GlobalEurope Anticipation Bulletin

In the 2 years of its existence, European think-tank LEAP/Europe 2020 has published a respectable number of thought-provoking reports, mostly in its subscription monthly newsletter GEAB:
The GlobalEurope Anticipation Bulletin is the confidential letter of think-tank LEAP/Europe 2020. As such, our aim is to provide our readers with state-of-the-art analyses of geo-political anticipation centered around the study and follow-up of the global systemic crisis, itself focussed on the evolution of the dollar and of the US economy, and their impact on international economy and financial markets, all that seen from a European perspective.
On Friday, 15, 2008, the latest GEAB saw the light, and parts were published on the LEAP website. It will likely take a while before an English version is available; therefore we at The Automatic Earth took it upon ourselves to translate the French version; the statements in the report certainly merit a little extra work, as well as attention.

Since the conclusions that LEAP/E2020's analysts reach in the report are, to put it mildly, more outspoken than just about any other publication, we feel they provide substantial food for thought and discussion. Are these guys nothing but a platoon of senile doomers, or are they? For more LEAP reports, go to their website.




Global systemic crisis/ September 2008 - Collapse phase of the real economy in the US
Public announcement GEAB no 22 (February 15 2008)

According to LEAP/E2020, the end of the third trimester will mark a new inflection point in the development of the systemic global crisis. By this time, the cumulative impact of the different strands of the crisis (see table below) will reach maximum strength and affect the heart of the systems involved in a decisive manner, led by the United States as the epicenter of the crisis.

In the US, this new inflection point will translate into the collapse of the real economy, the final socio-economic stage of the bursting of the series of the housing and financial bubbles (1) and the continuation of the fall in the value of the Dollar. The collapse of the real US economy represents simply the almost complete halt of the American economic machinery: private and public bankruptcies in great number, wide ranging closures of enterprises and public services (2),...

As a forewarning of events to follow, it is interesting to note that from March 2008, the US government will cease publication of its economic indices for reasons of budgetary constraints (3). The articles of GEAB N 2 and related alarms, remind us of the correlation between our anticipation of the fall to come in the Dollar with the end of the publication of M3 by the US federal Reserve. Here we see a new clear signal that the American leaders henceforth expect profoundly dark economic outlooks for their country.


Temporal perspective of the seven strands of the impact phase of the systemic global crisis anticipated since mid-2007 - Source LEAP/E2020, GEAB N°18 (10/2007) Click to enlarge

In this GEAB N 22, the experts of LEAP/E2020 anticipate the concrete consequences of this meltdown in the real American economy on the United States itself, and on other regions of the planet. In parallel, our team develops a series of five strategic and practical recommendations to protect oneself from the worsening of the systemic crisis of the coming months.

On the occasion of the second anniversary of the publication of its famous "Systemic global crisis warning" that circled the globe in February 2006, LEAP/E2020 wishes nothing less than to remind us that from now on we are entering a period without historic precedent. Repeatedly for two years, our team of researchers has stressed that comparisons with previous economic crises are fallacious.

It will not be in its effects a "remake" of the crisis of 1929, nor a repeat of the oil shocks of the 1970s or the stock market crash of 1987. It will be a systemic global crisis, that is to say affecting the integration of the planet and directly touching the foundations of the international system which has been the means of global organization for decades.

For LEAP/E2020, it is also edifying to note that two years after the publication of its famous "Systemic global crisis warning" which had simultaneously aroused the interest of millions of readers over the whole world and the condescending irony of the majority of the "experts" and "leaders" of the economic and financial world, everyone is now convinced that there is a crisis, that it is global and that it could well be systemic. Our team is constantly amazed at the incapacity of these experts and leaders to comprehend the nature of the phenomenon that we are living through.

To read them, this systemic global crisis would be only a sort of "classical" crisis, but "larger". This is how the financial media reflects the dominant interpretations of the on-going crisis. For our team, this approach is not only intellectually lazy but morally culpable, as it has as a principal consequence the denial of the opportunity for readers (whether they are simple citizens, individual investors or responsible private or public institutions) to prepare themselves for the shocks to come.

Thus, as opposed to what one could read these last weeks in the dominant media, always quick to try to camouflage reality in order to serve the interests which dominate them, LEAP/E2020 wishes to recall that it is above all in the United States that this global systemic crisis takes an unprecedented form (the "Very Great US Depression" as our team called it in January 2007 (7)), since it is around them, and them only, that the world which emerged from the second world war was gradually organized.

The various numbers of the GEAB largely explained this situation. To summarize, we consider it useful to stress that it is neither Europe nor Asia which has a negative rate of saving, a generalized housing crisis throwing millions of citizens on to the street, a currency in free fall, abysmal public and commercial deficits, an economy in recession and, to crown the whole, expensive wars to finance.

It will therefore be neither Asia nor Europe (more exactly ` the euro' zone) that will undergo the most brutal consequences, the most long lasting and most negative aspects of the crisis in progress; but the United States and countries or economies strongly tied to the United States (what our experts call "American risk") (8). There is indeed a "decoupling" between the US economy and those of the other great areas of the world.

But "decoupling" does not mean "independence". It is quite obvious, as LEAP/E2020 anticipated many months ago, that Asia and Europe will be affected by the crisis. "Decoupling" means that the evolution of the US economy and those of the other great areas of the world are no longer synchronized, that Asia and Europe will move henceforth according to trajectories no longer determined by that of the US economy.

The global systemic crisis marks in fact the beginning of "decoupling" between the US economy and those of the remainder of planet. The economies not "uncoupled" will be those which will be dragged into the American downward spiral.


Steep fall in the number of self-employed in the United States - Source Office of Labor Statistics/Merril Lynch (the shaded zones represent periods of recession). Click to enlarge

Concerning the stock markets, our team anticipated as of October 2007 that the world's bourses would lose between 20% and 60% by region during the year 2008. Today, we must revise our prediction in the direction of an even larger fall since, on the one hand, the stock exchanges have in general already lost between 10% and 20% since the beginning of the year (1°), and that, on the other hand, the meltdown of the real economy in the United States by the end of the summer 2008 will precipitate a downward spiral in all the world's bourses. For LEAP/E2020, we now predict a fall of 50% on average compared to 2007 (including in the emerging markets) (11).

In this number 22 of Global Europe Anticipation Bulletin, notably with our alert to the meltdown of the real economy in the United States from September 2008, we again try to warn those who are concerned by the consequences of this major event which will generate very serious socio-political disorder in the United States (13) as the economy is collapsing (14), which will of course have very heavy repercussions throughout all of the financial and monetary markets and for the world economy. We still have not reached the heart of the crisis. According to LEAP/E2020, it will be reached in the second half of 2008.



Posted by Ilargi at 11:40 AM
12 comments:
Anonymous said...

That's the news I've been waiting for. Celebrations all round. Bye Bye Yankees, Everyones had enough of your hegemony by violence, vainglorious delusions of grandeur, arrogantly blessing your nation as synonymous with God's name. Go forth and collapse into anarchy, make the best possible use of all those handguns you've got laying around - buy hollow point rounds.
February 16, 2008 3:49 PM
Burgundy said...

Wow, what an article. Thanks very much for bringing this to light.

I posted an article at Tod regarding Putin's threat of retaliation if Kosovo declared independence (which they are due to do tomorrow). Might be something to keep an eye on IMO.

Here's the link to the newspaper article:

http://www.telegraph.co.uk/news/main.jhtml?xml=/news/2008/02/15/wputin115.xml
February 16, 2008 4:05 PM
Anonymous said...

Thanks for this article and the link to the website.

I've gone back through the English language section of Abstracts& stories and read several of the articles listed there. There are about 3 pages of them from early 2006. After I read several of these articles, I read a lot more of them!

It's like reading a history of economic and some political things that have happened in the past two years! Yikes--this is an eye opening website. Actually, YOUR website is pretty eye opening, too.

thanks so much for your website and the work you're doing here.

A reader from TOD,

Shamba
February 16, 2008 4:19 PM
In The Shit said...

Thank you for the translation. I don't find LEAP's overall prognostications far-fetched, but I do find them rather vague. I wonder where they are getting their "currency in free fall" idea from. Seems like in a deflationary environment the currency would strengthen? Maybe just not relative to an also strengthening euro.

Also re the decoupling, it's interesting that the article makes such a strong effort to emphasize that the U.S. is the epicenter of the crisis, and that decoupling will spare some other parts of the world, which will only be "affected" (no further explanation) by the crisis. I must beg to differ... The UK is probably in deeper shit than we are. I think it's just not PC for French intellectuals to not try to blame whatever the problem is on the U.S. We didn't inflate Spain's housing bubble, or Greece's. Europe is going to get rocked. The only decoupling happening in Europe will be between bank depositors and their money...

I think the excess of the past few years was so massive that it's easy to cut a lot of it out and still live a comfortable life. Unemployment will definitely skyrocket and banks will fail and so on, but what it ultimately all leads to is an economy more in line with reality. The transition will be more painful for the spoiled, less so for the lean. Yes a lot of turmoil is on the way, but we are already so massively socially fucked up as a nation that it will be nothing new for us. We will stagger through like the drunken deaf idiots we are.
February 16, 2008 4:27 PM
Anonymous said...

Anything more on this; "In parallel, our team develops a series of five strategic and practical recommendations to protect oneself from the worsening of the systemic crisis of the coming months."
February 16, 2008 5:59 PM
ric said...

Anon,
Their recommendations start on page 15 of their (for subscribers) report:

"Five strategic and operational recommendations to be protected from the aggravation of the crisis
Stocks or bonds?
The recognition of a new « American risk
The new safe heaven currencies
Real estate: Selling, keeping or buying ?
Risking less for losing less (page 15)"
GEAB-N-22
February 16, 2008 7:43 PM
OuttaControl said...

Burgundy

Wow, what an article. Thanks very much for bringing this to light.

I'm not trying to be a jerk but what did you find particularly intresting in the article?
February 16, 2008 7:57 PM
Anonymous said...

Some of their predictions made a year ago:

In April 2007, nine practical consequences of the unfolding crisis will converge:

1. Acceleration of the pace and size of bankruptcies among US financial organisations: from one per week today to one per day in April
2. Spectacular rise of US home foreclosures: 10 million Americans out on the street
3. Accelerating collapse of housing prices in the US: - 25%
4. Entry into recession of the US economy in April 2007
5. Precipitous rate cut by the US Federal Reserve
6. Growing importance of China-USA trade conflicts
7. China's shift out of US dollars / Yen carry trade reversal
8. Sudden drop of US dollar value against Euro, Yuan and Yen
9. Tumble of Sterling Pound

No. 12
February 16, 2008 8:57 PM
doctorbob said...

I think the lesson from this is that changes happen rather more gradually than some would expect. There is a lot of inertia in the economic system and it takes a long time to turn around in either direction. Changes to "boom" are relatively slow and the coming "bust" will happen over years rather than months - but happen nonetheless.
February 17, 2008 5:08 AM
FB said...

Hello,

I tend to agree with ITS above.

Interesting but rather vague article.

A few points.

Concerning the free fall of the dollar, they did say currency, not money, meaning with respect to other (foreign) monies.

I agree that though the U.S. is certainly the epicenter and significantly responsible (e.g. the subprimes), it is not alone. A good part of Europe and Asia followed suit and so will suffer. But I am not sure why everyone thinks the U.K. will suffer so terribly.

Concerning turmoil, if this article is at all accurate, the situation will exceed turmoil. I am not sure how to qualify it, but it will be a shock.

Ciao,
FB
February 17, 2008 5:13 AM
doctorbob said...

I was going to add (in relation to points listed by "Anonymous" above):

1. Acceleration of the pace and size of bankruptcies among US financial organisations: from one per week today to one per day in April - NOT TO THIS EXTENT YET.
2. Spectacular rise of US home foreclosures: 10 million Americans out on the street - STEADY RATHER THAN SPECTACULAR.
3. Accelerating collapse of housing prices in the US: - 25% - SOME RECENT DATA ON THIS SITE SHOWS DROPS OF UP TO HALF THAT SO FAR, VARYING FROM STATE TO STATE.
4. Entry into recession of the US economy in April 2007 - DE FACTO RECESSION NOW, PROBABLY OFFICIAL BY SUMMER '08.
5. Precipitous rate cut by the US Federal Reserve - PARTLY SO NOW, PROBABLY APPLY BY SUMMER '08.
6. Growing importance of China-USA trade conflicts - JUST A FEW MINOR SPATS SO FAR.
7. China's shift out of US dollars / Yen carry trade reversal - MINOR AS YET.
8. Sudden drop of US dollar value against Euro, Yuan and Yen - SIGNIFICANT BUT NOT HUGE DROP.
9. Tumble of Sterling Pound - STERLING DOWN ABOUT 8% AGAINST EURO IN LAST 6 MONTHS, COULD WELL DROP FURTHER 10% BY YEAR END.

Overall, I'd expect "trauma months" like January '08 to happen every 3-6 months for rest of this year and expect the real crisis to hit in the second half of '09.
February 17, 2008 5:16 AM

Cholesterol control is pretty much a scam.

Cholesterol control is pretty much a scam. The cholesterol total is not as important as the ratio. Each HDL molecule can gather up to 6 LDL molecules and return them to the liver for processing. If the HDL is low in an individual then the LDL can add to the plaque building process in the arteries. Just as many people with low cholesterol have heart attacks as those with high numbers. A longevity factor is link to high HDL numbers. The secret is to boost HDL and it will take care of the LDL for you.
Omega 3 will boost the HDL significantly. Walnuts, Cod liver Oil, Almonds etc should be introduced into the diet and substituted for other fatty foods/calories that may be routinely found in the diet. I had cholesterol that totaled close to 300. My HDL was only 42 or so at the time. I learned how to eat correctly and exercise routinely. My cholesterol total is now 195 and my HDL is 85. My blood pressure was 120-130 ish. It's now between 95-105. It's not rocket science, and statin drugs never prevented anyone from having a heart attack. It's just a money making gimmic with deadly consequences imho. I tried a statin drug (Vytorin) early on, and after a couple months on 10mg/day the muscles in my lower back and thighs were giving out with terrible pain. I took myself off of the statin and researched the problem and corrected it myself. I happen to be a biologist and studied the cholesterol issue for a couple of years. Just make sure you intake plenty of:
(1) Soluble Fiber--retains bile (stored in the gallbladder and used in digestion for fat metabolism) and forces your liver to borrow cholesterol from the blood stream to produce more bile.
(2) Omega 3---HDL production
(3) Magnesium- for insulin transfer across cellular membranes
(4) Cinnamon---for glucose control
(5) Plenty of endurance exercising i.e. Long brisk walks etc.
(6) Substitute cooking oils with virgin coconut oil. Use olive oil cold for salads. Olive oil is a good oil but oxidizes easily under low heat and should not be used much in cooking.
(7) Use plenty of garlic in cooking and drink green tea
(8) Stay hydrated---plenty of water during the course of the day especially if you're a coffee drinker or consume alcohol.
(9) Hope that helps.

Burning down the house

Behind all the blather and bullshit about the Federal Reserve's rescue gambits and the machinations of the ratings agencies, and the wiles of foreign sovereign wealth, and the incomprehensible mysteries of markets, and the various weather forecasts of a gathering "recession" is the simple fact that the USA is a way poorer nation than we imagined ourselves to be six months ago. The American economy has been running on the fumes of "creatively engineered" finance (i.e. new-and-improved swindling) for years, and now these swindles are unraveling. In their aftermath, they leave empty wallets, drained bank accounts, plundered retirements funds, boiled away capital reserves, worthless stocks, bankrupt companies, vandalized housing tracts, ruined families, and Wall Street executives who are still pulling down multimillion-dollar pay packages despite running their companies into the ground.

We're burning down the house and kidding ourselves that there is a remedy for it. All the rate cuts and loans to big banks and bank-like corporate organisms, and "monoline" bond insurers, and mortgage mills amount to little more than a final desperate shell game to conceal the radioactive pea of aggregate loss. The losses are everywhere, and when you add up seven billion here and eleven billion there they probably amount to something like a trillion dollars in sheer capital evaporation -- not counting the abstract "positions" that the capital was leveraged onto by the playerz and boyz who mistook algorithms for productive activity.

The shell game may run a few more weeks but personally I believe the timbers are burning. The losses are no longer "contained" or concealable. A consensus has now formed that we're in for a "recession." The idea is that, yes, this seems to be the low arc of the business cycle. Fewer Hamptons villas will be redecorated in the interim. We'll gird our loins and get through the bad weather and when the sun shines again, we'll be ready with new algorithms for new sport-with-capital.

Uh-uh. Think again. This is not so much financial bad weather as financial climate change. Something is happenin' Mr Jones, and you don't know what it is, do ya? There has been too much misbehavior and it can no longer be mitigated. We're not heading into a recession but a major depression, worse than the fabled trauma of the 1930s. That one occurred against the background of a society that had plenty of everything except money. Back then, we had plenty of mineral resources, lots of trained-and-regimented manpower, millions of productive family farms, factories that were practically new, and more than 90 percent left of the greatest petroleum reserve anywhere in the world. It took a world war to get all that stuff humming cooperatively again, and once it did, we devoted its productive capacity to building an empire of happy motoring leisure. (Tragic choice there.)

This new depression, which I call The Long Emergency, will play out against the background of a society that has pissed away its oil endowment, bulldozed its factories, arbitraged its productive labor, destroyed both family farms and the commercial infrastructure of main street, and trained its population to become overfed diabetic TV zombie "consumers" of other peoples' productivity, paid for by "money" they haven't earned.

There is a theory (see Nouriel Roubini's blog) that a reform process will now ensue in the financial realm, new regulation and oversight of the same old familiar activities. This too, I'm afraid, will prove to be wishful thinking. The financial system will not be reformed until it lies in smoking wreckage, and when that "re-form" happens the armature of the re-organizing society will barely resemble the one that the previous burnt-down-house was designed to dwell in. Among other things, it will not support capital enterprise at anything like the scale that we became accustomed to lately. Globalism will be over. The great nations of the world will be scrambling desperately for the world's remaining oil supplies. It will not be a friendly contest, and anyone who thinks that current trade relations and capital flows will continue despite that is liable to be disappointed. (Are you reading this Tom Friedman?)

Long before the mathematical projections of oil depletion play out, the oil markets themselves -- and all the complex operations that they comprise, such as drilling and exploration, and the movement of tankers around the planet -- will destabilize and seize up. We will no longer be any oil exporter's "favored customer." Many of the exporters will enjoy watching us suffer. Contrary to the political platitude-du-jour, the USA will never become "energy independent" in the way we currently imagine. Rather we'll become energy independent by being deprived of imported oil, and we'll be thrown back on our own dwindling supplies -- which means that we're not going to run our system of daily life the way it has been set up to run. When Americans can no longer run their cars on a whim, they will simply go apeshit and you can kiss normal politics goodbye.

The financial system that emerges from this cataclysm, and the economy it serves (which is supposed to be the master of its capital deployment "arm," not its servant) will likely be modest to a degree that will shock and embarrass everyone currently connected with what we have lately called finance. If it even trades in paper, that paper will have to stand for something based in reality, either a productive activity or a genuine asset. It may take decades for this society to even regain the confidence necessary to operate such an elementary system -- or it may not come back at all, at least as far as the horizon lies before us. That's how bad the mischief and the damage has been.

It's not hard to understand why the Bernankes, Paulsons, Lawrence Kudlows and other public representatives of capital keep pretending that everything is under control. On the other side of their pretenses lies disorder and hardship. One wonders, of course, what they really see in their private minds' eyes. Do they actually believe that the statistics issued by their serveling agencies amount to a plausible picture of reality? Are they so lost in their fantasies of "management" that they think they're controlling events?

My guess is that their credibility is spent. In the weeks ahead, nobody will know who or what to believe. We may even run out of questions to ask as we just all collectively stand there in a thrall of wonder and nausea, watching the nation's financial house burn down.

What you don’t know can hurt us

The Bush administration has a long and comical history of going to great lengths to hide bad news from the public. Today, Amanda at TP reports on the latest gem:

The U.S. economy is faltering. Family debt is on the rise, benefits are disappearing, the deficit is skyrocketing, and the mortgage crisis has worsened. Conservatives have attempted to deflect attention from the crisis, by blaming the media’s negative coverage and insisting the United States is not headed toward a recession, despite what economists are predicting.

The Bush administration’s latest move is to simply hide the data. Forbes has awarded EconomicIndicators.gov one of its “Best of the Web” awards. As Forbes explains, the government site provides an invaluable service to the public for accessing U.S. economic data:

“This site is maintained by the Economics and Statistics Administration and combines data collected by the Bureau of Economic Analysis, like GDP and net imports and exports, and the Census Bureau, like retail sales and durable goods shipments. The site simply links to the relevant department’s Web site. This might not seem like a big deal, but doing it yourself–say, trying to find retail sales data on the Census Bureau’s site — is such an exercise in futility that it will convince you why this portal is necessary.”

Alas, as the economic conditions worsen, the administration decided to shut down this “necessary” website, citing “budgetary constraints.”

How expensive could it be for the Economics and Statistics Administration to keep a website online? Probably not much, but the political costs of making embarrassing data easily accessible to the public is probably quite high.

As long-time readers may recall, I started keeping track of instances in which the Bush administration would hide inconvenient data quite a while ago. Some of my favorite examples include:

* In March, the administration announced it would no longer produce the Census Bureau’s Survey of Income and Program Participation, which identifies which programs best assist low-income families, while also tracking health insurance coverage and child support.

* In 2005, after a government report showed an increase in terrorism around the world, the administration announced it would stop publishing its annual report on international terrorism.

* After the Bureau of Labor Statistics uncovered discouraging data about factory closings in the U.S., the administration announced it would stop publishing information about factory closings.

* When an annual report called “Budget Information for States” showed the federal government shortchanging states in the midst of fiscal crises, Bush’s Office of Management and Budget announced it was discontinuing the report, which some said was the only source for comprehensive data on state funding from the federal government.

* When Bush’s Department of Education found that charter schools were underperforming, the administration said it would sharply cut back on the information it collects about charter schools.

My friends at TPM took this even further, and compiled a comprehensive list, through a project they called, “What You Don’t Know Can’t Hurt Us.” Paul Kiel published the latest version a couple of months ago, and it’s chuck full of mind-numbing examples like these.

When public information conflict with the White House’s agenda, the Bush gang has a choice — deal with the problem or hide the information. Guess which course they prefer?

Utter Global collapse

In a recent interview on CNBC with Ron Insana, one of the “old-timer”funds manager, Julian Robertson, predicted “utter global collapse” as a consequence of the bursting of the world-wide property bubble.

Often called “Never Been Wrong Robertson”, the former head of Tiger Management (once the largest hedge fund in the world), is extremely worried about the speculative bubble in real estate.

Specifically, he is very worried about a world that is sustained by American consumer spending which is in turn 1/4 sustained by a property bubble. He predicts that 20 million people could lose their homes once the property bubble bursts.

Even more worrisome, he thinks central banks around the globe out of desperation will try to re-inflate the world economy with more liquidity that will create an inflationary spiral unseen in the economic history of mankind. “Where does it end?”, Insana asked Robertson. “Utter global collapse,” he answered. But not just economic collapse … collapse of epic proportions. Collapse and disintegration of all infrastructure, including government. Inflation will run into the double and triple digits. “Food production will fall. People will be carrying around U.S .

dollars in wheelbarrows like Germany,” he said.

There will be “total collapse of public infrastructure. Total collapse of medical care systems. All public pension plans, Social Security will collapse. All corporate pension plans will collapse.”

“The American consumer is effectively now supporting the rest of the planet,” he continued. “Consumption rates in all other nations are falling, have fallen to the point that the tax revenues to governments, that the business and industries those nation states are providing is now a net negative number relative to total debt service and public cost, that this exists in virtually every nation state on the planet now.”

And for much of this “doom”, interestingly, he blames the Bush-Cheney “regime”. “They have now consolidated power and money on the planet to the maximum extent possible. The planet’s net liquidity, that is its, net free cash flow. Is now a negative number. The planet is not simply sinking into a sea of red ink; it is already sunk. The people just don’t realize it yet,” he said.

According to Robertson, “the Bush-Cheney regime is preparing the nation for transition from democracy into dictatorship because a dictatorship will be necessary to control, in 5 years time, food and water riots.” He said “the federal government, that part of Patriot II Act, the internal exile, that the government is going to have to build now huge detention compounds on federal lands, probably in the West where the land is available, to potentially house 50 million or more citizens that will be in financial ruin.”

In 10 years time, whoever is left will be effectively starting again, he said. “More importantly, and I’m trying to think how we imply this or how we express this to the people, what extraordinary times we are living in and how the destruction of the planet has been engineered by the Bushonian Cabal from 1980 to 1992, and then from 2001 to present, which has effectively destroyed the economic liquidity of the planet,”

he said.

Robertson ended the interview by saying that he hopes he is not alive to see this. “The lucky ones are the ones who are my age now,” he said.

At the Heart of Deepening Monetary Disorder: Nolan

It was an eventful week for indications of the real economy’s (waning) soundness. At 15.2 million annualized, January vehicle sales were the weakest since October 2005 (that followed more than a year of very strong sales). A larger-than-expected increase in weekly initial unemployment claims (356k) pushed continuing unemployment claims rose to the highest level (2.785 million) since late 2005. The ABC/Washington Post weekly Consumer Comfort index sank a notable 6 points this week to negative 33, the lowest reading since the early nineties.

Importantly, this week’s Federal Reserve survey of senior bank-loan officers provided confirmation both that bankers have become much more cautious in lending and that borrowers have lost enthusiasm for taking on more debt. Moreover, any indication of general tightening of bank Credit takes on major significance today due to the seizing up and breakdown of Wall Street finance. Inarguably, what erupted last year in subprime has now evolved into a broad-based and severe Credit tightening. Notably, 80% of banks tightened Credit for commercial real estate lending and better than a third tightened commercial and industrial (C&I) Credit. It is worthwhile excerpting directly from the Fed’s survey:

“In the January survey, significant numbers of domestic respondents reported that they had tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the past three months; the remaining respondents noted that their lending standards had remained basically unchanged. About 55% of domestic respondents indicated that they had tightened their lending standards on prime mortgages, up from about 40% in the October survey. Of the thirty-nine banks that originated nontraditional residential mortgage loans, about 85% reported a tightening of their lending standards… compared with about 60% in October…”

“About 60% of domestic respondents…indicated that demand for prime residential mortgages had weakened over the past three months, and 70% of respondents…noted weaker demand for nontraditional and subprime mortgage loans over the same period… About 60% of domestic respondents indicated that they had tightened their lending standards for approving applications for revolving home equity lines… Regarding demand, about 35% of domestic banks…reported that demand for revolving home equity lines of credit had weakened over the past three months.”

“About 10% of respondents -- up from about 5% in…October -- reported that they had tightened their lending standards on credit card loans… About 30% of respondents noted that they had reduced the extent to which such loans were granted to customers who did not meet credit-scoring thresholds… About 15% of domestic banks -- up from about 5% in…October -- indicated a diminished willingness to make consumer installment loans… About one-third of domestic banks -- up from about one fourth… -- reported that they had tightened their lending standards on consumer loans other than credit card loans… Regarding loan demand, about 35% of domestic institutions, on net, indicated that they had experienced weaker demand for consumer loans of all types…”

“About 80% of domestic banks reported tightening their lending standards on commercial real estate loans over the past three months, a notable increase from the October survey. The net fraction of domestic banks reporting tighter lending standards on these loans was the highest since this question was introduced in 1990…”

“In the January survey, one-third of domestic institutions…reported having tightened their lending standards on C&I loans to small as well as to large and middle-market firms over the past three months. Significant net fractions of respondents also noted that they had tightened price terms on C&I loans to all types of firms… Compared with domestic institutions, larger net fractions of U.S. branches and agencies of foreign banks reported having tightened lending standards and terms on C&I loans…”

With Wall Street’s securitization markets basically closed for business and even bank Credit Availability now tightening meaningfully, January’s collapse in the ISM Non-Manufacturing index should have been less of shock to the markets. After all, the services-based U.S. economy is primarily finance-driven, and our financial system is floundering.

The ISM Non-Manufacturing index unexpectedly sank 12.5 points to 41.9 (below 50 indicates contraction), the lowest level since October 2001. Expectations had the index slipping only a point or so to a still expansionary 53. Instead, New Orders dropped more than 10 points to 43.5, while the Prices component dipped ever so slightly to a disconcerting 70.7. Alarmingly, the Non-Manufacturing Employment index sank to 43.9, the lowest reading since the 43.9 registered in the month subsequent to the 9/11 terrorist attacks. This report corroborates the recent dismal jobs report, where “Service-Producing” job growth collapsed from December’s 143,000 (5-month average growth of 138,000) to January’s 34,000.

It is worth noting that, despite the bursting of the technology Bubble, the Non-Manufacturing index remained above 50 (at 50.7) through February 2001. But as Credit problems engulfed the corporate debt market, the Employment component proceeded to drop 6.4 points in 11 months to fall to 44.3 by early 2002. Remarkably – and indicative of breadth and severity of the unfolding Credit Crises – the Non-Manufacturing Employment index sank 7.9 points just last month. Meanwhile, the ISM Manufacturing Employment index declined 4.7 points in two months to its lowest level since September 2003. The Bubble Economy is now clearly suffocating from insufficient Credit. In particular, the unfolding Corporate Credit Crisis has begun to impact jobs, incomes and the overall economy.

It was, as well, an eventful week for indications of the soundness of the U.S. and global financial systems. On the inflation front, major commodities indices (including the CRB and the UBS/Bloomberg Constant Maturity) surged to record highs. Platinum jumped 7% this week to a record on tight supplies and power shortages in South Africa. Lead gained 5%. Copper jumped 7.5% (biggest gain in almost a year), increasing y-t-d gains to almost 16%. Palladium rose to the highest price since 2002. Sugar rose 5% on Friday, and I’d be remiss not to note crude’s 4% one-day surge.

But when it comes to spectacular moves, wheat takes the cake. Prices surged to yet another record high (up 30% y-t-d), as forecasts have U.S. stockpiles falling to the lowest level since 1948. Global supplies are said to be the lowest since 1978. Alarmingly, wheat increased the 30 cent daily limit in Chicago trading for five straight sessions, with Bloomberg reporting this week’s 16% gain as the “biggest in history.” Prices are now up 140% y-o-y. Along for the ride, soybeans rose 4% this week to a near-record ( U.S. inventories at 4-yr low), increasing one-year gains to 80%. Corn prices gained 2% (having doubled in the past two years), also trading at record highs. Production and inventory concerns saw coffee prices rise 5.8% this week to the highest level since 1999. Cocoa gained 3.8% this week (37% 1-yr gain).

The question remains: How much will the Chinese, Indians, Russians, American consumers and others be willing to pay for wheat and other vital commodities? For energy? For stores of value such as gold, silver and the other (increasingly) precious metals in an age of unregulated, unrestrained, unanchored, electronic-based, securities-based, and market-driven global “money” and Credit. With trillions of dollar liquidity sloshing vagariously around the global financial “system”, there is clearly more than ample high-octane inflationary fuel to destabilize markets for myriad essential things of limited supply. And, increasingly, there is talk of problematic margin calls and derivative-related issues impacting commodities trading conditions. The talk is of trading dislocations and nervous “bankers” pulling away from the financing of hedging activities in various markets. Or, in short, we are witnessing a precarious ratcheting up of Monetary Disorder – in a multitude of key markets and on a global basis.

At the Heart of Monetary Disorder, we have a leveraged speculating community increasingly on the ropes. January was a tough month for the hedge fund community. In particular, it appears the (over-hyped) “long/short” (holding both long and short positions) and (over-hyped) “quant” funds had an especially tough go of it. To begin the New Year, last year’s favorite stocks (i.e. technology, emerging markets, energy, and utilities) were hammered, while the heavily shorted sectors have significantly outperformed (i.e. homebuilders, banks, retailers, “consumer discretionary,” and transports). The yen and Swiss franc (currencies traders had shorted to finance higher yielding “carry trades”) have rallied. Even the dollar has rallied somewhat. Many speculators have been (caught) short commodities, having expected negative ramifications from the bursting of the U.S. Credit Bubble. Others have been caught over-exposed to emerging equities and debt markets. And, increasingly, it appears various trades throughout the complex corporate Credit arena have run amuck.

Friday, various indices of corporate credit risk moved to record highs, including the previously stalwart “investment grade” sector. Leveraged loan prices fell to record lows late in the week, as talk of further bank and hedge fund liquidations captivated the marketplace. While the status of the (“monoline”) Credit insurers is now a central focus, behind the scenes there is increasing angst at the prospect for a disorderly unwind of various leveraged trading strategies in corporate Credits and Credit derivatives. “Synthetic” CDOs (collateralized debt obligations) – pools of Credit default swaps and other derivatives – are especially vulnerable and problematic for the system. In short, the Corporate Credit Crisis took a decided turn for the worse this week. There is, with the economy sinking rapidly and the leveraged speculating community faltering abruptly, little prospect at this point for stabilization. The downside of the Credit Cycle is attaining overwhelming momentum.

The Wall Street punditry seems to go out of its way to get things wrong. The latest talk is that the market will simply look over the “valley” and begin focusing on a recovery from what will be, at worst, a brief and mild recession. The relative strong performance of the banks, retailers, homebuilders, and transports is accepted as confirmation of the bullish view. I’ll instead take the view that the recent major squeeze in the heavily shorted stocks and sectors is only further destabilizing and indicative of dynamics troubling to the leveraged speculating community and the Credit system more generally. “Hedges” have stopped working, creating a backdrop of angst and forced liquidations.

Despite last year’s subprime collapse and mortgage turmoil, the leveraged speculating community overall chalked up another stellar year of performance. Actually, the “community” in total likely boosted returns with bets against subprime and mortgage Credit more generally. Certainly, the hedge funds profited nicely from shorts on the financial and consumer sectors. Ironically, the initial stage of the bursting of the Credit Bubble proved a favorable backdrop for many of the major players and the community in general. The deluge of industry inflows ran unabated through much of the year, a crucial dynamic that masked rapidly developing fragilities and vulnerabilities. These flows were surely critical in supporting speculative trading positions away from the mortgage bust.

In particular, I believe the general backdrop delayed a problematic unwind of leveraged and highly speculative positions in corporate Credits (securities, derivatives and other “structured products”). Shorting mortgage-related Credit last year provided a convenient mechanism for hedging corporate Credit and equity market risk. Meanwhile, the combination of profitable (mortgage bust-related) shorts and hedges – in concert with industry fund inflows – emboldened the speculators to press their (huge) bets on technology, energy, the emerging markets, global equities, and other speculative Bubbles. The relative resiliency of the U.S. corporate Credit market and global markets through 2007 played a critical role in delaying impending economic and stock market adjustment.

Well, I believe the dam broke in January. The leveraged players were hit with losses from all directions. Their long positions were immediately slammed with simultaneous bursting Bubbles round the globe. Meanwhile, a rush to unwind positions led to upward pressure on the heavily shorted sectors, only compounding the leverage speculating community’s predicament. Last year fostered an extraordinary dynamic of ballooning “crowded trades,” and January saw the bursting of this multifaceted Bubble.

The leveraged speculating community has suffered the occasional tough month – last August providing a recent case in point. Each time, however, performance quickly bounced back. In true Bubble fashion, each quick recovery from a setback emboldened all involved; industry fund inflows not only never missed a beat – they accelerated. Yet a strong case can be made today that this (historic) Bubble has now burst – that last year was the “last gasp” before succumbing to New Post-Credit Bubble Realities. I don’t expect performance to bounce back, while I do foresee a flight away from the leveraged speculating now beginning in earnest. With “crowded trades” unraveling virtually across the board, marketplace risk is now escalating significantly for leveraged strategies in general. Systemic liquidity issues and dislocated market conditions have created an environment where there is seemingly no place to hide.

Importantly, a leveraged speculating community “unraveling” would prove a death blow for myriad sophisticated trading strategies and risk models, with enormous ramifications for systemic stability. There are unmistakable “Ponzi Dynamics” involved here worthy of a few Bulletins.

Going forward, I expect a foundering leveraged speculating community to be At The Heart of Deepening Monetary Disorder. The initial victims appear the fragile global equities market Bubbles and the U.S. Corporate Credit market. Forced deleveraging of hedge fund corporate debt and derivatives is in the process of creating a massive overhang of securities to sell, in the process profoundly curtailing Credit Availability and Marketplace Liquidity throughout. The ramifications for our finance-based Bubble Economy are momentous. As an economic and financial analyst (as opposed to “fear-monger”), I feel it is imperative to highlight that it is more “technically” accurate to categorize the unfolding scenario in the historical context of an economic “depression” rather than “recession.” This is certainly not shaping up as a short-term inventory-led economic adjustment or “mid-cycle” slowdown. Instead, we have now entered the very initial stages of what will likely prove a deep, prolonged and arduous adjustment to the underlying structure of our Credit and economic systems.

The Credit Crunch – In 2008 The Worst May Keep Getting Worse

By: Satyajit Das

2007 may come to associated with the start of the "big" credit crunch. 2008 has begun with a number of "unresolved" items. Hope of an early resolution seems to be fading. In the words of Lily Tomlin, the American comedian: "Things are going to get a lot worse before they are going to get worse."

The total level of sub-prime losses is still far from clear. Based on current trading levels of ABS indices, estimates of losses range between US$ 150 and 400 billion, not all of which has been written off to date.

Interest rates on large volumes of sub-prime mortgages – estimated at around US$ 900 billion are due to reset by end 2008. Interest rates and repayments will rise significantly. The impact on delinquencies and losses are unknown. The rate reset freeze plan (which has not been in the news since being announced) and its impact are also still unclear.

As America's mortgage markets began unravelling, economists initially pointed to sub-prime mortgages issued to low-income, minority and urban borrowers. Closer analysis reveals risky mortgages in nearly every corner of the USA. Analysis by The Wall Street Journal indicates that from 2004 to 2006, when home prices peaked in many parts of the country, more than 2,500 banks, thrifts, credit unions and mortgage companies made a combined US$1.5 trillion in high-interest-rate, high risk loans. The potential losses on these loans are unknown.

There are also emerging concerns in the US$915 billion credit card debt markets. Credit card providers are all boosting loan loss provisions. There is anecdotal evidence that cash strapped mortgagors are using credit cards to make mortgage payments. Analysts expect credit card delinquencies to increase if consumers unable to use home-equity lines of credit to pay off their credit card debt start running up higher card debt. A number of banks have begun to boost reserves against anticipated losses.

Financial institutions have already incurred losses of over US$100 billion. A substantial volume of assets is likely to return onto bank balance sheets as off-balance sheet structures and hedge funds are forced to sell. The total amount to be re-intermediated by banks may be in the range of US$1 to 2 trillion. This will make substantial depends on bank liquidity and capital.

There are already signs that the major banks are hoarding liquidity in anticipation of the return of assets. They will also inevitably have to raise substantial amounts of capital. In the second half of 2007 commercial and investment banks raised US$83 billion in equity. This was an increase of more than 20% on the corresponding period in 2006.

Asset backed conduit vehicles and SIVs ("Structured Investment Vehicles") may need to sell assets as they breach their rules. Hedge funds face substantial redemption requests in the coming months. This will exacerbate the demands on bank capital and liquidity.

The credit issues have widened beyond banks, investors and hedge funds active in structured credit.

In the conventional mortgage market, Fannie Mae (Federal National Mortgage Association) and Ginnie Mae (Government National Mortgage Association) have recorded losses and been forced to raise capital. This suggests that the problems in the housing market are deep seated.

Mortgage insurers and monoline insurers have suffered serious collateral damage. A significant downgrade in the rating of insurers will be particularly damaging. It will affect around US$ 2.5 trillion of municipal bonds guaranteed by the insurers. It will also affect other bonds wrapped by the insurers. This may trigger further selling pressure and contribute to decline in prices as well as absorbing increasingly scarce liquidity.

There is already talk of a plan to re-capitalise the insurers. The sum being talked about is between US$15 and US$200 billion. It is not clear where the substantial amount of capital needed to recapitalise the banks and financial guarantors is going to come from.

The US$ 2 trillion of European pfandbrief or covered bond markets have also experienced liquidity problems.

The sub-prime model is also used for leveraged funding in private equity, infrastructure and commercial property financing.

US$300 billion of leveraged finance loans made by banks is still effectively "orphaned" - they can't be sold off. In late 2007, there were signs that the loan logjam was easing. Underwriters pointed to some sales of risky assets.

Caution is needed in interpreting these developments. Firstly, the sales only related to the less risky tranches and loans. The more risky exposures remain with underwriters for the moment. There are also concerns that some of the sales were not "genuine". The banks had provided the buyers with a variety of favourable terms including the ability to sell the loans back to them at a future date at a guaranteed price. Alternatively, MFN ("most favoured nation") clauses mean that the selling bank will need to compensate buyers if loans are sold at lower prices during an agreed time from the initial sale. Current prices indicate steep discounts will be needed to shift the paper to investors.

The crisis shows signs of spilling over into other markets. In Great Britain, Ireland, Spain, Australia and other markets strong house price appreciation similar to the US led to similar growth in mortgage and real estate lending. If economic growth slows and housing prices fall then similar problem may emerge in those economies as well.

There are already signs that there will be significant litigation against the banks. There may also be regulatory investigations and potentially prosecutions. State Street recently provided over US$250 million against future litigation claims. The total cost of all this is still unknown.

The financial elements of the credit crunch are becoming clearer - higher credit costs; lower availability of debt; forced de-leveraging of hedge funds and conduits/ SIVs; significant capital losses for financial institutions. The real economy effects will be slower to emerge. Higher credit costs and tighter credit standards will affect all business.

The US housing industry is badly affected with no immediate prospect of a quick recovery. The outlook for US house prices is poor. Growth forecasts for the US have already been lowered. The dreaded "R" word – recession – is now being talked about.

The fall in asset prices has "wealth" effects. Then there are employment and income effects. Wall Street has already issued "pink slips" by the thousands as banks and mortgage lenders shed staff. More will be issued in 2008 as the slowdown in the financial services business continues.

A slowdown in economic activity will affect many financial transactions. Corporations with significant debt face refinancing challenges. The shares of an Australian real estate firm – Centro – fell over 80 % as a result of difficulties in refinancing its short-term debt secured over commercial property, some of it in the US. Commercial property financing has slowed, the cost has risen significantly and terms have tightened affecting commercial property prices.

Private equity deals in recent years were predicated on a combination of a growing economy, cheap debt and a buoyant stock market allowing the quick resale of the company. Weaker earnings and more expensive debt could lead to losses and distressed sales over time. Recent private equity deals also face re-financing risk. Some US$ 150 billion of leveraged loans come due in 2008. Financial engineering techniques – toggles, pay-in-kind securities and covenant-lite (lack of maintenance covenants) structures – will delay the problem but probably cannot forestall the inevitable rise in defaults.

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. Since 2003, 42% of bonds of high yield bonds issues were rated B- or below. In the first 6 months of the year that percentage rose to around 50%. Some commentators believe that the losses of corporate bonds will peak between 10% and 20% leading to significant losses.

Warren Buffet once observed that: "it's the weak link that snaps you…in financial markets, the weak link is borrowed money." In the present credit crisis, all companies and business models reliant on debt – especially cheap and abundant debt - look vulnerable.

The real economy effects will feedback into the financial markets. A weaker economy are likely to see higher levels of actual defaults. This may set off new phases of the crisis.

CDS contracts used to hedge credit risk have significant documentation and operational problems. If actual defaults in markets increase and the contracts do not function as intended then there would be additional complexity. A significant volume of CDS contracts is with hedge funds and other investors secured by collateral agreements. The counterparty and performance risk of enforcing the contracts may be challenging. It is important to note that the structured credit market in its current form is substantially untested. If defaults rise and the CDS contracts prove to be difficult to enforce then bank exposures to losses may well much higher than anticipated.

Credit markets remain gloomy. Unlike their equity and emerging market cousins, they are waiting anxiously for "the shoes to fall", except it seems that the shoes are from Imelda Marcos' collection.

At the time of publication the author or his firm did not own any direct investments in securities mentioned in this article although he may be an owner indirectly as an investor in a fund.



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).

The Minsky Moment

Twenty-five years ago, when most economists were extolling the virtues of financial deregulation and innovation, a maverick named Hyman P. Minsky maintained a more negative view of Wall Street; in fact, he noted that bankers, traders, and other financiers periodically played the role of arsonists, setting the entire economy ablaze. Wall Street encouraged businesses and individuals to take on too much risk, he believed, generating ruinous boom-and-bust cycles. The only way to break this pattern was for the government to step in and regulate the moneymen.

Many of Minsky’s colleagues regarded his “financial-instability hypothesis,” which he first developed in the nineteen-sixties, as radical, if not crackpot. Today, with the subprime crisis seemingly on the verge of metamorphosing into a recession, references to it have become commonplace on financial Web sites and in the reports of Wall Street analysts. Minsky’s hypothesis is well worth revisiting. In trying to revive the economy, President Bush and the House have already agreed on the outlines of a “stimulus package,” but the first stage in curing any malady is making a correct diagnosis.

Minsky, who died in 1996, at the age of seventy-seven, earned a Ph.D. from Harvard and taught at Brown, Berkeley, and Washington University. He didn’t have anything against financial institutions—for many years, he served as a director of the Mark Twain Bank, in St. Louis—but he knew more about how they worked than most deskbound economists. There are basically five stages in Minsky’s model of the credit cycle: displacement, boom, euphoria, profit taking, and panic. A displacement occurs when investors get excited about something—an invention, such as the Internet, or a war, or an abrupt change of economic policy. The current cycle began in 2003, with the Fed chief Alan Greenspan’s decision to reduce short-term interest rates to one per cent, and an unexpected influx of foreign money, particularly Chinese money, into U.S. Treasury bonds. With the cost of borrowing—mortgage rates, in particular—at historic lows, a speculative real-estate boom quickly developed that was much bigger, in terms of over-all valuation, than the previous bubble in technology stocks.

As a boom leads to euphoria, Minsky said, banks and other commercial lenders extend credit to ever more dubious borrowers, often creating new financial instruments to do the job. During the nineteen-eighties, junk bonds played that role. More recently, it was the securitization of mortgages, which enabled banks to provide home loans without worrying if they would ever be repaid. (Investors who bought the newfangled securities would be left to deal with any defaults.) Then, at the top of the market (in this case, mid-2006), some smart traders start to cash in their profits.

The onset of panic is usually heralded by a dramatic effect: in July, two Bear Stearns hedge funds that had invested heavily in mortgage securities collapsed. Six months and four interest-rate cuts later, Ben Bernanke and his colleagues at the Fed are struggling to contain the bust. Despite last week’s rebound, the outlook remains grim. According to Dean Baker, the co-director of the Center for Economic and Policy Research, average house prices are falling nationwide at an annual rate of more than ten per cent, something not seen since before the Second World War. This means that American households are getting poorer at a rate of more than two trillion dollars a year.


It’s hard to say exactly how falling house prices will affect the economy, but recent computer simulations carried out by Frederic Mishkin, a governor at the Fed, suggest that, for every dollar the typical American family’s housing wealth drops in a year, that family may cut its spending by up to seven cents. Nationwide, that adds up to roughly a hundred and fifty-five billion dollars, which is bigger than President Bush’s stimulus package. And it doesn’t take into account plunging stock prices, collapsing confidence, and the belated imposition of tighter lending practices—all of which will further restrict economic activity.

In an election year, politicians can’t be expected to acknowledge their powerlessness. Nonetheless, it was disheartening to see the Republicans exploiting the current crisis to try to make the President’s tax cuts permanent, and the Democrats attempting to pin the economic downturn on the White House. For once, Bush is not to blame. His tax cuts were irresponsible and callously regressive, but they didn’t play a significant role in the housing bubble.

If anybody is at fault it is Greenspan, who kept interest rates too low for too long and ignored warnings, some from his own colleagues, about what was happening in the mortgage market. But he wasn’t the only one. Between 2003 and 2007, most Americans didn’t want to hear about the downside of funds that invest in mortgage-backed securities, or of mortgages that allow lenders to make monthly payments so low that their loan balances sometimes increase. They were busy wondering how much their neighbors had made selling their apartment, scouting real-estate Web sites and going to open houses, and calling up Washington Mutual or Countrywide to see if they could get another home-equity loan. That’s the nature of speculative manias: eventually, they draw in almost all of us.

You might think that the best solution is to prevent manias from developing at all, but that requires vigilance. Since the nineteen-eighties, Congress and the executive branch have been conspiring to weaken federal supervision of Wall Street. Perhaps the most fateful step came when, during the Clinton Administration, Greenspan and Robert Rubin, then the Treasury Secretary, championed the abolition of the Glass-Steagall Act of 1933, which was meant to prevent a recurrence of the rampant speculation that preceded the Depression.

The greatest need is for intellectual reappraisal, and a good place to begin is with a statement from a paper co-authored by Minsky that “apt intervention and institutional structures are necessary for market economies to be successful.” Rather than waging old debates about tax cuts versus spending increases, policymakers ought to be discussing how to reform the financial system so that it serves the rest of the economy, instead of feeding off it and destabilizing it. Among the problems at hand: how to restructure Wall Street remuneration packages that encourage excessive risk-taking; restrict irresponsible lending without shutting out creditworthy borrowers; help victims of predatory practices without bailing out irresponsible lenders; and hold ratings agencies accountable for their assessments. These are complex issues, with few easy solutions, but that’s what makes them interesting. As Minsky believed, “Economies evolve, and so, too, must economic policy.” ♦

"America's Suicidal Statecraft" At the Bistro

You might be interested in the following extract from "America's Suicidal Statecraft" which went into print in November 2006 and was actually written some months earlier. At that time, the "bankers" - which includes the formal and less formal banks - were still in the midst of the Ponzi mania. For them, the world was still wonderful and if any of them gave a thought to crashes of any kind, it was hard to catch any sign of it.
The extract reads:

The credit-derivatives concept is new, dating from about 1997 with the launch of a financial product called Bistro (Broad Index Secured Trust Offering). It caught on and spread like wildfire to the $12.4 trillion market today. In a world already gorged on massive credit, Bistro and imitations of it allowed banks to expand their loans, sell the risk of default and so leave their reserves at the ready for more loans whose risk again could be sold on. Just how much expansion of credit the new derivatives have created which would never otherwise have existed, we do not know, but $12 trillion must have allowed a lot.

A worrying feature is that we do not know where the risk of these loans – made almost certainly on the basis of significantly reduced borrower quality – has now settled. Further innovations are already on the drawing board: derivatives of derivatives and “derivatives cubed”. One observer says that “the whole credit derivatives world has exploded at such a dizzy pace that nobody is exactly sure where the loan risk has gone. Have all the investors who have bought credit derivatives contracts checked the fine print to see what losses they could sustain? Does anybody understand the chain reaction that might be triggered by such losses? Could the world’s trading system cope? And what would happen to those hedge funds that have been jumping into the credit derivatives world?” 8

In July 2006, Gabriel Kolko put the credit-derivatives market much higher: “The credit derivative market was almost nonexistent in 2001, grew fairly slowly until 2004 and then went into the stratosphere, reaching $17.3 trillion by the end of 2005.” He then put the question, “What are credit derivatives?” and answered it by saying that “The Financial Times' chief capital markets writer, Gillian Tett, tried to find out, but failed. About ten years ago some J.P. Morgan bankers were in Boca Raton, Florida, drinking, throwing each other into the swimming pool, and the like, and they came up with a notion of a new financial instrument that was too complex to be easily copied (financial ideas cannot be copyrighted) and which was sure to make them money. But Tett was highly critical of its potential for causing a chain reaction of losses that will engulf the hedge funds that have leaped into this market… Nominally insurance against defaults, [credit derivatives] encourage far greater gambles and credit expansion. Enron used them extensively, and it was one secret of their success, and eventual bankruptcy with $100 billion in losses. They are not monitored in any real sense, and two experts called them ‘maddeningly opaque.’ Many of these innovative financial products, according to one finance director, ‘exist in cyberspace’ only and often are simply tax dodges for the ultra-rich. It is for reasons such as these, and yet others such as split capital trusts, collateralized debt obligations, and market credit default swaps that are even more opaque, that the IMF and financial authorities are so worried.”

One of the interesting and, again, highly disturbing features of credit derivatives is that their trading processes tend to be primitive. Deals seem to be recorded with pen and paper – and one imagines on cramped and overwritten shirt-cuffs – while hedge funds and banks scramble to improve their credit-derivatives trading systems by spending hundreds of millions of dollars in aggregate on suitable information technology. As reported by the London Financial Times on 16 August 2006, “Credit derivatives are tools that let investors place bets on whether bonds or loans will default. The industry is estimated to have $17,000bn of total outstanding contracts…and the sector has doubled in size every year since 2002. This growth has taken institutions by surprise and forced them to handle deals with small levels of support staff. A recent survey from the International Swaps and Derivatives Association showed that one in five credit derivatives trades by large dealers in 2005 contained mistakes and many suffered settlement delays.”

All of this sharpens the picture of a financial industry in the dollar size of its deals as big as or bigger than anything in financial history, being conducted by unmonitored institutions and dealers, with staffs that are largely inexperienced and, as the Financial Times puts it, with “sloppy back-office procedures [that] could cause serious damage.” The financial magnitudes they handle are indeed so great that they could, it seems, precipitate a global crash of unprecedented proportions; yet they are being run with some of their procedures apparently comparable with those of a church-fête bingo game.
James Cumes

Nolan on the crisis

Credit then really began to flow. Greenspan’s assurances came at a critical juncture for the fledging Wall Street securitization marketplace; for Michael Milken, Drexel Burnham and the junk bond market; for private equity, hostile takeovers and the leveraged buyout boom; for the fraudulent S&L industry and for many banks’ commercial lending operations. While it sounds a little silly after what we’ve witnessed since, there was a time when the eighties were known as the “decade of greed.”

When the junk bonds, LBOs, S&Ls, and scores of commercial banks all came crashing down beginning in late-1989 to 1990, the Greenspan Fed initiated an historic easing cycle that saw Fed funds cut from 9.0% in November 1989 all the way to 3.0% by September 1992. In order to recapitalize the banking system, free up system Credit growth, and fight economic headwinds, the Greenspan Federal Reserve was more than content to garner outsized financial profits to the fledgling leveraged speculator community and a Wall Street keen to seize power from the frail banking system. Wall Street investment bankers, all facets of the securitization industry, the derivatives market, the hedge funds and the GSEs never looked back –not for a second.

In the guise of “free markets,” the Greenspan Fed sold their soul to unfettered and unregulated Wall Street-based Credit creation. What proceeded was the perpetration of a 20-year myth: that an historic confluence of incredible technological advances, a productivity revolution, and momentous financial innovation had fundamentally altered the course of economic and financial history. The ideology emerged (and became emboldened by each passing year of positive GDP growth and rising asset prices) that free market forces and enlightened policymaking raised the economy’s speed limit and increased its resiliency; conquered inflation; and fundamentally altered and revolutionized financial risk management/intermediation. It was one heck of a compelling – alluring – seductive story.

But, as they say, “there’s always a catch”. In order for New Age Finance to work, the Fed had to make a seemingly simple – yet outrageously dangerous - promise of “liquid and continuous” markets. Only with uninterrupted liquidity could much of securities-based contemporary risk intermediation come close to functioning as advertised. Those taking risky positions in various securitizations (especially when highly leveraged) needed confidence that they would always have the opportunity to offload risk (liquidate positions and/or easily hedge exposure). Those writing derivative “insurance” – accommodating the markets’ expanding appetite for hedging - required liquid markets whereby they could short securities to hedge their risk, as necessary. There were numerous debacles that should have alerted policymakers to some of New Age Finance’s inherent flaws (1994’s bond rout, Orange Co., Mexico, SE Asia, Russia, Argentina, LTCM, the tech bust, and Enron to name a few). Yet the bottom line was that the combination of the Fed’s flexibility to aggressively cut rates on demand; ballooning GSE balance sheets on demand; ballooning foreign official dollar reserve holdings on demand; and insatiable demand for the dollar as the world’s reserve currency all worked in powerful concert to sustain (until recently) the U.S. Credit Bubble - through thick and thin.

Despite his (inflationist) academic leanings and some regrettable (“Helicopter Ben”) speeches as Fed governor, I do believe Dr. Bernanke aspired to adapt Fed policymaking. His preference was for a more “rules based” policy approach of setting rates through some flexible “inflation targeting” regime, while ending Greenspan’s penchant for kowtowing to the markets. Today, it all seems hopelessly naïve. Inflation is running above 4%, while the FOMC is compelled to quickly slash the funds rate to 3%. And never – I repeat, never – have the financial markets been more convinced that the Federal Reserve fixates on stock prices while is permissive when it comes to inflationary pressures. Today, the contrast to the ECB and other global central banks could not be starker. The Fed has climbed way out on a limb, and it is difficult at this point to see how they regain credibility as inflation fighters or supporters of the value of our currency. It is not only trust in Wall Street-backed finance that is being shattered.

The greatest flaw in the Greenspan/Bernanke monetary policy doctrine was a dangerously misguided understanding of the risks inherent to their “risk management” approach. Repeatedly, monetary policymaking was dictated by the Fed’s focus on what it considered the possibility of adverse consequences from relatively low probability (“tail”) developments in the Credit system and real economy. In other words, if the markets (certainly inclusive of “New Age” structured finance) were at risk of faltering, it was believed that aggressive accommodation was required. The avoidance of potentially severe real economic risks through “activist” monetary easing was accepted outright as a patently more attractive proposition compared to the (generally perceived minimal) inflationary risks that might arise from policy ease. As it was in the late 1920s, such an accommodative (“coin in the fuse box”) policy approach is disastrous in Bubble environments.

The Fed’s complete misconception of the true nature of contemporary “inflation" risk was a historic blunder in monetary doctrine and analysis. To be sure, the consequences of accommodating the markets were anything but confined to consumer prices. Instead, the primary - and greatly unappreciated - risks were part and parcel to the perpetuation of dangerous Credit Bubble Dynamics and myriad attendant excesses. Importantly, the Fed failed to recognize that obliging Wall Street finance ensured ever greater Bubble-related distortions and fragilities – deeper structural impairment to both the financial system and real economy. In the end, the Fed’s focus on mitigating “tail” risk guaranteed a much more certain and problematic “tail” – a rather fat one at that.

Fundamentally, the Greenspan/Bernanke “doctrine” totally misconstrued the various risks inherent in their strategy of disregarding Bubbles as they expanded – choosing instead the aggressive implementation of post-Bubble “mopping up” measures as necessary. They were almost as oblivious to the nature of escalating Bubble risk as they were to present-day complexities incident to implementing “mop up” reflationary policies. “Mopping up” the technology Bubble created a greatly more precarious Mortgage Finance Bubble. Aggressively “mopping up” after the mortgage/housing carnage in an age of a debased and vulnerable dollar, $90 oil, $900 gold, surging commodities and food costs, massive unwieldy pools of speculative global finance, myriad global Bubbles, and a runaway Chinese boom is fraught with extraordinary risk. Furthermore, the Fed’s previously most potent reflationary mechanism - Wall Street-backed finance – is today largely inoperable.

I’m not going to jump on the criticism bandwagon and excoriate Dr. Bernanke for his panicked 75 basis point inter-meeting rate cut. From my vantage point, the “wheels were coming off” and I would expect nothing less from our increasingly impotent central bank. Yet it is silly to blame today’s mess on recent indecisiveness. The Fed has not been “behind the curve,” unless one is referring to the “learning curve.” The unfolding financial and economic crisis has been More than 20 Years in the Making. It’s a creation of flawed monetary management; egregious lending, leveraging and speculating excess; unprecedented economic distortions and imbalances on a global basis. And I find it rather ironic that Wall Street is so fervidly lambasting the Fed. For twenty years now the Fed has basically done everything that Wall Street requested and more.

It is also as ironic as it was predictable that Alan Greenspan - Ayn Rand “disciple” and free-market ideologue - championed monetary policies and a financial apparatus that will ensure the greatest government intrusion into our Nation’s financial and economic affairs since the New Deal. Articles berating contemporary Capitalism are becoming commonplace. I fear that the most important lesson from this experience may fail to resonate: that to promote sustainable free-market Capitalism for the real economy demands considerable general resolve to protect the soundness and stability of the underlying Credit system.

And, speaking of the Credit system, some brief market comments are in order. Stocks generally rallied this week, yet it was a backdrop that provided little comfort that the system has begun to stabilize. Sure, the banks rallied 10%, the homebuilders 20%, the retailers 7%, the transports almost 7%, and the restaurants 5%. One could easily assume that the bears were squeezed and leave it at that. There are, however, surely more complex and problematic dynamics at work. Notably, many of the favorite sectors were hit this week – the utilities, technology and biotechs all posted notable weakness. Coupled with this week’s extreme volatility, I will assume that the huge “market-neutral” and “quant” components of the leveraged speculating community have suffered even greater losses so far this month than those from last August. It is also worth noting that some important Credit spreads have diverged markedly, most notably many corporate, junk and commercial MBS spreads have widened as dollar swap spreads have narrowed. The spectacular Treasury melt-up must also be causing havoc for various strategies, ditto the recently strong yen and Swiss franc.

I’ll stick with the view that an unfolding breakdown in various trading models and hedging strategies is at risk of precipitating a crisis of confidence for the leveraged speculating community. I suspect hedge fund trading was much more responsible for chaotic global securities markets this week than a rogue French equities trader. There is, unfortunately, little prospect for markets to calm down anytime soon. There is no quick or easy fix to any of the myriad current problems – seized up securitization markets, sinking housing prices, faltering bond insurers, counterparty issues, a crisis in confidence for “Wall Street finance”, or acute economic vulnerability - to name only the most obvious. Again, they’ve been More than 20 Years in the Making.

Soros calls it right

The current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years.

However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.

Boom-bust processes usually revolve around credit and always involve a bias or misconception. This is usually a failure to recognise a reflexive, circular connection between the willingness to lend and the value of the collateral. Ease of credit generates demand that pushes up the value of property, which in turn increases the amount of credit available. A bubble starts when people buy houses in the expectation that they can refinance their mortgages at a profit. The recent US housing boom is a case in point. The 60-year super-boom is a more complicated case.

Every time the credit expansion ran into trouble the financial authorities intervened, injecting liquidity and finding other ways to stimulate the economy. That created a system of asymmetric incentives also known as moral hazard, which encouraged ever greater credit expansion. The system was so successful that people came to believe in what former US president Ronald Reagan called the magic of the marketplace and I call market fundamentalism. Fundamentalists believe that markets tend towards equilibrium and the common interest is best served by allowing participants to pursue their self-interest. It is an obvious misconception, because it was the intervention of the authorities that prevented financial markets from breaking down, not the markets themselves. Nevertheless, market fundamentalism emerged as the dominant ideology in the 1980s, when financial markets started to become globalised and the US started to run a current account deficit.

Globalisation allowed the US to suck up the savings of the rest of the world and consume more than it produced. The US current account deficit reached 6.2 per cent of gross national product in 2006. The financial markets encouraged consumers to borrow by introducing ever more sophisticated instruments and more generous terms. The authorities aided and abetted the process by intervening whenever the global financial system was at risk. Since 1980, regulations have been progressively relaxed until they have practically disappeared.

The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility.

Everything that could go wrong did. What started with subprime mortgages spread to all collateralised debt obligations, endangered municipal and mortgage insurance and reinsurance companies and threatened to unravel the multi-trillion-dollar credit default swap market. Investment banks' commitments to leveraged buyouts became liabilities. Market-neutral hedge funds turned out not to be market-neutral and had to be unwound. The asset-backed commercial paper market came to a standstill and the special investment vehicles set up by banks to get mortgages off their balance sheets could no longer get outside financing. The final blow came when interbank lending, which is at the heart of the financial system, was disrupted because banks had to husband their resources and could not trust their counterparties. The central banks had to inject an unprecedented amount of money and extend credit on an unprecedented range of securities to a broader range of institutions than ever befor e. That made the crisis more severe than any since the second world war.

Credit expansion must now be followed by a period of contraction, because some of the new credit instruments and practices are unsound and unsustainable. The ability of the financial authorities to stimulate the economy is constrained by the unwillingness of the rest of the world to accumulate additional dollar reserves. Until recently, investors were hoping that the US Federal Reserve would do whatever it takes to avoid a recession, because that is what it did on previous occasions. Now they will have to realise that the Fed may no longer be in a position to do so. With oil, food and other commodities firm, and the renminbi appreciating somewhat faster, the Fed also has to worry about inflation. If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an en d.

Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world.

The danger is that the resulting political tensions, including US protectionism, may disrupt the global economy and plunge the world into recession or worse.

The writer is chairman of Soros Fund Management

Supkis on Money and Magic

Money and magic: they are like intertwined snakes. They have the same properties. One of the top tricks of all magicians is the ability to make things vanish in a flash or reappear suddenly out of nowhere. Money does this, too, and for the same effects. The Brothers Grimm in Germany collected odd fairy tales. One important one is called 'Godfather Death.'


A man's wife had a thirteenth child. The father knew this was a magical child so he sought out the most powerful godfather for him. God, himself, came and offered to be the child's guardian. 'No, you give to the rich and let the poor starve,' said the man [aren't peasants cynical?]. Then the Devil came with the same offer and added lots of gold, too. 'No,' said the man, 'You are a liar.' Then Death said he would make all men equal in the end.' The peasant agreed this was a good thing [being at heart, a revolutionary, eh?].


Death then said, 'Of course, I also control the source of all wealth and gold as well as life. I will make your son rich and powerful.' But even with Death guiding him and getting very wealthy, the boy grew up and decided he wanted more and more and more. He began to interfere with Death and one day, prevented Death from carrying off a princess. So Death carried him off, instead, to the rage and horror of the godson.


When Spain found the New World, all they wanted was the gold. There was lots of gold in the New World unlike the old world where it had been mined our sought for thousands of years and thus, harder to get. The vast gold wealth of the New World came at a terrible price. Most of the people living innocently in the midst of this metal, innocent stone-age people, were worked to death, died of disease. Then, to make more wealth, millions of innocent Africans were rounded up and shipped to this world to toil in the mines and fields, producing wealth. Their only reward was death.


As we see the world go through another vaporization of vast wealth, we must remember that the real wealth is right under our feet and is all around us in the form of Nature, Life and Love. Love is as infinite as Wealth but unlike Wealth, it is Life, not Death. The wife of the peasant in the old story here had lots of love and lots of life. The godson saved the Princess not because he loved her but because he lusted for her and that was why he was punished. He wanted her body and her powerful position. If he loved her, he would have asked Death to take him, not her. But he didn't want to do that.


We are going to see a scramble as everyone will grab at every possible physical thing they can as money vaporizes. This rush to Safety does not surprise me. I have had a very rough life. I went from jet setting around the world to hitch hiking due to no money. I have lived several times in mansions, one of which I bought with cash I earned, myself. I have lived on the streets. At one point, we all lived in a tent complex I built out of cast off building materials from the dump...for ten years!


Now I live in a beautiful house on a mountain which I designed and built mostly by myself. With my son assisting as much as he could as he grew up. I have seen money come and vanish. And it vanishes very fast! A great deal can turn into a great liability in a matter of hours in a crash. If we let easy gains go to our heads or swift losses drive us to despair, we are missing the truth of Life.


Life is living. Some readers may be mystified as to why I pointed out the distress of the mothers of Gaza on today, of all days. To me, they are a clear indication of what is important: children are dying. A muscular move is being made in the real world, not the magic world of mirrors in the stock markets. People are dying. In Kenya, an election was stolen and people are dying in riots and insurrections. In Burma, the priests were put brutally down while the world did nothing. Pakistan seethes and bombs go off. Around the world, workers are going hungry due to the sudden rise in oil and food prices. We must feel the mercy of the angels in all this, not fret about the magic money.


The people who mastered the magic formulas and who got ahold of the power levers that controls magic money making got greedy and silly about this and pushed all the levers to the 'Endless Wealth' level. They set the system to make infinite money, forgetting that this means Death will take over as always.


The history of bubbles is long and well-known for hundreds of years yet the very sophisticated and powerful people at the top of global society have decided yet again. to create bubbles and blow them up as much as possible. Tomorrow will bring ruin to many here in America. They will run to the rulers and hold out their hands and beg to be saved from the follies of the rulers. The rulers will go to Death and demand more gold, more power and more land. 'Make us gods!' they will order, sternly. And Death will flick a finger and more wealth will vanish. Poof.


Alas, the temptation to use the ultimate tool for wealth and power will rise before everyone's eyes. What does a bank robber, a Spanish conquistador, a Napoleon, a Hitler do when they need money? It is too tempting, too simple: kill someone who has something to steal. No one can steal anything from the US that we can't take back using our nukes, no one but...China.


And we can see the world is breaking in two. Instead of the usual money flow we are accustomed to over the last 50 years we have a new flow. It was initiated last July after the G7 nations chose to protect the Japanese 0.5% carry trade that is flooding the world with liquidity in the form of debts being piled all over the place. China called a halt to all this. They said, if the yuan must rise in value, so must the yen. This logic is all-important. But the G7 refused so China has begun a process of shutting down inflation, shutting down the financial machine of the world. They did this by raising interest rates, bank ratios and instituting severe economic curbs that are now hammering world monetary flows.


It doesn't take much to reset a system. In nature, a few degrees difference in the oceans or atmosphere can trigger vast ice sheets or tremendous warmth. Scientists call these changes 'flips' and the economic world 'flips' all the time. These resets or redirections are like when the earth suddenly shifts north and south polarities. This happens regularly on this earth. We are very near such a flip. We have no idea how this will impact nature or our machines. The earth also resets whole regions moving them suddenly many yards or even a mile in one split second. Huge waves can appear out of nowhere and wash away millions of people. Volcanoes can suddenly erupt of a meteorite strike a city. Or nuclear bombs can be launched without warning.


The Chinese simply changed their plans for their banking system. They wanted to negotiate a consensus for change and have the Bank of Japan, in particular, raise rates and the value of the yen. Everyone knows the dollar is worthless but all the central banks of all our trade partners who have surpluses with us have kept the dollar stronger than it really should be. The Chinese wanted to change this the proper way, everyone cooperating.


But the whole INVESTMENT world is addicted to the Japanese carry trade. The Chinese proposals last summer irritated these people who are also our rulers. They told China to go to hell. They imagine the Chinese can be cheated out of their funds and think that if China uses these funds to buy up the West, they will simply lose it if the wealth vanishes.


But magic money has very odd properties. If we wish to cheat the Chinese, the vanishing act will destroy us. The money will not be in the top hat when the magician reaches in but out pops Death in all his malicious gory glory. For the Chinese are not the Japanese nor the Germans. They have a huge military and nuclear bombs. China can't be penned in while we mock them as we rub our hands with glee over the idea of cheating them.


People forget that the US has enemies. People hate us. And we can't play magic money games which involves cheating our trade partners. We won't go home, laughing. They will follow us and do something nasty. The US thinks, our nukes will protect us but we can't rule the world as bankrupts and liars. Any more than Russia could under the communists.

Doug Nolan -- Past Strategies have turned infeasible.

The Credit system is today an incredible mess. Literally Trillions of securities, previously valued in the marketplace based upon confidence in the underlying financial guarantees, are now suspect. This has severely impacted marketplace liquidity. And perhaps tens of Trillions of Credit and other derivative contracts are now subject to very serious counterparty issues. Many players throughout the Credit market are now severely impaired and have lost the capacity to hedge against/mitigate further losses.

To be sure, Discontinuous and Illiquid Markets have Wreaked Bloody Havoc on “dynamic” trading strategies used commonly to hedge various risks. I don’t believe it is hyperbole to suggest that “dynamic hedging” (in particular shorting Credit instruments to provide the necessary cashflows to pay on Credit derivative contracts written) became the critical linchpin of contemporary Wall Street risk intermediation. Yet today the models behind so many strategies that have come to permeate “contemporary finance” have completely broken down; the strategies of thousands of financial institutions - big and small - have turned infeasible.

From a macro perspective, Wall Street Risk Intermediation has essentially crashed and the “risk markets” essentially “seized up.” Almost across the board, the major risk operators are moving aggressively to rein in risk-taking. The leveraged speculating community is in turmoil. The “quants” are in a quandary. Basically, the entire market today desires, at least to some extent, to reduce/mitigate/transfer Credit and market risk. Inevitably, however, when “the market” is keen to hedge there’ll be no one with the necessary wherewithal to take the other side of The Trade. I have so many fears I don’t even know where to begin, although I will say that I am less than comfortable these days discussing individual companies. Tonight the (brief) analysis will be in generalities.

There are scores of financial players – from small hedge funds to the major “money center banks” – with complex books of derivative trades that now have a very serious problem. These “hedged books” contain various supposedly offsetting risk exposures that, in there entirety, were to (through financial “alchemy”) have created a reasonable and manageable portfolio risk profile. But the breakdown in Wall Street finance has transformed these too often highly leveraged “books” into essentially unmanageable “toxic waste” and financial land mines.

First, correlations between various instruments have broken down (i.e. junk bond spreads widen while “dollar swap spreads” narrow). Second, the liquidity profile (hence pricing) of various sectors has diverged radically (i.e. agency MBS vs. “private-label” MBS/ABS) - with the Treasury market melt-up causing further destabilization. Third, with the breakdown in Wall Street’s “private-label” MBS market and the collapse in confidence in the “monoline” Credit insurers, liquidity has all but evaporated throughout huge cross-sections of the debt securities and related derivatives markets. This dynamic is fomenting dangerous counter-party risks and uncertainties. The capacity of a rapidly rising number of market participants to fulfill their obligations in various types of derivative and “insurance” contracts is in question.

Imagine you have a “hedged book” of securities and derivative – for example a portfolio of CDOs hedged with Credit Default Swaps (CDS) from one of the “monoline financial guarantors.” Today, the value of your CDO portfolio is declining while the “value” of your offsetting CDS hedge is impaired by the increasing likelihood of a default by the “monoline” (who provided the CDO default “insurance”). The reality is that the hedged position has broken down and risk now rises by the day. And, unfortunately, your options are decidedly limited - there is little if any liquidity to sell the underlying CDO. One could go into the market and attempt to buy additional protection, although in many cases the cost would be prohibitive. Besides, there’s today little assurance that counter-party risks wouldn’t emerge in the second hedge as well.

The Wall Street firms and many of the more sophisticated hedge funds run very complex “books” of securities and derivatives. The dilemma they face today is commensurate with the complexity of their strategies. Recent developments – in particular heightened marketplace illiquidity, rising probabilities of “monoline” defaults, dislocation in the CDS markets, and a breakdown in typical correlations between instruments/sectors/markets – makes the job of effectively comprehending, quantifying, analyzing and managing risk impossible. Do the managers, then, attempt the highly problematic task of recalibrating hedges based on current conditions (i.e. spiking hedging costs, likely counterparty defaults, and recent market correlations) and risk compounding the problem if market conditions begin to normalize? Is it feasible for these players to recalibrate hedges, knowing full well that our well-intentioned policymakers are destined to intervene clumsily in the marketplace?

It is difficult for me to believe the leveraged speculating community is not in serious jeopardy. It became all too commonplace to leverage illiquid (and difficult to price) securities, while even the previously liquid markets today barely trade. Few speculative Bubbles in history were as vulnerable to a “run.” None were remotely as gigantic or global in scope. This “community” today creates a systemic weak link on several fronts, certainly including the vulnerability to outsized losses and resulting redemptions instigating panic dynamics. Today, market illiquidity increases the likelihood that many funds will be forced to halt redemptions. This dynamic has commenced and it holds the potential to batter industry trust and confidence.

The leveraged speculators create various systemic risks. Their desire to hedge risk exposures – as well as seek speculative profits – during market turbulence has certainly exacerbated the Credit Crisis. During the cycle’s upside, their affinity for leveraging securities greatly amplified the liquidity bull run. Today, their selling/deleveraging/hedging foments liquidity crisis, fear and market dislocation. Importantly, the speculators are today keen to short stocks, sell futures, and purchase equity put options. The “hedge funds” have, after all, sold themselves as capable of minting money in any kind of market environment. This could prove a major systemic risk.

Leveraged speculator dynamics in concert with a Bursting Credit Bubble now places enormous stains on the stock market. Not only have faltering Credit Availability and Credit Marketplace Liquidity dramatically diminished the prospects for companies, industries and the general economy. Limited liquidity in the Credit market has also created a backdrop where those seeking to hedge (or profit from) heightened systemic risks have few places to go for relatively liquid trading outside selling stocks and equity index products. And sinking stock prices further aggravates the unfolding Corporate Credit Crisis, fostering only greater systemic stress and greater selling pressure. “Contemporary finance” is being exposed as a daisy-chain of interrelated weak underlying structures, unrecognized risks and acute fragilities.

This Is It! buy Gold!!!!

Author: Jim Sinclair


Dear CIGAs,

All those that have joined our email list by adding their email address above received the following on Tuesday, October 23, 2007. Make sure information@jsmineset.com is added to your safe senders list if you are having problems receiving emails.

Nothing has changed. There is no fundamental basis for the US dollar and as Trader Dan noted, the technical factors are certainly quite short term.


This Is It!
Posted On: Tuesday, October 23, 2007, 2:11:00 PM EST
Author: Jim Sinclair

Dear CIGAs,

Many of you have asked what exactly I mean by “This is it,” so here it is in point form:

There is a rampant, serious financial problem with terminal potential and no practical solution hidden just outside of the public’s view (OTC Derivatives).
Because central banks have gotten so out of hand and political which cannot be controlled by investors or the man in the street, we need to adjust our actions so that each person takes on the responsibilities normal to central banks for their own finances.
Everything we buy is getting more expensive and many assets people have, other than gold, are losing value. Because of this credit is not a proper idea regardless of the weak dollar for the majority of people reading this.
Major financial institutions, Internet financial entities and banks operate without transparency where their derivative holdings are concerned. Losses the financial institutions are publishing are considered by media as having extinguished all the risk. I do not believe this. I believe they are still marked to model, only the model is moving slowly towards reality of worthlessness.
There is an acceleration of bankruptcy among financial institutions. This translates to the individual needing to act as their own financial institution by having their share investments in paper form, gold in their close possession with no one in-between and available cash. The individual must be their own bank and central bank as one has failed us and both may.
The savings rate in the US is negative while the expansion of credit is totally over the top.
Business is turning south so the US Federal Budget Deficit will move up exponentially.
The US dollar has become a bombed out and lost battle zone. There is nothing good anyone can say fundamentally about the US dollar.
Non US entities are fed up with financing the US consumer and US Federal activities. This is clear from the recent TIC report, which is now down trending.
Financial privacy is non-existent.
There is a model for exactly what is happening now and that is the Weimar Republic. Name war retributions as OTC derivatives and you begin to see the picture.
The US dollar has now made a clear indication of the final head and shoulders; the massive formation from the absolute top is breaking down.
Number 12 is the item that impacts all of the above because of the dollar’s technical position now beginning to reflect the dire fundamentals. This is it

This is it because you now have to perform not only as your own bank but also as your own central bank. This is it because the US dollar has completed a major head and shoulders bear formation, pulled back to the underside of the neckline and thereafter declining below the major support line drawn from the beginning of the big dollar bull under Chairman Paul Volcker. Volcker made the dollar and Greenspan gave it all back to Asia.

The dollar break below the recent and most important major, major support line drawn from 1980 to now is the fundamental basis which will push Gold to $1650. The US dollar is without any doubt in my mind is going to .7200, followed by .6200.

Ladies and gentlemen, prepare to defend yourselves.

Cramer Rants

Cramer rants again

Insight: Post credit bubble wealth transfer will beggar belief

By John Plender, chairman of Quintain

When financial market bubbles burst, a transfer of assets from the weak and undercapitalised to the strong and liquid invariably follows. The unprecedented scale of the credit bubble that burst last August suggests that the extent of the resulting wealth transfer will beggar belief.

The process is already well under way. So far, sovereign wealth funds have mopped up some $25bn worth of equity and debt in Citigroup, UBS, Merrill Lynch and Morgan Stanley. One of the safest predictions for 2008 is that this will lead to political friction of the beggar-thy-neighbour kind, with Western politicians complaining that their financial crown jewels are being sold for a song. Yet it is far from clear that the jewels are outright bargains.

In the long run it is admittedly hard not to believe that investing in an 11 per cent IOU in Citigroup with conversion rights attached represents good value. That said, it is possible that this and other comparable investments might be available on better terms at a later date. For while the immediate liquidity problems of the banks have been dealt with over the December 31 year end, more intractable difficulties remain.

A consequence of banks having set up off-balance sheet vehicles such as conduits and structured investment vehicles is that they are now having to put illiquid assets back on to the balance sheet under back-up agreements.

Those assets are piling up uncomfortably fast in relation to the banks’ ability to attract stable funding. They also put strain on bank capital just when dud assets are having to be marked-to-market under the eagle eye of auditors. After the experience of Enron, the Big Four firms are hell bent on providing a pro-cyclical twist to a dangerous financial downturn to protect their backs.

Meantime, a deterioration in credit quality is spreading from subprime mortgages across the financial system. The combined capital and liquidity constraint on the banks is in turn having a malign impact on the real economy where the banks will themselves induce a second round of asset transfers from weak to strong as they tighten lending conditions or put in insolvency experts, especially lower down the business scale.

A final problem is that until all the complex mortgage related structured products can be valued in a way that carries conviction, valuing banks will be a hazardous process. Much hitherto lucrative securitisation business may have gone for ever. The one certainty is that much more capital will have to be raised.

Then there is a currency question. To the extent that their investments in the west are unhedged, sovereign wealth funds take a big risk. There must be a fair chance that the dollar could weaken even further as financial unbalances in the US continue to unwind. There are few safe bets in currency markets, but in Europe the nearest thing to one is that sterling, attached to a debt-sodden UK economy afflicted with larger financial imbalances than the US, will sink. Those high growth economies of eastern Europe that have large current account deficits look similarly vulnerable on the currency front. So while there will be opportunities to buy these countries’ assets cheaply, the timing will be tricky.

For western politicians to complain about the loss of crown jewels is special pleading of a particularly invidious kind. For there is a marked similarity in what is happening today to what happened in the 1997-98 crisis in Asia. Then hot money from western banks exacerbated financial bubbles and inflation across the region. When the hot money pulled out, more stable western funds snapped up Asian assets on the cheap. Now official money from Asia and from the petro-economies has contributed to the western credit bubble. And the sovereign wealth funds are mopping up after the burst.

The significant difference is that the debacle in Asia was followed by truly appalling losses in output and employment whereas the US is merely at risk of recession rather than slump. Not only is hypocrisy an issue here. There is folly when people in current-account glasshouses throw protectionist stones.