normxxx ruminates...

Where The Crisis Came From

2009-11-26T07:51:00.000-08:00

Where The Crisis Came From

By Robert G. Wilmers, WP | 27 July 2009

Over the past three decades, there has been a sea change in the way that credit is extended in America, creating the problems— and the need for reforms— that we face today. At the heart of the financial crisis lie the complex, opaque derivative securities created not by traditional Main Street banks, but by Wall Street— with the passive complicity of regulators. Wall Street created, originated, and 'sold' an alphabet soup of derivative securities, and it was such synthetic instruments— not traditional mortgage loans, small-business loans or other standard/conventional lending originated by banks— that unleashed a flood of credit [[seeking investors, and not the other way around, as traditional: normxxx]], created a vast excess of housing, weakened the capital structure of the banking industry and undermined popular confidence in banks.

In previous generations, home buyers obtained mortgages and other loans from local, or Main Street, banks, which typically held those loans until they were fully repaid— and therefore had an interest in making loans that borrowers could afford. But then Wall Street started slicing, dicing and packaging mortgages into 'bundles' that served as the basis for 'bonds' sold in the securities markets. Traditional bank deposits were no longer the primary funding source for credit. Instead, loans were being financed by the [[much more risk tolerant: normxxx]] capital markets and packaged and sold by Wall Street. Mortgages were originated by one firm, packaged by another, sold by a third and serviced by yet another— but none of them worried about whether the mortgages would be repaid, because they didn't hold the loans on their books. [[In their defense, it was assumed that since "housing prices could only go up", these mortgages would be 'refinanced', should the 'homeowner' find himself unable to pay the 'reset' mortgage interest rate [[i.e., any rate higher than the introductory 'teaser' rate: normxxx]]. In effect, everyone including the homeowner was basing the housing purchase investment decision on the expectation that the good times would never end! : normxxx]]

Securitized debt grew nearly 50-fold from 1980 to 2000— compared with a mere 3.7-fold increase for bank loans. In 1998, traditional bank lending was surpassed by securitized debt for the first time. By the end of 2007, Wall Street accounted for two-thirds of all private U.S. debt. This growing market for synthetic mortgage-backed securities inundated the country with credit that, combined with historically low interest rates and exotic new mortgage products [[curtesy of Alan Greenspan: normxxx]], fueled the housing bubble and turned our financial markets into a virtual casino. In the collapse that followed, billions of dollars' worth of mortgage-backed securities were written off.

But the public continues to think of banks as the primary source of credit— and to blame banks for the credit crunch. Public officials contribute to the confusion by criticizing banks— while allowing Wall Street to operate this "shadow banking industry," which exists outside the standards for safety and soundness that apply to banks and without obligation to make clear the extent of such firms' debt, leverage, capital or reserves. Many Wall Street firms played significant and contributory roles in the evolution of this crisis.

Wall Street's most prominent investment bank, Goldman Sachs, historically the industry leader, was at the forefront of the creation, origination and sales of derivative securities— and also spent $40.6 million on lobbying and campaign contributions from 1998 to 2008. In 2008 alone, Goldman spent $8.97 million in this way— almost 11 percent more than the Financial Services Roundtable, a trade organization that represents 150 top financial institutions. The conversion of the Goldman Sachs investment bank into a giant hedge fund went unchecked by legislators and regulators [[who, in fact, actually facilitated this change by largely eliminating any remaining regulatory laws which impeded the investment behemoths (largely put into place to protect us from a repeat of the 1930's calamity): normxxx]], despite constituting a radical change to our financial system. And it has since received billions upon billions in taxpayer bailout funding to keep it alive.

By contrast, consider how regulators treat Main Street banks compared with the way they deal with this highly 'connected' investment bank: When M&T Bank applied for regulatory approval to acquire a modest-size bank in Utica, N.Y., it took 10 weeks and a promise to divest three branches before permission was granted. On the other hand, when the Goldman Sachs Wall Street investment house decided to seek a commercial bank charter in the midst of the financial storm, permission was granted in less than a week. By obtaining this charter, Goldman Sachs received access to the Federal Reserve Discount Window and the Federal Deposit Insurance Corp., which has long been funded by dues from thousands of community-based banks across the United States— and which has since guaranteed $28 billion of Goldman Sachs' debt securities. That's equal to 10 percent of all funds guaranteed under the government's Temporary Liquidity Guarantee Program.

The same could be said of many other large financial firms that are also big spenders in Washington. The 10 largest recipients of federal Troubled Assets Relief Program funds— including two Wall Street investment banks and three other, non-bank institutions that participated— spent $82.4 million on lobbying and campaign contributions in 2008 and $523.6 million over the past 10 years. This sort of behavior is simply wrong. Corporate leaders have an obligation to set the right tone— a moral tone— lest public confidence in our private enterprise system completely erode.

Also, we must restore the balance of regulatory oversight between commercial banks and other parts of the financial services industry. We should do so not only to be fair to banks but because the nation's ailments won't be cured unless solutions are directed at the entire financial system, not just the one-third of it [[that 'supports our legislators': normxxx]].

The writer is chairman and chief executive of M&T Bank, one of the 20 largest U.S. bank holding companies.

More Gloom And Doom From Our French Friends

2009-11-21T10:52:00.000-08:00

More Gloom And Doom From Our French Friends.
Click here for a link to ORIGINAL article:

By Public Announcement Geab N°39, November 16, 2009 — 19 November 2009

GEAB N°39: Global systemic crisis! States faced with three brutal options in 2010(!): inflation, high taxation or default!

[ Normxxx Here: Note: These are the same people who absolutely declared— with no uncertainty or caveats— that the US dollar and UK pound would be toast by end of summer 2009! They are notorious Francophiles and Anglophobes (the latter to include Americans). But, it is an alternative view, and they are very often correct. ]

As 'anticipated' by LEAP/E2020 last February [[not quite! : normxxx]], in the absence of major reappraisal of the international monetary order, the world is now entering the phase of geopolitical dislocation of the global systemic crisis. In 2010, as protectionism and the economic and social depression gain momentum, a large number of States will be compelled to choose between three brutal options: inflation, high taxation or defaulting on their debt. A growing number of countries (USA, United Kingdom, Euroland¹, Japan, China²,…) have exhausted their budgetary and monetary 'cartridges' in the 2008/2009 financial crisis and are now left with no other alternative. [[But, never underestimate the power of the human mind (especially those of politicians) to come up with yet "newer" solutions… and just 'muddle through'.: normxxx]]

Nevertheless, out of ideological reflex or in an attempt to avoid by any means having to make such painful choices, they will continue to try to launch further 'new' stimulus plans (under different names) even though it is now clear that the huge public effort made in the past months to boost the economy is having no impact on the private sector. [[I suspect that that is a gross exaggeration. Much less than hoped for, certainly; but way more than in similar periods since 1933 (when FDR ushered in a whirlwind of programs, which nonetheless was puny by today's standards).: normxxx]] Indeed the consumer-as-we-knew-him in the past decades is dead, with no hope of resurrection³.

Knowing that nearly 30 percent of Western countries' economies are now made of « economic zombies » (financial institutions, companies and even entire States, whose signs of life are only due to the occasional liquidity injections of the central banks), it is possible to confirm the inevitability of the "impossible recovery"⁴. Internationally and socially (i.e., within each country), the « everyman for himself » rule is beginning to prevail, as well as the general impoverishment of the erstwhile "First World" of rich Western countries, with the United States leading the way. In fact the West is being [[deliberately[!?!]: normxxx]] scuttled by leaders unable to face the reality of a 'post-crisis world', who keep resorting to methods from yesterday's world [[in a near desperate attempt to at least maintain "relative position" in a post-crisis world: normxxx]] despite the proved insufficiency/ineffectiveness of such methods.

In this 39th issue of the GEAB, our team has therefore chosen to focus our anticipations/expectations[!?!] on general developments ahead in 2010, a year when key states will see their choices restricted to three brutal options: inflation, high taxation or default, which they will struggle in vain to escape. Knowing that one of the reasons why 'stimulus plans' are doomed to fail is that the consumer-as-we-knew-him in the past thirty years is dead [[but, as Mark Twain so famously remarked, "the rumors of my demise have been greatly exaggerated," I believe that the wake in progress for the 'consumer' may yet prove premature.: normxxx]], we analyze this phenomenon in this issue of the GEAB, as well as fallout for companies, and for the marketing and advertizing businesses. In the field of geopolitics, we present a number of LEAP/E2020 anticipations regarding Turkey by 2015 with regards to both NATO and the EU. Of course, we also present our usual monthly recommendations, as well as the results of the last GlobalEurometre survey.

Evolution of German federal budget (1991— 2010) (estimates in 2009 and 2010 do not include Angela Merkel's recently announced tax cut plan)— Source: Financial Times / Thomson Reuters, 11/02/2009

But Yesterday's Recipes Have No Effect On The Global Systemic Crisis

The only chance for the states to escape the three brutal options noted above would be that either consumption resumes [[in a big way: normxxx]] or the private sector starts investing again. But in the absence of one or the other major positive dynamic, States will have no other alternative in 2010 than to raise taxes to match their huge public deficits, let inflation soar to diminish the relative weight of their debt, and/or 'file for bankruptcy'. Some of these countries (the US, UK, Ireland, Argentina, Latvia, or even Spain, Turkey, Dubai or Japan) could be confronting two, or even all three, options at the same time.

Trends regarding consumption and investment are extremely negative. The consumer is now 'incited' to save money, pay back his debt and, more generally, reject (willingly or not) the 'Western model of consumption' of the past thirty years⁵ due to which growth, in the US and UK in particular, became nearly entirely dependent on him⁶. Meanwhile, companies, due to their lack of foreward visibility (to be positive) or to actual negative forecasts, are cutting back on investment, a situation only made worse by new and more onerous banking credit restrictions [[as the banks desperately try to hold on to/build on to their remaining stock of capital: normxxx]]⁷.

Public investment also is reaching limits: it will be impossible to significantly extend or renew previous stimulus plans without excessively increasing public deficits and then being faced, at the end of 2010, with at least two of the three brutal options⁸. The states are indeed exposed to increasing pressure (general public, supervisory bodies, private investors)⁹ to balance their bad, i.e., dangerous, budgets. In other words, public investment in 2010/2011 is doomed to shrink rapidly.

"Foreign demand" is completely saturated: everyone wants to export in order to find abroad that greedy consumer or investing company that is no longer to be found at home. The great myth being that Asia, and China in particular, will provide for this « new Western-style consumer ». Besides the fact that many will be called but few will be chosen among non-Chinese or non-Asian to enjoy the region's market, it would be an underestimation of the systemic nature of the global crisis to imagine that this 'new' consumer will be as greedy as the now moribund Western consumer. The luxury industry and its current woes in Asia clearly illustrate this situation.

Comparative Evolution Of UK GDP During Each Recession Since The 1930s Crisis (In Months, From Official Start Of Each Recession)— SOURCE— National Institute Of Economic Review, 10/2009

So what's left?

« Zombie-Economy » Now Accounts For A Considerable Part Of The Global Economy.

Central banks continue to supply financial markets with liquidity, hoping that at some point their huge quantitative effort will result in some qualitative surge in the real economy. In the US and UK particularly, as they continue to pretend that the crisis does not reflect a general problem of insolvency (of banks, consumers, public organizations and companies), they "wait for Godot" and create the conditions for soaring inflation, and collapsing currencies and public money. States unflinchingly continue to bear the consequences of banks' mistakes, while still slavishly following their bankers' advice. Thus they have built up a debt of at first unreasonable and then intolerable proportions, and now they are on the verge of drastically cutting public spending¹⁰ and significantly increasing taxes in an attempt to avoid bankruptcy¹¹.

« Economic zombies »¹², private and public ones, now account for a large part of Western and Chinese economies: objectively defaulting states (like the UK or US) which no one dares technically declare as such; bankrupt companies still allowed to run for fear of increasing unemployment otherwise¹³; insolvent banks¹⁴ whose accounting rules are modified to hide the worthlessness of their assets, to postpone their inevitable implosion¹⁵. Financial markets are going up thanks to liquidity graciously offered by central banks¹⁶ eager to give back to the consumer/grant-holder a felling of wealth in the hope that he will start being himself again and consume, when in fact all categories of assets¹⁷, such as gold for instance, are also going up (even faster in most cases), clearly indicating that inflation has in fact returned.

Unemployed people are piling up by the dozens of millions in and out of official figures, suggesting that 2010 will be a tough year socially-speaking, placed under the sign of protectionism to save jobs by any means (i.e., by tariffs, environmental or sanitary barriers, or by simple competitive devaluations of currencies), while governments wonder how much longer they can take the global cost of so much unemployment when no recovery is in sight¹⁸. [[While over all looms the specter of the '30s: gross overcapacity of manufacturing facilities worldwide, but especially in China.: normxxx]]

Evolution of unemployment rate in the Euroland and in the US (1991— 2009)— Sources: Eurostat, Bureau of Labour statistics, Morgan Stanley

LEAP/E2020 wrote in February and March 2009 that, if the international monetary system was not completely reconsidered before summer 2009, the world would inevitably move towards a situation of global geopolitical dislocation, some sort of a worldwide "very great depression", centered on the collapse of yesterday's world's pillar, the US. That's where we are now¹⁹. [[They also wrote that the US dollar and the UK pound would be 'toast' by then.: normxxx]] Even 'adjusted' figures²⁰ can no longer hide the level of deterioration of the global economic and social situation nor the descent to hell of the US economy and society.

This reality is becoming clearer and will be obvious to everyone by the beginning of the second quarter of 2010. In this GEAB N°39, as every month, our team tries to anticipate the main trends so that everyone, personally or professionally, can get ready for a difficult year in 2010, a year when yesterday's recipes will prove their insufficiency in curbing the global systemic crisis.

_________________________________
NOTES:

¹Among these key countries, only Angela Merkel's Germany can still do it, and it will: indeed, the German chancellor has decided to launch a new stimulus plan based on … tax cuts. It is difficult to be more ideological and disconnected from the reality of the crisis! Germany must therefore now expect a substantial deterioration of its fiscal situation by the end of 2010… as well as significant tax increases to alleviate the fiscal debacle. According to our team, today's ideological blindness of Western leaders in tax matters is equal to that of communist leaders in the early months of 1989: no understanding whatsoever of the fact that past recipes no longer work. Just like the "good communist subject" was no longer willing to obey passively, the « good Western consumer » is no longer willing to consume actively. But no one ever said that Angela Merkel, Nicolas Sarkozy, or Barack Obama understood anything of the economy.

²China can still afford a stimulus plan, but the Chinese problem, as already analyzed by LEAP/E2020, is the time needed for a sufficient domestic demand to emerge and make up for collapsed exports. In this case, no stimulus plan in the world can « buy » this missing time, this decade, that the Chinese need in order to develop a significant domestic demand. In 2010, once the smoke-screen generated by artificially stimulated production will be dissipated, everyone will see that this production was not sold… for lack of buyers.

³This video-clip perfectly illustrates, with a lot of humour, the radical change in consumer ways currently taking place in the US.

⁴See GEAB N°37

⁵We shall develop this analysis in another chapter of this GEAB N°39.

⁶In 2008, household consumption accounted for 70 percent of US GDP and 64 percent of UK GDP, versus 56 percent of German GDP and 36 percent of Chinese GDP.

⁷Sources: MarketWatch, 11/09/2009; IrishTimes, 10/27/2009

⁸According to LEAP/E2020, the bitter irony of the situation lies in the fact states currently refusing to face the perspective of the three brutal options which would enable them to make their way at best amidst the three options, condemn themselves to suffer at least two of them at the same time by the end of 2010. "Taking a step back for a worst jump" so to speak.

⁹Because it is so unpopular, the « second » US stimulus plan [[under the current administration, but : normxxx]] in fact the third, if we take into consideration G. W. Bush's tax cut plan in 2008), is being prepared in an "undetectable" form. It will consist of a disparate set of measures that the Obama administration will avoid presenting as a single, coherent, unique 'plan' in order to conceal its true nature. In the same category, we also find the French government's « big national loan » which Nicolas Sarkozy pretends to be a long-term investment, but which Brussels will add to the French debt as a simple short-term economic stimulus plan. From 'overt' inefficient policies to 'hidden' inefficient policies… what a victory over the crisis! Sources: TheKatyCapsule, 10/22/2009

¹⁰The OECD is clear on that: to get over it, Western countries will have to proceed to drastic cuts in education, health, social programmes… Ireland, ultimate model for the same OECD, EU or IMF two years ago, is about to lead the dance: the first in its frenzy of ultra-liberal consumption, it will also be the first in applying ultra-liberal austerity. No wonder then that large demonstrations have started filling streets of the country's big cities. Sources: FinancialTimes, 09/22/2009; RTE News, 06/11/2009 [[But so far, lowly Iceland, a country about as given to 'socialistic' forms of social support as Ireland, and surely in far worse straits just a few short months ago, seems to be doing great since it snubbed the EU proscriptions for 'recovery!': normxxx]]

¹¹Sources: EUObserver, 11/10/2009

¹²It is worth reading the detailed definition of a « zombie economy » as proposed by PA Consulting Group on 11/10/2009.

¹³Walking around North-American and European cities is a good way to realize that, though many brands are still shining to attract buyers, they are in fact the deceptive appearances of bankrupt companies kept artificially alive by means of public money or uncertain restructuring, as in the case of CIT, GM, Chrysler, Saab, Opel, Karstad, Quelle, Iberia, Alitalia, … Superficially, things would appear to be moving along normally, but in fact a disease is striking deeper and deeper into the corporate fabric, filling it with true 'zombies'. In China, the zombies are made of all those factories kept running, not thanks to customers, but to state handouts. All those « economic living deads » are the result of the gradual injection into the real economy of the USD 20,000 to 30,000 billions in 'ghost-assets', previously described in the GEAB.

¹⁴Source: Bloomberg, 11/02/2009

¹⁵The expression « zombie bank » even has its definition in Wikipedia.

¹⁶Source: Financial Times, 10/22/2009

¹⁷Except real estate.

¹⁸Knowing that each job created roughly costs USD 324,000 (according to White House figures), one may indeed wonder how much longer such inefficient policies can continue. Source: Global Economic Trend Analysis, 10/31/2009

¹⁹Those who still doubt that the current crisis is provoking a major time acceleration should read this article by Michael Klare published in TomDispatch on 10/26/2009, showing how US decline forecasts by 2025 as analyzed one year ago by the CIA are in most case already coming true… right under our noses.

²⁰Even CNBC now mentions the fact, one extensively described in the previous GEABs. Source: CNBC, 11/09/2009

Lundi 16 Novembre 2009

ß§

Normxxx
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Looking Ahead: 2010 and Beyond

2009-11-13T12:36:00.000-08:00

[ Normxxx Here: Remember, above all things, we are merely in the MIDDLE of a secular BEAR market that has some 10 years or so left to run! ]

Breakfast With Dave
Looking Ahead: 2010 and Beyond

By Dave Rosenberg, Gluskin Sheff | 5 November 2009

While You Were Sleeping
• Global semi-conductor sales surged 8.2% MoM in September
• Gold glitters
• Equities rallying, commodities firming, U.S. dollar weakening
• Auto sales rev up … but still at anemic levels
• In the U.S., commercial real estate a disaster for banks
• A bounce in bankruptcies in October

It's all good. Equities are rallying, led by the emerging market space with a hefty 1.7% advance today. China is now [on a regular tear]— the longest winning streak in two months. U.S. equity futures are bid (maybe also responding some to the recent GOP gubernatorial successes— Virginia and New Jersey).

Bonds are selling off. Credit default swaps improved 20bps. The U.S. dollar is softening again as it struggles near its 50-day moving average and the reason being cited is that the Fed press statement today will acknowledge the recovery but stop short of discussing any 'exit strategy' or removal of "extended period" when it comes to discussing how long the funds rate can be expected to scale the zero line.

With the dollar soft, commodities are firming with oil breaking above $80/bbl and on its way for a third winning session in a row; the metals are following suit. Gold has broken out yet again and is up another 1% so far today as it begins to challenge the $1,100/oz mark (according to unofficial IMF estimates, the Reserve Bank of India bought gold at $1,045/oz. With the size of the purchase— 8% of annual mined production— and at that price it certainly helps establish a floor! The fact that the yellow metal is accomplishing this with ongoing deflationary developments— Euroland PPI came out for September and showed a 0.4% MoM decline and a -7.7% YoY trend— suggests that other factors are driving bullion to new bullish heights. It's called scarcity of supply relative to fiat currency.

Auto Sales Rev Up … But Still At Anemic Levels

Wow! U.S. auto sales surge 12% MoM in October, to the grand total of 10.3 million units at an annual rate, which was in line with the 'whispered' estimate. That is not a sign of strength at all. It is a sign of how horrible September was in the aftermath of the cash-for-clunker campaign. This will undoubtedly kick-start retail sales for the month but let's get a grip. At 10.3 million units, the outstanding stock of vehicles in the driveways and freeways of American is contracting. Secular changes are afoot in terms of how U.S. consumers are approaching credit, homeownership and 'discretionary' spending. Just to provide some perspective, 10.3 million units is the eighth lowest level since October 1982.

That said, we could well see a solid retail sales report for October outside of autos too— today's Wall Street Journal reports that store executives reported improved traffic and sales up 2.0% YoY (though from depressed levels a year ago); MasterCard's spending pulse index is flagging a +3.4% tally for apparel sales, which would be a 14-month high. Retailers are headed into the holiday shopping season with a subdued forecast and thus fairly lean inventories and so if these numbers are accurate, the prospect for markdowns could be limited. In fact, this was the case in the auto sector as average incentives were 12% lower than was the case a year ago.

U.S. auto sales surged 12% in September … it looks as though consumer spending is holding on.

Consumer confidence is in the doldrums, of that there is no doubt, and the job market backdrop, while better than it was earlier this year, is still in rough shape. Yet it does appear that spending is holding in and this could well still be a lagged response to all the government stimulus in the system. What does surprise us is the savings rate— the upward trend seems to have stalled out for the time being.

Commercial Real Estate A Disaster For Banks

7,771 U.S. Companies Filed For Chapter 11 Last Month

We see an article in the Investor's Business Daily citing a startling statistic that over the next 15 months, we are going to see $2 trillion of commercial mortgage debt rolling over. Rest assured that default risk will continue to rise as will the chance that we continue to see more regional bank failures. Estimates we have seen point to anywhere between $200 and $300 billion on bank-wide losses on commercial real estate loans.

Even though the delinquency rate has hit 16%, banks have thus far only written down 4% to 7% of construction loans. Losing 2.5 million office jobs suggests that we are going to see nationwide commercial vacancy rate of 20%; rents have already deflated 17% from the highs (more like 50% in places like Manhattan) and more declines are sure to come. As banks allocate more reserves in light of more writeoffs, the pressure to raise more capital is going to be intense.

Bounce In Bankruptcies

The number of U.S. companies that filed for Chapter 11 last month totalled 7,771— a 7.0% jump from September. Obviously these firms were not canvassed in the most recent ISM survey. Clearly, what we have on our hands is a situation where there are still far too many companies and individuals reeling from the effects of the credit collapse. We can understand the need for economists to wax about a 3.5% real GDP growth rate, but let's sit back, take a deep breath and understand that this is not the only measure of economic health.

Just as the Bank of Canada stressed in its last policy statement (October 20) that "the resumption in growth is supported by monetary and fiscal stimulus" and made no attempt to convince market participants that it was about to embark on a shift in policy, one would have to think that Mr. Bernanke's head is in the same space as Mr. Carney's. We will find out at 2:15 pm today, but to play around too much with the Fed press statement, especially changing the wording of the commitment to sustain its accommodative posture for an "extended period" would be a grave mistake, in our view.

Clearly, what we have on our hands is a situation where there are still far too many companies reeling from the effects of the credit collapse. Whether we are talking about housing, jobs or consumer spending, it still looks as though government assistance is still at the cutting edge between recession and expansion

The ADP Employment Report A Tad Worse Than Expected

ADP fell 203k in October— but September was revised higher, to -227k from -254k, which helps reduce some of the negativity around the headline for October (plus the news today that layoff announcements in the U.S., according to the Challenger report, hit their lowest level in 17 months). Moreover, the consensus was at -198k for the October ADP, so this was a "modest miss".

The ISM employment index had seemed to hint of stability at the very least in factory payrolls, but manufacturing employment actually fell by 65k in this report. The bright spot: it was the 'least negative' number since July 2008. (Come on, bring on those green shoots again!)

ADP has been overstating the weakness in private payrolls in the nonfarm payroll report survey in each of the past five months, so it would be a mistake to extrapolate from the ADP number (the consensus on payrolls this Friday is -175k). This could be because the ADP has a small-company "bias" to it— many large companies do their own payroll and as such do not use the payroll agency— and right now it is small businesses that are having the most trouble accessing credit for working capital (ie, staffing) purposes.

All that said, a -203k print on ADP is pretty horrible as a stand alone figure. The worst it ever got in the 2001 recession, post 9/11 terrorist attacks aside, was -212k.

No Reason For The Homebuilders To Like This Except

…it will accelerate talk of the need for even more pronounced housing tax credits (where the money is going to come from to pay for all this is ostensibly something that must have been going through the minds of India's central bank officials over the past few days). This morning we received the data for the past week on mortgage applications. While the overall index rose 8.2%, it was due to the spike in the volatile refinancing component, which rebounded 14.5%.

What is key for economic activity in a more direct sense is what the index of new home purchases is doing— and it fell 1.8% and is now down four weeks in a row. Not good news. In fact, two months of gains were aborted, again in a sign of how the economy really looks once the medicine is removed by Uncle Sam (or perceptions of such— in this case, the first-time buyer tax credit). In October, mortgage applications for new purchases plunged at a 34% annual rate and are now down to levels last seen in February— when the word "depression" was being bandied about. Whether we are talking about housing, jobs or consumer spending, it still looks as though government assistance is still at the cutting edge between recession and expansion.

Gold Glitters

Gold is in bull mode because of many factors, one being that the U.S. will continue to promote 'short-term' solutions to ensure that the economy embarks on an uptrend.

While the gold purchase by India's central bank is widely viewed as the trigger point for the latest jump in the gold price, there are good reasons why bullion is in bull mode. It comes down to a fiscal policy in the U.S.A. that will stop at nothing to ensure that the economy embarks on an uptrend. Even with a fiscal deficit north of 10% of GDP, the article from yesterday's WSJ that was titled Job-Creation Panel Leery of Spending really resonated. To wit:

"So far, the White House and Congress have been weighing a range of short-term tax ideas to spur job growth, such as expanded refunds for big companies that suffered losses; extension of a first-time homebuyer tax credit; and a new tax credit for hiring."

So the strategy remains on "short-term" tactics as opposed to any long-run measures to improve the capital stock, enhance skills and training, bolster education and enhance productivity growth. If Milton Friedman taught us anything from the permanent income hypothesis, it was that changes to income or wealth that are perceived to be permanent have a much more beneficial and enduring effect than measures that are only transitory. But of course the other problem is who will pay for this fiscal largesse, and the answer is nobody— the Fed will simply monetize the debt [[so, in the end, we all wind up paying— largely for the greed, hubris, and other excesses of those "too big to fail!" But, at least those bonuses seem safe…: normxxx]]. More dollars will be printed and that is bullish for gold whose production is in secular decline.

Then we saw this article on the WSJ yesterday too, titled Labor Gets Boost In Skies, on Rails. Anyone involved in the markets, has to read this article and understand the differences between what is happening now and when the secular bull market began under Reagan administration in the early 1980s. To wit:

"Organized labor appears to be gaining the upper hand in the skies and on the rails, as labor and business battle for influence under the Obama administration.

Another reason for our bullish stance on gold is that we are not seeing the onset of a secular bull market in equities like the one we saw in the early 1980s

The National Mediation Board wants to make it easier for thousands of airline and railway workers to unionize under the Railway Labor Act by seeking to junk a 75-year old election rule, according to a proposal published Monday in the Federal register. The move comes after a White House appointment shifted the balance of the government agency's three-person board. Linda Puchala, a former flight attendant union leader, was selected to replace Read Van de Water, a former Northwest Airlines lobbyist, earlier this year."

To reiterate, this is not the onset of a sustainable secular bull market in equities as we had coming off the fundamental lows of prior bear phases, such as August 1982, when:

• Dividend yields were 6%, not sub 2% (currently)
• Price-to-earnings multiples were 8x, not 26x
• The market traded at book value, not OVER two times book
• Inflation and bond yields were in double digits and headed down in the future, not near-zero and only headed higher
• The stock market competed with 18% cash rates, not zero, and as such had a much higher hurdle to clear
• Sentiment was universally bearish [[after more than a decade of bad stock market performance: normxxx]]; hardly the case today
• Global trade flows were in the process of accelerating as barriers were taken down; today, we are seeing trade flows recede as frictions, disputes and tariffs become the order of the day
• Unionization rates were on a secular decline; today labor power is clearly on the rise
• A Reagan-led movement was afoot to reduce the role of government with attendant productivity gains in the future; as opposed to the infiltration by the public sector into the capital markets, union sector, economy and of course, the realm of CEO compensation.

Final Word On Gold

Gold broke out to a new high yesterday of $1,084/oz (and continues to rally today). It did this despite the S&P 500 managing to tick up two points and despite the DXY index actually eking out an 8bps rise to 76.3. This is NOT just a U.S. dollar story— have a look at what bullion is doing in Euro terms. Very impressive. This is a broadly based breakout and that means a durable secular bull market.

Looking at the growth rates in fiat currency that central banks are creating to stimulate their economies and the amount of bullion that would be necessary to back up this massive global monetary infusion suggests that gold can at least double if not triple from here. If you missed the first 4x runup from the $250/oz lows a decade ago, don't worry about it. It's like worrying about how you would have missed the first half of the rally in the S&P 500 from 1982 to 1992 when the index was at 400 and still had 300% to go before finally peaking out and sputtering at the 1500+ highs eight years later. In other words, the cup is still half full— and still can be filled with gold eagle coins.

ß§

Normxxx
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Jeff Saut Says Buy The Dip

2009-11-13T08:26:00.000-08:00

Jeff Saut Says Buy The Dip

By The Pragmatic Capitalist | 4 November 2009

Jeff Saut continues to think the current dip should be bought heading into year-end. Yesterday's action [[3 November: normxxx]] in the transports following Buffett's purchase of BNI will certainly confirm Saut's belief that we did not and will not get a Dow Theory sell signal. After the near[!?!] Dow Theory sell signal, Saut was quick to quote Russell, who has been quite cautious of late:

The secret of the direction of the great primary trend of the market lies in the secondary reaction and what happens AFTER a secondary reaction. A secondary reaction usually takes three weeks to three months in duration while correcting one-third to two-thirds of the previous move. Since the March low, we have yet to experience a true secondary reaction. And I'm wondering whether we could be on the edge of a secondary reaction now.

Following a secondary (reaction), if BOTH Averages (Industrials and Transports) rise to new highs, the primary trend is taken to be bullish. Following the lows of a secondary reaction, there will be a rally. If (that) rally fails to take both Averages to new highs, and the Averages then turn down and break to new (reaction) lows, the primary trend is taken to be as bearish. Secondary reactions often start with one of the Averages sinking while the other Average continues to the upside.

With that said, Saut maintains his bullish view based on the idea that money managers will be forced to continue playing catch-up into year-end. Saut is unfazed by the recent downturn in stocks and believes the most investors have been hoping for such an opportunity:

…last week's "wilt" left everything we follow lower except for the U.S. Dollar Index. And while the DJIA (9712.73) averted a loss in October, none of the other indices we monitor did. Indeed, the S&P 500 (SPX/1036.19) slid 3.9%, bringing its two-week retreat to 5.6%. While our sense is that we are into a secondary correction, our proprietary overbought/oversold indicator is VERY oversold and the number of S&P 500 stocks that are above their 50-DMAs has fallen from more than 90% to 33.2%. Consequently, we continue to think it is a mistake to get too bearish. Ergo, until Dow Theory "tells us" otherwise, we think the primary trend remains UP, and we continue to trade, and invest, accordingly.

Saut is not alone in his sentiment. In fact, there appears to be a growing consensus that the rally will continue into the end of the year for none of the right reasons. In other words, the rally is expected to continue as investors fight to get to the top of the molehill. But be careful, as Saut says, there is also a growing consensus that 2010 will be a potentially treacherous year for investors.

Desmond Sees S&P 500 Gain Lasting

2009-11-07T12:11:00.000-08:00

Desmond Sees S&P 500 Gain Lasting: [Technical Analysis]

By By Elizabeth Stanton, Bloomberg | 7 November 2009

Sept. 29 (Bloomberg)— U.S. stocks are probably in the early stages of an advance that will last three more years, according to Paul Desmond, president of Lowry Research Corp. Desmond says he sees no signs the rally will end after expressing doubt in June about the sustainability of gains that went on to lift the Standard & Poor's 500 Index 57 percent from its March 9 low. He was named 2009's best chart analyst by Technical Analyst magazine.

Stock indexes in the U.S. reached "major bottoms" roughly every four years between 1962 and 2002, meaning the current rise will [probably?] last another three years, said Desmond, whose firm recommended investors avoid stocks three months before the S&P 500's peak in 2007. His current view, based on Lowry's analysis of price and volume statistics, is at odds with 'research' by Bank of America Corp. and UBS AG that shows the market is vulnerable to a decline of 10 percent or more in October. [[Probably substantially more than that, given the right catalyst; however, that "risk" in no way detracts from Desmond's position— never assume even a very high probable risk must occur, barring the occurrence of its catalyst (or if its catalyst is compromised) : normxxx]]

"Most investors seem to say, 'If the stock market goes up very fast over a short period of time, that kind of 'prosperity' can't continue,'" Desmond said in a telephone interview. "They get nervous and want to take profits to avoid having it taken away from them. But the history of the stock market says that that's one of the things investors have to fight."

While Lowry, founded in 1938, didn't recommend clients enter the market until Aug.4 of this year, the firm warned them away from U.S. stocks in July 2007, avoiding a plunge of as much as 57 percent in the S&P 500 from October 2007 through March.

Trading Above Average

Some measures, including the percentage of shares trading above their 10-day average price, may suggest the U.S. stock market is presently "overbought," but such kinds of indicators and techniques don't work early in bull markets [[i.e., during spells of heavy, prolonged accumulation: normxxx]], Desmond said.

"The indicators have generally been useless in this period," Desmond said. "The only time in history you see that pattern is in the early stages of a new uptrend". The S&P 500's rebound from a 12-year low in March is its steepest advance since the Great Depression, though the benchmark is still 32 percent below its October 2007 record. Mary Ann Bartels, technical research analyst at Bank of America, called it a "mature rally" that's at risk of a 15 percent to 20 percent retreat in a Sept. 20 report. Technical analysts such as Bartels and Desmond base their predictions on patterns in price and volume charts.

New Highs

Desmond examines the number of stocks reaching new highs to determine whether a market is peaking. He found that during major tops since 1929, no more than 11 percent of stocks hit highs when the Dow Jones Industrial Average peaked. Usually, the number of stocks making new highs begins to deteriorate four to six months before indexes fall, he says.

The number of New York Stock Exchange-listed companies reaching 52-week highs has been 149 a day in September, the highest monthly average since July 2007, according to data compiled by Bloomberg. The level didn't exceed 14 during the fourth quarter of 2008, after Lehman Brothers Holdings Inc.'s collapse sparked the worst financial crisis since the 1930s. "The patterns we see here are very similar to those that preceded previous major market bottoms," Desmond said.

Genzyme: Rare Buying Opportunity

2009-10-15T20:45:00.000-07:00

Third-Quarter Bloodbath Offers Rare Buying Opportunity

By Rob Fannon, Editor, Phase 1 Investor | 9 October 2009

Vesivirus 2117 has turned this year into a nightmare for Genzyme. In June, the rogue virus attacked the Boston-based biotech, infecting its main manufacturing plant. Vesivirus 2117 isn't harmful to people. Rather, it disrupts the cells Genzyme uses to manufacture its drugs. The FDA forced the company to halt production at the facility, jeopardizing nearly 40% of its $4 billion in annual sales.

Genzyme's top-selling drug, Cerezyme, will likely lose $150 million to $200 million in sales. A second drug, Fabrazyme, will fall $50 million to $60 million behind its $500 million goal. The two drugs treat Gaucher and Fabry disease, respectively. These rare genetic disorders cause particular fats to build up in the body, severely damaging organs. They affect about 10,000 patients worldwide.

Right now, Cerezyme and Fabrazyme are the only FDA-approved drugs to treat these disorders. But since Genzyme will fail to meet demand, the FDA granted a British drug company and an Israeli biotech special licenses to sell their similar drugs— even though neither has won official approval. With those lost sales, Genzyme will come up well short of its previous 2009 revenue guidance. The biotech sector is up 15% year-to-date. But Genzyme shareholders are down 15%. And they're likely in for more pain. That's great news for the rest of us…

On October 22, Genzyme will be one of the first large-cap biotechs to kick off third-quarter earnings season. The company didn't get production up and running again until late last month. And its newly-issued guidance falls well below previous Wall Street estimates. So Genzyme's stock will suffer in the short term.

I expect shares to drop about 10% after the earnings announcement, to below $50. Risk-takers could buy cheap Genzyme puts with strike prices above $50. If the stock falls as much as I think it will, the puts could prove to be a lucrative speculation.

For more conservative investors, Genzyme's third-quarter earnings miss could turn out to be a rare buying opportunity… Despite its near-term struggles, the company remains a best-in-class large-cap biotech. Its protein-based therapies, manufacturing plants, and expertise are valuable assets. And its rich pipeline includes several late-stage drug candidates.

Before the Vesivirus 2117 infection, the company grew revenue at a healthy 20% a year. While this year will be flat, that growth will return next year and beyond. I expect Genzyme to resume its earnings expansion, as well. Bottom-line growth should reach the high-teens next year.

Long-term investors would be wise to load up if the stock falls below $48 (about 15% below today's levels). That would price shares around 16-17 times next year's earnings, a downright bargain for this biotech bellwether. Buying Genzyme after its coming earnings miss could be one of the easiest ways to earn 10%-20% a year for the next decade.

Good investing,

Rob Fannon

The Credit Crunch Continues

2009-10-15T15:22:00.000-07:00

The Credit Crunch Continues
Click here for a link to ORIGINAL article:

By Meredith Whitney, WSJ | 15 October 2009

Anyone counting on a meaningful economic recovery will be greatly disappointed. How do I know? I follow credit, and credit is contracting. Access to credit is being denied at an accelerating pace. Large, well-capitalized companies have no problem finding credit. Small businesses, on the other hand, have never had a harder time getting a loan.

Since the onset of the credit crisis over two years ago, available credit to small businesses and consumers has contracted by trillions of dollars, and that phenomenon is reflected in dismal consumer spending trends. Equally worrisome are the trends in small-business credit, which has contracted at one of the fastest paces of any lending category. Small business loans are hard to find, and credit-card lines (a critical funding source for small businesses) have been cut by 25% since last year.

Unfortunately for small businesses, credit-line cuts are only about half way through. Home equity loans, also historically a key funding source for start-up small businesses, are not a source of liquidity anymore because more than 32% of U.S. homes are worth less than their mortgages. Why do small businesses matter so much?

In the U.S., small businesses employ 50% of the country's workforce and contribute 38% of GDP. Without access to credit, small businesses can't grow, can't hire, and too often end up going out of business. What's more, small businesses are often the primary source of this country's innovation. Apple, Dell, McDonald's, Starbucks were all started as small businesses.

What's especially disturbing is how taxpayer dollars have supported "too big to fail" businesses yet left small businesses unassisted and at a significant disadvantage. Small businesses do not have the same access to government guarantees on their debt. After all, most of these small businesses don't issue public debt.

As is true in most recessions, banks' commercial lending portfolios shrink as creditworthy customers pay down their debts and the less-worthy borrowers are simply denied loans. Banks, in other words, want to lend only to those that don't want to borrow. Challenging as that may be, in the last cycle small businesses at least had access to their credit cards. [[And their homes, whose values were skyrocketing!: normxxx]]

Small businesses primarily fund themselves through credit cards and loans from local lenders. In the past two years, credit-card lines have been cut by over $1.25 trillion. During the same time, 10% of all credit-card accounts have been cancelled. According to the most recent Federal Reserve data, small business lending is down 3%, or $113 billion, from fourth-quarter 2008 peak levels— the first contraction since 1993.

Credit cards are the most common source of liquidity to small businesses, used by 82% as a vital portion of their overall funding. Thus, it is of merit when 79% of small businesses surveyed tell the Small Business Association that credit-card lending standards have tightened drastically and their access to credit lines has decreased materially. Incentives should be provided to smaller banks to step up small-business loans on a greater scale.

Smaller banks could not only bridge gaps created by the shut down in the securitization market but also gaps being created by a massive contraction in credit-card lines. Arguably credit would perform better with these types of loans as they would reintroduce and reinforce the most important rule in banking: "Know Your Customer". I believe that we are only in the early stages of the second half of this credit cycle.

I expect another $1.5 trillion of credit-card lines to be removed from the system by the end of 2010. This includes not only the large lenders reducing exposure but also the shuttering of several major subprime credit-card lenders. Beginning in the fourth quarter of 2007, lenders began reducing available credit by zip code.

During the past four quarters, lenders have cut "inactive" accounts (whether or not the customer viewed the account as a liquidity vehicle). The next phase will likely be credit-line cuts as lenders race to pre-emptively protect themselves from regulatory changes associated with the Credit Card Accountability, Responsibility and Disclosure Act, passed in May of this year, and the 2008 Unfair and Deceptive Acts and Practices Act. Regulators should be mindful that regulatory change during the midst of a credit crisis often ends with unintended consequences.

Those same consumers that regulators are trying to help are actually being hurt by a vast reduction in available credit. Main Street represents the foundation of this country. Reviving it should take priority over any regulatory reform or systemic overhaul.

— Ms. Whitney is CEO of Meredith Whitney Advisory Group, LLC.

Inflation Or Deflation?

2009-10-15T13:28:00.000-07:00

Tech Ticker— Inflation Or Deflation?
Click here for a link to ORIGINAL article:

By Mike "Mish" Shedlock | 15 October 2009

Inflation or Deflation? "It's Definitely Deflation," Mish Says. Ask an economist about their biggest concern about the U.S. economy and you're likely to get one of two starkly different answers: America is either about to be swamped by a major bout of inflation or decimated by deflation. Count Mike "Mish" Shedlock of Sitka Pacific Capital among the deflationistas.

While some consumer prices are rising and the Fed is printing money like crazy, Shedlock says deflation is "definitely" a greater threat than inflation. "People looking [only] at [consumer] prices are completely missing the mark," says Shedlock. "Consumer credit is falling, banks aren't lending, and we've got bank failures at a massive rate. These are the same kind of conditions as in the Great Depression". [[Especially from about 1933 on, when FDR succeeded only in inflating the CPI and the stock averages.: normxxx]]

Indeed, bank lending has tumbled and the Fed reports consumer credit has shrunk for seven consecutive months and was down 5.8% on an annualized basis in August, the most recent month available.

…..

Tech Ticker— Ignore The Euphoria

Dow breaks 10,000: don't get caught up in "euphoria", Mish warns. The Dow Jones Industrial Average closed above 10,000 today for the first time in a year, and more than a decade after first breaking the mark. Since hitting lows in March, the Dow is up an astounding 50%, while the S&P 500 has gained 60%.

But before you get your broker on the phone or start trading that dormant online brokerage account, take heed of this warning from Mike "Mish" Shedlock, the blogger behind MISH'S Global Economic Trend Analysis: "Five years from now, I think its quite likely the Dow is not going to be much more than 10,000," he says.

Why so negative? "We've still not solved any of those structural problems" in the housing, banking and debt markets, that caused last year's crisis, he claims. Shedlock's advice: ignore the euphoria, and "take some chips off the table. Now's just not a good time to be invested". Shedlock, also an investment advisor representative for SitkaPacific Capital Management, thinks investors are better positioned in gold and cash.

Tech Ticker— Thoughts On Gold

Exploding Gold Prices have nothing to do with inflation. If there are two things that just about everyone agrees on these days it's that the dollar will continue to plummet and gold will continue to soar. The dollar will keep plunging, everyone agrees, because the Fed will keep printing so much new money that soaring inflation will eventually turn it into toilet paper. Gold, meanwhile, will go to the moon as investors rush to try to hedge against this impending monetary disaster.

Balderdash, says Mike "Mish" Shedlock, blogger and investment advisor with SitkaPacific Capital Management. The dollar's a buy here, in part because everyone is so darn certain that it's about to collapse. And gold?

Well, gold is indeed going higher, Shedlock argues, but not for the reason people think. Gold is actually a lousy inflation hedge, as evidenced by the period from the late 1980s to the early 2000s in which there was plenty of inflation but gold prices plummeted from $800 to $250.

But gold IS a good place to preserve value during a credit crunch, Shedlock says. And that's what we're still having here. So Shedlock is long gold, too, even though he thinks everyone else is buying it for the wrong reason.

Year-Over-Year CPI Negative 7th Consecutive Month; Rents Decline First Time In 17 Years

Bloomberg is reporting Consumer Prices in U.S. increased at slower pace. The cost of living in the U.S. rose at a slower pace in September, showing inflation will not be a threat as the economy emerges from the worst recession since the Great Depression. The 0.2 percent gain in the consumer-price index followed a 0.4 percent increase in August, as forecast, figures from the Labor Department showed today in Washington. Excluding food and energy costs, the so-called core index also climbed 0.2 percent, more than anticipated and pushed up by health care and a rebound in auto prices. Rents dropped for the first time in 17 years.

The number of Americans filing first-time claims for unemployment benefits dropped last week to the lowest level in nine months, indicating the 'improving' economy is leading to a slowdown in firings, another Labor Department report also showed. Applications fell by 10,000 to 514,000 [[that's only 2%, or well within the "noise" range: normxxx]]in the week ended Oct. 10, lower than forecast, from a revised 524,000 the week before. The total number of people collecting unemployment insurance also decreased. [[About half a million simply ceased to exist, since they 'hadn't looked for a job in the last month'.: normxxx]]

Compared with a year earlier, consumer prices were down 1.3 percent. For the core index, prices climbed 1.5 percent from September 2008 after a 1.4 percent increase in the 12 months ended in August. Food prices, which account for about a seventh of the CPI, decreased 0.1 percent in September, reflecting cheaper meats and produce. Lower food prices are dragging down revenue at some businesses. Spartan Stores Inc., which distributes groceries and runs supermarkets, said lower prices are hurting sales.

Dennis Eidson, the Grand Rapids, Michigan-based company’s chief executive officer, said yesterday in a statement that he expects weakness for the remainder of its fiscal year due to "product price deflation" as consumers "behave cautiously given the challenging economic environment." Rents, which make up almost 40 percent of the core CPI, fell. 'Owners-equivalent rent', one of the categories used to track rental prices, decreased 0.1 percent, the first drop since 1992.

Owners' Equivalent Rent Drops First Time Since 1992

Although new claims for unemployment are 'falling', they are still above 500,000 and businesses are still reluctant to hire. The combination certainly suggests higher unemployment numbers coming up. I do expect food prices to continue to decline; however, the most interesting thing in the report is that rents fell for the first time in 17 years. Let's take a look at just how realistic that is.

OER From Twilight Zone: Please consider a few snips from Bill Gross Bets On Deflation, written September 29, 2009.

Given that the official measure of CPI is based on rents NOT housing prices, please consider the following collection of links courtesy of Lanser on Real Estate:

Really? Rents Fall Almost Everywhere.

Manhattan: Apartment Rents Drop as Employers Cut Jobs

Houston: Renters are snagging deals in a slowing local market

Tuscon: On your mark, get set, go! Apartment firm makes game of it.

Nashville: Apartment rates squeezed by lower demand

Orange County: O.C. renters get twice the freebies

U.S. Nationwide: Renters look for thrifty comfort, not style

Tokyo: Apartment rents under pressure

Middle East: 17% fall in rents seen in Qatar this year

CTA Trader's Conference Call Notes

2009-10-15T12:29:00.000-07:00

CTA Trader's Conference Call Notes:
Click here for a link to ORIGINAL article:

By Bill Cara | 15 October 2009

In the old days, high profile stocks gapping to new highs on news related announcements, and reversing lower, then finishing near their daily range lows, would be said to be under distribution. Smart investors (large enough to influence price) use the good news to unload their stock at a handsome profit, happy to lock in gains and look elsewhere for undervalued situations.

After reporting sharply higher quarterly earnings, Intel (INTC +1.66%) traded up almost +6% Tuesday evening in after-hour trading on peanut volume, opening in the morning +3.5% at yearly highs before selling off on large volume, settling near the lows. JP Morgan (JPM +3.29%) also reported better numbers, opened on its high, and closed lower even though the broad market spent the day powering high all day long (S&P +1.75%). Linear Technology (LLTC -2.18%) beat estimates, opened near its highs, and actually closed lower on the day.

This is distribution, pure and simple.

US bonds (TLT -1.48%) took it on the chin Wednesday, the Fed's Permanent Open Market Operations (POMO) nearing completion; other buyers will have to step forward to purchase huge volumes of these securities in order for the US to continue borrowing money at artificially low rates. Support for TLT stands just above 94, with its upwardly sloping 89-day Moving Average, an up-trend line off the June lows, and the 50% retracement of the recent rally all converging in that same general area. The last thing the US needs right now is higher oil (USO +1.55%) and higher interest rates, the combination— perhaps a lethal one-two punch to a wobbly economic recovery. We think the Chinese, Saudis, and Japanese have their fill of US debt and are not inclined to be buying the same quantity of bonds at these levels.

Goldman Sachs (GS +2.70%) and Citigroup (C +3.52%) are reporting before the opening today, and that should set the tone for early morning action. But, with the Dow over 10,000 and the S&P barreling in on 1100, what can the market do for an encore? Time will tell. Time will also tell how long the $USD can be pushed lower by HB&B in order to support higher market prices. Beware; these people will coordinate the reversal, and that's how they make $100 million a day trading against you and me.

*********************

In any case, you might find the following article of interest. It was published in the Portuguese language in a European publication today, and is not likely something that would be heralded by the players in Washington and New York. I ran the Portuguese through the Google Translator, which was surprisingly accurate. [[As well, I did some additional cleanup, where the intent seemed plain: normxxx]]

(Heading) European Companies Abandon The NYSE

(Sub-head) High Costs, Bureaucracy, Crises And Scandals Caused Stampede

Since the outbreak of the crisis of housing loans due to excessive risk— the sub-prime crisis— more than 40% of European companies that trade on U.S. exchanges have left the largest financial market in the United States, the New York Stock Exchange (NYSE). European companies complain about the high cost to negotiate roles in New York and the excessive bureaucracy to prove the 'transparency' of transactions. Since 2007, companies like Allianz, BASF, E. ON, Vivendi, Lafarge, Suez and GDF Fiat returned to their home markets, like London, Paris, Milan and Frankfurt.

The withdrawal began in April 2007 and coincided with two factors: the worsening of the subprime crisis, and the 'reform' of financial accounting standards and the Security Exchange Commission (SEC) which, among other things, facilitated the withdrawal of foreign companies. Since then, players like Danone, British Airways, Adecco and Telekom Austria have abandoned the U.S. market, opting to trade their securities in squares closer to their headquarters, here in Europe.

The last major group to announce its departure was a German insurance company, Allianz. "When we first joined the NYSE in 2000, we wanted to have international visibility and attract the attention of new investors," argued a spokesman for the company in the newspaper Le Monde. "But things have changed, and 95% of our shares are traded on the German market. Frankfurt is our place". The company also makes markets in Milan, London, Paris and Zurich.

A similar decision had already taken the French advertising group Publicis, for which the cost of maintaining a place on the U.S. exchange was not worth it, since only 1% of their securities transactions are made in the USA. In 2007, Sergio Marchionne, CEO of Fiat, had taken the same initiative in terms of excessive costs. Marcus Schenk, chief financial officer of German utility E. ON, justified its decision the same way. "Our goal is to reduce complexity and costs," he said at the time.

Procedure Dear

These decisions weigh more heavily on the U.S. exchange than its competitors. Between 2000 and 2007, the number of European companies that trade stocks on the NYSE had risen 4%, even with the entry of legislation considered adverse to foreign companies into force— the Sarbanes-Oxley, after the Enron scandal in 2001— that created 'new' rules of 'accounting transparency', making it yet more difficult/costly to maintain shares in the U.S. market and, above all, increasing the complexity of the process.

Since then, the European presence has fallen 40%. The explanation of the phenomenon may be found in the early '90s, in the Nasdaq, the index of mostly 'high-tech' companies. With the breakdown of that index, many European names withdrew from the list of offerings in New York. Coincidence or not, the rout experienced by the NYSE comes amid a succession of crises and scandals [[and relatively poor performance: normxxx]]: subprime, Lehman Brothers, and Madoff are but three examples.

"The [U.S. markets] were tarnished by the Enron scandal in 2001. The financial crises and scandals that followed, such as Madoff, only accentuated the loss of credibility of the U.S. market," believes Jean-Pierre Agazzi, expert cabinet audit accounting firm Deloitte. In contrast, 71 new companies, largely foreign accented, settled on the London Stock Exchange (LSE) between 2006 and 2007.

This argument is not well accepted by three researchers at the University of Toronto, Craig Dodge, Andrew Karolyi and Rene Schultz. According to the study they produced on the subject, the decline in the number of companies has more to do with acquisitions, mergers, restructurings and bankruptcies. The fact is that while the NYSE loses European companies— but wins Chinese and Latin American— European markets are preparing for a resumption of new businesses, possibly in the first quarter of 2010. Companies like Polarcus Norwegian, Dutch Delta Lloyd, and the German Germany(?) and Unity Media have announced the raising of capital on the bourses of the European Union bloc.

— Andrei Netto, Correspondent, Paris

Have a great day.

Commodity Stocks On The Brink Of Disaster?

2009-10-12T17:34:00.003-07:00

These Commodity Stocks Are On The Brink Of Disaster

By Tom Dyson | 29 September 2009

Investors in natural gas stocks have lost their minds. They're about to lose their wallets, too… There's a major wipeout coming in the natural gas business. North America has too many natural gas producers. The industry needs a major cleaning out. The most inefficient, high-cost producers must fold. This will bring supply and demand back into balance.

Low prices are the market's mechanism for culling the weak players. Four weeks ago, natural gas prices hit a seven-year low of $2.50 per thousand cubic feet. But so far, nothing's happened. No player wants to cut production when they've invested so much money developing it [[and must continue to pay the interest on their loans: normxxx]]. "Getting $3 is better than nothing," they think. [[Where $3 mcf, m = 1000, is about break even. : normxxx]] "Better to pump out more now before it falls even farther."

In the last four weeks, the spot price for nat gas has jumped above $4 [[and the nearby futures contract is selling about $1 higher : normxxx]]and is [now hovering around there]. With higher prices, production is growing even more. According to industry researcher Baker Hughes, the number of rigs drilling for natural gas in the United States has gained in nine of the last 10 weeks. Meanwhile, the oversupply of gas is so great, we've almost run out of room to store it.

The Energy Information Administration says U.S. natural gas inventories rose again last week. They are now a just a chip shot from the record high hit in November 2007. Natural gas storage in producing regions— including Texas, Louisiana, and Oklahoma— already reached a record high last month.

Aubrey McClendon, CEO of Chesapeake Energy, the largest independent gas producer in America, figures America's natural gas industry will fill up all available storage by the end of the year. There'll be "involuntary curtailments," he says. This chart compares UNG, the exchange-traded fund (ETF) for natural gas (in black), with XNG, the AMEX index of natural gas producers (in blue). XNG is an index of natural gas producers like Chesapeake, Devon, Anadarko, and Apache.

In the last two years, the price of natural gas has fallen almost 70%, yet natural gas stocks are still trading at almost the same prices. In other words, investors in natural gas stocks have totally ignored the huge collapse in natural gas prices. And get this… This next chart shows the AMEX oil producer index (in black) cast against the AMEX natural gas producer index (in blue). The AMEX oil producer index contains names like ConocoPhillips, Chevron, and Hess.

Natural gas stocks have thrashed oil stocks over the last nine months, even though the price of oil gained 60% over this time, while the price of natural gas lost 13%. The guillotine is about to fall on natural gas production. And I can't see any reason for this strength in natural gas stocks. My only conclusion: Investors in natural gas stocks are living in la-la land The dream ends when storage runs out and gas prices plunge.

Aggressive traders should immediately short high-cost, speculative natural gas stocks. Conservative investors should wait for the storm to pass. They'll be able to pick up the highest-quality producers at bargain prices. I expect some of these companies will be paying 20%-30% dividend yields in the aftermath.

I'll let you know when the time comes…

Good investing,

.

We're Headed For A Huge Wipeout In Natural Gas

By Tom Dyson | 31 August 2009

Natural gas is plummeting… Last week, natural gas fell to a fresh seven-year low… trading as low as $2.70 per mcf (that's 1,000 cubic feet).

The big fall came on Thursday after a report by the Energy Information Administration (EIA) showed natural gas producers had put another 54 million mcf of gas in storage last week. There's now over 3 billion mcf of gas in storage in America. Here's the thing: I just read a transcript of the latest earnings conference call from Chesapeake Energy. Chesapeake is the largest independent natural gas producer in America.

One analyst asked Aubrey McClendon, Chesapeake's CEO, why he ramped up production recently even though gas prices had fallen so far. Normally, you'd expect the opposite. When you can't make a profit, you cut production to the bone.

McClendon said America's natural gas industry will have filled up all available storage by the end of the year. At this point, there'll be "involuntary curtailments". In a few months, the lack of storage will force gas companies to stop pumping gas.

In the meantime, McClendon needs to pump as much gas as he can before the storage caverns fill up. It's like a race to pick up pennies in front of a steamroller. "We didn't see any reason to take it on the chin for the team," he concluded.

Over the last few years, the gas industry has borrowed billions of dollars and used this money to develop new gas fields. Natural gas companies have built refineries, ports, pipelines, drilling rigs, platforms, and storage tanks. Even though the industry isn't making any money pumping natural gas at prices below $3 per mcf, it cannot cut production. These companies have to make interest payments and must earn whatever revenue they can get.

In other words, gas prices are falling because the industry keeps producing as much gas as it can, even though there isn't enough demand. For now, this hasn't been a showstopper. The U.S. has a huge capacity for storing natural gas. The trouble is, that storage is almost full…

When the storage fills to capacity, there's going to be a storm in the natural gas industry. Many companies will be forced to turn off the spigots. Can you imagine what will happen to earnings at these companies? They'll collapse. How will these companies pay the interest on their debts?

Gas is cheap, it's clean, and it's made in America. Gas has a great future. But until the storage runs out and half the producing companies go bankrupt, gas prices won't rise. There'll be too much supply. Shorting overleveraged, high-cost gas producers is the way to profit from this situation. Many of these companies are going bankrupt in the very near future.

Good investing,

Tom

P.S. The EIA is publishing a report on the amount of natural gas storage still left in America. This report comes out in the next few weeks. I'll let you know when they publish it… and what its implications are. Keep reading.

Meredith Whitney: Banks' Bounce Doubtful?

2009-10-12T17:34:00.001-07:00

Consumers In Trouble

2009-10-11T15:46:00.000-07:00

Consumers In Trouble: Loan Delinquencies Hit Record Highs In Second Quarter

By Jennifer Waters, Marketwatch | 1 October 2009

CHICAGO (MarketWatch)— The economy's chokehold tightened in the second quarter as consumers fell behind on their debt payments in record numbers, the American Banker's Association said Thursday. Delinquency rates hit record highs on home-equity loans, home-equity lines of credit and bank cards for the quarter that ended July 31, the latest numbers available. Everyone but government is deleveraging.

First it was Wall Street. Now it's households that are paying down their debts and starting to save a little [[mostly NOT through choice! : normxxx]] In the meantime, the government is still borrowing like there's no tomorrow, hoping to ease credit-contraction pains. WSJ's David Wessel discusses.

The composite ratio, which tracks eight closed-end installment loan categories, also hit a high at 3.35% of all outstanding accounts, seasonally adjusted, compared with the first quarter's 3.23%. This is the sixth straight quarter that delinquencies have risen. The culprit is the snowballing result of the longest and deepest recession since the Great Depression, according to ABA Chief Economist James Chessen.

"The problems now are the cumulative effect of the economy and job losses," he said. "Every single month there are jobs being lost and when income falls it makes it very difficult for consumers to meet debt obligations". Unemployment is at 9.7% , the highest since June 1983. [[now at 9.8% and still rising— the government released September employment numbers subsequent to this being written: normxxx]]

"Six consecutive quarters of job losses have taken their toll," Chessen added. "It's stunning what's happened. There's a lot of pain out there as people try to make ends meet… The picture won't change until the labor market improves and the economy picks up steam… That's going to take time."

Credit Cards Cause Most Trouble

Credit-card debts were hardest hit. Delinquencies jumped to 5.01%, up more than one-quarter percentage point over the first quarter to an all-time high. Among the closed-end loans, home-equity loan delinquencies rose to a record 4.01% from 3.52% in the first quarter. Home-equity lines of credit, which up until the first quarter of 2008, had never reached 1% of all loans, rose 0.3 percentage point to a high of 1.92%.

Personal-loan failures were at 3.90% of all loans compared with the prior quarter's 3.47%. Consumers skipped boat and other marine-related loan payments on 2.28% of all loans compared with 2.04% the quarter before while RV loans delinquencies were up to 1.72% from 1.52%. Property improvement loans delinquencies also grew, to 1.79% of all loans from 1.46% the prior quarter.

There were some decreases in delinquency rates on auto loans. Direct auto loans, those arranged by banks, fell to 2.46% from 3.01%. Indirect loans, put in place through a third party such as an auto dealer, were at 3.26% of all loans compared with 3.42% the quarter before. And mobile-home failures were at 3.53% versus 3.7% in the first quarter.

Chessen figures that the drop in auto-loan delinquencies is tied to the 'quick' decisions that are [being] made on 'bad' loans. "There are more aggressive efforts to recover car loans," he said. "Repossession rates are fairly rapid and banks charge off the loans quickly."

Jennifer Waters is a MarketWatch reporter, based in Chicago.

It's Never ALL Gloom And Doom: Energy Crisis Postponed

2009-10-10T16:15:00.000-07:00

It's Never ALL Gloom And Doom: Energy Crisis Is Postponed [Once Again] As New Gas 'Rescues' The World
Engineers Have Performed Their Magic Once Again. The World Is Not Going To Run Short Of Energy As Soon As Feared.

By Ambrose Evans-Pritchard | 11 October 2009

America is not going to bleed its wealth importing fuel. Russia's grip on Europe's gas will weaken. Improvident Britain may avoid paralysing blackouts by mid-decade after all. The World Gas Conference in Buenos Aires last week was one of those events that shatter assumptions. Advances in technology for extracting gas from shale and methane beds have quickened dramatically, altering the global balance of energy faster than almost anybody expected.

Tony Hayward, BP's chief executive, said proven natural gas reserves around the world have risen to 1.2 trillion barrels per day of oil equivalent, enough for 60 years' supply— and rising fast. "There has been a revolution in the gas fields of North America. Reserve estimates are rising sharply as technology unlocks unconventional resources," he said. This is almost unknown to the public, despite the efforts of Nick Grealy at "No Hot Air" who has been arguing for some time that Britain's shale reserves could replace declining North Sea output.

Rune Bjornson from Norway's StatoilHydro said exploitable reserves are much greater than supposed just three years ago and may meet global gas needs for generations. "The common wisdom was that unconventional gas was too difficult, too expensive and too demanding," he said, according to Petroleum Economist. "This has changed. If we ever doubted that gas was the fuel of the future— in many ways there's the answer."

The breakthrough has been to combine 3-D seismic imaging with new technologies to free "tight gas" by smashing rocks, known as hydro-fracturing or "fracking" in the trade. The US is leading the charge. Operations in Pennsylvania and Texas have already been sufficient to cut US imports of liquefied natural gas (LGN) from Trinidad and Qatar to almost nil, with knock-on effects for the global gas market— and crude oil.

It is one reason why spot prices for some LNG deliveries have dropped to 50% of pipeline contracts. Energy 'bulls' gambling that the world economy will soon resume its bubble trajectory need to remember two facts: one: industrial production over the last year is still down 19% in Japan, 18% in Italy, 17% in Germany, 15% in Canada, 13% in France and Russia, 11% in the US and the UK, and 10% in Brazil. A 12% rise in China does not offset this.

And, two: OPEC states are cheating on quota cuts. Compliance has fallen to 62% from 82% in March. Iran, Nigeria, Venezuela et al face a budget crunch. Why comply when non-OPEC Russia is pumping at breakneck speed?

The US Energy Department expects shale to meet half of US gas demand within 20 years, if not earlier. Projects are cranking up in eastern France and Poland. Exploration is under way in Australia, India and China.

Texas A&M University said US methods could increase global gas reserves by nine times to 16,000 TCF (trillion cubic feet). Almost a quarter is in China but it may lack the water resources to harness the technology given the depletion of the North China water basin. Needless to say, the Kremlin is irked. "There's a lot of myths about shale production," said Gazprom's Alexander Medvedev.

If the new forecasts are accurate, Gazprom is not going to be the perennial cash cow funding Russia's great power resurgence. Russia's budget may be in structural deficit. As for the US, we may soon be looking at an era when gas, wind and solar power, combined with a smarter grid and a switch to electric cars returns the country to near energy self-sufficiency. This has currency implications.

If you strip out the energy deficit, America's vaulting savings rate may soon bring the current account back into surplus— and that is going to come at somebody else's expense, chiefly Japan, Germany and, up to a point, China. Shale gas is undoubtedly messy. Millions of gallons of water mixed with sand, hydrochloric acid and toxic chemicals are blasted at rocks. This is supposed to happen below the water basins but accidents have been common.

Pennsylvania's eco-police have shut down a Cabot Oil & Gas operation after 8,000 gallons of chemicals spilled into a stream. Nor is it exactly 'green'. But natural gas has much lower CO₂ emissions than coal, even from shale— which is why the Sierra Club is backing it as the lesser of evils against "clean coal" (not yet a reality). The US Federal Energy Regulatory Commission said America may not need any new coal or nuclear plants "ever" again.

I am not qualified to judge where gas excitement crosses into hyperbole. I pass on the story because the claims of BP and Statoil are so extraordinary that we may need to rewrite the geo-strategy textbooks for the next half century.

A Simple, Incredible System

2009-10-08T21:47:00.000-07:00

A Simple, Incredible System That's Beaten The Market By 10% A Year

By Dr. Steve Sjuggerud, Daily Wealth | 9 October 2009

"Using a form filed with the government that's available to everyone, we've found ways to beat the market by as much as 10% a year." Investment analyst Mebane Faber told me that recently (in so many words), over dinner with my good friend and mentor Van Simmons. Mebane ("Meb" for short) is a relatively unknown young analyst, but he's doing fantastic work…

Last week [[see below: normxxx]], I told you about his simple investing system that didn't lose money for 35 years. (It's from his book, The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.) What's more, it beat the market with less risk. And astoundingly, you only have to look at your portfolio once a month— 12 days a year. It's simple, but incredible… the mark of a great idea.

Last night, he explained another simple but incredible idea…

"Big investors— those with over $100 million— have to disclose their investment holdings in government filings called 13Fs," Meb explained. "The information is backward looking… But I've studied it, and it turns out it can be extremely valuable". One thing Meb does is "clone" the big hedge-fund managers, like George Soros, David Einhorn, and Seth Klarman. Through these government filings, he can use these gurus' expertise without paying them big fees.

Meb explained that "mining" these government forms to copy the best portfolios works best with investment managers who hold stocks for a long period of time… investors like the world's second-richest man, Warren Buffett. Let's take a closer look at how you could use Meb's ideas to "clone" Warren Buffett's portfolio out of the government filings…

The 13F filings are quarterly. To keep it simple, Meb takes Buffett's top-10 holdings and equally weights them in his portfolio. Three months later, when the new 13F filings come out, he changes the portfolio.

Meb said, "It turns out that a simple portfolio that invests in Buffett's top 10 stock holdings, equal-weighted and rebalanced quarterly, beat the market by 10% a year from 2000 through 2008". (A recent academic paper, called Imitation is the Sincerest Form of Flattery, corroborates Meb's research. It used a similar strategy from 1976 to 2008, and it beat the market by 11% per year.)

"Mining" these 13F forms turned out to be so valuable, Meb created a way to backtest these ideas automatically. He and his partner Maz Jadallah founded AlphaClone and made his program available to the public… for way too cheap (with a free 14-day trial and a "Guest Pass"). Now, you can easily backtest the performance of a portfolio that simply follows the stock ideas of the biggest and best money managers as soon as their portfolios are available through government filings.

If you're interested in picking your own stocks, or you'd like to see how you could have performed if you'd followed the best hedge-fund managers in the business, give AlphaClone a try. And keep an eye out for Mebane Faber. This young analyst keeps delivering original, simple ideas.

Good investing,

Steve

P.S. Follow Meb at this site and try his AlphaClone program.

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This System Works So Well, I'm Not Sure I Should Tell You About It

By Dr. Steve Sjuggerud | 2 October 2009

If I weren't working on the same research myself, I wouldn't have believed it's possible… The results of this system are so powerful, I hesitate to share them with a large audience. But I get paid to share the best investment ideas I find. So I feel compelled to tell you about this one…

In short, investment analyst Mebane Faber came up with an incredibly "dumb" system that beats the market. It crushes it actually… Meb's system delivers the investment "Holy Grail"— higher returns with lower risk. It's hard to believe, but the system really is incredibly simple. And it's totally legit. While the traditional disclaimer "past performance doesn't equal future performance" applies, the fact is:

From 1973 (the start date for his data) through 2007, Meb's simple system never had a losing year. (Think about that!) In 2008, when everyone lost money, Meb's simple system beat everything and was barely down. (I'm not sure what the exact figure was, but I assure you, it was only slightly negative.)

I remembered Meb's story when I opened up the most recent issue of Fortune… It turns out, Harvard and Yale's college endowments are down 27% and 25%, respectively, in the 12 months ending June 30. I tell you this because I first learned of Meb's system in a book he wrote, called The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.

The book is interesting… He shows you how Harvard and Yale have beaten typical money managers over the long run, among other investment ideas. It's worth owning just for that section.

But what interested me most wasn't Harvard's famous system in the front half… it was Meb's unknown system later in the book. Way in the back, after all the stuff about the endowments, I found Meb's little timing system.

He wrote the book before the Great Recession. How has his system performed since? It's hitting new highs:

But that's the way it's always been… I think the worst performing 12-month period (out of all possible intra-year 12-month periods) was a loss of less than 10%. Great stuff.

In the simple version of Meb's system, you only look at the markets 12 days of the year. And there are only five funds to own: U.S. stocks, foreign stocks, bonds, commodities, and real estate stocks. In Meb's system, you have 20% of your portfolio in each of these five asset classes… and you are either in or out of each of them every month. So you might be only 40% invested one month, then 80% invested another month, depending on the system.

Look, Mebane Faber came up with this system… and he deserves credit for it… So I'm going to ask you to get it from him. Go to this site and get his book. Read his blog. If you want to know the "science" behind it, click on the "Timing Updates" tab and download his academic paper.

It's worth learning…

It's had only one down year since starting in 1973. [[2008, as noted.: normxxx]] And it's delivered the investment "Holy Grail" of higher returns with lower volatility… all in a portfolio of just five things that you only have to look at a dozen times a year.

What more could you want? Check it out.

Good investing,

Loan Delinquencies Hit Record Highs

2009-10-08T21:27:00.000-07:00

2009-10-08T12:23:00.000-07:00

Editor Steve's note: Investors are bombarded daily with warnings that inflation (rising prices) is a big threat to their wealth. Problem is, investors are also bombarded with warnings that deflation (falling prices) is a big threat to their wealth. To guide folks to the right "defense," there's no one more knowledgeable than multimillionaire investor Chris Weber. Here's his current take on the situation:

An Answer To The Biggest Question Investors Face Right Now

By Chris Weber | 8 October 2009

One year ago, in the October 1, 2008 issue of the Weber Global Opportunities Report, I used as a title "The Immediate Danger is Deflation". My view was, to put it briefly, that the world's Central Banks can try to inflate as much as they can, by 'creating' money and supplying it to banks. But if banks are afraid to lend it out, or are rebuilding their capital base, and if businesses and consumers are afraid to borrow— and rebuilding their own balance sheets, meaning saving more and spending less— then there is not much that central banks can do. [[Like trying to push the proverbial wet noodle up a hill! : normxxx]]

One year later, I am sorry to see no real evidence that things have changed. If anything, consumers are even more afraid to borrow and spend now than they were a year ago. The heightened threat of becoming jobless may have a lot to do with this. Those who borrowed madly in the past are now in a kind of hangover. They are now trying to save more. [[Even those not forced to do so by their lenders! : normxxx]]

The markets themselves are bearing witness to this. If they feared inflation, interest rates would be much higher than they were a year ago. Instead, they are lower. A year ago, the US 10 year T-note yielded almost 4%. Today it yields just 3.17%.

The Commodities Index, CRB, has fallen from 325 to 259 in the same year. Though the Dow Jones has risen sharply since last March, remember that last October 1 it was close to 11,000, not the 9,700 area it is now. London's FTSE is up a bit: from 5,000 to 5,100. But that's just 2%. Japan has fallen from over 11,000 to 9,800.

Nearly every piece of real estate can be purchased for less money today than was the case one year ago. In other words, cash has been king this past year. And that is another way of saying that deflation dangers have still not gone away.

But one area has done better than the rest. Let's turn to precious metals. One year ago, gold was $860. Now it is $1,042. Silver was $12.30 last September 30. Today it is $17.43. For my readers who have been with me for years, I know I have been repeating the same mantra for all that time: Have the core of your net worth in a mix of cash and precious metals.

For my new readers, I repeat this, and point out that this approach has saved a lot of money that would otherwise have been lost. Both cash and precious metals buy more than they did one year ago, two years ago, and even farther back. I meant it as a cautious method to conserve money in perilous times, but it has turned out to be pretty much the best approach one could have.

There are those who are absolutely certain that the future will be high and even hyperinflation. There are others equally certain that deflation will be our eventual outcome. To me, it seems like nothing has changed in the 35-plus years I've been in this business. Back when I started out, there were the same arguments, the same certainty on both sides. Only the names of the combatants have changed.

For me, let's just say I'm not smart enough to know what the outcome will be. The only thing on earth that I am absolutely certain of is that I will die; that indeed everyone alive today will one day die. Speaking only for myself, I may die tonight or I may live 50 more years.

Beyond that, I am reasonably certain that history shows that paper money not backed by gold or silver loses value over time. One million dollars 50 years ago was a lot of money. It was even more money 100 years ago. Today, well, it's not chicken feed, but let's say it doesn't buy what it did 50 years ago, or even 20 years ago. [[Or even 10 years ago!: normxxx]] But in terms of assets like stock and property, one million dollars (or euros, etc.) buys more than it did one year ago.

This may just be a temporary development; it may be the start of a new trend. I am not going to bet everything I have on either one or the other. Instead, I've been protecting myself from both. And that's why I have been owning and building cash right along with the precious metals I own.

I have cash in case I am wrong about inflation vaulting the price of gold and silver higher. I have gold and silver in case I am wrong about the value of holding cash. I have tried to protect myself against both inflation and deflation. I own some real estate in case that goes up. It would make sense for me to own some general stocks that would do well if the world economy does well too.

In other words, my watchword has been to protect yourself in case you are wrong: to protect yourself against being hurt by any eventuality. This was my view one year ago, and it remains my view today. To me, the future is unclear right now.

We stand on a kind of knife edge. On one side lies deflation, and on the other inflation. I have tried to hedge myself against both, and yet not be hurt if either happens. The recommended combination of cash and precious metals has not only done well in the past year. It has done well since 2000.

And while I am watching developments every day, I see no reason to change my approach, which has worked so well. Of course, it has worked in the sense that it has given me more money in my net worth than a decade ago. But more important, it has enabled me to sleep well during all that time— a decade which has been very turbulent and disappointing for many if not most. And to me, this gift is priceless.

Good investing,

Chris Weber

Editor Steve's Note: Chris Weber is, by far, one of the best investors we know. He started investing at age 16… and was so good at it, he became a millionaire by the time he was 20. Today, Chris has grown his fortune many times over, and he writes exactly what he's doing with his money. If you're interested in finding out about Chris' personal favorite recommendations for both cash and gold, click here to learn more.

Banks Brace For Latvia's Collapse

2009-10-07T20:22:00.000-07:00

Banks Brace For Latvia's Collapse

By Ambrose Evans-Pritchard, Telegraph.Co.Uk | 5 October 2009

Latvia's currency peg is back on the agenda

The Baltic states are once again in the eye of the storm after leaked reports that Sweden is bracing for a full-blown economic and political "breakdown" in Latvia. The Svenska Dagbladet newspaper said Sweden's finance minister Anders Borg had told banks 'secretly' that Latvia's political order was unravelling, advising them to prepare for the collapse of Latvia's rescue talks.

Latvia has failed to deliver draconian spending cuts agreed to secure the next tranche of its €7.5bn (£6.85bn) bail-out from the EU, the International Monetary Fund, and Sweden, balking at 20% cuts in pensions and a further 15% cut in public wages. The People's Party, the largest group in the coalition, voted against austerity measures last month, raising concerns that the country is ungovernable. Mr Borg said the 'world's' patience is running out. "It will be very hard to continue with these international programmes if they don't fulfill the spirit and the content in the agreements they have signed."

Latvia's economy contracted by 18.2% in the twelve months to June, trumped only by Lithuania at 20.4%. "Latvia's currency peg is back on the agenda," said Hans Redeker from BNP Paribas. "The government has to relax policy for social reasons. The hardship this winter is going to be unbelievable".

Youth unemployment in Latvia is already 31%, and concentrated among ethnic Russians. Premier Valdis Dombrovskis said his chief task is to "preserve social peace". Neil Shearing from Capital Economics said the appetite for austerity has been exhausted. Latvia is "more likely than not" to devalue, toppling pegs in Estonia and Lithuania. "Financial markets elsewhere in the region are likely to be hit by contagion, with Hungary, Romania, and Ukraine most vulnerable."

The area is better able to cope with shocks than during the panic this Spring. The G20 tripled the IMF's fire-fighting fund to $750bn in April, chiefly as an insurance for Eastern Europe. This has greatly reduced risk of a liquidity crisis. It does not alter the slow-burn damage of rising defaults.

The Baltic trio financed property booms in euros (and swiss francs) because rates were 'lower'. It was taken for granted that eventual euro entry had eliminated the exchange risk. This has become a trap. They need to devalue to break the cycle of depression, but cannot do so because of euro mortgages. Instead they hope to claw back lost competitiveness through wage deflation. This takes years, and discipline. [[Or, a totalitarian government! : normxxx]]

Mr Shearing said Latvia's economy would shrink by 30% whether it devalues or not. The peg merely draws out the agony, and slows the pace of inevitable defaults. Washington's Center for Economic and Policy Research said the IMF is enforcing a "pro-cyclical contractionary policy" in Latvia. Foreign banks (mostly Swedish) are being rescued at the cost of local taxpayers.

The IMF deal equals 34% of GDP. Latvia is piling up debt to defend its peg. The policy may backfire in any case. Fiscal contraction is causing tax revenues to implode, feeding a vicious circle.

Lars Christensen from Danske Bank said Latvia's political class is chiefly responsible for clinging to the peg. "It's their choice, but if they want the bail-out money, they must do what they promised. They don't seem to understand that the IMF and EU are willing to walk away now that the global economy has improved and spill-over risks have been reduced," he said.

Prospects are grim whatever happens "There is absolutely no sign of stabilisation. The economy is still contracting. It's paralysis," he added.

Office Rents Dive

2009-10-07T17:22:00.000-07:00

Commercial Real Estate: Office Rents Dive As Vacancies Rise

By Christina S.N. Lewis | 7 October 2009

Rent for office space is falling at the fastest pace in more than a decade as vacancies create a glut and landlords slash prices to attract tenants. Nationwide, effective office rents fell 8.5% in the third quarter compared with the same period a year ago, the steepest year-over-year decline since 1995, according to Reis Inc., a New York real-estate research firm. The decline came as companies returned a net 19.6 million square feet of space to landlords in the third quarter, slightly more than in the second quarter.

For the first three quarters of this year, the net decline in occupied space totaled a record 64.2 million square feet, the highest so-called 'negative absorption' recorded since Reis began tracking the data in 1980. (That doesn't count space that left the market as a result of the 2001 terrorist attacks.) The vacancy rate, meanwhile, hit 16.5%, a five-year high, according to Reis.

Declining rents and rising vacancies in the office sector signal more woes for the commercial-real-estate market, which already faces a lack of credit and plummeting property values. With landlords more likely to default, financial institutions, which hold trillions of dollars in commercial-real-estate debt also face more pain. "It means more losses for the banks, because they will have to write off more bad debt," said Victor Calanog, director of research for Reis.

For tenants, however, falling rents represent opportunities to save. Landlords are offering concessions, in the form of free rent and build-out costs. "There's a recognition [from some companies] that this is probably a bottom, let me lock in long term," said Mary Ann Tighe, a New York-based leasing broker with CB Richard Ellis, who has negotiated corporate relocations for tenants including advertising firm Ogilvy & Mather and retailer Limited Brands.

Click Here, or on the image, to see a larger, undistorted image.

As bad as the current environment is for landlords, analysts say it will worsen as unemployment continues to rise. "Even though the technical recession may be over, the labor market typically takes anywhere from 18 to 24 months to bounce back in a consistent way," said Mr. Calanog, who predicts vacancy will rise through 2010 and may not peak until 2011. "If employers are still shedding jobs, they are also going to shed space."

Vacancies are highest in areas with poor housing markets and industrial cities. They are approaching historic highs in Southern California; Las Vegas; Phoenix; southwest Florida; Detroit; Dayton, Ohio; and Hartford, Conn. Other cities, including Dallas and other parts of Texas, and Atlanta, are seeing high vacancy rates largely as a result of overbuilding.

Rent declines were steepest in big cities with large financial sectors, which saw the greatest run-up in rents in 2006 and 2007. They include Seattle, which has been slammed by the failure of Washington Mutual Inc., New York and San Francisco. But the office market deteriorated broadly across virtually all regions: Of the 79 metro areas that Reis tracks, office vacancies rose in 72 of them and effective rents declined in 68 of them.

In Boston, intellectual-property law firm Fish & Richardson PC recently signed a lease for 124,000 square feet of space in a new development under construction on the South Boston waterfront, paying about $48 a foot with about $85 a foot in tenant improvements from the landlord, according to a person familiar with the deal— compared with the roughly $55 a foot the firm is paying now to landlord Equity Office. In its attempt to persuade the tenant to stay, Equity Office, which is owned by private-equity firm The Blackstone Group, initially offered the firm $84.50 a foot in December 2007, but dropped the price over time to stay competitive and sent wine and champagne gift baskets to all of the firm's 45 principals, according to Tim French, Fish & Richardson's Boston managing principal.

"We were like the belle of the ball," said Mr. French.

What To Do If Q3 Earnings Fail To Deliver

2009-10-06T11:32:00.000-07:00

Frost Warnings For October: What To Do If Third-Quarter Earnings Fail To Deliver

By Jim Lowell, Marketwatch | 1 October 2009

NEWTON, Mass. (MarketWatch)— Thoughts of cycles and seasons, turnings from growth toward annual decay and perennial conservation in the real world and its mirror image found on Wall Street, are migrating in and out of my market musings. Talk of a big chill is circulating in the real world marketplace, and on Wall Street. It certainly feels as if the overall cycle on both fronts is overdue for a frost of some magnitude.

But I think the long-term bullish trend remains inexorably intact, whether you think that some one or group had a hand in the cycle or not is not as relevant as the fact that the cycle persists. We know that around this column's corner, we'll get an important earnings season but it won't be as significant as the prior one. Second-quarter earnings not only pulled the herd back from the cliff, they created a stampede of gains whose dust-up was the best since the Great Depression. But third-quarter earnings will be essential to supporting or supplanting this remarkable rebound.

We also know that even before we get to those earnings, we're going to continue to build a case for an economic floor on which we can stand. The production pace has been cut so dramatically below even the anemic pace of sales that a positive outcome is all but a foregone conclusion. Loosely conjectured, this could mean that we're on the road to something like a surprising 5% growth inside the third and fourth quarters. But, if third-quarter earnings fail to deliver broad-based evidence of top line sales growth and not just bottom line management via cost cutting or production efficiencies, then we could be in store for a growing economy and falling market.

So, this month's trading opportunities are biased toward risk management. Last month, we went further out on selective branches of the global market tree in order to grab a few more fruitful gains. Our best pick, iShares Comex Gold Trust (IAU 101.89, +2.06, +2.07%) , returned 5.8%. Our worst pick gained 1.6%, while the S&P 500 (SPX 1,052, +11.47, +1.10%) delivered 4.8%.

Against this year's backdrop, our weekly ETF Trader service here on MarketWatch continues to do what it's designed to do: capitalize on growth trends in the marketplace. Through Sept. 20— and against the solid 20.5% gain for the S&P 500— the service's ETF Aggressive Trader model portfolio is up 72.6%, ETF Total Market gained 39.8%, ETF Sector climbed 34.3% and ETF Seasonality Portfolio added 17.1%. To learn more about ETF Trader, and to sign up for a free 30-day trial, click here.

Here and now, my picks have us returning closer to the stocks/bonds/cash trunk to withstand better the likely near-term blows of a market that is ahead of the near-term fundamentals. My picks for managing the risk and return potential of October's landscape:

Stocks: Fidelity Select Health Care (FSPHX 98.65, +0.96, +0.98%) — Buy. Up 25.3% year to date. Manager Eddie Yoon invests in the gamut of healthcare options: pharmaceuticals, biotechnology, medical equipment and HMOs. The trumped up political crisis that has engendered a rush to 'cure' our healthcare system has done little to dent the fundamental reasons— earnings growth, demographics, and innovation— for keeping a core holding in healthcare now.

I also like Vanguard Healthcare (VGHCX 113.43, +0.72, +0.64%) by virtue of its stellar manager, Ed Owens, and its complementary Hartford Global Health (HGHAX 13.49, +0.05, +0.37%), run by Owens' team. There's also a stealth global market dose here: foreign stocks make up 13% of the holdings, but the companies that aren't listed as foreign stocks derive increasingly greater amounts of revenue form the burgeoning global marketplace.

Bonds: Fidelity New Markets Income (FNMIX 15.39, +0.16, +1.05%), up 41.2% year to date. Manager John Carlson, who used to run the Emerging Market stock fund, has a simple maxim— if you want to own the stocks, you should want to own the debt. Research, analysis, knowledge and judgment are Carlson's calling cards in this often-volatile trade. Carlson manages risk through all of that diversification— 128 plus holdings— but not at the expense of his best ideas. A total of 26% of the fund's $2.1 billion is in his top-10 picks. His debt securities range from Venezuela to Russia, Turkey to Brazil and the Ukraine to the U.S.— in the form of a 7% stake in the Fidelity Cash Central fund.

I view this fund in much the same way that I view our stake in high income, as a hedge against its correlated equity markets risks. Similarly, the yield offers a way to help salve any specific selloff while the holdings offer a way to stem the flood if panic selling in the equity markets ensues. That's a negative imprint of this positive snapshot: long-term, the growth of emerging markets and the debt needed to finance that growth are two rails on which our portfolio's financial engine can run.

Cash: My pick of the litter remains last month's exchange-traded fund, the PowerShares DB G10 Currency Harvest Fund. (DBV 23.18, +0.18, +0.78%) It's up 17% year to date. DBV ostensibly does all the currency trading work for you: it tracks the Deutsche Bank G10 Currency Future Harvest Index, intended to take advantage of the fact that currencies with high interest rates tend to rise in value relative to those with low interest rates. The 10 currencies that the index selects from include the U.S. dollar, the euro, the Japanese yen, Canadian dollar, Swiss franc, British pound, Australian dollar, New Zealand dollar, Norwegian krone, and Swedish krona.

When you combine all three 'alloctions', you have a reasonable offense and a reasoned defense for a month where harvesting gains might be the rule rather than the exception. If this does turn out to be the case, look to next month's column to spotlight seeds we can sow in November's greenhouse for next year's even more bountiful harvest.

2009-10-04T19:07:00.000-07:00

Wells Fargo: Ready To Blow?
Buying Wachovia Was Strategically Astute But Financially Messy
Or, The Trials And Tribulations Of A "Conservative" Bank In A Gangbuster's World

By The Economist | 24 September 2009

"Together we'll go far." Wells Fargo's corporate slogan is a pledge to its customers, but it might just as well reflect the San Francisco banking giant's optimism about its takeover of Wachovia, a teetering rival it snatched from under Citigroup's nose last October. Losses from the acquisition are "still in the same zip code" as the sum envisaged at the time, says John Stumpf, Wells's chief executive. In another sign of self-confidence, Dick Kovacevich will step down as chairman at the end of the year, a move that would be hard to imagine if the bank's hands-on former boss were worried about the future.

Others are less convinced, suspecting Wells of understating Wachovia's loan losses and questioning its accounting. Fuelling these worries, says Dick Bove of Rochdale Securities, is "extraordinarily poor" communications and disclosure. Alone among big banks, Wells does not hold a quarterly 'call for analysts'.

Had it not bought Wachovia, Wells would be one of finance's clear winners. Long one of America's more conservative lenders, it avoided the most noxious property loans and securities. As Warren Buffett, a fan and shareholder, put it in April: "What Wells didn't do is what defines their greatness". Wachovia changed that. It brings [great] opportunities, but also [great] risks.

On the positive side, the merger has doubled the number of Wells branches to more than 6,600, giving it a footprint that only Bank of America comes close to matching. Wells and Wachovia were "mirror images" of each other, says Mr Stumpf, with Wells strong west of the Mississippi and Wachovia powerful to the east. This gives Wells huge deposit-gathering power, as well as an opportunity to pump more products to Wachovia customers, who typically have four to five products with the bank, compared with almost six for Wells clients.

Mr Buffett sees echoes of Wal-Mart in Wells's retailing ethic. The merger gives Wells a formidable position in areas such as mortgages. In the first half of the year it handled a staggering 23.5% of all new home loans, according to Inside Mortgage Finance, a newsletter. But Wachovia also brings credit problems that could take years to resolve. A big worry is its range of [[Option ARM: normxxx]] retail loans, which allowed borrowers to defer principal as well as interest payments: of those that were still current at the time of the merger, 3.2% were seriously delinquent as of June 30th, up from 1.1% in March.

The default rate on the bank's $38 billion of property-development loans is several times the national average (though Wells argues that the official numbers do not reflect merger-related adjustments). A big chunk of its $127 billion commercial-property portfolio consists of interest-only loans with a balloon payment at the end, the 'wholesale' equivalent of [[Option ARMs: normxxx]]. These will be hard to refinance.

Another worry is the large amount of 'credit protection' [[CDOs: normxxx]] that Wachovia is thought to have sold on risky 'tranches' of mortgage-backed securities. Wells points to its latest filing, which shows $105 billion of protection sold and a similar amount bought. But the extent to which the latter really offsets the former is unclear.

Then there is capital. Among big banks, Wells scores poorly on Tier-1 common equity, the core-capital measure favoured by regulators (see chart, left). It is well below the 6% level that is likely to be the minimum required in future. And at some point it will have to repay the $25 billion of government capital it got last year.

Wells puts its relative capital paucity down to "purchase" accounting at the time of the Wachovia deal. It immediately wrote down $40 billion of the $60 billion in total losses it envisaged. This upfront hit took a big chunk out of its equity, but put it ahead of peers in dealing with losses. Andrew Marquardt of Fox-Pitt Kelton estimates that Wells has swallowed 60-70% of its expected losses, twice the proportion recognised by a typical large bank.

Wells also argues that analysts and regulators underestimate its earning power. It generates pre-provision profits of around 3% of assets, compared with 2% for its peers. Wells has already plugged the gap identified in this year's "stress" tests, generating almost half the necessary capital internally (and the rest from a share offering). But, thanks to the uncertain economy and concerns about Wachovia, doubts linger. Mr Bove likens the bank to a rumbling volcano. If it blows, Wells will need lots more capital than it produces internally.

European Autocracy Established

2009-10-04T17:46:00.002-07:00

The Result In Ireland Shows That Europe's Usurpers Have Succeeded

By Ambrose Evans-Pritchard | 4 October 2009

The deed is done. Ireland has been coerced at a moment of acute distress into accepting an EU treaty that emasculates the Irish Supreme Court and that voters have already rejected once.

Eurosceptics always feared that the mechanisms of monetary union would force recalcitrant states to knuckle down in the end. This has occurred exactly as they predicted. Only a fool can believe that the Irish people have genuinely embraced the European Constitution (now 'Lisbon') as a "positive good". They acquiesced with their backs against the wall.

The Irish economy contracted by 11.6% in the 12 months to June. Nominal GDP shrank by nearer 13%, which is what matters for debt dynamics. It is not for outsiders to judge those such as radio star Eamon Dunphy for switching sides to save "jobs and livelihoods". The country is in deep depression.

The reason why this crisis is so grave is intimately tied to euro membership, even if this is not obvious to Irish voters. They appear to have believed the great lie— repeated by Ryanair's Michael O'Leary— that Europe saved their country from Iceland's fate. It did no such such thing.

Iceland's economy contracted by 6.5% to June (less than Germany) and is already turning the corner. Exports are surging. Unemployment fell in August to 7.7%. Such is the magic of a floating currency. The plunging krone acted as a shock absorber. Icelandic society remains intact.

The euro did indeed shield Ireland from the storm, but it is not the storm that does the damage— any more than 1929 crash caused the Depression. The country no longer has the means in EMU to counter debt deflation, as will become painfully clear over the next two years. It has become a laboratory for the roll-back of the modern welfare state.

There is something demented about this 'Lisbon' drive. The EU has already pushed the integration of Europe's states beyond viable limits. It obsesses over 'institutional' [[bureaucratic: normxxx]] machinery even as it ignores the social crisis of youth unemployment at 39% in Spain, 31% in Lithuania, 28% in Latvia, 26% in Ireland and Slovakia, 25% in Italy and Hungary, 24% in France.

It cannot run Europe's fisheries, farms, aid projects, and budget with a minimum of competence. Yet it presses for more and is willing to sell its political soul to get its way. "The EU seems blind to a central insight of liberal democratic thought— that the means of reaching public decisions are just as important as the ends," says Oxford professor Larry Siedentop. The means were to ignore the verdict of the French and Dutch people when they voted no to the original text in 2005, with half Europe waiting do exactly the same had Brussels not called off the kill for the sake of decency.

Common sense called for a halt then. But no, they tried to slip it through by parliamentary majorities in the House of Commons, Holland's Tweede Kamer, Denmark's Folketing, and France's Chambre, with the specific and sole of purpose of denying citizens the chance to express their will, confirming what we long suspected— that the EU's authoritarian habits are spreading to our national legislatures. Dublin alone was left to grapple with its voters, obliged to do so by its Supreme Court. And when they too said no last year, the political classes refused to accept the verdict yet again.

It is worth remembering how this Lisbon monster came to life. It was supposed to be the answer to the Danish and Swedish no votes to EMU, the Irish no to Nice, and anti-EU riots that set Gothenburg in flames. Henceforth, there would be no more 'stitch-ups'. The Laeken Declaration in 2001 acknowledged that the EU was seen by the peoples as "a threat to their identity", that "deals are all too often cut out of their sight", that there was no appetite for "a European superstate or European institutions inveigling their way into every nook and cranny of life". It spoke of returning powers to the member states. A convention— modelled on [that of] Philadelphia, US— would draw up an EU constitution to restore "democratic legitimacy".

What then happened? The EU insiders hijacked the process. Dissident utterings were silenced in the working groups. A praesidium under super-elitist Valéry Giscard d'Estaing employed Commission lawyers to draft the wording. The final text called for an EU president, foreign minister, justice department, a supreme court with jurisdiction over all areas of EU policy for the first time, and fresh powers to enter yet more nooks and crannies— in other words, the apparatus of an aspirant [[autocratic?: normxxx]] state. And this how it remains in Lisbon disguise.

"The convention failed: it was a self-selected group of the European political elite," said Gisela Stuart, Britain's member on the praesidium. The experience was enough to turn her into fervent opponent of Lisbon. The methods being used to force this treaty through after electorates have already spoken cross a line that may not be crossed. The European Project has become the enemy.

This is the treaty that Gordon Brown was too ashamed to sign in public with fellow EU leaders in Lisbon. Yet sign he did. The question for David Cameron is whether he will continue this practice, or take a stand before any more pages are ripped out of our own Magna Carta. Go on, David, sock the usurpers between the eyes.

Rational Irrationality

2009-10-03T10:00:00.000-07:00

Rational Irrationality: The Real Reason That Capitalism Is So Crash-Prone.

By John Cassidy, The New Yorker | 5 October 2009

In finance, actions can be both individually prudent and collectively disastrous.

On June 10, 2000, Queen Elizabeth II opened the high-tech Millennium Bridge, which traverses the River Thames from the Tate Modern to St. Paul's Cathedral. Thousands of people lined up to walk across the new structure, which consisted of a narrow aluminum footbridge surrounded by steel balustrades projecting out at obtuse angles. Within minutes of the official opening, the foot way started to tilt and sway alarmingly, forcing some of the pedestrians to cling to the side rails. Some reported feeling seasick.

The authorities shut the bridge, claiming that too many people were using it. The next day, the bridge reopened with strict limits on the number of pedestrians, but it began to shake again. Two days after it had opened, with the source of the wobble still a mystery, the bridge was closed for an indefinite period.

Some commentators suspected the bridge's foundations, others an unusual air pattern. The real problem was that the designers of the bridge, who included the architect Sir Norman Foster and the engineering firm Ove Arup, had not taken into account how the foot way would react to all the pedestrians walking on it. When a person walks, lifting and dropping each foot in turn, he or she produces a slight sideways force. If hundreds of people are walking in a confined space, and some happen to walk in step, they can generate enough lateral momentum to move a footbridge— just a little.

Ah, but once the foot way starts swaying, however subtly, more and more pedestrians adjust their gait to get comfortable, stepping to and fro in synch. As a positive-feedback loop develops between the bridge's swing and the pedestrians' stride, the sideways forces can increase dramatically and the bridge can lurch violently [[and eventually break! : normxxx]] The investigating engineers termed this process "synchronous lateral excitation," and came up with a mathematical formula to describe it.

[ Normxxx Here: That formula has been around since the dawn of engineering. They knew about this effect as far back as the Roman Empire, when marching Roman Centurions had to be trained to "break step" when crossing a bridge. Norbert Wiener specifically addressed this in his book: "Cybernetics or Control and Communication in the Animal and the Machine", 1948. ]

What does all this have to do with financial markets? Quite a lot, as the Princeton economist Hyun Song Shin pointed out in a prescient 2005 paper. Most of the time, financial markets are pretty calm, trading is orderly, and participants can buy and sell in large quantities. Whenever a crisis hits, however, the biggest players— banks, investment banks, hedge funds— rush to reduce their exposure, buyers disappear, and liquidity dries up.

Where previously there were diverse views, now there is unanimity: everybody's moving in lockstep. "The pedestrians on the bridge are like banks adjusting their stance and the movements of the bridge itself are like price changes," Shin wrote. And the process is self-reinforcing: once liquidity falls below a certain threshold, "all the elements that formed a virtuous circle to promote stability now will conspire to undermine it". The financial markets can become highly unstable.

This is essentially what happened in the lead-up to the Great Crunch. The trigger was, of course, the market for subprime-mortgage bonds— bonds backed by the monthly payments from pools of loans that had been made to poor and middle-income home buyers. In August, 2007, with house prices falling and mortgage delinquencies rising, the market for subprime securities froze.

By itself, this shouldn't have caused too many problems: the entire stock of outstanding subprime mortgages was about a trillion dollars, a figure dwarfed by nearly twelve trillion dollars in total outstanding US mortgages, not to mention the eighteen-trillion-dollar value of the US stock market [[nor the $33.5 trillion US bond market. But, there is about $800 trillion of various kinds of derivatives in the world (Warren Buffet's "instruments of mass destruction"), mostly credit swaps of one kind or another, and some unknown number of those derivatives had been poisoned to an unknown degree by tiny slices from those sub-prime mortgages! And it is uncertainty— not knowing or being able to calculate the risks— that kills markets! So, many large financial institutions (including banks) and other large investors in the Commercial Paper market held back (since many of the loans in that market were more or less secured by longer term ABBs or other derivatives), the CP market froze, and all hell broke out! : normxxx]]

At this point banks, which couldn't estimate how much exposure other firms and especially other banks had to losses, started to pull back all credit lines and hoard their capital— and they did so en masse— confirming Shin's point about the market imposing uniformity— [[and when banks won't lend to each other, the entire world financial system is frozen, and that's the end of trade and the capitalistic economy!: normxxx]]

An immediate collapse was averted when the European Central Bank and the Fed announced that they would pump more money into the financial system. Still, the global economic crisis didn't ease up[!?!] until early this year, and by then governments had committed an estimated nine trillion dollars to propping up the system. A number of explanations have been proposed for the great boom and bust, most of which focus on greed, overconfidence, and downright stupidity on the part of mortgage lenders, investment bankers, and Wall Street C.E.O.s.

According to a common narrative, we have lived through a textbook instance of the madness of crowds. If this were all there was to it, we could rest more comfortably: greed can be controlled, with some difficulty. Admittedly, overconfidence gets punctured; but even stupid people can be educated. Unfortunately, the real[!?!] causes of the crisis [[as given by God?: normxxx]] are much scarier and less amenable to reform: they have to do with the inner logic of an economy like ours [[ those economists are at it again: reading entrails, tea leaves, and Rorschach blots: normxxx]]. The root problem is what might be termed "rational irrationality"— behavior that, on the individual level, is perfectly reasonable but that, when aggregated in the marketplace, produces calamity.

Consider the freeze that started in August of 2007. Each bank was adopting a prudent course by turning away questionable borrowers and holding on to its capital. But the results were mutually ruinous: once credit stopped flowing, many financial firms— the banks included— were forced to sell off assets in order to raise cash. This round of forced asset selling caused stocks, bonds, and other such securities to decline in value abnormally, which generated a new round of selling and losses, and so on.

A similar feedback loop was at work during the boom stage of the cycle, when many mortgage companies extended home loans to low- and middle-income applicants who couldn't afford to repay them. In hindsight, that looks like reckless lending. It didn't at the time. In most cases, lenders had no intention of holding on to the mortgages they issued. [[And so, for the eventual end buyer, caveat emptor?: normxxx]]

After taking a generous fee for originating the loans, they planned to sell them to Wall Street banks, such as Merrill Lynch and Goldman Sachs, which were in the business of 'pooling' mortgages and using the monthly payments they generated to issue mortgage bonds [[aka, mortgage backed bonds, MBBs, and other mortgage backed securities, MBSs : normxxx]]. When an individual borrower whose home loan has been "securitized" in this way defaults on his payments, it is the buyer of the mortgage bond who suffers a loss, not the issuer of the mortgage. [[A tiny loss, normally, since each MBB represents hundreds and thousands of tiny slices (aka, tranches) of as many individual mortgages. : normxxx]]

This was the climate that produced business successes like New Century Financial Corporation, of Orange County, which originated $51.6 billion in subprime mortgages in 2006, making it the second-largest subprime lender in the United States, but which filed for Chapter 11 on April 2, 2007. More than forty per cent of the loans it had issued were stated-income loans, also known as 'liar' loans, which didn't require applicants to provide any documentation of their supposed earnings [[and were possibly intended for money launderers: normxxx]]. Michael J. Missal, a bankruptcy-court examiner who carried out a detailed inquiry into New Century's business, quoted a chief credit officer who said that the company had "no standard for loan quality". Some employees had queried its lax approach to lending, but without effect. Senior management's primary [[sole?: normxxx]] concern was that the loans it originated could be sold to Wall Street. As long as there were downstream investors eager to buy subprime securities, with few questions asked, expanding credit recklessly was a highly rewarding strategy. [[And, indeed there were such eager buyers! Remember, many of these "packaged" securities were rated AAA, yet paying out above 'normal' market rates in interest. Indeed, they were paying out higher than 'normal' market interest rates at every investment rating level.: normxxx]]

When the subprime-mortgage market faltered, the business model of giving loans to all comers no longer made sense. Nobody wanted mortgage-backed securities any longer [[tainted as they were by those sub-primes to an unknown degree: normxxx]]; nobody wanted to buy the underlying mortgages. Some of the Wall Street firms that had financed New Century's operations, such as Goldman Sachs and Citigroup, made margin calls. Federal investigators began looking into New Century's accounts, and the company rapidly became one of the first major casualties of the subprime crisis. Then again, New Century's executives were hardly the only ones who failed to predict the subprime crash: Alan Greenspan and Ben Bernanke didn't, either. Sharp-dealing companies like New Century may have been reprehensible. But they weren't 'simply irrational'.

The same logic applies to the decisions made by Wall Street C.E.O.s like Citigroup's Charles Prince and Merrill Lynch's Stanley O'Neal. They've been roundly denounced for leading their companies into the mortgage business, where they suffered heavy losses. In the midst of a credit bubble, though, somebody running a big financial institution seldom has the option of sitting it out. What boosts a firm's stock price, and the boss's standing, is a rapid expansion in revenues and market share.

Privately, he may harbor reservations about a particular business line, such as subprime securitization. But, once his 'peers' have entered the field, and are making money, his firm has little choice except to join them. C.E.O.s certainly don't have much personal incentive to exercise caution. Most of them receive compensation packages loaded with stock options, which reward them for delivering extraordinary growth rather than for maintaining product quality and protecting their firm's reputation [[or, eventually, its solvency. : normxxx]]

Prince's experience at Citigroup provides an illuminating case study. A corporate lawyer by profession, he had risen to prominence as the legal adviser to Citigroup's creator, Sandy Weill. After Weill got caught up in Eliot Spitzer's investigation of Wall Street analysts and resigned, in 2003, Prince took over as C.E.O. He was under pressure to boost Citigroup's investment-banking division, which was widely perceived to be falling behind its competitors.

At the start of 2005, Citigroup's board reportedly asked Prince and his colleagues to develop a growth strategy for the bank's bond business. Robert Rubin, the former Treasury Secretary, who served as the chairman of the board's executive committee, advised Prince that the company could take on more risk. "We could [then have] afford[ed] to seek more opportunities through intelligent risk-taking." Rubin later told the Times, "The key word is 'intelligent'".

Prince could have rejected Rubin's advice and told the board that he didn't think it was a good idea for Citigroup to take on more risk, however intelligently it was done. [[But what does a lawyer know of modern finance? : normxxx]] Citigroup's stock price hadn't moved much in five years and maintaining a cautious approach would have involved forgoing the kind of growth that some of the firm's rivals— UBS and Bank of America— were already enjoying. To somebody in Prince's position, the risky choice would have been remaining aloof from the subprime craze, not joining the crowd.

In July, 2007, he intimated as much, in an interview with the Financial Times. At that stage, three months after New Century's collapse, the problems in the subprime market could no longer be ignored. But the private-equity business, in which Citigroup had become a major presence, was still thriving, and Blackstone, one of the biggest buyout firms, had just issued stock on the New York Stock Exchange.

Prince conceded that a collapse in the credit markets could leave Citigroup and other banks exposed to the prospect of large losses. Despite the danger, he insisted that he had no intention of pulling back. "When the music stops, in terms of liquidity, things will be complicated," Prince said. "But as long as the music is playing, you've got to get up and dance."

The reference to the game of musical chairs was a remarkably candid description of the situation in which executives like Prince found themselves, and of the logic of 'rational irrationality'. Whether Prince knew it or not, he was channelling John Maynard Keynes, who, in "The General Theory of Employment, Interest, and Money," pointed to the inconvenient fact that "there is no such thing as liquidity of investment for the community as a whole."

Whatever the asset class may be— stocks, bonds, real estate, or commodities— the market will seize up [[ie, cease to act like a market— in this case, no buyers to be found, only sellers: normxxx]] if everybody tries to sell at the same time. Financiers were accordingly obliged to keep a close eye on the "mass psychology of the market," which could change at any moment. Keynes wrote, "It is, so to speak, a game of Snap, of Old Maid, of Musical Chairs— a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops". Keynes's jaundiced view of finance reflected his own experience as an investor and as a director of an insurance company.

Every morning, in his rooms at King's College, Cambridge, he spent about half an hour in bed studying the financial pages and various brokerage reports. He compared investing to newspaper competitions in which "the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view". If you want to win such a contest, you'd better try to select the outcome on which others will converge, whatever your personal opinion might be.

"It is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest," Keynes explained. "We have reached the third degree, where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees."

The beauty-contest analogy helps explain why real-estate developers, condo flippers, and financial investors continued to invest in the real-estate market and in the mortgage-securities market, even though many of them may have believed that home prices had risen too far. Alan Greenspan and other free-market economists failed to recognize that, during a speculative mania, attempting to "surf" the bubble can seem a perfectly rational strategy. According to orthodox economics, professional speculators play a stabilizing role in the financial markets: whenever prices rise above fundamentals, they step in and sell; whenever prices fall too far, they step in and buy.

But history has demonstrated that much of the so-called "smart money" aims at getting in ahead of the crowd, on both buying and selling, and that only adds to the mispricing [[and instability at turning points. : normxxx]]Markus Brunnermeier, an economist at Princeton, and Stefan Nagel, an economist at Stanford, obtained data from S.E.C. filings for fifty-three hedge-fund managers during the dot-com bubble. In the third quarter of 1999, they discovered, the funds raised their portfolio weightings in technology stocks from sixteen to twenty-nine per cent. By March of 2000, when the Nasdaq peaked, the funds had invested roughly a third of their assets in tech.

"From an efficient-markets perspective, these results are puzzling," Brunnermeier and Nagel noted. "Why would some of the most sophisticated investors in the market hold these overpriced technology stocks"? We know that many such investors had no illusions about the prospects of the financial products they traded. But their strategy was to capture the upside of the bubble while avoiding most of the downside— and, with timely selling, [at least some] of them succeeded.

Because financial markets consist of individuals who react to what others are doing, theories of 'free-market economics' are often less illuminating than the Prisoner's Dilemma, an analysis of strategic behavior that game theorists associated with the RAND Corporation developed during the early nineteen-fifties. Much of the work done at RAND was initially applied to the logic of nuclear warfare, but it has proved extremely useful in understanding another 'explosion-prone' arena: Wall Street.

Imagine that you and another armed man have been arrested and charged with jointly carrying out a robbery. The two of you are being held and questioned separately, with no means of communicating. You know that, if you both confess, each of you will get ten years in jail, whereas if you both deny the crime you will be charged only with the lesser offense of gun possession, which carries a sentence of just three years in jail. The best scenario for you is if you confess and your partner doesn't: you'll be rewarded for your betrayal by being released, and he'll get a sentence of fifteen years. The worst scenario, accordingly, is if you keep quiet and he confesses.

What should you do? The optimal joint result would require the two of you to keep quiet, so that you both got a light sentence, amounting to a combined six years of jail time. Any other strategy means more collective jail time. But you know that you're risking the maximum penalty if you keep quiet, because your partner could seize a chance for freedom and betray you. And you know that your partner is bound to be making the same calculation. Hence, the rational strategy, for both of you, is to confess, and serve ten years in jail. In the language of game theory, confessing is a "dominant strategy," even though it leads to a disastrous outcome. [[What you are trying to do is minimize your maximum possible loss.: normxxx]]

In a situation like this, what I do affects your welfare; what you do affects mine. The same applies in business. When General Motors cuts its prices or offers interest-free loans, Ford and Chrysler come under pressure to match G.M.'s deals, even if their finances are already stretched. If Merrill Lynch sets up a hedge fund to invest in collateralized debt obligations, or some other shiny new kind of security, Morgan Stanley will feel obliged to launch a similar fund to keep its wealthy clients from defecting.

A hedge fund that eschews an overinflated sector can lag behind its rivals, and lose its major clients. So you can go bust by avoiding a bubble. As Charles Prince and others discovered, there's no good way out of this dilemma. Attempts to act responsibly and achieve a coöperative solution cannot be sustained, because they leave you vulnerable to exploitation by others.

If Citigroup had sat out the credit boom while its rivals made huge profits, Prince would [almost certainly] have been out of a job earlier. The same goes for individual traders at Wall Street firms. If a trader has one bad quarter, [e.g.,] because he refused to participate in a bubble [[along with everyone else: normxxx]], the results can be career-threatening. [[On the other hand, even if he has a disastrous quarter, if he is only one among many, his results are overlooked. It's all relative.: normxxx]]

As the credit bubble continued, even the credit-rating agencies, which exist to provide investors with 'objective' advice, were caught up in the same sort of competitive behavior that had persuaded banks like Citigroup, UBS, and Merrill Lynch to plunge into the subprime sector. Instead of [keeping their proverbial] 'arms-length' approach and establishing a uniform set of standards for issuers of mortgage securities, the big three rating agencies— Fitch, Moody's, and Standard & Poor's— [through in their lot] with the Wall Street banks! [[They assumed that Wall Street's hordes of analysts and their sophisticated tools were far better equipped to rate these arcane instruments than the mere few analysts and their rather pedestrian tools at the rating agencies: normxxx]], and ended up giving AAA ratings to financial junk. But under the rating industry's business model, in which the issuers of securities pay the agencies for rating them, the agencies are dependent on Wall Street for their revenues.

Before Goldman Sachs, say, issued a hundred million dollars of residential-mortgage bonds, it would pay an agency like Moody's at least thirty or forty thousand dollars to issue a credit rating on the deal. As the boom continued, investment bankers played the agencies off against one another, shopping around for a [most] favorable rating. If one agency didn't think a bond deserved an investment-grade rating, the business would go to a more generously disposed rival. To stay in business, and certainly to maintain market share, the credit analysts at the rating agencies had to accentuate the positive.

The Prisoner's Dilemma is the obverse of Adam Smith's theory of the invisible hand, in which the free market coordinates the behavior of self-seeking individuals to the benefit of all. Each businessman "intends only his own gain," Smith wrote in "The Wealth of Nations", "and he is in this, as in many other cases, led by an invisible hand to promote [[a socially positive: normxxx]] end which was no part of his intention". But in a market environment the individual pursuit of self-interest, however rational, can give way to collective disaster. The invisible hand becomes a clenched fist.

One is reminded here of the little town in Sicily who used to have an Autumn festival each year during which everyone in the town and immediate region, as well as all visitors were treated to free wine from a giant vat in the center of the town. For a month prior to the festival, every farmer in the region was supposed to add at least a full keg of wine to the vat from his bounty. But, as one farmer supposed, "what is one keg compared to the hundreds that are poured into the vat". Surely, no one would notice if he substituted a keg of water for his measly contribution, instead of valuable wine. But on that fateful festival day, when the spigot was opened for the first flagon of wine, pure water poured out instead of wine!

In February of 2002, the Millennium Bridge was reopened. The engineers at Ove Arup had figured out how the collective behavior of pedestrians caused the bridge to sway, and installed dozens of shock absorbers— under the bridge, around its supporting piers, and at one end of it. The embarrassing debacle of its début hasn't entirely faded from memory, but there have been no further problems.

It won't be as easy to deal with the bouts of instability to which our financial system is prone. But the first step is simply to recognize that they aren't aberrations; they are the inevitable result of individuals going about their normal business in a relatively unfettered marketplace. Our system of oversight [routinely] fails to account for how sensible individual choices can add up to collective disaster [[our regulators need more training in Game Theory!: normxxx]]

Rather than blaming the pedestrians for swarming the foot way, governments need to reinforce the foundations of the structure, by installing more stabilizers. "Our system failed in basic fundamental ways," Treasury Secretary Timothy Geithner acknowledged earlier this year. "To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game."

Despite this radical statement of intent, serious doubts remain over whether the Obama Administration's proposed regulatory overhaul goes far enough in dealing with the problem of rational irrationality. Much of what the Administration has proposed is welcome. It would force issuers of mortgage securities to keep some of the bonds on their own books, and it would impose new capital requirements on any financial firm "whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed."

None of these terms have been defined explicitly, however, and it isn't clear what the new rules will mean for big hedge funds, private-equity firms, and the finance arms of industrial companies. If there is any wiggle room, excessive risk-taking and other damaging behavior will simply migrate to the [least] regulated sector. A proposed central clearinghouse for derivatives transactions is another good idea that perhaps doesn't go far enough. The clearinghouse plan applies only to "standardized" derivatives.

Firms like JPMorgan Chase and Morgan Stanley would still be allowed to trade "customized" derivatives with limited public disclosure and no central clearing mechanism. Given the creativity of the Wall Street financial engineers, it wouldn't take them long to exploit this loophole [[creating a sinkhole of such "customized" derivatives which would swallow up all other forms of derivatives. : normxxx]] The Administration has also proposed setting up a Consumer Financial Protection Agency, to guard individuals against predatory behavior on the part of banks and other financial firms, but its remit won't extend to vetting complex securities— like those notorious collateralized debt obligations— that Wall Street firms trade among themselves.

Limiting the development of those securities would "stifle innovation", the financial industry contends. But that's precisely the point. "The goal is not to have the most advanced financial system, but a financial system that is reasonably advanced but robust," Viral V. Acharya and Matthew Richardson, two economists at N.Y.U.'s Stern School of Business, wrote in a recent paper. "That's no different from what we seek in other areas of human activity. We don't use the most advanced aircraft to move millions of people around the world. We use reasonably advanced aircraft whose designs have proved to be reliable."

During the Depression, the Glass-Steagall Act was passed in order to separate the essential utility aspects of the financial system— customer deposits, check clearing, and other payment systems— from the 'casino' aspects, such as investment banking and proprietary trading. That key provision was repealed in 1999 [[and the rest essentially gutted since: normxxx]]. The Administration has shown no interest in reinstating it, which means that "too big to fail" financial supermarkets, like Bank of America and JPMorgan Chase, will continue to dominate [[and threaten: normxxx]] the financial system.

And, since the federal government has now demonstrated that it will do whatever is necessary to prevent the collapse of the largest financial firms, their top executives will have an even greater incentive to enter perilous lines of business. If things turn out well, they will receive big bonuses, and the value of their stock options will increase. If things go wrong, the taxpayer will be left to pick up [most] of the tab.

Executive pay is yet another issue that remains to be tackled in any meaningful way. Even some top bankers have conceded that current Wall Street remuneration schemes lead to excessive risk-taking. Lloyd Blankfein, the chief executive of Goldman Sachs, has suggested that traders and senior executives should receive some of their compensation in deferred payments. A few firms, including Morgan Stanley and UBS, have already introduced "clawback" schemes that allow the firm to rescind some or all of traders' bonuses if their investments turn sour.

Without direct government involvement, however, the effort to reform Wall Street compensation won't survive the next market upturn. It's another version of the Prisoner's Dilemma. Although Wall Street as a whole has an interest in controlling rampant short-termism and irresponsible risk-taking, individual unregulated firms have an incentive to hire away star traders from rivals that have introduced pay limits. The compensation reforms are bound to break down. [[It's already happening!: normxxx]] In this case, as in many others, the only way to reach a socially desirable outcome is to enforce compliance, and the only body that can do that is the government. [[As the repeated cases of tardy, belated arrests of a very few malefactors like Michael Milken, Berny Madoff, et al, prove!?!: normxxx]]

This doesn't [[cannot: normxxx]] mean that government regulators would be 'setting the pay' of individual traders and executives. It does mean that the Fed, as the agency primarily responsible for insuring financial stability, should issue a set of uniform rules for Wall Street compensation. Firms might be obliged to hold some, or all, of their traders' bonuses in escrow accounts for a period of some years, or to give executive bonuses in the form of restricted stock that doesn't vest for five or ten years. (This was similar to one of Blankfein's suggestions.)

In one encouraging sign, officials from the Fed and the Treasury are reportedly working on the details of Wall Street pay guidelines that would explicitly aim at preventing the reemergence of 'rationally irrational' behavior. "You don't want people being paid for taking too much risk, and you want to make sure that their compensation is tied to long-term performance," Geithner told the Times recently.

The Great Crunch wasn't just an indictment of Wall Street; it was a failure of economic analysis. From the late nineteen-nineties onward, the Fed stubbornly refused to recognize that speculative bubbles encourage the spread of rationally irrational behavior. Convinced that the market was a 'self-regulating' mechanism, it turned away from its traditional role, which is— in the words of a former Fed chairman, William McChesney Martin— "to take away the punch bowl just when the party gets going". A formal renunciation of the Greenspan doctrine is overdue. [[Though he has since recanted on his view that Wall Street is 'self-regulating'.: normxxx]]

The Fed has a congressional mandate to insure maximum employment and stable prices. Morgan Stanley's Stephen Roach has suggested that Congress alter that mandate to include the preservation of financial stability. The addition of a third mandate would mesh with the Obama Administration's proposal to make the Fed the primary monitor of systemic risk, and it would [[should? : normxxx]] also force the central bank's governors and staff to think more critically about the [overall] financial system and [the Fed's special responsibility and] role in [maintaining the (international) financial system and] the broader economy.

It's a pity that economists outside the Fed can't be legally obliged to acknowledge their errors. During the past few decades, much economic research has "tended to be [[incredibly narrow and largely: normxxx]] motivated by the internal logic, intellectual sunk capital and esthetic puzzles of established research programmes rather than by a powerful desire to understand how the economy works— let alone how the economy works during times of stress and financial instability," notes Willem Buiter, a professor at the London School of Economics who has also served on the Bank of England's Monetary Policy Committee. "So the economics profession was caught unprepared when the crisis struck." [[Not true! It was manfully engaged in assessing the amount of lint in its (collective) naval, and admiring the arcane mathematical tools it had invented to do so!: normxxx]]

In [helping to promote] this state of unreadiness, the role of free-market ideology cannot be ignored. Many leading economists still have a vision of the 'invisible hand' satisfying wants, equating costs with benefits, and otherwise 'harmonizing' the interests of the many. In a column that appeared in the Times in May, the Harvard economist Greg Mankiw, a former chairman of the White House Council of Economic Advisers and the author of two leading textbooks, conceded that teachers of freshman economics would now have to 'mention' some issues that were previously relegated to more advanced courses; such issues as the role of financial institutions, the dangers of leverage, and the perils of economic forecasting.

And yet "despite the enormity of recent events, the principles of economics are largely unchanged," Mankiw [[baldly: normxxx]] stated. "Students still need to learn about the gains from trade, supply and demand, the efficiency properties of market outcomes, and so on. These topics will remain the bread-and-butter of introductory courses."

Note the phrase "the efficiency properties of market outcomes". What does that refer to? Builders constructing homes for which there is no demand? Mortgage lenders foisting costly subprime loans on the cash-strapped elderly? Wall Street banks levering up their equity capital by forty to one? The global economy entering its steepest downturn since the nineteen-thirties? Of course not.

Mankiw was referring to the 'textbook' economics that he and others have been teaching for decades: the economics of Adam Smith and Milton Friedman. In the world of such utopian [sic] [academic, ivory-towered?] economics, the latest crisis of capitalism is always a blip. As memories of September, 2008, fade, many will say that the Great Crunch wasn't so bad, after all, and skip over the vast government intervention that prevented a much, much worse outcome.

Incentives for excessive risk-taking will revive, and so will the lobbying power of banks and other financial firms. "The window of opportunity for reform will not be open for long," Hyun Song Shin wrote recently. Before the political will for reform dissipates, it is essential to reckon with the financial system's fundamental design flaws. The next time the structure starts to lurch and sway, it could all fall down. [[As it could yet do so!: normxxx]]

Jobless Conditions Ominous

2009-10-03T09:28:00.000-07:00

Jobless Conditions Have Ominous 1930s Overtones

By Barrie Mckenna | 18 September 2009

If you factor in differences in how the jobless rate is calculated, current unemployment would be about 17 per cent, or a bit worse than 1930. Amid all the reminiscing about last September's financial mayhem, it's worth pointing out the obvious: A year isn't a very long time. The Great Depression didn't end in 1930. It had barely begun. [[On the other hand, the reaction of the governments and CBs of the world, especially in the US and UK, has been 180 degrees different! : normxxx]]

This summer's rebound in stocks, inspired by 'improving' [[!?! or, simply less worse?: normxxx]] economic indicators, is nice, for sure. But it's too early to relegate the crisis to the history books. And it's way too early for anniversary celebrations. It's easy to confuse the end of a recession with a full recovery.

That is particularly true in Canada, which was spared the worst of the crisis. Not so the United States. Americans have suffered a devastating financial and economic blow that will take years, not months, to heal, while the housing collapse has wiped out trillions of dollars worth of wealth. And the jobs that came with the boom are gone for a long time[[— construction and housing related— probably for good at the rates we saw during the boom!: normxxx]]

Consider the U.S. employment landscape. The jobless rate hit 9.7 per cent in August, and most economists expect it to breach the 10-per-cent mark by the end of the year, or early next year. Employers aren't done cutting jobs yet, wiping out hundreds of thousands more every month. Those may not seem like Depression numbers.

In 1930, the unemployment rate nearly doubled to 15.9 per cent from 8.7 per cent. But Daniel Albert, managing partner at New York-based Westwood Capital, has highlighted a few ominous parallels between the post-crash economies of 1930 and 2009. If you factor in differences in how the jobless rate is calculated, current unemployment would be about 17 per cent, or somewhat worse than in 1930 [[especially if you count the "off the books workers.": normxxx]]. The government now excludes vast numbers of workers who have given up looking for work, are on leave, on strike, working part-time or enrolled in job training programs. That wasn't the case in 1930.

"Suffice it to say that … we are in the same relative range right now," he argues. And then, like now, there was a hopeful rebound in stocks [[and a healthy drop in unemployment, which was almost cut in half between 1933 and 1937, once FDR started his "stimulus" programs>: normxxx]]. Mr. Albert insisted he isn't predicting a repeat of the Dirty Thirties. "The world today is, of course, vastly different than that of the 1930s," he said. That doesn't mean anyone should ignore history.

You don't have to go all the way back to the Depression to get some perspective. Economist Ed Yardeni points out that in the two most recent recessions— 2001 and 1991— unemployment went up after the slumps officially ended. It both cases, the jobless rate still had a full percentage-point of upside.

Mr. Yardeni figures that the recession probably ended in June. Based on the two earlier recessions, unemployment won't peak for another 15 to 19 months. He offered the sobering prediction that it could take as late as March, 2011, for employment to recover.

"This recovery will be much more jobless than the previous two," Mr. Yardeni argued in a recent research note. "The industries that have cut back the most— durable goods manufacturing, construction and retail— are inherently labour-intensive, and they are likely to remain in intensive care for quite a while". And it's hard to see where the momentum will come from to drive the U.S. economy once the impact of all the fiscal and monetary stimulus now being pumped into the system runs out.

"When the punch of these measures wears off, economic growth will fizzle," Mr. Yardeni said. "In other words, unlike every other recovery since the Great Depression, this one won't be self-sustaining". Does that mean the United States is headed for a double-dip, or W-shaped recession?

Not necessarily. But it could take a lot more fiscal stimulus to keep the recovery on track. The wildly successful cash-for-clunkers program has ended. An $8,000 (U.S.) tax credit for first-time home buyers is due to expire in November. And much of the federal stimulus money is already out the door. Many of these programs will need to be renewed to ensure that by next year's crash anniversary, no one is talking about the ominous parallels to the dark days of 1931 and beyond.

Germany Declares Economic War

2009-09-30T18:51:00.000-07:00

Germany Declares Economic War

By Ambrose Evans-Pritchard, Telegraph.Co.Uk | 23 September 2009

Economics Last Updated: September 23rd, 2009

If there are any German readers of this blog, I would like to know what they think of the latest breath-taking provocations of German finance minister Peer Steinbrück.

Ill-informed belligerence: Peer Steinbrück
[[All he needs is a little more hair and a small mustache.: normxxx]]

Remember that Herr Steinbrück is not a journalist, pundit, or back-bench maverick. He speaks officially for the German government and for the German nation on the international stage. Every assertion that he made about Britain in his interview with Stern is either factually wrong, or such a serious distortion of events that it amounts to a smear. Furthermore, it was quite threatening.

What he said, in effect, is that Germany will 'marshal its forces' to ensure that a chunk of the British economy is shut down— whatever the social consequences. This is the closest thing I have seen to a declaration of economic warfare in Western Europe in my lifetime. "There is clearly a lobby in London that wants to defend its competitive advantage tooth and nail."

Stern said that he sees "dark powers at work" in Britain. He accused the UK government of "doing its best" to sabotage stricter financial regulation at the G20 in Pittsburgh. This resistance will be crushed. "We WILL effectively change the rules on the financial markets. Politics is sometimes like a locomotive which comes slowly up to full speed."

"The British financial industry gains 15 per cent of the gross domestic product, in Germany it is six per cent." Britain is out of step with the rest of Europe in trying to keep this "advantage going". It must "share the burden" of the financial crisis in the form of a tax on exchanges.

"The central question is who pays the bill? It cannot be that the citizens of Europe should carry the whole cost." Britain was having "an especially hard time, to put it politely", agreeing to tougher regulation of hedge funds.

Now, I understand that this Westphalian bully is fighting an election on Sunday, and may well be forced out of government. But let me state a few points.

1. Britain is not blocking the G20 deal on bonus caps for bankers. It broadly supports the idea. It backs the push for greater transparency.

2. Hedge funds had almost nothing to do with crisis as agreed by the Turner Report and the EU's Larosiere Report. They are already well regulated by the FSA in London (unlike New York, where they are not regulated). The FSA's hedge fund code is generally viewed as a model for others.

3. UK financial services are 7.8% of GDP, not 15%.

4. German Landesbanken and mortgage lenders got into trouble on their global ventures because they tried to extract extra profit and were badly regulated by BaFin, the Bundesbank, and Mr Steinbrück himself. Their use of Irish SIVs, etc, to conduct off-balance-sheet speculation is the direct result of bad rules (Basel, etc.) drawn up after earlier crises— a perfect example of how knee-jerk regulation by ignorant populists backfires.

5. Mr Steinbrück is the arch-cover-up artist himself. He has been resisting— "tooth and nail"— a transparent stress test of the German banks. This comes despite a string of criticisms from the IMF, OECD, and European Commission. It is blindingly obvious that he has swept the problems under the rug until after the election.

6. Britain is in considerable trouble right now— entirely of our own making, and caused by a decade of inept government, fiscal incontinence, and excess debt. Is that a moment to kick us in the teeth? One reason why the budget deficit has exploded to 13% of GDP is that the collapse of City profits has cut a huge hole in government revenues. There is already a brutal adjustment underway. What is the benefit of further contracting credit in the middle of severe downturn. The man is mad.

7. In terms of morality, I don't see much to choose between Germany's car industry (with its stress on high-powered engines that consume scarce resources, and pollute) and the 'City' of London. They are both core national industries, pillars of our respective economies.

8. Angela Merkel shares the British view that "binding powers" for the EU's new trio of super-regulators is a step too far, and a breach of Germany's constitution.

If a British Chancellor gave an interview on behalf of the British nation saying the German car industry should be shrunk massively, it would be viewed as a gross and gratuitous attack on Germany.

Need I add, yet again, that the banks did not cause this global crisis. Governments around the world caused the crisis by forcing down the price of credit (Greenspan, Bank of Japan, and ECB on short rates: China et al on long rates, by flooding the global bond market) far too low for many years, encouraging debt. Banks were the instruments, not the cause. That is an elementary point that many people— including Mr Steinbrück, obviously— still fail to understand.

The Westphalian bully likes taunting Britain. He made waves earlier this year mocking the "crass Keynesianism" of Gordon Brown at the most dangerous moment of the crisis. This prompted a formal protest by the British ambassdor in Berlin.

Mr Steinbrück subsequently engaged in a great deal of crass Keynesianism himself, as well as outright protectionism through the Deutschland Fund. [[A clear violation of EU rules!: normxxx]] If he remains in office, he will soon have to deal with the second leg of the German banking crisis that he has so artfully dodged until now. We must resist Schadenfreude when that moment comes.

.

German State To Lend Directly As 'Second Credit Crunch' Looms

By Ambrose Evans-Pritchard | 26 August 2009

Germany could directly intervene in the credit insurance and lending markets as soon as September, 2009 to head off a looming credit crunch, as it fears the economic recovery may soon falter as banks refuse to roll over loans. Tough action for tough times: the German government will be 'proactive' in heading off another credit crisis.

The finance minister, Peer Steinbrück, said broad sectors of the German economy are in trouble even if the country has avoided a full-blown lending crisis so far. "Conditions have become much tougher for some industries— electrical engineering, machine tools, suppliers, chemicals and shipbuilding. We have clear evidence from both small and large companies that lending is jammed. "The banks are not stepping up to their responsibility to provide credit," he told the German paper Handelsblatt.

"Some indicators have performed better, but… it is too early to say we have shaken off this crisis. There is still lots of risk and uncertainty, and no grounds for complacency. The fact that GDP proved better in the second quarter with 0.3% growth is somewhat reassuring, but let's not forget the economy has shrunk 7% from a year before."

Mr Steinbrück has now backed away from talk of forcing banks to lend, recognising they have to rebuild their capital, and shifted the focus to direct lending by the state. Among likely measures are use of the state-bank KFW to make "global loans" to industry on terms that pass on the full benefit of lower interest rates, as well state aid for credit insurance and trade finance. He said the bank rescue fund SoFFin still had €60bn left for support.

While some measures have been discussed before, there appears to be a new urgency. Decisions may be made by "early September". The comments are hard to reconcile with the a record surge in the IFO business confidence index, which jumped for a fifth month to 90.5 in August. Market sentiment is racing ahead of hard economic data.

Axel Weber, the Bundesbank chief and until recently the arch-hawk, last week spoke of a 'second wave' of the credit crisis as home-grown problems come to light, triggered by ratings downgrades that force banks to put aside more capital. "The first round of disruption in the bank balance sheets from structured credit products is behind us. Now we are threatened by stress from our domestic credit industry," he said.

"They are in panic," said Hans Redeker, currency chief at BNP Paribas. "They know the money supply and credit figures coming out are going to be awful". He added that Germany's stimulus measures have put off deep problems until after the election in September. The 'car scrappage scheme' has brought forward demand, implying a cliff-edge drop when the scheme expires. Kurzarbeit (short work) schemes that subsidise companies to keep idle workers on their books are slowly bleeding corporate balance sheets. "This has delayed the restructuring that needs to occur," he said.

Mr Steinbrück said markets are awash with liquidity again, but little is going into the real economy. "The banks evidently prefer to put their money into securities rather then granting new loans because they can get a higher return. After two years of financial crisis the gambler mentality is gaining the upper hand again."

The German authorities are deeply frustrated that so few banks have resorted to the 'rescue' scheme to rebuild their capital base. Critics say the Bundestag imposed such stringent conditions that lenders have opted instead to rein in lending. Mr Steinbrück said 'state lenders' pose a "systemic risk" to German finance. Few of the regional banks have a "viable" business model.

[[Sounds like a new new call for nationalizing (or, semi-nationalizing?) the banks! : normxxx]]

The Mortgage Machine Backfires

2009-09-30T12:26:00.000-07:00

The Mortgage Machine Backfires

By Gretchen Morgenson | 26 September 2009

With the mortgage bust approaching Year Three, it is increasingly up to the nation's courts to examine the dubious practices that 'guided' the mania. A ruling that the Kansas Supreme Court issued last month has done precisely that. It has significant implications for both the mortgage industry and troubled borrowers.

The opinion spotlights a crucial but obscure cog in the nation's lending machinery: a privately owned loan tracking service known as the Mortgage Electronic Registration System (aka, MERS). This registry, created in 1997 to improve 'profits and efficiency' among lenders, 'eliminates' the need to record changes in property ownership in local land records[!?!] Dotting i's and crossing t's can be a costly bore, of course. And eliminating the need to record mortgage assignments locally helped keep the lending machine humming at hyperspeed during the boom.

But the MERS system also led to confusion. When MERS was involved, borrowers who hoped to work out their loans couldn't identify who they should turn to. And now, however, this 'clever' setup (for those 'clever' mortgage asset packagers) is coming under fire. Legal experts say the fact that the most recent assault comes out of Kansas, a state not known for radical jurists, makes the ruling even more meaningful.

Here's some background: For centuries, when a property changed hands, the transaction was submitted to county clerks who recorded it and filed it away. These records ensured that the history of a property's ownership was complete [[and 'freely' (notwithstanding minor administrative fees) and readily available to all: normxxx]] and that the priority of multiple liens placed on the property— a mortgage and a home equity loan, for example— was accurate. During the mortgage lending spree, however, home loans changed hands constantly [[and rapidly: normxxx]]. Those that ended up packaged inside of mortgage pools, for instance, were often involved in a dizzying series of transactions.

To avoid the costs and complexity of tracking all these exchanges, Fannie Mae, Freddie Mac and the mortgage industry set up MERS to record loan assignments electronically. This company didn't own the mortgages it registered, but it was listed in public records either as a nominee for the actual owner of the note or as the original mortgage holder. Cost savings to members who joined the registry were meaningful. In 2007, the organization calculated that it had saved the industry $1 billion during the previous decade. Some 60 million loans are registered in the name of MERS.

As long as real estate prices rose, this system ran smoothly. When that trajectory stopped, however, foreclosures brought against delinquent borrowers began flooding the nation's courts. MERS filed many of them.

"MERS is basically an electronic phone book for mortgages," said Kevin Byers, an expert on mortgage securities and a principal at Parkside Associates, a consulting firm in Atlanta. "To call this electronic registry a creditor in foreclosure and bankruptcy actions is legal pretzel logic, nothing more than an artifice constructed to save time, money and paperwork". As cases filed by MERS grew, lawyers representing troubled borrowers began questioning how an electronic registry with no ownership claims had the right to evict people.

April Charney, a consumer lawyer at Jacksonville Area Legal Aid in Florida, was among the first to argue that MERS, which didn't own the note or the mortgage, could not move against a borrower. Initially, judges rejected those arguments and allowed MERS foreclosures to proceed. Recently, however, MERS has begun losing some cases, and the Kansas ruling is a pivotal loss, experts say. While the matter before the Kansas Supreme Court didn't involve an action that MERS took against a borrower, the registry's legal standing is still central to the ruling.

The case involved a borrower named Boyd A. Kesler, who had taken out two mortgages from two different lenders on a property in Ford County, Kan. The first mortgage, for $50,000, was underwritten in 2004 by Landmark National Bank; the second, for $93,100, was issued by the Millennia Mortgage Corporation in 2005, but registered in MERS's name. It seems to have been transferred to Sovereign Bank, but Ford County records show no such assignment.

In April 2006, Mr. Kesler filed for bankruptcy. That July, Landmark National Bank foreclosed. It did not notify either MERS or Sovereign of the proceedings, and in October, the court overseeing the matter ordered the property sold. It fetched $87,000 and Landmark received what it was owed. Mr. Kesler kept the rest; Sovereign received nothing.

Days later, Sovereign asked the court to rescind the sale, arguing that it had an interest in the property and should have received some of the proceeds. It told the court that it hadn't been alerted to the deal because its nominee, MERS, wasn't named in the proceedings. The court was unsympathetic. In January 2007, it found that Sovereign's failure to register its interest with the county clerk barred it from asserting rights to the mortgage after the judgment had been entered.

The court also said that even though MERS was named as mortgagee on the second loan, it didn't have an interest in the underlying property. By letting the sale stand and by rejecting Sovereign's argument, the lower court, in essence, rejected MERS's business model. Although the Kansas court's ruling applies only to cases in its jurisdiction, foreclosure experts said it could encourage judges elsewhere to question MERS's standing in their cases.

"It's as if there is this massive edifice of pretense with respect to how mortgage loans have been recorded all across the country and that edifice is creaking and groaning," said Christopher L. Peterson, a law professor at the University of Utah. "If courts are willing to say MERS doesn't have any ownership interest in mortgage loans, that may eventually call into question the priority of liens recorded in MERS's name, and there are millions and millions of them". In other words, banks holding second mortgages could find themselves in the same pair of unlucky shoes that Sovereign found itself wearing in Kansas.

Asked about the ruling, Karmela Lejarde, a spokeswoman for MERS, contested the court's reasoning. "We believe the Kansas Supreme Court used an erroneous standard of review; this is not the end of the judicial process," she said. "The mortgages on which MERS is the mortgagee will remain binding contracts."

But Patrick A. Randolph, a law professor at the University of Missouri, Kansas City, who describes himself as "a friend of MERS", described the recent decision as unsettling. "This opinion is hostile to the notion of MERS as nominee and could lead to problems for it in foreclosing," he said. "The entire structure of MERS as a recorded nominee could collapse in Kansas, and that could lead to a patch-up job where they would have to run around and re-record the mortgages."

If so, MERS would be hoisted on its own petard. And it would be a rare case of poetic justice in this long-running mortgage mess. [[Well, maybe not so poetic, as the eventual 'stuckees' for those mortgages will actually be the buyers of most of those ABSs— pension funds, retirement funds, insurance companies, municipalities, private individuals— even foreign cities.: normxxx]]