Vigilant Investor

We’ll, we’ve talked about it for years here on Vigilant Investor.   Your chief editor here has referred to it in annual reports to clients in his private consulting practice:  When honestly looked at the U.S. fiscal situation implies inevitable, long-term insolvency.

I don’t come to this conclusion lightly, although I’m reminded of it by reading that President Bush has signed the bill allowing for the Freddie and Fannie bailout to go forward, which includes the debt ceiling being raised to $10.62 trillion.  Yes, with a T.

Now, we’ve pointed out the sleight of hand that goes on with reporting deficits in the United States. This leads most of the sheep to accept at face value that the official federal deficit hovers around $200-300 billion each year.  Granted, that’s no song, but the reality is far higher when you actually account for all the obligations decades of Congressional profligacy has chained to the U.S. taxpayers’ backs.

The whole number is over $54 trillion - some $175,000 per living person in the United States — once you actually stop with the facade that the obligations of Social Security, Medicare and Medicaid are somehow not worthy of being included on the balance sheet.  Broken down to a net present value of future obligations figure, we’re talking an annual deficit number closer to $4.6 trillion, a gargantuan figure that keeps building each year politicians pretend it really does not  exist because doing so will only scare the electorate.  That’s because fixing the problem will require draconian cuts and tax increases; although tax increases of the levels required to make a difference won’t work since they’ll only strangle what little economic growth is going on at the moment, further reducing revenues.

But, alas!  When it comes to politicians, they do have another “out” that can maybe work for another election or two: inflation!  By inflation, I don’t mean rising prices, but rather the cause of the rising prices: increasing money supply.    This is the easiest way for politicians to pay down the promises they and their predecessors have made, and in case you have not yet noticed, it’s been coming to a gas pump and grocery check out near you for a number of years now.  Heck, when you can print money and your official department of statistics filled with lackeys looking to keep the guys controlling their salaries happy, we’ll…  This might explain why Social Security recipients received an unconscionable 2.7% raise for their 2008 payments when the price of eggs, milk, and flour are climbing at well over 10 times that pace!

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We’ve monitored David Morgan for years. He’s been as right about the economic situation as we’ve been since our start in April 2005. Give it a watch.

This is too ripe. From the Financial Times:

ECB voices ‘high concern’ over liquidity scheme
By Paul J Davies and Norma Cohen in London and Anousha Sakoui in Vienna
Thursday May 15 2008 17:45

The European Central Bank on Thursday voiced its “high concern” at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged.

Yves Mersch, a governing council member, said the ECB was now “looking very hard at whether there is not a specific deterioration of collateral” which the central bank is accepting in return for funds.

He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for treasuries at the European Central Bank.

Who are these people trying to kid? The very essence of all the emergency action at CBs, including the Federal Reserve, has been to provide a way for banks (and now others) getting sucked under by toxic assets backed by plummeting collateral to find cash to bail themselves out. The Fed has entirely rewritten the rules, including going outside of the banking community by rescuing Investment Brokerage Firms. At one time the Fed required AAA Treasuries as collateral, but now it will swap those AAA Treasuries from its reserves and accept in its place those tens of billions in mortgage backed toxic waste that has no marketplace. And CBs claim to be caught off guard? What a joke!

“The Federal Reserve as other central banks is obviously taking onto its balance sheet a lot of mortgages these days.” “Well, the creators of the Federal Reserve system would be rolling over in their graves if they knew the Federal Reserve is buying mortgages.”
– Former Federal Reserve Chariman Paul Volcker

Whether or not the creators of the Fed would be rolling over in their graves is debatable in our opinion. Like Andrew Jackson — we believe central bankers have always been dangerous, incompetent meddlers. We feel the Fed should never have been created — and and that it continues to prove itself as bungling as any other central planning committee. But we digress…. That said, the former chairman’s grave concern over the central bank taking on billions of not so hot private debt is quite valid.

Volcker went on to warn that recent intervention by the Fed in securities markets might compromise it’s independence. He went on to say that the Fed’s inability to contain inflation will create a 1970’s like scenario. Again, he’s right there. We’ll also add, it’s too late Paul — the nationalization of the US private debt has begun. When politicians, who’s outlook is only as far as the next election — get involved, the trend will only accelerate. So to will corresponding inflation and Dollar degradation.

Beyond the blatant example of the Fed’s $30 Billion bailout of Bear Stearns — we now see Senator Christopher Dodd proposing the creation of an FHA program to insure refinanced mortgages following partial forgiveness of the loans by lenders. OK, let’s think about this. In an environment where U.S. foreclosures have risen 65% over the past year — and private banks/lenders are preferring to seize homes rather than renegotiate with already defaulting borrowers — the Federal Government is going to step in with money it does not have (but will be all to happy to print) — to back already bad debt.

Also, earlier this month, the Fed agreed to accept securities backed by student loans pledged as collateral for Treasuries the central bank would in turn lend to Wall Street Investment Banks. Let’s analyze that deal. Investors had become far less willing to finance student loan debt at pre-existing prices — due to liquidity issues, the economy, and the fact that consumers (including students) are hurting — and are therefore higher credit risks. The cost to finance such loans would have to naturally go up. Wall Street investment banks (you know, the ones who paid themselves billions in record bonuses over the past year) were less willing to hold onto securities they owned backed by this type of debt. However, if they tried to sell it — they would sell it for a loss. No worry, the Fed would lend/swap them Treasuries for the riskier (and worth far less) student loan backed securities.

Effectively, you have the government, or quasi government institutions backing substandard debt with money it will have to print. That spells one thing — accelerating inflation — and the always accompanying confiscation of private savings. And we’re not talking the low single digit inflation figure the government “calculates” (and bases Social Security payment increases on). We’re talking about the inflation you see in the supermarket ($4 for a handful of blueberries anybody?) — and at the gas pump.

When we hear the Treasury Secretary, or the Chairman of the Fed talk tough on inflation and defending the Dollar — we just smile. When we hear political candidates blaming oil companies and “speculators” for rising prices — we smile again.

We think the next 3-5 years will be quite interesting.

Its always a small sidebar in these type of crisis: the banks too small for the big guys to care.  Rather than being bailed out, they simply are absorbed at pennies on the dollar by the big boys whose hands are firmly in the till of the Fed.

Only three banks have failed year to date, but the third — ANB Financial, which controlled $2.1 billion in assets with $1.8 in deposits — much of it demand deposits like your checking account — is no small fry.  Expect more as the recession really takes hold and payments hit the skids on the extreme overhang caused by massive easy-credit-caused dislocations.  Seems the Feds expect more, as well:

“FDIC is planning to beef up its staff, including temporarily hiring up to 25 retired FDIC employees who worked in the agency’s more than 200-person division that handles failed banks. They will handle an anticipated increase in bank failures.”

Obviously the failure of Bear Stearns would have triggered cascading defaults given so many players were writing credit default swaps on securities that did not even exist, thus adding multiples to Bear’s actual debt market value — at least in terms of liabilities to those who were insuring the risk.   You can imagine 12 months ago those writing these derivatives never would have dreamed Bear Stearns could go under, and you can be sure there premiums were well under priced vs. the risk, yet still considered easy money.  Think there’s any coincidence that JP Morgan had been writing upwards of 45% of all credit default swaps in the market place and the fact that the Fed enabled them to keep Bear’s head above water? Imagine the liabilities that would have sucked JP Morgan down with the ship.

Again, some banks are small enough to fail.  Tough luck. Others?  Let the shell game continue.

You have to love Alan Greenspan.  Today he’s quoted as having declared the worst over for the credit crisis during a speech in New York.  Yet, at the same time he still thinks housing has a long way to go down, and will not be hitting bottom by year end.  Well, which one is it going to be, Sir Alan?   Given the implications of the latter, it certainly can’t be both!  Perhaps that’s why Mr. Greenspan is requesting the press not cover his speech comments?

Longtime readers of VI know where we stand on the issue, but as of late your writers have been busy in our full time consulting business — the economy unfolding much as we predicted to many people we’ve talked to over the years has brought much interest as you can imagine.  That aside, though, updates like this one will continue as our schedules allow.

Currently we’re taking the approach that we’re now amid a sort of eye of the hurricane situation, with one glaring exception.   The eye of the storm is welcome to those enduring the prior chaos, but even though it might appear that the worst is past, there are still plenty of signs that all is not normal.   Usually the eye represents the half-way point for a hurricane, but in our economic case, our estimation is that we are fortunate to be about 1/3 of the way through.  Just consider the signs:

• Oil Record Smashed: $126 Barrel
• Citigroup Plans to `Wind Down’ About $400 Billion of Bank Assets
• Citigroup Leads Wall Street Drive to Punish Taxpayers in Auction-Rate Debt
• UBS’s Exit Strikes at Heart of Municipal-Bond Market
• UBS Set to Cut 5,500 Jobs After First-Quarter Loss
• Swiss Re First-Quarter Profit Falls on Writedown
• Legg Mason hit by first loss in 25 years
• Bad Investments and a $7.8 Billion Loss at A.I.G.
• Commodities Aren’t in a Bubble, Demand Key Factor, Economists Say
• Mortgage crisis seeps to prime loans
• D.R. Horton swings to $1.3 billion loss
• Property Mogul Poised to Take a Second Fall
• Americans unload prized belongings to make ends meet
• Credit crunch to claim 40,000 financial jobs
• Bankruptcies and defaults gather pace
• GE to stop financing boat, motor home purchases
• Doubts Raised on Big Backers of Mortgages
• Home lender ResCap facing cash crunch
• Economic Troubles Affect the Vegas Strip
• Tight Credit Worries for a Hotel and Mall Operator
• Tropicana casino group files for bankruptcy
• Las Vegas used to be a recession-proof oasis. Not anymore
• Key facts about U.S. April auto sales
• Auto dealers face tough road for second-quarter sales

Does this sound like a real “all clear” signal to you?  We’ve been hearing the calls of “the bottom” since the implosion hit last summer with Bear Stearns at the epicenter.  These calls keep coming from the people who failed to see any of this mess arriving, and are the same ones who’ve continually misdiagnosed problems since then.

Don’t count on these same rascals to correctly call anything, especially Honest Al Greenspan who is doing whatever he can to salvage his eroding reputation as the man who tamed inflation and the business cycle.  In reality, he merely compounded the distortions on both ends.

Recessions are like earthquakes — better to have the pressure relieved in many smaller releases.  In the real world, you rarely feel earthquakes since most are so mild.   Consider that the natural business cycle, where you have normal ups and downs. Only problem is the meddling policy maker find those not politically tenable while the banker finds their restraint terribly inconvenient, so in cahoots they inflate and create boom / bust cycles. Everyone loves the highs these injections give the economic addict, but nobody likes the abyss of withdrawal. And the abyss is deep.

Instead, Fed policy under Greenspan and now Bernanke is all about holding off any release of tension as long as possible.  In an attempt to sustain the unsustainable (overly inflated asset prices backing the entire Wall Street system) they’ll go back to the old inflationary tricks and rewrite the rules for the Fed without any Congressional authority.   The tension only compounds, and eventually the release will be much uglier thanks to their meddling.

We expect serious consumer pull back as more jobs are hacked in the face of tight credit. We also expect stagflation — the Fed, its Wall Street backers, and the Dependent politicians in D.C. will do what they can to punt this problem into some future administration’s lap. Problem is, they appear to have finally run out of rope.

Hence, as the eye of the storm passes, get ready for the worst 2/3′rds of it.

Stay Vigilant!

“I think we were really on the verge of a financial collapse of unbelievable proportions that we haven’t seen since the 1930’s.”
– Former U.S. Treasury Secretary Paul O’Neill describing the Bear Stearns bailout in an April 16, 2008 interview on Bloomberg

Read that quote again by Paul O’Neill – because, yep folks, that’s really where things stand. Our financial system effectively patched together by an inflationary, money printing band-aid. And, as the real estate markets in England, along with those in Spain, Ireland, et al. continue to melt down, we maintain our belief that the whole fiasco is far from over. (Our regular readers know we said the same when conventional pundits said the worst was over in 2007).

The interesting thing about economics is that people have been conditioned to believe in the charade that it is a mysterious, complex, science – and to be successful at understanding it, explaining it to the great unwashed, and at running large portfolios – one must be a superior mathematician educated at the most prestigious of universities. As we watch the same geniuses educated at said universities – some of whom had supposedly developed mathematical models which had eradicated risk – continue to drive hedge funds (and at least one major Wall Street brokerage firm) valued in the $ billions straight over the cliff – we say – “oh really?”

We instead choose to take Harry Truman’s quote — “There is nothing new in the world but the history you do not know” – to heart when we look at economics. History is in fact the study of human behavior – of what has worked, and what has failed. To ignore historical facts one must be either arrogant, a fool – or an arrogant fool. So, as Sir Alan Greenspan and his knights at the Fed Round Table repeatedly cut rates earlier this decade – we warned that the unfolding scenario looked a whole lot like Japan in the 1980’s and 90’s! A Stock market bubble, followed by a stock market crash – and subsequent economic pain. Then came massive interest rate cuts to supposedly “stimulate” – which instead caused a real estate bubble – followed by a real estate collapse, and a severe, prolonged recession.

Sound familiar?

What next? We see the bailouts continuing — simply because the alternative is the severe and necessary corrective pain to clean out the mess and get prices of all things back in line. And what politician, Wall Street banker, investor, or voter wants to deal with that reality? And bailouts spell inflation. Not the fudged low-ball inflation that’s used to calculate Social Security payment increases or “official” economic growth. We’re talking about real inflation. The rapidly rising kind you are seeing at the supermarket and the gas pump on a daily basis. As these inflationary bailouts continue – look for prices of all things tangible to increase dramatically.

Commodities bubble? We think not – because bubbles require excessive stockpiles/inventory/supply – and we don’t see that at all – in anything. And we see inflationary (money printing/bailout) policies accelerating.

Oil at $125 in the near future anyone? $5 Dollar gas at the end of the year? Food prices continuing through the roof? It would not surprise us at all.

Regulators “are playing with fire,” said Allan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh. “With good luck, none of these liabilities will come due. We can’t expect that good luck, and we haven’t had it.”
– Bloomberg (March 26, 2008)

The reason you want solid collateral to secure a loan is obvious. You want to protect adequately against the borrower’s potential inability to pay you the loan back. How interesting that the Fed is taking 30 $ Billion of illiquid mortgage securities as collateral from otherwise insolvent Bear Stearns to bail the Wall Street firm out. As intriguing (alarming) — is the Treasury’s encouragement of Fannie Mae and Freddie Mac to buy more mortgage-backed bonds.

We ask — who in their right mind would lend out their own money backed by such risky collateral? Who today would buy mortgage backed bonds with their own money?

Ah, there lies the rub! It’s not their money which backs these shenanigans – it yours!

We’ve continually warned about the bailout addicted U.S. Another voice of clarity and reason all along has been Bill Fleckenstein. As usual, he nails it in his latest commentary, “Catering to the Bailout Nation.” BTW, Bill’s recently released book Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve – is definitely worth a read! We wonder — has anyone ever been un-knighted? Can they do that?

Any reasonable person knows that bailouts beget more (and larger) bailouts. Like a drunk having another drink, it’s just going to make the hangover (and resulting inflation) even worse.

Also, ask yourself this one – why are big Wall Street banks getting bailed out (with taxpayer money) – when the 5 largest recently paid themselves 39 $Billion in bonuses?

Think long and hard about the answer to that one – because you are paying for it – in overt taxes, and the great hidden tax – accelerating real inflation.

With today’s 75 basis point rate cut – we see continued evidence as to whom the Fed really serves. As we have long said, it’s not you and I – it’s the Big Wall Street Banks. The “Big Rip-Off” of your savings continues. Jon Markman gets right down to it…

A list of articles worth perusing to grasp the depth of our problems:

• Fed takes boldest action since the Depression to rescue US mortgage industry
• Fears That Bear Stearns’s Downfall May Spread
• Another Source of Quick Cash Dries Up
• Jim Rogers Says Fed Support of Bear Stearns `Outrageous’: Video
• U.S. 3-month bill yield seen lowest in 50 years
• Gold hits $1,010 on flight from paper currencies
• Foreign investors veto Fed rescue
• Wall Street asks who will follow Bear Stearns
• Bear Stearns takeover sparks fresh financials rout
• Dollar Doomsayers Draw Signs From Bernanke Rate Cuts
• Fed Takes New Steps to Ease Crisis:Cuts Lending Rate to Financial Institutions to 3.25 Percent
• Wall Street waits for the next domino to fall
• Luxuries are cheap, necessities are expensive
• Debt Reckoning: U.S. Receives a Margin Call
• U.S. Fed Cuts Discount Rate, Says Securities Firms May Borrow
• Houses are left behind to pay car, credit bills
• CDS sector weighs Bear Stearns backlash

Seems like Sir Al can’t try hard enough to absolve himself from the monster he created with the tools available via The Creature From Jekyll Island. Here are our thoughts on Honest Al’s latest comments.

We will never have a perfect model of risk
(By Alan ‘Master of obvious” Greenspan)

The current financial crisis in the US is likely to be judged in retrospect as the most wrenching since the end of the second world war. It will end eventually when home prices stabilise and with them the value of equity in homes supporting troubled mortgage securities.

Since World War II? Try since the Great Depression. This situation is as if 1930 met 1973 and used a fertility clinic to produce sextuplets.

Home price stabilisation will restore much-needed clarity to the marketplace because losses will be realised rather than prospective.

It will, however, not restore clarity to Sir Al’s amorphous use of the English language to convey something without really saying anything. Look, the pricing mechanism has been so badly distorted — and not just in housing — it’ll take a substantial cleansing to restore any sense of rational order. The Fed’s meddling will do nothing but continue to subsidize the fantasy that is “price” across many asset classes, housing included. Al should know this.

The major source of contagion will be removed.

How so? By propping up prices artificially as is being done as we speak?

Financial institutions will then recapitalise or go out of business.

With whose wealth? With wealth confiscated from dollar holders via every more inflationary credit expansion!

Trust in the solvency of remaining counterparties will be gradually restored and issuance of loans and securities will slowly return to normal. Although inventories of vacant single-family homes - those belonging to builders and investors - have recently peaked, until liquidation of these inventories proceeds in earnest, the level at which home prices will stabilise remains problematic.

Trust may be restored, but that’s badly placed trust if it is through yet another bailout. As for home prices, any price stabilization that comes from bailout is merely fantasy stabilization. With the Fed fixing the price of money, we’ll — expect as many dislocations as you would from some arbitrary panel fixing the price of Corn, gas, or anything else. But this is at the heart of the central planning meddlers in the Fed and Treasury (and their many supporters), who trust price fixing well ahead of free market allocation of scarce resources, some out of misguided economic beliefs, but as many if not more out of being directly enriched by being able to tap into the Fed printing press and create massive personal profits form the privileged.

The American housing bubble peaked in early 2006, followed by an abrupt and rapid retreat over the past two years. Since summer 2006, hundreds of thousands of homeowners, many forced by foreclosure, have moved out of single-family homes into rental housing, creating an excess of approximately 600,000 vacant, largely investor-owned single-family units for sale. Homebuilders caught by the market’s rapid contraction have involuntarily added an additional 200,000 newly built homes to the “empty-house-for-sale” market.

Uhh… Al? How nice of you to comment from the sidelines as if you weren’t the head cheerleader behind this mess? Homeowners were lured in by none other than You, pal. You told everyone that housing was not in a bubble, and denied being able to rationally indentify one even if it was beating you over the head with a lead pipe. You were the one that suggested ARMs were a good way for consumers to go. You were the one encouraging everyone to help the economy by borrowing and consuming more and more.

Home prices have been receding rapidly under the weight of this inventory overhang.

Created by the artificial oversupply of easy mortgage credit, created by YOUR POLICIES!

Single-family housing starts have declined by 60 per cent since early 2006, but have only recently fallen below single-family home demand.

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Well… Hedge funds were supposed to be the super geniuses for the mega rich… and then downward they trickled to the filthy rich, and then the super rich, and eventually the rich, the neveau riche and the Me-Tooue Riche.  Well, we said last summer when Bear Stearns blew up that none of these super geniuses were getting it, and we’ve been saying that before and since. Just read our archives and don’t buy that “nobody saw it coming” rubbish because that’s a half-assed excuse for neglect, hubris, vast volumes of conceit (at those pointing out this inevitability) and downright greed. So here we are.

At what point the conventional wisdom shifts in this country to comprehend how severe the U.S. and Global economic situation is is unknown to us. Until then, read the cards: You can weep, or you can play ‘em right. Your Choice.

In the meantime, all those who jollied around using the contemptuous term “tin foil hat wearing crowd” when describing publications like ours… Well, we hope you’ve not gone and just lost your shirt. Good luck at exiting your trades.

As for their victims… So very sorry… You could have listened.  Will you learn?

Think. Don’t Sink.

• Hedge funds stem exits as credit lines tighten - Reuters (03/06/2008 12:28 PM)
• Deleveraging’s Vicious Spiral Picks Up Speed - WSJ ($) (03/06/2008 05:17 AM)
• Carlyle Fund Gets Default Notice After Margin Calls - Bloomberg (03/06/2008 07:50 AM)
• Carlyle Capital Receives Additional Default Notices - WSJ ($) (03/07/2008 04:50 AM)
• Carlyle Capital Suspended; Lenders Force Asset Sales - Bloomberg (03/07/2008 04:32 AM)
• Hedge Funds Frozen Shut - Business Week (03/06/2008 05:21 AM)
• Hedge Funds Lock the Gates - NY Times (03/06/2008 07:55 AM)
• Hunter among hedge funds is now the hunted - FT ($) (03/05/2008 02:33 PM)
• Collateral Call Goes Unanswered - WSJ ($) (03/07/2008 06:04 AM)
• Hedge Funds Squeezed As Lenders Get Tougher - WSJ ($) (03/07/2008 04:46 AM)
• Peloton ABS Fund Investors May Get Nothing Back - Bloomberg (03/05/2008 04:33 PM)
• Switzerland’s Focus Capital Likely To Liquidate Fund After Losses - FinAlternatives (03/04/2008 11:52AM)
• Hedge Funds’ Fire Sales Send Muni-Bond Yields To Historic High Levels - WSJ ($) (03/01/2008 05:44 AM)

We’ve been exceptionally busy with our real careers (that don’t involve writing) which you can imagine is keeping us from doing as much writing given what’s transpiring in the economy and markets as we speak.

What?  You haven’t heard?   Well, here’s a list.  And for those of you looking for answers, please just leaf back through the past few months of our writing and you’ll have a good idea of not only what, but why this is happening — as well as some serious insight about vigilant thinking for your future.  If you can’t take the time to investigate, well… You have only one other choice!

That said, here’s our list of current crisis points, victims, et. al. with some occasional commentary:

U.S. Unexpectedly Lost 63,000 Jobs in February - Bloomberg (03/07/2008 07:45 AM)

This should come as no surprise to anyone.   The job numbers, while rigged to carry momentum on the upside long after prior real job growth dissipates, eventually fall under the weight of the prevailing trend.  Our trend is hardly filled with light winds:  housing, the primary driving sector of the pre bubble break economy, has been jettisoning jobs faster than a drug runner dumps his stash when pursued by the Feds.  Those figures have simply not been getting a real voice, while at the same time the essence of the unemployment stat is also somewhat fictitious.  What do you call someone of able body and mind who does not have a job?  Well, if he’s not looking for work, he’s not unemployed — he’s “discouraged.”  Real unemployment by the standards used back when stats were less fiddled with (e.g. during the depression when unemployment was 25%) is closer to 13%.  Expect that to worsen.

• Texas gasoline prices reach record highs - Houston Chronicle (03/07/2008 08:47 AM)
• U.S. home foreclosures hit record high - Reuters (03/06/2008 10:00 AM)
• U.S. Mortgage Foreclosures Rise as Owners `Give Up’ - Bloomberg (03/06/2008 02:38 PM)
• U.S. Household Worth Fell for First Time Since 2002 - Bloomberg (03/06/2008 03:50 PM)
• Defaults soar on auto loans in pattern likened to mortgage crisis - Boston Globe (03/07/2008 06:01 AM)
• Consumer Confidence at Lowest Since 2002 - AP (03/07/2008 04:40 AM)

Consumers can only go on for so long before they buckle.   That’s a problem when you’re economic policy is built on the foundation of sand that is consumption rather than savings.   So many other shoes are readying to drop. Look out. Be careful.

This is a nice video of Jim Rogers in unflattering terms describing the current official efforts to fix the price of money and other commodities. As for Bernanke? Hehehe.