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Financial Skeptic Bulletin, February 2008

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NEWS CONTENTS

Old News ;-)

"The dollar is our currency, but your problem."

Nixon's Secretary of State John Connally to European peers
who were carping at him about a falling dollar

All the middle-class 401K frogs are welcomed to the slowly warming stagflation pot.
Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.

John Maynard Keynes
"You can fool some of the people all of the time and those are the ones you want to concentrate on"

George W. Bush

[Jan 29, 2008] Unwinding the Fraud for Bubbles

What was the business model behind all this craziness ? Is it worth it to originate or buy 49 fraudulent loans in order to get that one good one ?

March 26, 2007 | Calculated Risk

My theory of the Fraud for Bubbles is, in a nutshell, that it isn't that lenders forgot that there are risks. It is that the miserable dynamic of unsound lending puffing up unsustainable real estate prices, which in turn kept supporting even more unsound lending, simply masked fraud problems sufficiently, and delayed the eventual "feedback" mechanisms sufficiently, that rampant fraud came to seem "affordable." So many of the business practices that help fraud succeed-thinning backoffice staff, hiring untrained temps to replace retiring (and pricey) veterans, speeding up review processes, cutting back on due diligence sampling, accepting more and more copies, faxes, and phone calls instead of original ink-signed documents-threw off so much money that no one wanted to believe that the eventual cost of the fraud would eat it all up, and possibly more.

... ... ...

I suspect most of us feel, generally, that fraudsters-borrowers, lenders, anyone else-who get burned just got what they deserved. True enough. But lending fraud, like warfare, creates quite a bit of "collateral damage," in all senses of the term. Those honest homeowners watching their neighborhoods collapse after the fraud-bombs finally detonated are not probably very comforted by the fact that it wasn't their fault. So when we debate the question of potential "bailouts," we keep running up against the question of who needs or deserves the bailout. If you want to do something to assist the honest homeowner who bought with an 80% loan but is now upside down because of the neighbors' fraud, how do you do that without, inevitably, helping out the lender who facilitated that fraud, too? If you want to do something to protect the stability of the honest lenders, how do you do that in a way that doesn't, inevitably, also protect the scumballs and incompetents?

Getting into a bubble is easy. Getting out?

[Jan 29, 2008] fed-approaches-negative-real-interest

While the question of whether the Fed will lower interest rates again after its emergency cut last week is still up in the air, it is pretty clear that further cuts in the Fed's target rates are in the offing. And the markets believe the Fed will continue to cut quickly, putting the odds of a 50 basis point cut tomorrow at 88%

At a Fed funds rate of 3.5%, some would say the Fed has already created negative interest rates

Re: Aggressive rate cuts are justified if there's ``conclusive evidence'' that household income prospects are in danger

> By overreacting to stock market trivialities, like an index going down 3%, or 5%, we have a Fed panic to sustain the good times for speculators, by setting up the possibility of successive rate cuts to continuing goosing the market.

Even in a casino, you kind of expect the invisible hand of economic uncertainty to be a probability factor to hedge against (people do lose cash in Vegas), but when The Fed is on an outright Mission From God To Save The Stock Market, they are synthetically removing variables for market efficiency and increasing future risk. If they create the implied illusion that they can subsidize risk and failure and become an insurance agency, this goes back to Greenspans warning of moral risk!

If they had collective Fed brain cells, they would keep the Fed powder dry and begin an aggressive program to have audits performed and game the regulation side of this equation coin, instead of being part of the casino collusion, where they design new ways to rig the game.

We need accountability, and if you listened to that link about The Economic Summit, Blair is to have said we need the equivalent of a UN rapid reaction force to step in, or some type of early warning system linked to global accounting regulation; he also says the worst is to come. If The Fed keeps putting more free chips on the blackjack table, they will come, they will play....

January 29, 2008 3:05 AM

Selected Comments
Brock said...
I'm in Singapore, and the inflation is in my opinion much, much higher than their stated figure. I think the government is just full of it. Unfortunately, when I communicate to my North American friends that the stats are likely political mumbo jumbo they compare this position to 9/11 "truthers".

January 29, 2008 4:37 AM

Independent Accountant said...
I blasted the Boskin Commission when it was first formed. It was designed to reduce reported inflation and it did as told. No one should believe any government statistic.

[Jan 28, 2008] Video - CNBC.com High Time For High Yield

There is risk, but there is a reward too. In any case 401K investor needs to stick to junk funds that are focused on BB and B issues of the junk bond spectrum. The latter is higher end of the spectrum.

Pimco, T. Row Price and Vanguard high yield funds belong to this category...

[Jan 28, 2008] AmEx CEO Clear signs of a weakening economy and business environment

Calculated Risk

From American Express:
"... we saw clear signs of a weakening economy and business environment in December,"
Kenneth I. Chenault, chairman and CEO.

[Jan 28, 2008] Financial Crisis: '20 Years in the Making'

"Irrational enthusiasm" is finally over and confidence in Fed is lost. "Fed bubble" was the last bubble to pop.
January 26, 2008 | Economic Dreams - Economic Nightmares

Doug Noland tells us - preaching to the choir, since no one else will listen - that the stage for the mess now unfolding was built on a foundation laid over 20+ years by US Federal Reserve policy, cheerled by Wall Street finance. Noland says, "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." Here's more:

More than 20 Years in the Making, Doug Noland, Credit Bubble Bulletin, Jan. 25: … 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. …

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. …

[Jan 28, 2008] Spectre of sovereign wealth funds by K. SUBRAMANIAN

October 09 , 2007, | Sify.com

With apologies to Karl Marx, a spectre is haunting the capitalist West: that of sovereign wealth funds (SWF).

The rates at which foreign exchange reserves of emerging economies rise, and the efforts made by them to invest abroad are scary.

In recent years, the International Monetary Fund (IMF), the Bank for International Settlements (BIS) and major banks have been publishing data on the rising reserves of these countries. Until two years ago, they were not troubling.

What set the cat among the pigeons was a study by Morgan Stanley published in May 2007 (⌠How big could sovereign wealth funds be by 2015?). It reported that SWFs could turn absolutely massive and rise from the current level of $2.5 trillion to $12 trillion by 2015, with an annual rise of $500 billion. The report went on to suggest how this would affect fundamentally the risky assets trade and give rise to ⌠financial protectionism.

The Economist described SWFs as a "secretive society" flush with assets and added how, if they continued with their spree, ⌠the world will witness the intriguing spectacle of its largest private companies being owned by governments whose belief in capitalism is often partial.

Sebastian Mallaby of The Washington Post (⌠The Next Globalization Backlash, June 25, 2007) narrated the challenges posed by them to globalisation and how ⌠chunks of corporates could be bought by Beijing"s government - or, for that matter, by the Kremlin.

It is evident is that the fear of SWFs that has been creeping in recently has degenerated into paranoia. A Cold War-like atmosphere permeates discussions on the subject.

This turnaround is surprising as, till recently, members of the developed world were the advocates of globalisation with capital freedom and foreign investment as its centre-pieces.

Further, economists sympathetic to the concerns of emerging economies were cautioning the latter about the "excessive" build-up of reserves and investing them in low-yielding US Treasuries. Prof Lawrence Summers, former US Treasury Secretary, in a lecture in Mumbai in March 2006, bemoaned the irony of the emerging nations wasting their reserves. He pleaded for a new focus toward the challenge of deploying them effectively.

Separate vehicles

Within the emerging economies, public opinion turned against their central banks and pressed them to adopt bolder investment strategies. With the levels of reserves far exceeding prudential liquidity needs, the central banks themselves realised the need for setting aside a part of the reserves in separate vehicles for investments to get better returns.

Singapore set the precedent by creating Temasek. Oil exporters such as Kuwait, Abu Dhabi and Saudi Arabia had set them up earlier. Russia, with its equalisation fund, is a recent addition to the pantheon.

China setting up a State Foreign Exchange Investment Corporation with a capital of $300 billion was a thriller when it was reported. The formal launch on September 28 of China Investment Corp (GIC) with a capital of $200 billion was a low-key affair, ostensibly in order not to ruffle the feathers of western critics.

On date, the SWF club has 25 members and includes small countries such as Kazakhstan and Botswana. Truly, it is a motley assortment. Many are new to the game and do not have any common strategy. And yet, their emergence has disconcerted the older players.

The chorus voicing concerns over SWFs is from Western governments, academics and journalists. Broadly, they allege that SWFs are state-owned and, ergo, are not commercially driven and thus their motives suspect. Prof Summers would argue that these funds "shake capitalist logic" (Financial Times, July 29, 2007) as they seek non-economic objectives.

More transparency

It is also suggested that SWF operations are clothed in secrecy and lack transparency. Most attacks on SWFs harp on these themes in some form or other.

Clay Lowry, Acting Under-Secretary of the US Treasury, gave his views in a lecture delivered in San Francisco. He felt that the ⌠common objective should be an international financial system where countries do not accumulate more foreign exchange assets than they want or need. Sadly, he could not elaborate how this utopia could be achieved with the US" uncontrolled twin deficits.

Indeed, he was pragmatic and added, "SWFs are not going away, and it will be increasingly necessary to work to integrate these funds as smoothly as possible into the international financial system". His main thrust was on transparency of their operations and adoption of "best practices." He hoped a joint task force of the IMF and the World Bank could work out the guidelines.

There are reports about Germany drawing up plans to stop strategic assets falling into the hands of ⌠giant locust funds controlled by Russia, China and West Asian governments. Germany"s fear was over Russia "stealing" its technology, though it does not say it openly. It is said to be drafting new legislation to cover national security and, possibly, energy.

The EU Commissioner for Economic and Monetary Affairs, Joaquin Almunia, explained in an interview on September 27 that unless investments by SWFs are more transparent, they would be restricted. The intention, as he explained, was not to be "protectionist" but to protect the region"s interests without being "protectionist." Though somewhat ambivalent, the UK holds a similar position.

Southern shift

Fear of SWFs has deep roots. There has been a southern shift in economic balance in recent years. The US has been losing its hegemonic role even in financial markets. In the post-bubble era, its strength was boosted by the passive piling of reserves by emerging economies. In fact, they were subsidising the US financial market and some economists even dubbed it ⌠Bretton Woods II which would subsist for long.

As Prof Brad Setser of Oxford put it in his blog (of July 10), The BRIC taxpayers are subsidising the US to the tune of roughly $130 billion a year. That is roughly 1 per cent of US GDP. It helped Americans buy BRIC goods and services at lower prices. It kept interest rates low and helped banks and brokers make huge capital gains selling debt back to emerging economies in complex packages.

Private equity firms might not be the kings of Wall Street in the absence of huge surge in central bank for debt, and the resulting easy availability of liquidity. They would lose their kingdoms if emerging economies withdrew their reserves or diversified into other economies. True, there are limits to which they may do it individually or collectively. However, there are signs that the trend has commenced.

Stephen Roach of Morgan Stanley puts it more trenchantly: "The day will come when surplus funds will begin to shift focus away from functioning as lender to the external world". It would lead to a shifting mix in composition of global savings and tradeoffs associated with the alternative uses of funds. There will be downward pressure on the dollar and upward pressure on long-term US real interest rates. Investment through SWFs is another major and significant trend. All these together would end the party in New York. This is the spectre that haunts the US.

[Jan 28, 2008] IMF, Larry Summers- The Wile E. Coyote Moment Has Arrived

naked capitalism
Larry Summers is an interesting transformation of an economist emerged in casino capitalism environment. He was implicated in the "privatization" team that destroyed the economics of Russia more successfully that Hitler armies ;-). Later he tried to protect from prosecution professors Andrei Shleifer and Jonathan Hay "who illegally speculated in Russian stocks and bonds, even as they directed a US-funded, Harvard-backed project to help the Russian government set up honest and transparent capital markets -- a project whose rules expressly forbid them to invest in the host country." Economic Principals He was also implicated in Enron fraud as well gold manipulations. Not surprisingly Summers he has a plan on how to solve the current crisis with monolines.

It is critical that sufficient capital is infused into the bond insurance industry as soon as possible. Their failure or loss of a AAA rating is a potential source of systemic risk. Probably it will be necessary to turn in part to those companies that have a stake in guarantees remaining credible because they have large holdings of guaranteed paper. It appears unlikely that repair will take place without some encouragement and involvement by financial authorities. Though there are many differences and the current problem is more complex, the Long-Term Capital Management work-out is an example of successful public sector involvement.

[Jan 28, 2008] Global Recession Risk Grows as U.S. `Damage' Spreads (Update1) by Rich Miller

If global growth slows, the idea that export will save the USA economics is a wishful thinking...

Bloomberg.com

Global growth may decelerate close to the 3 percent pace economists deem a worldwide recession, from a 4.7 percent rate in 2007.

... ... ....

The meltdown of the U.S. subprime-mortgage market has pushed up credit costs worldwide and forced European and Asian banks to write down billions of dollars in holdings. Tumbling U.S. stock prices are dragging down markets elsewhere.

"We'll see more collateral damage," says Allen Sinai, chief economist at Decision Economics in New York. "The risk of a global recession is rising."

...the IMF postponed publication of its latest world economic forecast, originally due Jan. 25, to take into account recent market turbulence.

In Davos, Klaus Kleinfeld, chief operating officer of Alcoa Inc., the world's third-largest aluminum producer, said he foresees ``a difficult year. I don't think the world can decouple itself from what's happening in the U.S.''

[Jan 28, 2008] Time To Move On to the Next Bubble Clean Energy by Mark Braly

The U.S. economy is a bubble economy -- going from bubble to crash to the next mania -- and the new bubble is likely to be clean energy, says Wall Street insider Eric Janszen in the cover story of the February Harper's.

We've seen two bubbles, internet and housing, within a decade, writes Janszen, "each creating trillions of dollars in fake wealth."

"There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle."

Here's why Janszen thinks the necessary next bubble will be clean energy. The new bubble sector must:

1. Already be formed and growing as the previous bubble (housing) deflates. Check.

2. Have in place or in the works legislation guaranteeing investors favorable tax treatment and other protections and advantages. Check.

3. Be popular, "its name on the lips of government policymakers and journalists." Check.

4. "Support hundreds or thousands of separate firms financed by not billions but trillions of dollars in new securities that Wall Street will create and sell." Is that coming? Janszen is quite expansive in his definition of clean energy, including a massive retooling of the country's transportation and power infrastructure.

Janszen, a one time venture capitalist and serial entrepreneur, thinks the financial sector is driving the U.S. economy (and, per force, much of the global economy). The financial sector gets behind whatever new thing they think can provide the hyperinflated returns they require. And they bring to bear massive political influence, well lubricated by money, to insure whatever public policy they require.

Advocates of renewable energy might say bring on this bubble. But Janszen cautions: "Bubbles are to industries that host them what clear-cutting is to forest management. After several years of recession, the affected industry will eventually grow back, but slowly."

In an email interview I asked Janszen if a clean energy bubble was a good thing - bringing massive investment to vital new industries - or bad, leaving those industries struggling in the wreckage of the inevitable crash down the road.

"The term 'bubble' is pejorative," he replied. "The alternate title for the Harper's piece was 'The Good Bubble.' These are changes we need but lack the political ability to make due to the inertia of entrenched interests...Employment of the bubble system that was responsible for the tech and housing bubbles may be the only means available both to fight the impact of the debt deflation recession that started in Q4 2007 and also to deploy resources on the scale required."

In this scenario, the big losers will likely be the investors or taxpayers, as in the housing collapse.

[Jan 28, 2008] Reflation without Representation - iTulip.com Forums

The System is not designed to purify credit addicted lost souls or soulless bankers through poverty and perdition, and if a soup line forming and mass bank failure inducing economic debacle did occur the primary victims–as usual and in the current instance of historically unprecedented distribution of wealth, more than usual–will be the middle class on down the economic prosperity ladder. This group has hardly any liquid assets net of what's put aside to cover the housing bubble bloated mortgage and refinancing payments on the rapidly depreciating homestead.

...With millions of households fragile from a decade of excessive borrowing and thousands of businesses levered up on debt from the LBO boom, the US economy is better poised for a 50 foot swan dive into a dirt pit than at any time in the last 70 years. (You remember the LBO boom, right? It was the nearly daily announcements of multi-billion dollar buyouts that suddenly stopped last summer. Here's an idea for a new web site: Forgotten Financial News. If you create it, don't forget to feature Jim Cramer. He's busy now recasting himself as a champion for the little guy who warned about the bear market, again.) Thus it is the majority, the great mass of voters, who in our great republic are carefully managed during a recession, especially in an election year.

[Jan 28, 2008] Maybe Securitization Really is Casino Capitalism

That's an apt new term "casino capitalism". BTW inflation is a regressive tax.For example, the DOE and DOT say an American car gets an average of 24 MPG. The average price of a gallon of regular gas a year ago was $2.27 versus $3.11 today. The average car owner who earns less than $30,000 a year will spend about $375 more this year than last year just on gasoline, while the car owner who makes more than $100,000 will spend $492 more.

December 26, 2007 | International Political Economy Zone

Securitization involves the packaging of various assets to be sold to other investors in the form of, well, securities. Most infamously, residential mortgage backed securities or RMBS have been in the limelight as the subprime mess has hit primetime and housing loans which should never have been granted in the first place have begun defaulting in ever higher numbers. Actually, I am not a hardened critic of the idea of securitization as it can serve as a worthwhile way for securing additional funding. However, there isn't much you can do when what is being securitized is garbage to begin with like in the case of the housing mortgage mess. Garbage in, garbage out--there is no such thing as financial alchemy that allows trash to end up golden. King Midas is not a mortgage broker.

I got a chuckle after visiting the American Securitization Forum website and seeing a notice that its 2008 annual conference will be held in Las Vegas for the second year in a row--at the Venetian, no less. If you're a hard boiled critic of the whole securitization mess, the choice of location is rich with irony. Las Vegas, the "ultimate boomtown," is now beset with the highest rates of foreclosure in the US as that market has cratered, to state things conservatively. Is securitization all smoke and mirrors, mere hocus-pocus, or both? And, is securitization a fancy word for gambling, oftentimes with the fortunes of others? You've got all the Star Wars droids being discussed at this event, that's for sure--CDOs, CLOs, RMBS, ABS, ABCPs, SIVs, etc. In particular, I am keen on the concept of "whole business securitization." While pretty much any asset which yields an income stream can be securitized, this kind of securitization involves what it says--securitizing an entire business operation. As the link above suggests, this kind of securitization is more worthwhile for firms that are rich in intellectual property--brands, patents, and trademarks. Given the current rate of financial innovation, maybe we'll see "whole country securitization" in a few years' time...

[Jan 27, 2008] The Great Private Equity Cash Robbery of 2007 by Jeff Matthews

Looks like S&P500 might fall below 1200, which was the starting point of "Paulson rally" :-(.
January 23, 2008 | Is Not Making This Up

Well, as far as NotMakingThisUp is concerned, the most obvious thing missing in all of yesterday's headlines was this: no share buybacks were announced by any major company before, during or after the brief morning sell-off.

Not one.

During the panic of October 1987, grey-beards will recall, the tape was clogged not only with headlines of trading-halts amidst the worldwide rush to sell, but also with a steady stream of share buyback announcements by U.S. companies.

Coke, P&G and many others that week and in weeks subsequent to the Crash of '87 used the substantial cash on their balance sheets to take advantage of the market dislocations that caused even the good here no share buy-backs announced yesterday?

Could it be that the Great Private Equity Cash Robbery of 2007, in which previously healthy companies either "cleared" their balance sheets of cash-to use the euphemism employed by Steve Odlund, the Chief Cash Clearer at Office Depot-by buying back their own stock at bull-market peaks or faced the prospect of having it cleared for them by the Private Equity Cash Robbers?

We suspect that is precisely the case, and in continuing our look-back here at previous efforts to Not Make It Up, reprint this review of the Great Private Equity Cash Robbery of 2007 through the eyes of a made-up public company CEO ruefully ruminating on the after-effects of his effort to "return value to shareholders"

[Jan 27, 2008] To Build Confidence, Try Better Bricks by Robert Shiller

Now with confidence in banks being a toast and Greenspan name becoming similar to a dirty word, more, not less regulation might be beneficial. After Depression measures were actually a big success in taming excesses of 'wild' capitalism...

NY Times

... We need to restore confidence in the markets' basic ability to function, not in their presumed tendency to make us all rich by always going up...

One main response to the Depression that helped was a set of tools that improved confidence by truly improving market security. One of these was the Federal Deposit Insurance Corporation, in 1933, but there were also a large number of others, especially the Securities and Exchange Commission the next year.

These were not obvious innovations and, in fact, were highly controversial at the time. Indeed, it is never obvious how the government should foster well-functioning markets. The fundamental role of governments in promoting markets is clear, but the design of their instruments must make creative use of a great deal of information about financial theory, human psychology and existing institutions and practices. The successful markets we have are a result of considerable inventive effort.

The F.D.I.C. was controversial because it was established amid the ruins of various state-level deposit insurance plans that had just gone bankrupt. Critics at the time also argued that federal deposit insurance would encourage unsound banking. But it turns out that the F.D.I.C. was a very good idea. It restored confidence in the banking system during the Depression, and with hardly any cost.

The S.E.C. was similarly controversial. Critics said it would hamstring or straitjacket the markets. But it is now the model for securities regulation around the world.

We need ... to set up a national study commission and to pay for serious creative research on how to adapt important ideas, like deposit insurance and securities regulation, to a modern financial world. ...

[Jan 27, 2008] LTCM-style bailout for ABK and MMBI ?

There is still a disconnect between the general level of optimism and the reality of the "post subprime" economy. Unemployment rate dynamics is quite worrisome.
Accrued Interest

Bail-out for ABK and MBI? Sounds more and more likely something is going to happen. The story from the WSJ makes it sound similar to the LTCM bailout, where a group of parties interested in seeing the bond insurers survive provide the capital, not as a strategic investment, but to protect themselves from bigger losses. I've said before that I don't like a government bailout, but if a group of banks/brokers have essentially bet too heavily on bond insurers surviving, then they should pay the price when the insurers need more capital. Nothing wrong with that.

[Jan 26, 2008] Job Description – Rogue Trader

The following is an extract from "Traders, Guns & Money: Knowns & Unknowns in the Dazzling World of Derivatives"J (2006; Pearson Education) © 2006 Satyajit Das

Position Title

(Rogue) Trader. (The "rogue" term is generally not to be used explicitly especially with senior management, directors, shareholders and clients for fear of misunderstanding.)

Reporting Line

The position reports along "functional' and "geographic" lines to the Head of Trading and Head of the Region. (Nobody, really. A multi-dimensional matrix structure is currently in operation so that everybody reports to several people allowing a total absence of accountability.)

Location

Optional. (Some candidates may have a preference for working in head office where total confusion and chaos reigns facilitating successful rogue trading. Other candidates may prefer a remote location where benign neglect and absence of supervision may provide rogue trading opportunities.)

Organisational Environment

A leading edge investment bank with a global brand, presence in key financial markets, superb product range and unparalleled client list.

(Our PR firm told us this.)

A global trading team trading in a wide variety of cash and synthetic instruments, including a number of "proprietary" structures.

(You can lose money pretty much any way you like. There are some trades that even we don't understand but the models say we are making money).

Supported by a world class risk management team (they are readily identifiable by their guide dogs) and operational staff and systems (they have been specially chosen for their total ignorance.)

Excellent career prospects (We have sinecures for everybody who has failed to perform.)

Key Responsibilities

Trading with the bank's capital to achieve targeted risk adjusted returns on capital under the bank's unique Economic Capital Allocation system. (If you are half as smart as you think you are then you will be able to game the system from day 1. Everybody else has.)

Developing innovative trading strategies. (You need to be able to come up with hare brained trading schemes based on the relationship between the El Nino cycle and market prices.)

Closely managing trading positions. (You need to be able increase your bet when your position shows losses until you bankrupt the firm.)

Major Challenges

Develop proper models and valuation procedures (You need to ensure that all pricing models are impossible to understand and give the valuations that you want by simple unverifiable changes in model inputs.)

Risk management of positions (You will need to fudge all the Greek risk measures. We suggest you start to report risk data in an ancient Nubian dialect that is purely oral. You will ensure that your risk always appears miniscule irrespective of market conditions. People have a tendency to panic otherwise.)

Monitoring (You will need to be able to disguise breaches by not booking the trades or taking advantage of systems deficiencies.)

Control losses and volatility of earnings (You must disguise losses either by recording them as amounts owed to you (the Leeson gambit), undertaking off-market trades such as deep in-the-money options (the Rusnak variation) or incorrect valuations (Rogue Trading 101).)

You need to be able to take the trading function to a new plane. (You need to show larger losses than the last rogue trader the firm employed.)

Selection Criteria

Detailed knowledge of financial markets and trading techniques.

(You should wax lyrically about obscure markets (the Zambian Kwatcho and Islamic finance techniques) and complex mathematics (field theory; neural networks; fractals; Frank copula models). Everybody will think you are a genius or a fool but will be unsure of which.)

Detailed knowledge of derivatives, including exotic and non-standard structures. (Everybody knows that derivatives allow highly leveraged positions that are impossible to understand or value accurately.)
No minimum formal educational qualifications or direct previous experience in a similar role is necessary. (Nobody believes your CV. It is merely a statement of your aspirations. Nobody will believe you if you said that you had rogue trading experience.)<

Ability to communicate and work closely with senior management (You will need to make sure that you generate enough "phantom" profits to make sure their bonus expectations are met.)

Ability to work closely with operational staff (You must bully them or cajole them into concealing limit breaches and losses.)

Strong leadership qualities (You will claim all profits are the result of your perspicacious skills. All losses will either disappear or if found will be hedge losses offset against gains in other positions.)

Desirable Criteria

Preferred age – under 30 years. (Have you ever heard of an old rogue trader? There is an exception for Japanese rogue traders who are generally older.)

Strong personal qualities. (You will have "attitude". A year round sun tan and a wisp of beard underneath your chin is good. You will treat everybody around you as idiots incapable of understanding the complex nature of your trading strategies.)

Highly motivated. (You will need to be able to hide losses and limit breaches. The Japanese rogue traders never took holidays.)

Remuneration

Negotiable including a strong performance linked component. (You don't need to be paid as it is assumed that you will defalcate ample amounts.)

Social Responsibility Statement

We are proud to be an equal opportunity employer. (We do not discriminate on any basis. How else can you explain the calibre of Directors and Senior Management not to mention risk managers and auditors that we have?)

Note: The idea is based on a column published by Trevor Sykes (writing as Pierpoint) of the Australian Financial Review [see "Indispensable Guide For Rogue Traders" (30 January 2004) Australian Financial Review] However, the text is different.

[Jan 26, 2008] Andrew A. Samwick - A Better Way to Deal With Downturns - washingtonpost.com

Treacherous time for 401K investor. Bond rates are no longer compensatory and Fed can cut to 2.5%; stocks are too dangerous. Deficit spending means inflation or worse stagflation.

Let's drop the euphemism of "stimulus package" and call this agreement by its proper name: "deficit spending."...

This "stimulus bill" is really $150 billion worth of some future generation's resources appropriated to finance our own consumption....

The imperative to do "something" is all the entitlement politicians need. In political arguments, you can't beat something with nothing. But we can learn from this experience to have a better menu of fiscal policy options the next time around. Two changes to our budget policy would go a long way toward that goal.

First, we should rule out deficit spending to finance a consumption binge. As the economy slows, the deficit will widen even without changes in fiscal policy. But an honest budget policy would be calibrated to balance the budget over a complete business cycle.... [W]e must not waive pay-as-you-go rules that require spending that increases the current deficit to be offset later, when the economy is stronger.

Second, we can plan well in advance. The federal government has a critical role in maintaining and developing public infrastructure, whether in transportation, telecommunications or energy transmission projects. A sensible capital budget would include a prioritized list of projects that need attention. Some would be slated for this year, some for 2009 and so on, over the useful lives of the projects. When economic growth falters, the government would be in a position to move some of the projects from later years into the present year....

With a little forethought, short-term economic concerns and long-term budget goals need not be in conflict.

[Jan 26, 2008] Who Is Jerome Kerviel - Seeking Alpha

Citi and Merrill can lose $20 billion in one quarter and is S&P 500 did not decline much that's OK. But a sharp stocks drop because unwinding of trades of a rogue trader who managed to lose $7 billion for the whole year forced Fed jump into the action... "The mistaken belief of market fundamentalism" is more dangerous that you can infer from the paper. "If, as Soros argues, the underlying cause of the problem is the end of the dollar's hegemony, then the Fed is doing more damage by treating the symptom, i.e. cutting interest rates to support the stock market. "

Some commentators may nominate Jerome Kerviel as the poster boy for everything that is wrong with the Federal Reserve's policies. The Fed has demonstrated by now that they prefer to treat the symptom, and not the cause. Monday's carnage on stock markets was the symptom, and Societe Generale's weak internal control was one of the causes. Cutting interest rates by 0.75% isn't going to stop Jerome Kerviel v2.0 from trying to cheat the system.

Of course, the Fed has little control over the internal controls at banks, but the above example illustrates the futility of treating the symptom instead of the cause. Let's take the cause/symptom analogy a step further. What if the current crisis is merely a symptom of a deeper cause? To quote the legendary investor George Soros: "The current crisis is not only the bust that follows the housing boom [symptom], it's basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency [underlying cause]. Now the rest of the world is increasingly unwilling to accumulate dollars."

If, as Soros argues, the underlying cause of the problem is the end of the dollar's hegemony, then the Fed is doing more damage by treating the symptom, i.e. cutting interest rates to support the stock market. By using aggressive interest rate cuts to shore up stock markets, the Fed devalues the yield advantage of the greenback. Why should other nations hold the dollar as a reserve currency if the Fed shows no restraint in damaging its value? Why should other nations hold the dollar when the Fed is reactive instead of proactive? Not to mention the wave of inflation that will come on the back of the recent rate cuts.

What if every modern day financial crisis is a symptom of a deeper cause? Once again, to quote George Soros: "This is the end of credit expansion [the symptom] based on the mistaken belief of market fundamentalism [the cause], that you should let markets have total freedom." If you give the market total freedom, you create myriad opportunities for Jerome Kerviel v2.0. I assure you that he is not the only "computer genius" conducting fictitious futures trades to lift bonuses or cover up embarrassment. How much of the world's derivatives market is fiction?

[Jan 26, 2008] Massachusetts Subpoenas MBIA and Ambac Over Disclosure

Are monolines the next domino to fall in this mess ? To what extent Fed bears the responsibility for the failure of oversight ?

From CNN:

'This office wants to know when and if MBIA and Ambac disclosed to bond issuers -- the cities, towns, districts and other public authorities -- that their financial condition as an insurer was being severely impacted as a result of their involvement with these highly risky securities,' Galvin said.

[Jan 25, 2008] Jeff Matthews Is Not Making This Up The Great Private Equity Cash Robbery of 2007

Wednesday, August 08, 2007

The Shareholder Letter You Should, But Won't, Be Reading Next Spring

Dear Shareholder:

Well, it seemed like a good idea at the time.

I am referring to your board's decision to approve a massive share buyback and huge special dividend last summer, when the buzzwords going around Wall Street were "returning value to shareholders."

Why we did it was this: a smart banker from Goldman Lehman Lynch & Sachs came in, all gussied up and looking sharp, and made a terrific PowerPoint presentation to the board with multi-colored slides that showed how paying a special $10 a share dividend, plus buying back a bunch of our stock at the 52-week high, would "return value to our shareholders."

We should have thrown the fellow out the window, along with his PowerPoint slides, but what happened was, my fellow board members and I were so busy deleting emails from our Blackberries that we just didn't notice the last slide showing (in very tiny numbers) the "Trump-style" debt we would be incurring to do so.

We also missed the footnote showing the fees that would go to Goldman Stanley Lynch & Sachs for the courtesy of their showing us how to wreck our balance sheet.

Those fees, I am embarrassed to say, amounted to more money than we made the quarter before we "returned value to shareholders."

But the fact is, we'd been getting so much pressure over the last few years from the hedge fund fellows who own our stock for ten minutes tops, not to mention the so-called "analysts" on Wall Street (around here we call them "Barking Seals"), to do something with the cash...well, the truth is we just couldn't stand answering our phones any more.

So, in order to finally start getting things done instead of spending all day explaining to these hedge fund fellows and the Barking Seals on Wall Street why we weren't "returning value to shareholders," we decided to do the big buyback and the big dividend.

And for a few weeks there, it was pretty nice.

The stock jumped, the phones stopped ringing, and the Barking Seals started congratulating us on the conference calls instead of asking us when we were going to get rid of our cash.

Unfortunately, not only did getting rid of our cash and taking on a huge debt load NOT "return value" to you, our shareholders, it actually crippled the company for years to come.

For starters, as you know, the aftermath of last summer's sub-prime debt crisis is forcing perfectly fine companies to liquidate businesses at fire-sale prices…but we can't take advantage of those prices, because we have no cash. And thanks to the debt we incurred "returning value to shareholders," the banks won't loan us another dime.

Secondly, as you also know, we've had to lay off hundreds of loyal, hard working employees to pay the interest expense and principal on all that debt, because unlike Donald Trump, we actually feel like we ought to repay our debts.

Furthermore, as you probably don't know, we've also scaled back some interesting research projects that had great long-term potential for the company, but were deemed too expensive to continue in light of the fact that we have no cash.

Now, I'd feel a heck of a lot worse about all this if we were the only company suckered into buying our stock at a record high price and paying a big fat dividend on top of it.

But I'm happy to report there were others who also did the same stupid thing.

For example, Cracker Barrel, the restaurant chain that depends on people having enough money for gas to get to its stores along Interstates across America, spent 46 bucks a share for 5.4 million shares of its stock early last year to "return value to shareholders."

Cracker Barrel's stock now trades at $39.

And Scott's Miracle-Gro, whose business is so seasonal it loses money two quarters out of four, put over a billion dollars of debt on its books with the kind of special dividend and share buyback we did.

Health Management Associates-a healthcare chain that can't collect money from about a quarter of the patients it handles-paid shareholders ten bucks a share in a special dividend to "return value to shareholders" and then missed its very next earnings report because of all those unpaid bills and all that new interest expense it was paying.

Oh, and Dean Foods, a commodity dairy processor with 2% profit margins, returned all sorts of value to shareholders early last year-almost $2 billion worth-just before its business went to hell in a hand basket when raw milk prices soared.

So, you see, everybody was doing it.

And boy, do I wish we hadn't.

Jeff Matthews
I Am Not Making This Up

Greenspan's Client List Needs Someone Like Me by Caroline Baum

Jan. 18 | Bloomberg

Mr. Alan Greenspan Greenspan Associates
1133 Connecticut Avenue NW Washington, DC 20500

Dear Mr. Greenspan:

I was somewhat surprised to read that you had been hired as an adviser to John Paulson, the hedge fund manager who made a killing last year betting against the mess you made. The irony is really rich: Paying someone whose policy mistakes and missteps were the source of your success! I'm sure it will be a productive working relationship for everyone involved.

What got my wheels turning, though, was re-reading your comments about your ``Rule of One,'' as I call it. You have said that you would consult with only one client in each industry.

So far, your roster includes one bank (Deutsche Bank AG), one bond-fund manager (Pimco), and now one hedge fund. I'm sure there's some overlap in what these firms do, but my intent here isn't to quibble about details.

If I understand you correctly -- you speak much more clearly than you did when you were Fed chairman, now that you're getting paid a bundle per word -- you still have an opening for a media company. So I'd like to propose what I think could be a mutually beneficial relationship between you and, yes, me.

The benefits to you should be immediately apparent.

1. Buying Access

With each announcement of your exclusive consulting relationship with a client, the chatter is that these firms are buying ``access'': access to your institutional knowledge of the Fed; access to your Rolodex; access to any inside information you might get from policy makers in the U.S. and overseas.

The way I see it, it wouldn't be a bad idea for you to buy access -- from me. Lots of politicians see my column; maybe even a few who are running for president. I might be able to put in a good word for you that would give you a shot at Treasury secretary, an opportunity lost when Jimmy Carter defeated Jerry Ford in 1976.

Running the mint isn't nearly as glamorous as controlling the printing press, but at least it keeps you in the public eye (not that you ever left it).

2. Keep Your Friends Close, And Your Enemies Closer

Let's face it: No one has been a bigger thorn in your side than yours truly. I started my journalism career a few months before you landed at the Fed, and we've been joined at the hip ever since.

If I were on your payroll, you can be pretty sure I'd be talking you up rather than putting you down. I mean, it wasn't until Bill Gross hired you that he stopped trashing you. And you didn't even have to pay him to change his tune!

If you put me on retainer, you'll be surprised how easily I can be persuaded to see economic history in a different light.

Remember how you denied there could be a housing bubble, only belatedly acknowledging some ``froth'' in certain local markets? I've already forgotten you said that, along with your lament on how homeowners would have done better with adjustable- rate mortgages.

Or how about that ridiculously low federal funds rate that overstayed its usefulness for years, not months? I think I could make an argument, based on a ``risk-management'' approach, that it was necessary to ward off deflation.

In other words, Mr. Greenspan, money talks -- or in this case, money would encourage me to talk less, if you know what I mean.

3. Playing Cyrano to Your Christian

Just as Christian de Neuvillette used Cyrano de Bergerac's words to woo Roxane, you, sir, could use a bit more dash when it comes to preserving or, at this point, resuscitating your legacy.

No one ever accused me of being dull or uninspired. And I've always had a hankering to play Cyrano, sucker that I am for that swashbuckling, romantic stuff.

``I draw my sword and raise it high.'' ``Let me choose my rhymes.'' ``Then, as I end the refrain, thrust home!'' Oh, it will be grand. Together we can win their hearts!

4. A Better Crystal Ball

This may be a sore subject with you, but your forecasting acumen hasn't been the best. Your visibility on bubbles has been close to zero. You were late to see recession in both 1990 and 2001. Your rationalizations for your forecasts have been pretty lame as well.

Money manager Bill Fleckenstein sets your record straight in a just-published book, which isn't likely to be a coffee-table fixture in your household.

If you saddle up with me, you can get rid of all those arcane manufacturing ratios and obscure indicators you used to pull out of a hat to justify a policy action. You can do better watching two rates -- the overnight rate that the Fed sets and the long-term rate determined by the market -- than you can with the 18,500 indicators you reportedly track in the bathtub.

I'd like to thank you in advance for considering my offer. I'm ready to proceed with negotiations as soon as I hear back from you.

Very truly yours,

Caroline A. Baum

Robert Reich Grasps the Enormity of the Problem

Although Robert Reich is a smart fellow (and I mean that sincerely), like a lot of Beltway types, he isn't as well versed in the ways of the world of finance as he is in the workings of public policy and opinion.

Thus I found his recent post, "The Politics of an Economic Nightmare," intriguing due to its shift in posture. Heretofore, Reich has been calling for stimulus to save the working man. It's been well argued, but nevertheless pretty standard "here's' what you do in a slowdown" fare. But it is now clear that Reich has engaged the problem more deeply, and realizes that a stimulus package is not only more likely as a sop to the voting public in an election year, but is almost guaranteed to be badly focused, overly large, and ineffective. If Reich now understands most of the elements of our problem that is a positive sign from a policy standpoint, i.e, that influential people who are not finance types are wising up.

He also acknowledges the ugly fact that our salvation lies in the hands of rich foreigners, but misses the fact that trashing our currency via aggressive rate cuts and an even larger fiscal deficit won't exactly endear us to them. But there is only so much you can say in a single post, particularly since Reich's preference is for brevity.

From Reich:

A possible economic meltdown is worrisome enough, but a possible meltdown in an election year is downright frightening. For months now, Republicans have been pushing the White House to take some action that looked and sounded big enough to give them some cover if and when things got worse. President Bush has now responded with a stimulus package more than twice as large as the one Bill Clinton briefly entertained at the start of 1993 but couldn't get passed.

Not to be outdone, Democrats want to appear at least as bold, which means they'll suspend pay-go rules and throw fiscal responsibility out the window. In other words, hold your noses, because the "bipartisan" stimulus package that's about to be introduced could be a real stinker, including tax cuts for everyone and everything under the sun -- except, perhaps, for the key group of lower-income Americans. These are the people who don't earn enough to pay much if any income taxes, but who are the most likely to spend whatever extra money they get and therefore are most likely to stimulate the economy. The real behind-the-scenes battle will be over whose constituencies get what tax cuts, and for how long. Don't be surprised if the only thing Congress really stimulates is campaign contributions.

Meanwhile, Fed chairman Ben Bernanke and Co. have surprised everyone with a rate cut larger and sooner than expected. The three-quarters of a percentage point ("75 basis points" in biz-speak) cut announced Tuesday morning may not sound like much, but it's bigger than any rate cut in decades. The politics here are more subtle because Bernanke and his Federal Reserve governors are supposed to be independent of politics. But as witnessed under the reign of previous chairman Alan "it's prudent to reduce the surplus with a tax cut" Greenspan, Fed chairs can have political agendas. Bernanke has been under a lot of pressure lately to cut rates big-time -- and the pressure has come not only from Washington Republicans but from panicked Wall Street Democrats, including, apparently, my old colleague Robert Rubin, formerly President Clinton's treasury secretary. (By the way, what could Rubin have been thinking when he allowed Citicorp to sell all those fancy securitized debt instruments, while agreeing to buy them back if they couldn't be resold?) Expect lots and lots more Washington activity -- enough seemingly bold strokes to convince voters that our nation's capital is doing whatever is necessary to stop whatever seems to be going wrong with the economy.

The problem is, people have different views about what's going wrong. Wall Street sees it as a credit crisis -- a mess that seems never to reach bottom because nobody on Wall Street has any idea how many bad loans are out there. Therefore, nobody knows how big the losses are likely to be when the bottom is finally reached. And precisely because nobody knows, nobody wants to lend any more money. A rate cut won't change this. It's like offering a 10-pound lobster to someone so constipated he can't take in another mouthful.

Main Street sees it as a housing crisis. As I've noted, homes are the biggest assets Americans own -- their golden geese for retirement and their piggy banks for home equity loans and refinancing. But home prices have been dropping quickly. It's the first time this has happened in many decades -- beyond the memories of most Americans, which is why they never expected it to happen, why they bought houses so readily when credit was so easily available, and why so many people bought two or more of them, speculating and fixing up and then flipping. But now several million Americans may lose their homes, and tens of millions more have only their credit cards to live on and are reaching the outer limits of what they can spend. As consumer spending shrinks, companies will reduce production and cut payrolls. That has already begun to happen. It's called recession.

How much worse can it get? As I said before, the housing bubble drove home prices up 20 to 40 percent above historic averages relative to earnings and rents. So now that the bubble is bursting, you can expect prices to drop by roughly the same amount, and new home construction to contract. The latter plunged last month to its lowest point in more than 16 years. A managing partner of a large Wall Street financial house told me a few days ago the scenario could get much worse. He gave a 20 percent chance of a depression.

Even if a stimulus package were precisely targeted to consumers most likely to spend any money they received, the housing slump could overwhelm it. According to a recent estimate by Merrill-Lynch, the slump will hit consumer spending to the tune of $360 billion this year and next. That's more than double the size of the stimulus package President Bush or any leading Democrat is now talking about. And the Merrill-Lynch estimate is conservative.

In reality, the crisis is both a credit crunch and the bursting of the housing bubble. Wall Street is in terrible shape and Main Street is about to be in terrible shape. And there's not a whole lot that can be done about either of these problems -- because they are the results of years of lax credit standards, get-rich-quick schemes, wild speculation on Wall Street and in the housing market, and gross irresponsibility by the Fed, the Treasury and the Comptroller of the Currency.

As a practical matter, our only real hope for avoiding a deep recession or worse depends on loans and investments from abroad -- some major U.S. financial firms have already gotten key cash infusions from foreign governments buying stakes in them -- combined with export earnings as the dollar continues to weaken. But this is something no politician wants to admit, especially in an election year. So we're going to go through weeks of posturing about stimulus packages of one sort or another, and then see enacted the big fat bonanza of a temporary tax break that will likely have little effect. That, perhaps along with a few more rate cuts by the Fed. The presidential candidates will be asked what should be done about the worsening economy, and they'll give vague answers. None will likely admit the truth: We're going to need the rest of the world to bail us out.

The Dollar Crisis and Coming Gold Boom - Seeking Alpha

Interestingly enough, remember what the IMF's solution for the Asian tigers was back in 1997 (a solution that worked by the way) ? (1) Cut back on government spending to reduce deficits; (2) Allow struggling illiquid banks and financial institutions to fail, and (3) Aggressively raise interest rates. When faced with the exact same scenario (caused by similar conditions), the U.S. Feds instead chose to (1) Raise the national debt ceiling and increase deficits; (2) Bail out insolvent banks and financial institutions by printing as much money as they needed; and (3) Aggressively reduce interest rates. Does anyone really believe that this solution will end well?

Strong and continued inflation of a currency will always invoke a couple of reactions:

  1. Wealth will be stored not in domestic currencies but in non-monetary assets or in a relatively strong foreign currency to maintain Purchasing Power Parity (PPP).

  2. Monetary and trade transactions occur in a foreign stable currency, not the domestic currency.

Certainly condition (1) has been executed by Americans, at least among savvy investors, for many years now with the accumulation of foreign currencies as well as the accumulation of lots of gold, silver and real estate in emerging and developing countries. Condition (2), while not yet common, is starting to appear. I've seen U.S. based merchants online now demand Euros as the default currency of payment rather than the dollar.

naked capitalism

Two more such rate cuts and we might need to learn Japanese. Main Street will definitely pay for the sins of Wall Street but US always has something in the sleeves when the situation became untenable. Last time it was PC revolution that saved the day. then collapse of the USSR helped enormously. Still in the short time frame the most plausible trajectory for S&P500 for the next couple of quarters is down. Defensive allocation like 80% bonds 20% stocks might be better then banalced ( 50%/50% or 100%-your age) for 401K health.

A comment by Ricardo Hausmann in today's Financial Times takes US policymakers to task for trying to prop up demand and stave off a recession.

We've pointed out repeatedly, as have various economists quoted here, that consumption as a percentage of US GDP is unsustainably high and saving correspondingly too low. It can only continue with massive foreign borrowing, and there are limits to how long friendly central bankers will keep bailing us out. If the US does not reduce consumption and increase savings, it will eventually and even more painfully be foisted on us when our creditors start cutting the debt supply.

Lower consumption means lower domestic demand. At a minimum, that translates to lower growth, and give how far our savings rate has plunged, probably a recession.

The US has repeatedly given that sort of tough-medicine advice to developing nations, and many readers have commented on the hypocrisy of the US deciding that it is a special case, exempt from normal good economic practice.

"Expansionary Aggregate Demand Policies are Likely to Bring about a Period of Stagflation"

Guillermo Calvo responds to Larry Summers call to to move beyond monetary and fiscal stimulus and begin repairing the underlying problems in the financial system. While he agrees that the financial system needs to be strengthened, he does not have much faith in monetary and fiscal policy and believes their use will result in stagflation:

Guillermo Calvo, Economic Forum: I agree that we need "consistent, determined approaches" which will probably take us far beyond conventional monetary and fiscal policy. The main problem, however, is that we don't seem to have a consistent macro view that is widely agreed upon and is itself consistent with the stylized facts of the current crisis. Thus, for example, policy has strongly relied on lowering the reference interest rate, a policy that is typically justified in models that abstract from credit market difficulties. The same applies to fiscal expansion. This lack of intellectual consistency is bound to create further confusion. Thus, I would encourage Larry and the other high-profile commentators to give a simple but clear view of their underlying assumptions.

To be consistent with my preaching, let me say that I am of the view that the current subprime crisis is starting to look more and more like those in emerging markets. The big but somewhat superficial difference, however, is that initially the problem did not entail a whole country but a sector (and, incidentally, since a sector does not print its own money, its situation is similar to that in emerging markets which suffer from Liability Dollarization, or Original Sin).

Since the subprime sector hit the global financial market, it had the potential to damage other sectors through contagion, much like it happened in emerging markets after the Russian August 1998 crisis. Thus, we are witnessing the effects of a "supply" shock, implying that the crisis is unlikely to be fully resolved by a stimulus to aggregate demand through lower interest rates.

And even less by transitory fiscal expansion, for the additional reason that credit crises involve "stocks," while transitory fiscal policy involves "flows." Thus, if you agree with my view, a key to resolving the current crisis is to reinforce the financial sector which, incidentally, leads me to enthusiastically agree with Larry's thrust in his column. But, on the other hand, I have a much less favorable opinion about expansionary monetary and fiscal policy. These aggregate demand policies are easy to implement in the short run, while strengthening the financial sector is time consuming. Since the latter would be key for avoiding a slowdown, expansionary aggregate demand policies are likely to bring about a period of stagflation, seriously undermining the credibility of policymakers.

Dr. James K. Galbraith Interview - Janszen - iTulip.com Forums

Should not military spending keep the USA out of recession ?

EJ: So what you are saying is that post-bubble reflation policies, including tax cuts and an increase in deficit spending, allowed a few of the areas that benefited from the tech stock bubble to benefit from government policies designed to support the economy after the tech bubble popped-in effect bubble double dipping?

JG: No, the geographic pattern changed. Under the Democrats, income growth was led by companies, large and small, in the tech sector. After the tech bubble collapsed, the recovery was led by the government sector, especially military spending, and by the continued expansion of housing.

EJ: Interesting that you mention the increase in military spending. That's not discussed much. I'll relate it to events here in the Boston area for local readers. The Boston Globe recently ran a piece-"The defense dollars flow: In antiwar state, contracts have soared since 9/11"-that goes a long way toward explaining why the economy is doing as well as it is in our area, the suburbs outside Boston. The growth ain't coming from biotech: I'll quote from the article, "Since 2001, contracts awarded annually to Massachusetts companies by the Pentagon have surged from $5.3 billion to $8.3 billion. Almost $1,300 is being spent by the military for every man, woman, and child in Massachusetts." Military spending contributes three times as much to the local economy as biotech. This explains why the nearby Burlington Mall, for example, is packed this holiday shopping season. Since we didn't make your county list, this local phenomenon is apparently not outstanding and so perhaps is occurring across the United States near the levels we are seeing here, with defense contracts increasing 30 to 40 percent.

Federal Reserve Bank of Philadelphia Speeches

Looks like Fed partially lost the credibility and stimulated inflation: after 0.5% cut 10 years note yield is moving up not down +0.0690 (+1.89%)
As we have already noted, the Fed lost all credibility in the 1970s as inflation soared into the double digits.

By the time Paul Volcker became Chairman of the Federal Reserve, it was painfully obvious that inflation had to be brought under control. He was committed to lowering inflation, but neither he nor the Fed had much credibility with the public. The price we had to pay to regain that reputation and credibility was severe, as I suggested earlier.

We would rather not go through that experience again. It was the price we paid for operating without commitment.

Flagstar Bancorp: Concerned About Consumers Walking Away

Can mass "home walking" (sending the lender keys and moving to a similar house that costs probably $100K less then current loan" create an interesting new situation ?

"Another effect we are seeing has been a challenge with the media and consumer groups; and with consumers willingness just to walk away from homes. We haven't seen anything like this since Texas during the oil bust and people just willing to declare bankruptcy and walk away. We are seeing a lot of that similar type social phenomenon occurring, especially in California. And that is concerning to us."
Mark Hammond, CEO, Flagstar Bancorp conference call. (hat tip Scott)

Hammond also expressed concern that a larger percentage of homeowners - as compared to previous housing busts - that go delinquent, don't cure. They just "go under" in Hammond's words.

Here is what Hammond means: Say a homeowner misses a payment and becomes delinquent. Historically most homeowners try to make future payments - even if they stay 30 days late. Now, according to Hammond, once they go 30 days late, many homeowners just give up and keep missing all payments; they go 60 days late, 90 days late, and on to foreclosure.

Also, there was some concern expressed about CRE loan concentrations and delinquencies.

[Jan 25, 2008] Even Tobin Smith is now a bear

"this won't be a drive-by recession like the one we experienced in 2002." I think that the US economy will just scrape through 2008 without one due to huge military spending.

The Mess That Greenspan Made

For those of you who have seen those loopy Fox Business infotainment shows on the weekend with their uber-bullish cast of characters and seemingly endless optimism about owning stocks, this report of an about-face by Tobin Smith, formerly the uberist of the uber-bulls, might come as a bit of a surprise.
The evidence has been building that we are in a recession.

And according to all of the indicators I study, this won't be a drive-by recession like the one we experienced in 2002.
...
All four key barometers used by the National Bureau of Economic Research-employment, real personal income, industrial production, and real sales activity in retail and manufacturing-are negative.

The US economy is stalled, and without another historic set of interest rate cuts by the Federal Reserve and another round of big tax cuts, we are likely going to continue crawling.

He goes on to talk about things like getting rid of high P/E stocks, holding more cash, and recommends against any sort of panic selling.

If he is as wrong about panic selling as he was about what the Fed would do (this was written two days ago), his inbox will probably fill up rather quickly between now and the next Bulls & Bears.

[Jan 24, 2008] How to Stop the Downturn, by Joseph Stiglitz, Commentary, NY Times:

America's economy is headed for a major slowdown. Whether there is a recession ... is less important than the fact that the economy will operate well below its potential, and unemployment will grow. The country needs a stimulus, but anything we do will add to our soaring deficit, so it is important to get as much bang for the buck as possible. The optimal package would contain one fast-acting measure along with others that could lead to increased spending if and only if the economy goes into a steep downturn.

We should begin by strengthening the unemployment insurance system, because money received by the unemployed would be spent immediately.

The federal government should also provide some assistance to states and localities, which are already beginning to feel the pinch, as property values have fallen. Typically, they respond by cutting spending, and this acts as an automatic destabilizer. Federal assistance should come in the form of support for rebuilding crucial infrastructure.

[Jan 24, 2008] The Big Picture Fed's Folly Fooled by Flawed Futures

"For a few days there it looked like overconsumption and the lack of domestic savings in a bubble-economy that had run out of bubbles was about to meet its inevitable end."
Regardless, it took only 2 days to learn just how ill-considered the Fed's emergency market rescue plan was: To wit, a fraudulent series of losses led to a major European bank unwinding a huge trade: Societe Generale Reports EU4.9 Billion Trading Loss.

SG's $7.1Billion dollar unwinding led to panicked futures selling on Monday and Tuesday.

Hence, we quickly learn what sheer folly and utter irresponsibility it is for the Fed to use its limited ammunition to intervene in equity prices. Their panicky rate cute were not to insure the smooth functioning of the markets, but rather, to guarantee prices.

As we have been saying for the past two days, this is not the Fed's charge. They are supposed to be maintaining price stability (fighting inflation) and maximizing employment (supporting growth) -- NOT guaranteeing stock prices.

Comments

Helicopter Ben | Jan 24, 2008 10:51:12 AM

If we are realists (rather than members of the bull or bear dogmatic religions), then we need to accept that the Fed is a put on the investment community. It matters not what their job description is in the public arena -- aren't we all believers in the maxim "actions speak louder than words"?

One of the underlying presuppositions that seems to cause faulty expectations is that the US exhibits either a free market system or is aspiring to do so. As a student of history, I do not believe either are true. The wealthy will always protect one another, and they will manipulate the system to maintain the orderly structure that has benefited them in the past. With all do respect, anyone who does not believe such behavior will continue is a bit naive (or waiting for a messiah).

The power elite will never support a true free market system because in practice it means chaos or at least letting go of the yoke they so tightly grasp. "Free market" is nothing more than the catch phrase of the day. Anyone who knows economic reality knows that all markets are manipulated by laws and power (including money). Kudlow is a perfect example of why "free market" is nothing more than double speak for "fiscal and legislative aid for investor capitalists."

Also note that although the Fed is bailing out speculators, they are ALSO providing a put for all the boomers who are currently or in the near future set to retire (or supplement income) on the worth of their two major assets: house AND EQUITIES. The value of equities play a very real role in consumer sentiment and per capita wealth. Thus, with all due respect, I think focusing on the Fed's effect on speculators over simplifies the issue.

Every Major U.S. Bank Was Profitable Last Year"

John Berry says we shouldn't feel too sorry for banks, or worry that credit is about to dry up and ruin the economy [Update: After today's events, I'll be curious to see if John Berry, who has been more bullish (or at least less bearish) than many other commentators, changes his tune at all.]:

Every Major U.S. Bank Was Profitable Last Year, by John M. Berry, Bloomberg: With all the large writedowns and losses announced for the fourth quarter, hardly any attention is being paid to just how profitable U.S. banks really are.

That inattention has raised unnecessary concerns that the banks may be so crippled by losses that they will cut lending to the point it might undermine the U.S. economy.

Some commentators have said the banks are in the worst shape since the Great Depression. That isn't close to being correct.

Other analysts have raised the specter of the stagnant Japanese economy of the 1990s, when banks there were crippled by huge losses when a real estate price bubble burst... This comparison also is off base.

Even Citigroup Inc., by far the hardest hit of the big U.S. banks by subprime-related problems, earned $3.62 billion last year. That was with a $9.83 billion fourth-quarter net loss and more than $22 billion in writedowns and additions to loan-loss reserves.

For JPMorgan Chase & Co., the third-biggest U.S. bank, the focus was on the 34 percent drop in fourth-quarter profits from a year earlier. Its full-year $15.4 billion profit, a record, was largely ignored. ...

Economist Robert E. Litan, a senior fellow at the Brookings Institution who has done numerous studies of the U.S. financial system, said the banks are in far better shape than the dire assessments suggest.

''Strip out the losses and Citi could make close to $10 billion a quarter,'' Litan said. Noting how quickly the bank has been able ... to replace the capital depleted by losses, he added, ''Why would anybody buy stock if they thought Citi was going down the tubes?''

''And this is nothing like the Japanese situation,'' Litan said. ... The story is largely the same at Merrill Lynch & Co., the world's largest brokerage, though the losses are greater relative to its size. ...

Credit isn't as readily available as it was for several reasons, including a less favorable economic outlook, tighter lending standards, particularly for mortgages, and a lack of a secondary market for some types of loans such as jumbo mortgages.

On the other hand, the interest rates many borrowers are paying have dropped. The bank prime rate, to which many loans are linked, is 7.25 percent, the lowest since January 2006.

As of Jan. 17, the average interest rate on 30-year fixed- rate mortgages dropped to 5.69 percent, the lowest level since June 2005.

In the two weeks ended Jan. 18, corporate borrowers sold $50 billion worth of investment-grade bonds at the lowest interest rates since April 2007.

The credit well hasn't run dry and it's not about to. And the nation's banks will be supplying a large share of it.

[Jan 22, 2008] Preemptive easing - Paul Krugman - Op-Ed Columnist - New York Times BlogThis is the largest rate cut in the modern era in which rate changes have been publicly announced. Bernanke put ???

Wow. First the markets, now the Fed's reaction.

What you probably should know is that Ben Bernanke, in his capacity as a professional economist, spent a lot of time worrying about Japan's experience in the 1990s. (So did I.) What was so disturbing about Japan was the way monetary policy became ineffective; by the later 1990s the short-term interest rate was up against the ZLB - the "zero lower bound." This is alternatively known as the "liquidity trap." And once you're there, conventional monetary policy can do no more, because interest rates can't go below zero.

There was a lot of discussion of various unconventional monetary things you could do. But the best answer was not to get there in the first place. A 2004 paper co-authored by Bernanke argued that the ZLB could and should be avoided by "maintaining a sufficient inflation buffer and easing preemptively as necessary".

[Jan 20, 2008] The price of everything Keeping your balance on Dover Beach

It's amazing how many people now want heads of "best friends of Alan Greenspan" -- investment bankers...

The price of everything

The ways of Wall Street invariably seem impenetrable to outsiders. This may indeed be because they defy conventional commercial logic. Most listed businesses are presumed to be run for the benefit of shareholders, employees and "stakeholders" (whatever that means), in that order. But as Bloomberg's Michael Lewis writes ("What does Goldman know that we don't ?"), conventional commercial logic and Wall Street make uneasy bedfellows. How else to explain, for example, the payment for failure pocketed by outgoing Merrill Lynch CEO and amateur golfer Stan O'Neal ($161.5 million) versus Merrill's latest $16.7 billion writedown ? Commercial language can't really cope with this mismatch between reality and the money-porn fantasy that passes as executive compensation. Fiction can at least attempt to – we can legitimately say that this is 'Alice through the Looking Glass' stuff.

...even at today's battered down valuations, it is debatable whether investors have truly priced in the disappearance of so many different revenue streams for what may be some time to come, and the likely permanent closure of some of the more exotic or opaque structuring areas.

Those investors who bought what they presumed to be AAA rated debt offering a riskless premium to Treasuries and saw it default in a matter of months will surely take a more skeptical view of Wall Street's plat du jour in future – if they have the luxury of retaining their jobs at all.

Inflation or Deflation

"By coining unnecessary paper, as the Fed has done and continues to do, the Fed effectively freezes prices at stratospheric levels, to the benefit of the institutions who screwed up, and at the expense of "ordinary Joes" whose savings are in bonds, CDs, etc. It subsidizes speculators over savers."

naked capitalism

Michael Panzner offers a useful post, "The Wrong 'Flation" on this topic, arguing for the deflationary outlook. The most powerful evidence for this view comes from the fact that the monetary authorities have lost control of credit generation (broader money, the old M3) as observers ranging from market mavens like Michael Shedlock to Serious Economists like Mohamed El-Erian have pointed out. The credit crisis means credit contraction, a process the Fed will likely be unable to staunch. That in turns points to deflation.

However, "unlikely" does not necessarily mean "unable". Bernanke is a well known expert on the Great Depression, and well schooled in the dangers of letting contractionary processes feed on themselves. So he and his colleagues will be doing everything in their power from keeping a vicious circle from setting in. The Term Auction Facility was a creative measure that managed to stave off a crisis in the money markets. Perhaps he will be able to use a combination of novel measures, liquidity injections, and smoke and mirrors to keep confidence at a reasonable level (confidence and willingness to extend credit are what really is at risk here).

Comments

Yes, in the near term, it leads to plunging consumption, which, in turn, forces a plunge in prices, until a new, cheaper equilibrium is reached. By coining unnecessary paper, as the Fed has done and continues to do, the Fed effectively freezes prices at stratospheric levels, to the benefit of the institutions who screwed up, and at the expense of "ordinary Joes" whose savings are in bonds, CDs, etc. It subsidizes speculators over savers. Again.

[Jan 20, 2008] The Education of Ben Bernanke

God knows what will happen if the 401K lemmings became scared enough to pull their money out of stock funds. Looks like a real crisis in confidence can be in the cards.

Roger Lowestein's 8,000 word article on Ben Bernanke.

As a doctoral candidate at M.I.T., he blossomed into a star, and at the tender age of 31 he received a tenured position in the economics department at Princeton. (what a joke -- tender age; 31 is not 21 --NNB)

His academic research was steeped in the increasingly sophisticated discipline of econometrics, which uses computer models to simulate (and predict) the economy. By contrast, Greenspan often relied on his hunches. The difference is partly generational, but Bernanke is clearly more comfortable working with mathematical formulas than with anecdotal examples. (One looks in vain in his Depression writings for stories of banks that failed or of workers who lost their jobs.). (looks like Greenspan was grossly undereducated for the job, but he was a shrewd politician and an excellent PR man; Bernanke might be well over-educated --NNB)

[Jan 19, 2008] Asia Times Online Asian news and current affairs

A lot of 401K participants out there might also enter a steep learning curve a kind of replay of 2001-2003 scenario.

Drunk in a bankrupt world
By Chan Akya

Rising interest rates in turn made bankrupt the people borrowing money they couldn't pay for houses they couldn't afford on incomes they didn't have.

[Jan 18] [link]

"Bankers caught with their hands in the cookie jar are reprimanded, but almost never dismissed thanks to the complete lack of accountability The running total is that there has now been $100bn of subprime-related write-offs and $59bn of capital injections (see FT report on the latest shocker, from Merrill Lynch)."

Wall Street's five biggest firms together paid a record $39 billion in bonuses, even though three of them suffered the worst quarterly losses in their history and shareholders lost more than $80 billion.

Goldman Sachs Group, Morgan Stanley, Merrill Lynch, Lehman Brothers Holdings and Bear Stearns together paid $65.6 billion in compensation and benefits last year to their 186,000 employees. Year-end bonuses usually account for 60 percent of the total, meaning bonuses exceeded the $36 billion distributed in 2006 when the industry reported all-time high profits.

[Jan. 17] Bloomberg.com Worldwide by Mark Pittman

Merrill Lynch Plans to Write Off ACA Bond Insurance (Update1)

January 17, 2008 | Bloomberg

Merrill Lynch & Co., the biggest underwriter of collateralized debt obligations, said it will write off $2.6 billion in default protection from bond insurers including ACA Capital Holdings Inc. because it's worthless.

Merrill Lynch cut $1.9 billion of debt insured by ACA, whose debt ratings were lowered 12 levels to CCC in December, and $679 million from other insurers. Guarantors including MBIA Inc. and Ambac Financial Group Inc. are under threat of losing their AAA ratings from Moody's Investors Service and Standard & Poor's.

"We are reserving against ACA dollar for dollar so it's 100 percent reserved,'' said John Thain, chief executive officer of New York-based Merrill Lynch, during a conference call today with analysts and journalists.

Merrill Lynch's writedowns demonstrate how a downgrade of bond insurer credit ratings can spread throughout financial markets. Losing the AAA stamp would cripple the bond insurers and throw doubt on the ratings of $2.4 trillion of securities.

The bond insurers guaranteed almost $100 billion of CDOs backed by subprime-mortgage securities as of June 30, according to an Aug. 2 report by Fitch Ratings. Most of those guarantees are in the form of derivative contracts. Unlike insurance, those contracts are required to be valued at market rates.

ACA Financial Guaranty Corp., a unit of ACA Capital, had to seek approval from the Maryland Insurance Administration before pledging or assigning assets or paying dividends, the New York- based company said in a filing Dec. 27 with the U.S. Securities and Exchange Commission.

Delinquency Proceedings

A telephone call to Karen Barrow, a spokeswoman for the Maryland Insurance Administration, wasn't immediately returned. A message left for Alan Roseman, ACA's chief executive officer, also wasn't immediately returned.

New York-based ACA reached agreements to avoid posting collateral until tomorrow against credit derivatives it uses to insure the debt. The Maryland regulator held off filing delinquency proceedings while ACA seeks ways to raise capital.

ACA was required under its agreements with swap counterparties to post collateral on those contracts if its rating fell below A-.

Canadian Imperial Bank of Commerce had to sell more than C$2.75 billion ($2.7 billion) in stock to investors to rebuild its balance sheet after taking writedowns tied to ACA guarantees. Canada's fifth-biggest bank sold C$1.5 billion in stock to institutions and another C$1.25 billion to individual investors, the Toronto-based bank said in a statement Jan. 14.

CDOs are created by packaging debt or derivatives into new securities with varying ratings.

Default Risk

ACA, down 94 percent this year, fell 12 cents to 47 cents in over-the-counter trading at 3:27 p.m. in New York. The company was founded in 1997 by former Fitch executive H. Russell Fraser.

S&P's projected losses for the bond insurance industry will be 20 percent higher than in its previous review, based on updated results from a new "stress scenario,'' the ratings company said today.

Credit-default swaps tied to MBIA's bonds soared 15.5 percentage points to 31.5 percent upfront and 5 percent a year, according to broker Phoenix Partners Group in New York. The contracts trade upfront when investors see a high risk of default. The price means it would cost $3.15 million initially and $500,000 a year to protect $10 million in MBIA bonds from default for five years.

Contracts on Ambac, the second-biggest insurer, rose 15 percentage points to 30 percent upfront and 5 percent a year, prices from CMA Datavision in London show.

To contact the reporter on this story: Mark Pittman in New York at [email protected]

[Jan 17] Cramer on Merrill 'Where's the SEC!' - Stock Market US News Story - CNBC.com

Nicely executed and probably pre-rehearsed Cramer rant :-) It's clear that a fundamental weakness of free-market system is that in boom periods there is a significant decline in ethical standards. There is only one analog in the last 100 years for the five year, 200% rise in the Dow in the late 1990s -- the 1920s. The cultural context ("greed is good", Greenspan, etc) is also reminiscent of the 1920s.

"How can we have these levels of fiction in financials after Sarbanes-Oxley? How do people get away with this? How do they live with themselves?"

Cramer made his comments while reviewing results from Merrill. But his real consternation surrounded the insurers who cover banking investments. Some of those insurers haven't come clean about their liabilities, Cramer speculated. Eventually they will, and then the "fiction" will disappear, he said.

The banking sector and its related industries are all too chummy, Cramer accused. That led the numbers related to mortgage investments -- investments that are currently souring -- to break from reality.

"I think the financial guys all belong to the same club and they got to protect each other," he said.

Worse, those executives behind the current credit crunch are unlikely to get any punishment for their mistakes and disingenuousness about their numbers, Cramer opined.

"I'm fed up with it. The American people should be fed up with it. And the SEC should be fed up with it," Cramer said.

"This is what the SEC is supposed to protect us from," he added.

[Jan 17, 2008] today S&P500 return from Jan 1996 using cost averaging starting from zero retuned -2% in comparison with Vanguard institutional stable value fund

Here are stable value returns used in the calculation

1996 7.31
1997 7.21
1998 7.14
1999 6.71
2000 6.81
2001 5.98
2002 4.68
2003 4.54
2004 4.39
2005 4.39
2006 4.50
2007 5.00
2008 5.00

[Jan 17] A new type of writedown: monolines hit Merrill's numbers by Helen Thomas

This is the first acknowledgement a major institution that part of the bond insurance as "worthless". Aren't monoline bond insurers the next shoe to drop. "Merrill Lynch cut $1.9 billion of debt insured by ACA, whose debt ratings were lowered 12 levels to CCC in December, and $679 million from other insurers."
Buried amid a rather dismal set of numbers from Merrill Lynch on Thursday, proof positive that the ailing monoline bond insurers have the potential to inflict further pain on the Wall Street banks.

... ... ...

But the bank also took "credit valuation adjustments of $2.6bn related to hedges with financial guarantors on US ABS CDOs."

These amounts reflect the write down of the firm's current exposure to a non-investment grade counterparty from which the firm had purchased hedges covering a range of asset classes including U.S. super senior ABS CDOs.

(5 comments)

  1. apparently Jim Cramer has just been ranting on CNBC about this:

    "great to be rich in America everyone makes $30m by doing nothing".
    "I could make lots of "money" from what is going on "but I have a conscience"
    "All about commissioning, jamming stupid people to make money"

    can't wait to see this on youtube :)

thomas-palley-investing-in-china-fools

Having worked with the Japanese, and knowing how hostile they are to any meaningful foreign role in their economic affairs, I never saw Chinese attitudes, at their core, as fundamentally different (although their playbook bears little resemblance to that the Japanese, who have the disadvantage of being a military protectorate of the US, despite the existence of the Japanese Self Defense Forces). Push comes to shove, the Chinese would have few inhibitions about nationalizing foreign assets.

... ... ...

From Palley:

Americans tend to disregard history. Henry Ford declared bluntly, "History is bunk," while Gore Vidal calls the U.S. "the United States of Amnesia." Usually, this disregard has few consequences, but sometimes not. That may be so with investing in China, where history suggests profits will be far below expectations, possibly making those investments fool's gold.

China's history is completely different from that of the United States and it has left deep imprints on China's politics. Therein lies the trap for investors and policymakers who ignore history and wishfully think market forces will inevitably make China just like the United States.

One critical factor is China's attitude to foreigners. That attitude is captured by the Great Wall of China, which provides a metaphor for China's long history of isolationism and xenophobia. A second critical factor is the legacy of China's humiliating defeats in the unjust 19th century opium wars with Great Britain. At the time, Britain was importing large amounts of tea and silks from China, and demanded the right to sell Indian opium in exchange. As the opium trade grew, not only did it cause massive addiction, it also caused a damaging monetary outflow of silver from China. That prompted China to stop the trade, and Britain then turned to military force to keep China's market open.

[Jan 15, 2008] How Wall Street broke the free market by Andrew Leonard

Came on, state capitalism is alive and well in the USA.And the fact the Wall street strayed from the course is partically due to the fact the a bank loggist was at the helm of Fed for too long.

Salon

Less than two decades after the collapse of the Soviet Union and the West's gleeful jig dancing on the grave of communism, state capitalism is suddenly threatening the autonomy of the global "free" market. Wall Street's elite banks, longtime freedom fighters for deregulation and scorners of all government intervention in the marketplace, are now begging, cup in hand, for aid from a gallery of regimes that includes some of the most authoritarian and undemocratic governments on the planet.

... ... ...

...The root of Wall Street's woes leads back directly to their own strategic missteps, greed, speculation-run-amok, and lack of appropriate supervision. The brightest minds in finance had exactly what they wanted, a playground where the monitors were looking the other way, and they blew it. When the China Investment Corp. pumps in $5 billion to Morgan Stanley, we are not witnessing the triumph of state capitalism, but rather, the embarrassing, humiliating failure of Reagan-Thatcher style unregulated capitalism. So now the U.S. buys Chinese toys at Wal-Mart, and China uses the resulting cash to buy American banks. Hey, anything's fair in love and war and free markets.

Mish's Global Economic Trend Analysis

The suburban living was an experiment that might recently enter a failure mode due to high costs and inefficiencies.
We do not need more Steak n Shakes (SNS), Pizza Huts (YUM), McDonald's (MCD), Panera Breads (PNRA), Starbucks (SBUX) or any other restaurants for that matter, at least in the US.

Layoffs related to all of the above are coming. Consumers are tapped out.

Those who think Europe will disconnect from the US are likely to be sadly mistaken. Investing in restaurants with PEs of 20+ when the economy is in a recession and you can still get 5% guaranteed on a CD does not make a lot of sense to me.

[Jan 14] FT Alphaville / CDS might just be the new subprime.

CDS might just be the new subprime. "Last week Bill Gross of Pimco gave a round-about figure of $250bn as a potential loss from CDS contracts defaulted."
Here's Wolfgang Münchau, writing in Monday's FT:

If this had been a mere subprime crisis, it would now be over. But it is not, and nor will it be over soon. The reason is that several other pockets of the credit market are also vulnerable. Credit cards are one such segment, similar in size to the subprime market. Another is credit default swaps, relatively modern financial instruments that allow bondholders to insure against default.

This is a theme that the FT's markets team picked up on Friday. Credit default swaps, it seems, are in for a lot of column inches in 2008. CDS might just be the new subprime.

As Münchau explains, the reasons for that are principally linked to the now-likely prospect of a US recession.

At a time of low insolvency rates, many investors used to consider the selling of protection as a fairly risk-free way of generating a steady stream of income. But as insolvency rates go up, so will be the payment obligations under the CDS contracts. If insolvencies reach a certain level, one would expect some protection sellers to default on their obligations.

Last week Bill Gross of Pimco gave a round-about figure of $250bn as a potential loss from CDS contracts defaulted. Commenters on FT Alphaville picked up that figure and took umbrage with it: pointing out that some cases -namely Delphi - CDS contracts are taken out for up to ten times the value of the bonds they insure.

[Jan 14] Bloomberg.com Audio-Video Reports

The key question is how much capital will be diluted by those write downs. Citi need to raise 10 billion dollars to offset write-downs.Mark to make belief need to be replaced with the realistic mark, but they cannot write down them to zero.Same financials that did well in the last quater might outperfom in the next.

Jeff Harte Expects `Stunning' Writedowns for Financials: Video January 14 (Bloomberg) -- Jeffery Harte, an analyst at Sandler O'Neill & Partners, talks with Bloomberg's Carol Massar from Chicago about the outlook for fourth-quarter earnings at U.S. financial-services companies and his investment strategy. Bloomberg's Julie Hyman also speaks.

(Source: Bloomberg) Play Watch

[Jan 14]CFC's Kowalczyk Sees Earnings Guidance Depressing Stocks: Video

The miracle of compounding is working against US now.Perhaps the question that should be asked is: How much time will be required to get all the rot out of the system?10 year ? More then that ?

(Bloomberg) -- Darius Kowalczyk, chief investment strategist at CFC Seymour Ltd., talks with Bloomberg's Mark Barton and Sara Walker from Hong Kong, about fourth-quarter corporate earnings, guidance for this year and the outlook for investment in banks by sovereign wealth funds.

Citigroup Inc., the largest U.S. lender, is seeking a total of $8 billion to $10 billion from investors including Saudi Prince Alwaleed bin Talal, who already owns almost 4 percent of its shares, and China's government, the Wall Street Journal reported Jan. 12, citing people familiar with the matter.

(Source: Bloomberg) Play Watch

Calculated Risk/ We're All Subprime Now

A lot of financial companies disclosed additional subprime losses.Who will bail out citi ?
From Wolfgang Münchau at the Financial Times: This is not merely a subprime crisis (hat tip FFDIC)
If this had been a mere subprime crisis, it would now be over. But it is not, and nor will it be over soon. The reason is that several other pockets of the credit market are also vulnerable. Credit cards are one such segment, similar in size to the subprime market. Another is credit default swaps, relatively modern financial instruments that allow bondholders to insure against default.
The article focuses on Credit Default Swaps (CDS) and suggests the current downturn could be longer than most anticipate (including me):
The German experience has taught us that persistent problems in financial transmission channels cause long economic downturns. Today, the really important question is not whether the US can avoid a sharp downturn. It probably cannot. Far more important is the question of how long such a downturn or recession will last. An optimistic scenario would be a short and shallow downturn. A second-best scenario would be for a sharp, but still short, recession.

A truly awful scenario would be a long recession.

And from Robin Sidel and David Enrich at the WSJ: High-End Cards Fall From Grace (hat tip Brian)
The luster on all those silver, gold and platinum credit cards is getting tarnished. For the past few years, banks that issue credit cards have aggressively wooed affluent customers with lavish perks and fat credit lines. Now, that high-end strategy is coming back to bite the banks: There are growing signs that some of those consumers are having a hard time paying their bills.
Affluent customers aren't paying their credit card bills? How did the credit card companies define "affluent"? The same standard as the mortgage lenders: Fog a mirror, get a Platinum card?

We're all subprime now.

[Jan 14, 2008] Mish's Global Economic Trend Analysis

Looks like "home slaves" will suffer most... And it might be that 2008 is just a second inning...For now, risk remains very high for equities.

Growth of houses exceeded growth in jobs. Wages did not keep up. It was an artificial boom. Driving around I have been wondering for years "How can everyone afford to live like this?" Here is the answer. They can't. That shiny new SUV parked in the driveway may signal trouble, not prosperity.

...This is the suburbia trap in action. People are trapped in a gridlock of homes, a gridlock of roads, and a gridlock of false prosperity. Things appear to be booming. It's an artificial boom that's now collapsing.

...people here cannot afford the interest rates, the property taxes, the upkeep on a house compared to an apartment, rising gasoline prices, energy prices and a whole bunch of other things. Affordability is a mirage. Foreclosures are proof.

...As stated earlier, it was an artificial boom, not a real one. Artificial booms eventually collapse when the pool of greater fools dries up. Things Are Going To Get Worse. Much worse.

...This is the equity trap. And collapsing prices will keep folks trapped for much longer than anyone thinks.
...The boom is not coming back anytime soon. Rising foreclosures are going to keep putting on home prices. Will county is still overbuilding commercial real estate right now. What happens when the last remnants of that commercial real estate boom fade away? What happens to traffic at all those restaurants and shopping malls when consumers cut back even more than they have?

Here is the answer to both questions. Jobs are going to vanish into thin air. They are starting to already: Unemployment Soars as Private Sector Jobs Contract. Those stores, malls and restaurants you see are going to start sporting "For Rent" signs in the not too distant future.

People are trapped in their homes, with nowhere to go, struggling to pay bills. In the meantime foreclosures keep adding to supply. Soon, foreclosure may be seen as an easy way out of the trap. Certainly it is a good option for anyone who bought with no money down and is now $50,000 or more in the hole.

Heaven help us if the masses decide that walking away from a home is a socially acceptable thing for someone with a job to do. Even if that doesn't happen, banks will eventually be forced to dump the properties they own. This will further suppress prices.

...Anyone who thinks this blows over in 2008 is in fantasy land. Payback for the unsupported boom we experienced is just in the second inning. A severe recession is coming that has not yet hit full force.

This post is not really about Will County Illinois, Portland Oregon, or (ya gotta love the name) Happy Valley. There are thousands of "Happy Valley USA" suburbia stories out there.

"Happy Valley" is not so happy. Many are trapped. Many more will be trapped as the recession worsens. Unfortunately, foreclosure may be the only viable way out.

BofA's Countrywide Purchase is a Huge Mistake - Seeking Alpha

Imagine a rookie investor sitting on a wad of cash, and itching to invest it. He makes a decision to invest in a stock and it goes down. Yeah, bad move, but the stock will go up, I just know it will, he thinks. So he throws the rest of his money at the stock, in effect catching that falling knife with both hands. Next thing, he's nearly wiped out. How many times have you heard this story?

[Jan 12, 2008] 7 years of the stock market

A very educational chart. Such moments happen from time to time as S&P500 returns oscillate around T-bill returns.Jan 2001 was bounce back from lows in Dec 2000 but it still was lower then peak (1460 I think) by approximately 100 points. That means it is very dangerous to buy S&P500 close to the all time peak.

Angry Bear

Earlier today Cactus posted on the real Dow over the past seven years. Another comparison is to look at the alternative strategy, investing in cash or 3 month T bill.If in January, 2001 you had placed your investments in 3 month T bills and reinvested the income in 3 month T bills, at the end of December, 2007 your total returns would have been almost exactly the same as if you had invested in the S&P 500 with daily dividend reinvestment.


Way to go team Bush.

P.S. In looking at the current stock market and listening to strategist this chart is an important lesson to think about. You will hear from Wall Street analysts that if you do not go back into the market and miss the first leg off the bottom you are missing a great opportunity. Of course they are right. But if you miss that first bounce off the bottom and wait to go back into the market as long as you return while the market is below the cash line you are still better off than if you rode the market down and back up.

Comments:

Spencer, way to go, nothing more drives home a point other than a chart. Only but a few astute investors actually understand that wall st makes money from fees and the pandering of marked to model flawed investments that our fine pension fund managers are so easily duped into buying. Great visual and it is exactly what I try to convey to all of my colleagues and cohorts, the buy and hold strategy in equities is over, the smart investor will move around his portfolio according to market conditions and if that means staying out of equities for years than so be it.......but it is very hard to change the human brainwashed psyche, but visuals like this are a necessary tool...thanks
magne13 | 01.12.08 - 10:51 am | #

Thanks spencer, indeed a good reminder. Extend it out another ten years and of course it will look differently.

But to Bruce's point, investors hope for better returns than for cash, which means some return for risk assumed to invest in non-cash. Most average investors use advisors, or investment managers, or invest in managed mutual or ETF funds. They have a right to expect the experts to do exactly what Bruce says - have a crystal ball to make better than cash returns.

Otherwise, why have all the analyst and trading infrastructure of Wall Street? It turns out they all use a variant of the same portfolio models and trading models, instead of acute analysis and insights tailored to changing times. I got tired of paying for some moron's MBA school debts after years of mediocre results.
OldVet | 01.12.08 - 1:45 pm | #

I think one thing worth taking away from this dialog is that it is very hard to stop working and live on economic rent for a long period.

Most people who think they will "retire" soon-or-someday WILL NOT.

If they are lucky -- they will work until they die. If unlucky -- they will need to work -- but be unable to.

With or W/O SS -- all this imaginary paper "wealth" will not support tens of millions of people for dacades.
Edward Charles Ponzi Jr. | Homepage | 01.12.08 - 3:28 pm | #

i love the way that the likes of formerly anonymous and corev completely miss the point: returns from stocks in a period of growth, low interest rates, and high profitability should beat returns on 90-day federal paper, yet they haven't.

it doesn't matter which individual did or did not time the market correctly.

Ponzi, just to check your memory: right after the '87 crash, stocks fell about as low as 1400, so at the highs a few months ago, stocks were up 10x over 20 years. meanwhile, real gdp growth over that span has been a little under 3% annually, or roughly 75-80%. The rest of the stock price growth has been multiple expansion and an increase in relative share of profits within the distribution of gdp growth.

that said, as this chart shows, stocks were also up 10x after 13 years; indeed, real gdp growth from january, 2001 to now has been roughly 18%, profits have increased, and as i've noted now several times, we still haven't seen any stock price gain over that span.

(i'm pulling the data from here: http://www.data360.org/dsg.aspx?...t_Group_Id=230)
howard | 01.12.08 - 6:08 pm | #

jeff, from my perspective the EMH (which version, strong, semi-strong, weak?) is not correct, market price does not capture all relevent information; there can be large gaps between price and value. OK, is that just juan speaking? No, also Shiller, Bernstein, Arnott, Russell, Smithers, probably Vogel, certainly Marx and Keynes.

I'll add something which I wrote last October:

'It's more than an opinion that the quality of financial accounting deteriorated* from the early 1980s on, with listed firms increasingly presenting results distinct from their realities, with the financial press and msm not sufficiently questioning but, rather, all 'getting with the program', as did most analysts, politicians, etc etc as the Grand Casino was built up and as price(s) failed to capture gross inefficiencies but instead depend on them. Corruption and mispricing became endemic with investors, if that's the proper word, of all sizes being taken to the cleaners while constantly fed a stream of easily digested 'always up' pablum.

*See, e.g., Walter Cadette, David Levy, and Srinivas Thiruvadanthai, Two Decades of Overstated Corporate Earnings: The Surprisingly Large Exaggeration of Aggregate Profits , The Levy Institute Forecasting Center, September 2001.
Or - Robert Kuttner; The Market Can't Soar above the Economy Forever, Business Week, 15 April, 2002. (clip: "For two decades, stock prices have outstripped corporate profits and the growth of the economy.")'

Bluntly, GIGO, share prices and earnings rose even as underlying economic profit deteriorated, something which at least I took to be very relevent -- conversely, even as the Southern Cone's economies entered into recovery, most (U.S.) 'players' failed to notice but, instead, paid attention to such MSM stupidities as 'leftist former labor leader may win the election', so drove prices further down.

As the real global economy's real condition becomes increasingly clear, Ponzi's prediction will prove true. BTW, there are dedicated short funds which, unless we see a complete vaporization of fictitious capital, can be used to offset long side risk and/or gain during down markets. The world is not either/or.
juan | 01.12.08 - 6:18 pm | #

[Jan 12] Econbrowser What Are the Prospects for a Two Recession Bush Presidency

"...the Fed will be forced to choose between inflation stabilization and output stabilization. With Ben Bernanke at the helm, I think I know on which side he would err. "

Decoupling, Again

Will the rest of the world save the US economy? Well, e-forecasting's index of leading indicators (January 2 newsletter; documentation here), besides indicating a 81% probability of recession, incorporates a large negative effect coming from the foreign demand component. This has been described to me as being based on incoming orders of manufactured goods coming from foreign countries.

bush2recessions6.jpg
Figure 6: Components of the e-forecasting eLEI. Source: e-forecasting.com.

Not good news for the decoupling hypothesis. This is consistent with my earlier skepticism regarding the decoupling hypothesis, and ambivalence regarding whether net export growth could prevent the US economy from going into recession.

[Jan 12] Mish's Global Economic Trend Analysis

He said, she said...But there is supporting evidence for this statement from http://forestpolicy.typepad.com/economics/ : " So did the U.S. economy dodge a bullet? Yes, it did... While we dodged a bullet, however, there are between one and three more bullets headed our way."

Paulson said he expects the U.S. will avoid a recession, helped in part by record exports. Yet he acknowledged the U.S. economy is heading for tougher times.

...Paulson knows that things have weakened considerably. That much is clear. However, he somehow thinks we can avoid a recession that we are already in. In addition, his export theory does not fly. Exports are not going to save the US because the world (the UK and EU in particular) is not going to decouple from a US recession.

If grain prices keep rising, oil prices collapse, and consumers stop buying junk from China then yes, trade imbalances will improve. but it will take a collapsing economic picture to sink oil prices. For the record, I think oil prices have reached a near term peak, but prices could easily double if Bush was to do something stupid like invade Iran.

[Jan 12] naked capitalism

MBIA's yield is equivalent to 956 basis points higher than U.S. Treasuries of a similar maturity. The extra yield, or spread, on investment-grade bonds is 217 basis points, according to Merrill Lynch index data. The premium to own high-yield, or junk-rated, debt is 663 basis points. A basis point is 0.01 percentage point.

``That would be close to distressed levels,'' said Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York. Distressed bonds trade at 1,000 basis points over Treasuries of similar maturity.

[Jan 12] UBS - Letter to shareholders

Although we can take measures to strengthen UBS, we cannot control the environment in which we operate. Our geographical diversity is an advantage, as are our very strong fee earning businesses in wealth management, asset management and investment banking. Nevertheless, it is important to recognize that the problems that the financial industry faces have not evaporated with the turn of the year, and that 2008 is likely to be another generally difficult year.

[Jan 12] Nationalization of the Banking System

Eminent Nationalization of the Banking System ? Aren't we seeing the "internationalization" not nationalization as SWF are players? If yes, then 10% drop of S&P 500 probably is just a beginning and 20% are in the cards...If no,then all bets are offin "Back in the USSR" scenario...

Mish's Global Economic Trend Analysis

Mr. Practical chimed in this morning with these comments on the deal:

We are starting to see the first steps in nationalization of the U.S. banking system. Large institutions are being "cajoled" into buying smaller ones. They could wait for bankruptcy to buy the assets, which would be smart, but they aren't as I believe the show is worth much to Washington: it is very important that equity investors be calmed by that stabilization effect.

No matter. As the bad assets are pooled we will eventually see some type of government bailout or quasi-nationalization of the banking system. Banks literally have no capital left.

Stay the course. Risk is high. We will be seeing many more "interesting" things from government as it becomes a larger and larger part of the economy. But remember, stocks are options on profits. The real owners of companies are bondholders who always get paid first.

When companies raise capital at 12%, like Citigroup (C), profits go away. When the government steps in, profits go away.

[Jan 11] Greenspan's Reputation at Risk as Recession Odds Growbe Alan Greenspan's reputation."

Is not the process already started ? Should not high federal officials prohibited from publishing books for at least 4 years after leaving office ?

Bloomberg.com

The next bubble to deflate may be Alan Greenspan's reputation.

... ``He's had a bubble reuta U.S. household wealth,'' said Edward Chancellor, author of ``Devil Take the Hindmost: A History of Financial Speculation.'' ``As that goes down, his standing as a superstar will suffer.''

At stake is not only Greenspan's legacy but also the future of policies he espoused during 18-1/2 years atop the central bank. Critics blame his aversion to regulation and reluctance to use interest rates to puncture asset bubbles for the boom in mortgage lending and house prices that has since gone bust, threatening to throw the economy into recession.

... ... ...

Fed Chairman Ben S. Bernanke has already moved away from the laissez-faire approach of his predecessor by proposing new restrictions on subprime mortgages.

... ... ...

The 81-year-old former Fed chief falls short of that lofty grade, though, for his oversight of the banking industry, Blinder said.

`Slow on the Draw'

``The Fed and the other regulatory agencies were slow on the draw,'' Blinder said. ``They could have made this debacle substantially smaller, not by better monetary policy, but by better regulatory and supervisory policy.''

Desmond Lachman, a former International Monetary Fund official now at the American Enterprise Institute in Washington, blames Greenspan's libertarian bent for his failure to curb lending abuses: ``That philosophy got us into a lot of trouble.''

... ... ...

Some economists, including Blinder, also fault Greenspan for fostering the housing bubble by keeping interest rates too low for too long. The Fed cut its benchmark rate to a 45-year low of 1 percent in June 2003, held it there for a year, then raised it only gradually, in quarter-percentage-point increments.

``For that episode of monetary policy, I would probably give him a B, where my overall grade is A or A-plus,'' Blinder said.

A simulation by Stanford University professor John Taylor suggested that much of the housing boom could have been avoided if the Fed hadn't cut rates so deeply and had raised them back up more quickly.

Meltzer said that while Greenspan was a ``great Fed chairman,'' he erred in ignoring warnings about the risks of keeping rates low.

``I think he lets himself off much too easy,'' Meltzer said, adding that he told Greenspan at the time that he was exaggerating the danger of deflation and thus making a mistake in cutting interest rates to 1 percent.

Rethinking Approach

Allen Sinai, chief economist at Decision Economics Inc. in New York, said the Fed's experience is leading other central banks to rethink their approach to asset bubbles.

``There is a growing body of thinking in central banking that one should not let these bubbles run and allow them to burst,'' he said. ``They should lean against them.''

... ... ...

[Jan 10] Capital One Profit Expected to Fall Short As Loan Woes Worsen by Valerie Bauerlein

Ok, Citi can be nationalized, but what to do with others ?
WSJ.com

Word Count: 318|Companies Featured in This Article: Capital One Financial

Capital One Financial Corp. is expected to announce today that its 2007 profit will fall about 20% short of its previous forecast because of deepening loan troubles and the weakening U.S. economy.

The results by the McLean, Va., credit-card company are the latest sign that mortgage woes are spreading to other types of loans. Capital One is also a major originator of auto loans, ...

[Jan 9] More on Goldman Recession Call

...Goldman also sees "a significant decline in profit growth" in 2008...
...excerpted from the WSJ: Goldman Sees Recession This Year. Here is the current Goldman GDP forecast by quarter:
Quarter Change Real GDP
Q4 2007 1.5%
Q1 2008 0.0%
Q2 2008 -1.0%
Q3 2008 -1.0%
Q4 2008 0.5%

Goldman also sees "a significant decline in profit growth" in 2008 and significant declines in house prices with "an ultimate peak-to-trough decline of 20%-25%". This decline in house prices would mean the value of existing household real estate, as reported by the Fed Flow of Funds report, would decline by $4 Trillion to $5 Trillion (yes, Trillion and I think that deserves a capital "T").

...Finally note that Goldman sees the duration or the recession as less than one year, and therefore not as a severe recession. I tend to agree, but I think the recovery will be sluggish too, especially for employment growth following the recession, so it will probably feel like the recession is lingering into 2009.

[Jan 8] Minyanville - NEWS & VIEWS-Article

M&A activity contributed to 20% rise of S&P500. Andoversized financial sector for another, say, 10%-20% rise. Now this factor is out of picture does this mean that there is a chance ofa 30%-40% drop ? "Some U.S. $150 billion of leveraged loans come due in 2008. " Who and how will refinance themwhen the banks will fight for life due to huge subprime exposure ?

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 U.S. $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.

[Jan 8] Merrill double loss estimates for Citi by Sam Jones

Looks like Citi needs another Arab prince to for bail out, does not it ?How much S&P500 will drop when citi results for the quarter will be announced ?
It's a bit like guessing the number of pennies in a jar. Except the jar is the world's biggest bank. And the pennies are quite big too.

Roughly half-way between the estimate from Sanford Bernstein analysts ($12bn) and Goldman Sachs analysts ($19bn). The variance alone here is surely something to be worried about. A breakdown of Citi's likely losses, courtesy of Goldman, is available here.

Faustian markets: dealing with the devil

"The combination of financial innovation, opacity and leverage is generally explosive."

Risk can't be measured. Competition is destructive. Oh, and that bonus… you didn't deserve it.

Three cursory observations from rating agency Moody's (by their own admission, now measurers of the unmeasurable) sent out in a note to clients on Monday. And that's before we get onto the "Faustian pact" Pierre Cailleteau, chief international economist at the agency, says is behind it all. What matters this financial endless toil/when at a snatch crisis should end the coil?

Risk traceability has declined, probably forever. It is extremely unlikely that in today's markets we will ever know on a timely basis where every risk lies.

This is brave stuff. Moody's are barring no holds. They paint a picture of a market where risk is unquantifiable and the value of products unknowable -- papered over by sky-high bonuses.

Here, from "Archaeology of the Crisis", are a few highlights - all worthy of extensive discussion in their own right:

On risk:

The combination of financial innovation, opacity and leverage is generally explosive.

Information asymmetries are the source of profits for some and, at the same time, of mispricing and excessive risk-taking for others. The "originate-and-redistribute" model for banks has entailed some degree of system-wide information loss once banks have started transferring risk that they would have preferred not to keep on their balance sheets.

Financial innovation often leads to an uneven distribution of the information available to the different parties at risk - usually until a crisis forces a more equal and adequate sharing. The problem in the case of extreme complexity of interconnecting financial systems is that it is hard to see how the level of information could reach levels adequate to enable reasonable risk management standards.

On competition and stability:

… a second, somewhat disquieting, reason: in the financial industry, in contrast with other businesses, there is a point beyond which increased competition is not stability-enhancing, but rather potentially destabilising.

Heightened competition is beneficial in terms of providing a better service and eliminating poor performers in the industry; however, past a certain point - difficult to identify - more competition means more, and perhaps socially undesirable, risk-taking.

On bonuses and compensation:

In plain English, it is not clear that existing compensation mechanisms effectively ensure that traders take into account the long-term interests of the bank for which they work - i.e. its survival. A recent policy announced by several banks to cap wages at a "moderate" level and pay the rest of the compensation in the form of stock is an acknowledgement of this problem. However, such "good intentions" do not generally survive a boom period, and in any event typically have unintended consequences of their own.

On asset valuation (and why your bonus was to blame):

The mark-to-market approach has obvious and compelling advantages in terms of apparent neutrality, timeliness and transparency. It is in tune with the explosion in the tradability of financial claims. It is also clearly superior to highly subjective mark-to-model accounting and apparently retrograde historical accounting systems.

However, somewhat like democracy, it is only the "worst system after all the others".

The key issue is whether the market value corresponds to the economic value of an asset. One could, of course, retort: what is the economic value if it is not the tradable value of the asset.

At the same time, however, pretending that the economic value is necessarily equal to the market value ignores the possible existence of bubbles, overshooting, panic, mis-alignments… Or simply the fact that the "price" in question is only the fortuitous offspring of a handful of transactions.

In the credit market, an imperfect valuation paradigm has combined with misaligned incentive structures. In boom times exuberant market prices led to excessive investor returns; in bust times, doomsday valuations are feeding perverse market dynamics. In a way, inflated boom-time profits fuel individual remunerations (and risk-taking), whilst pessimistic spirals call for public intervention.

The road to a "perfect" valuation paradigm in credit mar-kets is not in sight, and it is not at all clear that equity or exchange rate markets have reached this point either. However, relying on a valuation system based on efficient market theory is - unless it is accompanied by other types of safeguards- a recipe for trouble.

Credit cycles are redundant concepts:

The idea of the "end of the cycle" at the end of the 1990s for instance proved to be an illusion - even if cycles now appear to be more moderate. Sorting out what in the recent decade is cyclical and what is structural is a most complex question and one on which a considerable volume of investments depend.

The difficulty of measuring risk over time is compounded by the way in which regulation is designed. Modern banking regulation aptly requires a proportionate increase in capital when risk increases. But all depends on what "risk" means. If the measure of risk accompanies the business cycle - i.e. risk is perceived as lower at times of boom and higher at times of downturn - the odds are that regulation will be pro-cyclical. Indeed, contrary to casual perceptions, risk in fact increases during boom times and simply "materialises" during the downturn.

And finally, the subprime crisis, and what the rating agencies were "supposed" to do:

As it happened, risk transfer has not been information-neutral: in other words, the final holder of a financial claim has probably less information than the originator of the claim. Rating agencies were supposed to bridge some of the information asymmetries, but this proved to be some-what unrealistic when the incentive structure of (sub-prime) loan originators, subprime loan borrowers, and market intermediaries also shifted in favour of less information.

So what to do about all this? The trouble of course, is that Moody's can talk only in the most general terms. The problems are deeply ingrained… bust follows boom. With that in mind then, better the devil you know.

Commentary elsewhere:

[Jan 7, 2008] Bear Stearns CEO Cayne Pressured to Quit After Losses (Update1)

Is Bear Stern harbinger of what the rest of Wall Street firms report for a quarter ?

Bloomberg.com

...In addition to the mortgage-related losses, fourth-quarter revenue from equity sales and trading dropped 11 percent to $384 million. Investment-banking fees during the quarter fell 44 percent to $205 million.

Lehman Brothers Holdings Inc., Morgan Stanley and Goldman Sachs Group Inc. posted gains for the quarter from trading stocks and advising on mergers.

Merrill analyst Guy Moszkowski has also doubled his loss estimate for Citi; putting it at $1.43 a share, up from 73 cents.

Bear Stearns's return on equity dropped to 1.8 percent for 2007 from 19 percent the year before. Morgan Stanley reported a 7.8 percent return; Lehman generated 21 percent. Goldman Sachs delivered 33 percent for the year. All the firms are based in New York.

[Jan 6, 2008] Larry Summers' Why America Must Have a Fiscal Stimulus

"Leamer believes we bought ourselves a boom in 2004-2006 at the expense of a recession in 2007-2008." Was not Sir Alan over-engaged in protecting his lucrative franchise ?
Naked capitalism

Consider this selection from a recent post on the Fed's Jackson Hole conference:

James Hamilton (enough of a Serious Economist to get to present a paper as Jackson Hole) comments approvingly on an observation by UCLA's Ed Leamer (note he was lukewarm about other aspects of Leamer's presentation):
I found another of Leamer's main themes to be an intriguing suggestion. He claims we should think of monetary policy as doing very little about the long-run growth rate (which he thinks will be within 3% of a 3% annual growth line regardless of policy), and that stimulating the housing market therefore just changes the timing. Specifically, Leamer believes we bought ourselves a boom in 2004-2006 at the expense of a recession in 2007-2008.

Now what if Leamer is right, that cheap credit pushed the US above trend-line growth and a period of below-average growth is inevitable? That means that the best stimulus measures can do is reduce the severity of the slowdown but at the cost of increasing its length. At worst, if they succeed in pushing growth to or above trend line, they will make the inevitable contraction worse.

So the real problem may be that we want to have our cake and eat it too. There is some evidence that a service based economy will show lower productivity gains than a manufacturing-driven economy (remember, economic growth is due to population gains and productivity improvements). But high growth periods help assure re-election, among other things. So the public at large approves of the good times they enjoy in unsustainable high growth periods, and then wants to avoid the inevitable consequences of a retrenchment.

And if you subscribe to the Schumpeterian line of though, recessions are a useful, "creative destruction" phase.

[Jan 4, 2008] How Democrats Failed to Learn From FDR's New Deal

The author analysis is far from being impressive but one comment on this weak article . Time to a new FDR, is not it ? The rule of economic Rasputins made a mess that their beloved unregulated free market might not not be able to sort out without FDR-style intervention.

FDR railed against "economic royalists" and "privileged princes" who sought to establish an "industrial dictatorship" and a "new despotism." Roosevelt issued about 3,700 executive orders, many limiting business activity, and let lose a plague of anti-trust lawyers on American industry. New securities laws made it difficult to raise capital. FDR ordered the breakup of the nation's strongest banks, including those with the lowest failure rates.

[Jan 4, 2008] Minyanville - COMMUNITY-Exchange - Discussion#cmt119

Rewriting the Depression from 75 years hence by Alan Harvey

Now that the well-informed are dead, it makes sense for the right-wing rewrite of the Depression experience.

To say it was a result of government when government was a minor part of the economy is in need of review.

I am not aware of the liberal scholar who argues that New Deal policies brought us out of the Depression. Rather, World War II ratified the theory, and the three decades of growth following the War further ratified the theory and practice.

The war was organized with Keynesian tools and so was the subsequent economy. Free marketeers ought to be dealing with the current collapse as a perfect laboratory for their theories. The financial sector since 2000 has been substantially free of interference by government and free to show its self-correcting and universally beneficent nature.

[Jan 2, 2008] Mish's Global Economic Trend Analysis How Does One Invest For Muddle Through

Those who claim the Fed is currently printing like mad simply have no solid evidence to support it. What the printing like mad crowd is talking about is M3 (credit) which indeed has been soaring. Unfortunately these "printing" claims keep making the rounds but repeating a false claim 200 times does not make it the truth.

Printing claims are typically made by people who do not understand the difference between money and credit. While credit acts like money in most circumstances, when debt can no longer be serviced, the difference is enormous.

Right now we are seeing huge warning signs that debt can no longer be serviced. Those signs are soaring foreclosures, soaring bankruptcies, soaring defaults in credit cards, and a slowdown in consumer spending.

In spite of what one thinks about the CPI and how manipulated it might be, one can expect treasuries to rally in this environment. Indeed they have.

[Jan 2, 2008] naked capitalism Investors Looking for Subprime Bargains

The Journal piece, "Investors Reconsider The Pariahs of '07," is longer and is careful to discuss the downside as well as the potential of taking a flier on subprime-damaged entities:
Fallout from subprime-mortgage woes and the global credit crunch has weighed heavily on stocks in the financial and housing sectors, and has driven down prices of riskier corporate bonds. But while these assets could still drop further, many mutual-fund managers, Wall Street strategists and financial advisers say they are starting to engage in some bargain hunting....

The shifting sentiment comes as some foreign governments' sovereign funds place big bets on U.S. financial companies....

Citigroup Inc.'s Citi Global Wealth Management is calling for a rebound in financials in 2008. IMS Capital Management's Capital Value and Strategic Allocation funds have begun buying home-builder stocks. And Deutsche Bank Private Wealth Management says that "junk" bonds, issued by companies with lower credit ratings, are now giving investors good yields in exchange for their added risk.

But investors need to step carefully. No one knows the full extent of the subprime problems, and many beaten-down stocks may fall further or simply take years to get moving again. Many investors also may already be heavily exposed to financials through a broad market holding like an S&P 500 index fund.

A slowing economy, or possibly even a recession, poses added risks. It could prolong the pain for financial firms and home builders. And while high-yield bonds may appear more attractive than they were earlier last year, the current low level of defaults is expected to rise...

"There is no free lunch in the investment world," says Alan Skrainka, chief market strategist at Edward Jones. "These stocks are cheap because the risks are very high, and there's a lot of uncertainty."

[Jan 2, 2008] In the Land of Many Ifs - New York Timesby PETER S. GOODMAN and VIKAS BAJAJ

I doubt that changes of recession are 50/50 as Iraq war spending still provide a cushion for any drop.Inflation is the other story...Interesting forecast: "..many economists expect national housing prices to fall by 5 to 10% more in 2008, and perhaps into 2009 as well, before hitting bottom. "

January 2, 2008 | NYT

"There are even odds of a recession," said Mark Zandi, chief economist at Moody's Economy.com. "It literally could go either way."

The year that just ended was not for the faint of heart. As mortgage debt became synonymous with toxic waste, banks got spooked and tightfisted. Job growth slowed. Inflation fears grew. Still, consumers kept spending, and unemployment stayed flat. American companies found enough sales abroad to compensate for weakness at home.

The bursting housing bubble remains a locus of concern. An era of free-flowing credit and speculation has led to a far-flung empire of vacant, unsold homes - 2.1 million, or about 2.6 percent of the nation's housing stock, Mr. Zandi said. Even in the worst years of recessions in the early 1980s and 1990s, the share of vacant homes did not exceed 1.9 percent.

... ... ...

Though default rates on loans to homeowners with relatively good credit are far lower, they are rising sharply, too. In November, 6.6 percent of so-called Alt-A home loans - those deemed somewhat less risky than subprime - were either delinquent by 60 days or more, in foreclosure, or had been repossessed. That was up from 4.3 percent in August.

This is a potentially ominous sign, because subprime and Alt-A mortgages issued in 2006 together made up about 40 percent of all mortgages. Like many of the subprime loans that have landed in trouble, Alt-A loans often begin with a low introductory interest rate that later escalates.

The spike in foreclosures is happening even before many mortgages have reset to higher rates, suggesting that borrowers are falling behind because their homes are worth less. Many are having trouble refinancing as banks tighten lending standards.

All of which explains why many economists expect national housing prices to fall by 5 to 10 percent more in 2008, and perhaps into 2009 as well, before hitting bottom.

Such a drop could ripple out to the broader economy by depressing consumer spending, which accounts for about 70 percent of all economic activity.

[Jan 2, 2008] Buckle up, it could be a bumpy 2008 - Dec. 31, 2007

The real question is not GDP, but the level of inflation in 2008, is not it ? What is the level of temptation solve the insolvency crisis by inflating the currency like Weimar Germany ?

At the end of 2008, however, Lehman Brothers predicts 1.8 percent overall growth, and Merrill Lynch believes that GDP growth in 2008 economy will be only 1.4 percent. Thomson Financial more optimistically expects GDP to grow between 2 percent and 2.5 percent over 2008.

Many analysts point out that although the economy and housing market will struggle in the new year, this may not necessarily result in recession.

[Jan 17, 2007] Mohamed El-Erian A Backhanded Indictment of Central Banks

"While undeniable accurate, the fact that these recommendations are on his list is an appalling indictment of the job central bankers are doing." The Fed, for instance, did not do its own homework and was unduly influenced by Brave New World views of investment banks

naked capitalism

Their power has diminished as the financial system has gotten much better at generating liquidity outside their purview. Yet despite this shrunken role, politicians and the public expect them to be able to steer macroeconomic policy as before. Any manager will tell you that having responsibility without having authority is a terrible position to be in.

El-Erian gives a five point program. Two items are revealing:
First, they need to improve their understanding of the new financial landscape....Third, they need to improve, directly or indirectly, scrutiny of financial activities that have migrated outside their formal jurisdiction.

While undeniable accurate, the fact that these recommendations are on his list is an appalling indictment of the job central bankers are doing. The Fed, for instance, did not do its own homework and was unduly influenced by Brave New World views of investment banks and commercial banks merrily reaping current profits with little thought as to the long-term consequences of their moves (and why should they be? They don't affect this year's bonus).

Reader comment:

As someone who did have the Fed inspect his books once upon a time, my memory tells me that they were very big on invoking "street practice". If you're up to it, you were okay. But there is no questioning whether the entire street might be bonkers, and certainly no attempt (and no ability) to understand the products on the book.

[Jan 16, 2007] Bond Insurer Death Watch Continues

naked capitalism

Pershing Square believes, based on MBIA's latest SEC filing, that the firm will need $10 billion in additional capital to maintain its AAA rating, up from an estimate of $8 billion in November (note that this is the requirement over time, not an immediate need).

[Jan 16, 2007] Somber Fed Says Economy Has Lost Punch Financial News - Yahoo! Finance

Problems will be amplified by diminished local governments spending due to lower tax revenues...

The Fed's snapshot of business conditions showed a national economy losing momentum heading into the new year and a future riddled with uncertainty. The persistent housing slump and harder-to-get credit are making people and businesses ever more cautious, it said.

Separately on Wednesday, more big banks reported losses and said people were having trouble making payments for everything from credit cards to cars. Stocks were mostly down for the day, the Dow Jones industrial average declining 34.95 points, or 0.28 percent.

The Fed report was the unwelcome icing on a recent batch of economic indicators -- ranging from a plunge in retail sales to a big jump in unemployment -- raising concern that the country is heading for its first recession since 2001.

At the beginning of last year, many economists put the chance of a recession at less than 1-in-3; now an increasing number say 50-50 or even worse. Goldman Sachs, the biggest investment bank on Wall Street, thinks a recession is inevitable this year.

[Jan 16, 2007] Clusterfuck Nation by Jim Kunstler

This is a little bit alarmist post but author makes a couple of interesting points. The efficiency of individual car-based transit is really unacceptably low and its feasibility depends on the low price of gasoline. Sitting for hours in the traffic to get to metropolis is just the waist of time and resources. Hybrids like Toyota Prius can greatly help but railways looks like are "back to the future" transportation.

The dark tunnel that the US economy has entered began to look more and more like a black hole last week, sucking in lives, fortunes, and prospects behind a Potemkin facade of orderly retreat put up by anyone in authority with a story to tell or an interest to protect -- Fed chairman Bernanke, CNBC, The New York Times, the Bank of America.... Events are now moving ahead of anything that personalities can do to control them.

The "housing bubble" implosion is broadly misunderstood. It's not just the collapse of a market for a particular kind of commodity, it's the end of the suburban pattern itself, the way of life it represents, and the entire economy connected with it. It's the crack up of the system that America has invested most of its wealth in since 1950. It's perhaps most tragic that the mis-investments only accelerated as the system reached its end, but it seems to be nature's way that waves crest just before they break.

This wave is breaking into a sea-wall of disbelief. Nobody gets it. The psychological investment in what we think of as American reality is too great. The mainstream media doesn't get it, and they can't report it coherently. None of the candidates for president has begun to articulate an understanding of what we face: the suburban living arrangement is an experiment that has entered failure mode.

I maintain that all the "players" -- from the bankers to the politicians to the editors to the ordinary citizens -- will continue to not get it as the disarray accelerates and families and communities are blown apart by economic loss. Instead of beginning the tough process of making new arrangements for everyday life, we'll take up a campaign to sustain the unsustainable old way of life at all costs.

A reader sent me a passle of recent clippings last week from the Atlanta Journal-Constitution. It contained one story after another about the perceived need to build more highways in order to maintain "economic growth" (and incidentally about the "foolishness" of public transit).I understood that to mean the need to keep the suburban development system going, since that has been the real main source of the Sunbelt's prosperity the past 60-odd years. They cannot imagine an economy that is based on anything besides new subdivisions, freeway extensions, new car sales, and Nascar spectacles. The Sunbelt, therefore, will be ground-zero for all the disappointment emanating from this cultural disaster, and probably also ground-zero for the political mischief that will ensue from lost fortunes and crushed hopes.

From time-to-time, I feel it's necessary to remind readers what we can actually do in the face of this long emergency. Voters and candidates in the primary season have been hollering about "change" but I'm afraid the dirty secret of this campaign is that the American public doesn't want to change its behavior at all. What it really wants is someone to promise them they can keep on doing what they're used to doing: buying more stuff they can't afford, eating more shitty food that will kill them, and driving more miles than circumstances will allow.

Here's what we better start doing.

Stop all highway-building altogether. Instead, direct public money into repairing railroad rights-of-way. Put together public-private partnerships for running passenger rail between American cities and towns in between. If Amtrak is unacceptable, get rid of it and set up a new management system. At the same time, begin planning comprehensive regional light-rail and streetcar operations.

End subsidies to agribusiness and instead direct dollar support to small-scale farmers, using the existing regional networks of organic farming associations to target the aid. (This includes ending subsidies for the ethanol program.)

Begin planning and construction of waterfront and harbor facilities for commerce: piers, warehouses, ship-and-boatyards, and accommodations for sailors. This is especially important along the Ohio-Mississippi system and the Great Lakes.

In cities and towns, change regulations that mandate the accommodation of cars. Direct all new development to the finest grain, scaled to walkability. This essentially means making the individual building lot the basic increment of redevelopment, not multi-acre "projects." Get rid of any parking requirements for property development. Institute "locational taxation" based on proximity to the center of town and not on the size, character, or putative value of the building itself.

[Jan 01, 2007] naked capitalism The Rising Tide of Liquidity, Part 3

Last week I received an e-mail that made chilling reading. The author claimed to be a senior banker with strong feelings about a column I wrote last week, suggesting that the explosion in structured finance could be exacerbating the current exuberance of the credit markets, by creating additional leverage.

"Hi Gillian," the message went. "I have been working in the leveraged credit and distressed debt sector for 20 years . . . and I have never seen anything quite like what is currently going on. Market participants have lost all memory of what risk is and are behaving as if the so-called wall of liquidity will last indefinitely and that volatility is a thing of the past.

"I don't think there has ever been a time in history when such a large proportion of the riskiest credit assets have been owned by such financially weak institutions . . . with very limited capacity to withstand adverse credit events and market downturns.

"I am not sure what is worse, talking to market players who generally believe that 'this time it's different', or to more seasoned players who . . . privately acknowledge that there is a bubble waiting to burst but . . . hope problems will not arise until after the next bonus round."

He then relates the case of a typical hedge fund, two times levered. That looks modest until you realise it is partly backed by fund of funds' money (which is three times levered) and investing in deeply subordinated tranches of collateralised debt obligations, which are nine times levered. "Thus every €1m of CDO bonds [acquired] is effectively supported by less than €20,000 of end investors' capital - a 2% price decline in the CDO paper wipes out the capital supporting it.

"The degree of leverage at work . . . is quite frankly frightening," he concludes. "Very few hedge funds I talk to have got a prayer in the next downturn. Even more worryingly, most of them don't even expect one."

International Political Economy Zone Casino Capitalism

FAST WEALTH AND BITTER BREAD

The oil prices start to soar
While Real Estate has hit the floor,
The Stock Market is jittery,
The future prospects bitterly
Surveyed on Wall Street and Main Street,
As all alike know they must eat
Their bitter bread, their bitter bread,
Who let fast wealth get to their head.

So China props the dollar up,
But will not fill your beggar´s cup
When she determines not to prop you--
So will not common sense then stop you
From your spendthrift indulgences?
No priest nor prophet comes to bless
Your bitter bread, your bitter bread,
Who let fast wealth go to your head.

It was a fond, elusive dream,
Illusory as it would seem,
But, though superb ambitions went
Before, it was all fraudulent,
This hope, sans rolling up one´s sleeves
To profit--them delusion leaves
But bitter bread, such bitter bread,
Who let fast wealth fill all their head.

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