30 May 2008

Tectonic Shift

Globalisation belonged to us; financial crises happened to them.

The world has been turned on its head. Consumers in the wealthiest nations are struggling with the consequences of the credit crunch and with the soaring cost of energy and food. In China, retail sales have been rising at an annual 15 per cent. I cannot think of a better description of the emerging global order.

The trouble is that the politics of globalisation lags ever further behind the economics. For all its tacit recognition that power has been flowing eastwards, the west still wants to imagine things as they used to be. In this world of them and us, “they” are accused by Democratic contenders in the US presidential contest of stealing “our” jobs. Now, you hear Europeans say, “they” are driving up international commodity prices by burning “our” fuel and eating “our” food.

The other day I listened to an eminent central banker offer a lucid explanation of the collapse of confidence that last summer paralysed international credit markets. I say lucid because he kept it simple, skipping the indecipherable stuff about algorithms, bundled securities and mark-to-market accounting rules.

The crisis, this banker told a conference hosted by the Weidenfeld Institute for Strategic Dialogue, flowed from the coincidence of a global savings glut with the explosion in financial innovation made possible by ever more sophisticated information technology. This had engendered among all those highly paid investment bankers and traders an insouciant indifference to risk. It was always going to end in tears.

The savings had come largely from the fast-growing Asian economies and from the burgeoning incomes of oil and gas producers, though some could be traced to a disinclination to investment in developed nations after the bursting of the dotcom bubble. As risk premiums had fallen and spreads narrowed, central bankers and regulators had warned of the dangers. What they had not foreseen was that the explosion in subprime mortgage lending in the US would be the catalyst for such a sudden bust.

None of the above, I suppose, is any great revelation to those in the banking business now counting the bonuses lost to irrational exuberance. What struck me, though, was how this crisis (no one is sure it is over) provides a perfect metaphor for the new geopolitical landscape.

Think back to the financial shocks of the 1980s and 1990s. For those of us in the west, these were unfortunate events in faraway places: Latin America, Russia, Asia, Latin America again. There was a risk of contagion, but in so far as rich nations paid a price, it lay largely in the cost of bailing out their own feckless banks. The really unpleasant medicine, prescribed by the International Monetary Fund, had to be taken by the far less fortunate borrowers.

The parameters of globalisation were set by the west. Liberalisation of trade and capital flows was a project owned largely by the US. It was not quite an imperialist enterprise, but, while everyone was supposed to gain from economic integration, the unspoken assumption was that the biggest benefits would flow to the richest. The rules were set out in something called, unsurprisingly, the Washington Consensus.

Against that background, the west’s present discomfort is replete with irony. A sizeable chunk of the excess savings that inflated the credit bubble were a product of the Washington Consensus. Never again, the victims of the 1997 east Asian crisis said to themselves after being forced to take the IMF’s medicine in 1997. This would be the last time they were held hostage to western bailouts. Instead they amassed their own huge foreign currency reserves.

So the boot is now on the other foot. The IMF is forecasting that the advanced economies will just about keep their heads above water. With luck, growth this year and next will come in at a touch above 1 per cent. If they do avoid recession – and most of my American friends think it unlikely as far as the US is concerned – they will have to thank robust growth rates in Asia and Latin America. The forecast for China is growth of about 9 per cent in both years, for India 8 per cent and for emerging and developing economies as a whole something more than 6 per cent.

The old powers have not grasped this new reality. There are nods, of course, to a need to restructure international institutions. The rising nations, your hear western politicians aver, must be given more of a voice. More seats, maybe, at the World Bank, the United Nations and, yes, on the board of the IMF. But the assumption is that the rising powers will simply be accommodated within the existing system – a small adjustment here, a tweak there and everything will be fine again. Missing is a willingness to see that this is a transformational moment that demands we look at the world entirely afresh.

One of the reasons for such reticence has been the emergence of another “them and us” – this time within western societies. The “us” in this case are the well educated and well positioned who have been able to extract sizeable rents from the process of global economic integration. The “them” are the under-educated and less fortunate who have seen their jobs lost or their incomes depressed by big shifts in comparative advantage flowing from technological innovation and open economies.

The response of governments thus far has lain somewhere between despair and denial: there is nothing to be done in the face of global market forces; or the benefits of globalisation will eventually trickle down. The active education and welfare policies necessary to ease the adjustment have been conspicuous by their absence. How do you tell your electorates that all the old assumptions about welfare capitalism must be rethought?

Difficult. But these two sets of pressures – between nations and within them – cannot indefinitely be ignored. That way lies an inexorable slide into the beggar-thy-neighbour protectionism that would make the recent financial storm seem like a summer squall. However it is handled, the adjustment process to the new world order will be wrenching. The US and Europe, after all, have between them have enjoyed the best part of two centuries of effortless political and economic hegemony.

There is no reason they should not continue to prosper in a world where power is more evenly spread. Globalisation need not be a zero-sum game. But if the west is going to adapt, it must recognise that it can no longer expect to write the rules.

The End of the Beginning – Developments in the Credit Crisis

May 27, 2008

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

Equity markets believe the worst is over. Banks also seem to have convinced themselves that the worst is behind us. An alternative and, arguably, better view of the current state of the financial crisis is that stated by Winston Churchill: “… this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

Nuclear De-leveraging

There is acknowledgement that an extraordinary level of debt and leverage precipitated the problems. However, there is limited recognition of the massive de-leveraging of the global financial system that is under way. Leverage amplifies returns but also accelerates de-leveraging.

The Exhibit below shows how de-leveraging takes place in a highly levered world. Assume a hedge fund with $20 of unlevered capital. If a bank or prime broker allows it to leverage 5 times, then the hedge fund can acquire $100 of risky assets with $20 of equity and $80 of debt. Assume the asset falls $10 (10%) in value. The hedge fund leverage increases to 9 times ($10 of equity (the original amount less the loss) and $80 of debt supporting $90 of assets). If the permitted leverage stays constant at 5 times then the hedge fund must sell $50 of assets - 50% of its holdings ($10 of equity and $40 of debt funding $50 of the asset). If lenders (more realistically) reduce permissible leverage, say, to 3 times, then the hedge fund must then sell $70 of assets - 70% of its holdings ($10 of equity and $20 of debt funding $30 of the asset).

Impact of Losses on a Leveraged Investor

De-leveraging requires liquid markets and buyers with capital to purchase the assets. Ultimately, prices of risky assets must adjust to market clearing levels as the system reduces debt. The process described is now under way in the global economy.

The first phase of de-leveraging is focused on financial markets. Banks have suffered losses in excess of US$200 billion (with more possible). Approximately US$1 trillion of assets have returned onto bank balance sheets. This included “warehoused” assets that could not be securitised and assets previously “parked” in asset backed security commercial paper (“ABSCP”) conduits, structured investment vehicles (“SIVs”) and Collateralised Debt Obligations (“CDOs”). An additional unknown amount of assets will return onto bank balance sheets as hedge funds gradually de-leverage.

Banks require funding and capital to cover losses and returning assets (christened IAG (involuntary asset growth). High inter-bank rates and the deceleration in bank lending reflect, in part, banks husbanding their cash resources to accommodate the involuntary increase in assets.

They have been raising money both via “helpful” central banks and in the market. Major financial institutions have issued substantial volumes of term debt at very high credit spreads. In one week in April 2008, financial institutions raised a record US$43.3 billion in debt at the highest credit spreads since 2001.

Banks will also need substantial new capital to cover losses and the regulatory capital required against returning assets as follows:

Losses: US$ 200 to 400 billion

Additional Capital: US$ 100 to 300 billion (calculated as 10% (the Basel minimum is 8% but few banks operate at that level) of returning assets)

For bank’s operating under Basel 2, probabilities of default in credit models will increase resulting in regulatory capital increases. This is the pro-cyclical nature of the capital ratios in the current regulatory model.

The capital required is around 15-25% of total global bank capital. Banks have raised in excess of US$ 200 billion in new capital. The pace of new equity raisings is accelerating.

It is not clear how this capital requirement will be meet. Initially new capital was supplied by sovereign wealth funds (“SWFs”) and Chinese banks. Given that most investors have (sometimes) significant losses on their investment, this source of capital is less likely to be available in the near term. Banks have resorted to “hybrid” capital issues such as perpetual preference shares. The major attraction for investors has been the high income. Investors, especially retail investors, may not understand the equity risk in these structures. Rating agencies have expressed concern about the increasing level of hybrid securities in the capital structure of many banks.

Other sources of capital include asset sales. The current state of asset markets makes this problematic. Asset sales will put further pressure on available liquidity and prices.

One bright spot is investment in emerging market banks; for example, investments in Chinese State banks. For those lucky enough to have made these investments, there are still significant unrealised gains. Many banks see disposition of these shareholdings as an attractive source of capital. The recent decline in the Chinese stock market, the large size of many stakes and the unknown liquidity of the underlying stock remain issues.

The new capital noted above will merely restore bank balance sheets. Growth in lending and assets will require additional capital. The banking system’s ability to supply credit is significantly impaired and will remain so for the foreseeable future. Credit is clearly being rationed in the global financial system. If the banks are not able to re-capitalise, then the contraction in credit supply will be sharper.

In recent years, off-balance sheet vehicles – ABS CP conduits, SIVs, CDOs and hedge funds (collectively known as the “shadow banking” system) – provided additional leverage. These vehicles relied extensively on bank funding or support. The withdrawal of this support means that these vehicles are also de-leveraging rapidly.

ABS CP conduits, SIVs and CDOs are being gradually dismantled and the assets returning onto bank balance sheets. Hedge funds have been forced to reduce leverage by between a third and a half times. Prime brokers and banks have significantly tightened credit, increasing the level of collateral needed even against high quality assets. Each 1 times leverage reduction in hedge fund leverage represents in excess of US$2 trillion of assets. This accelerates the de-leveraging process.

The next phase of de-leveraging will focus on the real economy. The availability of debt has contracted sharply. The cost of funding has increased. This will force de-leveraging of corporate and personal balance sheets.

High quality corporations with maturing debt face face higher borrowing costs. For companies with less than stellar business outlook and credit quality, refinancing may prove difficult. Some US$150 billion + of leveraged loans comes due in 2008. A similar amount also must be refinanced in 2009.

Non-investment grade bond issuance over the last few years was concentrated in the weaker credit categories and is vulnerable to deterioration in economic conditions. Standard & Poor’s rating agency estimates that Two-thirds of non-financial debt issuing companies are junk-rated currently, compared with 50 per cent 10-years ago and 40 per cent 20 years ago. In recent years, around half of all high yield bonds issues were rated B- or below. These borrowers will face refinancing challenges.

Personal balance sheets will also de-leverage. Consumers in the USA and to a lesser degree in the UK, Ireland, Australia and New Zealand have used borrowings (against inflated real estate values) to offset a reduction in real incomes. Falling real estate prices and the reduced availability of “easy” credit will force de-leveraging.

Inflation is also a factor in the de-leveraging in personal balance sheets. Higher prices for the necessities of life reduce cash flow available to support debt. Higher food and energy cost, especially over a sustained period, may affect the degree of de-leveraging if income levels do not adjust.

An economic slowdown will exacerbate the de-leveraging. A fall in asset values can be sustained where the borrower has sufficient income and cash flow to service the debt.

In the US economy, the household, housing and financial sectors constitute over half of all economic activity. A (perhaps protracted) slowdown may be difficult to avoid. US demand is a significant driver of global activity. Recent reductions in global growth forecasts reflect these concerns.

Reduction in corporate cash flows as revenues slow down reduces the ability of companies to sustain leverage. Loan covenants (debt and interest coverage) will reinforce the de-leveraging.

There has been a systemic “financialisation” of corporate balance sheets. Changes in financial markets will have a significant impact on many companies that now rely on “financial engineering” rather than “real engineering”. The problems of GE may not be isolated.

For personal borrowers reduced personal income and unemployment will sharply accelerate the de-leveraging. Uncertainty about the future and market volatility will also accelerate the de-leveraging as companies and consumers reduce debt and aggressively save.

De-leveraging in the real economy may result in increasing defaults. Firms and individuals with unsustainable borrowings will fail. This will result in further losses to financial institutions setting off negative feedback loops as both asset prices and the level of aggregate leverage adjusts.

Central banks and governments actions have been directed at maintaining liquidity and (increasingly) directly supporting the financial sector. In the US and Spain, direct fiscal stimulus is already being administered.

These actions are designed to prevent a catastrophic collapse in the financial sector. They are also designed to help maintain a normal supply of credit to creditworthy business and individuals. These actions are designed to help the real economy from slowing down to a degree that the de-leveraging accelerates further. At best, these actions will smooth the inevitable de-leveraging and adjustment to financial asset prices.

What is to be Done?

The current focus is on reforming the financial system. This is like discussing lifestyle changes with a patient admitted to ER in full cardiac arrest. What is needed is the defibrillator paddles!

While the system will need to de-leverage over time, it is imperative that immediate steps be taken to restore functioning of banks and the supply of credit.

The first step is to establish certainty - the holdings and values of risky assets held by banks and investment banks must be accurately determined. The need for greater certainty of values applies to sub-prime securities and leveraged loans as well as other risky assets. Without certainty about what is held by whom and their values, it will be difficult to restore confidence in financial markets.

Risky assets must be valued on a hold-to-maturity basis (in absence of clear trading intent) at 100% (the security will pay back) or 0% (the security will not pay back). Mark-to-market accounting should be suspended reducing volatility in asset values, earnings and capital.

In the aftermath of the 1997-1998 Asian crisis, unfashionable insolvency practitioners, employed by the IMF, established asset values for distressed Asian banks in this precise way.

Market values (based on increasingly unreliable or meaningless indices or quotes) or model based prices (to 16 decimal places) should be abandoned. There is no market for many risky assets currently. The models have not performed and are what got us here in the first place.

The manifest problems of valuation can be easily illustrated. Bank holdings of Level 3 assets have increased in recent months. These are assets or liabilities that cannot be priced using observable inputs and requires the use of modeling techniques and substantially subjective assumptions – also referred to as “mark-to-make-believe”. There is concern about the accuracy of these valuations.

The increase in Level 3 assets may reflect a re-classification of assets previously classified as Level 2 assets. These are instruments that are valued using observable inputs that can be put through an accepted model to establish values (i.e. mark-to-model). This reclassification is consistent with deteriorating market conditions and unavailability of market prices.

Market values may be distorted. In recent months, investment banks have sold leveraged loans on the basis that the bank lends the buyers 75-80% of the price at below market rates. In this way, the sellers were able to avoid marking down its positions.

There is also significant disagreement between banks as to the values. A comparison between some US and European banks shows substantial differences in where similar assets are valued.

Even central banks, it seems, can’t agree on the current price of difficult to value assets. For example, market sources indicate that under its special term lending arrangements the Bank of England is placing a market value of 75 to 90% per cent on highly-rated non-government collateral, depending on type and the availability of prices. In contrast, the Fed is placing market values of 80 per cent to 98 per cent for similar securities. Greater certainty regarding positions and values are essential.

Once the true positions are known, then the capital levels that banks must hold against these assets can be set.

Capital levels should be set on a bank-by-bank basis by regulators rather than based on an inflexible formula that is frequently gamed by banks. Capital requirements should be eased, where appropriate. A “desired” long-term capital ratio for banks should be set. Banks should be allowed to transition to these levels over time. If all asset positions are known with clarity and confidence, banks can operate with lower than the normal capital requirements for a period.

Proposals to accelerate Basel II or increase bank capital are ill considered in the present market conditions. The banking system needs significant amounts of capital to cover losses. It also needs additional capital to cover assets returning onto balance sheet. Increased capital ratios would accelerate the de-leveraging already under way worsening the contraction in economic activity.

The final step is a government guarantee of all major bank liabilities. The step is not as radical as it appears. The Federal Reserve (for example, in the case of Bear Stearns), the Bank of England (Northern Rock and the Special Liquidity Scheme (“SLS”)) and Germany (the Landesbanks) have de facto already done this.

The extent of central bank support is significant.(1). For example, the US Federal Reserves 7 May 2008 statement shows that it holds $537 billion of US Treasury bonds out of a total of US$795 billion in securities. This amount to 68%, a fall from 98% a year ago. Closer scrutiny reveal that the US$537 billion includes US $143 billion of Treasury bonds lent to dealers under the liquidity support schemes. The US$143 billion is “fully collateralized by……. highly-rated non-agency mortgage-backed securities”. In effect, the Federal Reserve has provided over US$400 billion (around 3% of US GDP) in funding to banks and (now) investment banks. This funding is at subsidised, negative real interest rates.

Term lending through the support facilities means that the central bank is doing more than providing liquidity. The central banks are underwriting the solvency of banks. If at maturity, the bank can not repay the advance, the central bank will be forced to continue to fund the borrowing bank to avoid triggering default. Bank’s generally fail due to liquidity risk. It is sobering to consider that Bear Stearns was technically solvent when a withdrawal of liquidity brought it to the brink of a bankruptcy.

An explicit guarantee has many advantages. It avoids inflationary money supply expansion and the need for money market sterilisation operations. It would directly help restore confidence in banks and in the inter-bank market.

The Central Bank would charge explicitly for the guarantee based on the underlying risk. In this way, the taxpayer is properly compensated for the risk assumed. Central banks currently are providing a similar underwriting of financial risk at money market rates. This contrasts with the high costs being paid by banks on their equity capital raisings. For example, banks are paying 7% to 11% on hybrid capital raisings. Similarly, bank equity offerings are at substantial discounts to already low stock prices.

Support of the global banking system will be difficult to avoid. The originate-to-distribute and risk transfer models did not, as we now know, distribute risk through the financial markets. Instead, it linked the financial solvency of all financial market participants in a complex web. Government underwriting of the banking system is now critical to resuscitating normal financial activity.

The proposed actions are contrary to free market orthodoxy and raise familiar concerns about moral hazard and rewarding greed. There seems to be no choice. There will be a high price to be paid but that will come later. As Charles Kindleberger noted in his history of financial crisis: “today wins over tomorrow”.

Credit markets have become dysfunctional. As Walter Bagehot observed: “Every banker knows that if he has to prove that he is worthy of credit, however good may be his argument, in fact his credit is gone”. The outlined actions would help restart the credit heartbeat in the US and global economy. Vital life signs need restoration before longer-term lifestyle changes are contemplated.

Implementation of the three steps outlined above allows monetary policy, interest rates and fiscal policy to be directed to ameliorate any economic slowdown. As noted above, falls in asset values can be sustained where the borrower has sufficient income and cash flow to service the debt. Initiatives in the US mortgage market to help those with salvageable debt positions to avoid foreclosure are also valuable in this regard. Attempts by governments in the USA and England to maintain supply of “normal” housing finance are also targeted at this objective.

The defibrillator shocks must be accompanied by far reaching and fundamental changes in financial architecture and global capital flows. Regulation of banks, capital regimes, risk transfer, asset valuation, risk management, use of collateral, counterparty risk, model risk, rating agencies and financial accounting need radical surgery. Fundamental economic imbalances - excessive reliance on US consumption and excessive savings by other nations – must be addressed.

Present proposals by various bodies are tepid and do not address the fundamental problems. Many of the suggestions, such as derivatives clearing houses, have been doing the rounds for 20 years. Giuseppe di Lampedusa (author of “The Leopard”) would have seen the proposals for what they are: “everything must change so that everything can stay the same”.

Failure to address the major structural problems of financial architecture and global economic imbalances may mean that any improvement is short-lived. It will also sow the seeds of future, perhaps more serious, financial crises. The present problems and government steps already are creating problems in commodity and emerging markets.

Resolution of the crisis requires brave and decisive steps that transcend geography, jurisdiction, regulatory silos, nationalism and rigid economic formalism. John Maynard Keynes knew the problem well: “the difficulty lies not so much in developing new ideas as in escaping from old ones”. But as John Kenneth Galbraith observed: “faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy on the proof.”

[1] I am grateful to Charles Morris for drawing this to my attention.

Megabubble waiting for new president in 2009


'Numbers racket' exposes potential disaster for economy, markets
By Paul B. Farrell, MarketWatch
Last update: 10:13 a.m. EDT May 20, 2008
This update of a story originally published May 19 fixes the title of Kevin Phillips book "Bad Money: Reckless Finance, Failed Politics & the Crisis of American Capitalism."
ARROYO GRANDE, Calif. (MarketWatch) -- Remember that big ah-ha moment in the 1939 classic "The Wizard of Oz?" Dorothy wants to see the Wizard. His voice booms: "Do not arouse the wrath of the Great and Powerful Oz! Come back tomorrow!" Afraid, Lion, Tin Man, Scarecrow shake. Dorothy's dog runs up, tugs on a curtain. She chases Toto, pulls curtain open:
"Who are you?" Dr. Marvel stutters: "Well, I - I - I am the Great and Powerful, Wizard of Oz." Dorothy: "You are? I don't believe you!" He replies: "No, it's true. There's no other Wizard except me." Dorothy's miffed: "Oh, you're a very bad man!" Wizard: "Oh, no, my dear. I'm a very good man. I'm just a very bad Wizard."
2009 Sequel: Script exposes diabolical cover-up conspiracy
Flash forward: Real life, Washington, new leaders, a new Congress, old wizardry. Be forewarned: No matter who's elected president, America will soon see a massive statistical curtain pulled back, exposing a con game of historic proportions. And when that happens, you and I will suffer another ear-splitting global meltdown, bigger than today's housing-credit crisis, dragging us deep into a recession and bear market for years.
Cast: New 'leading man' from old Nixon political machine
Yes, the lead character pulling back the curtain is none other than Kevin Phillips, a former Republican strategist for Nixon, and today America's leading political historian. Phillips just published "Bad Money: Reckless Finance, Failed Politics & the Crisis of American Capitalism," everything you need to know about today's credit meltdown.
Scene 1: Numbers racket hiding behind Washington curtain
Opening shot: Phillips pulling back the curtain, exposing charlatan Wizards in a brilliant Harper's Magazine article: "Numbers Racket: Why the economy is worse than we know." Far worse. Buy it, read it -- this is essential reading if you really want to understand the depth of today's political as well as economic impending meltdown, and the harsh realities facing Washington, Wall Street, Corporate America, and Main Street in 2009 and beyond ... harsh because we cannot cover up the truth much longer.
Scene 2: Statistics, Washington's new WMDs, a time bomb
"If Washington's harping on weapons of mass destruction was essential to buoy public support for the invasion of Iraq, the use of deceptive statistics has played its own vital role in convincing many Americans that the U.S. economy is stronger, fairer, more productive, more dominant, and richer with opportunity than it really is. The corruption has tainted the very measures that most shape public perception of the economy," especially three key numbers, CPI, GDP and monthly unemployment statistics.
Scene 3: Backflash, 'It's always the cover-up, stupid!'
As I read further I couldn't help but think about similar traps politicians get themselves (and us) into. Remember nice guys like Scooter Libby and Bill Clinton: The crime wasn't their original stupidity, but their lying during the cover-up. Here, Phillips reviews endless statistical cover-ups since the 1960s and concludes there was no "grand conspiracy, just accumulating opportunisms." I call it plain old greed. And every step of the way the media went along with the con game played by politicians and economists.
Scene 4: Real numbers torture us ... like water-boarding!
How bad is it? "The real numbers ... would be a face full of cold water," says Phillips. "Based on the criteria in place a quarter century ago, today's U.S. unemployment rate is somewhere between 9% and 12%; the inflation rate is as high as 7% or even 10%; economics growth since the recession of 2001 has been mediocre, despite the surge in wealth and incomes of the superrich, and we are falling back into recession."
Scene 5: Most economists hushed, work inside conspiracy
Compare that to the phony stats Washington feeds the press and public: Unemployment 5%, inflation 2% and long-term growth at 3%-4% (actually more like 1%). For example, just last week the L.A. Times reported that while "gasoline prices are up more than 20% from a year ago and food prices have risen 5%," Washington says "inflation was fairly mild last month." A Wells Fargo economist shook his head in disbelief: That report isn't "worth the paper it was printed on." Most economists are quiet, working for the conspiracy.
Scene 6: No integrity, they cannot be trusted to tell truth!
The same can be said of any government report, every speech made by today's leaders: All hype, lies and propaganda intended to deceive us. Treasury Secretary Henry Paulson's clearly playing the game: Remember what the former Goldman Sachs CEO told Fortune last July as our credit meltdown was metastasizing into a worldwide contagion: "This is far and away the strongest global economy I've seen in my business lifetime." He has no credibility. He knew the truth. He knew the government's "numbers racket;" after all, he helped create the problems years earlier at Goldman.
Scene 7: There's enough Kool-Aid for everyone to drink
The plot's unraveling: The lies accumulate and compound one on top of the another ... get passed on ... keep mounting ... forcing successive new generations of politicians to drink the same poisonous Kool-Aid ... keep the lies alive ... going strong ... till everyone believes the lies are really "the truth," or at least an inconvenient truth ... as the hoax becomes the conventional wisdom ... not only by Washington, Wall Street, Corporate America and the media, but also 300 million Main Street Americans.
Scene 8: Inflation statistics are America's new 'guillotine'
The biggest of all lies is with inflation. Understating inflation "hangs over our heads like a guillotine," says Phillips. Yet if Washington told us the truth "it would send interest rates climbing and thereby would endanger the viability of the massive buildup of public and private debt (from less than $11 trillion in 1987 to $49 trillion last year) that props up the American Economy." So we keep sipping the Kool-Aid.
Scene 9: Washington and Wall Street delusional in 'Land of Oz'
"Were mainstream interest rates to jump into the 7% to 9% range -- which could happen if inflation were to spur new concern -- both Washington and Wall Street could be walking on quicksand," warns Phillips. "The make-believe economy of the past two decades, with its asset bubbles, massive borrowing, and rampant data distortion, would be in serious jeopardy."
Scene 10: Cover-up failing ... king really has no clothes
Yet everyone still acts paralyzed, unable (or unwilling) to do anything to stop this lethal musical chairs charade ... till it's too late, or a catastrophe wakes us. Meanwhile, we act as if we had no choice but to put up with the crashes of 1987 and 2001 and 2007. Just "normal" bull/bear cycles. So like lemmings driven over a cliff, we'll blindly accept the next crashes, as each increase in frequency and intensity. Next in 2011? As war debt piles? As reforming health care, Social Security and Medicare are delayed? As we deny and deceive ourselves, perpetuate the lie ... except notice, out of the corner of your eye, at the edge of the screen, a curtain's being pulled open, slowly, our once-mighty statistical king, the Wizard of Washington really has no clothes on.
Scene 11: Millions of co-conspirators in massive cover-up
Still, we let ourselves be conned. Why? "The rising cost of pensions, benefits, and interest payments -- all indexed or related to inflation -- could join the cost of financial bailouts to overwhelm the federal budget," says Phillips. But it's a heads-we-lose-tails-we-can't-win bet. "As inflation and interest rates have been kept artificially suppressed, the United States has been indentured to its volatile financial sector, with its predilection for leverage and risky buccaneering" Yes, Wall Street and the rich love playing this game.
Scene 12: Rich get richer hiding under 'statistical camouflage'
So who really "profits from the low-growth U.S. economy hidden under statistical camouflage?" he asks rhetorically. Certainly not the masses: "Might it be Washington politicos and affluent elite, anxious to mislead voters, coddle the financial markets, and tamp down expensive cost-of-living increases for wages and pensions?" Yes, yes, yes, a voice screams off-camera! Then a gun shot rings out ... dull thud ... silence ... haunting music builds, filling the theater ... signaling the end of this tragi-comedy ... although like Sartre's "No Exit," you know this drama will never end ... until ... the next sequel ...
Roll credits: Who was that masked man?
Kudos to the masked curtain-puller. Yes folks, it's the same Kevin Phillips who wrote "American Theocracy, The Peril and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century;" "The Politics of Rich and Poor: Wealth and Electorate in the Reagan Aftermath;" "American Dynasty: Aristocracy, Fortune, and the Politics of Deceit in the House of Bush" and others. In his "Wealth and Democracy: A Political History of the American Rich," Phillips warned us that "most great nations, at the peak of their economic power, become arrogant and wage great world wars at great cost, wasting vast resources, taking on huge debt, and ultimately burning themselves out." Slowly, fade to black ....

The Geopolitics of $130 Oil

By George Friedman

Oil prices have risen dramatically over the past year. When they passed $100 a barrel, they hit new heights, expressed in dollars adjusted for inflation. As they passed $120 a barrel, they clearly began to have global impact. Recently, we have seen startling rises in the price of food, particularly grains. Apart from higher prices, there have been disruptions in the availability of food as governments limit food exports and as hoarding increases in anticipation of even higher prices.

Oil and food differ from other commodities in that they are indispensable for the functioning of society. Food obviously is the more immediately essential. Food shortages can trigger social and political instability with startling swiftness. It does not take long to starve to death. Oil has a less-immediate -- but perhaps broader -- impact. Everything, including growing and marketing food, depends on energy; and oil is the world's primary source of energy, particularly in transportation. Oil and grains -- where the shortages hit hardest -- are not merely strategic commodities. They are geopolitical commodities. All nations require them, and a shift in the price or availability of either triggers shifts in relationships within and among nations.

It is not altogether clear to us why oil and grains have behaved as they have. The question for us is what impact this generalized rise in commodity prices -- particularly energy and food -- will have on the international system. We understand that it is possible that the price of both will plunge. There is certainly a speculative element in both. Nevertheless, based on the realities of supply conditions, we do not expect the price of either to fall to levels that existed in 2003. We will proceed in this analysis on the assumption that these prices will fluctuate, but that they will remain dramatically higher than prices were from the 1980s to the mid-2000s.

If that assumption is true and we continue to see elevated commodity prices, perhaps rising substantially higher than they are now, then it seems to us that we have entered a new geopolitical era. Since the end of World War II, we have lived in three geopolitical regimes, broadly understood:
The Cold War between the United States and the Soviet Union, in which the focus was on the military balance between those two countries, particularly on the nuclear balance. During this period, all countries, in some way or another, defined their behavior in terms of the U.S.-Soviet competition.
The period from the fall of the Berlin Wall until 9/11, when the primary focus of the world was on economic development. This was the period in which former communist countries redefined themselves, East and Southeast Asian economies surged and collapsed, and China grew dramatically. It was a period in which politico-military power was secondary and economic power primary.
The period from 9/11 until today that has been defined in terms of the increasing complexity of the U.S.-jihadist war -- a reality that supplanted the second phase and redefined the international system dramatically.

With the U.S.-jihadist war in either a stalemate or a long-term evolution, its impact on the international system is diminishing. First, it has lost its dynamism. The conflict is no longer drawing other countries into it. Second, it is becoming an endemic reality rather than an urgent crisis. The international system has accommodated itself to the conflict, and its claims on that system are lessening.

The surge in commodity prices -- particularly oil -- has superseded the U.S.-jihadist war, much as the war superseded the period in which economic issues dominated the global system. This does not mean that the U.S.-jihadist war will not continue to rage, any more than 9/11 abolished economic issues. Rather, it means that a new dynamic has inserted itself into the international system and is in the process of transforming it.

It is a cliche that money and power are linked. It is nevertheless true. Economic power creates political and military power, just as political and military power can create economic power. The rise in the price of oil is triggering shifts in economic power that are in turn creating changes in the international order. This was not apparent until now because of three reasons. First, oil prices had not risen to the level where they had geopolitical impact. The system was ignoring higher prices. Second, they had not been joined in crisis condition by grain prices. Third, the permanence of higher prices had not been clear. When $70-a-barrel oil seemed impermanent, and likely to fall below $50, oil was viewed very differently than it was at $130, where a decline to $100 would be dramatic and a fall to $70 beyond the calculation of most. As oil passed $120 a barrel, the international system, in our view, started to reshape itself in what will be a long-term process.

Obviously, the winners in this game are those who export oil, and the losers are those who import it. The victory is not only economic but political as well. The ability to control where exports go and where they don't go transforms into political power. The ability to export in a seller's market not only increases wealth but also increases the ability to coerce, if that is desired.

The game is somewhat more complex than this. The real winners are countries that can export and generate cash in excess of what they need domestically. So countries such as Venezuela, Indonesia and Nigeria might benefit from higher prices, but they absorb all the wealth that is transferred to them. Countries such as Saudi Arabia do not need to use so much of their wealth for domestic needs. They control huge and increasing pools of cash that they can use for everything from achieving domestic political stability to influencing regional governments and the global economic system. Indeed, the entire Arabian Peninsula is in this position.

The big losers are countries that not only have to import oil but also are heavily industrialized relative to their economy. Countries in which service makes up a larger sector than manufacturing obviously use less oil for critical economic functions than do countries that are heavily manufacturing-oriented. Certainly, consumers in countries such as the United States are hurt by rising prices. And these countries' economies might slow. But higher oil prices simply do not have the same impact that they do on countries that both are primarily manufacturing-oriented and have a consumer base driving cars.

East Asia has been most affected by the combination of sustained high oil prices and disruptions in the food supply. Japan, which imports all of its oil and remains heavily industrialized (along with South Korea), is obviously affected. But the most immediately affected is China, where shortages of diesel fuel have been reported. China's miracle -- rapid industrialization -- has now met its Achilles' heel: high energy prices.

China is facing higher energy prices at a time when the U.S. economy is weak and the ability to raise prices is limited. As oil prices increase costs, the Chinese continue to export and, with some exceptions, are holding prices. The reason is simple. The Chinese are aware that slowing exports could cause some businesses to fail. That would lead to unemployment, which in turn will lead to instability. The Chinese have their hands full between natural disasters, Tibet, terrorism and the Olympics. They do not need a wave of business failures.

Therefore, they are continuing to cap the domestic price of gasoline. This has caused tension between the government and Chinese oil companies, which have refused to distribute at capped prices. Behind this power struggle is this reality: The Chinese government can afford to subsidize oil prices to maintain social stability, but given the need to export, they are effectively squeezing profits out of exports. Between subsidies and no-profit exports, China's reserves could shrink with remarkable speed, leaving their financial system -- already overloaded with nonperforming loans -- vulnerable. If they take the cap off, they face potential domestic unrest.

The Chinese dilemma is present throughout Asia. But just as Asia is the big loser because of long-term high oil prices coupled with food disruptions, Russia is the big winner. Russia is an exporter of natural gas and oil. It also could be a massive exporter of grains if prices were attractive enough and if it had the infrastructure (crop failures in Russia are a thing of the past). Russia has been very careful, under Vladimir Putin, not to assume that energy prices will remain high and has taken advantage of high prices to accumulate substantial foreign currency reserves. That puts them in a doubly-strong position. Economically, they are becoming major players in global acquisitions. Politically, countries that have become dependent on Russian energy exports -- and this includes a good part of Europe -- are vulnerable, precisely because the Russians are in a surplus-cash position. They could tweak energy availability, hurting the Europeans badly, if they chose. They will not need to. The Europeans, aware of what could happen, will tread lightly in order to ensure that it doesn't happen.

As we have already said, the biggest winners are the countries of the Arabian Peninsula. Although somewhat strained, these countries never really suffered during the period of low oil prices. They have now more than rebalanced their financial system and are making the most of it. This is a time when they absolutely do not want anything disrupting the flow of oil from their region. Closing the Strait of Hormuz, for example, would be disastrous to them. We therefore see the Saudis, in particular, taking steps to stabilize the region. This includes supporting Israeli-Syrian peace talks, using influence with Sunnis in Iraq to confront al Qaeda, making certain that Shiites in Saudi Arabia profit from the boom. (Other Gulf countries are doing the same with their Shiites. This is designed to remove one of Iran's levers in the region: a rising of Shiites in the Arabian Peninsula.) In addition, the Saudis are using their economic power to re-establish the relationship they had with the United States before 9/11. With the financial institutions in the United States in disarray, the Arabian Peninsula can be very helpful.

China is in an increasingly insular and defensive position. The tension is palpable, particularly in Central Asia, which Russia has traditionally dominated and where China is becoming increasingly active in making energy investments. The Russians are becoming more assertive, using their economic position to improve their geopolitical position in the region. The Saudis are using their money to try to stabilize the region. With oil above $120 a barrel, the last thing they need is a war disrupting their ability to sell. They do not want to see the Iranians mining the Strait of Hormuz or the Americans trying to blockade Iran.

The Iranians themselves are facing problems. Despite being the world's fifth-largest oil exporter, Iran also is the world's second-largest gasoline importer, taking in roughly 40 percent of its annual demand. Because of the type of oil they have, and because they have neglected their oil industry over the last 30 years, their ability to participate in the bonanza is severely limited. It is obvious that there is now internal political tension between the president and the religious leadership over the status of the economy. Put differently, Iranians are asking how they got into this situation.

Suddenly, the regional dynamics have changed. The Saudi royal family is secure against any threats. They can buy peace on the Peninsula. The high price of oil makes even Iraqis think that it might be time to pump more oil rather than fight. Certainly the Iranians, Saudis and Kuwaitis are thinking of ways of getting into the action, and all have the means and geography to benefit from an Iraqi oil renaissance. The war in Iraq did not begin over oil -- a point we have made many times -- but it might well be brought under control because of oil.

For the United States, the situation is largely a push. The United States is an oil importer, but its relative vulnerability to high energy prices is nothing like it was in 1973, during the Arab oil embargo. De-industrialization has clearly had its upside. At the same time, the United States is a food exporter, along with Canada, Australia, Argentina and others. Higher grain prices help the United States. The shifts will not change the status of the United States, but they might create a new dynamic in the Gulf region that could change the framework of the Iraqi war.

This is far from an exhaustive examination of the global shifts caused by rising oil and grain prices. Our point is this: High oil prices can increase as well as decrease stability. In Iraq -- but not in Afghanistan -- the war has already been regionally overshadowed by high oil prices. Oil-exporting countries are in a moneymaking mode, and even the Iranians are trying to figure out how to get into the action; it's hard to see how they can without the participation of the Western oil majors -- and this requires burying the hatchet with the United States. Groups such as al Qaeda and Hezbollah are decidedly secondary to these considerations.

We are very early in this process, and these are just our opening thoughts. But in our view, a wire has been tripped, and the world is refocusing on high commodity prices. As always in geopolitics, issues from the last generation linger, but they are no longer the focus. Last week there was talk of Strategic Arms Reduction Treaty (START) talks between the United States and Russia -- a fossil from the Cold War. These things never go away. But history moves on. It seems to us that history is moving.

Change can come at us in very interesting ways.

Your fed up with $4/gallon gas analyst,

John F. Mauldin

28 May 2008

The Bagholder Battles: Investors vs. Banks

Two stories with one common theme: Things Falling Apart

As reported at Calculated Risk: From Ruth Simon at the WSJ:Investors Press Lenders on Bad Loans.

Unhappy buyers of subprime mortgages, home-equity
loans and other real-estate loans are trying to force banks
and mortgage companies to repurchase a growing pile of
troubled loans. The pressure is the result of provisions in
many loan sales that require lenders to take back loans
that default unusually fast or contained mistakes or fraud.
The potential liability from the growing number of disputed
loans could reach billions of dollars ...

Quote: "Tanta and I were discussing who the eventual bagholders would be way back in 2005 - while the bubble was still inflating - and although the picture is much clearer today, some bagholders still don't want to be, uh, bagholders! And who could blame them?"

Monoline Death Watch: CDO Unwind Disputes

Yves Smith (Naked Capitalism) comments on NY Post article about "simmering disputes between investment banks trying to unwind CDOs and monolines that provided credit enhancement".

To clarify a wee point that is a bombshell if true.

One of the big defenses of the bond insurers against Ackman, the other shorts, and the regulators, was "You don't get it. On many (by implication, most) of these structured finance guarantees, we don't have to pay the piper till so far down the road that on a DCF basis this is chump change."

I dimly recall that the terminus was asserted to be when the CDO was finally dissolved and all claims finally settled (or it might have even been when the underlying mortgages finally matured). Given that most CDOs have a three to five year life, I failed to understand how these vehicles could have gotten AAAs if the insurance really worked in most cases as asserted (as in it would pay out only ages after the CDOs were fini). But never underestimate rating agency stupidity, I suppose.

The article suggests (but isn't clear) that the bone of contention is that the unwinding of the CDOs would accelerate the insurer's liability. On one level, that makes sense, but on another, if it is tied to the final resolution of the underlying mortgages, I don't see who you can dissamble these CDOs (which was a conclusion I had reached a long time ago).


Update 5:00 AM: - The alert folks at FTAlphaville have come to the rescue:

The Post, we assume, is picking up on disputes such as this one, between XLCA and Merrill Lynch. The quid pro quo for cheap insurance on senior CDO tranches then appears to have been “control rights” over the liquidation of those CDOs in the event of default.

The whole thing is a legal mess. Existing CDO documentation would likely have given “control rights” to the most senior noteholders, not distant swap counterparties, so there's plenty of room for disagreement.

Monolines back in the spotlight (Alphaville)

Yves Smith at Naked Capitalism picks up a piece in Tuesday's New York Post - surprisingly, on collateralised debt obligations and monoline bond insurers.
In a nutshell, the Post is reporting that monolines are hampering banks' efforts to liquidate CDOs.

The Post, we assume, is picking up on disputes such as this one , between XLCA and Merrill Lynch. The quid pro quo for cheap insurance on senior CDO tranches then appears to have been “control rights” over the liquidation of those CDOs in the event of default.

The whole thing is a legal mess. Existing CDO documentation would likely have given “control rights” to the most senior noteholders, not distant swap counterparties, so there's plenty of room for disagreement.

But Smith wonders how this plays into the long-standing ‘you dont understand‘ defence the bond insurer's have hitherto used. To wit, under existing CDO insurance contracts liabilities dont have to be met instantaneously, but gradually over a period of 20-30 years or so.

That, however, is rot - or at least, rotten - if it's based solely on the legal sureity of those “control rights”, which is anything but certain.

Whatever the situation regarding paydown is, things broadly are once again, getting tricky for the remaining monolines. MBS fundamentals continue to deteriorate and impairment charges are already biting deep into freshly raised capital cushions at MBIA and Ambac.

The FASB too, has just changed accounting rules, making further impairments all but inevitable.

The triple A is anything but secure.

RE: Second-lien fallout ray_heritage NEW 5/28/2008 3:08:14 AM
Second-lien fallout Alphaville

There's a monoline-related barney going on.

After raising capital in February and March, temporarily easing concerns about their future, the bond insurers are back in the spotlight.

First there's the matter of accountancy - and the prospect of having to set aside money to cover losses on troubled securities earlier, namely when there are signs of deterioration rather than on default.

Shares fell on Friday on the news - and deteriorating sentiment over the past week has pushed MBIA and Ambac's 5-year CDS back towards record wides seen in April, according to Gavan Nolan at Markit. There's been other bad news for the sector, with the downgrade of CIFG to junk status.

There is also a growing spat over second-lien exposure (or exposure to second mortgages) - a brouhaha which now involves Moody's, MBIA, Ambac, and research outfit CreditSights.

The rating agency earlier this month put out a comment, noting the “persistent poor performance and continued downward rating migration among 2005-2007 vintage second lien mortgage securities.”

Moody's notes that financial guarantors have significant exposure to second lien RMBS, primarily through guaranties on direct RMBS transactions, and to a lesser extent, through exposure to ABS CDOs, where second lien RMBS securities typically constitute less than 5% of collateral within such CDOs.

In a nutshell, the agency thinks that losses on these securities will be higher than previously thought, with ensuing impact within the monolines' RMBS and ABS CDO portfolios.

Moody's now expects 2005 vintage subprime second lien pools to lose 17% on average, 2006 vintage pools to lose 42% on average, and 2007 pools to lose 45% on average.

The two largest monolines begged to differ. At least as far as their portfolios are concerned.

From MBIA:… - we believe that there are significant differences between subprime second lien pools referenced in Moody's report and the prime second lien securitizations we have guaranteed. As we discussed on our earnings call on Monday, May 12, we have modeled our portfolio on a deal by deal basis using issuer specific data and we are comfortable with the resulting loss reserves and stress analysis we reported to the market.

Ambac too responded with details of its exposure to home equity lines of credit (HELOC) and closed-end second mortgages (CES), arguing that it had been aggressive in its reserving against its exposure.

Then CreditSights got involved

The research outfit last week published a note arguing continued deterioration in second-lien exposure would be problematic for the two largest bond insurers. Specifically, the analyst wrote:

If losses were to migrate toward the higher end of Moody's stress test, we think that a downgrade of both companies would become inevitable. Based on Moody's most stressed case scenario, Ambac could be facing losses of more than $8bn and MBIA could be facing losses of more than $10bn.

In our opinion, it is likely that both Ambac and MBIA will see continued deterioration in their second lien exposure in the second quarter.

Which is arguably where the matter should have been left. Moody's had raised the issue first off, and both companies had responded robustly and publicly.

But Ambac is apparently in fight-back mode. The monoline has put a 23-slide presentation, running through second-lien RMBS on its website - and issued a statement taking issue with the CreditSights note.

"The Credit Sights article offers little independent analysis, fails to consider the basic structural arrangements of individual transactions (one cannot simply multiply a cumulative loss assumption by net par outstanding to determine ultimate loss) and does not attempt to reconcile to Moody's previously reported RMBS losses for Ambac.

To which CreditSights has this week responded in kind, in support of its analyst.

They argue that the note was merely running a worst-case scenario, and that “in the context of ABK's myriad issues, we looked at the piece as relatively benign given the many slings and arrows that the monolines face on a daily basis.” It concludes:

In the end, we stand by our analyst and his right to an opinion (misrepresented by third parties or otherwise) based not only on the data presented but also a minor dose of common sense based on what has transpired over the past year. Ambac has a right to its view as well.

Regardless, the market appears to have made some decisions long before this point, and the conclusions do not reflect well on Ambac or the credibility of risk models in place and underlying assumptions. The experience has been a bitter one for securities holders and more painful than the minor “sticks and stones” of critical analysis.

None of which serves to inform us whether the Armageddon-esque second-lien scenario will come to pass. But there is now, for those interested, ample more information to ponder in sizing up the possibilities.

ray_heritage NEW 5/28/2008 2:47:24 AM

The Shell Game

Modern economics is not rocket science. In fact, it’s not science at all. It’s a game, a confidence game. Once paper passed for money, economics became an elaborate shell game designed to hide the fact paper had been substituted for silver and gold. Debt ratings are an attempt to quantify confidence in paper assets and are an essential part of the game. The shell game is called “Where’s The Money?” The answer is simple, it’s not there.

The question “where did the money go during the Great Depression?” has now been answered to my satisfaction. During the Great Depression, money essentially disappeared and, as a consequence, consumer and business demand collapsed as did prices, beginning a downward coreolis-like spiral that was to suck the global economy into an economic black hole.

My study of the Great Depression began in the 1990s and the subsequent collapse of the dot.com bubble provided a real-time corroboration of assumptions about the connection between loose credit, excessive speculation, and financial bubbles; and, now, in 2008, one of my most troubling questions about the depression has been answered—where did the money go during the Great Depression?

Plunge In US Commercial Property, an article by Daniel Pimlott posted on FT.com (Financial Times) May 21, 2008 provided a critical clue:

Commercial property prices in the US in February saw their sharpest decline since records began nearly 15 years ago as sources of finance for deals has dried up, according to data from Standard & Poor’s out yesterday.

The value of commercial buildings fell 1.03 percent between January and February, the largest monthly decline since at least 1993, when the industry was just emerging from a deep slump.

The fall in national property prices comes as banks have retrenched on lending due to credit crisis and the slowing economy, causing the volume of deals to slow sharply. The market for commercial mortgage-backed securities, which until last August was a major route to cheaper borrowing, has largely ground to a halt.

Sales of commercial properties were down 71 per cent in the first quarter compared with a year earlier, according to data from Real Capital Analytics.

The fact that sales of US commercial real estate fell an astounding 71 % from 1st quarter 2007 to 1st quarter 2008 is shocking and the implications are quite serious. The cause of the slowdown, however, provided the very clue I was seeking.

Commercial property prices in the US...saw their sharpest decline…as sources of finance for deals has dried up… as banks have retrenched on lending due to credit crisis…


The answer to: Where did the money go in the Great Depression? is found in the metaphor of the shell game. It is now clear that money didn’t disappear during the Great Depression, credit disappeared.

The money was never there in the first place. Money had been replaced by credit in the shell game introduced by the Federal Reserve in 1913 when the Federal Reserve began issuing credit-based Federal Reserve notes in place of the savings-based money from the US Treasury.

For details on how the shell game is run, Professor Antal E. Fekete’s description of the check kiting scheme between the US Treasury and Federal Reserve provides crucial information for those perhaps wishing themselves to live off the earnings of others.

It is epitomized by an elaborate check-kiting conspiracy between the U.S: Treasury and the Federal Reserve. Treasury bonds, contrary to appearances, are no more redeemable than Federal Reserve notes. It’s all very neat: the notes are backed by the bonds, and the bonds are redeemable by the notes. Therefore each is valued in terms of itself, rather than by an independent outside asset. Each is an irredeemable liability of the U.S: government. The whole scheme boils down to a farce. It is check-kiting at the highest level. At maturity the bonds are replaced by another with a more distant maturity date, or they are ostensibly paid in the form of irredeemable currency. The issuer of either type of debt is usurping a privilege without accepting the countervailing duty. They issue obligations without taking any further responsibility for their fate or for the effect they have on the economy. Moreover, a double standard of justice is involved. Check-kiting is a crime under the Criminal Code. That is, provided that it is perpetrated by private individuals. Practiced at the highest level, check-kiting is the corner-stone of the monetary system.

GOTTERDÄMMERUNG The Twilight of Irredeemable Debt, Antal E. Fekete, April 28, 2008


In the shell game of modern economics, credit replaces money and when credit gives rise to speculative bubbles, the collapse of those bubbles leads to the defaulting of debt which causes credit to disappear and the economy to collapse.

The credit based shell game, however, is nearing its end. The historic credit contraction that began in August 2007 is still in progress. Despite the efforts of central bankers, credit is still disappearing and, just as in the Great Depression, the credit contraction is continuing to spread causing more and more debt to default.

Credit, the fertilizer of human debt, when no longer available effectively spells the end of the legalized shell game masquerading as modern economics; but the kreditmeisters, their global confidence game now damaged by an unexpected lack of confidence on the part of the marks, sic investors, however, will not give up their scam easily.


Those running the shell game, the central bankers and their codependent brethren, investment bankers, are terrified of losing their day jobs, They have lived well for three hundred years (since the establishment of the Bank of England in 1694) leveraging the productivity of others and we can be assured they will do everything in their considerable power to keep their lifestyle intact..

At this time the central bankers are collectively engaged in financial triage as they attempt to replace the credit that is rapidly being withdrawn in the face of ever increasing amounts of defaulting debt.

Following the same play book they used in the aftermath of the dot.com collapse, the Fed has quickly cut rates from 5.25 % to 2 % but this time they will not ignite a housing bubble as they did the last time. This time, they will do worse. This time, they will burn down the house.

In the long run, there is no short run

In retrospect it will all be clear, the mistakes, the reasons, the excuses, the results. Now, however, in the beginning of the collapse, events appear more problematic, the outcome still unknown. Nonetheless, even in the fog of unexpected events, certain things can be known and safely predicted; and, one of them is that we are now on the road to hyperinflation.

Appointing “Helicopter Ben” Bernanke to head the Federal Reserve now is akin to sending Sammy the Bull, the mafia hit-man, to negotiate with the Palestinians and Israelis; and when the news comes back that Sammy the Bull shot and killed the Palestinians and Israelis at the negotiating table, we should not be surprised—just as we should not be surprised that Ben “the printing press” Bernanke is erring on the side of excess in the current economic crisis by providing even more credit, by shoving even more debt based paper into now a burning house.


Hyperinflation is to inflation like pneumonia is to a cold. Though similar, the former is much more consequential; and whereas pneumonia can sometimes kill, hyperinflation is a veritable death sentence. Hyperinflation always ends in the total destruction of paper money. In hyperinflation, the value of paper money reverts to its mean—ZERO.

The past is indeed prologue when it comes to humanity, printing presses, and the recurrent desire of governments to turn paper into gold; which through the alchemy of central banking is possible—though only for a limited time.

While central bankers and governments do not intend to cause hyperinflation anymore than drunk drivers intend to crash, they are nonetheless responsible for the decisions that lead to hyperinflation and deflationary depressions.

The United States has experienced high rates of inflation in the past and appears to be running the same type of fiscal policies that engendered hyperinflations in 20 countries over the past century.
Professor Laurance Kotlikoff, Federal Reserve Bank Review St Louis July/Aug 2006

The US is the largest economy in the world and the US dollar is the world’s reserve currency. Its central bank, the Federal Reserve, is the most influential, and Ben “the printing press” Bernanke is its chairman. We should not be surprised at what is now going to happen to the US, the US dollar and the world economy.

As the Fed is busy bailing out international investment banks with America’s money, we should be more concerned with what is going to happen to us; because when the US dollar goes up in smoke, the US economy will go down in flames and the world economy will stumble badly, if not collapse completely.

Hyperinflation will destroy both the US dollar and the US economy and the world will not be unaffected. Professor Kotlikoff’s warning about a US hyperinflation was published in 2006; and, now in 2008, US printing presses under Fed chairman Ben Bernanke are running faster than they’ve ever been run before.


Friedrich Kessler, a law professor at Harvard and at Boalt Hall UC Berkeley described the onset of hyperinflation during the Weimar Republic in Germany.

It was horrible. Horrible! Like lightening it struck. No one was prepared. You cannot imagine the rapidity with which the whole thing happened. The shelves in the grocery stores were empty. You could buy nothing with your paper money.
From Fiat Paper Money, The History And Evolution of Our Currency $28.50 by Ralph T. Foster, tfdf@pacbell.net (510) 845-3015 This book, a primer on the end game, is everything you wanted to know about fiat paper money and were too afraid to ask.

At Session III of Professor Fekete’s Gold Standard University Live in February, I discussed the possibility of a sequential or simultaneous hyperinflationary deflationary depression, the economic equivalent of having both a severe heart condition and a possibly fatal cancer at the same time. Such is not impossible; in fact, it is increasingly likely.

I highly recommend the thorough and studied analysis of hyperinflation and concurrent possibilities in John Williams’ Hyperinflation Special Report, Shadow Government Statistics, Series Issue No. 41, April 8, 2008, http://www.shadowstats.com/article/292. John Williams also references and recommends Ralph T. Foster’s Fiat Paper Money, The History And Evolution of Our Currency noted above.

The critical question should now be asked: What can we do?


The following is from The Nightmare German Inflation, Scientific Market Analysis, 1970, which describes the extreme hyperinflationary conditions during the Weimar Republic in the 1920s:

The ones who fared best were the small minority who had the foresight to exchange marks into foreign money or gold very early, before new laws made this difficult and before the mark lost too much value.

The difference between 1920s Germany and today is that there are no longer any currencies convertible to precious metals. In the 1920s, when hyperinflation destroyed the German mark, other currencies were still tied to gold. Today, this is no longer the case. Today, only gold and silver will offer guaranteed monetary refuge during the coming crisis.

A hyperinflation is a monetary phenomena caused by the rapid printing of money not convertible to gold or silver. The inflation of the paper money supply happens gradually, but hyperinflation is itself a sudden-onset phenomena. Suddenly and unexpectedly, inflation becomes hyperinflation and unless you are already prepared, it is already too late.

Today, we are moving closer to the end game, the resolution of past monetary sins when the banker’s shell game is exposed for what it is—a monetary abomination, a parasite on the economic body that over time kills the host on which it feeds.

Be aware. Be careful. Be safe.

Have faith.

Note I: I now have a blog, Moving Through The Maelstom with Darryl Robert Schoon. My first blog discusses the underlying reasons for our increasing series of crises.
see http://www.posdev.net/pdn/index.php?option=com_myblog&blogger=drs&Itemid=106

Note II: I will be speaking at Professor Antal E. Fekete’s Session IV of Gold Standard University Live (GSUL) July 3-6, 2008 in Szombathely, Hungary. If you are interested in monetary matters and gold, the opportunity to hear Professor Fekete should not be missed. A perusal of Professor Fekete’s topics may convince you to attend (see http://www.professorfekete.com/gsul.asp ). Professor Fekete, in my opinion, is a giant in a time of small men.

Darryl Robert Schoon

Darryl Robert Schoon



27 May 2008

The Haves and the Have-Nots: of Time (May 23, 2008)

Is it just me, or does it seem people with more responsibilities have less and less time, while tens of millions of those with fewer responsibilities have ever more leisure time to spend on entertainment?
Many managerial/entrepreneural types report that they barely have time for a quick lunch, or time to breathe after "regular work" (before their second shift as parent/accountant/manager starts that evening), yet according to the research firm Nielsen, American households are watching 8 hours and 14 minutes of television a day while individual viewers watched TV 4 hours and 35 minutes per day: Nielsen Media Research Reports Television's Popularity Is Still Growing

Does anyone else detect a wee disconnect here? If you're actually busy, who the heck has time to watch television 8 hours a day?

I was worried that 4.5 hours of TV per person wouldn't leave everyone with the hours required for talking and text-messaging on cellphones, the hours needed for videogaming, and the all-important hours spent emailing, websurfing and clicking through YouTube. So imagine my relief to find that all those additional hours of New Media haven't impinged on television's premier status:

"These results demonstrate that television still holds its position as the most popular entertainment platform," noted Patricia McDonough, Senior Vice President of Planning Policy & Analysis at Nielsen Media Research. "At this point, consumption of emerging forms of entertainment, including Internet television and video on personal devices seem not to be making an impact on traditional television viewing. This is especially true among teenage girls, who have shown significant increases in viewing during the past year."
Whew. For a minute there I was afraid teenage girls might be too busy learning math, science, Mandarin, guitar, etc. or playing field hockey or water polo or volleyball or working on their 4-H project or helping Mom and Dad with the family business to get in their 5 hours of TV a day.
Meanwhile, back in the world of responsibility and productive labor, academic departments and corporate offices have been stripped of admininstrative support; professors and senior managers are supposed to process their own paperwork, attend umpteen meetings, answer a couple hundred emails a week--and of course, do their "real" job, too.

And to reach these heights of responsibility and reward, go-getters are getting more extreme, too, as frequent contributor Albert T. notes regarding this BusinessWeek article: Meet Your New Recruits: They Want to Eat Your Lunch:

This is basically a story about how kids are huddled into striving for perfection, ergo conditioned for maximum profit potential with all else falling away. The gist of the story is freshmen in ivy league schools are competing so fiercely for internships, etc., setting up clubs of exclusivity where the reward is working for free in order to boost your resume. Upsetting. Why can't any of these seemingly "excellent" people understand that it is always the outsider whom succeeds? There are a million names out there, Steve Jobs, Mark Cuban, etc. all of them started by doing what they liked.
Excerpt from the article:

"Completing what Stanford students call a rare "triple crown," Yu also gained admission to Stanford Consulting. That group rejects four out of five applicants with a notorious entrance interview. Yu's included a business-school-style question about how a deodorant company ought to reverse its declining market share. "It's so competitive to get into Stanford, and then it's kind of a shock you still have to apply for the student groups," says Yu, clutching her personalized Stanford Consulting tote bag to her chest.

The reward for getting into 20-member Stanford Consulting is the chance to do volunteer work 15 hours a week for a real consumer-products company, which Yu declines to name because she signed a nondisclosure agreement."

So am I wrong in discerning a two-tiered society in which one slice of citizenry carries more and more of the responsibility and workload and pays more and more of the taxes, while the other 80% (assuming the Pareto Principle holds more or less true) are spending increasing amounts of time in idle pursuit of "entertainment"? (a.k.a. killing time).
There's only three possible explanations: either Nielsen managed to select the only 10,000 households watching staggering amounts of TV; all 10,000 selected households fiendishly left their TVs on 8.25 hours a day but went off to play in a band, tend the garden, etc., fooling those poor devils at Nielsen; or millions of Americans are watching stupendous amounts of TV.

So what's the correct answer? Ding! You win! It's number three.

And who's complaining about being too busy? Everyone, it seems; those in the top rank are working longer hours, paying more taxes and receiving less admin assistance every year, while those in the lower ranks are complaining about paltry/non-existent raises, less benefits, more demands at work and increasing insecurity every year.

But if life is so darned busy every day from dawn til dusk, who the heck is watching 8 hours of mind-numbing TV a day? Is anyone cooking a real meal at home, or are they watching TV while they cook? Are they cleaning house, or are they able to watch TV while they scrub the bathroom floor? Are they making jam for the church fundraiser while they watch TV? Are they practicing martial arts or riding a bicycle to the farmer's market, or can they do that while watching TV, too? Or are they foregoing sleep, and then relying on powerful, crazy-making drugs to finally pass out after 8 hours of electronic distraction?

Can we be frank and suggest that if someone is watching 4.5 hours of TV a day plus another 4.5 hours spent fooling around with other media and devices, either they're unemployed and not in school, or they're spending every waking minute not spent at work or school being "entertained" by the mass media? And if that's the case, then how can they possibly have time to exercise, cook, clean, read a book, walk the dog, learn something useful, go to night school, sew a new outfit, volunteer at the church, mentor a kid, coach Little League, i.e. live a full active life engaged with family, friends and community, while having some time for their own hobbies/interests?

Can we assume the people working in demanding roles or striving to get a top-notch education simply don't have enough time to kill on 8+ hours of "entertainment" every day?

And can we further assume that the people who are spending half of their waking life seeking distraction/entertainment could be doing a wee bit more on their own behalf if they cut back on passively watching TV or playing some moronic videogame? You like football? Then rip that stupid little controller out of the box and go outside and toss a real football around. Maybe even fall down and scratch a knee as you dive for the "long bomb" catch of a lifetime. Exactly what adventure is there in canned "entertainment"?

Of course nobody with a college degree ever watches TV--or at least, not much. It's a guilty pleasure for those who "know better," while those who don't feel a shred of guilt leave the TV on all day, as if life isn't real unless the TV is droning somewhere in the background.

Memo to America: life isn't real when the TV is on. Maybe we should be demanding a bit more of ourselves instead of whining about how "busy" we are or what a rotten deal we got. Because you can't have it both ways; if you're truly busy, you're lucky to find the time and energy to watch 4.5 hours of TV a week, not a day. Ditto for YouTube, Grand Theft Auto, etc. If you're truly busy, you're busy with active pursuits like playing an instrument or getting into shape or tinkering with an old pickup truck or repainting a set of chairs or, well, anything active which actually engages real people and real goals and real interests. Your interest in TV is nil because you don't have time for all that you want to do.

Yes, I know how it is to be shattered, and too tired to play an instrument or do anything remotely useful; you just want to watch something unchallenging. OK, fine, we all know the feeling. I too watch TV or a movie occasionally. That's why I keep a list of worthy films on the site; a movie is entertainment, to be sure, but it can also be much more than a TV show; it can be a window on another culture, for instance. In any event, let's say you watch a few movies a week or the Food Channel, etc. for relaxation; wouldn't that total 6-8 hours a week, not 32 hours?

And if we're not busy, then what do we expect? Lifelong security, better pay, a trim physique, glowing health and a life of meaning? From what inputs/effort? Yes, ambition can be misdirected, as Albert T. pointed out; but Mark Cuban, Steve Jobs, Larry Ellison, et al. did not storm the gates of the Establishment by sitting around playing videogames and watching TV.

Frequent contributor Harun I. sent in this quote which seems highly relevant to the revelation that the average U.S. household passively watches 60 hours of TV a week, and many more on the spirit-crushing distractions of one "entertainment platform" or another:

Security is mostly a superstition. It does not exist in nature, nor do the children of men as a whole experience it.
Avoiding danger is no safer in the long run than outright exposure. Life is either a daring adventure, or nothing.
To keep our faces toward change and behave like free spirits in the presence of fate is strength undefeatable.
Helen Keller
I know many of you agree because you're written me that your household doesn't have a TV or video game console. To you I say: Bravo. It's amazing what people can find to do when there's no TV or console or device to snap on and zone out.

26 May 2008

The Trillion Dollar Meltdown

The Trillion Dollar Meltdown by Charles Morris and The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means by George Soros:
The Sunday Times review by Edward Chancellor
For several years, debt has been growing faster than incomes in most corners of the English-speaking world. Our economic high priests claimed there was nothing to fear. Sure, there was more debt around, but the architecture of the financial system was more robust and could bear more strain. Then last summer, the great edifice of credit started to collapse. How we arrived here and what it means is the subject of two timely books.

Charles Morris's The Trillion Dollar Meltdown has many excellent qualities besides brevity. In fewer than 200 pages, Morris provides a comprehensive and jargon-free description of the hideously complex financial securities that have brought the credit system to collapse. It is a remarkable story. In the 10 years to the beginning of 2007, Americans borrowed a staggering $9 trillion against their home equity. This surge of credit contributed greatly to the prosperity that Anglo-Saxon economies have enjoyed over the past decade.

Yet credit was plentiful only because lenders had abdicated their traditional role. Bankers discovered how to package loans, insure them, and sell them off. As a result, the credit system turned into a game of hot potato. But last summer, the music stopped and Bear Stearns, a Wall Street bank that had been particularly aggressive in the mortgage field, was left holding the hot potato. By February, the prospect of Bear's bankruptcy sent the financial world into convulsions and the Federal Reserve was forced to embark on a multibillion-dollar bailout.

While the financial crisis is not just about souring mortgages provided to the least creditworthy American home-buyers, subprime loans are a fitting symbol of what went wrong. Creditors might normally be expected to have two thoughts uppermost in their mind: the return of principal and the receipt of sufficient interest to cover prospective losses. This was not the case with subprime loans. The fact that these had little prospect of being repaid bothered no one. Everyone in the credit system (the home appraisers, mortgage brokers, lending banks, Wall Street firms that acquired bundles of mortgages and sold them on, ratings agencies that stamped these securities with their investment-grade imprimatur, as well as the hedge funds that snapped up the riskiest slices of debt) was primarily concerned with fees. This encouraged reckless and predatory lending.

Buy the books here
Morris points out that the new credit system actually favoured riskier loans because they meant higher rates and produced more “spread” for market participants to play with. When the American housing market turned down, lenders turned to financing leveraged buyouts - the subprimes of the corporate world. Clever bankers even found a way to create debt securities when there was no bona fide borrower. Frankenstein securities, which replicated real loans, were constructed out of credit insurance contracts. The supply of credit became infinite, utterly divorced from its traditional role of allocating scarce capital. Financial profits and bankers' bonuses soared.

Alan Greenspan, the chairman of the Federal Reserve, repeatedly praised such financial innovation. He said that risk was better understood and better distributed, and hailed a “new paradigm of active credit management”. His Panglossian view - markets could be left to regulate themselves - blinded him to increasingly dubious activities in the credit markets.

George Soros, the billionaire investor and philanthropist, claims that free-market economists - or “market fundamentalists” - such as Greenspan, are responsible for the current crisis. In The New Paradigm for Financial Markets, Soros proposes an alternative model. Conventional economics holds that markets comprise rational and all-knowing participants and, as a result, tend towards equilibrium. Soros, however, maintains that man is incapable of perfect knowledge. In markets, he argues, people hold views and act upon their opinions. Yet their actions change the nature of what they observe. Soros calls his theory “reflexivity” (he first expounded this notion in his 1987 The Alchemy of Finance).

Economists pretend not to understand what Soros is on about. However, his central insight is intuitively obvious. Mortgage loans are provided because the lender believes houses are a good bet. But a ready supply of loans drives up the value of homes. Rising prices inflate collateral values, making bankers feel even more secure. Builders respond by increasing supply. Home prices, the supply of new homes, and provision of fresh credit escalate. At the start of every bubble is a plausible idea which in time becomes corrupted. The notion that American home prices were essentially stable was one such “fertile fallacy”.

Soros believes that the current crisis exposes the limits of the free-market ideology that has held sway since the early 1980s. Morris is like-minded. Both authors conclude that the crisis threatens to end the era of American financial supremacy, in which the dollar has served as the global reserve currency. Both see problems ahead as more corporate and commercial real estate loans go bad. It's time for a change in economic thinking, says Soros. The next generation of economists will have to understand financial bubbles rather than ignore them, as Greenspan and his fellow central bankers have done. They would be well advised to give Soros's theory of reflexivity serious consideration.

The Trillion Dollar Meltdown by Charles Morris
PublicAffairs £13.99 pp194
The New Paradigm for Financial Markets by George Soros
PublicAffairs £12.99 pp162

19 May 2008

Credit losses per employee

We've all seen those league tables of asset writedowns and credit losses taken by firms since the beginning of last year. The numbers are quite incredible.

But we thought it would be interesting to work out just how much in writedowns and credit losses firms have written off per wholesale banking employee. Detailed below are our amazing findings:

Please note that the headcount figures may not be exact, as some firms do not give out their wholesale staff numbers. We have used our own best estimates, and have tried to exclude brokerage staff numbers where available.

1. Mizuho Financial Group - $5.5bn in writedowns / credit losses, 2,000 wholesale banking employees, $2,750,000 per employee.

2. Wachovia - $7bn, 3,900, $1,794,872 per employee

3. UBS - $37bn, 22,000, $1,681,818 per employee

4. Citi - $40.9bn, 30,000, $1,363,333 per employee

5. Bank of America - $14.8bn, 20,000, $740,000 per employee

6. Merrill Lynch - $31.7bn, 48,100, $659,044 per employee

7. Dresdner Kleinwort - $3.3bn, 6,000, $550,000 per employee

8. Credit Agricole - $6.9bn, 13,000, $530,769 per employee

9. Barclays Bank / Barclays Capital - $7.7bn, 16,200, $475,309 per employee

10. JPMorgan Chase - $9.8bn, 25,000, $392,000 per employee

11. Deutsche Bank - $7.6bn, 20,000, $380,000 per employee

12. SG Corporate & Investment Banking - $3.9bn, 10,500, $371,429 per employee

13. Morgan Stanley - $12.6bn, 38,050, $331,143 per employee

14. Credit Suisse - $6.3bn, 20,000, $315,000 per employee

15. Lehman Brothers - $6.6bn, 30,000, $220,000 per employee

16. Goldman Sachs - $4.1bn, 30,000, $133,667 per employee

17. BNP Paribas - $1.7bn, 13,000, $130,769 per employee

Bush to Arab nations: You're running out of oil

Published Date: 19 May 2008
PRESIDENT George Bush yesterday told leaders of the oil-rich states of the Middle East that they must face up to a future without their precious hydrocarbons.
In a stark warning, he said their supplies were running out and urged them to reform and diversify their economies. The outgoing United States president told the World
Economic Forum, meeting in the Egyptian resort of Sharm el-Sheikh, that it was time
to "prepare for the economic changes ahead".

Mr Bush's family name is inextricably linked to the oil industry, and this was his strongest statement yet on the future of global supplies.

He told the conference: "The rising price of oil has brought great wealth to some in this region, but the supply of oil is limited, and nations like mine are aggressively developing alternatives to oil.

"Over time, as the world becomes less dependent on oil, nations in the Middle East will have to build more diverse and more dynamic economies."

Mr Bush also used his speech to call for more investment in people and "extending the reach of freedom", as well as urging other nations to prevent Iran from obtaining nuclear weapons, and to isolate Syria.

He particularly mentioned women's rights, saying they were key to building powerful economies. He cited Egypt as a model for the development of professional women, girls going to school in Afghanistan and women joining political parties in Iraq and Kuwait.

In an apparent criticism aimed at Saudi Arabia, he told the forum: "This is a matter of morality and of basic math. No nation that cuts off half its population from opportunities will be as productive or prosperous as it could be. Women are a formidable force, as I have seen in my own family and my own administration. As the nations of the Middle East open up their laws and their societies to women, they are learning the same thing."

The president's speech was made only days after he urged Saudi Arabia to increase oil production to ease prices at the pumps, as millions around the globe face increasing costs of filling up and even more grapple with rising food bills.

The future of Scotland's own North Sea oil supply is an issue for both politicians and consumers, who were given a taste of limited fuel shortages during the Grangemouth refinery dispute.

The US has turned dramatically towards biofuels, with Congress raising the federal requirement for using the oil alternative from 6.5 billion gallons last year to nine billion gallons this year. As a consequence, about a quarter of the American corn crop was used for biofuels last year, driving up the price of corn and, hence, also the price of food for millions of families.

Predictions of when the world's oil supplies will fall below global demand range from as early as the next decade, to as late as 2050. Mr Bush has been criticised throughout his term in office for not encouraging more energy alternatives in the US, and for allowing controversial drilling explorations for new fossil-fuel supplies in often environment-ally sensitive areas, such as Alaska.

Analysts warned last night that few in the Middle East, which has two-thirds of the world's oil reserves, are likely to heed Mr Bush. Many have already started diversifying their economies and do not like being preached to by someone so unpopular in the region.

Gerald Butt, editor of the authoritative Middle East Economic Survey, said: "The Gulf states have been trying to diversify their economies away from oil for years, so they'll say, 'This is like teaching your grandmother to suck eggs'.

"Arab states don't like being told what to do by outsiders, and especially by America, whose standing in the region is very low. Bush's comments will be dismissed as unwarranted interference."

Although he praised parts of the Arab world, commentators said Mr Bush had angered many with a speech at the Israel parliament last Thursday, in which he offered unflinching support for the Jewish state but mentioned the Palestinian dream of statehood only once.

Walid Khadduri, a Beirut-based consultant, pointed out that the Gulf states had already been investing windfall profits from high oil prices in major infrastructure projects, including education and housing, and in diversifying their industrial bases.

He said: "Bush's credibility is zero anyway. I really don't know anyone who follows what he says, especially after what has happened in Iraq and then his Knesset speech the other day."

The knock-on effect of rising fuel costs has led to increasing food prices and subsequent riots around the globe, as high prices hit some of the world's poorest.

There is now a desperate attempt to find oil from alternative sources to keep the supply flowing.

Potential sources in Canada would cost almost three times as much to produce as conventional crude oil because they have to be extracted from tar sands. Although the supply, in Alberta, is estimated to be second in size only to Saudi Arabian reserves, the production costs are unlikely to offer much relief for consumers.

While the Bush presidency has tried to reduce its dependence on foreign oil, it has yet to decrease fuel use, say critics.

While the UK produces about 0.3 per cent of the world's supply of oil and uses about 2 per cent, the US produces 2.5 per cent but uses 24 per cent.

Family dynasty is soaked in black gold

BOTH George H Bush and George W Bush will be remembered almost as much for their connections to oil as to the presidency.

Bush Snr owes his fortune to Texas crude, while his son also took posts in the industry before following in his father's footsteps into politics.

Commentators have accused Bush jnr's drive to war in Iraq as merely a quest for oil, with potentially billions of dollars in profit to be made from opening up the country's oil reserves – if Iraq was ever stable.

George Bush Snr, who was president from 1989 to 1993, became a millionaire off the oil industry by the age of 40 in Texas. He started the Bush-Overby Oil Development company in 1951 and co-founded the Zapata Petroleum Corporation two years later. He served as the firm's president from 1954 to 1964. He then entered politics.

After gaining an MBA from Harvard University, Bush Jnr worked in the family oil businesses.

He became a senior partner and chief executive officer of Arbusto Energy, Spectrum 7 and Harken Energy.

Arbusto Energy obtained financing early on from James Bath, a close Bush family friend and in 1979 the sole US business representative of Salem bin Laden, head of the wealthy Saudi family and brother of Osama bin Laden.

Don't expect high prices and shortages of petrol to improve in the short term

ANALYSIS: George Kerevan

HOW close are we to "peak oil", when the world's oil supplies will start to diminish? Petroleum output has shot up by a nearly third since the early 1990s to around 83 million barrels per day, suggesting we are able to squeeze more production when necessary.

But the International Energy Agency predicts oil demand will double between now and 2030 as a result of rising car use in countries such as China. As no major oil fields – those with over 500 million barrels – have been discovered for a generation, this rising demand will be very difficult to meet.

One source will be in small oil fields of the kind being hunted by Scottish companies such as Cairn Energy. Such fields are expensive to find and costly to tap due to the huge infrastructure required. The fact that oil has shot up to $128 (£65) a barrel – the highest ever even taking account of inflation – might make this possible.

But it is unlikely there will be a serious increase in global output for around a decade given the time it takes to build pipelines and tanker terminals. So expect high petrol prices (and shortages) to remain for the near term. Even then, this is likely to be the last surge in oil output and we will reach peak oil by 2030, if not before.

Another source of oil lies in the vast tar sands of Canada. But extracting useable oil from tar involves a vastly expensive industrial process which also results in big emissions.

It is possible to squeeze extra oil from older fields such as the North Sea. This is done by pumping water (or ) into the wells to blow out more oil. But this destroys the sponge-like membranes which contain the petroleum, meaning you get more oil out in the short term but less in the longer term.

Gordon Brown wants Opec to pump more oil to bring down prices. But experts suspect that the size of Opec reserves (80 years at current consumption) have been greatly exaggerated by local politicians. If so, peak oil could be here sooner than we think – some predict as early as 2012.