That’s the subjec of this week’s Bernie Sanders Unfiltered. Watch and enjoy:

The Chairman gets no respect from some of the Congress’s members( Sen. Jim Bunning is long-winded, isn’t he?)….his approval for new term has been stalled…but he’s a lock for another term…..man he has a tough job…..and very few friends…..

Macro

Kentucky Fried Bernanke

Happy Friday.

Naughty Boy, Mr Greenspan, sorry… err… I mean Mr Bernanke - watch this clip of Bernanke getting an absolute grilling from Kentucky (R) Senator Bunning - Kentucky Fried Bernanke. I bet Bernanke is happy it this week is over too! Although I have to sound one note of advice to Senator Bunning; read your notes before delivering a tirade – it is much more effective!

I was reading an interesting piece by one of my favourite economists, Stephen Roach (I still view him as an economist first, and CEO of Morgan Stanley Asia, second!). He cited that, China’s problems are far from over (reducing imbalances, boosting domestic demand, pollution), but I was happy to see that he did actually recognize a move to the, more labour-intenstive, and thus more socially stabilizing, service industry – something which I alluded to last week (27th November).

Roachie also felt that the Chinese economy would experience severe headwinds in 2010 as the stimuli run out and the World’s greatest consumers remain in contraction-mode. This, he felt, would likely be met by another huge stimulus injection to the economy, which could send Chinese investment share of GDP to a mindboggling 50%. Fears of Non-Performing Loans will no doubt arise.

However, Roach reminds us that the Chinese have embarked on “5-year-plans”. The next one, the 12^th of its kind, will be unveiled in 2010 for the next leap forward to 2011-2016. Roach, like myself, thinks that this is not time for central macro policy-makers in China to choke on responsibility or cower from taking courageous, even controversially bold strides into their 21st Century. I have a feeling they will not disappoint.

Incidentally, here he is on Bloomberg TV telling investors why China is not the next Dubai – a callow theme-question which seems to have gathered momentum in the Western media.

Here is an interesting piece on the EU Hedge Fund Directive in the WSJ (An Old Solution Applied to a New Problem) last week which I forgot to highlight to you. Here it is. Reminds me of what an investor said to me about something a London-based asset manager said in a speech:

Look, this EU Directive will not affect our operations, nor will it affect our investments or our clients’ ability to access their capital. Clients can call us up at any time to get information or even visit us … in what will be our new offices… in GENEVA!

Man, if this new EU directive goes ahead, the best investment out there might be to buy property in Geneva or Zurich!

Lastly, a bit of fun. Some of you may remember that on a bygone Friday I copied a weird piece I wrote a while back comparing the US superpower to the empires of old, it was called: Who, Where, What, When and How Are We? Seeing as it is Friday and time for fun I thought I’d share this graphic with you on the theme of Empires. It is a beautifully simply concept visualizing empires’ decline by Pedro M Cruz. I just love stuff like this… cool.

Macro Data to Watch:

• South Korean GDP Growth (just came out at +3.2%)
• Swiss Inflation

Markets

I have so say Geithner looked very much at ease with the way he delivered answers to CNBC’s Squawk Box Panel yesterday – a far cry from his Rough Day in the Office highlighted by a blog on Seeking Alpha. The market went along with the mood for a bit and then… whoops! Slipped on a banana skin in the last few minutes of trade. Pretty sure we’ll close comfortably up for the week though.

Japanese interest rates have bounced a little from the lows of this week but look at where we are with the 5 year yen swap rate, for example. A bit of risk aversion creeping back into the Japanese bond markets this week I think.

Global Stocks to Watch:

• Biggest Index Movers yesterday were Siemens (earnings not so good after all), Wells Fargo, Rio Tinto.
• Still lots of debate in the UK about capping banker’s bonuses – let’s see how Lloyds and RBS close the week out.

Macro Data to Watch:

• South Korean GDP Growth (just came out at +3.2%)
• Swiss Inflation

A couple weeks ago, on November 19, 2009, the Paul-Grayson Audit the Fed Amendment, or H.R. 1207, passed the House Financial Services Committee with a vote of 43-26. One notable nay vote, Barney Frank, is an amendment to Frank’s “Financial Stability Improvement Act of 2009 (H.R. 3996),” calling for a comprehensive audit of the Federal Reserve.

Fellow Libertarian, Texas Congressman Ron Paul, wants to complete a full audit of the Federal Reserve, which hasn’t been executed in the 96-year history of the Fed. Paul and Grayson successfully added the amendment 69B to Franks H.R. 3996. Congressman Paul, is an advocate and vocal supporter of auditing the Fed, and the leading crusader in pursuing the demise of the Federal Reserve.

Since its inception in 1913, with the enactment of the Federal Reserve Act, the Fed has placed the United States at monetary insecurity with its unsound monetary policies. The Federal Reserve System, the central banking system, is an independent entity within the government, not owned by the federal government either. Its primary function is to control our nation’s currency and monetary policy by maintaining stability of the financial system.

The enactment of the Federal Reserve Act of 1913 was a response to the 1907 Bankers Panic, in which the New York Stock Exchange fell 50 percent from its previous year. As panic ensued, the economic recession caused numerous runs on the bank and trust companies. The answer to address the financial issues was a central banking system. The Federal Reserve Act, as the Christian Science Monitor observes, was “merely a plan to allow 12 new banks to do what other banks were prevented from doing themselves, namely, establish branch networks and issue currency backed by commercial assets.”

Essentially what this Act did was grant monopolistic privileges to these banks, by allowing them to tamper with the nation’s monetary policy without oversight. According to Article I, Section 8 of the Constitution, Congress has the power “To coin Money, regulate the Value thereof…and fix the Standards of Weights and Measure.” Congress’s constitutional duties is to print and regulate our currency by controlling the printing press that the Federal Reserve was given power to do, by a Congress that decided to give up their responsibility.

Since then we’ve lived through the Great Depression and numerous economic downturns since the enactment of the Federal Reserve Act of 1913, which every economic downturn could be traced to the Fed’s unsound monetary policy. Some scholars claim that the Fed’s monetary policy caused the Depression to become the Great Depression. The fact is, a uncheck, unaudited Federal Reserve, separate from the U.S. government, and lacking transparency, has placed our monetary policy on the fast track to devaluing our dollar. A devalued dollar, according to the Federal Reserve Bank of New York’s website, could “aggravate inflation. If this happens, the government may have to raise interest rates to control inflation, but at the cost of slower economic growth.”

Congressman Paul’s amendment to Barney Frank’s bill is the right step forward, towards Congress taking charge of an out of control Federal Reserve, by taking a look into their books and auditing their gold reserves. As his bill journeys through Congress, and hopefully passes the legislature, and is signed into law and not vetoed by President Obama, could push us towards reclaiming our monetary policy. As Thomas Jefferson observes about central banking, “I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the Government at defiance. The issuing power should be taken from the banks and restored to the people to whom it properly belongs.”

Distortions, Lies, and Muggings by the Fed, Bank of England

Courtesy of Mish

Just kidding.  Senator Chris Dodd (D-Connecticut, and chairman of the panel) gave Bernanke a tongue bath in saying, “Under your leadership, the Fed has taken extraordinary actions to right the economy.”  While there has been outcry over needed Fed transparency, Bernanke and his minions have made great strides at propping up our fragile financial system.  Transparency is a joke, really, when dealing with Government agencies.  The last thing the Fed needs, is everyone on Planet Earth knowing their business.  I hate the idea of politicians being, guys I’d like to have a beer with. I want my politicians and power brokers to have a superior pedigree than that of Norm from Cheers. I want secrecy, I want condescension, and I want guys who can do the fucking job.  Bernanke got a 1590 on his SATs, and I just googled that, and you know what – it’s pretty good.  His PhD from M. I.  fucking T. isn’t a bad thing to hang your hat on, either.  In some ways, I suppose it’s hard to gauge an approval rating on a guy most of America doesn’t know.  I’ll take it a step further and say that some of the BB backlash can be attributed to old-school bellyaching politics and jealousy.  The undressing that many of the country’s big banking brass took last fall would be enough to stir up some resentment toward the world’s most powerful agency.  As the day moves forward, I look forward to quoting Pete Townshend, Meet the new boss, same as the old boss.

The Huffington Post has a far more intelligent take over here.

Macro

Hypocritical Fed?

Back in the saddle and feeling much better, thank you very much. After a full two days in front of CNBC (lucky me) I thought I might as well enlighten you on things which caught my eye.

Firstly, you may remember my recent comments on 14^th October (Confessions of a Hedge Fund Operator) about the lack of transmission mechanism in the banking system to effect the inflationary impetus the Federal Reserve desires so much. Which made ZeroHedge’s article on how the Fed does not want the banks to increase lending a little intriguing, I have to say. In particular the following excerpt from the Fed Minutes:

 …participants noted that banks might seek to reduce appreciably their excess reserves as the economy improves by purchasing securities or by easing credit standards and expanding their lending substantially. Such a development, if not offset by Federal Reserve actions, could give additional impetus to spending and, potentially, to actual and expected inflation.

 … which could easily have been read as: “yes we are doing everything to create inflation, and you can see this by our actions, but we are getting very worried about… errmmm … inflation…”.

Confusing statement I’ll admit, but I put this down, in part, to a misinterpretation of the Fed minutes (I hope). However, when one of the World’s most prominent distressed debt investor says outright that this is the best environment he has ever experienced for finding investments in distressed assets and that this is opportunity is directly due to the Fed’s insistence on reserve requirements by the banks (restricting their ability to make new loans) then one has to sit up and take notice. Here is the CNBC clip, you can fast forward to 5 min 20 seconds but it’s quite interesting to listen through if you have time.

I’ve attached the Bloomberg Article on the European Pressure on China to revalue the Yuan (old news). but for those of you who have been reading my stuff, this of course, would be even older news and the notion of a European backlash as predictable as China’s contemptuous rebuttal.

On the subject of China, Chris Rynning’s comments on asset-prices in China are worth listening to, I think. Especially given that he’s an expert in non-mainstream private investments in China.

Just want to highlight something Asian Investor wrote. Apparently Taiwanese fund managers see little benefit from this cross-Strait MOU – perhaps things will change in due time.

Macro Data to Watch:

• Eurozone compiled GDP growth report
• French Jobs
• Dutch Inflation
• US job numbers

Markets

So the saga of Dubai - the “MC Hammer of all sovereign defaults” – continues to weigh on investors’ minds. I say MC Hammer, can you remember when he went bankrupt? We all couldn’t believe it. He had only just gotten famous, how on Earth could he have accumulated that much debt? He was so rich, so fly, so “bling”. Then suddenly he was broke… priceless… all I can say is: “U can’t touch this“.

Gold just gone loopy- now comfortably trades above $1200 /oz .

Mexican Peso hits a new high on the Dollar as the central bank raises its inflation forecast – no grey areas about exit strategies there.

On a subject dear to my heart: the convertible bond market. Skander Chabbis stands his ground on CNBC and (finally) answers the repetitive question on the product – why are convertibles “good for companies” when they are dilutive to shareholders? It’s not because they are “selling their soul”, but, rather, because convertible typically come on hefty premiums to current stock prices while at the same time at lower interest cost to typical straight loan. Skander makes another good point too though – that, in effect, companies are monetizing the volatility on their balance sheet.

Global Stocks to Watch:

• Earnings:
  • Sekisui House – Japanese real estate co.
  • Some Canadian Banks reporting (Toronto-Dominion, CIBC, National Bank of Canada)
  • Siemens
  • Kingfisher – UK retail giant

Ambrose Evan Pritchard  reports S&P says European companies face $1.5 trillion funding shortfall next year

“This is definitely a threat on the horizon,” said Blaise Ganguin, the agency’s European credit chief.

Some 75 companies large enough to be rated face likely default in 2010 as the slow-burn effects of the crisis hit home. The default rate peaked near 13pc this year, the highest since S&P began to collect data.

The shortage of funds will raise borrowing costs for business by an extra 75 basis points, with the risk of a more serious crunch for small companies. “While the worst of the recession may be behind us, the recovery is likely to be extremely shallow,” he said.

Mr Ganguin said capital spending in vulnerable sectors such as automobiles, home furnishing, and forestry may fall by as much as 50pc as they struggle to cope with excess capacity. “These are enormous numbers. It is clearly going to put a dampener on the recovery,” he said.

Mr Ganguin said the severity of problems depends how quickly the Bank of England and the US Federal Reserve step back from quantitative easing. The Anglo-Saxon central banks have between them bought almost $2 trillion of government debt and mortgage bonds. This has propped up the entire global debt market and capped borrowing costs. As the support is withdrawn – and ultimately reversed – bond yields may rise rapidly to uncomfortable levels.

There is no sign yet that governments are about to cut their deficits. State borrowing will continue to rise overall next year, “crowding out” global debt markets.

Governments are continuing to act like weed in the garden of credit. They’re choking of credit to the market, which is the only source and hope for a real recovery.

All is well in Wonderland.

Having a few days off from the grind felt great.  The first day back after a long weekend of too much food, wine and relaxation was not easy. 

Usually we don’t experience much activity the first few days after Thanksgiving.  This year seems to be different.  It’s the first day of December and the phones are ringing.  Our pipeline has remained steady as we consistently replenish our closed loans.  What a difference a year makes.

Even though business remains steady, uncertainty about the economy keeps the environment  oppressive.  We continue to hear news about friends loosing their jobs or feeling that it’s only a matter of time.  Apparently many others feel the same.  News about Dubai caused a big shake up in the markets this week.  That news caused yields on the 10 year Treasury moved 15 or 20 basis points right before the holiday.  Yields have started to move back up again as fears of Dubai’s default have subsided. 

Yields on mortgage-backed securities followed the treasury yields lower.  Lenders have resisted offering lower interest rates.  Yields on the MBS’s point to rates in the low to mid 4% range.  Banks have not reduced rates much below the  4.75% to 5% range, go figure .  The banks are profit taking at consumers’ expense.

Washington has tried to force banks to loosen up their lending standards over the last few days.  Most of the new regulation and oversight enforced over the last few months will make it difficult to loosen up the markets.  The government needs to make up their minds.  Do they want more regulation or freer markets?   They can’t have it both ways.

It’s a festive time of year! If big messy gobs of financial regulation are what you hope to hang on your tree that is…either way you look at it, the week ahead promises the kind of Hill lineup that C-SPAN lives for.

Treas Sec Geithner arrives on the Hill Wednesday to testify before the Senate Agriculture Committee on regulation of OTC derivatives. According to reports in The Hill today, chairwoman Sen. Blanch Lincoln (D-Ark) is the real one to keep an eye on, as she will be calling the shots on new reforms for derivatives.

Ben Bernanke appears before the Senate Banking Committee Thursday for a long-awaited hearing to approve Bernanke’s second term as Fed Chairman. Despite recent skewering in Congress, Bernanke is expected to be re-confirmed, though the highly visibile opportunity for committee members to play populist politics and roast Bernanke should make for some good television.

House Financial Services Committee Chairman Barney Frank is expected to finalize work on a wide-ranging committee bill proposing new regulatory procedures for financial institutions considered to pose systemic risk – yes, this means those considered “too big to fail” (but who is a little sick of that term by now?) Reports are out that Frank wants to have this bill before the House for a vote by mid-December, and a close on the systemic risk piece would put him on track.

Of course, what would this pretty picture be without the lobbies? The Hill’s Silla Brush reports tonight that The Financial Services Roundtable, which acts on behalf of 100 large financial firms, is calling for more hearings on financial regulatory reforms. Are they looking to stall Frank’s bill? Of course, but are they also, perhaps understandably, hoping to stave off some near-sighted political fumbling on the matter? Brush quotes the group’s president, Steve Bartlett, as saying:

“We agree that financial regulatory reform must happen sooner rather than later – but we are concerned with the speed of the committee to push this legislation forward without conducting a hearing regarding all of issues raised by the various amendments…without such a hearing, the Committee will not be able to fully contemplate the effect such amendments will have on the industry.”

Bartlett’s interests are clear, nevertheless, it is a little hard to disagree with him.

So, fire up the C-SPAN! And here we go…

Draining the Swamp: The Fed’s Tri Party Repo Machine

Courtesy of  Jesse’s Café Américain

In this case as outlined by the New York Fed memo below, a triparty repo transaction is a transaction among three parties: a cash lender acting on behalf of all holders of dollars (the Fed), a borrower that will provide collateral (dodgy debt holder in shaky financial condition), and a clearing bank, most likely a primary dealer like J.P. Morgan, which is only too happy to collect its fees as an agent of the Fed.

The triparty clearing bank provides custody (agency) accounts for parties to the repo deal and collateral management services. These services include ensuring that pledged collateral meets the cash lenders’ requirements, pricing collateral, ensuring collateral sufficiency, and moving cash and collateral between the parties’ accounts. What if any liabilities the clearing bank such as J.P.Morgan or Goldman Sachs might obtain for the mispricing of risk remain undisclosed, but are probably negligible at worst.

This is the method of obtaining toxic assets from the books of non-primary dealers, and providing stability and liquidity from the aggregate value of all dollar holders to cover the misdeeds of diverse financial institutions and other favored parties.

In other words, the Fed is draining the financial debt swamp and toxic waste dumps into your basement, if you hold Federal Reserve Notes. Your IRA’s, your 401k’s, your savings, as long as you hold Federal Reserve Notes, which are claims on their balance sheet loosely backed by the Treasury. When the Fed’s balance sheet contained nothing but Treasuries and explicity backed agencies that relationship was firmer. Now, we are into the realm of make believe and Timmy’s credibility.

The Fed pledges that Goldman and Morgan assure them that there will be no radioactive material in the sludge pond headed your way, and levels of carcinogenic and toxic contamination will be within levels that they believe are adequate based on the non-binding estimates.

In practice the Fed has a defaults account on its book for the shortfalls from fat valuations due to the toxic debt it has already assumed on your behalf.

The source and composition of the sludge will remain a secret among the bankers, without oversight. This seems like taxation without representation, at least for holders of dollars that are US citizens, since the Fed is engaging in the expenditure of public money without hearings, votes, public oversight, or controls. The Fed seeks to become a financial Star Chamber, dispensing ‘justice’ as it pleases.

Statement Regarding Reverse Repurchase Agreements
Federal Reserve Bank of New York
November 30, 2009

As noted in the October 19, 2009 Statement Regarding Reverse Repurchase Agreements, the Federal Reserve Bank of New York has been working internally and with market participants on operational aspects of triparty reverse repurchase agreements to ensure that this tool will be ready if the Federal Open Market Committee decides it should be used.

In the coming weeks, as an extension of this work, the Federal Reserve Bank of New York plans to conduct a series of small-scale, real-value transactions with primary dealers. Like the earlier rounds of testing, this work is a matter of prudent advance planning by the Federal Reserve. It does not represent any change in the stance of monetary policy, and no inference should be drawn about the timing of any change in the stance of monetary policy in the future.

These forthcoming operations are being conducted to ensure operational readiness at the Federal Reserve, the triparty repo clearing banks, and the primary dealers. The operations have been designed to have no material impact on the availability of reserves or on market rates. Specifically, the aggregate amount of outstanding transactions will be very small relative to the level of excess reserves, and the transactions will be conducted at current market rates.

The results of these operations will be both posted on the Federal Reserve Bank of New York’s public website where all temporary open market operation results are posted and reflected as a liability in tables 1 and 9 in the Federal Reserve System’s consolidated balance sheet statements.

Ben Bernanke Pleads For His Job; My Response to Bernanke

by Michael Shedlock

Ben Bernanke is on yet another self-serving mission to save his job. Please consider The right reform for the Fed an op-ed by Ben Bernanke in the Washington Post.

Here is Bernanke’s entire article (in italics) with my comments interspersed in plain type. Most of my comments are made straight to Ben Bernanke, but they apply in general to all central bankers.

Bernanke: For many Americans, the financial crisis, and the recession it spawned, have been devastating — jobs, homes, savings lost. Understandably, many people are calling for change.

Mish: Ben, the reason people are calling for a change is that you and the Fed wrecked the economy. You did not see a housing bubble, nor did you foresee a recession. I would also like to point out your selective memory loss about your role in bailouts. To refresh your memory, please refer to Bernanke Suffers From Selective Memory Loss; Paulson Calls Bank of America “Turd in the Punchbowl” for details.

Bernanke: Yet change needs to be about creating a system that works better, not just differently. As a nation, our challenge is to design a system of financial oversight that will embody the lessons of the past two years and provide a robust framework for preventing future crises and the economic damage they cause.

Mish: No Ben, we need a system that works differently. You have proven beyond a shadow of a doubt that you and the Fed are incompetent and cannot be trusted.

Ben here is a compilation of your own statements made from 2005-2007 proving you have no idea what you are talking about.

Lots of buzz this weekend over a WaPo editorial written by Fed Chairman Ben Bernanke – the piece appears in the Post’s Sunday paper today but was released on its site late Friday.

Who thinks Bernanke actually wrote this himself? If he did, that’s impressive, because he is getting it on all fronts right now. First, he is scheduled to appear before Sen. Chris Dodd and the Senate Banking Committee this week to advocate his confirmation for a second term as Fed Chairman. Add to that Rep. Ron Paul – yes, that kooky Texan congressman/fringe presidential candidate – and his emergence as a credible threat not only to Bernanke, but also to the very autonomy of the Fed itself. As a member of the House Financial Services Committee, Paul successfully inserted an amendment to a committee bill earlier this month that aims to subject the Fed to an annual audit from the congressional Government Accountability Office, (GAO). The HFSC bill, and Paul’s amendment, still has to clear both the House and the Senate, but if it does it will set a dangerous precedent. Paul authored a book last year entitled “End The Fed’” – I think there should be little doubt as to what his ultimate plans entail.

It is clear the Fed has made grave errors not only in handling the financial crisis but also Wall Street in general. But guess who else made – perhaps worse – errors? Congress. If it wasn’t so scary, it would be almost laughable to think that the same congressmen who let Wall Street run wild now want a stake in monitoring monetary policy. Um, no. Ron Paul says that opponents of his Fed audit plan are simply masters of secrecy and deception. Um, Congressman, please take a look around you.

Notwithstanding this general stupidity, the autonomy of the central bank is a hallmark of the historic institution and should be left as such. It is designed to prevent political interference in our country’s economic and financial health. In his editorial for the Washington Post, Bernanke writes:

“Many studies have shown that countries whose central banks make monetary policy independently of such political influence have better economic performance, including lower inflation and interest rates…independent does not mean unaccountable.”

I agree with Bernanke on this. He notes in the beginning of his editorial that proposals like Paul’s “are at least in part the product of public anger over the financial crisis and the government’s response, particularly the rescues of some individual financial firms.” Again, true.  Are we really going to let public officials – many (and this does not include Paul) with little working knowledge of financial markets -  write new rules simply to satisfy populist outrage?

In short, if you’re unhappy with Bernanke, then throw him out. Don’t hand him a second term. It’s that easy. Audit the leadership. But don’t go and inject permanent Congressional snoops into the Fed – the last thing this economic recovery needs is more politicians.

Dubai Defaults – Deflation In Action – Watched Pot Theory Revisited

by Michael Shedlock

Last night after a 10 hour drive I was up at 5:00AM watching the futures plunge but not knowing why. Now we know: Dubai default fears spook investors

Global stock markets endured heavy selling on Thursday as investors were spooked by the spectre of a default by Dubai and after a febrile foreign exchange market saw the yen surge to a 14-year high against the dollar.

The turmoil caused a flight to less risky assets. Gold, which had challenged $1,200 in Asian trading, fell back from its highs and money flowed into havens such as German government bonds.

US markets are closed for the Thanksgiving holiday, but electronic trading of the benchmark S&P 500 equity futures contract showed a potential drop on Wall Street of 2.2 per cent.

As the European trading day progressed it became clear it was Dubai World’s difficulties that had hit a particular nerve, reminding investors of the lingering damage wrought by the financial crisis.

Banking stocks tumbled on concern about their potential exposure to Dubai. Indeed, the cost of insuring against default by the emirate jumped, with Reuters reporting the Dubai five-year credit default swap being quoted as high as 500-550 basis points. This means it would cost about $500,000 a year to insure $10m of Dubai’s debt. On Tuesday it would have cost about $360,000.

Greek and Irish government five-year credit default swaps also moved higher as nations with supposedly precarious fiscal positions were punished. In contrast, investors sought out comparative haven assets, pushing the yield on the German Bund down by 8 basis points to 3.16 per cent.

Dubai Debt Delay Rattles Confidence in Gulf Borrowers

Please consider Dubai Debt Delay Rattles Confidence in Gulf Borrowers

Dubai shook investor confidence across the Persian Gulf after its proposal to delay debt payments risked triggering the biggest sovereign default since Argentina in 2001.

The cost of protecting government notes from Abu Dhabi to Bahrain rose, extending the steepest increase since February as Dubai World, with $59 billion of liabilities, sought a “standstill” agreement from creditors.

Dubai World’s assets range from stakes in Las Vegas casino company MGM Mirage to London-traded bank Standard Chartered Plc and luxury retailer Barneys New York through asset-management firm Istithmar PJSC. The Dubai government’s attempt to reschedule debt triggered declines in stocks worldwide that had been rebounding from the worst financial crisis since the Great Depression.

Unlike Argentina, which stopped payments on $95 billion of debt eight years ago after yields on benchmark bonds more than doubled in four months to more than 40 percent, Dubai’s announcement yesterday “was a surprise,” said Alia Moubayed, a London-based economist at Barclays Plc.

Gold And The Watched Pot Theory

While some were spouting US government debt default theories or dollar devaluation theories others were looking for the “unwatched pot”.

Inquiring minds are taking another look at Gold And The Watched Pot Theory written October 07, 2009.

Message Of Gold

The reason for the strength in gold is not US inflation. As I have pointed out many times, gold fell from 850 to 250 over the course of 20 years, with inflation every step of the way. Thus, the inflation story just does not fit.

However, it should be clear that a major financial crisis is in store following a long period of competitive currency devaluation and massive debt and derivatives expansion by nearly every major country on the planet.

Might the US dollar blow up? Yes it might. But so could the RMB if China floated it, and so could the British pound. No one seems to see the crisis brewing in Japan with a huge demographic problem, a shrinking population, falling exports, and no way to pay back its national debt.

There is seldom a mention of the problems in European banks who foolishly lent money to the Baltic States in Euros or Swiss Francs and now those Baltic country currencies have collapsed and the loans cannot be paid back. European banks also lent to Latin America and those loans are also suspect. Arguably, European banks are in worse shape than US banks, but no one talks about it, at least in the US.

Spain has unemployment approaching 20% yet must suffer through the same interest rate policy as Germany. Seldom does one hear about this either.

Certainly the UK is a complete basket case with its banks on government life support. Iceland has already blown up, who is next?

Most are not aware of the problems in China, Japan, or Europe. However, the problems in the US are universally well understood. Indeed all eyes are on the dollar and everyone is talking about deficits, monetary printing, and especially unfunded liabilities even though the latter is tomorrow’s problem, not today’s.

Watched Pot Theory Revisited

A watched pot may boil, but it’s not likely to explode, especially when everyone watching the pot expects an explosion any second.

Indeed, it would be fitting if the Ridiculous Hype Over Secret Oil Meetings, helped form a bottom on the US dollar.

Yet, it’s easy to see that a financial crisis is brewing.

Somewhere, something is going to blow sky high, but from where I sit, it’s as likely to be in the Yen, the Swiss Franc, the British Pound, or something no one is watching at all as opposed to the US dollar specifically.

Hyperinflation?!

Amazingly some see this as hyperinflationary.

Nadeem Walayat writing for the Market Oracle says Deflationists Are WRONG, Prepare for the INFLATION Mega-Trend

Nov 18, 2009 – 12:58 AM

The jist of the deflationists argument is that debt deleveraging MUST trigger huge consumer and asset price deflation. Whilst we have all witnessed huge asset price deflation and some consumer price deflation during 2008 and into 2009. However we have also witnessed unprecedented government and central bank actions of this year, which have ignited asset price inflation with more to come that is now starting to feed into consumer price inflation.

Why do deflationists have it wrong ?

It is that focusing on the deleveraging of the the debt mountain is a red herring, taken on its own then yes it DOES imply deflation as the debt bubble ’should’ contract. But given the asset price reaction of 2009 that is NOT what is actually taking place! the Debt bubble is NOT deleveraging, the bad debts are being dumped onto the tax payers! The huge derivatives positions that act as the icebergs under the ocean as compared to the asset price tips that we see above water are not contracting but expanding!

The DEFLATIONISTS ARE DEAD WRONG !

The last 8 months have proven it to be so ! But STILL they cling on as though they have blinkered visions as a function of presumably not having to put their own money on their deflation calls. What will there position be in another 8 months – it will be to REINVENT HISTORY TO IMPLY THEY SAW IT COMING ALL ALONG!

What’s amazing is how hyperinflationists who have blown the call for 10 years running now accuse deflationists in advance of rewriting history.

Here’s the deal. Deflation happened, the only debate is how long it lasts. It is more than premature to proclaim the end of it on the basis of an 8 month period. Things do not progress in a straight line and a rebound after a 51% plunge in the S&P 500 and 10 year treasury yields close to 2% was expected.

That rebound is a much proof of the end of deflation as any of half a dozen 50-100% rebounds in the Nikkei over the last two decades, or the massive rebound in the DOW in 1931 before it plunged to new lows.

Many of those pointing to 8 month timelines as if that is what matters ignore an even bigger timeline in which stocks fell that 51%. If this rally is proof of inflation the the plunge must be proof of deflation.

The reality is neither is true. What is true is that in a credit based fiat economy, what matters is ability of the Fed and Central Banks in general to foster bank lending. And that is not happening.

Total Bank Credit

click on chart for sharper image

More Deflationary Writeoffs Coming

click on chart for sharper image

Allowances for loan losses will decrease as charge offs increase. However, the above charts are in relation to non-performing loans.

Because allowances for loan losses are a direct hit to earnings, and because allowances are at ridiculously low levels, bank earnings have been wildly over-stated.

The $trillions poured into the economy got a measly 2.8% rise in GDP.

Now what? Jobs are still contracting, businesses are not borrowing, banks are reducing credit card limits, etc, etc.

Those are not conditions of inflation, let alone hyperinflation. Now concerns are rising in Congress and the administration over the national debt. Meanwhile, more defaults loom: on housing, on commercial real estate, and on credit cards.

Two year treasury yields are at a record lows of .74 and five year treasuries are at 2.11.

If hyperinflation is coming, buy houses. Nowhere else can you get the leverage you can get in houses. It’s a sure thing. Meanwhile I suggest gold has been rising for another reason: credit stress and fears of deflationary economic collapse.

Dubai just stepped up to the plate out of the blue, defaulting on debt. Defaults are part of the deflationary process. Prepare for more of them because they are coming.

I see no reason to change my stance that the US is in for a long slug of hopping in and out of deflation for quite some time. Ironically it is the hyperinflationsts who are rewriting history. The hyperinflationists had it wrong, deflation happened first.

Deflation is here, the only debate is how long it lasts. Some of us saw it coming, the rest still scream about the massive inflation that is supposedly coming. They may be correct eventually, but when?

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post ListMike “Mish” Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Marc Faber Sees War Against an Invented Enemy and a Big Financial Bust

by Michael Shedlock

Inquiring minds are reading In his gloomiest prediction yet, Marc Faber sees big financial bust leading to war.

Marc Faber, the Swiss fund manager and Gloom Boom & Doom editor, said eventually there will be a big bust and then the whole credit expansion will come to an end. Before that happens, governments will continue printing money which in time will lead to a very high inflation rate, and the economy will not respond to continued stimulus.

Speaking at a conference in Singapore on Wednesday, Faber said: “The crisis has not solved anything. On the contrary there is less transparency today than there was before. The government’s balance sheet is expanding, and the abuses that have led to the one cause of the crisis have continued”.

“I think eventually there will be a big bust and then the whole credit expansion will come to an end,” Faber added.

“Before that happens, governments will continue printing money which in time will lead to a very high inflation rate, and the economy will not respond to stimulus”.

In one of his Gloomiest predictions, Faber, referred to as Dr Doom, said “the average family will be hurt by that, and then in order to distract the attention of the people, the governments will go to war”.

“People ask me against whom? Well, they will invent an enemy,” Faber said.

“At some stage, somewhere in future, we will have a war – that you have to be prepared for. And during war times, commodities go up strongly,” said Faber.

“If you want to hedge against war, you don’t want to own derivatives in UBS and AIG, but you have to own them physically, like farmland and agricultural commodities. That is something to consider for you as a personal safety and hedge. You have to own some commodities,” he added.

Discussion of Ideas From The Article

Faber: There will be another war and it will be against an imaginary enemy
Mish: I certainly agree the next war will be against an imaginary enemy. Nearly every war is against an imaginary enemy and/or of no vital interest of the US. WWI, Korea, Vietnam, and Gulf War II were all needless. WWII was a direct result of WWI. The “War on Terror” is preposterous. Terror is a method. Waging a war on a method against an enemy that has no real country is bound to fail and waste a lot of money in failure. As for where next, given Obama’s sabre rattling against Pakistan, that is one place to keep an eye on. Iran is another.

Faber: The S&P 500 and the Dow Jones will go down relative to gold.
Mish: I concur. The question is in what way. The key word in the above sentence is “relative”. Gold can easily stay flat, rise, or drop while the bottom falls out of the S&P.

Faber: Eventually there will be a big bust and then the whole credit expansion will come to an end. Before that happens, governments will continue printing money which in time will lead to a very high inflation rate, and the economy will not respond to stimulus.
Mish: The economy is not responding to stimulus right now, at least in any meaningful way. 100% of the GDP growth was directly related to government stimulus. The idea that government spending can start a genuine economic recovery is ridiculous. Nonetheless, government spending can start an artificial boom. The housing bubble is an example of an artificial boom. However, for a boom to start, individuals and businesses have to be willing to go along.

That is the way it works in a credit based economy. Right now personal credit is contracting, credit card lending is falling, and businesses simply do not want to expand in the face of tax increases and high unemployment. Unless and until the Fed reignites another credit boom, high inflation is unlikely. The fear now should be more of what Congress does than what the Fed does. Yet it seems Congress is getting a bit leery over these huge deficits. Congress will spend of course, but will it be enough to matter much? I doubt it, at least until we have more purging of consumer and corporate debt via bankruptcy.

Faber: US government will increase its stimulus spending should the Standard & Poor’s 500 Index fall toward 900.
Mish: Agreed but it will not help for reasons stated above.

Faber: The S&P will not drop below 800 or 900, and eventually will go higher in nominal terms, but not necessary in real terms. A correction is coming in the near term.
Mish: I doubt the bottom is in, but it could be. If it is in, then I expect a retest closer to 700 than 900. It is conceivable the S&P drops to 500, which by the way I think is fair value. Japan had two lost decades and I expect the US will have them as well.

Faber: The capitalistic system ‘as we know it today’ will collapse.
Mish: Agreed. The credit based fiat model of fractional reserve lending and fabrication of money out of thin air has reached its pinnacle. See Fiat World Mathematical Model for more details. Global wage arbitrage and outsourcing are icing on the cake. Mathematically it is impossible for the current Ponzi scheme of ever increasing levels of debt to survive. When and how it finally blows up is the only issue.

Faber: Central banks will continue to print money at full speed, but long-term this strategy will lead to a fall in purchasing power and living standards, especially in developed countries.
Mish: Agreed

Faber: The years 2006 and 2007 were “the peak of prosperity” and the world economy is not likely to return soon to that level.
Mish: Agreed. I had quite some time ago proposed Peak Credit and her twin sister Peak Earnings have arrived. Here is a snip from the former. … That final wave of consumer recklessness created the exact conditions required for its own destruction. The housing bubble orgy was the last hurrah. It is not coming back and there will be no bigger bubble to replace it. Consumers and banks have both been burnt, and attitudes have changed.

Faber: The best way to deal with any economic problem is to let the market work it through.
Mish: Agreed

Faber: The way communism collapsed, capitalism will collapse.
Mish: I disagree on a technicality. Capitalism will not collapse, because we are not practicing capitalism. Instead, we are practicing a perverse blend of corporate fascism, socialism, corruption, and padding of the pockets for and by those running the country. Yes, that will collapse.

Faber: “No decent citizen should trust the Federal Reserve for one second. It’s very important that everyone own some gold because the government will make the dollar (in the long term) useless.”
Mish: No decent citizen should trust any central bank anywhere. The problems go far beyond the Fed and in the long run all fiat currencies are worthless. Fiat currencies do not float, instead they all sink at varying rates.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post ListMike “Mish” Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific

Macro

Abraham’s Alternative Asset Class

“…with anybody that stands right, stand with him while he is right and part with him when he goes wrong” – Abraham Lincoln.

In his Latest Piece, Bill Gross writes about his horror when, after looking at his bank statement, he realized that he was only getting one basis point (0.01%) interest on his bank account. For those of us not living in Australia, it’s a familiar feeling. Not only that, as account holders at Northern Rock will tell you: just because your money is in a bank does not mean that it is safe. In fact, once you probabilistically account for the risk of losing everything, the fees and hidden charges its quite conceivable that as honest, law abiding citizens you’re actually paying to lend (that’s right lend) money to the banks! What sort of deal is that? We’d all be better off withdrawing all our money and putting it in a safe deposit box in Zurich. Seriously, though, we would. As Gross points out, the pain of 0.01% simply becomes too much to bear “anything but this 0.01%”!

OK, so where does that leave you, the individual investor, the small saver who is paying the price of the .01%? Damned if you do, damned if you don’t. Do you buy the investment grade bond market with its average yield of 3.75% (less than 3% after upfront fees and annual expenses at most run-of-the-mill bond funds)? Do you buy high yield bonds at 8% and assume the risk of default bullets whizzing at you? Or 2% yielding stocks that have already appreciated 65% from the recent bottom, which according to some estimates are now well above their long-term PE average on a cyclically adjusted basis? Two suggestions. First, as emphasized in prior Investment Outlooks, the New Normal is likely to be a significantly lower-returning world. Diminished growth, deleveraging, and increased government involvement will temper profits and their eventual distribution to investors in the form of dividends and interest. As banks, auto companies and other corporate models become more regulated and therefore more like utilities and less like Boardwalk and Park Place, they will return less.

It’s actually a difficult conundrum to solve when the World is so awash with liquidity. Old Abraham’s challenge is yet more convoluted because in the distorted reward system that is the banking and thus investment universe, it is getting harder and harder to decipher which investment avenues are “right” and which are “wrong”.

There is also a not-so-subtle point about cash-hoarding, which I’ve made numerous times before: a central bank hell-bent on extreme monetary policy to stoke inflation will destroy your savings – if not purely for the reason that they have stated (as explicitly as a central banker can) that they will keep the stance extremely accommodative until the lagging indicator of rising employment is baked-in-the-cake. That means the money you lend to the bank at risk could yield much less that 0.01%. How long could you bear this risk at a MINUS 5% real yield on your money? Heck you might as well load up on equities at the top – at least they pay a dividend! Which pretty much explains the movement of the equity markets thus far.

At a fundamental level, this is quite sickening. In running extremely accomodative, inflationary regimes, policy makers are rewarding failure of individuals and institutions alike for taking too much risk and incurring too much debt at the sacrifice of the diligent, responsible savers. Why are they doing this? In part due to their own failure to provide adequate oversight of inflation and risk in the banking sector. Consequently, the size of the irresponsible contingent became so dangerously large (and politically powerful) it put everybody at risk. Banking profits are indeed being privatized while risks are socialized across the tax-paying public and this is being marketed as a burden we all have to bear “for the greater good”. The judiciousness naturally inherent in a capitalistic model has been (temporarily, we are told) thrown out of the window, the book on creative destruction has been torn up. But this is not the only time intervention from the meddling classes have contaminated the soil of the financial ecology we used to call free-market capitalism, and it will certainly not be the last.

Interestingly, Gross does mention that there are good reasons to expect asset price volatility in the Global market place – in particular, from the Renminbi-Pegged Elephant-in-the-room - not to mention uncertain inflation expectations, ballooning deficits, exploding debt-to-GDP ratios, sky rocketing Fed Balance Sheet etc etc (don’t get me started). This will also add frictional cost, as well as frightening risk, to the leap of faith required to invest hard earned savings in the more conventional, most accessible and liquid assets. Gross (uncharacteristically) recommends investors put their money in utility stocks. In my opinion, that’s effectively a concession that there is absolutely nothing in the bond markets for the small investor.

Perhaps he is right, but there are other asset classes which are becoming more and more accessible to smaller investors and which seek to benefit from both the economic and technical predicament. I am talking about “Alternative Investments” or Hedge Funds – and no, I have not gone bonkers.

Much berated, hedge funds have paid their price for lax risk management and inefficiency. Some so-called “hedge” funds were not even hedging, they were just “long and wrong” and leveraged to boot. Some, like Madoff, were not even funds – they were simply crooks. Some hedge funds simply did not have the talent or the “alpha” they claimed to have and were just bandwagon merchants happy to ride the Greenspan-engined gravy train of liquidity and lax financial regulation. Some were simply unlucky – in the wrong place at the wrong time. Those funds are now gone.

Despite my natural penchant for cynicism and accountability, I cannot agree with ignorant media monkeys who, without much comprehension for the concept of arbitrage or hedging strategies, seem to lay the blame for the crisis at the feet of the Alternative Investment Industry or the “shadow banking system”. That includes the wise men at PIMCO. Granted, the Hedge Fund Bubble was an ugly symptom of the problem, but the original, true, honourable Hedge Fund Model of absolute return and capital preservation was certainly not a cause of the irrational exuberance which lead to the crisis. On the contrary, looking back, in time I think we’ll understand that it was a desperate attempt by investors to avoid it.

Indeed, despite leverage ratios at only a fraction of the banks (like, less than one tenth), many of the good hedge funds which survived are just shadows of their former selves. Unlike the banks, as withered funds struggle to reach their “high water marks” (they have to recoup losses to investors before paying themselves) on a depleted asset base, there will be few hedge fund managers paying the big bonuses of yester-year. In fact, given the streets are literally littered with out-of-work hedge fund portfolio managers, most just count themselves lucky to still have a job. There was no blatant reward for failure in the hedge fund industry, and rightly so.

There is comfort to be taken from the fact that at least one facet of the banking industry is not being directly rewarded for direct failure – the Darwinian forces of capitalism are still working in parts of the system. How many Hedge Fund Bailout Plans did you hear of? How many hedge funds had bad investements directly supported with tax-payers money? I can’t remember many. In fact hedge funds were made directly accountable to their investments by their investors – many of whom were the portfolio managers themselves.

The Alternative Investment got knocked off its feet, “took an 8-count” (as we say in boxing) and is slowly dusting itself down and rising to its feet again. Lessons have been learnt, egos have been humbled, relationships have been tested. Consequently, the survivors are the strong, diligent, committed players with genuinely applicable talent and innovation within the industry. Investors are rightly demanding more transparency, more liquidity and less fees. Gone are the days when any half-successful 25 year old investment banking trader can woo a couple of seed investors and run off with $100 million to start up a hedge fund with an automatic “2-and-20” (2% management fee and 20% performance fee). Expect a tiering of fee structure with only those who can justify 2-and-20 keeping that privilege.

So if you have enough cash and you, like Gross, are feeling the pain of 0.01% (potentially, soon to be  minus 5%) return on your cash, then perhaps you should consider looking at the real alternative: Alternative Investments. In particular seek out investments that stand to benefit from the economic predicament and rising volatility – like certain macro hedge funds and volatility strategies. In my opinion, volatility rates are as much an asset class now as fx rates. There is only one thing which is sure to rise over the next few years and remain elevated for a long time and it’s not Gold – it is volatility. The more uncertainty over inflation/deflation, the more leverage in the economy (via rising deficits), the more political uncertainty (regarding China’s exit strategy for the Renminbi and the US “strong Dollar policies”) the more potential for volatility – not just in equity prices, but in fx rates, interest rates, credit spreads, commodity prices. It’s all out there whether we have inflation or disinflation. To make things easy for you, the VIX is at an all time low.

Lastly, just want to show an article which is kinda related to the above comments: Taiwanese Investors do not Understand the Risks of Bond Funds. There really are few alternatives to the Alternative Investment space.

Macro Data to Watch:

• Rumors that GDP will be revised down to +2.5% from the +3.5% preliminarily reported figure. Ouch! As Rosenberg says “is that all we get for our money!?”
• German GDP (expected +0.7%)
• South African GDP – expected to be positive (+0.5%)

Markets

Stocks and commodities rallied as the Dollar got hit again.

Gold, Silver and Platinum both hit new highs yesterday. Gold touched $1174 per oz. Roubini is starting to look a little humiliated I think – once we break through $1200 he’ll have to concede that Rogers may be right.

Meredith Whitney on the state of the banks says that she has never seen this level of credit contraction. For all this talk of inflation, that pretty much puts her in Rosenberg’s deflation camp. The jury is indeed still out. Clearly Meredith thinks that the banking sector is one to watch over the next 6 months – from a volatility perspective, I do too for that matter.

Global Stocks to Watch:

• Earnings:
  • Heinz
  • Medtronic

By Ron Paul,

I was pleased last week when we won a vote in the Financial Services Committee to include language from the Audit the Fed bill HR1207 in the upcoming financial regulatory reform bill.  As it stands now, if HR 3996 passes, because of this action, the Federal Reserve’s entire balance sheet will be opened up to a GAO audit.  We will at last have a chance to find out what happened to the trillions of dollars the Fed has been giving out.

Finally, the blanket restrictions on GAO audits of the Fed that have existed since 1978 will be removed.  All items on the Fed’s balance sheet will be auditable, including all credit facilities, all securities purchase programs, and all agreements with foreign central banks.  To calm fears that we might be trying to substitute congressional action for Fed mischief in tinkering with monetary policy, we agreed to a 180 day lag time before details of the Fed’s market actions are released and included language to state explicitly that nothing in the amendment should be construed as interference in or dictation of monetary policy by Congress or the GAO.  This left no reasonable objections standing and the amendment passed with a vote of 43 to 26.

This was a major triumph for transparency and accountability in government.  With unprecedented turmoil in the financial markets, the people are demanding to know and understand the extent of the Federal Reserve’s involvement in the creation of out-of-control business cycles, who they are helping, and how.  We need information.  The excuses for not giving out this information are flimsy at best, and the passage of this amendment is a major step to finally getting at the truth.

Of course I could not have done this without the help and support of many other members who have been strong allies in this fight.  Having over 300 cosponsors was obviously helpful.

However, as great as this victory is, we have to remember that this amendment is attached to a bill that would give sweeping new powers to the Federal Reserve. The Fed has taken its mandate to maintain stable prices and full employment and used its immense power to help elite friends at the great expense of everyone else.  The answer is not to increase their powers and ability to interfere in the economy, but that is what the legislation will do.  It is a disaster waiting to happen, and unfortunately it looks as if it will pass.

At least with the Audit the Fed amendment attached to the bill, the Fed will not be able to do its destructive work in secret. The people will know exactly who the beneficiaries are of this immoral system of money management.

Audit the Fed Attached as an Amendment originally appeard in Ron Paul’s Texas Straight Talk on 23/11/2009.

It’s the elephant in the room again.

As we start another fresh Monday morning, looking forward to a shortened work week and a wonderful holiday coming up, everyone from CNBC to XYZ is talking about how great the stock market is doing.  People are blabbering on about ‘animal spirits’ (click here to find out what that really means) or even a ‘recovery’ to explain what’s happening.

Bunk.  I’m here to talk turkey, I mean, elephant with you guys.  That elephant that everyone is ignoring A-GAIN:  the big fat ugly smelly old Federal Reserve.

The Federal Reserve controls our nation’s interest rates.  (For all you beginners, that means the free market doesn’t control it.)  I read a comment somewhere recently where someone was complaining about the .09% interest rate her bank was giving in her checking account.  I haven’t checked my bank rates lately–it’s too depressing and is there really any point?–but I’ll bet dollars to donuts it is something similar.  Something WAY below the rate of inflation, anyway.  (Heck, they were even toying with the idea of a negative interest rate for awhile!  Punishing people for saving–now that’s irrational!)  Everyone knows you are loosing money if you keep it in the bank (or cash).  Yes, you’ve got to keep some there, but people are not stupid (or animal/irrational)–they put their money where it at least has a fighting chance or retaining it’s value:  in the stock market.

So there you have it: abysmal interest rates are compelling people to put their extra money into the stock market.  It’s a new bubble, courtesy of the Federal Reserve—AGAIN!!!  It’s history repeating itself.  When are we going to stop feeding the ravenous elephant in the room, stop ignoring its smelly mess and kick it’s greedy butt out of the room?

I Retract My Apology and Call for More Regulation of Goldman Sachs (pdf)

Courtesy of Janet Tavakoli at TSF

(see also Apology)

According to SIGTARP¹, both the Federal Reserve and Treasury agreed that an AIG failure posed unacceptable risk to the global financial system and the U.S. economy.  On March 24, 2009, Fed Chairman Ben Bernanke testified before the House Financial Services Committee [P.9]:

[C]onceivably, its failure could have resulted in a 1930’s-style global financial and economic meltdown, with catastrophic implication[s].

From July 2007, AIG’s financial situation deteriorated while so-called “AAA” collateralized debt obligations (CDOs) dropped in value. AIG sold credit default swaps (CDSs) on these CDOs and had to post more collateral, as the prices plummeted.

Goldman Sachs was AIGFP’s (UK-based AIG Financial Products) largest CDS counterparty with around $22.¹ billion, or about one-third of the problematic trades.  Goldman underwrote some of the CDOs underlying its own CDSs, and also underwrote a large portion of the CDOs against which French banks SocGen, Calyon, Bank of Montreal, and Wachovia bought CDS protection.  Goldman provided pricing on these CDOs to SocGen and Calyon. Goldman was a key contributor to AIG’s liquidity strain and the resulting systemic risk.  (See “Goldman’s Undisclosed Role in AIG’s Distress”)

Apocalypse AIG

By mid September 2008, AIG’s long-term credit rating was downgraded, its stock price plummeted, and AIG couldn’t meet its borrowing needs in the short-term credit markets.  According to SIGTARP, “without outside intervention, the company faced bankruptcy, as it simply did not have the cash that was required to provide to AIGFP’s counterparties as collateral.” [P.9] The Federal Reserve Board with Treasury’s encouragement authorized a bailout. ²

The Federal Reserve Bank of New York (FRBNY) extended an $85 billion revolving credit facility, so AIG could make its collateral payments to Goldman and some of its CDO buyers.  AIG also met other obligations, such as payments under its securities lending programs owed to Goldman and some of its CDO buyers.  (See also: “AIG Discloses Counterparties to CDS, GIA, and Securities Lending Transactions.”)

Goldman “Would Have Realized a Loss”

Fed Chairman Bernanke said AIG’s crisis put the world at risk for a global financial meltdown.  Goldman purchased little credit default protection³ against an AIG collapse.  Even if Goldman escaped a collateral clawback of the billions it held from AIG4, the underlying CDOs posed substantial market value risk (SIGTARP P. 17).  As for systemic risk, Goldman CEO Lloyd Blankfein worried about untold billions in losses. (Too Big to Fail, P. 382.)

On September 16, 2008, as the FRBNY arranged AIG’s $85 billion credit line, Goldman CFO David Viniar said whatever the outcome, he would expect the direct impact of credit exposure to be “immaterial to [Goldman’s] results.” The CDOs’ ($22.1 billion) value was down around $10 billion, and AIG still owed Goldman $2.5 billion in collateral (hedged and partly collateralized by CDSs on AIG).  SIGTARP shows the CDOs’ value fell another $2.5 billion in two months, and AIG’s new credit line provided more collateral.  The CDOs were losing market value.  If AIG had collapsed, the value drop would have been swift and brutal with new protection either unavailable or too expensive, if past CDS market mayhem provided any information.  As the Wall Street Journal put it, SIGTARP “throws cold water on [Goldman’s] claim.”

Before September 16, 2008, AIG tried to negotiate a settlement for forty cents on the dollar.  Other insurers have negotiated even deeper discounts to settle their CDS contracts on CDOs.   The SIGTARP report shows that the FRBNY’s decision to pay 100 cents on the dollar to resolve $13.9 billion (part of Goldman’s $22.1 billion) of credit default swaps by purchasing the underlying CDOs in Maiden Lane III was important to Goldman Sachs.  “Goldman Sachs…did not agree to concessions, because it would have realized a loss if it had.”  [P.16]

Treasury Secretary Timothy Geithner, then President of FRBNY, is revealed in this New York Times article with apparent Stockholm syndrome rivaled only by Patty Hearst.   He seems to echo Goldman’s talking points after discussions with Goldman’s CFO.  In the fall of 2008, Henry (“Hank”) Paulson was Treasury Secretary.  Paulson was formerly CEO of Goldman Sachs and held that role when Goldman executed its trades with AIG.  Stephen Friedman, a former Goldman Sachs co-chairman, was Chairman of FRBNY.  Friedman owned shares of Goldman Sachs, and was a member of Goldman’s board, while he held his influential Fed position.  He resigned the Fed position in May 2009, but not before purchasing 50,000 shares of Goldman Sachs, when the public was still in the dark about the terms of the bailout.

Goldman’s Turn to Apologize

In light of the SIGTARP report, I withdraw my earlier apology to Goldman.  Public commitments to AIG are currently around $182 billion.  If you wonder what Goldman CEO Lloyd Blankfein meant when he said: “[Goldman Sachs] participated in things that were clearly wrong and we have reason to regret and we apologize for them,” think of Goldman’s role in AIG’s crisis, Goldman’s bailout, and Goldman’s ongoing heavy taxpayer subsidies.  That way, one of you will be genuinely sorry about it.

◊◊

1  The November 17, 2009 report of the Office of the Special Inspector General for the Troubled Asset Relief Programs, “Factors Affecting Efforts to Limit Payments to AIG Counterparties.”  The report does not address the risk of collateral clawbacks by authorities on behalf of AIG or the public, and it does not address the relative size of Goldman’s CDS positions and CDO underwriting activity related to AIG’s CDSs mentioned in the above commentary.

2  Fed and Treasury officials thought AIG’s derivatives were “more risky and unbalanced than Lehman’s.”  They were concerned about loss of confidence in AIG’s subsidiaries, AIG’s failure to perform on annuities and wraps, losses to state and local governments, global banks and investment banks, losses to 401k plans, and the credit markets.  The Reserve Primary Fund had fallen below $1.00 per share after it wrote off Lehman’s debt causing a run on the fund, and officials worried about an AIG failure causing further “breaking-of-the-buck.” (P. 10)

3 SIGTARP says Goldman would have trouble collecting on the credit default protection it bought to protect against an AIG collapse—which by deduction seems to only be around $2.5 billion.  It is usual to have mark-to-market collateral, but it is unlikely this position was 100% collateralized.  In November 2008, it seems $1.2 billion of this hedge was allocated for Maiden Lane III assets and $1.1 billion to another $8.2 billion position leaving an apparent slight excess notional amount.  But even if it were 100% collateralized, that seeming advantage could quickly disappear in a volatile market when pricing discounted illiquid assets that lack transparency.  [P. 16, 17]

4 According to SIGTARP, private participants felt AIG’s financial condition was so tenuous that on September 15, they refused to fund AIG making the Fed’s bailout necessary.  Their analysis showed AIG’s liquidity needs exceeded the value of the company’s assets.  [P.8]

Goldman’s status in the event of an AIG collapse would have been that of a credit default swap counterparty during a global crisis with very special circumstances.  Goldman thought it would get to keep the billions in dollars it received from AIG, if AIG collapsed.  That would normally be the case, but these would have been extraordinary circumstances inflamed by value-destroying CDOs over which Goldman had pricing power, and Goldman had underwritten some of the CDOs.  Authorities charged with resolving a collapse of AIG may have clawed back a substantial portion of the collateral.

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based consulting  firm to financial institutions and institutional investors.  She is the author of a book on the cause global financial meltdown: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009), Structured Finance & Collateralized Debt Obligations (Wiley 2003, 2008), and Credit Derivatives & Synthetic Structures (Wiley 1999 and 2001).

Janet Tavakoli

President

Tavakoli Structured Finance, Inc.

web site: www.tavakolistructuredfinance.com

*****

So. Central Rain (I’m Sorry): REM

Why the Stock Market Should Crash by Charles Hugh Smith at seekingalpha.com

The current politics of experience is so warped by misleading statistics and orchestrated propaganda that it feels strange to state the obvious and find it is “that which cannot be spoken” — the credit-dependent, consumer-dependent U.S. economy is going down, and going down hard, and the trillions of dollars borrowed and spent by the U.S. government and Federal Reserve to crank up a recovery have failed completely, utterly and totally.

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Go read it. Every word.  I don’t mean to scare you, but it’s important to be realistic and know which ignorant TV pundits to tune out.  This article is very data driven.  Screaming numbers.  Listen to them.

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