not as shocking as what caused it: Fewer newcomers were moving to the state for the first time in decades. The state's legendary growth machine had ground to a halt, compounding the troubles brought on by the global recession.

For years, governors and legislators relied on population growth to create jobs, avoid raising taxes and shield the state from recession. They saw Florida's population swell annually by 2 to 3 percent, enough to add a city the size of Miami or Tampa each year. By marketing itself as a low-tax, low-cost retirement haven, Florida literally bet its future on growth.

Every few years, an event would expose weaknesses in Florida's economic system: a recession in 1991, a school overcrowding crisis in 1997, a steep drop in tourism after the terrorist attacks on Sept. 11, 2001. But the growth machine always roared back to life until now.

With the mortgage crisis, the credit crunch and the flatlining of the population, the twin industries that buffered Florida through two previous recessions, real estate and construction, are weighing down Florida's economy, complicating a recovery and making it likely Florida will be among the last to bounce back.

"This recession is not only going to be bad for us. It's going to be worse than the nation's," said David Denslow, a University of Florida economist. The primary reason: Florida's residential construction boom grew at twice its normal rate and "we got overbuilt."

The backlog of unsold homes nationwide coupled with the credit crisis makes it almost impossible for Florida to lure people from other states when they can't sell their homes, he said. At the same time, cuts in property taxes and a deepening state budget shortfall squeeze basic public services, making the state less appealing to retirees. State economists this month predicted the recession will linger throughout 2009, with a gradual return to very slow growth in employment and population in 2010.

The pessimism of the revenue experts, however, stands in stark contrast to the optimism of Gov. Charlie Crist, who said, after economists completed their latest forecast: ''Florida will probably come out of it first. I mean, the sun always comes up in Florida first."

• • •(snip) more

[Tansy_Gold]

45. Ditto for Arizona, and Obama is likely to take our Dem gov -- leaving us

with a lollapalooza of a rightwing nutcase of a SoS to take Janet's place.

Cut cut cut cut cut, says the puke legislature.

Where? asks the gov.

We don't care, but don't raise taxes, says the puke legislature.

It's a joke.

But maybe it will wake up a few people




ha ha, only kidding.


Tansy Gold

[Demeter]

50. Resurrection Sunday

Welcome back, all! It's been one of those weekends. Anyway, posting shall resume forthwith!

[Karenina]

60. Love you, Demeter!!

Glad you're feeling better. :loveya:

[Demeter]

63. .

:blush:

[Demeter]

51. Is Britain going bankrupt?

http://blogs.telegraph.co.uk/ambrose_evans-pritchard/blog/2008/11/24/is_britain_going_bankrupt

The bond vigilantes are restive.

We are not yet facing a replay of the 1970s 'Gilts Strike', but we are not that far off either.

There is now a palpable fear that global investors may start to shun British debt as the budget deficit rockets to £118bn - 8 per cent of GDP - or charge a much higher price to cover default risk.

The cost of insuring against the bankruptcy of the British state has broken out - upwards - over the last month. Yes, credit default swaps (CDS) are dodgy instruments, but they are the best stress barometer that we have.

Today they reached 86 basis points, near Portuguese debt in the league table. For good reason. Alistair Darling has had to admit that the British economy faces the most sudden economic collapse since World War Two, and the worst budget deficit of any major country in the world.

Ok, this is a lot lower than Iceland, Ukraine, Hungary, and other clients of the IMF, but is significantly higher than Germany (35), USA (43), and France (49).

After trading at similar levels to our AAA-rated peers for years, we started to decouple in August and then began to soar in October.

We reached a fresh record the moment the Chancellor told the House of Commons that the budget would not return to its already awful condition until 2016.

Should we be worried? Yes.

Marc Ostwald from Insinger de Beaufort said Gilt issuance would reach £146bn in fiscal 2008/2009. Britain will have to borrow £450bn over the next five years.

This is an utter fiasco.

With deep embarrasment, I plead guilty to supporting the Brown-Darling fiscal give-away - though with a clothes peg clamped on my nose. As the Confederation of British Industry and many others have warned, we face an epidemic of bankruptcies unless we tear up the rule book and take immediate counter-action.

The Bank of England's drastic rate cuts are a necessary but not sufficient stimulus. Monetary policy is failing to get traction because the credit system has broken down.

We face the risk of a rapid downward spiral if we misjudge the threat at this dangerous moment, as we sit poised on the tipping point. Besides, the whole world is now resorting to fiscal stimulus in unison under IMF prodding. Sticking together is imperative. If countries reflate in isolation, they can and will be singled out and punished. That is the lesson of 1931.

But this is not to excuse the Brown Government for the total hash it has made of the British economy. It presided over a rise in household debt to 165pc of personal income. How could the regulators possibly think this was in the interests of British society? What economic doctrine justifies such stupidity? Why were 120pc mortgages ever allowed? Indeed, why were 100pc mortgages ever allowed? Debt is as dangerous as heroin.

Labour ran a budget deficit of 3pc of GDP the top of cycle. (We had a 2pc surplus at the end of the Lawson bubble, so we go into this slump 5pc of GDP worse off). The size of the state has ballooned from 37pc to 46pc of GDP in a decade, and will inevitably now rise further.

It is because Gordon Brown exhausted the national credit limit to pay for his silly boom that today's fiscal stimulus - just 1pc of GDP (China is doing 14pc) - is enough to rattle the bond markets. Our national debt will jump in what is more or less the bat of an eyelid from under 40pc of GDP to nearer 60pc - according to Fitlch Ratings. It is enough to make you weep. But is this bankruptcy territory? Not yet. Britain will remain at the mid to lower end of the AAA club.

A Fitch study today estimates the "fiscal cost" of the bank bail-outs (which is not the same as just adding guarantees to the national debt) is 6.9pc of GDP for Britain - compared to Belgium (5.7pc), Germany (5.8pc), Netherlands (6.3pc), and Switzerand (12.9pc). We are not alone in this debacle.

If and when the storm blows over, Britain should still have a lower national debt than Germany, France, or Italy. It will certainly have a better demographic structure that most of Europe (except France and Scandinavia), and less catastrophic pension liabilities than most.

The situation is desperate, but not serious - as the Habsburgs used to say. Fingers crossed.


IF THE UK IS HURTING THIS BADLY, IS THE US FAR BEHIND? NOT MUCH, IMO. STILL PULLING THE TRICKS WITH STATISTICS, THAT'S ALL, TRYING TO STRETCH IT TO JANUARY 20.

[Joe Chi Minh]

55. The Tories are furious at the idea of any Keynsian expenditures on infrastructure,

regeneration of the economy in favour of the Ordinary Joe, and are feverishly painting it as adding debt to future generations.

Well, that may be so, but it also could be the case that their own more than ample fortunes might bear the cost of the borrowings by way of higher upper income-tax rates.

[Demeter]

57. Well, Then, It's Your Gift from WE!

Glad you could drop in and provide commentary!

[Joe Chi Minh]

69. WE the people? Anyway, I wouldn't miss out these economic threads

in my daily reading for all the tea in China. I've bookmarked some articles I can't see myself ever getting rid of. Spectacular reads. More surreal accounts of what's been going on than anything Joseph Heller could have dreamed up! Or Munch, for that matter. The mordant wit they're invariably related with is a perfect analgesic, too.

[Demeter]

52. All US Financials Will be Nationalized in a Year: Manager

http://www.cnbc.com/id/27835645

It's not preferable, but all major U.S. financial companies will eventually be under government control because the alternative is so much worse, Hugh Hendry, chief investment officer at hedge fund Eclectica Asset Management, said Friday.

"All financials will be owned by the U.S. government in a year," Hendry said. "I bet you."

Nationalizations take dramatic losses from the private sector and places them on the larger balance sheet of the public sector, he said.

"It's not good," but society is vulnerable and society is going to have to intervene, Hendry said.



Shareholders Should Get Nothing

Because the taxpayers are forced to foot the bill for bailout out the banks, shareholders shouldn't be compensated, Hendry added.

(Watch the accompanying video for Hendry's full comments...AT THE LINK)



"Actually the shareholders of Citigroup have looked the other way for more than a decade" while management took excessive risk, he said.

Shareholders should take nothing away if it is nationalized, because the taxpayer will be "paying this for a long, long time," he added.

[DemReadingDU]

61. Be sure to watch the video

Hugh Hendry is in despair:
""How can I convey to you the seriousness, the bleakness of all of our futures? Because I can't do it justice, and I think my wife is gonna divorce me because I'm the most miserable person to live with. I look around me, and I can see dead people.""


The video is 21 minutes in length. He's up 40%, but not in stocks, rather long on the bond market. Keep your eye on Hendry during the video, even when he's not talking. He's the guy in the glasses. He has some funny comments about Warren Buffet and Jimmie Rogers.

[Demeter]

62. Please Accept It With My Compliments

You are VERY hard to post for!

[DemReadingDU]

65. Well, the article was mainly about the banks being nationalized

Besides, I had seen the video elsewhere, and knew the key points to look for about Hendry.
:)


There is so much to read and videos to watch, it's hard to keep up with it all, and remember which to post. You do a great job here with the weekend thread. Thanks!


p.s.
Be sure to read Stoneleigh's latest Debt Rattle, post #64.

[Demeter]

53. Congress Should Approve Bills Introduced in House and Senate to Shut Down Treasury's $140 Billion Gi

http://www.ctj.org/taxjusticedigest/2008/11/congress-should-approve-bills.html

Last week, House and Senate offices received a letter signed by Citizens for Tax Justice, the Coalition on Human Needs, and OMB Watch, asking Congress to reverse a Treasury notice that essentially told banks that they could ignore an explicit provision in the revenue code intended to prevent abusive tax shelters. The notice, dubbed the "Wells Fargo ruling," after its largest beneficiary to date, will cost the federal government $140 billion according to one widely-cited analysis.

As the letter was being sent, legislation was introduced in both the House and Senate to reverse the Treasury notice. (In the House, Congressman Lloyd Doggett (D-TX) introduced H.R. 7300. In the Senate, Vermont's Bernie Sanders introduced S. 3692.)

As the letter sent to the Hill explains, IRS Notice 2008-83 essentially repeals, for banks only, Section 382 of the tax code, which bars companies from using the losses of companies they acquire to reduce their own tax liability. Section 382 was enacted by Congress in 1986 to stop companies from sheltering their income by purchasing shell companies with losses on their books. Before that time, many mergers took place not because they made economic sense but merely because they offered a tax shelter. Ever since Section 382 was enacted to end these abuses, corporate lobbyists have been promoting its repeal.

Now it seems those lobbyists have achieved their goal without using the same long and difficult legislative process that lawmakers and advocates face when they want to enact, say, a $3 billion increase in the child tax credit for low-income families. Instead, bank lobbyists achieved their $140 billion goal through an agency action that contradicts the explicit intent of a statute enacted by Congress.

Another alarming aspect of the Wells Fargo ruling is its impact on states. As CTJ's recent report explains, because most state corporate taxes are linked to the federal corporate tax, a cut in the federal corporate tax leads to a reduction in state revenues as well. It has been reported that the total loss in state revenue for California alone will be $2 billion, and $300 million of that will be lost this year.

Many lawmakers and analysts are rightly concerned about the economic effects of any change in tax law enacted by Congress. But that can be no excuse to leave unchallenged a $140 billion tax subsidy for bank mergers created in direct contradiction to a law enacted by Congress. The House and Senate will likely meet in December to consider a bailout for the automotive industry and other legislation to boost the economy. During that time, they should approve legislation to reverse the Wells Fargo ruling.

[Demeter]

54. This One's for Burf: Leverage by the numbers (Includes Scary Table)

http://optionarmageddon.ml-implode.com/2008/11/24/leverage-by-the-numbers/



So what is the capital cushion underneath our largest financial institutions? I spent today compiling this spreadsheet:

http://spreadsheets.google.com/pub?key=p3aLsZsuX06ZuRis35HAuSg&output=html&gid=0&single=true&range=a1:h10

SEE ORIGINAL LINK OR CLICK ON SPREADSHEET LINK)

Those are some ugly numbers and I’ll explain why. Citigroup’s leverage ratio of 56 means that the bank has $56 of assets for every $1 of common equity. If the value of those assets falls 2%, then common stockholders are wiped out. Here’s why: Assets = Liabilities + Equity. If you understand this formula, you will understand the credit crisis. So read on…


That formula is known as “the accounting equation.” Fundamentally, it shows how an asset (like a house) or collection of assets (like a company) is financed—either with borrowed money or your own, with debt or with equity.

One side of the equation has to equal the other. If the assets fall in value, and not because cash was used to pay off a liability, then equity has to fall by an equal amount. If assets fall far enough, then equity falls below zero.

Take a house for example. A house is an asset, typically paid for with both a mortgage (liability) and a down payment (equity). If you pay $100,000 for the house and put 20% down, you have an $80,000 mortgage and $20,000 of equity. The leverage ratio is 5. ($100,000 asset / $20,000 equity = 5x assets/equity). Notice that we’re taking two components of the accounting equation and putting one over the other: Assets / Equity = Leverage

A higher leverage ratio means greater potential for profit AND loss on your initial investment. Let’s apply the accounting equation to a few scenarios. For the first two, let’s take the above example where your leverage ratio is 5x:

House value INCREASES $10k to $110k. Remember: Assets = Liabilities + Equity. $110k house = $80k mortgage + $30k equity. $10k increase on original equity investment of $20k = 50% return!
House value DECREASES $10k to $90k. $90k house = $80k mortgage + $10k equity. $10k decrease on $20k investment = -50% return. Boo!
What if, just like so many home-borrowers did during the days of the housing bubble, you put 5% down instead of 20%? First of all, your leverage ratio jumps to 20. ($100k house / $5k equity investment = 20x assets/equity). Let’s see how this impacts returns…

House value INCREASES $10k to $110k. $110k house = $95k mortgage + $15k equity. $10k increase on original equity investment of $5k = 200% return. Yippee!
House value DECREASES $10k to $90k. $90k house = $95k mortgage - $5k equity. $10k decrease on $5k investment means not only have I lost my original investment, but now I owe $5k more than I started with. I’m upside-down on the mortgage. F*ck me!
In this last scenario, I keep the house as long as I keep paying the mortgage. If I default, however, the bank forecloses and sells the house. If it can only get $90k for it, it has to take a $5k loss on ITS asset, which was the mortgage loan.

Here’s where the rubber meets the road, where a housing crisis becomes a banking crisis.

You see, that same equation (A = L + E) applies to banks. Just like you save for a down payment and borrow money to buy a house, a bank will take deposits, sell debt and raise equity capital to make loans. But if the value of its loans fall, then it has to write down them down by that amount. To keep the equation in balance, if it writes down assets, it must simultaneously write-down equity by the same amount. Look at the last of the four scenarios above. If the borrower stops making his payments, the bank has to foreclose and sell the house. If it recovers less in the sale than the home-borrower owed on the mortgage, that’s the amount by which the bank has to write down its assets.

Since the equation (A = L + E) applies to the bank, it’s important to know the bank’s leverage ratio. As it does with our imaginary home-borrower, the leverage ratio tells us how much cushion the bank has to lose money on the asset side of the balance sheet before equity goes negative. The higher the leverage ratio, the less cushion. Now go back to the top and look at the table.

All of those leverage ratios are high. And they actually understate the truth. For instance, besides the $2.1 trillion of assets Citi has ON its balance sheet, it has another $1.2 trillion OFF its balance sheet. The only reason I didn’t include these in my calculation is I wasn’t sure how much off-balance sheet exposures the other banks have and I wanted the leverage calculations to be consistent. (I tried to look it up in their SEC filings, but disclosure varies by company. Citi is the only one of the bunch that spells it out clearly.)

With such stupendously high leverage ratios, is it any wonder that bank stocks are dropping like rocks? Common stock is just another word for common “E”quity. Market capitalization (share price * shares outstanding) is the Equity value of a company after Liabilities are deducted from the value of its Assets. A = L + E. If A/E is huge, then it takes only a small decline in A to wipe out all of E.

As more Americans fall behind on their mortgages, credit card bills, auto loans, student loans, etc., the financial companies that own these assets and have to write them down see the value of their equity get hammered, especially if they’ve employed excessive leverage.

Note today’s announcement by Citigroup and the government that the latter will “guarantee” (i.e. absorb losses) for some $306 billion of Citigroup’s toxic assets. If Citigroup had to take those losses, it would wipe them out. The same will be true for the other big banks. The Fed is already on the hook for $29 billion of debts owed by JPM’s new subsidiary Bear Stearns. And a few weeks ago the government agreed to guarantee $139 billion of GE’s debt. And then there’s the $100 billion promised each to Fannie and Freddie, $150 billion for AIG.

This is the story of the housing crisis, the banking crisis and the global financial meltdown. Everyone, everywhere was levered to the hilt, using piles of borrowed money to make leveraged bets on everything from real estate, to stocks, to currencies, to bonds, to companies themselves (LBOs), etc. With so many people maxing out leverage to drive returns, all it takes is a small decline in asset prices for all of them to go bust. Unfortunately, the decline in asset prices isn’t going to be small. Consequently, the value of equity capital will continue to get hammered.

All of these government bailouts, er, “guarantees” are simply a transfer of risk from the balance sheets of various financial companies to governments’. To prevent “A” from falling too far, and thereby wiping out the “E” of the financial companies, the government absorbs the assets itself, immunizing the financial companies from loss.

The trouble is, the losses don’t just go away. Someone will lose. First it’s common shareholders. Next it will be the U.S. taxpayer.

…

(Don’t forget to read Part 2 and Part 3 of this series Leverage by the Numbers. The leverage numbers actually get scarier when you factor in “other assets”…)

[Demeter]

58. Chris Whalen Looks at Geithner's Record and Finds it Sorely Wanting

http://www.nakedcapitalism.com/2008/11/chris-whalen-looks-at-geithners-record.html


We have been less than enthusiastic about the choice of Timothy Geithner to be the next Treasury Secretary. Granted, the idea that we will have someone who is intelligent, knows a thing or two about the markets, and is not from Goldman Sachs makes him a big improvement over the Bush incumbents.

However, competence should be a minimum standard, but the Bush years seem to have lowered expectations for public officials considerably. The commentary about Geithner has been uniformly positive. yet commentators have focused on his experience in a general manner and his personal attributes. Given that he has been actively involved in the central bank's policy before and during the financial crisis, it would make sense to look at his track record. Yet Geithner has been given a free pass, with some of his noteworthy actions mentioned in the media but not analyzed.

Chris Whalen at Institutional Risk Analytics fills that gap in his current newsletter, "What Barack Obama Needs to Know About Tim Geithner, the AIG Fiasco and Citigroup." For those readers who may not know of him, Whalen is a banking industry expert (he sells a very high end research product) and has extensive contacts in Washington. After Whalen, we will also provide some hesitant criticism of Geithner from Andrew Ross Sorkin at the New York Times, who pens a piece that is guardedly critical.

Whalen also discusses the ugly consequences of a GM bankruptcy.

From Institutional Risk Analytics::

If you look at how the Fed and Treasury have handled the bailouts of Bear Stearns and AIG, a reasonable conclusion might be that the Paulson/Geithner model of political economy is rule by plutocrat.

Facilitate a Fed bailout of the speculative elements of the financial world and their sponsors among the larger derivatives dealer banks, but leave the real economy to deal with the crisis via bankruptcy and liquidation. Thus Lehman, WaMu, Wachovia and Downey shareholders and creditors get the axe, but the bondholders and institutional counterparties of Bear and AIG do not.

Few observers outside Wall Street understand that the hundreds of billions of dollars pumped into AIG by the Fed of NY and Treasury, funds used to keep the creditors from a default, has been used to fund the payout at face value of credit default swap contracts or "CDS," insurance written by AIG against senior traunches of collateralized debt obligations or "CDOs." The Paulson/Geithner model for dealing with troubled financial institutions such as AIG with net unfunded obligations to pay CDS contracts seems to be to simply provide the needed liquidity and hope for the best. Fed and AIG officials have even been attempting to purchase the CDOs insured by AIG in an attempt to tear up the CDS contracts. But these efforts only focus on a small part of AIG's CDS book.

The Paulson/Geithner bailout model as manifest by the AIG situation is untenable and illustrates why President-elect Obama badly needs a new face at Treasury. A face with real financial credentials, somebody like Fannie Mae CEO Herb Allison. A banker with real world transactional experience, somebody who will know precisely how to deal with the last bubble that needs to be lanced - CDS.....

.... until we rid the markets of CDS, there will be no restoring investor confidence in financial institutions....

1) Start with the $50 trillion or so in extant CDS.

2) Assume that as default rates for all types of collateral rise over next 24-36 months, 40% of the $50 trillion in CDS goes into the money. That is $20 trillion gross notional of CDS which must be funded.

3) Now assume a 25% recovery rate against that portion of all CDS that goes into the money.

4) That leaves you with a $15 trillion net amount that must be paid by providers of protection in CDS. And remember, a 40% in the money assumption for CDS is VERY conservative. The rise in loss rates for all type of collateral over the next 24 months could easily make the portion of CDS in the money grow to more like 60-70%. That is $40 plus trillion in notional payments vs. a recovery rate in single digits.

Q: Does anybody really believe that the global central banks and the politicians that stand behind them are going to provide the liquidity to fund $15 trillion or more in CDS payouts? Remember, only a small portion of these positions are actually hedging exposure in the form of the underlying securities. The rest are speculative, in some cases 10, 20 of 30 times the underlying basis. Yet the position taken by Treasury Secretary Paulson and implemented by Tim Geithner (and the Fed Board in Washington, to be fair) is that these leveraged wagers should be paid in full.

Our answer to this cowardly view is that AIG needs to be put into bankruptcy....pay true hedge positions at face value, but the specs get pennies on the dollar of the face of CDS. And the specs should take the pennies gratefully and run before the crowd of angry citizens with the torches and pitchforks catch up to them.

President-elect Obama and the American people have a choice: embrace financial sanity and safety and soundness by deflating the last, biggest speculative bubble using the time-tested mechanism of insolvency. Or we can muddle along for the next decade or more, using the Paulson/Geithner model of financial rescue for the AIG CDS Ponzi scheme and embrace the Japanese model of economic stagnation....

BIG CUT--SEE LINK


Now from Andrew Ross Sorkin at the New York Times:

President-elect Barack Obama unveiled on Monday an economic team with deep experience handling economic crises. But does the man at the center of this star-studded cast, Timothy F. Geithner, the nominee for Treasury secretary, have what is needed to take the nation in a new financial direction?...

Mr. Geithner is clearly a 47-year-old wonder boy....

But Mr. Geithner’s involvement in several ultimately ill-fated efforts to buttress the American financial system is the very reason some Wall Street C.E.O.’s — a number of whom spoke on the condition of anonymity for fear of piquing the man who regulates them — question whether he’s up to the challenge....

While Henry M. Paulson Jr., the current Treasury secretary, has taken a drubbing for the changeable nature of the government’s efforts to bolster the financial industry — some of which clearly contradicted each other — Mr. Geithner has managed, for the most part, to remain unscathed. He’s been widely praised as a bright, articulate out-of-the box thinker who is a bailout expert, to the extent anyone can truly be an expert at fast-changing emergencies.

Behind the scenes, Mr. Geithner was the point person for weeks of sleep-deprived Bailout Weekends. It was Mr. Geithner, not Mr. Paulson, for example, who put together the original rescue plan for the American International Group.

And, of course, Mr. Geithner also oversaw and regulated an entire industry whose decline has delivered a further blow to an already weakened American economy. Under his watch, some of the biggest institutions that were the responsibility of the New York Fed — Bear Stearns, Lehman Brothers, Merrill Lynch and most recently, Citigroup — faltered. While he was one of the first regulators to smartly articulate the potential for an impending disaster, a number of observers question whether he went far enough to stop the calamity.

Perhaps what has most people on Wall Street stirring is Mr. Geithner’s role in the fall of Lehman. At the time of its bankruptcy, he, along with Mr. Paulson, appeared to be the most vocal in supporting the government’s refusal to bail out the firm, according to people involved in various meetings. With hindsight, many in the financial industry blame a deepening of the global financial crisis on the government’s decision to let Lehman crumble.

[Demeter]

59. Another Crisis, Another Guarantee By FLOYD NORRIS

http://www.nytimes.com/2008/11/25/business/25assess.html?_r=1&ref=business


Guarantees that could not be honored thrust the world financial system into its worst crisis since the Great Depression. Will a guarantee by the United States government finally restore confidence in the American financial system?

Only a week after Treasury Secretary Henry M. Paulson Jr. said that the government bailouts had stabilized the most important financial institutions, plunging stock prices forced the government to step in again, both to make another direct investment and to guarantee that losses would be contained from $306 billion in possibly toxic assets on Citigroup’s balance sheet.

The move sent stock prices soaring Monday, with financial stocks leading the way. But those gains did not come close to erasing last week’s losses, and left open the possibility that a renewed sense of concern about the safety of other banks could force still more bailouts in coming weeks.

One lesson may be that it is perilous for the government to even hint that it thinks it is through bailing. That can renew fear about banks, driving down share prices and forcing the government to do the opposite of what it had intended. Since the government has a printing press, it need never be short of dollars. That fact makes this guarantee much more credible than the ones, from bond insurers and other companies, that helped persuade banks and others to take what turned out to be huge risks. Many of those guarantors, it turned out, could not honor their obligations. The government feared financial chaos if there was a string of collapses.

Even if Citigroup is the last bailout, the Bush administration, whose rhetoric was perhaps more supportive of free, unhindered markets than was that of any of its predecessors, will leave a trail of socialized risk.

But that trail may not be at an end. The auto companies want billions in bailouts, and other industries are lining up.

And as the nation’s obligations rise into the trillions, at some point investors may begin to question whether a government running huge deficits can also credibly promise that the dollar will not lose its value. Such a worry conceivably could push up the very low interest rates the Treasury now pays to borrow from foreign investors to foot an ever-larger rescue bill.

But those are problems for another day. Now the priority is to keep the financial system from collapsing. The problems of recession, constricted lending markets and falling real estate prices will remain even if everyone concludes the big banks are safe.

In the latest bailout, the government injected an additional $20 billion into Citigroup, on top of the $25 billion it invested a few weeks ago. It also said that it would cover 90 percent of the losses on those $306 billion in securities after Citigroup absorbed the first $29 billion of losses.

The fact that it was necessary to guarantee so many assets — about a sixth of the $2 trillion in assets that Citigroup reported at the end of September — was another indication of both the complexity and the opacity of many of the securities that were created by financial engineers in the great wave of innovation.

The assets in question — described by the government as “loans and securities backed by residential real estate and commercial real estate, and their associated hedges” — must be valued at current market value before the guarantee kicks in, but the government and the bank have yet to agree on those values.

That phrase “associated hedges” captures the fact that Citigroup, like many others, had sought to insure itself against losses with a variety of transactions, including the purchase of insurance, only to learn that the losses were overwhelming those who had promised to pay.

The boom of the first half of this decade will be remembered as a time that financial innovations overwhelmed the capacity of both regulators and banks to assess risk.

The collapses of Bear Stearns and Lehman Brothers, both of which were primarily regulated by the Securities and Exchange Commission, served to focus attention on the agency, which was effectively forced out of that financial soundness regulation area after the Federal Reserve assumed oversight of several of the large companies for which it had been responsible.

But Citigroup had always been under Fed regulation, and the need for repeated bailouts there shows both that the regulation was ineffective and that even after the crisis began, the government underestimated its severity.

At first, the Fed hoped that just making more loans available to banks would reassure markets. Then, as losses mounted, the government tried capital injections. In both cases, investors first showed relief, then grew afraid again.

The newest bailout includes more than the guarantee and the capital injection. It enables Citigroup to treat the guaranteed assets as being relatively safe, thereby improving its apparent capital position.

It could need all the reported capital it can get. David Hendler, an analyst at CreditSights, pointed out that Citigroup’s other assets included $91 billion in credit card receivables, $272 billion in non-United States consumer loans, $163 billion in corporate loans and a net $104 billion in assorted derivatives. Those assets, he wrote, “are not immune to weakness in the overall economy.”

STILL MORE BAD NEWS AT LINK

[DemReadingDU]

64. Debt Rattle, November 30 2008: How to Build a Lifeboat

This is a continuation of post #33.

11/30/08
Stoneleigh: Yesterday we talked about why we are facing deflation and today I wanted to review and explain the suggestions we have made previously for dealing with a deflationary scenario. In short, this is the list we have run periodically since we started TAE (with one addition at the end):

1) Hold no debt (for most people this means renting)
2) Hold cash and cash equivalents (short term treasuries) under your own control
3) Don't trust the banking system, deposit insurance or no deposit insurance
4) Sell equities, real estate, most bonds, commodities, collectibles (or short if you can afford to gamble)
5) Gain some control over the necessities of your own existence if you can afford it
6) Be prepared to work with others as that will give you far greater scope for resilience and security
7) If you have done all that and still have spare resources, consider precious metals as an insurance policy
8) Be worth more to your employer than he is paying you
9) Look after your health!

1) The reason that getting rid of debt is priority #1 is that during deflation, real interest rates will be punishingly high even if nominal rates are low. That is because the real rate (adjusted for changes in the money supply) is the nominal rate minus inflation, which can be positive or negative. During inflationary times, this means that the real rate of interest is lower than the nominal rate, and can even be negative as it was during parts of then 1970s and again in the middle of our own decade. People have taken on huge amounts of debt because they were effectively being paid to borrow, but periods of negative real interest rates are a trap. They lure people into too much debt that they may not be able to service if real rates rise even a little. Most people are thoroughly enmeshed in that trap now as real rates are set to rise substantially.

When inflation is negative (i.e. deflation), the real rate of interest is the nominal rate minus negative inflation. In other words, the real rate is higher than the nominal rate, possibly significantly higher. Even if the nominal rate is zero, the real rate can be high enough to stifle economic activity, as Japan discover during their long sojourn in the liquidity trap. Standard money supply measures don't necessarily capture the scope of the problem as they don't adequately account for on-going credit destruction, when credit has come to represent such a large percentage of the effective money supply.

The difficulty from the point of view of debtors can be compounded by the risk that nominal interest rates will not stay low for years, as they did in Japan, but may shoot up as the international debt financing model comes under stress. For instance, on-going bailouts may cause international lenders to balk at purchasing long term treasuries for fear of their effect on the value of the dollar, even though those bailouts are not increasing liquidity thanks to hoarding behaviour by banks. We are not there yet, but the probability of this scenario rises as we move forward with current policies. The effect would be to send nominal interest rates into the double digits, and real interest rates would be even higher. The chances of being able to service existing debts under those circumstances are not good, especially as unemployment will be rising very quickly.

There is no safe level of debt to hold, including mortgages. For those who are not able to own a home outright, most would be much better off selling and renting, as real estate becomes illiquid faster than almost anything else in a depression. By the time you realize that you need to sell because you can no longer pay the mortgage, it may be too late. Renting is essentially paying someone else a fee to take the property price risk for you, which is a very good bet during a real estate crash. It would also allow you address point #2 - having access to liquidity.

2) Holding cash and cash equivalents (i.e. short term treasuries) is vital as purchasing power will be in short supply. Cash is king in a deflation. Access to credit is already decreasing and will eventually disappear for ordinary people. Mass access to credit has been a product of an historic credit expansion that expanded the supply of pockets to pick to an unprecedented extent, feeding off widespread debt slavery in the process. As you can't count on the availability of credit for much longer, you will need savings in liquid form that you can always access.

When interest rates spike, not only will debt become a millstone round your neck, but a debt-junkie government forced to pay very high rates will be in the same position. As a result government spending will have to be cut drastically, withdrawing the social safety net just as it is most needed. In practical terms, this means being on your own in a pay-as-you-go world. You do NOT want to face this eventuality with no money.

3) Keeping the savings you need in the banking system is problematic. The banking system is deeply mired in the crisis in the derivatives market. Huge percentages of their assets are not marked-to-market, but marked-to-make-believe using their own unverifiable models. The market price would be pennies on the dollar for many of these 'assets' at this point, and poised to get worse rapidly as the forced assets sales that are coming will lower prices further. The losses will eventually dwarf anything we have seen so far, pushing more institutions into mergers or bankruptcy, and mergers are becoming more difficult as the pool of potential partners shrinks.

If we do see a rash of bank failures, each of which weakens the position of others as the sale of their assets and unwinding of their derivative positions can re-price similar 'assets' held by other parties, then deposit insurance will not be worth the paper it's written on. When everything is guaranteed, nothing is, as the government cannot guarantee value. Savings held in these institutions are at much higher risk than commonly thought due to the systemic threats posed by a derivatives meltdown and spreading crisis of confidence. Fractional reserve banking depends on depositors not wanting their money back all at once, in fact with reserve requirements so whittled away in recent years, it depends on no more than a fraction of 1% of depositors wanting their money back at once. This is a huge vulnerability and the government deposit guarantee is a bluff waiting to be called.

4) The general rule of thumb in a deflation is to sell everything that isn't nailed down and then sell whatever everything else is nailed to, for the reasons that assets prices will fall further than most people imagine to be possible, and the liquidity gained by selling (hopefully) solves the debt and accessible savings problems (provided you don't lose the proceeds in a bank run). Assets prices will fall because everywhere people will be trying to cash out, by selling not what they'd like to, but what they can. This means that all manner of assets will be offered for sale at once, and at a time when there are few buyers, this will push prices down to pennies on the dollar for many assets.

For those few who still have liquidity, it will be a time when there are many choices available very cheaply. In other words, if you manage to look after the proceeds from the sale of your former assets, you should be able to buy them back later from much less money. Of course flashing your wealth around at that point could be highly inadvisable from a personal safety perspective, and you may find that you'd rather hang on to your money anyway, since it will be getting harder and harder to earn any more of it. During the Great Depression, some of the best farms in the country were foreclosed up on and received no bids at auction, not because they had no value, but because those few with money were hanging on to it for dear life.

Being entirely liquid has its own risks, which is why I wouldn't sell assets that insulate you from economic disruption if you didn't buy them on margin (ie with borrowed money that you may not be able to pay back) and if you have enough liquidity already that you can afford to keep them. For instance, a well equipped homestead owned free and clear is a valuable thing indeed, whatever its nominal price. It is totally different from investment real estate owned on margin, where the point of the exercise is property price speculation at a time when doing so is disastrous.

One important point to note with regard to commodities is that commodities have already fallen along way since I first published the above list of suggestions. At that time, selling commodities was a very good idea, but now, since commodities are already down a very long way, it may depend on the commodity in question. If you only own commodities in paper form then selling is still a good idea in my opinion, as there are generally more paper claims than there are commodities, and excess claims will be extinguished. At some point soon I will write an intro on my view of energy specifically, since energy is the master resource. In short, we are seeing a demand collapse now, but eventually we will see a supply collapse, and it is difficult to predict which will be falling fastest at which times.

5) If you already have no debt and have liquidity on hand, I would strongly suggest that you try to gain some control over the essentials of your own existence. We live in a just-in-time economy with little inventory on hand. Economic disruption, as we are already seeing thanks to the problems with letters of credit for shipments, could therefore result in empty shelves more quickly than you might imagine. Unfortunately, rumours of shortages can cause shortages whether or not the rumour is entirely true, as people tend to panic buy all at once. If you want to stock up, then I suggest you beat the rush and do it while it's still relatively easy. You need to try to ensure supplies of food and water and the means to keep yourselves warm (or cool as the case may be). Storage of all kinds of basic supplies is a good idea if you can manage it - medicines, first aid supplies, batteries, hand tools, wind-up radios, solar cookers, a Coleman stove and liquid fuel for it, soap etc.

At the moment, there are many things you can obtain with the internet and a credit card, but that will not be the case in the future. Water filters are a good example, as the quality of water available to you is likely to deteriorate. You can buy the kind of filters that aid agencies use oversees for all of about $250, with extra filter elements for a few tens of dollars at sites such as Lehmans Non-Electric Catalogue or the Country Living Grain Mill site.

6) Most people will not be able to get very far down this list on their own, which is why we suggest working with others as much as possible and pooling resources if you can bring yourself to do so. Together you can achieve far greater preparedness than you could hope to do alone, plus you will be building social capital that will stand you in good stead later on.

7) If you have already taken care of the basics, then you may want to put at least some of whatever excess you still have into precious metals (in physical form). Although the price of metals should still have further to fall, since distressed sales have not yet had an effect on price, obtaining them could get more difficult. Buying them now would amount to paying a premium price for an insurance policy, which may make sense for some and not for others. Metals will hold their value over the long term as they have for thousands of years, but you may have to sit on them for a very long time, so don't by them with money you might need access to over the next few years.

Metal ownership may well be made illegal, as it was during the Great Depression, when gold was confiscated from safety deposit boxes without compensation. That doesn't stop you owning it, but it does make ownership far more complicated, and makes trading it for anything you might need even more so. You could easily attract the wrong kind of attention and that could have unpleasant consequences. In short, gold is no panacea. Other options may be far more practical and useful, although there is an argument for having a certain amount of portable wealth in concentrated form if you should have to move suddenly.

8) Being worth more to your employer than he is paying you is a good idea at a time when unemployment is set to rise dramatically. This is not the time to push for a raise that would make you an expensive option for a cash-strapped boss, and in fact you may have to accept pay cuts in order to keep your job. During inflationary times, people can suffer cuts to their purchasing power year after year, but they don't complain because they don't notice that their wage increases are not keeping up with inflation. However, deflation brings the whole issue into the harsh light of day.

People would have to take pay and benefit cuts for their purchasing power to stay the same, thanks to the increasing value of cash, but keeping people's purchasing power the same will not be an option for most employers, who will be struggling themselves. In other words, expect large cuts to pay and benefits. As unions will never accept this, for obvious reasons, since their membership has its own fixed costs, there will be war in the labour markets, at great cost to all. You need to reduce your structural dependence on earning anything like the amount of money you earn now, and don't expect benefits such as pensions to be paid as promised.

9) Your health is the most important thing you can have, and most citizens of developed societies are nowhere near fit and healthy enough. Already medical bills are the most common reason for bankruptcy in the US, and while you can't protect yourself against every form of medical eventuality, you can at least improve your fitness. You will be be living in a world where hard physical work will be much more prevalent than it is now, and most people are ill-equipped to cope. The solution Ilargi and I have chosen, as we have mentioned before, is the P90X home fitness programme. While it wouldn't be the right choice for everyone, if I can do it, as I have for 11 months already, then most people can. For others, there are gentler options available, but everyone should consider doing something to make themselves as healthy and robust as possible.

We here at TAE wish you the best of luck at this difficult time. We will all need it.

click for related articles and comments
http://theautomaticearth.blogspot.com/2008/11/debt-rattle-november-30-2008-how-to.html


p.s. Ilargi and Stoneleigh are co-editors of http://theautomaticearth.blogspot.com/

[Hugin]

66. I'm good up to number 8.

You should consider reposting this in the SMW tomorrow.

[DemReadingDU]

68. ok, good idea

Thanks
:)

[Demeter]

67. This Answers The Question: What to Do Now?

Another item--build a personal network of trustworthy and helpful people and build relationships of give and take. There's safety in numbers, if the numbers work together and respect each other.

[DemReadingDU]

70. yes, I think that is implied in #6

'work' with others, build relationships, play well together. Survival will depend on how well we get along with the people in our neighborhood.


6) Most people will not be able to get very far down this list on their own, which is why we suggest working with others as much as possible and pooling resources if you can bring yourself to do so. Together you can achieve far greater preparedness than you could hope to do alone, plus you will be building social capital that will stand you in good stead later on.
http://theautomaticearth.blogspot.com/2008/11/debt-rattle-november-30-2008-how-to.html

[Joe Chi Minh]

71. What brilliantly insighful articles these people produce.

[DemReadingDU]

72. Yes, indeed

I am much appreciative of both Stoneleigh and Ilargi, and various responders in the comments section. I have learned a lot, what to do and how to prepare. I have talked about this to my family and friends, some kinda get it, but most still roll their eyes.

Originally, they posted at the oil drum, http://www.theoildrum.com/

They started this blog in January 2008, as a kind service to others, because the financial crisis is here, and it's urgent.
http://theautomaticearth.blogspot.com/

edit:
F.Y.I. It's just been recently that they started a fundraiser, the green box in the upper left corner of the home page.

[Joe Chi Minh]

73. Yes, I've read a few really fascinatingly informative articles of theirs on here.