Don't Be Fooled by Wall Street's Happy Talk

The next phase of the financial and economic crisis is creeping up on us. You can see the signs in the U.S. stock market, where all the major indexes have reversed a three month rally and are now declining back to their March lows. This decline is led by the Dow and is in fact accelerating, taking with it last month’s cheerful prognostications that the U.S. not only has escaped a recession, but is bouncing back into full growth mode for the second half of this year.

The economic data do not confirm this picture at all. The employment situation continues to worsen, industrial production and factory utilization are lodged firmly in recessionary territory, and the only retail stores showing any sign of life are the deep discounters like Wal-Mart, benefiting temporarily from the tax rebates. Wall Street executives are telling us that the credit crisis is halfway over, but their behavior suggests otherwise. Lehman Brothers, for example, assured us last week that it was well-capitalized and fully in control of its future, but a few days later it announced a $2.8 billion loss and was forced to turn to the stock market and private investors to raise $6 billion more in capital. Where have we heard this story before?

Vote for this story at Buzzflash and at Digg

Wall Street continues to underestimate the spreading default carnage that is going to bring down a few more financial powerhouses before this crisis is over. The big story emerging in the housing markets is the galloping number of foreclosures affecting ”œdecent ordinary folks” with prime mortgages (as opposed to the sub-prime customer species that kicked off the housing market crisis). Defaults and foreclosures on alt-A and prime mortgages are jumping to record levels. It seems that quite a lot of these customers, just like their sub-prime brethren, never really had much equity in their houses in the first place, and now that housing prices are declining across the nation, nearly 20% of them are in a negative equity position. If you can’t afford the mortgage in the first place, why continue to make payments on a property that is continuing to lose value?

These people are not typically walking away from their mortgages, as the ”œjingle mail” stories suggest. They would like to stay in their homes, but they can no longer make the payments. In many cases, the financial entity that they need to talk to in order to obtain some relief is a ”œmortgage servicer” who doesn’t own the mortgage, and can’t possibly get agreement from all the hundreds of investors worldwide who own a tiny sliver of the mortgage that was long since sold off in a security. Congress can pass all the legislation it wants to provide relief from foreclosure for these homeowners, but it will be mostly fruitless. The securitization of mortgages in the past eight years has legally and practically destroyed the ability for the financial industry to come through with any accommodations, so the homeowner is ejected and the banks wind up owning the property.

The banks now own so many homes through foreclosure that cities across the U.S. are suing them to force them to keep the properties in decent shape. It most places it costs thousands of dollars to get the lawn mowed and trash picked up, and there are many circumstances where the home has been vandalized, costing the banks much more. The banks are learning a terrible lesson last experienced in the Depression ”“ foreclosure is something to be avoided at all costs. It doesn’t just destroy the profit a bank may have had in the mortgage ”“ it can destroy the bank. We are now seeing banks dump whole subdivisions onto the real estate market at 20% of the value at the market peak in 2006.

The bond market has learned that the mortgage crisis is just the beginning of the problems that banks are facing. Stage two is underway with deterioration in corporate debt, starting with the bonds issued by real estate developers, but spreading now to the high yield securities and bank loans of poorly capitalized and over-leveraged corporations. Well over 50% of all the corporate debt issued in the past eight years has been rated as junk debt, meaning it is not even investment grade (Baa rated or higher) and it has a very high probability of default. These probabilities are now working against the holders of these bonds, and the banks that have lent to these companies.

In normal circumstances the economy can work through these excesses, as consumers and corporations reduce their leverage and banks absorb the losses on bad debts. But these aren’t normal circumstances. The U.S. is no longer entirely in control of its economic destiny, and it isn’t even the engine that drives the global economy. China and India have created their own self-reinforcing economic dynamic, in which exports finance a growing demand for raw materials, starting with oil. As the price of petroleum has now crossed $130/bbl., an intolerable burden is being placed on a U.S. economy sinking in recession.

Consumers are increasingly turning to public transport ”“ if it is available ”“ to avoid paying over $4/gal. for gasoline. Part of the pricing pressure on the suburban McMansions built in the past five years comes from the cost of commuting to these homes built 50 miles or more from any jobs. Independent truck drivers are going out of business because the cost of diesel fuel over $5/gal. has shredded what were already dangerously thin profit margins. Their trucks are piling up on dealer’s lots, and used car dealers are now hesitant to accept any more SUVs. General Motors is thinking of canceling altogether its Hummer model, a war-chic road hog that at its best gets only 11 miles to the gallon.

The high price of oil is now clearly affecting all facets of the global economy, with one exception: wages. Workers are not being given pay increases, but instead are being pressed to put in longer hours, which is always management’s way of coping at first with an economic downturn. But usually around six months into a recession, companies cave in to reality and start letting people go. We’ve just passed the six month mark for this downturn, so expect the unemployment data to noticeably deteriorate; last month the unemployment rate jumped up ½% of a percentage point alone.

Just about the last people in America to recognize that we have an inflation problem are the esteemed governors of the Federal Reserve, who preferred to concentrate on the fictitious construct of ”œcore inflation”, which eliminates from the calculation energy and food costs. But even Fed chairman Ben Bernanke is now beginning to face up to everyday reality, and has announced this month that Fed policy is now focused on combating inflation and fighting any further depreciation of the dollar on the foreign exchange markets. The days of interest rate declines are over, and the market is now estimating there is more than a 75% chance that the Fed will raise interest rates at their next Open Market committee meeting.

That’s just what the economy needs: higher interest rates on top of raging energy and food inflation, at the same time the entire housing sector is deflating. Obviously the Fed wouldn’t be piling on to our economic woes if it had a choice. The fact that it has no choice, and that it is trapped in the policy dilemma it now faces, is in good part its own fault. It’s not enough to blame China and India for oil price increases. There is still a lot of loose cash around the world that is being pumped into oil futures, which has helped as well to push prices to record levels. Most of this loose cash has been generated by the United States. We continue to flood the world with Treasury securities to finance both our domestic federal budget deficit, and our current account deficit, which combined exceed $1.5 trillion per year. On top of this, Bernanke’s dramatic interest rate cuts in the past six months have added yet more ”œliquidity” to the market. The banks aren’t using these funds to make loans, and investors aren’t eager to plow the money into the stock market given the inevitable decline ahead in corporate profits. That leaves the last great bubble as the only investment alternative: the commodities market, and specifically energy.

You’ve read no doubt about the nasty speculators who are involved in the commodities bubble. While there are certainly hundreds of hedge funds engaged in this speculative exercise, most of the money is coming from staid mutual funds, pension plans, university endowments, and other respectable entities desperate to find some investment vehicle that returns anything even matching the rate of inflation. Senator Joe Lieberman already has a bill submitted to restrict speculators from investing in commodity funds, but we’ll see how far this measure gets when Yale University’s endowment management have a quiet word with him about just who is going to get hurt if the bill is passed.

What can we expect in stage two? Expect first of all for the credit crisis to return with a vengeance. The omens are already lining up. Remember when Congress was all excited a few months ago about turning loose the Federal Housing Administration, and allowing them to jump-start the mortgage market with low-cost loans and down payment guarantees? It turns out the FHA isn’t interested in these broad new powers. It has enough problems of its own with its existing portfolio, which took a $4.6 billion write-down this past quarter due to rising foreclosures. That ate up over 25% of the FHA’s equity, and the commissioner had to reassure the market that the FHA itself isn’t facing bankruptcy ”“ it just may need to turn to the Congress for an ”œappropriation.”

Right behind the FHA will be Freddie Mac, the Home Loan Banks, and the behemoth of them all, Fannie Mae. All of these federally chartered agencies are under stress from the worsening housing crisis, and all of them operate on thin amounts of capital. Congress thinks at the moment it has the luxury of opening up the taps of federal largesse in order to do something about the housing crisis, but the reality is that the agencies set up to help at a time like this will all have their hands out looking for taxpayer money just so they can survive.

The second thing you should watch for is the coming wave of corporate and municipal bankruptcies. Too many corporations are poorly capitalized and completely unprepared to meet their liabilities in a weak economy. Too many state and local governments are seeing tax revenues plummet, just at a time when decades of promises on employee pensions and medical plans are coming due. Something will have to give here, and ultimately the weakest players will seek protection from the bankruptcy courts.

That will leave hundreds of thousands of retired government workers facing an abrupt shift in their fortune, and equally large numbers of currently employed workers suddenly facing unemployment. That’s the third thing you should watch for: large-scale layoffs in the public and private sector, with significant second order economic effects on consumer spending. This is all part of the vicious cycle common with recessions ”“ stressed out employers let staff go, leading to declines in consumer spending, leading to yet more pressure on corporations and government to fire even more workers. The difference now is that the viciousness of this cycle will far outweigh whatever pain was experienced in the last oil recession of 1974. This recession will be lucky to avoid being labeled as a depression when it is over.

Fourth, this recession is spreading globally. Housing markets in the U.K., Spain, Australia and Ireland are all reversing direction and following the U.S. into an implosion of foreclosures. Energy costs are rising everywhere, driving up as well the cost of basic food and things like livestock feed and fertilizer. This has led to riots in many emerging markets where fundamentals such as wheat and rice are hard to come by. Even the oil producing countries in the Gulf States are not immune to food scarcities. Central banks everywhere are talking tough about battling inflation, and a few are raising interest rates. Many of them are also raising margin requirements in the commodities markets to prevent speculation, and there is widespread condemnation of profiteers.

This is a very nasty situation for the central banks, forced to choose between accepting inflation that is accelerating well beyond target ranges, or raising interest rates and throwing the global economy into a much worse recession. As part of this conundrum, there is serious doubt about the value of repeating the Fed’s rescue for a financial firm like Bear Stearns, but if another such disaster crops up, letting yet another large bank or broker fail could lead to a systemic crisis of unimaginable magnitude. At some point though, governments including their central banks have to do something about the plight of the average citizen rather than continue to coddle millionaire bankers. To do otherwise is to risk social disorder.

These dreadful policy choices are only now beginning to play out in the U.S. electoral campaign, which is also beginning to focus on the domestic burden of continuing to fund the Iraq war. The American public has already turned against this war because of the high price that is being paid in death and injury, but the interplay between the war and America’s economic woes is beginning to become apparent. You can expect the Democrats to emphasize this linkage, and to ask Americans how fair it is that they are spending $12 billion a month to build Iraq, a country rich in oil, when at home people are losing their jobs, their pensions, their medical insurance, and in many cases their homes and the ability to feed their family. It will be the first time that the electorate will have to confront the economic costs of maintaining the vast American empire.

There is a point of inflection in any economic crisis where it becomes apparent to everyone that something has gone dramatically wrong and painful course corrections are needed. It often takes a major bankruptcy, or a sharp rise in unemployment, or a stock market crash, to awaken the public to the realities they have ignored or that have been hidden from them. The U.S. could experience any or all of these calamities, and at any time now. Heaven help the Republicans if this should occur prior to the first Tuesday in November.

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Numerian is a devoted author and poster on The Agonist, specializing in business, finance, the global economy, and politics. In real life he goes by the non-nom de plume of Garrett Glass and hides out in Oak Park, IL, where he spends time writing novels on early Christianity (and an occasional tract on God and religion). You can follow his writing career on his website,

45 CommentsLeave a comment

  • Heaven help the Republicans if this should occur prior to the second Tuesday in November.

    Heaven, help us all if it happens after the second Tuesday of November.

    Conservatives are not necessarily stupid, but most stupid people are conservatives. John Stuart Mill

  • who owns the lion’s share of these CDO’s and MBS’s?

    banks or institutional investors or someone else?

    can they make a Trillion dollars in commodities to make up for their losses in real estate?

  • I corrected it. Federal elections follow the Tuesday after the first Monday in November, which is often the second Tuesday, but not this year (Nov. 4). I suppose if some financial calamity occurs before then and jeopardizes Republican chances, the Bush administration can always launch a late October military crisis to distract everybody. The only problem here is that if the crisis is an attack on Iran’s nuclear installations, the consequent jump up in oil prices might get just as much attention.

  • This has been a problem at Merrill Lynch because they bought so many of these mortgage backed securities to back up their lucrative home mortgage securitization business. They only bought the Aaa variety and thought they were being ultra conservative, never guessing that the ratings were meaningless. A few other big players have plenty of these securities but no one knows what they are worth because they are hidden in the accounting category of Level 3, which gives the bank wide latitude on valuing them.

    Some banks like JP Morgan Chase have a hefty portfolio of CDOs because they are big market makers in credit derivatives. One of the motivations for saving Bear Stearns from collapse was, supposedly, to protect JP Morgan and other big dealers from the credit derivatives losses that would have ensued.

    Still, it is suspected that most of the mortgage securities were sold to private investors around the world – hedge funds, mutual funds, investment pools, pension and retirement plans, endowments, charitable organizations, etc. We are only beginning to see these institutions take write-downs on this stuff, because unlike banks, they can argue they were holding the paper until maturity and don’t have to take mark to market losses. They would only take a loss if they felt the paper was permanently impaired in value. Unfortunately, it is now becoming obvious that this is exactly the case for a lot of these securities.

  • However, you’ve left out the likely reality that we are at peak oil (the end of cheap oil). All these things combined with global climate change do not paint a pretty picture of the future. Food dependent on cheap oil, fertilizer dependent on cheap oil, transportation of all things dependent on cheap oil, plastics dependent on cheap oil, etc.

  • Peak oil is a long term force at play that does not disallow periodic declines in the price for crude oil. A severe global recession could drive oil prices down to $50/bbl. or lower for at least a few years. This doesn’t negate peak oil, and in fact the workings of the market could produce another bout of complacency while nothing is done. This would only serve to exacerbate the next round of oil price shocks when the economy turns up.

  • Fine piece of reasoning and writing. Having lived through the incessant global turmoil beginning w/ the assassinations of the U.S. political/social figures in the 1960’s, I have always derided the worst-case Gold Bugs’ scenarios of impending disaster. At his point in time, I cannot contain my sense that there are just too many convergent factors to prevent what Numerian is implying is occuring in the USA. However, it will not be contained to the U.S.; the stress on the underpinnings of the global political economy is profound. Akin to the 1930’s, but now w/ the WTO operating in the background, any further shoes that drop will be stamping on the planet as a whole. Inflation was reported this a.m. in India & it came in over 8.2%. Last update last month on China was over 9%. Any person with a fraction of their brain intact knows “core” inflation in the USA is in the same range once food and energy and the ubiquitous use of oil are accounted for. What to do with ANY savings one has is in part why the CRB is @ a record near 450; institutions and individuals are trying to find a safe place (as Numerian suggests) to park their funds as a store of value. Forget about trying to keep up with inflation, especially w/ the U.S. dollar/peso having lost 40%+ in the current decade. What to do? Tick-tock, tick-tock.

  • That’s annualizing a CPI of 0.6% for the month. What did the stock market do? It rallied over 150 points for the Dow on the good news that core inflation came in as planned at 0.2% for the month. This is entirely a knee-jerk reaction because the Fed has trained the market to think that only core inflation matters.

    At the same time, this morning’s consumer confidence survey fell to a level last seen in 1980. Consumers are not fooled like all the professional, educated people who work in the financial markets. Consumers know that the only inflation rate that matters is the real one, not some imaginary number that the stewards of our economy seem to think is meaningful.

  • Given that banks everywhere–from the US to Europe–are exposed to this toxic stuff, and that the Asian banks’ practices are probably as sloppy if not more so, there has to be a point when some bank somewhere, it could even be some backwoods savings & loan, will implode. Some unknown pile of derivatives will flash like gunpowder, causing a cascade of spectacular failures. There could be several runs on banks everywhere.

    What’s happening so far seems to be somewhat different from 1929 on, where wages didn’t keep up with corporate profits, earnings went down, then a stock flop, then margin calls, then a run on the banks, then mortgage collapse. Same cause–the oligarchs let their work oxes get poor. Different order though.

    So where do you put your money, if you have any? Gold? Gold is already astronomically high and due for a turn. Deflation across the board–instead of for deflation solely in their largest and most important investment, the home–might be overdue. But if burying your money is the only way to keep it, maybe gold’s the way to go.

    All of this is, of course, due to the GOP’s policies, regulatory jury-rigging, deregulation, accounting policies, etc. They’re all cut from the same cloth and need to be wiped out along with the rest of us.

  • …that we’re in the “eye of the storm” by walking about Aspen, Colorado today! The prestigous Aspen Food & Wine Festival is underway this weekend. THREE thousand people (virtually all white) paid $1,150 dollars per ticket to attend gourmet food classes by renowned chefs and myriad wine & liquor tastings. Add the cost of flying here to Aspen (there must be forty Grumman G-6s at the little Aspen Airport right now), expensive hotels and dining out, plus “special” (read:$$$) tastings and dinners and you’re talking north of $10,000.00 per person.

    Numi, I’d NEVER resent the success of a Jonas Salk, a Steve Jobs or a Sergy Brin. Brilliance, risk-taking and a lot of hard work. But I have a helluva problem with the hedge-hogs, the corporate execs who pretend to be entrepreneurs (and are compensated as such) and the recipients of dynastic wealth and privledge who pretend to be self-made (the latter is a big problem for me here in Aspen, daily). Despite the far-sighted practices at many American universities, the U.S. seems to be lurching towards an ossified class system. 5 and 25 are not hedge fund fees, but rather our percentage of the world population, AND our percentage of those incarcerated! I think we have a conundrum with our huge military. It’s becoming our albatross as costs approach 1 trillion; but it’s also been a societal safety valve for lower-middle and working class kids.

    “When sorrows come, they come not single spys but in battalions”(Hamlet, of course).

    Numerian, big kudos for a superb missive!!! JB

  • I keep my money in Treasuries or CDs (you should have no more than $100,000 in any one bank). If I play the stock market I am usually short and only own stocks if there is a good possibility of a short term rally.

  • “Ossified Class System”? Indeed. How many M.D.s marry or hang out with carpenters (educated or not)? How many concert musicians hang with health care workers? Shall I go on? The striation of society is already in place, and the last 4 decades of financial stratification have taken its toll. An active democracy requires a fair number of rules and regulations to curb the human illness of greediness. Ever see the size of the Baseball rules book? Golf? As long as ‘merika continues along the dumbing-down process, the middle class will shrink and the bifurcation of society into extremes will continue. As for your concern for the military’s magnitude, it is a well-justified concern and Eisenhower was right on target with his “military-industrial complex” speech nearly 50 years ago. As the money flows are followed as Numerian has written on, so too are the inevitable ‘have-and-have-not’ dualisms. History should be highlighting for us all one of its lessons: you can’t let the democracy genie out of its bottle as it has been for several centuries without a related financial debacle resulting from the inequalities that build up in a civilization that refuses to adequately regulate itself. Or, a society that allows itself to be hijacked by a segment of its population lacking in wisdom and character. CEO pay and corporate influence in the U.S. are symptoms of that. Numerian’s essay is simply outlining some consequences of this fact. Another result, equally worthy of a companion essay would be the effect on the hopes, a sense of the future, a feeling that betterment of one’s conditions that is STOLEN from our culture by these imbalances in opportunity and social mobility.

  • We’re developing an aristocracy where privilege and power are passed down to the children. It is so pervasive we don’t see it, perhaps because the only thing missing are titles. The extent of nepotism in American society is mind-boggling. Politics, business, entertainment (especially the acting side), and entertainment-related industries like sports and televangelism – they are all corrupted by passing down choice jobs to the children. No one notices, in part because the media treat nepotism as perfectly normal, if not cute.

    In the 19th century America had a reputation for egalitarianism, strict inheritance laws, and enviable public financing. It was a country where opportunity existed for anyone. All of this has changed completely for the worse. No one notices.

  • The middle class has nothing to loose.

    Fear of loss is the greatest motivator. The rich fear those who have nothing to loose, becuase their eyes turn to the rich…and the rich react with violence, but, when one has nothing to loose the violence of the rich upon the have-nots is ineffective.

    The poor have nothing, so they have little fear of loss.

    The middle have some, and fear its loss.

    The rich have much, and fear its loss, and clamp down on the poor to avoid loosing.

  • the middle class does not yet understand the cliff they are heading for and, until they do, the Obamas of the world will not have the political capitol to make things right but if things gets too bad, then unpredictably bad things can happen as they did during the French Revolution.

  • Crawler on Bloomberg News this a.m.:
    Stock at low point, GE says it has sufficient capital

    GE??? THEY needed to put out a “we are financially secure” memo?

    “les Etats-unis, c’est le seul pays à être passé de la préhistoire à la décadence sans jamais connaitre la civilisation…”…Georges Clemenceau

  • Based on the cost of fertilizer, water, and fuel this spring, food this fall is either going to get very expensive or I am going to be out of business as a farmer.

  • The U.S. was more egalitarian 150 years ago and society did offer opportunities for many. Family fortunes were broken up within two or three generations, thanks to the inheritance tax and estate laws. This doesn’t excuse slavery or the lack of rights for women, but American society stood in contrast to ossified aristocracies in Europe.

    A century later things were even more egalitarian, but around 1970 to 1980 some fateful decisions were made that allowed the eruption of an aristocracy. This has occurred with a cultural background that makes it perfectly acceptable for a successful, wealthy person to maneuver their children into the exact same position of money and power. Perhaps the greatest single contributor to this situation was the near abolishment of the death tax, which is the most effective means for leveling society yet devised.

  • They’ve made most of their money these past 25 years in financial services, as well as the buying and selling of companies. Jack Welch rode the booming stock markets with clever trading and a bit of good luck, and his company became the epitome of the corporate giant that eschewed making things for trading things. Sears, General Motors, Ford, and so many others followed the same route. No wonder GE has to assure the markets they have sufficient liquidity to support their financial commitments.

    The question is, will the Fed step in to rescue them?

  • … who have been warning about GE financial shenanigans are you, Jack Bogle (Vanguard)and Jim Grant over at the Interest Rate Observer.

    Most either ignored or derided your assertions.

    You just might have the last laugh, if at considerable public expense!

  • I hate you, man. Everything you say makes so much damn sense, but its all so negative. Maybe sometime in 5 years you’ll throw me a a little ray of sunshine.

  • 40 years ago intergenerational mobility studies found the US had the most mobility in western nations. Now they find it has the least. Yes, class has always had a fair bit of “stickiness”, in every society. But the US used to be better – both compared to now and compared to other societies.

  • But you have to survive this crisis, which will take many years. One clue will be when the general public is disgusted with stocks and sees no way they could ever produce a decent return. In terms of real estate, wait for the moment when hardly any banks are interested or willing to extend a mortgage. If you can qualify for one, it will be a great opportunity to buy real estate. My wife and I qualified for a mortgage at the depth of the 1980 recession, but with a 30% down payment and an interest rate of 17.5%. But the house has quintupled in value since then. I doubt if that exact experience can be duplicated, but on the other hand the mortgage cost will be a lot less when the bottom is reached in this market.

  • The Republicans will answer the crisis with a tax cut on money that comes via mailbox, not the earned with your hands type. Taxes will be raised on people making fewer than 200k a year. The big save the economy tax cut will be the complete elimination of any inheritance taxes, in fact there may even be a tax credit applied if you inherit more than 10 million, as a reward for being smarter and closer to god, than the unwashed non-ivy leagers. The Democrats will bitch a lot, but enable of course, after all lots and lots of Dems are wealthy and god has given them their hard earned spoils.

    Never fear Congress will answer with tax breaks for the wealthy, and taxes on the rest of us.

    Numarian, thanks for writing what runs through my mind each time I see the growning number of private jets that fill our municipal airports. The demand is so high for Golfstreams, that people who are in line to take delivery in the next year or two are able to sell their delivery position for several million more that the jet to be delivered is worth. A nice reward for being in the rich line. After all, all those newly minted oil Zillionaires have to have a nice ride.

    “There are two types of folk music:
    quiet folk music and loud folk music.
    I play both.”

    Dave Alvin

  • One thing I’ve noticed is how far the US has dropped since its creation. Just think of all the geniuses the US had at the time of the American War of Independence (a/k/a to Americans as the American Revolution) and how few there have been since!

    One reason is that the US educational system has been abysmal and the mentality of the American public and the triviality of US politics are two of the consequences. (Compare US standards to other G-8 countries).

    Historically, the US university system had low standards and it was only when Hitler in the ’30s forced the creme of German academia (Jews and leftists) to flee to other countries, including the US, that the US developed world-class universities.

    At the same time, the lowering of standards has occurred in the US primary and secondary school systems, a result of the pernicious influence of Dewey, the so-called pragmatist. The acceptance of curriculum based on Dewey’s philosophy of education has varied in the US and consequently, led to a rather uneven quality of education.

    In other countries, people don’t go around asking whether the schools are good in a neighbourhood before they move in. Incidentally, the quality of US schools is not just a reflection of socio-economic circumstances. It is also affected by the importance the people in a school district place on education.

    Over time, this failure to improve has affected US universities.


  • What this says to me is a return to the days before 0% interest rates in Japan led to a flood of cheap $$$ into the U.S. and, as money does, that money went looking for places to go. If you can’t run your business on the cost of credit today then you’ve got other problems, like living off leverage rather than productivity. Yes, Japan is pulling its cash out, correlations between FX and equities are way up as money retreats from low-interest rate areas and carry trades unwind. (Hedge funds with big correlation exposures are getting hammered.)

    Damn. This may mean earning a living for a change, America.

    So after much wailing and gnashing of teeth America will go back to manufacturing, protected by the de facto trade barriers raised by expensive transportation. Unfortunately, this time the easy oil of Pennsylvania, Texas and California will be gone, so no more freebies there either. Maybe in 10 years or so someone will get around to implementing algae to oil in a way that brings if not cheap then at least adequate chemical transportation energy back (back-of-the-envelope it’s quite feasible). Nuclear won’t take up the slack; too $$$ to build and too slow to commission. It’s going to be painful, not armageddon.

    For those fomenting revolution, let’s keep in mind that the American rebellion was led by the a rich land-owner and prominent military man.
    The middle class won’t be doing anything.

  • Calm down everybody!

    Just ignore all this stuff. Go shopping. Buy a house or re-fi the one you have. Gas prices? Just don’t pay attention. As Exxon teaches the kids – “to fuel is cool!”

    America is the greatest nation on Earth. All other countries just want to be like us. America is the richest nation on earth too. Everybody loves us, because we beat up bad guys and we have great TV shows and cool pop music too.

    Hummers are the most fantastic car in the world. Everyone should have one. After you re-fi your house, you can use some of the free dough from the re-fi to buy a Hummer. Ain’t America a great place?

    But is isn’t all fun and luxury being an American. We have the tough job of making the world safe for Democracy and protecting everyone from terrorists.

    That’s why it’s very important to invade Iran right now, because the bad guys, like that Osama dude, are all over there. Don’t worry about your kids over there – like Bush says, they are dying for a Noble Cause.

    Plus – wars create jobs and help the economy.

    So don’t worry. Fill the tank and take Mom, Buddy & Sis on a Great American Road Trip. You can still see the World’s Biggest Frying Pan and other cool things on America’s great highways.

    Just like 1950 all over again. The post WWII years will never end! Speaking of which – WWII – ahh! Now there’s a war you can feel good about!

    So stop worrying. The Great American Free Market will take care of itself. No need to change a thing.

    And vote Republican – because we need that war and we don’t need no taxes (especially on big corporations, because they provide jobs!)

    It’s been fun, y’all, but I gotta go now and watch some football on my big plasma screen. I gotta six-pack of rice brewed beer and a two extra large pizzas with everything on ’em waiting for me along with the game too.

    America, F*ck Yeah!

  • But CDs in a time where we may have massive, rolling bank insolvency? I don’t think FDIC has enough to cover everything in that case, and there’s a real risk of having FDIC either a) not honoring its obligations, or b) honoring its obligations so slowly that you go BK before you can access your money.

    The other thing is: if Cash is King, what currency do you want it in? Traders are already pricing in a raise in interest rates, but I seriously doubt Bernanke & Co are going to raise rates.

  • While this has never happened, in a severe banking crisis like the 1930s the strains on the FDIC would be significant. What made the 1930s crisis much worse was the uncertainty that you could get any of your money out of a failing bank. The FDIC removes that uncertainty up to $100,000. If it appeared that the FDIC couldn’t meet its obligations, the federal government would have to step in with taxpayer money. Would the federal government refuse to do this? This seems very unlikely since it is already rescuing investment banks. If you line up all the prospective claimants on the taxpayer in a time of economic crisis (investment banks, commercial banks, Fannie Mae, Freddie Mac, Home Loan Banks, FHA, FDIC), the one institution that certainly helps prevent public panic is the FDIC. I would think they would come first and foremost if it gets to that.

    Would the federal government itself go bankrupt? Countries do go bankrupt in the sense that governments cannot immediately meet their liabilities, or better put, they “defer” repayments or completely stiff bondholders by forcing a cramdown. The U.S. could face this situation, especially in meeting foreign obligations, but domestically it can effectively nationalize all consumer bank deposits if it had to in order to keep cash, checks, and electronic money denominated in U.S. dollars still legal tender within the country.

    To avoid all this you can place your cash in foreign currency deposits. The favorites tend to be the Swiss franc, Canadian dollar, yen, euro, and sterling, not necessarily in that order. Just make sure you tell the IRS what your earnings are on these deposits.

  • The Fed has created an alphabet soup of lending facilities for the investment and commercial banks so that they can put their toxic M3 effluvia on the Fed’s books. Each of them appears to have been tailor made by Ben Bernanke to address particular situations with each institution. And the banks have used these exotic, dubious facilities with abandon, trading all sorts of derivatives at face value (their true value could theoretically be pennies on the dollar) for treasuries.

    So if you’re a foreign investor, and you see that the Fed has traded over half of its reserves ($1 Trillion), which were treasuries, into a what is generally called “Big Shitpile,” of what value is a treasury from a country whose currency is in meltdown mode? Whose banks are defacto insolvent? Whose rating agencies are demonstrably lying through their teeth?

    The Swiss Franc is no guarantee–I spoke to a representative at a Swiss Cantonal bank and their opinion seemed to be that if UBS or Banc Suisse went down, all the banks in Switzerland would almost immediately go belly up, due to their many agreements, investments, and counterparty relationships. And those two entities have been taking huge, huge writedowns from US mortgage-backed investments that will probably only get worse over the next two years.

    I’d also seen a report on Bank of Montreal that indicated they’d somehow defaulted on a line of credit and were raising capital. My contention is that Canada is especially vulnerable to the radioactive bank situation in the US. The UK and continental European banks are also vulnerable. Mortgages are exploding in Spain, Italy, Ireland, and the UK. Want to find refuge in Germany? Sachsenbank, a regional German bank has already gone into receivership. Deutschebank has taken huge writedowns and probably still has more to go. Can’t bank with the Australians. Same is happening there, too.

    Want to bank with the Chinese? The Shanghai stock indexes have taken huge losses off their unsustainable highs, and an economic slowdown is sure to come after the Olympics–the Chinese don’t like high oil prices either, and much of their economic activity seems dependent on oil prices, like our own economy.

    What about the banks of Gulf states? Can they be trusted? Probably only if you have millions, and maybe not even then. I really don’t know. Maybe UAE or Dubai.

  • I thought I’d stick this idea in here again. A few more years and it might start being taken seriously;

    I’d like to offer my own version of reverse shock doctrine as something to think about. After all these years of privatizing any and all possible public assets, the pendulum has the momentum to swing back the other way, but it has to do it as an effective step into the future and not just trying to reverse what has already happened. My argument is that money has evolved from its origins as an accounting of private property to a public medium of exchange and this point should be introduced into the public conversation.

    Money is a medium of exchange, store of value and accounting device. The first two work at cross purposes because as a medium of exchange, money functions as a public utility, while as a store of value, it is a form of private property. By and large it is as private property that most people think of it, due to its historical origin as an accounting device of valuables, yet the reality is that modern monetary systems are fundamentally a medium of exchange and only as a function of that are they a store of value, as they have no real backing other than faith in the issuing institution and must be invested for the system to function and maintain value. If this understanding of money as a form of public utility, or commons, were to be broadly considered, it would have definite repercussions in the context of the current crisis. The monetary system, with its broad connectivity, is similar to a road system. You own your car, house, business, etc., but not the roads connecting them. Money is in many ways identical to the road system. Money is not private property, since you cannot print what you want, as the government retains copyrights, but effectively loans it out to the private banking system. Its value is based entirely on public faith in the institution issuing it, so the taxpayer is ultimately responsible for guaranteeing its value. The result being private gains and public responsibility.

    I think the concept of abstract wealth as a store of value has reached the point of being socially and environmentally destructive. Given the human tendency toward intellectual reductionism, that ability to distill out abstract wealth from ones social interactions and environmental situation is profoundly corrosive to both society and the environment. It is similar to processed sugars, and other forms of distilled ingredients which then must be diluted to be palatable. Consider how society would function if money were to be considered entirely as a public medium of exchange, similar to a road system. For one thing, in most circumstances, it simply wouldn’t be a factor, as outside of the financial system, most money is in circulation and wealth is stored as tangible assets. Even in situations where one might be selling and buying a house, or a business, it functions as a medium of exchange. Similar to a road, where large vehicles need more space and pay more taxes, while smaller vehicles naturally give them more room. Now consider the situation of storing value. The overwhelming problem with capitalism isn’t that there are poor people in the world without recourse to income, as poverty has always been a problem. No, the problem with Capitalism it that by focusing on money as a store of value, it has created a large surplus of capital. Since the demand for money is so large, as everyone thinks they must have enough to personally insure their own security and health, as well as viewing it as proof of success to accumulate as much as possible, a savings glut, as Bernanke put it, has been produced that cannot be effectively invested. This encouraged ever more lax lending standards as a way to absorb savings and sustain further growth of the money supply. Now that bubble is bursting and this evaporating wealth is panicking and driving up commodity prices, I think the very basic question of whether we should even have a system of stored abstract wealth needs to be re-examined. If people cannot suck value out of their social connections and environment to store in a bank as a form of ego gratification and social status, they would have to resort to putting their efforts and desires to increase status and build security directly back into restoring and strengthening their social and environmental health. So I don’t think there needs to be a currency for storing wealth, but only currency as a public utility for exchange. Not only are the enormous pools of personal wealth that it enables an excess the planet can no longer afford, but more importantly they provide an destructive role model for everyone else.

    This isn’t socializing wealth, but understanding what money is in the first place. The effort to privatize Social Security is a good example of the disconnect between assumption and reality, since there is simply no place to invest this amount of additional personal savings and would only be a boon to the brokers given the responsibility for handling it. We invest in our old age by investing in our parents old age, so that our children might continue the practice. It is a clear example of investing in the larger community as a viable form of savings.

    Obviously we would have personal savings accounts, but what sets the amount of viable savings isn’t the cumulative desire for wealth, but what can be productively invested. So there has to be some regulatory method for distributing the potential to invest as broadly as possible. The logical method is to reinstate higher tax rates, but there might be a whole range of ways to encourage those able to accumulate large amounts of wealth productively to be able to invest in ways that benefit aspects of society and or the environment in ways they chose, much like Bill Gates and Warren Buffett are currently doing. Wealth is a convective cycle of rising assets and precipitating benefits. Stopping this process only creates large storm clouds of marginally productive wealth hanging over a parched economy, much like we have now.

    Currency did originate as a store of wealth, because it started as a accounting of specific assets, but political power also started as a projection of individual influence and evolved into a very complex corporatization of personal power called monarchism before the inherent instability and corruption drove society to devise methods for making political power a public trust. It has come time to make economic power a public trust as well. Money lubricates the economy, rather than fuels it. Ideas, labor and resources are the real economic fuel.

    An effective financial system must express the dichotomy of bottom up process and top down structure that is the basis of nature, from ecosystems and the organisms which inhabit them to the political model of the democratic process constantly revitalizing the republican state. How to do this is to make the currency a national function to provide broad stability and accountability, while the banking system would be a function of local and regional government, with the necessary profit, generated by interest rates required to make investment decisions be based on viability, a form of public income to support the healthy social infrastructure necessary for a healthy economy. Since money would be considered a form of public utility, the desire to accumulate large quantities would be curtailed, since it would be viewed as infringing on the health of the society in which one exists and this wouldn’t have the desired effect of raising ones social status, or even ones economic position, as it couldn’t be used to generate the increasing returns which wealth currently aspires. If hoarding currency lost its civic standing, inflation wouldn’t be necessary to maintain circulation of currency, so accounting values would be more stable.


    John B. Merryman
    Sparks, Maryland

  • The savings glut you refer to is not from Americans, who overspend and rack up huge debt nor from the various levels of US governments with their huge deficits, but from foreigners and their governments, who receive essentially worthless dollars printed to finance your various deficits and then have to either spend them (causing inflation in their country), save them (in the hopes that they may have some future value) or lend them back to Americans.

    At the present time, all you Americans have is your military might to push through these transactions. So in advocating your view, you are admitting in effect that might makes right because otherwise your view would make no sense.

  • Did you sell it? Do you live in a state (unlike California) that rolls up property taxes as the house land price rises? Was it investment or consumption?

    Housing is such a dubious investment.

    “The Playboy reader invites a female acquaintance in for a quiet discussion of Picasso, Nietzsche, jazz, sex.” – Hugh Hefner

  • Because there is no mortgage, and property values are not (yet) declining. However, property taxes now equal what we use to pay on our fixed rate mortgage, and have gone up 7.5% p.a. since 2000. That’s eating up some of the paper profit and taking away a lot of disposable income. Housing ain’t cheap even if you own the home free and clear – or maybe that’s the same thing as saying there is no such thing as free and clear.

  • They hold the bulk of U.S. dollar foreign investments. When they get tired of losing billions each month on their investment, the free ride will be over. Of course, there is a second free ride provided by OPEC since they price oil in dollars. What would Americans do if they had to pay for oil in euros and the euro continued to appreciate? A double whammy.

  • we could very well be faced with a situation where the frugally inclined will be on equal footing with the spendthrifts. They’ll all be broke!

    “While not a Playboy reader, she invites a male acquaintance in for a quiet discussion of Chagall, Nietzsche, jazz, sex.” – not a Hugh Hefner quote

  • I think that’s why all the big boys are panicking: there’s no place to hide. During other crises, it seems they’ve always had the first-class lifeboat and got out of positions while all the other rats and assorted suckers drowned. But even if you make profits, the uncertainty of the currency makes the profit meaningless. In a time when inflation is growing out of control, even huge profits may be only treading water, or even losing ground. Since most of them are actually losing money, and there are no suckers left, their pain is especially acute. The inflation is also squeezing margins at corporations that actually make things as they try to maintain consumer prices. But the conditions seem to be setting up a very bad scenario for retailers and manufacturers that supply them. More unemployment = fewer goods sold. Higher oil/food prices = profit margins get squeezed or actually turn into losses. Stock prices tumble.

    Question is, if the conditions are so bad that institutions are “running to ground” and speculating on the commodities bubble, creating a sort of market trading phenomenon of hoarding, what happens to those prices if/when DJIA gets whacked? I think they go down momentarily, but maintain their prices until they become so unaffordable that that bubble bursts too.

  • Your last paragraph is not just plausible but probable. The commodities bubble, including oil, becomes the last to collapse after it is clear the global economy has to shrink in the face of eroding credit availability.

    The oil producers aren’t going to fall into the Chinese trap of lending to their customers. They’ve already done that to an extent with the recent investments in banks and investments firms, and according to this morning’s NYT, those investments are down 50% or more.

  • What would Americans do if they had to pay for oil in euros

    Is that not precisely the principal true motivating factor behind

    1) The Iraq Invasion

    2) Sabre rattling towards Iran leading to possible invasion.

    A brief 2003 analysis is online at Bush’s Deep Reasons for War On Iraq: OIL, PETRODOLLARS, AND THE OPEC EURO QUESTION (No author cited in this Berkeley item.)

    Iraq was one of the first OPEC countries, in 2000, to convert its reserves from dollars to euros. At the time a commentator for Radio Free Europe/Radio Liberty predicted that Saddam’s political act “will cost Iraq millions in lost revenue.” In fact Iraq has profited handsomely from the 17 percent gain in the value of the euro against the dollar in that time.”

    Regarding Iran, see an article by William Clark entitled The Real Reasons Why Iran is the Next Target: The Emerging Euro-denominated International Oil Marker

    To date, one of the more difficult technical obstacles concerning a euro-based oil transaction trading system is the lack of a euro-denominated oil pricing standard, or oil ‘marker’ as it is referred to in the industry. The three current oil markers are U.S. dollar denominated, which include the West Texas Intermediate crude (WTI), Norway Brent crude, and the UAE Dubai crude. However, since the spring of 2003, Iran has required payments in the euro currency for its European and Asian/ACU exports – although the oil pricing for trades are still denominated in the dollar.]

    Therefore, a potentially significant news development was reported in June 2004 announcing Iran’s intentions to create of an Iranian oil Bourse. (The word “bourse” refers to a stock exchange for securities trading, and is derived from the French stock exchange in Paris, the Federation Internationale des Bourses de Valeurs.) This announcement portended competition would arise between the Iranian oil bourse and London’s International Petroleum Exchange (IPE), as well as the New York Mercantile Exchange (NYMEX). It should be noted that both the IPE and NYMEX are owned by U.S. corporations.

    The macroeconomic implications of a successful Iranian Bourse are noteworthy. Considering that Iran has switched to the euro for its oil payments from E.U. and ACU customers, it would be logical to assume the proposed Iranian Bourse will usher in a fourth crude oil marker – denominated in the euro currency. Such a development would remove the main technical obstacle for a broad-based petroeuro system for international oil trades. From a purely economic and monetary perspective, a petroeuro system is a logical development given that the European Union imports more oil from OPEC producers than does the U.S., and the E.U. accounts for 45% of imports into the Middle East (2002 data).

    After much chikanery and many delays the Iranian Oil Bourse opened in February of this year.

    Of course, the ramifications of oil purchases denominated in Euros extends far beyond the requirement that the US purchase oil in a non-US currency. It’s self evident that means that all US purchases are subject to the vagaries of the ever fluid monetary exchange rates – but more importantly, it puts US banks out of the global business of gleaning those same benefits arising from converting every other nation’s cash for oil into US bux.

    For an overview of currencys and oil purchases, see WIKI on the subject.

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