Vigilant Investor

“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.

“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

Philip Manduca, who co-manages $2 billion as head of investments at ECU Group Plc, says “another death lunge still to come.” His arguments are close enough to give them a listen, especially on the Fed’s additional .50% rate cut and the consequent risks of inflation, currency weakness, and, generally speaking, the impending payback for years of free lunch Ponzi finance.

Give his interview with John Dawson of Bloomberg a watch here.

NEW YORK — Wall Street was expected to plunge at the opening of trading Tuesday, extending its huge losses from last week and taking more cues from heavy selling that has spread throughout the world. Indicators showed the Dow Jones industrial average was set to fall by more than 500 points when trading begins.Fears of a recession in the United States that could pull down the global economy as well have infected markets around the world, and those declines further unnerved U.S. investors who were unable to trade Monday, when Wall Street was closed for Martin Luther King Jr. Day. Meanwhile, U.S. bond prices soared as investors fled the stock market, and the price of oil skidded as investors dumped futures in the belief that a recession would slash demand for energy.

It looks like the markets are finally taking the credit crisis and recessionary risks seriously. It was as if a switch was flicked at the turn of the year, from “will there be a recession?”, to “Yikes! A recession! How long and how deep?”

Our answer? Deep. Long. And very liquid.
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Today we learn that the Fed has again made another temporary liquidity injection to qualify as the largest since the times around 9/11 in order to provide grease for the still shrinking U.S. commercial paper market. The amount, $47.25 billion, was to defend the federal funds target of 4.50% that had traded as high as 4.81% earlier in the day — and was largely attributed to $40.5 billion of rollovers in “maturing operations.”

Now, if you’re like most folks, much of what that means — well, it may as well be in Greek. Moreover, what lies beneath the surface is opaque and functionally down the rabbit hole that even pros have a hard time making sense of what actually has been going on. After all, is that not largely what we can deduce from the lock-up of the credit markets?

Some might suggest FAS 157 — the new accounting rule that makes it harder for banks to hide market values of hard to value securities through mark to model valuations — might be a little painful, but will also finally restore some clarity to the system. We encourage readers to catch up on the changes: No doubt it will provide clarity, although we believe the recent large write-offs from major players are only the tip of the iceberg on institutions coming clean.

Now, while the difference between what FAS 157s Level 1, 2, and 3 assets actually mean in real terms is still quite Greek (and yet to be valued), we can’t help but remind readers that the fundamental problem of this highly public fiasco that started in the mortgage back securities markets really are a distraction from the actual problem that will eventually be exposed. Continue Reading »

Our long–term readers know we have continually cautioned about serious economic consequences to come. Not because we’re “doom and gloomers” – but because we feel the best way to take advantage of the truth – is to first acknowledge it. Our opinion has been that when these truths gain increasing acceptance – the full brunt of their effect will soon to be felt. While those in the mainstream conventional camp have long been in denial over unpleasant, troublesome, displeasing economic facts (i.e. the truth) – things are beginning to change.

In today’s New York Times, Bob Herbert writes an “on the money” op-ed titled, “Recession? What Recession?” In it he describes increasingly looming economic eventualities we have long warned about – and he does not sound optimistic – at all.

We feel the consequences of unhealthy, dysfunctional economic policies will, for the uninformed – and those in stubborn denial – have sadly devastating effects. One being their savings & purchasing power inflated into oblivion. However, for those who acknowledge the truth – and act appropriately — this is a time of incredible opportunity.

The window is closing. The boat is pulling away. There is still time. Are you prepared?

“And you can kiss it Goodbye!”
— Former Pittsburgh Pirates broadcaster, Bob Prince

The legendary Bob Prince would utter that call, as Pittsburgh Pirates hitters of a bygone era would knock ‘em out of the ballpark. Today, you can say the same thing about your U.S. Dollar.

After the drubbing the markets took at the end of last week – things seem unlikely to get better. To be honest – odds are they will get a lot worse. The well-established housing slump continues its nosedive. Job losses seem poised to mount. President Bush has directed the FHA to guarantee loans for delinquent borrowers (a massive bailout). Foreign ownership of U.S. government debt is dropping. Nobody knows what time bombs tick regarding mortgage-backed securities, as massive amounts of adjustable mortgages begin to reset.

And — what we have long warned about – is in no uncertain terms, coming to pass. The Dollar is getting crushed.

The Fed – along with U.S. policymakers are stuck between a rock and a hard place. The lowering of interest rates to re-stimulate the credit based American economy would certainly have an inflationary effect. A bailout of mortgage borrowers & lenders (via money printing) would also. Not only would a further acceleration in price increases be the result of such policies – so would the continued degradation of the value of American savings. Even more disconcerting is the potential that foreign lending to debt addicted America would continue to dry up at an extremely quick pace. (Why get paid back down the road with far more worthless Dollars)? Like all bad creditors – the U.S. may soon be required to pay a higher cost (interest rates) to continue borrowing. And that is never good for the bottom line.

So – will U.S. policy makers swallow the necessary bitter medicine? Will they let more hedge funds sink? Will they not bail out Wall Street. Will they let homeowners who got themselves into ridiculous, unrealistic mortgages either tighten their belts and cut spending in other areas – or become renters again? Will they let home values sink to more realistic levels? Will they watch the cleansing effects of a recession (caused by the artificial bubbles they created) take its course? Will they let the Dollar fundamentally strengthen?

Or will they try to take the easy, short-term solution way out – by greasing the wheels via the easing of credit and printing of money?

We predict the latter. But they are running out of rope.

Kiss that Dollar Goodbye!

As we write, Asian indexes are rising on the Fed’s half percent cut in the discount rate, and pundits are touting the move as saving global markets. We say – “Please!” We also ask the simple question, “What’s fundamentally really changed?” (Hint – “Nothing)!

The sub-prime fiasco is far from resolved. In September, an estimated $60 Billion of adjustable mortgages begin to re-set through next year. Because the riskiest lending practices took place during the final years of the real estate bubble – and thus the shakiest mortgage loans are soon going to cost borrowers more to pay off — there has to be a lot of breath holding taking place on Wall Street and in the credit markets. In other words — we would not be surprised to see a dramatic increase in defaults which, could make current problems with mortgage-backed bonds look minor. The subsequent required bailout could make that performed by central banks over the past few weeks – seem miniscule in comparison. All of this has nothing other than inflationary implications.

If you really boil it down to it’s simplest – central banks – Fed included – are giving institutions a place to get rid of their garbage. Only a central bank (certainly not a private one) would offer loans AT A DISCOUNT for collateral of highly questionable quality (of course with money created out of thin air)! Well, not exactly folks. That money is being taken from your hard earned savings. Yep — as the monetary system is flooded with newly created money designed to bail out reckless lending, banking, and Wall Street business practices – your hard earned savings (and purchasing power) is diluted commensurately. In other words – you are paying for this. And you are going to keep paying.

All along we’ve been cautioning that continual injections of liquidity – whether through cheap credit, increased government borrowing, or central bank bailouts will have inflationary ramifications. We’ve also said that the Fed is between a rock and a hard place. If they try to fight inflation by keeping rates higher (or raising them) – the credit dependant, consumer based U.S. economy could go over the cliff. If rates are lowered to re-stimulate (or bail out credit markets) – the Dollar will be sacrificed. Based on the last few weeks, the latter has begun.

Well, well. That didn’t take long. As we’ve predicted all along – the cavalry has come to the “rescue.” This morning we learn that the Federal Reserve has bought $19 Billion of mortgage backed debt. The is flatly a bailout of reckless lending practices, Wall Street greed, and large hedge funds who have made a ton of money – and now don’t want to pay the piper for the inordinate risk they have taken.

Folks, that’s $19 Billion created with the flick of a button – injected into the financial system (and into the money supply). More importantly – this bailout has diluted your hard earned Dollars by the same $19 Billion.

If the trend continues – kiss the Dollar goodbye – and say hello to the $5.00 cup of coffee, gallon of gas, and carton of eggs.

World central banks are following suit. As we have always warned, the debasement of ALL paper money inevitably continues until it devolves to it’s true value — that of the paper it is printed on.

As the equity markets continue to launch through the stratosphere — we have to step back and marvel. Friday’s Dow closed at 13,556 – posting gains for the seventh week in a row. (Heck, another 400 points or so and the Dow will again reach its inflation adjusted high from 2000)! Fueled by buyout fever, stock markets climb ever upward — and it appears no news is capable of changing their trajectory. Not record levels of debt, record budget deficits, massive trade deficits, negative personal savings rates, a bursting housing bubble, sub-prime mortgage woes, rising real inflation, slowing consumer spending, rising consumer credit, rising energy prices, a slowing economy, weakening dollar, and to quote Yul Brynner from “The King and I” “Etc., Etc., Etc.!”

Is this all madness? It depends on your definition of the word. In our opinion the answer is no. There is a logical and easily understandable explanation. It’s simply massive amounts of liquidity (much of it leverage/debt) being injected into the financial (and other markets). The reason the Dow sits at 13,556 and housing prices skyrocketed until recently — is also why gas, oil, and basically everything else is becoming so expensive. Simply put, if we were all playing Monopoly and decided to inject massive liquidity into the game – the price of Park Place and everything else on the board would soon skyrocket. It would not surprise us to see the markets continue their upward march. 20,000 Dow? Who knows! If the Dow does hit such a level, don’t be surprised to also see a $40 Pizza, $5 Cup of Coffee and $12 Beer.

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It is time to soak readers with another sobering observation on the reliability of official U.S. financial data, which is an appropriate follow up to yesterday’s post on the unusual behind the scenes adjustments made to jobs data.

Today we ask you think back to 30-years or so to a different time – the late 1970s and early 1980s. Most would agree that “back then” was not the best economic era for the United States. Inflation was rampant. GDP was lousy. Recession, inflation and unemployment were the dominant conversations of the day.

Now let’s overlay today’s economic environment on that era. Consider that if it were 1980 right now and we were dealing with the exact economic situation we have today, our government would be publishing a GDP figure showing a contraction of about -2.1% from a year earlier. CPI would be clocking in at about 10.2%. Consider that first quarter 1982 GDP was officially at -2.46%, we’re not all that far behind.

How can this be given the official numbers today are so much better than those just described?

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