Friday, December 19, 2008

Help Save The Freedom

A special thanks to Will Bonner for the following:

Fifty years ago, Leonard E. Read urged Americans to "help save the freedom mankind is so unhappily losing."

Read, the founder of the Economic Foundation for Freedom, was warning of the dangers of central planning, statism, interventionism, socialism - whatever you want to call it.
His words seem more relevant now than ever.

I, Pencil

My Family Tree as told to Leonard E. Read (1898-1983)

I am a lead pencil—the ordinary wooden pencil familiar to all boys and girls and adults who can read and write.

Writing is both my vocation and my avocation; that's all I do.

You may wonder why I should write a genealogy. Well, to begin with, my story is interesting. And, next, I am a mystery—more so than a tree or a sunset or even a flash of lightning. But, sadly, I am taken for granted by those who use me, as if I were a mere incident and without background. This supercilious attitude relegates me to the level of the commonplace. This is a species of the grievous error in which mankind cannot too long persist without peril. For, the wise G. K. Chesterton observed, "We are perishing for want of wonder, not for want of wonders."
I, Pencil, simple though I appear to be, merit your wonder and awe, a claim I shall attempt to prove. In fact, if you can understand me—no, that's too much to ask of anyone—if you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing. I have a profound lesson to teach. And I can teach this lesson better than can an automobile or an airplane or a mechanical dishwasher because—well, because I am seemingly so simple.

Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn't it? Especially when it is realized that there are about one and one-half billion of my kind produced in the U.S.A. each year.

Pick me up and look me over. What do you see? Not much meets the eye—there's some wood, lacquer, the printed labeling, graphite lead, a bit of metal, and an eraser.

Innumerable Antecedents

Just as you cannot trace your family tree back very far, so is it impossible for me to name and explain all my antecedents. But I would like to suggest enough of them to impress upon you the richness and complexity of my background.

My family tree begins with what in fact is a tree, a cedar of straight grain that grows in Northern California and Oregon. Now contemplate all the saws and trucks and rope and the countless other gear used in harvesting and carting the cedar logs to the railroad siding. Think of all the persons and the numberless skills that went into their fabrication: the mining of ore, the making of steel and its refinement into saws, axes, motors; the growing of hemp and bringing it through all the stages to heavy and strong rope; the logging camps with their beds and mess halls, the cookery and the raising of all the foods. Why, untold thousands of persons had a hand in every cup of coffee the loggers drink!

The logs are shipped to a mill in San Leandro, California. Can you imagine the individuals who make flat cars and rails and railroad engines and who construct and install the communication systems incidental thereto?

These legions are among my antecedents.

Consider the millwork in San Leandro. The cedar logs are cut into small, pencil-length slats less than one-fourth of an inch in thickness. These are kiln dried and then tinted for the same reason women put rouge on their faces. People prefer that I look pretty, not a pallid white. The slats are waxed and kiln dried again. How many skills went into the making of the tint and the kilns, into supplying the heat, the light and power, the belts, motors, and all the other things a mill requires? Sweepers in the mill among my ancestors? Yes, and included are the men who poured the concrete for the dam of a Pacific Gas & Electric Company hydroplant which supplies the mill's power!

Don't overlook the ancestors present and distant who have a hand in transporting sixty carloads of slats across the nation.

Once in the pencil factory—$4,000,000 in machinery and building, all capital accumulated by thrifty and saving parents of mine—each slat is given eight grooves by a complex machine, after which another machine lays leads in every other slat, applies glue, and places another slat atop—a lead sandwich, so to speak. Seven brothers and I are mechanically carved from this "wood-clinched" sandwich.

My "lead" itself—it contains no lead at all—is complex. The graphite is mined in Ceylon. Consider these miners and those who make their many tools and the makers of the paper sacks in which the graphite is shipped and those who make the string that ties the sacks and those who put them aboard ships and those who make the ships. Even the lighthouse keepers along the way assisted in my birth—and the harbor pilots.

The graphite is mixed with clay from Mississippi in which ammonium hydroxide is used in the refining process. Then wetting agents are added such as sulfonated tallow—animal fats chemically reacted with sulfuric acid. After passing through numerous machines, the mixture finally appears as endless extrusions—as from a sausage grinder-cut to size, dried, and baked for several hours at 1,850 degrees Fahrenheit. To increase their strength and smoothness the leads are then treated with a hot mixture which includes candelilla wax from Mexico, paraffin wax, and hydrogenated natural fats.

My cedar receives six coats of lacquer. Do you know all the ingredients of lacquer? Who would think that the growers of castor beans and the refiners of castor oil are a part of it? They are. Why, even the processes by which the lacquer is made a beautiful yellow involve the skills of more persons than one can enumerate!

Observe the labeling. That's a film formed by applying heat to carbon black mixed with resins. How do you make resins and what, pray, is carbon black?

My bit of metal—the ferrule—is brass. Think of all the persons who mine zinc and copper and those who have the skills to make shiny sheet brass from these products of nature. Those black rings on my ferrule are black nickel. What is black nickel and how is it applied? The complete story of why the center of my ferrule has no black nickel on it would take pages to explain.

Then there's my crowning glory, inelegantly referred to in the trade as "the plug," the part man uses to erase the errors he makes with me. An ingredient called "factice" is what does the erasing. It is a rubber-like product made by reacting rape-seed oil from the Dutch East Indies with sulfur chloride. Rubber, contrary to the common notion, is only for binding purposes. Then, too, there are numerous vulcanizing and accelerating agents. The pumice comes from Italy; and the pigment which gives "the plug" its color is cadmium sulfide.

No One Knows

Does anyone wish to challenge my earlier assertion that no single person on the face of this earth knows how to make me?

Actually, millions of human beings have had a hand in my creation, no one of whom even knows more than a very few of the others. Now, you may say that I go too far in relating the picker of a coffee berry in far off Brazil and food growers elsewhere to my creation; that this is an extreme position. I shall stand by my claim. There isn't a single person in all these millions, including the president of the pencil company, who contributes more than a tiny, infinitesimal bit of know-how. From the standpoint of know-how the only difference between the miner of graphite in Ceylon and the logger in Oregon is in the type of know-how. Neither the miner nor the logger can be dispensed with, any more than can the chemist at the factory or the worker in the oil field—paraffin being a by-product of petroleum.

Here is an astounding fact: Neither the worker in the oil field nor the chemist nor the digger of graphite or clay nor any who mans or makes the ships or trains or trucks nor the one who runs the machine that does the knurling on my bit of metal nor the president of the company performs his singular task because he wants me. Each one wants me less, perhaps, than does a child in the first grade. Indeed, there are some among this vast multitude who never saw a pencil nor would they know how to use one. Their motivation is other than me. Perhaps it is something like this: Each of these millions sees that he can thus exchange his tiny know-how for the goods and services he needs or wants. I may or may not be among these items.

No Master Mind

There is a fact still more astounding: the absence of a master mind, of anyone dictating or forcibly directing these countless actions which bring me into being. No trace of such a person can be found. Instead, we find the Invisible Hand at work. This is the mystery to which I earlier referred.

It has been said that "only God can make a tree." Why do we agree with this? Isn't it because we realize that we ourselves could not make one? Indeed, can we even describe a tree? We cannot, except in superficial terms. We can say, for instance, that a certain molecular configuration manifests itself as a tree. But what mind is there among men that could even record, let alone direct, the constant changes in molecules that transpire in the life span of a tree? Such a feat is utterly unthinkable!

I, Pencil, am a complex combination of miracles: a tree, zinc, copper, graphite, and so on. But to these miracles which manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies—millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human master-minding! Since only God can make a tree, I insist that only God could make me. Man can no more direct these millions of know-hows to bring me into being than he can put molecules together to create a tree.

The above is what I meant when writing, "If you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing." For, if one is aware that these know-hows will naturally, yes, automatically, arrange themselves into creative and productive patterns in response to human necessity and demand—that is, in the absence of governmental or any other coercive masterminding—then one will possess an absolutely essential ingredient for freedom: a faith in free people. Freedom is impossible without this faith.

Once government has had a monopoly of a creative activity such, for instance, as the delivery of the mails, most individuals will believe that the mails could not be efficiently delivered by men acting freely. And here is the reason: Each one acknowledges that he himself doesn't know how to do all the things incident to mail delivery. He also recognizes that no other individual could do it. These assumptions are correct. No individual possesses enough know-how to perform a nation's mail delivery any more than any individual possesses enough know-how to make a pencil. Now, in the absence of faith in free people—in the unawareness that millions of tiny know-hows would naturally and miraculously form and cooperate to satisfy this necessity—the individual cannot help but reach the erroneous conclusion that mail can be delivered only by governmental "master-minding."

Testimony Galore

If I, Pencil, were the only item that could offer testimony on what men and women can accomplish when free to try, then those with little faith would have a fair case. However, there is testimony galore; it's all about us and on every hand. Mail delivery is exceedingly simple when compared, for instance, to the making of an automobile or a calculating machine or a grain combine or a milling machine or to tens of thousands of other things. Delivery? Why, in this area where men have been left free to try, they deliver the human voice around the world in less than one second; they deliver an event visually and in motion to any person's home when it is happening; they deliver 150 passengers from Seattle to Baltimore in less than four hours; they deliver gas from Texas to one's range or furnace in New York at unbelievably low rates and without subsidy; they deliver each four pounds of oil from the Persian Gulf to our Eastern Seaboard—halfway around the world—for less money than the government charges for delivering a one-ounce letter across the street!

The lesson I have to teach is this: Leave all creative energies uninhibited. Merely organize society to act in harmony with this lesson. Let society's legal apparatus remove all obstacles the best it can. Permit these creative know-hows freely to flow. Have faith that free men and women will respond to the Invisible Hand. This faith will be confirmed. I, Pencil, seemingly simple though I am, offer the miracle of my creation as testimony that this is a practical faith, as practical as the sun, the rain, a cedar tree, the good earth.

Leonard E. Read (1898-1983) founded FEE in 1946 and served as its president until his death. "I, Pencil," his most famous essay, was first published in the December 1958 issue of The Freeman. Although a few of the manufacturing details and place names have changed over the past forty years, the principles are unchanged.

Thursday, December 4, 2008

Architects of Destruction

Many thanks to Ian and all the guys at Energy and Capital for the image.

All the above people are in the group I like to call "the few." "the few" is not limited to the pictures above, but to be a member of the few takes one special circumstance - you got filthy rich, I mean filthy "live on your yacht sailing the world for the rest of your life" rich, by creating the financial mess the world has only begun to experience.

What these people did was to create an environment which culminated with fraudulent bonds sold to unsuspecting investors. The story begins many years ago, and many accomplices were involved. Subtle changes to national lending laws meant to help the disadvantaged, elimination of regulatory controls over banks, creation of obtuse and opaque accounting rules were all used by those at the top of financial corporations to rig the system for profit, and lie to investors.

I say lie because "the few" gamed the system by conning the ratings agencies to give the same rating to risky bonds based on consumer debt as the rating given US Treasury Bonds. At the same time, they also convinced those in charge of policing them, ie. the SEC, the Fed, The Senate Banking Committee among others, that this was the new world order, the fantastic paradigm that the US would enjoy.

In fact, the economic model for the US since 1981 has been the elimination of good paying jobs here, in exchange for cheaper imported products in combination with more government spending via sale of US Treasuries, thus increasing the National Debt. In the 1980's, the US was able to increase GDP only through the massive increase of military build-up, which was funded increasingly by foreigners through the sale of US Treasury bonds, which they bought with the profits from the increasing exports we bought from them.

The benefit to the US economy came only after we increased the National Debt, and that money was filtered through military spending, not free market productivity. Our automobile manufacturers were not making more money, they were actually losing money in the 1980's, GM to the tune of $10 Billion per year from 1981-1990. We ceded electronics production to Asia and Latin America, textiles to the Indian sub-continent, and automobile advances to the Japanese and Germans. The swiftness of the manufacturing base dismantling was only buffeted by the increase in military spending.

Next, we began to get the Chinese on board. They relished having foreign capital, mainly from the US, pour into their country. US corporations took the savings they realized by eliminating good paying jobs here, and built shiny new state of the art factories there. It has grown today to such proportions that Peter Schiff calls it the "Tom Sawyer Effect." Schiff likens it to Tom convincing his friends that there was such joy in painting the fence, that his friends actually paid him to paint. Well, the sad part is there was only so much of the Sawyer's fence. That job was finite. And for Tom, he hoped they would finish before they realized painting was really not that joyful.

Unfortunately, the US economy, and the global economy, are not that finite. In 2007, the pace of production in China supported the consumption in America at a 5:1 ratio. That means it took 5 Chinese to meet the buying demands of 1 American. By November 2008, 50% of the toy factories in China have closed. The percentages for other goods is rapidly approaching that level. Just ask your local overhead fan supplier how sales are this year. Ask the hardware store. Ask your furniture store. All these businesses, plus most others based on the consumer, are not just slowly dying, they are at the grim reaper's door. And they all get the majority of the goods they sell from China.

Wall Street used this system to gain huge profits. American corporations that could eliminate jobs here the fastest were the ones whose stock price rose quickest. Bad news is the party could never last. Unless you have a consumer base that makes enough money to buy all the goods, the model would stop working. By 2000, we were at the end of that model. We no longer had enough good paying jobs to trade for cheaper imports.
Congress was convinced by Phil Gramm that Banking deregulation was the answer. Eliminate the wall between investment and commercial banks and large amounts of money will create more jobs was his argument. In 1998, passage of the Gramm, Leach Bliley Act accomplished just that, and removed one of the last vestiges of post-depression laws meant to keep the banking industry sound. Enron was a direct consequence of this law being passed.
In the late 1990's, many more banking regulations were removed by congress, yet nothing was keeping the economy from sinking into recession.

In comes the Fed. Greenspan recognized the need for a spark to rekindle spending. But how to create that spark was the answer. All the data pointed to wages going down. Less money = less spending. So in January 2001, at the behest of Wall Street and the incoming Bush Administration, Greenspan lowered the rate at which banks could borrow money. To fund this, he increased the number of US Treasuries for sale.

For a short time, it worked. Homeowners, under constant advertising from mortgage lenders, refinanced their homes en masse. There were even some homeowners who refinanced 6, 7, 8 times and more within a few years span. They were able to do so because as the stimulus of the lower Fed rate wore off, Greenspan, under encouragement from the White House, would lower the Fed rate again, and again, and again. Each time the rate lowered, it provided a little stimulus. Until the Fed rate got to 1%.

The Fed could not really go any lower. There is always a certain cost to doing business. For mortgages, the processors, underwriters, office space, office machines etc all need to be there to do business, so mortgage rates could not get any lower. Some money must be there to support the organization.

Now Wall Street needed something else. Since the lowering of interest rates had the effect of allowing more buyers into the real estate market, real estate was making dramatic climbs in value. At the same time, since the Fed rate was so low, so were the Treasury yields low. Wall Street, hungry for more profit, and knowing certain investment vehicles such as annuities, pension programs and the like needed a guaranteed rate of return much higher than the the 3.5% of Treasuries, went to work.

First, in order for the plan to work, the ratings agencies must agree. The largest pools of money available for investing reside with entities that, by law in most cases, are allowed to buy only AAA rated securities. So a plan was hatched that the ratings agencies could be convinced to give certain securities, otherwise deemed risky, the highest ratings. The Mortgage Backed Security was born. MBS were, in theory, structured in a way that they contained both good (prime) mortgages and bad (subprime) mortgages, and the argument Wall Street used was since only a portion of the MBS had risky mortgages, and historical models show only a certain rate of default, then if we plan for that default as reflected in the overall rate of return, then the MBS is extremely safe.

Next, Wall Street began selling MBS at a rabid pace. Investors were clawing for greater returns than government bonds. Soon, all the mortgages that could be securitized had been securitized. Wall Street needed more.

The birth of the CDO now came. Several MBS were combined, and packaged as a new type of bond. An average MBS may have contained between $50 - $100 Million worth of mortgages. The CDO's would be a bet on the performance of as many as 10, sometimes more, MBS in one single bond. Most CDO's were sold for more than $1Billion. Wall Street sold these new bonds, the CDO's, CLO's, CMO's, as the way for fixed income investments to realize the rate of return they needed. What Wall Street did not tell these investors is the underlying MBS owned the mortgages, not the CDO. Wall Street did not tell them the CDO was only a bet on the positive performance of the underlying MBS.
The fees were enormous. The demand from pension funds, money market account managers, sovereign wealth funds, annuity funds etc. for higher yield than Treasuries was increasing. Wall Street needed more loans. So the system expanded. Some banks, such as Wamu and IndyMac, already were realizing greater profits from lowering guidelines, and Wall Street was buying all of their loans. Some dealers set up internal channels to service loans they could then package into MBS, and then CDO's. It got to the point that people with very poor credit histories were being given loans that exceeded the value of the property by as much as 25%. Debt to income ratios, forever at the 35% or less level, were raised sometimes to as high 60%. Some people were even allowed to have three, four or more properties at one time with these new guidelines.
Very few people lied to get a mortgage, they did not have to. Wall Street and the banks were eager to let someone into a house, fully knowing the terms would never be filled, because they were selling the risk of that loan defaulting to someone else.
Again, Wall Street was selling the risk to someone else, at huge profits. They were doing everything they could to get more loans in, even giving loans to people they knew never had a chance of fulfilling the obligation.

The real problem with all of this is housing values must keep increasing at an escalating rate greater than at the time of origination of the MBS. If a plateau is reached where housing prices remain steady, the people who had been given loans that exceeded their ability to pay had no way to get out of the house without default. If they had borrowed more than the house was worth, and housing prices remained flat, they could not flip the house for profit.
This was compounded by the credit card companies giving new homeowners cards with $10,000 to $50,000 limits. This practice escalated in 2005 when the banks figured out that a lot of people were buying houses, putting in granite counter tops and new appliances and selling the house for profit as the market rose. Why not give them a seperate line of credit through a card which would be used at Home Depot, then paid off at the closing when they sold the house?
Well, as we all know, housing prices not only have remained flat, they have fallen. More than 25% nationally. This has grave consequences for the buyers of CDO's. Since the MBS that the CDO is a bet on owns the mortgages, the CDO gets nothing from a short sale, deed in lieu or loan modification. The CDO is a 100% loss.
A 100% loss.
Among the coming casualties will be any and all pension funds. If you have money, or are being paid from any pension program, get ready. Most pension programs are near half the value they were one year ago. And the bottom is nowhere in sight. Money market accounts - find out today if they have anything besides US Treasuries. If they do, it is only a matter of time before that account will be valued lower. Most insurance companies bought these to bolster their annuity funds - Guess what - sometime in the near future the billions represented by derivatives will be marked down.
Here is why I call "the few" the architects of destruction. There are somewhere over $500 Trillion in derivatives that have been sold over the last 6 years by American Investment Banks.
There isn't enough money in the world, let alone the US Treasury, to replace the capital losses of even half of the derivatives. In most cases, derivatives will have a 100% loss by the end of this.
It is hard to believe that "the few", who have been called "the smartest people on the planet" by many, did not know what they were creating.

That's the really scary part

Bailout Fill'up

"I better go now, I'm almost at the wall"
Bailout the automakers. The Big Three crash test dummies are sitting in front of Congress, answering questions, and know they will get the money. What a sham, scam and complete boondoggle.


Because if these guys are smart enough to run an efficient company, how is it they are begging for money in the first place? Why did not one of them see this coming? What kind of cars have been the best sellers in the world, not just the US, and why don't we make those here. Why do Hondas and Toyotas last 200,000 miles and more with minimal maintenance, and American cars have trouble getting to 100,000 miles of use without thousands of dollars in repair?

Who chose these guys as the CEO's? I guess the same people that decided it was a good thing to ramp up production of gas guzzling super-sized SUV's that use much more gas, which we buy from Saudi Arabia. SUV production and sales more than doubled between 2002 and 2005. Am I the only one that realized it was Saudi Arabians that flew those planes into the WTC Towers?

When did we cede making the best cars in the world? And more importantly, why? The answer to that question is not a riddle to many. History will show Honda and Toyota got a foothold in this country when American automobiles began to show wear and suffer repairs around three years after they were made. Funny, that is the average length of an auto loan.

This is not a coincidence (my wife says there are no such things as coincidences).

And, please, do not tell me US auto workers are compensated at $72 per hour and foreign workers make $42 per hour. That is a big lie. Those that wish to see all unions die use a funny method when devising that number. They take all the money that is paid to retirees through pensions, and take all the medical benefit money paid to retirees, and take all monies used for retraining and unemployment, and every penny of benefit given to anyone who has ever received money from the US auto companies, add that to to the money paid current workers and divide by the number of currently employed auto workers.

They don't use that method when calculating for Honda, or Toyota, or BMW or..... When calculating how other auto companies pay their employees, they use only the current wages paid to current employed workers.

That is not only disgusting, it is immoral. Why? Because Japanese autoworkers are actually paid more per hour than US auto workers, and they have as good if not better benefits. Ever hear one of these guys who use these numbers point that out? No. It would alert the listeners or readers to the fact that they are a liar.

Such is the circumstance of what we hear for news everyday.

Tuesday, December 2, 2008

The Legacy of Keynesianism

As we wait for the other, or more accurately the many other, shoes to drop, blame flies in all directions. The reality is there is only one place for it to rest. Temptation of that which glitters can be strong, and our leaders have fallen under the spell.

What is happening in the world markets is the utter climax of supply-side economics. Trickle down theory is a lot like the most beautiful woman in the world working as a prostitute, asking only pennies for service, in all the neighborhoods.

So seductive, so sexy, and so within your means that you succumb. Few can resist her.

She is beyond compare, the experience unequaled. Those who enjoined her charms tell others. The line for her wiles grows.

The problem resides in the fact she charges so little for she is disease-ridden. Once you partake, the disease begins to eat away at you. Slowly at first, almost undetectable, the disease grows.

Soon, others you know have also fallen for her charms. The disease spreads, everyone infecting others, especially loved ones, until the first infected begin to outwardly show signs of deterioration. All the others, whether directly, or indirectly infected, ignore the signs for they will not acknowledge the ugly truth. Surely their ailments are not that. Surely there is an easy cure.

The secret must not come out.

Unfettered, the disease reaches proportions beyond control. The beautiful prostitute dies, yet the disease grows. Those that partook deny involvement. Those that are but innocent participants refuse to believe their beloved infected them, even as the symptoms grow.

Simple, ineffective cures are tried. An aspirin here, some antibiotic there. Even more of the same is tried as the healers suggest another trip to the den of iniquity may cure the infected, just as the disease started, so may it end. Of course it does not help, but spreads the infection yet further.

All the while the healers remind all those that enjoined the beautiful woman of her great charms, and did they not want those again? They respond "Yes, Yes, we want those charms again."

Soon the infection is complete. Almost all who joined in the activity, whether guilty of sin, or not, will whither to dust. All who played no part will suffer the same fate.

The few who survive were those who created the infection, gave it to the beautiful woman, and then made her a prostitute. Yes, they also partook of her charms, yet were guarded by the prophylactic, only passing the risk on to the next in line. The few never raised alarm, nor warned of the risk, because they were able to sell tickets for the line.

As the infection grew, these few took the treasures of the infected. Their vaults busting at the seams, these few just built more vaults, all the while telling the infected all was good. Society is strong, resilient, and will be better than before.

Of course, society was in trouble. Resilience was less than needed. Society would not be better than before. The many who never even saw the beautiful woman would suffer the most. Yet, all would suffer, except the few. The world would be changed, dramatically, forever, all in the fews' favor.

All because the few wanted more than they should have.

All because the many wanted to be like the few.

The many believed the swan song of the few, thinking they could not be like the few if they did not believe.

The world is close to the end of this story. The only way this ending changes is the many gather and change the few. The few must be held accountable, and their system denied. The other shoes of the world markets are very close to dropping. The many does not have much time left.

Sunday, November 9, 2008

Pillaging - NeoCon Style

From Bloomberg;

"Nov. 10 (Bloomberg) -- The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.
Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn't require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.

Bush, Paulson and Bernanke have free reign to print new Treasuries, yes, dilute the money supply, and hand them out as they see fit. With no oversight. Some think the Federal deficit will at least double in the next few quarters, others believe it will go higher.

``The collateral is not being adequately disclosed, and that's a big problem,'' said Dan Fuss, vice chairman of Boston- based Loomis Sayles & Co., where he co-manages $17 billion in bonds. ``In a liquid market, this wouldn't matter, but we're not. The market is very nervous and very thin.''

``It's your money; it's not the Fed's money,'' said billionaire Ted Forstmann, senior partner of Forstmann Little & Co. in New York. ``Of course there should be transparency.''

"The Fed's lending is significant because the central bank has stepped into a rescue role that was also the purpose of the $700 billion Troubled Asset Relief Program, or TARP, bailout plan -- without safeguards put into the TARP legislation by Congress. "

The worst part is this - everything Bernanke, Paulson and the White House has said about this matter has been untrue. Lending has not increased, it has gotten significantly tighter. Homeowners are being saddled with Federally authorized new debt, not realizing relief as they were promised. The banks are using the money to pay off losses on derivatives, and if, and I emphasize if, they have any left over, they are using it to buy crippled banks.

To give the banks money, they are printing new Treasury notes. Each new note dilutes all those that came before. Sooner or later, the global markets will begin to price in the flood of new dollars.

It is far from over. There are hundreds of trillions of dollars worth of derivatives that have lost 80-90% of their original value. Right now, the Fed is accepting those for exchange with US Treasury notes. You can trust this - they aren't buying the bad derivatives for 90% off. It would do the banks no good to only get 10% of a CDO's original value, the bank would still be insolvent. So, the Fed is setting the value far higher than the market would, and giving banks hundreds of times the real value on these bad derivatives. That money is lost forever.

"$2 Trillion "

"Total Fed lending topped $2 trillion for the first time last week and has risen by 140 percent, or $1.172 trillion, in the seven weeks since Fed governors relaxed the collateral standards on Sept. 14. The difference includes a $788 billion increase in loans to banks through the Fed and $474 billion in other lending, mostly through the central bank's purchase of Fannie Mae and Freddie Mac bonds."

That amount will grow, and keep growing until resets peak in the first quarter of 2011. Every dollar they give out in bailouts and swaps with the Federal Reserve goes into a blackhole to cover losses, never having a chance to be relent into the economy. Any government official in the past 6 months that has said the Fed is attempting to ease lending has outright lied.

Is it a coincidence that Goldman Sachs, where Henry Paulson came from, was AIG's biggest buyer of CDS, and when AIG was about to go bankrupt and swallow billions in Goldman profits, Paulson used taxpayer money to buy AIG? Now Goldman Sachs won't go bankrupt because the American taxpayer will give billions to them through AIG, or should I say the US Treasury.

So for now, the Federal Reserve and the Treasury Department does not want you to know where they are putting your money.

Nationalizing whole industries. With little explanation as to how or why. Past leaders have done the same things, and we ended up at war with them.

Update Nov. 13, 2008 - Forbes Magazine has reported the amount is now $5 trillion the government has sent into the black hole. This amount will keep going up. As long as failed businesses, and their failing CEO's, are allowed to use false accounting rules, and not forced to suffer bankruptcy as a failed business, the taxpayer is on the hook for every dime they lose. This includes losses on transactions as far back as 6 years ago. Keep in mind, these corporations that are at the taxpayer trough use their current stock price when evaluating how much is in their asset base. As their stock price goes lower, the losses increase. So, the taxpayer will cover the difference when the big players decide to sell a stock and it goes down.


Saturday, November 1, 2008

"The Beatings Will Continue Until Morale Improves"

The Financial Times has been one of the best sources for the all things financial. At least for the five or six years I have been reading.

In their latest addition to the blog Alphaville, I recommend you read "Time for the Darwinian Flush."

Written by J. Kyle Bass, Managing Partner of Hayman Advisors, this article, in terms of companies, debt ratios, overall prognostications, and downright clarity concerning what is next, is one of the best I have read in a long time.

Some excerpts (in italics), with my commentary following:

"Standard and Poor’s recently penned a report that they expect up to 23% cumulative corporate defaults by 2010. BB spreads are headed to at least 1500 basis points over their current level of roughly 1000 bps. This suggests that we will see at least $1 TRILLION of corporate debt default over just the next 2 years. In addition, all financing costs for nonfinancial corporate borrowers will be substantially elevated and pose an ongoing severe headwind to corporate earnings."

The keywords are "at least $1 Trillion." Corporate debt defaults may vastly exceed that, as over the last 8 years the US economy was 70% consumer driven, not corporate driven. Without consumer spending, the corporations have no income streams.

"How did Lehman, a firm with a STATED TANGIBLE BOOK VALUE of $15.1 billion, go from this number to ZERO overnight? The CDS auction of their senior unsecured liabilities just ended at 8.625c on the dollar. When Lehman filed, they said they had $650 Billion in assets. It wasn’t even worth $340 billion the very next day. WHERE DID THE $310 BILLION DOLLARS OF ENTERPRISE VALUE GO?!?!?!?!?!?!? BOOK VALUES MEAN NOTHING TODAY."

Herein lies the biggest rub - The firms that were leveraged well above a 10-1 or 12-1 ratio, such as Lehman (30-1), have been given prodigal status. The truth of how Lehman made its profit, which has been proven to be phantom, should have every regulatory entity in the books of all corporations levered over 10-1. Today. Lehman was far from the biggest player with these kinds of ratios. Hint - All companies levered anywhere above 10-1 are getting ready to eat your tax dollars, and your great grandchildren's tax dollars, before they fail anyway.

"......isn’t it easy to understand the shotgun marriages of WaMu with JP Morgan and Wachovia with Wells Fargo? If the FDIC had to take them over, they would have had to estimate losses to the taxpayer/FDIC in doing so. With WaMu alone, it would have cost the FDIC over $80 BILLION. They had $320 billion of some of the worst possible assets you could put together. They were basically Countrywide with a horrible credit card portfolio. Imagine the headline that morning…”FDIC steps in to take over WaMu. They estimate that it will cost the taxpayer $80 billion even though there is only $45 billion left in the FDIC insurance fund.” Imagine the bank run we would see if the public knew that the FDIC doesn’t have the money to cover depositors. So, each deal that has been done recently has a clever scheme behind the scenes for the Government to take the losses without admitting the emperor is already naked."

Yes, the "bailouts" will end with several trillions of dollars being added to the national debt. The companies who made the bad decisions, such as imprudent guidelines for lending, will pass the losses to the government (you) while they keep their jobs, bank accounts, yachts and bonuses.

"Lehman had $150 Billion of senior unsecured bonds and $400 billion of CDS was written against it producing $360 billion in losses to those contracts alone.

'The remaining broker dealers are the bookies for the CDS markets, and in some cases; they are even the participants playing with proprietary capital. The recent almost failure of AIG would have eliminated the counterparty on the insuring side of $441 billion of these contracts. Guess who would have been left holding that bag? The bookies would have to make good on AIG’s bets."

Guess who was the counter-party to a large portion of these CDS - Goldman Sachs - The place where US Secretary of the Treasury Henry Paulson worked before going to Washington. AIG did not have the $85 Billion to cover reserve requirements on the down grades to derivatives it covered - this means they would not be able to pay any losses - and Goldman Sachs would immediately be bankrupt.

Yes, Goldman Sachs now gets your tax dollars, to cover bad bets. Guess who was CEO of GS when they began placing these bets? Ahh, Henry Paulson. GS actually wrote and issued CDO's, then sold them to get rid of the bad risk, then turned around and bought insurance policies (CDS) betting the CDO's, that they sold, would fail. The premium for the CDS was a fraction of what should have been charged, because GS convinced the ratings agencies that CDO's and the like were extremely safe. So, GS, errrr, Henry Paulson, now controls how tax money is to be spent, and he is spending it to maintain GS profits. Actually, it is worse than this, but too lengthy for now.

" Housing busts are generally prolonged experiences with severe economic and banking implications. We believe house prices will drop approx 34% from peak to trough and the economic decline will take at least another 2 ½ years. The average home price decline of the 24 that were studied was 31% and the average duration was a staggering 25 quarters (just over 6 years)! "

We are already down over 20% nationally, and the number of adjustable rate mortgages resetting will reach a peak in the first quarter of 2011. Remember, these loans were originated at the height of the real estate bubble. Either the principle gets severely lowered (huge losses) or the defaults escalate (huge losses). Or both. A 34% decline from the top is an optimistic number.

Keep in mind, the US Treasury is now paying banks for the difference in principle reductions. Where do they get that money?

"We think we will see 10-12% unemployment, a 4-5% decline in GDP, and the equity markets could drop at least 70% from peak to trough. Remember, the capital structures of most of America’s companies have taken on more and more senior debt, subordinated debt, preferred, convertible preferred, trust preferred, and God only knows what else in front of equity. A drop of 70% for the S+P is absolutely possible. Remember, all of the loss estimates we have reviewed have really ignored the coming losses in credit card debt, commercial and industrial loans, commercial real estate loans, CDS contracts, auto loans, and unsecured personal loans. We are experiencing the global deflationary bust of all time."

The stock market is roughly a little more than 35% down from the peak. See you all at the bottom.

Friday, October 10, 2008


As I write, Henry Paulson, Secretary of the Treasury of the United States is, in proposal, suggesting a one-world-government.

Surprise, surprise, surprise!

Mr. Paulson established, only weeks ago, a corporate socialist nation as the future for the US. Now, to keep from exposing the lie of how deep the losses created by the removal of Glass-Steagall 1933, he, and President Bush, are ready to cede decision making processes among all things financial to a world body. Yes, this includes what the US does within its own borders, as well.

Today, and continuing through this Columbus Day Weekend, the G7, and G20, respectively, are meeting to coordinate efforts in attempts to stem the collapse of the global financial system. Mr Paulson has agreed to adhere, and bind the US, to any solutions the group develops.

All of which will be in vain. The banks cannot reasonably trust one another, for the simple fact no one knows who is solvent, and who is bankrupt. Until all financial institutions are forced to declare exactly what is on their balance, and off-balance, sheets, and its exact value, no one will loan anyone a penny, unless they pay dearly for it.

Most of the world blames the US.

For all of it.

I guess it is only right. We have delivered havoc to other countries, wholesale. Our investment banks, once the pride of the global financial world, have created financial instruments, which, at their heart, were nothing more than smoke. These instruments were predicated on the belief that prices could never go down as long as regulation and oversight were made ineffective.

De-regulation, belief in ever-increasing prices, and the idea America could transform herself from manufacturer for the world, to banker of the world, allowed the US to develop hubris and sanctimony unrivaled in the modern era. Those who developed and championed this ideology forgot to add one variable to the equation - greed. Most assuredly it is hard to measure greed, yet should it not be accounted for, since it is quite possibly the most dominant variable?
Evidence I am correct is only a slight read away. Derivatives - do you know what they are? Mark to market versus mark to model - explain that to your children. Level 3 accounting - wish my bank allowed me that privilege. Supply-side economics - only with deficits supported by foreign purchases of our Treasuries. All of these things together created false wealth, at dizzying speeds. The second the wind blew enough to cause one card to quiver, those above it began to fall, until the whole house was in danger.
Now the real power grab begins. Trust this, the big banks that survived the Great Depression already have a blueprint to follow. The Federal Reserve will now rule this country, no matter who you vote for. The most powerful man in the world will, for a short time, be the Chairman of the Federal Reserve. Within twenty years, someone in a similar role in China may well have that honor.

You must understand - The Federal Reserve does not bow to the President, it bows to its shareholders. The CEO's at the heads of the companies that own the most Treasuries held by the Federal Reserve are who every real American should come to know. To not know means your vote is a puff of smoke in a hurricane.

Maybe we like it that way. The world has become a very complicated place. Politics are mere deflections by their very nature in this new world. One against the other, sic et non. The media is now engaged in a desperate fight against and amongst itself. So caught in the fight to represent one side or the other, the voices of sense and reason are drowned amidst the vast ocean, like a person overboard. Should the sole swimmer reach eager ears, sharks, by the hundreds, devour the voice, until even the whimper is only memory.

How much more can you bear? $800+ Trillion in derivatives, all bets, on the performance of an underlying $30 Trillion, that has lost at least 20% in value. So - A minimum of $160 Trillion in losses... and counting. These losses are already gone forever, they cannot come back. Should housing values continue to drop, the losses grow.
There is a solution. All institutions must eliminate level 2 and level 3 accounting. All financial instruments must be marked to market, no exceptions. This will restore confidence on who is solvent, and who is not. This is at the heart of the "liquidity" problem. No one trusts anyone else.
Yes, some firms will be insolvent, maybe quite a few, but the government could then step in to recapitalize them, after their derivatives have been cleared off the books. They would be much smaller, but if they are that smart, they will grow again. As Karl Denninger writes:
"If there is recovery value (in most cases there will be, as we saw with Lehman) then the bondholders get newly-issued equity in ratable proportion to their (former) ownership of the bonds. The existing equity is wiped out. The firm, having no balance sheet debt whatsoever, can then immediately raise capital in the market to recapitalize itself (having a clean balance sheet this is a trivial task)

For those firms that have zero equity remaining, the government can step in and inject capital via a super-senior tranche as necessary to establish a working capital base. Remember, with a 6% Tier 1 capital requirement a little goes a long way - $10 billion injected results in over $160 billion of available gearing! Bingo - the firm is back on its feet. Protect the taxpayer in these transactions by attaching an onerous coupon to the issue so that it will be rapidly repaid (e.g. 3mo LIBOR + 600 bips) and cleared.

The objection to this plan will be that existing equity holders will be wiped out and bondholders will take a haircut.

Well, bond holders are no worse off than if the firm went under. They would get their recovery value anyway, and they still do - its just in the form of equity instead of cash.

As for equity holders, they're wiped out in a bankruptcy too.

The real objection to this is going to come from the executives, who will see their stock options rendered worthless along with their restricted shares. However, they remain in place (if the shareholders will have 'em) and as a consequence can rebuild their equity over time."
Leverage must also be returned to sustainable levels. Bear Stearns, Lehman Brothers, Wamu and others all had borrowing levels that exceeded capital by 30 or more times.
Most of all, these suggestions will not require one dime of taxpayer money be exposed to losses. The bailout last week will end up increasing the Federal deficit by trillions. The bailout does nothing to restore confidence in inter-bank lending as evidenced by action in LIBOR this week, and it does nothing to stop a firm from going under.
Any further actions that do not resolve the underlying issue of who has what losses will be futile. Any money put into action without solving who has what losses will be lost, in entirety.

Should no group stand up and demand that Mr Paulson stop, our great nation will take a step most Americans may not agree with. Unless, you believe a few more dollars, in the very short term, is a fair trade for sovereignty.

Wednesday, September 17, 2008

Goodbye Yellow Brick Road

Well, here we are, with the "purchase" of AIG by US taxpayers, the Fed, Treasury and everyone on Wall Street are praying the bond market does not collapse. 

What has happened is AIG, the largest insurer in the world, was about to eat hundreds of billions of dollars in Credit Default Swaps they wrote. These CDS are insurance policies written to protect against losses by exotic financial instruments called derivatives. So, the US taxpayer is now the proud owner of AIG, insurer to the world. The $85 Billion the Fed "loaned" to AIG gives the Treasury 79.9% ownership. Imagine that, the US Government now owns a publicly traded insurance company.

Not good news.

The problem is somewhat complicated, yet resides in the fact that most of the derivatives AIG wrote CDS on are now worth almost nothing. AIG has written CDS for $441 Billion, $307 Billion to European banks. The $85 Billion was the amount needed today to meet reserve requirements as the derivatives lose their AAA ratings and go to AA, A, BBB and lower. With each downgrade of a derivative class, the reserve requirements increase. Expect a lot more taxpayer money to go to AIG. Eventually, the reserve requirements will match the insured amount. So, AIG (now the American taxpayers) will cover the losses on derivatives for the European banks. 

Simply put, $85 Billion is a drop in the bucket. 

To add to this, AIG, and other insurers, are important cogs in the wheels of the financial world. AIG and other insurers MUST keep up their business lines, or no one will put new money in the system.

AIG is only one of dozens of companies to write CDS. What happens to other large insurers and reinsurers when they have to pay on derivative losses? To get the original AAA rating, issuers of derivatives had to buy the CDS. The reason US Treasury Notes are rated AAA is they have the full faith and backing of the US Government. They rated these risky financial vehicles the same as US Treasury Notes!

There are a lot of derivatives that have, are, and will go bad. Over $700 Trillion of them have been sold since 2002. 

Did you get that?

More than $700 Trillion in real value at the time of purchase has lost somewhere between 50% to 95% of its original price.

That's the real reason the Fed bailed out Fannie Mae and Freddie Mac. China had bought over $1 Trillion of these derivatives from Fannie and Freddie. Japan and Korea together had bought around $500 Billion. So, in one fell swoop, Mr. Paulson and Mr. Bernanke and the current administration thought it was better that the US taxpayer eat those losses than our trading partners. Even though these countries bought them hoping to make a profit, it is now going to the average American to cover the losses. Mr. Paulson knows that the federal deficit instantaneously increased by $1.5 Trillion, and he is being disingenuous when he states it might be $300 Billion.

Any action taken by congress to save the housing and mortgage market through Fannie and Freddie can only increase the burden of the federal deficit. Smarter people than I believe the recent actions involving the mortgage giants will eventually add somewhere around $5 Trillion to the national debt.

I can only guess what is next. All arrows though, point to disaster. Foreign investment in US Treasury notes is declining - very bad news, since we need purchases of at least $2 Billion per day just to manage the interest owed, never mind retiring some of the deficit. The amount we must sell each day increases with each bailout. Soon, we will not find enough buyers for Treasuries. That will be the day the US loses its AAA rating. 

There ain't no going back from that point.

It is hard to blame the media for not keeping up. Without advertising revenue, no media outlet is there to print or broadcast a story. 80+% of advertising comes from multi-national corporations. The majority of media outlets are now owned by a few corporations, whose sole interest is profit. If the advertisers don't like the stories, they take their money elsewhere. This is why FOX has been so successful - from the beginning, they made no bones about what they were. They told the big corporations "go ahead, write the story. As long as you spend your money with us, we will allow you news input." To remain in the game, most other media companies have had to accede a little, sometimes a lot,  just to survive. 

Problem is, deflection from the real story has become central. Why do I write about finances so much? Numbers never lie, they are immutable truths. In other words, in the financial world it is easy to find inaccuracies. Really, it is low hanging fruit, and I am lazy.

Monday, September 15, 2008

Black Swan Day

September 15, 2008.

So much to write about today.
The first day which truly marks a turning point no one wants to see. All caused by the people we elect, and the people we pay to manage our money and economy. In the end, they will be the only ones to prosper, with your tax dollars.
Major news is missing the boat, as they have for the last twenty years. The financial storm that is coming has been building in plain sight for decades. Many we trust to give us good information actually lied, or were too stupid to see the truth. There is no other way to describe their behavior. 
As long as they were on television, they were "experts." The journalists assigned to present the stories gave us fiction, a point that will be salient soon enough. 
Our politicians have taken bribes to get their jobs, which come with benefits average people do not get. In return, they gave a wink and a nod and a few bills introduced to pay back the bribes, so they could get more bribes.
Back to events of the day.
From itulip;
FIRE Economy D-Day: Greenspan's Black Swan
Following this economic and financial market crisis, the cycle of global recession will not have the same impact on the US in 2008 as it did in the previous case in 1930. The US in 1930 was a net creditor but is today a net debtor, with its dual trade and fiscal deficits funded by massive daily capital flows from foreign private investors and central banks – mostly the latter.

What A Mess

Market Ticker lays out the basics;
"So this weekend everyone who is a "who's who" huddled in New York at The Fed to figure out what to do with Lehman Brothers. 
I'm here to tell you that there is no resolution, no fix, and we now face a stark choice between most of American Finance being sucked into the vortex, and everything, including you, being sucked into the vortex
Yes, those are some stark - and harsh - words.
They're also true.
Let's begin with what we were told wouldn't happen after Bear Stearns.  We were told that Bear was an "extraordinary" event, and that it was a "liquidity run" that doomed them; absent that, they were "fine."
The media, led by CNBC and Fox Business has paraded every analyst they could pay, er, find, to tell us all is well and the crisis is over. They have consistently done this for the past two years. Not one major US news source has gone against this trend.
Bernanke, Paulson and the White House have also been consistent. So far, the count is over 100 announcements in the past eighteen months alone that all is "contained" and the need to spend taxpayer money to give to the banks that made bad bets is in our country's best interest.
"Our best interest" will increase the deficit by at least $3-5 Trillion over the next few years, and it could be a lot more. The banks knew, after 1998 with LTCM, that the Fed would put a floor in to prevent market collapse. So, they decided that pawning off risk through loans made to people who had no possibility of repayment would be OK, as long as someone else held the bad paper, and the government would come in and bail them out if it went bad. For the banks, it was a no lose situation. Huge fees, huge profits, huge bonuses would be paid out, and if their bets went bad, the taxpayer pays for the loss. Pretty sweet deal, for the banks. Pretty crappy deal, for the taxpayers.
Market Ticker continues;
"So America, what are you going to choose to do about this?  Sit on your hands?  Tap your foot?  Drink another beer?  Turn on the NFL?
Its your money they're spending in DC, you know. You've been lied to repeatedly by the clowns inhabiting Washington. Democrat, Republican, elected, appointed, its all a piece of the same mess.
Here, once again, is The Truth for those of you who wish to hear it:
Homes cannot sell, on average, for more than three times average incomes.  Period.  Short-term distortions can and do occur, but over longer periods of time (decades)house prices cannot advance faster than wages.
  • We will not see the bottom of the mess in housing or the economy generally until houses sell for that three times income.  Those who say we will are simply wrong.  Attempts to delay or reverse this adjustment will make the total economic impact far worse and in fact can easily lead us to an economic depression.
  • Those firms who made bad investments must be forced to eat them.  If this results in their insolvency then it does.  We cannot clear our credit and economic systems until we know who is bankrupt and who is not.
  • We as individuals and our nation as a whole must stop spending more than we make.  This is not negotiable.  We as a nation are beholden to foreign interests at present to the tune of $2 billion per day in external funding requirements.  If that funding is interrupted for any reason - such as a loss of confidence - we are instantaneously plunged into DEPRESSION
  • The market is vastly overvalued with essentially the entirety of its "future earnings appreciation" predicated on a resumption of the "FIRE" (Finance, insurance and real estate) economic boom.  The only "boom" that is occurring and will occur is a series of explosions.  The S&P 500, without that "acceleration", has a fair value somewhere around eight hundred.  Yeah - 1/3rd lower from here and fully half off its all-time high."

    Will we hear the news on what's next? Will it be accurate? Or at least try to be. 
    I can tell you this, if there is a happy face put on the events over this last weekend, watch out. Bank of America has to be the in the race for "Most Stupid Bankers." First, they buy Countrywide. At the time, Countrywide was bankrupt by at least 5 or 6 times their assets, and BAC bought them for $4 per share. The pesky bondholders from Countrywide refuse to lose their money, so BAC's plan to pick the good assets and scuttle the rest of Countrywide has been hampered. They are afraid additional lawsuits will only add to their losses.
    Now, it looks like they will buy Merrill Lynch for $29 per share. MER is not worth anything. They have exposure on derivative losses exceeding capital by 10 times, they are bankrupt. The only reason the market doesn't know it is because accounting rules allow them to hide the losses in level 3. Those losses can never come back, because they are on bets on MBS that has already gone bad. 
    BAC knows the Fed will give them taxpayer money to cover the losses. 
    McCain and Obama know this, too. Both candidates have people advising them who created this problem. Just google Gramm Leach Bliley Act for McCain. Google Penny Pritzker for Obama. Don't take my word on it, read for yourself.
    The more the Fed and the government try to "save" some of these banks that got us into this mess, the bigger the mess will be.
    When will we have the media tell us this. 
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