Vigilant Investor

We’ve been quite busy the past few days, so here’s a quick summary with links of articles with more details.

The Fed and the world’s central banks are now well aware they’ve got a global credit crisis on their hands that is far nastier than they expected.  So to work they go!

In the U.S. we are seeing what the authorities have in mind with their $700 billion package, which is the first of many to come — never mind the assurances that this is all it’ll take.  It looks like we’ll be seeing a great deal of nationalization in banking.  Paulson, no doubt, appears ready to use the full authority granted him as U.S. Treasury Secretary.   We worry about the blank check Congress has just obligated taxpayers and dollar holders to.  As we noted in a post a few days ago, the Monetary Base suggests the flood of freshly minted cash is to be hitting our shores soon.

• Fed, ECB, Central Banks Cut Rates in Coordinated Move
• White House considers ownership stakes in banks
• Fed eyes plan to fund short-term business loans
• Fed Considers Plan to Buy Companies’ Unsecured Debt
• More Treasury Bonds on Way to Ease Crisis
• Paulson Says U.S. to Use All `Authorities’ in Crisis

In the U.K. things have gone from bad to worse.   Socialization has even less of a stigma in Europe, so as in the U.K. you’ve got all sorts of intervention falling in line to bail out the banking system.  Meanwhile, Iceland is in such bad shape, it appears the small nation could be hit with insolvency fairly soon.

• Darling unveils bank rescue
• U.K. Banks Get Unprecedented Government Bailout; Stocks Fall
• In Flailing Iceland, Disbelief and Regret
• Icelandic Regulator Takes Control of Kaupthing Bank
• Barclays, RBS in Talks on U.K. Government Funding
• Russia Lends Iceland 4 Billion Euros to Save Banks
• Belgium, Luxembourg scramble to sell Fortis

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Funny as this cartoon is, the implications of an angry victim of inflation are quite serious!

As we’ve said for a long while, to date we’ve only experienced the outer wisps of the big storm that’s coming ashore.  You know, what meteorologists call “squall lines” that stretch out from a hurricane’s thicker clouds and eye.  Hours before the bulk of the storm hits, those in a hurricane’s way are treated to series of heavy rain squalls and then breaks of sun.  Eventually, those end and you’re in the storm for real.

That’s where we are right now.  Stated another way, the problems we’ve had so far have been just mere appetizers for the main course, and more than a few who’ve pooh-poohed this whole problem so far for not such a big deal will be eating crow.

Here are a few items that tell us we’re getting close to a serious capitulation point:

U.S. Auto Industry is in a shambles with sales collapsing.

Folks who mattered used to say, “However goes GM, so goes the U.S.A.”  Well, that went out the window with the collective belief in the myth that the U.S. could simply become a service economy, and that the productivity measurement was all that mattered — with technology at the helm of the ship.  Well, we’re all learning now first hand that if we can’t all just sell mortgages to one another, of houses inflated by excessive money printing through the credit system.  Unless we actually produce something to exchange with the rest of the world, we can’t afford to buy the things even we make — like autos.

Well, U.S. auto sales have plummeted 15.5% since August 2007, with the Big Three getting hammered. First the good news: GM is down 20%.   And now the bad news: Ford is down 26.5%.  The Ugly: Chrysler is down 34.5%!   We don’t expect that to improve any time soon.  Some folks — the auto companies themselves — are pointing to lower gas prices they say will jump start sales again. But a 40 cent drop is hardly a reprieve compared to just a few short years ago, and moreover will not last.   As we warned years ago, the 0% financing incentives would merely urge people to advance buy autos, half of which seem to have done so in massive gas guzzlers.  As more buyers default on their car payments further crunching available credit, this situation will only worsen.

The United States of Bailouts

All said, add the Auto Industry to the folks in line with their hands out to get the U.S. taxpayer and fellow dollar holders (by printing money) to bail them out.  Let’s see, there’s the implied nationalization of Fannie Mae and Freddi Mac…  There’s Bear Stearns and a host of others who’ve been swapping their garbage credit for U.S. Treasuries from the Fed.  We expect the Airlines to be next.

Then there is the FDIC which expects an $8.9 million ding on its bank insurance fund from IndyMac alone — although some estimate that number is understated for effect, with the real number closer to $12 billion, and even upwards of $20 billion.   The FDIC just upped from 90 to 117 the number banks on its danger of failing list, which, while only recently released, only covers expectations through the end of June — a number it expects to continue to rise.  The fund only has about $45 billion in it, just a hair above 1% of the deposits it actually insures.  Add them to the line  — they’ll be there soon enough.  The last time they had to go to the Treasury was during the Savings and Loan crisis — which is a comparative picnic at Disneyland compared to our current environment.

Then there is the Pension Benefit Guarantee Association, the government’s woefully underfunded pension insurance.  And we fully expect municipalities that to be part of the benefit problem since many have done very little to control spending with real estate values rising steadily and ever more rapidly since the mid 1990s.  They’ve not bothered to fund their benefits. Rather, politicians have punted those obligations to future generations while gathering as many votes as they could with generous benefit agreements with government employee unions.

But from where will that money come when the Federal government itself is running massive deficits already?  This is the same federal government, if you recall, that if you apply real business accounting to its entire shortfalls — including the necessary accruing to account for the present value of the gargantuan future promises of Social Security, Medicare and Medicaid — with the prescription drug program as insult to injury — you’re talking a $4.6 trillion hole.  And that’s just going to grow more massive each year we don’t deal with it.

So back to our question: from where will the bailout money come?  We’ll answer that in future posts in the coming days. Stay tuned!

In the meantime, a few headlines for your perusal:

• National City offers cash to cut equity lines.
• Wells Fargo Increased Dividend 10 Percent only to Raise $1.5 Billion via preferred offering this week (why the dividend if you’re scraping for cash?)
• Main Bank of China Is in Need of Capital The Central bank of China is looking for ways other than printing to come up with cash.  (We’ll post more on this later!)
• Banks head to the Emergency Fed Lending Program as Wall Street Investment Firms Pass on it.
• Russia to continue Backing off Freddie and Fannie holdings

Nothing really adds up all that much regarding the severity of the drop in oil and gold.  Quite naturally we expected some venting — nothing goes straight up forever.  Nonetheless, why gold — the traditional declaration of “BS” on a currency and a country’s financial sector — should start its plummet just when things start to get really sticky (talk of the Freddie and Fannie bailouts, and worsening bank balance sheets) does not  make any rational sense.    This is why we suspect the physical bullion market is showing unprecedented demand –even scarcity in that most in the biz can’t deliver small denomination gold simply because the backlog of orders…. While the paper market, which can see tremendous manipulation on the short term, has plummeted.  “Orchestrated” is the word that comes to mind, but it’s only buying time.

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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Well, it looks as if we’re coming out of the calm before the more serious part of the mega economic storm we’ve predicted over the past few years.

We’ve heard a couple of analogies related to the economic crisis as it was over the past few months following the Herculean bailout of Bear Stearns by the Fed.  Indeed, the calm lulled many an expert (many of the same ones who were blindsided by the problems in the first place) to sound an “all clear” that the worst had passed.  For many of those, it was not the first time they called a bottom since last Summer when it grew clear there was a more serious problem that was not to be simply contained in the subprimes as most predicted.

As for this little respite of recent months, some called it the eye of the storm — Not bad.  But we are gravitating to the squall-line analogy.  Those are the broad wisps of clouds that push forth in advance of a hurricane.   When the early squall lines hit, you get intermediate breaks that would suggest to someone not in possession of a barometer or sattelite imagery that the worst has passed.   Yet, plain as day, the meat of the storm lies dead ahead.

That is where we stand today regarding this economic crisis.  The meat of the storm is now readying to make landfall. Batten down the hatches.

And, just for effect, here’s a weather report:  (Our comments italicized between headlines)

Federal Reserve blames high energy, food prices for a weak economy heading into summer

Uhh.. Maybe they should look in the mirro. And who is responsible for printing all the money that has reduced the dollar’s purchasing power?  The Fed!

Fed’s Kohn says inflation pshychology higher

Neo-keynesian meddlers at the Fed and in most of academia always worry about people catching on to inflation being baked into the system, so they spend a great deal of the time engaged in a confidence game.  Gigs up, though, on this one. Inflatino is out of the bag for the simple reason that the Fed has increased the money supply by well over 5X since 1980.  It was only temporarily vented into fun asset prices, like stocks, bonds, and real estate, and that was so long as the massive capacity in emerging markets kept making the gadgets we buy cheaper and cheaper.  But those dollars are out there, now.

Oil soars as high as $138 a barrel as dollar falls and Energy Department reports supply drop

Oh, you don’t say!  Looks like our warnings about Peak oil smacking hard into rising demand and far too many dollars have come true!

Why It’s Worse Than You Think

You know when Newsweek is on the bandwagon, its for real!

US sees a shadow of the Bundesbank

Wall St falls led by financials

London banks, builders and retailers savaged

That liberal (Maixine Waters) is all about wrecking the U.S. economy. Goes to show how politicians act like spoiled little children, and with very little understanding of economics.

Needless to say, if Maxine has her way, we may as well get into the rickshaw business.

It didn’t take long for Congress to make an emphatic point that it does not understand the value of a free market, or for that matter, that it fails to comprehend the importance of a freely operating pricing mechanism. Said another way, Congress is proving its members to be the economic jackasses they’ve generally always tended to be.  In this case, some are attempting to disrupt the free flow of dollars into commodities — the same dollars whose supply were expanded at a decent clip over the last few decades.

The attempt at preventing the market place from determining the real price of commodities as dollars flood  from other, bloated priced items — real estate and related securities, financial equities, and less attractive, low interest rate debt — and into real, hard, tangible assets that are forced to be backed by labor and sacrifice as opposed the Wall Street alchemy, Ponzi finance, and the money printing press.  Robert Mugabe’s inflation in Zimbabwe clearly is far more dramatic abuse of a currency, but his policies to hide inflation are fundamentally no different.  He attempts to prevent price discovery as well, and the consequences he has will be what the U.S. can expect — earlier stages, of course, but dramatic nonetheless:  capital shifting to where it can find a true price vs. being hampered by centralized cover-up.

Yesterday Bloomberg began reporting that the Chairman of the Senate oversight committee, Joseph Lieberman, is considering legislation limiting what he defines as speculation in the commodities markets. While it is geared at preventing mostly larger players — hedge funds, and other institutional investors — from hedging in the commodities market, the effects of this proposal, should it be enacted, will cause shudders all the way down to the average person.

Mind you, we’ve been pointing out since the early part of this decade that Greenspan’s attempts at warding off the market crash and ensuing recession of 2001 would create severe dislocations in the economy as prices bubbled into new bubbles and economic activity would be distorted as the all elements of the economy restructured itself around what it perceived to be legitimate economic growth. Yet we were clear that this activity would serve only as a head-fake to the economy given it was rooted not in genuine growth, but rather through credit and monetary inflation — a process that rips wealth from the organic / functioning sections of the economy, reallocating it to the hot money, synthetic areas of the economy that can’t stand on their own absent the artificially created life support. With the collapse of the housing and credit markets, we’ve been proven about as correct as one can be — especially when compared to the supposedly reliable experts on Wall Street, at the Fed, and in Washington D.C. who were overwhelmingly blindsided by the collapse.

Says Lieberman:

“We may need to limit the opportunity people have to maximize their profits because a lot of the rest of us are paying through the nose, including some who can’t afford it.”

Meanwhile, Senator Claire McCaskill, Democrat of Missouri, is warning that the people are ready to reach for the Pitchforks. Well, let’s make sure they know who the real culprits are.  In short summary, here’s a few key reason why commodities are going up:

• Too much money has been printed over the last few decades. The consequences of this were beneficial as they often are when the government and its sanctioned central banks (ala our Federal Reserve) inflate in the early stages in that some “nice” assets were inflated in price, such as stocks and bonds, and houses. Only, investors failed to make the connection that these bubbles, with bonds still in high gear, were inflationary.
• The other benefit was a double edged sword: free trade.  While many lost there older, higher paying jobs in the United States, most Americans were only mildly inconvenienced as newly minted dollars were quickly vented off shore with the trade deficit.  All that wealth was invested by foreigners into vastly expanding low cost production capacity, and hence, the U.S. consumer benefitted as prices plummeted.  Were these dollars stuck in the United States, its high cost labor and cumbersome regulatory nonsense would have combined with the natural consequence of an increasing money supply facing a supply of goods and services growing at a dramatically slower pace.  Inflation would have strangled the economy pretty quickly.
• All this foreign production and accumulation of wealth requires commodities to feed it. That demand is competing with the U.S. as supply has not increased so drmatically. Flush with U.S. dollars, trade partners are ever more willing to part with dollars to satiate their demand for commodities.
• All those dollars are printed, and they exist in the economies of many countries across the globe. Most still remain invested in the Bond bubble, focusing heavily in the perceived safety of U.S. Treasuries. However, other U.S. bond assets, especially the once sturdy mortgage sector has imploded.   This, as commodities were gaining pretty much since 2002.  Since then, Sovereign State and Central Bank investors have been contemplating the problems of the dollar, and have begun braodening their positioning of new dollars in areas other than just bonds and equities.  Hello, commodities as an asset class.
• More private and institutional Investors have been looking to diversify as well, with the most savvy having understood the nature of the inflation that took  place over the last twenty years and its contribution to a vast credit bubble that will require yet more inflation to support Wall Street investment banks. They’ve also noticed the U.S. government has a long term insolvency problem given politicians have promised the sun, moon, and stars at such a level that it will literally bankrupt the nation, and with that they expect politicians to to the politically surreptitious method of paying off things like Social Security, Medicare and Medicaid.  They’ll do it with freshly printed dollars vs. doubling taxes and cutting benefits by a third.  These savvy investors have diversified into commodities as a basic inflation hedge given they believe the die were long ago cast.
• Other savvy investors expect foreign sovereigns to lose their appetite for U.S. debt at near 50 year low yields given they expect the emerging recession will be severe.  This will result in more commodity hedging / dumping of the dollar, they expect.   F
• or decades we exported our inflation, and foreign nations gladly imported it for trade purposes. Now we will pay for it as foreigners slowly export it back to us.
• Finally, Peak Oil theory has been right on, and this problem of decreasing light sweed crude supply means oil producers will be forced to retrieve harder to get and less easily refined resources vs. what so easily flowed for the past sixty years.  The quality of Saudi oil has been steadily decreasing suggesting that the Saudis are not so flush as in the past, further explaining their recent shift to preserve their resource for future generations of their own people (a trend emergin among all OPEC nations) vs. supplying the United States, which refuses to develop its own resources while it’s politicians, delusional as always, wag their fingers at the OPEC for not producing enough.
• U.S. energy policy has been swamped by Green and NIMBY (not in my back yard) legislation that simply has caught up with the U.S. via higher priced energy.  Oil is a crucial factor in the production of everything, including fertilizer, transportation, and every single facet of production. As it goes up in price, invariably so will all else.  Nuclear energy has been virtually outlawed while many nations globally use it very safely.  Meanwhile, alternative energy has been a goal, but its still not viable technology.  NIMBY and environmental legislation hammers some of it, such as wind farms, which have been prohibited for killing some birds and making unsightly beach views.
• Just in Time Delivery was dependent on low energy costs. Supply will be constrained as the economy rewires itself to slower delivery and larger inventories in order to lower costs.

So there you have it, and that’s just the tip of the iceberg. Congress can reshuffle the deck chairs and search to blame, blame, blame everyone but themselves and the private banking cartell they collude with called the Federal Reserve.  But inflation is catching up to us, and it the stupid legislation in the United States that made the U.S. too complicated for doing business, and its currency so common, well… that’s to blame.

That said, expect the politicians to distract from the real problems as they always do. They will, instead, look for politically popular scapegoats to help their re-election.

No doubt, there are quite a few problems behind why oil has jumped above $128 a barrel.  Never mind hooey arguments about greedy oil companies that resonate with the economic illiterates among the loudmouth media and the complaining voters.

While we don’t have much good to say about any politician on the matter of energy, we really can’t disagree with President Bush’s observations about pressuring the Saudi’s for more output:

“Our problem in America gets solved when we aggressively go for domestic exploration. Our problem in America gets solved if we expand our refining capacity, promote nuclear energy and continue our strategy for the advancing of alternative energies as well as conservation,” he said.

“One interesting thing about American politics these days is those who are screaming the loudest for increased production from Saudi Arabia are the very same people who are fighting the fiercest against domestic exploration, against the development of nuclear power and against expanding refining capacity.”

This, said Bush, after noting that Saudi output really is not the ultimate solution to the U.S. price problem.  Mind you, many in the U.S. Congress are wagging their fingers at the Saudis — like candidate Hillary Clinton — for not increasing their production significantly enough to alleviate U.S. price pressures, as if the world should rotate around the U.S. dilemma.  The same folks giving grief to the Saudis are the same ones who refuse to allow the U.S. to develop its own energy resources as Bush notes above.

Not that the Republicans have been any great movement as of late to get anything done themselves, with R candidate John McCaine having been a pivotal vote in the Senate preventing the development of Alaskan reserves.  Indeed, the U.S. has not built a new refinery in three decades, and refuses to allow development of both oil and clean burning coal, not to mention nuclear reactors.  Even environmentalists are preventing air windmills, much to the happiness of those with fancy homes on the coasts who loath having their million dollar views ruined by windmill farms harvesting the constant ocean breezes.

Hypocrisy aside, we’re not hearing one of the core causes for skyrocketing energy costs: plain old fashioned inflation. And by “inflation”, we don’t mean the modern misuse of the word to describe the consequences of inflation — rising prices –, but rather the actual cause of the rising prices: climbing money supply.   The world is now awash with dollars thanks to a steady thirty years of the Fed and the U.S. banking system creating dollar after dollar with its fractional reserve, fiat privilege.

Looking at the money supply graph, you can see that the various measures of U.S. dollars have been on a steady rise since the 1980s, and especially ramped up in the 1990s.   Most were lulled to sleep about the ugly effects of inflation due to two factors, both of which served as siren songs for the unsuspecting public and the herd of sheep hitting their record bonuses on Wall Street:

1. Inflating nice asset prices like stocks, bonds, and houses
2. Exported inflation dollars bought cheap goods made abroad, a honeymoon that lasted until the last few years, when foreign nations were flush to the gills with dollars and ready to part with them to buy things that were not so easily printed and common — and very essential, like energy!

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.

When your dealing with an addict, you don’t trust their word when they say they’re going in the right direction when they won’t even admit they have an addiction problem.

That’s the problem with our financial system. Consumers are addicted to credit and money supply expansion policies. Wall Street enjoys the comfy ability to profit from deals financed with money minted out of thin air. The banking system enjoys being able to profit from loaning and deal-making with the money you think is there in the bank, ready for withdrawal when you want it. (No doubt, those banks really love their 10% fractional reserve requirement and having the Fed a the ready bail them out with fresh cash when the de-facto embezzlement is revealed when depositors actually decide to withdraw their supposedly liquid money all at once, as amid bubble-bursting environments they’re wont to do.) And, of course, Washington D.C. loves having a secretive, privately held central bank finance its shortfalls. What politician won’t practically sell the sun, moon, and stars to win an election, to hell with the future generations that will suffer when the tab for said free lunch comes due? Just print the difference, and let some other sucker figure it out down the road.

And that’s the problem. Down the road is arriving leaving us with no good options. And, so, above we have Glen Beck and Ron Paul soberly discussing the issue the other primary candidates pretend doesn’t exist because the only realistic solutions are too controversial to assure victory among the masses of voters, who most assuredly have made it clear they much prefer having their ears anoint with yet even more impossible to promises delivered in language soaked in honey. As such, Ron Paul and Glen beck will be dismissed as they are always, although we’ll admit it is a good sign that at least Glen Beck is catching on.

Nonetheless, the addicts out there– voters included — consider Ron Paul to be among the Tinfoil Hat Wearing Crowd (a title which yours truly has been labeled a few times). So the system continues to conjure up more ways of getting our addict more of the junk he craves, and the Fed — the dealer who has steadily and stealthily pilfered over 95% of the dollars value since its creation in 1913 — stands ready to give the addict his fix.

The addict, no doubt, loves the party — the good times of the high. But even more desperately, the addict wants to avoid the pain of cleaning up his act and enduring the awful reality that is withdrawal. Addicts will sell themselves into prostitution, and worse, to avoid cleaning up. And so, too, our actors in our economy resist reality — choosing instead to prop up asset prices based in fiction — houses, condos, irrationally priced securities –, and systems rooted in fleecing dollar holders and those on fixed incomes for the benefit of the few. Addiction is a bitch.

But we all know, feeding an addiction is not the path to restoring health, and unfortunately our addicted economy is long in the tooth in juicing itself up into artificial cycle-highs and juicing up more in warding off cycle-lows. No doubt our addict economy has swooned a few times; recently it almost fell over during the 2000-2002 fiasco, but for the good fortune of Alan Greenspan standing on the corner telling everyone that he had the good stuff that would make everything OK.

And so the next bubble crashes — a big one — rife with dislocations so massive one wonders if this time the addict will be forced to face reality… or if he’ll make it through another bubble with another fix. If he gets back up to his old ways, I’d not be betting on his good fortune lasting long.

What of the Fed? Congress? The people? The cry for another fix has been heard loud and clear. Its just a waiting game now.

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!