The Resurgence of Risk – A Primer on the Developing Credit Crunch
Posted by Stoneleigh on August 14, 2007 - 10:15am in The Oil Drum: Canada
We have been living in inflationary times, for as long as most of us can remember. The money supply keeps expanding and prices increase over time as a result. Central bankers have many tools at their disposal which they can use to tweak the economy – they can raise or lower interest rates, can control reserve requirements for fractional reserve banking and can inject liquidity into the banking system, among other things – and we have become used to thinking that they can prevent the kind of 'economic accidents' that previous episodes of excess have led to in the past. Especially in recent years – since the apparently successful containment of the dot com aftermath - we have acted as if risk were a thing of the past. Sliced, diced and spread around Wall Street and the rest of the global financial system, risk has seemed tamed, contained and controlled, until last week that is.
For years, industry insiders and so-called experts have proclaimed the virtues of slicing, dicing, and repackaging risk. They waxed on about how borrowers and savers, and society as a whole, could only benefit from such machinations. They suggested any sort of exposure could be disbursed and dissipated to the point where it essentially disappeared. Some even claimed that the crises of the past would no longer exist.
Yet amid the hype and assurances, few supporters spoke of the dark side of wanton and widespread risk-shifting. They didn’t seem — or want — to acknowledge that by combining complicated risks in unfamiliar and unnatural ways, the end result could be an uncontrollable monstrosity—one that eventually turned on its masters.
Nor did they heed the notion that by scattering risk into every nook and cranny of the global financial system, the vast web of overlapping linkages virtually guaranteed that serious problems in one sector, market, or country would trigger far-reaching shockwaves.
All of a sudden, markets are reeling around the world, deals are unraveling, the mainstream press is talking about a credit crunch and the world’s central bankers are injecting unprecedented amounts of liquidity to calm the markets. Risk has made a comeback, and in that environment the evident concern of the central bankers does not seem very reassuring.
The Dot Com Crash and Money Dropped From Helicopters
As the dot com boom morphed into the dot com bust (threatening to become a full-blown meltdown by the end of 2002) central bankers cut interest rates drastically and held them down for a long period of time.
In 2001, the US Federal Reserve Bank, the spigot of credit in America’s debt-based economy, drastically slashed its interest rates 84 %, from 6.5 % in 2001 down to 1 % in 2002. The Fed did so because the collapse of the dot.com bubble in 2000 had so damaged US financial markets (the NASDAQ fell by 80 %) the Fed feared a depression could result.
As Ben Bernanke was preparing to take over from Alan Greenspan at the Federal Reserve, he promised to drop money from helicopters if necessary to prevent deflation. Having spent his academic career studying the causes of the Great Depression, Bernanke understood the danger of deflation and was determined to avoid the liquidity trap by maintaining the demand for credit. As good as his word, Bernanke, and Greenspan before him, oversaw a doubling of the money supply since 2000. Adjusted for changes in the money supply (inflation), real interest rates (the nominal rate minus inflation) were negative for several years. Instead of dropping money from helicopters, Bernanke dropped free debt.
The key in all of this is not inflation, as most believe. The Fed says they are most worried about inflation risks, but the reality is that they are most worried about deflation risks. Always. Always deflation. The Fed has no choice but to always remind us that the risks are tilted toward inflation, just as the Treasury Secretary, whichever one happens to be in office at the time, must always say that the U.S. maintains a strong dollar policy, even if monetary policy and fiscal policy are conspiring to devalue the dollar.
Fractional Reserve Banking and the Expansion of the Money Supply
Fractional reserve banking allows banks to lend into existence money they do not have (on the assumption that their depositors will not all want their money back at once), provided that they keep a certain percentage of their deposit base with the Federal Reserve to cover withdrawls. Ten percent would once have been a typical figure, but since the 1990s, the Fed has deliberately shepherded reserve requirements down, essentially to zero, through dropping required reserve percentages, reducing the categories of funds needing a reserve and allowing funds to be swept from a reservable category to a non-reservable category overnight (using sweep accounts). As reserve requirements have fallen, banks have been able to expand the money supply far more rapidly than would previously have been the case, at the cost of removing the cushion they previously held as insurance against financial accidents. As with everything else, the resilience has been stripped from the system in the name of efficiency, in this case in the use of capital to generate maximum returns.
The Housing Bubble and the Debt Mountain
The combination of drastically reduced reserve requirements and negative real interest rates predictably led to a borrowing binge of epic proportions, increasing what was already a dangerous level of indebtedness. Many of those whose fingers had recently been burned in the stock market turned to real estate, and, by extension, all of the supporting industries surrounding it. People moved to larger properties, bought investment properties, renovated, upgraded and re-equipped. The surge in demand, and depreciation of the currency through rapid expansion of the money supply, led to a huge increase in property prices. This enabled owners to use their appreciating properties as ATMs, at first using the windfall for luxuries, but increasingly relying on it to fund basic living expenses through refinancing. This created both a debt mountain and a structural vulnerability to a fall in property prices.
Banks offered credit to those further and further down the credit-worthiness scale, with scant regard to the ability of those borrowers to repay their loans. Instead of holding debt on their own books as they would once have done, banks now make their money from fees and sell the loans on to investors as mortgage-backed securities. As they no longer bear the risk of default, they are unconcerned about it. They often asked for little or no information from prospective borrowers – often no proof of income, employment or even identity - leading to the label of ‘liar’s loans’.
With rates so low, borrowers were far more concerned with the level of monthly payments than with the balance outstanding. Exploiting this blinkeredness, banks offered a range of loans called neg am ARMs – adjustable rate mortgages with negative amortization. Borrowers were offered low ‘teaser’ rates for the first few years, paying less than the interest owed on their loan during that time, while the unpaid interest was added to the principle in the meantime. Often they signed the loan documents without understanding the concept of teaser rates. At the end of the teaser period, the full monthly interest payment would be due on the now larger principle at the new prevailing interest rate. As interest rates have increased recently, monthly payments on resetting ARMs are often set to more than double. In October of this year, $50 billion dollars worth of ARMs will reset, with a further $30 billion a month doing the same for over another year.
Marginal borrowers, who were often already only barely affording their existing payments, are highly unlikely to be able to afford the new ones. Their only recourse would be to sell, but falling prices have made this difficult. Some are already in negative equity – owing more on their home than its current market value. Foreclosure lies ahead for many, but mass foreclosure sales will depress property prices, exacerbating the debt problem for a wider range of borrowers. Even many quite high-income families have been enticed into a lifestyle their income could not support, and could find that falling property prices push them over the edge. As sales will be very challenging, and bankruptcy laws have been tightened, many people could be tethered to unpayable debts for a prolonged period.
Financial Engineering – Hedge Funds, Derivatives, Leverage and the Repackaging of Risk
[In December 2006], another bit of news reached us: the derivatives market , in which hedge funds tend to speculate, has reached a face value of $480 trillion…30 times the size of the U.S. economy…and 12 times the size of the entire world economy. Trading in derivatives has become not merely a huge boom or even a large bubble - but the mother of a whole tribe of bubbles…dripping little big bubbles throughout the entire financial sector.
The ability to expand the money supply almost infinitely has been seized on by financial engineers interested in finding new and tempting ways to dress up leverage - seemingly eliminating risk while actually making it endemic through the financial system. The resulting derivatives have been called ‘financial weapons of mass destruction’ by Warren Buffet.
In order to sell mortgage-backed securities to investors, banks packaged them into different risk tranches of Collateralized Debt Obligations (CDOs) – investment, mezzanine and equity - concentrating the lowest risk elements in funds able to earn an investment grade rating. In order to sell the higher risk tranches, banks commonly set up hedge funds with enough seed capital to sell the securities to themselves. As housing prices rose, the securities appeared less risky, and so were able to attract outside investment and to be leveraged by being used as collateral for further loans. High performing funds, during the era of rising house prices, were tremendous engines of credit expansion.
Alternatively, equity and mezzanine tranches were often sold to large institutional investors, such as pension funds, willing to unwittingly accept illiquid securities with fictional marked-to-model valuations ultimately based on the ‘documentation’ provided with liar’s loans. These investors were chasing yield without realizing that they were chasing risk. The practice was colourfully referred to by insiders as ‘landfilling toxic waste’.
Rather than selling the risky securities, banks could also keep them, and the cash flows they generate, but insure them against default through a Credit Default Swap (CDS) – swapping the risk of default for a cash payment. The underwriting institution can then aggregate the CDS income stream into pools, themselves divided into tranches with different risk profiles. These synthetic CDOs are based, not on cash flows derived from borrowing money, but on cash flows derived from insurance premiums paid to cover the risk of mortgage default. Institutions can even insure against the risk of default on securities they do not own – creating synthetic CDOs and effectively shorting subprime mortgages or risky corporate bonds while once again hugely expanding supply of leveraged credit. Any default could therefore result in claims to underwriters many times as large as the supposed value of the underlying securities.
The danger is that underwriting institutions willing to accept huge amounts of risk in exchange for apparently being paid to do nothing, may not actually have the ability to pay out on default. The original institutions did not seem to ask too many questions of those to whom they had readily assigned the risk of default, but risk does not go away merely because one institution has paid a fee to another. The risk guarantee is only as good as the credit worthiness of the guarantor, and one commentator has described many credit default swaps as being guaranteed by Madame Merriweather’s Mud Hut in Malaysia.
International banking rules say that banks have to hold a certain level of spare funds (or reserves) to protect themselves from the danger that their loans might turn bad. However, since the banks had sold the risk of default on to somebody else, they could now argue that they did not need to hold these funds.
To anybody outside the world of finance, this might look odd (after all, the banks were still making loans); but the regulators accepted this argument, since the risk had moved, in accounting terms. And that let the banks free up funds to make even more loans. It was the financial equivalent of calorie-free chocolate: almost too good to be true.
Conflict of Interest - The Role of the Ratings Agencies
The ratings agencies that grade securities for investment purposes, and also depend on doing business with the same institutions whose bonds they rate, gave high ratings to mortgage-backed securities and did not lower them even as the housing bubble began to deflate. As the securities were not actively traded in a liquid market, the nominal marked-to-model valuations remained constant, and so did the ratings until recently. The danger is that lowering ratings below investment grade would force many institutions to sell them, potentially forcing those ‘assets’ to be marked-to-market where real bids, or the lack of them, would result in real market valuations. That would revalue a whole asset class at a stroke – revealing that the Emperor had no clothes.
It was a responsibility that ratings agencies were unwilling to take until forced by Bear Stearns’ declaration that two of its hedge funds were essentially worthless. A small percentage of mortgage-backed securities funds have since been down-rated and more have been placed on watch, but as yet there has been no real price discovery. Many investors are currently locked into hedge funds, delaying asset sales, but financial institutions can only maintain their solidarity for so long before they will have to act to extract what value they can from their collateral, even if that amounts to only pennies on the dollar. Ratings are likely to be downgraded only when they absolutely have to be. Ratings agencies have made it clear that rating securities does not mean that they do due diligence.
Moody's: "Moody's has no obligation to perform, and does not perform, due diligence."
S&P: “Any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision.”
What then is the purpose of a ratings agency?
Private Equity and Leveraged Buyouts
As the housing market was beginning to decline in late 2006, the market for private equity deals, or leveraged buyouts, was taking up the slack and feeding the credit expansion boom. Private equity was able to use a small amount to borrow huge sums of credit in order to take large companies private, with the underwriting banks able to sell the resulting securities to investors. The target companies were then often asset stripped, loaded up with debt and sold back to the public in a private equity ‘strip and flip’. In this way, private equity was able to play off the public markets, extracting real value through the use of cheap credit loaned into existence for the purpose.
Many of these huge deals are now threatened, as investors are no longer willing to purchase the securities generated, leaving the underwriting banks holding the risk. Bridging loans are becoming ‘pier loans’ as they no longer lead anywhere.
The Inverted Pyramid - Money versus Credit (or Hyperinflation versus Hyperexpansion)
Money and credit are not the same thing, although people currently use them interchangeably. Money is a physical commodity, while credit is virtual wealth borrowed into existence. Money can be subject to inflation, either by printing currency or by debasing specie (reducing the precious metal content of coins), but does not disappear. Credit, on the other hand, can expand dramatically through financial alchemy, but has no physical existence, although its effects are certainly tangible.
Because credit is used as a money substitute in the financial markets, it acts as an inflationary force in the asset markets (and this spills over into the real world as the imaginary wealth thus created leads to overconsumption and malinvestments), but it is all ephemeral - in the end, it is still credit, not money. As soon as money is needed in lieu of credit, such as has now happened in the CMO and CDO markets, it becomes clear that the money simply isn't there."
Weimar Germany or present day Zimbabwe are examples of hyperinflation, but the Roaring Twenties and our situation are instead examples of credit hyperexpansion. Inflation is a chronic scourge, but credit expansions are self-limiting – they proceed until the debt that creates them can no longer be serviced, at which point that debt implodes in a sea of margin calls.
There is actually very little real cash out there relative to credit. The "sudden demand for cash" is in fact the world's biggest margin call to date.
The value of credit is only as good as the promise that stands behind it, and when that promise cannot be kept, value abruptly disappears.
Let's suppose that a lender starts with a million dollars and the borrower starts with zero. Upon extending the loan, the borrower possesses the million dollars, yet the lender feels that he still owns the million dollars that he lent out. If anyone asks the lender what he is worth, he says, "a million dollars," and shows the note to prove it. Because of this conviction, there is, in the minds of the debtor and the creditor combined, two million dollars worth of value where before there was only one. When the lender calls in the debt and the borrower pays it, he gets back his million dollars. If the borrower can't pay it, the value of the note goes to zero. Either way, the extra value disappears. If the original lender sold his note for cash, then someone else down the line loses. In an actively traded bond market, the result of a sudden default is like a game of "hot potato": whoever holds it last loses. When the volume of credit is large, investors can perceive vast sums of money and value where in fact there are only repayment contracts, which are financial assets dependent upon consensus valuation and the ability of debtors to pay. IOUs can be issued indefinitely, but they have value only as long as their debtors can live up to them and only to the extent that people believe that they will.
Essentially, the gargantuan edifice of leveraged debt that has been accumulated during the years of credit expansion can be described as an inverted pyramid. Its point rests squarely on those at the bottom – for instance the subprime mortgage holders who’s relatively modest debts have been leveraged into trillions of dollars worth of derivatives. Each dollar of subprime mortgage debt probably underpins at least a hundred dollars of additional debt, and these loans will go into default en masse once the ARMs begin to reset in earnest. The leverage that has magnified gains on the way up, will magnify losses in a debt implosion on the way down.
Until now, his debt was an asset of the fund, and was being used as collateral against loans ten times its value. But the moment that Mr. Jones gave up on the idea of home ownership, the value of his mortgage simply disappeared. The paper asset, which derived its value from Mr. Jones’s promise, was destroyed. This had a cascading effect, since Mr. Jones’s mortgage was being used as collateral to borrow money to buy even more subprime mortgages, many of which were also defaulting. Assets purchased on borrowed money were now worthless. Only the debts remained, and suddenly there was more debt than the original amount that investors had put into the fund. These original funds would be needed repay the debts incurred by the fund. Nothing is left to return to investors.
Liquidity Traps and the Mood of the Market
Central bankers act as midwives for credit expansion – manipulating the cost of credit in order to encourage borrowing and lending. However, this cannot continue indefinitely as it does not occur in a vacuum. Central bankers have a range of options open to them, but ultimately the financial circumstances, and the mindsets, of both borrowers and lenders are important to whether or not credit expansion can be maintained.
The Fed really only can do two things. They can lower margin requirements for banks, the amount of capital they have to hold to make loans. That it has already driven to basically zero. So the Fed cannot allow banks any more “leeway” than it already has.
They can also perform open market money operations like REPOS and coupon passes. The Fed calls up big banks and buys their government bonds out of their portfolio. But they don’t buy them with real money; they buy them with credit newly created just for that purpose. The big bank can then lend that credit out in a much greater amount because the Fed only requires them to keep a small fraction of that credit to support whatever the bank wants to lend out. This is our wonderful fractional reserve system. If everyone went to the bank to get their “savings” at once they would find that they could get out less than 1%.
But here is the key. The bank must ultimately be willing to lend it and then find some investor to borrow it. This has been no problem whatsoever over the last several years. Now most investors realize that they have too much debt, that their level of income cannot support it. Banks realize this too and have increased their lending requirements. The last borrower is always the most aggressive speculator.
So most market participants are now looking for ways to pay back debt (deflation) just when the Fed is desperate to get investors to borrow more (inflation).
This conundrum is a form of liquidity trap - a shortfall in demand for credit that the policy tools of central bankers have great difficulty influencing. Keynes referred to this type of scenario as “pushing on a piece of string”. We are still in the early stages of this credit crunch and as yet, the Fed has not employed all the tools at its disposal. Most notably, it has not yet cut interest rates, likely due to recent Chinese threats to dump the dollar.
As the dollar should benefit from a flight to quality as credit spreads (the risk premium over treasuries) widen, there should be scope to cut interest rates later in the year. It is likely, however, that this will be less effective than the Fed would hope.
The theory is flawed. Central banks promising new credit to strapped banks only helps them with their current problems. It will not get new credit into a system that can't take anymore. Banks, given their situation, are reducing drastically their new commitments, as they should. Borrowers can't afford to borrow more.
The continuation of the credit expansion will remain dependent on a supply of ready, willing and able borrowers and lenders, and those already appear to be in short supply.
A trend of credit expansion has two components: the general willingness to lend and borrow and the general ability of borrowers to pay interest and principal. These components depend respectively upon (1) the trend of people's confidence, i.e., whether both creditors and debtors think that debtors will be able to pay, and (2) the trend of production, which makes it either easier or harder in actuality for debtors to pay. So as long as confidence and productivity increase, the supply of credit tends to expand. The expansion of credit ends when the desire or ability to sustain the trend can no longer be maintained. As confidence and productivity decrease, the supply of credit contracts.
A significant headwind faced by the central bankers is the dramatic change in the mood of the market in recent weeks. It is said that humans have only two modes - complacency and panic, and markets, being a human construct, are no exception. The current mood of the market is one of fear, and if fear becomes panic, it can remove liquidity from the market far faster than even a central banker can pump it in. Actual cash is in short supply, and the many investors are afraid that the game of musical chairs will end before they can grab one of the very few chairs. If they do manage to find a chair, it will be difficult to convince them to part with it, no matter what the inducement. Risk has made a definitive comeback.
Deflation and the Mother of All Margin Calls
A credit expansion cannot be sustained indefinitely. At some point the burden of debt begins to stifle the ability to produce. The debt industry can take on a parasitic life of it’s own, becoming an integral part of the culture, from the level of the individual, as documented by James Scurlock in Maxed Out, to the level of corporations and government. The attention paid to assessing credit ratings, monitoring credit activity, hounding defaulters, writing off bad debt, juggling minimum payments, thinking of creative ways to exploit leverage, and encouraging every last entity to take on more debt in order that predatory lenders might wring out every last penny of profit, is attention not paid to productive activities of the kind that build successful economies. Eventually, it requires so much energy to maintain that economic performance suffers and extracting sufficient profit to cover interest payments on ever-increasing credit balances becomes impossible. A mood of conservation eventually takes hold, replacing the expansionary fervour, and reducing the velocity of money.
When the burden becomes too great for the economy to support and the trend reverses, reductions in lending, spending and production cause debtors to earn less money with which to pay off their debts, so defaults rise. Default and fear of default exacerbate the new trend in psychology, which in turn causes creditors to reduce lending further. A downward "spiral" begins, feeding on pessimism just as the previous boom fed on optimism. The resulting cascade of debt liquidation is a deflationary crash. Debts are retired by paying them off, "restructuring" or default. In the first case, no value is lost; in the second, some value; in the third, all value. In desperately trying to raise cash to pay off loans, borrowers bring all kinds of assets to market, including stocks, bonds, commodities and real estate, causing their prices to plummet. The process ends only after the supply of credit falls to a level at which it is collateralized acceptably to the surviving creditors.
In such an environment, financial values can disappear very quickly, leaving behind only stranded debt. All it takes for an asset class to be devalued is for as few as two parties among many to agree to a new lower price. The remainder need do nothing, other than refrain from disputing the new valuation, for their net worth to fall. In this way, a few discounted house sales can bring down the value of a neighbourhood, and that lost value, which may have been underpinning a hundred times its worth in leveraged debt, is magnified through the inverted debt pyramid. The majority who do nothing end up watching the investment value of their assets plummet, while the owners of debt attempt to call in whatever value they can, from wherever they can, through margin calls.
The United States faces a severe credit crunch as mounting losses on risky forms of debt catch up with the banks and force them to curb lending and call in existing loans, according to a report by Lombard Street Research.
"Excess liquidity in the global system will be slashed," it said. "Banks' capital is about to be decimated, which will require calling in a swathe of loans. This is going to aggravate the US hard landing."
"The complexity of this era of credit liquidation," as Robert Smitley wrote of the Great Depression in '30s America , "is far too great for the mob mind to grasp. It is hardly possible for them to see the picture wherein about $700 billion dollars of physical and intangible wealth is attempting to be turned into about $5 billion dollars of money."
How much intangible debt now needs to be squeezed back into how much real money? It would be easier to find a cheap mortgage – with no ugly ARM once the teaser is finished – than guess at those numbers today.
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The Comptroller General of the United States is still sounding the warning alarm,,but few appear to be listening:
"The US government is on a ‘burning platform’ of unsustainable policies and practices with fiscal deficits, chronic healthcare underfunding, immigration and overseas military commitments threatening a crisis if action is not taken soon, the country’s top government inspector has warned."
http://www.ft.com/cms/s/80fa0a2c-49ef-11dc-9ffe-0000779fd2ac.html
Today in the New York Times C1 section and the Wall St. Journal C1 section (Wednesday, August 15, 2007) I read that some money market funds are actually invested in collateralized mortgage obligations.
What about my "cash account" at my brokerage?
Business News from Reuters:
Dow -161 11:08 edt
http://www.reuters.com/article/marketsNews/idINN1443019520070814?rpc=44-...
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The only business news from CNN this morning so far: 'Mattel has major toy recall'.
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If there is no Devil, then why do we dance with him?
You state that money is a physical commodity. This is a result of much wishful thinking. The article you link to may contain the phrase but not much of an argument.
Gold is a physical commodity. Whether or not you put the king or a president on a specified lump of it is ceremonial. Paper money is paper, also a physical commodity. When it says 'will pay to the bearer on demand', it pretty much explains itself as a form of debt.
If we define money as a physical commodity, there isn't very much out there. I could go on and on, but I don't think there is much more to say unless I want to get into negating the ceremonial obfuscation of the financial world since Gutenberg and Paterson brought forth the Bank Note, the official IOU or I Owe You.
While alchemy failed to turn lead into gold, Paterson turned gold into paper - just as lucrative for a while, for a few. While both paper money and gold have a notional value, only one is a significant physical commodity. Hogs or barrels of oil would do as well, but are harder to put in your pocket. All economies are, in the final analysis, barter systems; money is just a more convenient intermediary mechanism.
The rest of your post is pretty airtight, welcome, and very accessible. Well done. Too bad people only seem to realize there's a pile of dishes to do after the party's run out of booze, or credit in this case.
I realize that paper money is debt based, but the point is that even something as flimsy as paper still has a physcial existence. Short of having a large bonfire (or reissuing the currency as Russia did some years ago), it isn't going to disappear the way pure financial value does when as few as two people simply decide an asset (and by extension an asset class) is worth less they used to believe.
If that financial value was propped up by credit loaned into existence for the purpose, then when the value disappears, all that is left behind is the debt. Credit is far more ephemeral than paper.
Petrosaurus,
This is likely the time when all the gold comes out of the strong boxes and is sold for cash to prop up the economy, and gold has very little intrinsic value. It can be used for jewelry, and electronic connections, and as an art supply (gold leaf). Any other value is just an agreed upon value, just like paper money. Land and productive capacity is the only wealth, but they may not be fungible if we have no currency.
Gold and silver can get you robbed and killed. The value is likely to crash too.
My point is don't put your faith in specie, or paper anything. Good luck!
Well, I guess I'm in pretty good shape then. Sitting on a few acres of forest & farm land including mineral rights. Over the Black Warrior Basin, which also provides me with a little beer money. ;) One other thing that works well as currency, btw, is 'shine. :) Learning to make your own is worthwhile.
Gene, just tell the revenooers that your building your own home ethanol plant!
Y'all been watching too many old movies; revenoors are my best customers. They are "fuel" conscious also. :)
Heh, I was just thinking that prostitutes (or perhaps these days porn) and booze can almost be said to have "intrinsic value" in that one can hardly imagine demand for them ever being destroyed.
Not being much one for pimping I'm starting to take a real, um, shine to the prospect of distilling as a relatively bomb proof post-carbon livelihood. Desperation to run cars on anything that burns, coinciding with exploding demand for something to kill the desperation, should make for the mother of all growth industries.
Cheers,
Jerry
Ah, moonshine production. Good idea! Uh, except you'll have to stand in line with the ethanol producers and hungry people just to get the core ingredient: grain.
Then again, you could grow your own potatoes....
You can't buy bread, or pay your rent with gold or silver. You have to sell it, trade it from paper money.
If everyone is selling, and nobody is buying, then gold is little different from any other asset; it might be more liquid, but it still has to be liquidated to be of any use.
We paid off our land, and our heirloom fruit trees are two years old. Hopefully next year they will bear. Getting off the money wheel is the best thing my wife and I ever did (besides getting married... :)
What we call "money" is simply a portable and convenient mechanism for valuing real goods and labor that would otherwise be bartered for. Practically everything you can think of that can be strung on a vine, stuck in a purse, or pocket has been used to fill that role. Rocks, shells, etc.
The barter system ( I got cattle, you got women, let's trade. :) )is still alive and well world-wide, including the USA, which really irritates governments (of all types, including religions ) because they have no control of it for taxation purposes. An arbitrary assignment of value to a bag of rocks or string of seashells makes it much easier than taking a cut of veggies and livestock. Breaks my heart - NOT.
Excellent piece Stoneleigh.
Fannie and Ginnie Mae are being floated as the buyers of last resort for liar's mortgages and more. We remember Fannie as that quasi- public private corporate entity which hasn’t been able to provide an audit in several years.
A related tie-in is the change in U.S. bankruptcy laws, which effectively create a new perpetual surf class.
This is indeed an important point. I mentioned this briefly in the article. Indentured servitude comes to mind.
A perpetual surf class?
That IS funny, Rick.
Somehow doesn't sound all that bad, does it?
Gnarly, dude.
Ah yes, SERF, o.k.? A serf underclass has no time to surf, or spell. Serfs up!
Serfs down!
Indeed.
Perhaps worth noting, though, something that I have discussed with Nate on these lists and others: that a society which surfed and ate breadfruit and smoked wackyweed would be a society which needed nothing much more than a way to make surfboards. Turning society into surfers is probably the best we could hope for. (feel free to substitute alternate local exhilarating hobby).
One question I have is what does the world look like if all of the stuff that was put in place in the last few years gets unwound and goes away?
It seems like we have a whole lot of bond defaults, as businesses cannot repay their debts and homeowners cannot pay the loans on their houses and cannot sell them for what they are worth. Insurance companies, banks, and hedge funds that hold those loans will be in tough shape.
We will still have a lot of physical houses. I am not sure exactly what happens. Are lots of folks evicted, and they move in with friends, (or become homeless) so that there are lots of unoccupied houses that deteriorate quickly? Clearly the market for building new houses nearly disappears.
We also have lots of businesses. Do they just go out of business because they cannot repay their loans? Or do they go to bankruptcy court, come out the other end without much debt, and continue sort of as usual?
The banks have FDIC insurance. There is virtually no cash in this, so it would not by itself hold up more than a few small banks. But I can see this as an excuse for a different type of re-injection of credit into the system by the federal government.
What thoughts do other people have?
Following is a missive I sent out to some joint venture partners last week. BTW, I've heard rumors of money market funds taking losses because of mortgage backed securities.
WesTexas, Jeffry,
that's exactly right. We are importing 14.25 million barrels per day now, 68% of the oil we use. I have no doubt that we will use all we can produce domesticly forever.
The most important thing that people at this site can do personally is follow your good advice-get debt down, learn to get by on half your income. In other words, economise.
Learn to get your needs locally, build a community, and stop buying Wallcrap from China. Use your money at the local hardware store, keep your neighbor in business. Maybe he'll remember when the trucks stop running and you need a padlock. Buy from the local farmer, its fresher and tastes better. Find all you need in bicycle distance, localise.
And get something you can do or make to barter.Make art, learn to cobble, get handsaws and chisels and do old fashioned carpentry, learn to garden, get some shovels-produce. Get a real job .
Yeah, I know the whole economy will fall apart if everyone does this, but since most people won't follow good advice, I'm not worried. I do know that even if Jeffry's wrong your life will be better, a whole lot less stress. Its his (in)famous ELP program. I prefer to be in a city, but he says farmland. Like Alan from Big Easy, I'm in a port,Galveston, which has a great hospital and medical school, fishing boats, public transit and 1% of city revenues dedicated to the library system, a college Texas A&M Galveston Campus, a nursing school, commmunity college.
Don't forget to relax a little and have fun, after all the Mayan calender gives us to 2012!
It was mentioned yesterday that Donald Trump had commented on this and I think it's a good idea. - People should just stay put and negotiate like hell with the banks for better terms. Don't just give in and take it. Make the banks and financials work hard for their pennies on the dollar.
-Don
Gail,
There is nothing I can see that would halt the drawdown process anytime soon. It has to simply play out to a large extent.
Many people will be foreclosed upon, many businesses will close and milllions of jobs will vanish. There is a large group of banks out there that are basically insolvent at present. In attempts to stay alive and in business, they have no choice but to call in every single loan that they can. This will be true for mortgage loans, business loans, everything. Don't forget: they have shareholders, and are obliged to try to do what they can. Too bad for the newly homeless and unemployed.
Governments are powerless in the face of all this. The amount of credit that would be required to let broke and unemployed people stay in their homes, by the millions, combined with the credit needed to keep businesses going, would overwhelm a government's financial capacities. If they'd try, their currency would sink like a stone.
And it's not just the US. I posted some articles on yesterday's Round-Up that should make clear that European (and Asian) banks and funds are much deeper invested in MBS, CDO etc. than they let on. Here's another one: Eurobanks may take months to reveal subprime woes.
After another credit shot of €7.7 billion today, the ECB has now injected almost $300 billion into its banks. While this has calmed markets somewhat for now, it will just evaporate. All these people, the banks, the funds, and governments, are becoming aware that they sit on rapidly decomposing paper. And they are like deer in a headlight.
Once it gets officially downgraded, read: soon, many will by law be required to get rid of it, since they can only hold AAA. What will it be worth? I think 10 cents on the dollar is a good guess for now, but they would still all have to find buyers for that price. But still, 10 cents is better than nothing. And so is 5 cents.
I think the closing quotes in Stoneleigh's excellent article say it quite well:
Everyone will be forced to choose that $5 billion (or$10, $25, $70 billion), since it's better than nothing.
It's very important to put numbers on the mortgage and subprime problem. The best I've seen on this is: http://www.loanperformance.com/infocenter/whitepaper/FARES_resets_whitep... (from First American Real Estate Solutions, which claims to be the number 1 source on real estate in the US, used by Moody's)
- FARES projects approximately $300Bn loans at risk over the next 5 years from interest rate resets, and, as losses will represent the loss on collateral, approximately $100Bn of total losses to the financial system, spread over 5 years. Note that losses are after the bank/lending institution takes ownership of the collateral (house) and sells.
- A weakness of the study is that only the loans made in 04 and 05 are represented, most likely significantly underrepresenting 06 and years before
03. (study completed in 2/06, but I haven't found anything of good quality newer) So one should increase the total at risk amount (unscientifically) by approximately 30-60% to account for the extra years.
- Another weakness of the study is that interest rate reset is at current interest rate levels -- all bets are off if interest rates rise significantly -- but note that much higher interest rates are not extremely likely.
- Study assumes a level of 30% from the approximate $1 Trillion in loans that will reset at risk, which the author considers "conservative" -- and walks the
reader through his methodology. I would tend to agree as the average mortage and other credit card interest payments to income is currently under 18.20% (see
http://www.federalreserve.gov/Releases/housedebt/default.htm) -- which indicates the average consumer in the US is NOT hurting by any means.
- All in all what is most interesting is that the total amount is manageable, as the total housing stock value is approximately $18-20 trillon, and value of
outstanding loans are approximately $10 trillon (according to Moody's). The defaults and losses will be spread over at least 5 years, representing in total
3% of total mortgage value (number from the study, although more like 5% taking into account other years) and losses at 1% of total mortgage loan value.
I assure you not in California. Once these houses go underwater and the loans reset everyone will walk. The payments are simply to high on these loans compared to income.
Your making a big mistake assume this will be like past housing busts when loans where not so out of proportion with income. Also at least in my area home equity loans are a big problem and its not clear that they are getting included correctly. So you will probably see up to 70% of the homes sold in the last four years in California go into foreclosure in addition you probably will see 10% of the homes sold over the last 30 years go into foreclosure because of HELOC's.
This I expect to play out over the next three years for the first wave say about 30% and the next 5 for the rest before it finally ends.
Also a lot of the HELOC money was used to buy speculative properties in California and other states all over the country so a lot of these California foreclosures will cause multiple additional for closures in other states and even a lot of homes in Canada and Mexico.
Of course its different in California.
Ok, one more estimate of the size. Stratfor had an interesting article on the subprime issue yesterday, comparing the current mess with the Savings and Loan mess of the early 80's:
"Federal Deposit Insurance Corp. estimates that the total amount of assets involved in that crisis was $519 billion. Note that these are assets in the at-risk class, not failed loans. The size of the economy from 1986 to 1989 (the period of greatest turmoil) was between $4.5 trillion and $5.5 trillion. So the S&L crisis involved assets of between 8 percent and 10 percent of GDP. The final losses incurred amounted to about 3 percent of GDP, incurred over time."
The current amount of subprime loans out are between $500Bn and $1.2Tr (estimates from Reuters and NERA, respectively). This comes out to 3.8% to 9.1% of gdp. On the basis of these numbers, the current subprime problem can be compared to a smaller version of the 1980's SNL crisis.
I don't think you quite understand the problem.
In California maybe 10-20% of ALL buyers bought a house they could afford to make payments on. And this does not include how many of these are involved in "flipping" most of the flipper that drove up prices in other markets are from California.
What you need is how many people bought with 20% down and a debt/income ratio of 5 or less over the last 5 years in California and further did not try and flip houses or HELOC.
This gives you the number of buyers who won't be underwater with a 20% reduction in prices. Considering that for values to return even to high California income/home ratios of about 5/1 vs the standard of 3/1 for the rest of the nation we have to see a price cut of about 50% the only ones who would make it out at the end at ZERO are the ones that paid 50% for their homes. So tell me how many Californians did that ? Everyone else in California that was involved in the recent bubble either through a HELOC flipping or crazy loan will be underwater and generally way beyond their budget as the ARMS reset.
A 100% rise in home prices that takes the ratio of price to income from already high 5/1 to 10/1 is going to be a absolute bloodbath. And again a lot of these people have ARM loans on multiple homes across the US. And again you have to know how many with good credit "liberated" all of their equity in California. Most of the sob stories in the local paper are about people that have had homes for 10-15 years that HELOC'd themselves into foreclosure.
So for California its armageddon and certain because of the flipper houses to hit other states.
What you need is how many people bought with 20% down and a debt/income ratio of 5 or less over the last 5 years in California and further did not try and flip houses or HELOC.
One. Me. A thirty year fixed at five and a eighth. It would still be at a debt/income ratio of 5 or less if I wasn't laid off.
All the people I knew in CA that listened (about 75%) bailed about 2 or 3 years ago. Originally I thought that it was the safe move while leaving some money on the table.
In retrospect it turned out to be a good move.
The ones that want to bail now aren't going to need much luggage.
Richard Daughty doesn't see it that way:
And what should be clear from Stoneleigh's article is that we are not talking about a subprime or even a mortgage issue here. That's nothing more than the first pimple in a 7-year adolescent acne hell.
Subprime loans are important in that they were the vehicle that provided a large part of the leverage for building a zillion new homes, and corporate buy-outs, and home price rises, and equity withdrawals, etc etc. It's precisely that leverage that wasn't there 25 or 10 years ago, and that makes this malaise so much bigger and different. Subprime falls, everyting falls. The inverted pyramid. S&L could fall on its own. This is 100 times bigger. Leverage.
This is an all-out complete credit and finance crisis. Neither S&L nor LTCM were that vast. Not even close. Just look up US personal and federal debt numbers, then vs now.
To wit: look at what's happening to the Leveraged Buy-Out market. It's dead.
Nothing subprime, nothing housing necessarily. Just credit crunch. If people feel better believing that this is not the case, go right ahead. But comparisons like the S&L one fail on just about every point by now, already.
And the horse hasn't even left the barn, it's just flaring its nostrils.
Stoneleigh,
Thanks for your hard work! But, I don't mind telling you that its terrifying, it looks like the bottom card in the house of cards has been palmed, and its all tumbling down. I sure hope the powers that be can hold it together, but I'm suspecting that it can't because of the worldwide dispersion of our debts, between China and the OPEC nations, a least 2 trillion dollars in debt instruments is in the hands of countries that love us not.
They may not foreclose because then all that debt becomes worthless, but they sure won't lend us much more, except as extensions of the interest on the loans. Its like we have become an IMF basketcase country, and our spending is going to come under control no matter what. It may be the end to the war, to social security, to our military's money, to everybody's pension and 401K.
This has tipped me over. I thought George W. Bush was the second worst preident after Franklin Pearce because Pearce allowed the Civil War to happen. If we have now become a nation that can't even defend itself, Bush is the now the worst.
For your entertainment:
http://www.bartcop.com/posters/hi-rez/worst-president-ever.pdf
That would be great news if the US couldn't sustain its military. (At least we, the others, would be safer.) But I really doubt that'll happen.
It is way more likely that your government cut civil spending and sends the country into a much bigger recession just to keep the military running.
A military weak USA would not make me feel safer.
What for coal to liquid schemes as the troubles grow. The airforce will take it hard - 80% of the military's fuel use is their stuff.
SacredCowTipper
Kerosene is a product of coal gas manufacture and was first made from coal, kerosene from petroleum is a substitute. Don't worry, jet fuel isn't going away. The planet may die because of global warming, but the US will still be able to distroy it with nuclear weapons. Does that make you feel safer? (source, Wikipedia article on coal gassification) Bob Ebersole
Well, military power in the hands of the adventuresome Bush administration does not make me feel safer. The same in the hands of an administration that qualifies as a rational actor in terms of foreign policy would be a better thing. A nice, slow motion slide in the use of military force until we're back to cavalry would be better but ego and circumstances would seem to place this out of reach.
Magnus, I am truly ashamed for you, to see you write this.
You are a SWEDE, for heaven's sake. And, apparently (and thank God) not a representative one.
I might also say that some tens of thousands of your forefathers joined the Waffen-SS to fight for Hitler. Hey, it's not that much of an insult. My own grandfather died fighting for Hitler, but he at least had the excuse of being German, and your people weren't even occupied by Nazi Germany at the time. (Apparently the Wiking division has next to no war crimes to its name).
Old habits die hard, huh? Any old Fascist will do?
A militarily weak USA? It already exists (and in truth always has done).
Please wake up. Someone who lives in the land of actual military genius (Gustavus Adolphus, anyone?) ought not to be trembling about the vanishing of a largely imaginary US military power.
Franz--
I'm a U.S. service academy grad and ex-officer, so please don't accuse me also of being fascist because I think that a militarily weaker U.S. would not be a bad thing. Say what you want about an alleged 'imaginary US military power', but a lot of people are dead, maimed, or homeless by its actions. I doubt they thought it was imaginary. I do believe in a strong defense from actual threats; I don't believe in power projection for the sake of maintaining an unsustainable lifestyle.
Sweden had quite a run after Gus invented the mobile cannon. Eventually 100 million Soviets figured out how to overwhelm 8 million Swedes.
200 million Soviets figured out how to overwhelm 100 million Germans. We let them march to Moscow and then watch the mercury drop. Let's see how much good those tanks will do them when the temperature is below the cloud point of diesel fuel. Wonder how well a horse drawn supply line works when it is 55 below.
Nitpick here... I believe the panzer tanks had gasoline engines. The Russian tanks had diesel engines which added to the problems the Germans encountered. They took over fuel depots left behind by retreating Russians only to find lots of fuel they couldn't use.
Yes, but the Germans had captured a lot of diesel powered Russian tanks. :>)
USA has been in better shape, Americans were once the realy good guys. If you dont take care of your democracy, economy and infrastructure we will instead get a world that might be dominated by Putin:s Russia or China. The best to hope for then is EU and India.
The instability alone after a US downsizing would make lots of transactions more expensive and could initiate arms races and so on.
Our biggest shame during WW-2 was to allways trade with the dominant power in exchange for some goods and not being invaded. The nazi war machine used lots of swedish iron ore, lumber and industrial products.
That some people got the dumb idea to travel to nazi controlled areas and volunteer to join the nazi military where their personal decision and not government policy. The government policy where to forbid open recruiting on Swedish soil and that people could do whatever dumb thing they wanted with their lives after leaving Swedish territory. There were Swedish volunteers on all sides of probably every conflict before and during WW 2. Those who fared worst were probably those who volunteered for Stalins Sovjet who were tortured and sent to gulag to die as spies. The nazis were unfortunately intelligent enough to use the volunteers.
The foreign debt can be handled. We can simply print out however much money we need and ship to the foreign countries in 747s.
Of course, from that point on, we will need to run a balanced budget, produce all products we need internally, and pay for all imported commodities with gold, silver, euros, etc. Personally, I think it is a great idea.
I think we should wipe all private and public debt, pay off foreign debt with printed money, then go back to the gold standard. I bet the average person would come out the other end of that operation in much better shape.
I love this. Back in the 70's, 80's and 90's Africa was going to the wall paying back loans the IMF made.
I think the US should be similarly forced to the wall.
How convenient now that you are all messed up with debt it should all just be forgiven.
Then what happens to responsible people who have a small apartment or are renting? What happens to the speculator with 12 properties does his debt just get wiped and he owns that property.
It's a mess pure and simple. They should have allowed proper recessions and redistribute wealth in the form of wage increases to the middle class. Not the idle losers at the top and bottom.
Fools. You lent to us in our own currency. We can print as many dollars as we want. "Africa" went to the wall paying back the IMF loans. The bigmen in charge had already stuck the money in their foreign back accounts. Why would they care?
http://reddit.com/info/2f4yb/comments
http://digg.com/business_finance/The_Resurgence_of_Risk_n_A_Primer_on_th...
If you are so inclined...
Thanks Stoneleigh for your very clear and insightful writing on a very confusing subject.
I tend to agree with your opinions and conclusions, however, I've heard all this before. This has been the doomsday scenario since Nixon closed the gold window in the 1970s. And each time we approach the precipice, disaster is averted and we go into another growth cycle. So even while I agree that there is a wolf outside somewhere, how do we know it's at the door this time?
My question is: do you think it's possible that we'll avert this disaster once again, or do you think it's a sure thing?
While I don't look forward to the hardship that these problems will cause me and many others, I think it's better to clean house now because it will only get harder to recover in the future. On the other hand, maybe it's not possible to recover if we slide too far now, so it would be better to send in the helicopters and continue as long as we can.
-Don
I think the credit expansion has essentially reached its limit - the point at which efforts to restore liquidity are about to be over-run by a stampede for the exits. I don't think the helicopters can help, although they may well be able to make things worse....
Being a reader of the author Kevin Phillips, I can’t help but feel that in a way this has happened before, to complicate the situation of people of the United States, the U.S. is in the same relationship with China that the British were with the U.S. a couple hundred years earlier. That is, “offshoring” hollowed the British Industrial Revolution too.
Quite so. I covered this point in March in an article called Entropy and Empire.
This article represents a good overview of credit market issues.
Combine those issues (which are systemic and not going away) with the advent of Peak Oil (or Social Security/Medicare insolvency which are other systemic problems).
That's the point where we will find ourselves unable to avert disaster.
Neither politics nor industry is forward looking enough to handle Peak Oil. "Profit Today" is one of the mantras that will bring us down.
Sure enough, in the past, we could grow again.
But this time may be different, if we remember that our mission is Peak Oil analysis and note Ace's forecasts.
This fall will put a NAIL in this coffin. We are looking at a global shortage of 3.5MMBPD starting in 4Q07 into 1Q08...and it never improves from there on out.
So I think a new bubble ISN'T possible...although they will TRY.
Hello Stoneleigh,
A very interesting article. Thanks for putting it together. What is your evidence for the statement that "since the 1990s, the Fed has deliberately shepherded reserve requirements down, essentially to zero, through dropping required reserve percentages, reducing the categories of funds needing a reserve and allowing funds to be swept from a reservable category to a non-reservable category overnight"? As far as I know US banks capital adequacy ratios are still around 10% - ie they maintain $1 of capital for every $10 of loans (and deposits, in aggregate) - I didn't think that this had changed signficantly in the last 10 years.
Secondly, does the "household cash less liabilities" chart include mortgage debt? I would assume not, since the total mortgage market in the US is around $10 trillion. But then it's hard to believe that it is purely personal and credit card debt. since $3500 billion is more than $10,000 per person????
Regards,
Cuchulainn
See what the Fed itself (PDF warning) has to say about reserve requirements and the use of sweep accounts. The section on the recent history of reserve requirements is page 42-44.
See also Mish's commentary on reserve requirments (under the heading Massive Surge in Sweeps).
That Fed article is absolutely fascinating, thanks for the link. (Warning - for severe financial nerds only).
I particularly liked the bit on page 43 where they admit that reserve requirements were cut in 1990 to stimulate borrowing after the S+L crisis and uh..... they've kinda forgotten to raise them since. The paragraph after that makes the point you were making about 'sweeps' and how they allow banks to not hold reserve requirements against what are (ostensibly) deposits. The chart on that page (44) does indeed show a huge drop in the amount of reserves banks hold at the Fed. That is new to me and very very interesting indeed. Thanks alot for the link to the article.
Cuchulainn
There is speculation (front page Financial Times yesterday) that the ECB is going to ask the Fed for a currency swap.
Interesting recent info:
* The ECB has injected much more liquidity than the Fed recently
* Indications are that European (and Asian) banks were the primary purchasers of subprime debt
* One banker in the FT article said "Don't show me anything east of [New York] 212-area code. If you lend to those banks it could be a career ending experience."
And this fairly recently:
(Financial Times, page 1, Aug 2) “The rescue of IKB, a specialist lender based in Dusseldorf, began on Sunday when Peer Steinbruck, German finance minister, called leading banking executives to discuss a bailout. According to people who took part in the conference call, Jochen Sanio, head of Germany’s financial regulator, is said to have warned of the worst banking crisis since 1931.”
It certainly seems like the losers are going to be in Europe.
Many seem to have ignored the real estate boom in Europe and China. While the US has problems, they are in the main isolated rather than general, and the average house on the average street in Des Moines isn't that far from normal multiples of income.
This debacle will, hopefully, trim the markets down to something approaching reality in time for the real shocker of inability to print oil comes down.
Somehow I get the sense that there was a lot of money looking for a home, probably as a result of the profit from the wage differential between China and 'us'. It should have gone into solar thermal instead of McMansions. So much for the invisible hand, which seems to have been picking its nose.
I have no good guess who will fare better, but housing in the UK is a different issue to the US. We have a massive housing shortage, and very old stock. So I can't see the price dropping in free fall.
My guess is that all western assets will end up being owned by arabs and Russian mafia
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_lynn&sid...
True, the rise in prices beyond normal wealth is bizarre. There is a feeling that lots of property is bought as 'portfolios', maybe some by overseas investors. We will have a crash of sorts, but it wont be due to too many houses
You have a bit of misconceptions about the housing bubble.
Two of the area's with the greatest gains where Massachusetts and Southern California in both areas cheap land is not readily available. Note I did not say no land or that their was not plenty of land just its not particularly cheap. So builders hesitate to tie up a lot of money in land speculation. At least in normal times. But in both places they built thousands of houses during the boom and both will suffer massive price declines. Mass is very close to England in its housing offerings but this does not prevent it from crashing.
The critical factor is pric if your customers cannot afford your product then either you go out of business or lower the price. You don't have a housing shortage if no one can afford a house. I've heard their is a massive Lamborghini shortage in Southern California so even though I'll never buy one I'm confident that prices will remain high even if Lamborghini has to go out of business to ensure it gets the price it deserves.
So just substitute Lamborghini for a house and the arguments are obviously nonsense.
I think the difference is Europe is more transparent than the US about its current financial condition. And yes they have problems but they at least seem to be working to correct them.
I feel EU does not quite have all the insider ability to manipulate problems like the US and worse Japan. So yes I think early on it will look worse but the US will not only surpass Europe but lap it a few times before this is over.
What's special about the ECB interventions the past week is the size: closing in on $300 billion. What's special about the Fed interventions is somewhat different.
Interesting that mises.org focuses on the Fed saying in that same article:
"While the purchases are only temporary — the cash must be returned by Monday — one wonders how long before the Fed grants itself the power to buy MBS permanently."
I can quote something from the WSJ:
"That the ECB flooded the market with liquidity is both interesting, and understandable, given that the ECB doesn’t have Lender of Last Resort (LLR) powers. What should have happened (and this is still a missing piece of information) under the current arrangements within the European system of central banks is that BNP, or any other bank experiencing a liquidity problem, should have had access to its respective central bank’s Lombard facility. But the ECB stepped in ahead of the national central banks."
So why is mises so obsessed with the Fed? Who's out of bounds already? -- not the Fed.
They've always been able to purchase mortgage backed securities (backed by the Macs).
The Fed clarified this in an August 10th press release:
http://www.newyorkfed.org/markets/operating_policy_081007.html
But that was just a clarification, there have been several mortgage backed repos this year prior to the recent ones (search for "mortgage"):
http://www.newyorkfed.org/markets/omo/dmm/temp.cfm?SHOWMORE=TRUE
The requirement is backing by a federal agency, so mortgage securities backed by the Macs are acceptable.
It is scary that the Fed can expose itself to this type of debt, but the Macs have higher requirements than other lenders (so sub-prime lenders have no where to turn).
Thanks for putting that together. Good piece of work that will come in handy for reference.
Wealth is measured in its future usefulness. Money is only as good as the Perception of future value (Inflation is the difference between tomorrow's perception and today's perception, or today's receipt and your perception of tomorrow's value).
Gold is good as long as there are valuable commodities which it can be traded for, or resources available to meet the basic needs of the populations. Once the System of Energy-based specialization breaks down, value can no longer be assigned nationally, and will be determined locally, depending on hunger levels.
The best course of action would be to immediately begin some kind of a Descent plan for consumption restriction. Apparently, we can't do that unless we start a bigger war first. Do we want to find out how bad a president can really get (well, a vice-president, actually)?
"If you want Change, keep it in your pocket. Your money is your only real vote."
Stoneleigh - thanks very much for this excellent, well written piece. Its one of those pieces where I understand most when reading - but am still left grappling to understand the whole.
Your description of how risk has been "sliced and diced" - explains a lot. In developing these instruments the banks did indeed reduce their exposure to risk - and of course their response to that was to expand their risk taking behaviour to compensate.
One of the best metaphors for risk I have come across is a car with a 12 inch spike sticking out of the stearing wheel aimed at the drivers chest - arguably a very safe car where serious risk is obvious to see, and behaviour will be adjusted accordingly. Compared with a 4 wheel drive, bouncy castle fitted with abs etc - which folks drive at absurd speeds with the feeling of invincibility.
It seems the banks have concealed risk and passed it on, whilst greatly increasing the risk profile of the whole system.
It is also clear that regulation has gone out of the window where the banks sell on the risk to widows and orphans - and as you say the ratings agencies seem to be failing the sytem.
One bit I didn't grasp was the inverted pyriamid - how does one poorly secured mortgage prop up several more?
You mention October. In the UK, fixed interest mortgages have been popular for many years - x% for y years. This blunts the interest rate lever as changes in interest rate do not feed through to indebted consumers immediately. I seem to recall that their is a tranche of fixed interest debt comming up for renewal in the UK this October. In the good old days when you repaid capital and interest, interest rate rises were de-geared. If you are sitting on a fixed rate, interest only mortgage pitched at 4 * family earnings in the UK - you are probably in for a miserable Christmas.
The UK government has let house price inflation rip - and our now trying to devise schemes called "affordable housing" - 10% interest rates I imagine will create ample amounts of affordable housing.
The one crucial point where I find it difficult to agree with what you say is the deflationary conclusion. Whilst your explanation and logic seem sound, deflation with all this debt would preclude that the debt ever gets repaid and this will lead to total system failure. So I suspect at some stage, the central banks will just continue to pump in money resulting in inflation and the inflating away of both consumer and national debts. Deflation first, followed by inflation.
A mortage is an asset to the mortgage issuer (or more precisely to whomever the mortgage has been passed on to by the issuing bank). Leveraging that assetthrough credit expansion can provide the capacity to make other investments, perhaps in other mortgages. The credit-worthiness of the poor sod at the bottom of the pile unerpins a much larger credit structure.
I think system failure is indeed a risk. I think we will see margin calls where those at the top of the inverted pyramid try to press their claims on those beneath them. Most claims would go unpaid as there simply isn't enough real wealth to cover more than a tiny fraction of the outstanding claims on it, but that doesn't mean they won't try. I expect to see loans called in, and for much of the asset base now nominally owned by the middle class (actually owned by their creditors) to end up in other hands as those debts come home to roost.
As you say, I think we face credit deflation first, then inflation (hyperinflation in fact). Credit deflation is an enormous hurdle to cross first though. I would expect it to ravage the global financial system and eventually cut off international capital flows for perhaps a long period of time. Isolated national economies no longer at the mercy of the international bond market would almost certainly inflate their currencies (in a hyperinflation rather than a credit hyperexpansion) while trying to keep national 'body and soul' together.
My WAG for a timeline would be credit contraction (deflation) and depression in mutually reinforcing downward spiral for perhaps 10 years (at a minimum I would think), and localized hyperinflation beginning some time after 2020. Energy will, of course, be a large part of how this plays out in practice. Initially, energy prices should fall with purchasing power and a fire-sale of assets as everyone tries to cash out. That might not last for long though, as a global resource grab (neo-mercantilism and gunboat diplomacy) could deal a crushing blow to supply. We live in interesting times (in a Confucian sense).
I'm sure someone has used the term 'laundering' to describe this. In the underworld, especially the drug world, one 'launders' cash to make it seem legitimate. We have a much worse phenomenon here of 'laundering' credit to make it seem worth trading. Once it is laundered, it is used as any other monetary equivalent, even though there might be virtually nothing backing it up. At least a drug lord's laundered money is worth something!
For years, industry insiders and so-called experts have proclaimed the virtues of slicing, dicing, and repackaging risk. They waxed on about how borrowers and savers, and society as a whole, could only benefit from such machinations. They suggested any sort of exposure could be disbursed and dissipated to the point where it essentially disappeared. Some even claimed that the crises of the past would no longer exist.
And dilution is the solution to pollution.
Yeah, right.
Why is it that the folks who are most focused on the dynamics of money, wealth, and value seem to be the most willing to drink the koolaid at every turn, and keep forgetting that TANSTAAFL?
Interesting piece. Long story short. It went up. It will go down. It always has. it always will.
It's just that nowadays, we have a bunch of educated twits who cannot accept the reality of market declines. The solution? Get on the web and howl.
Good day.
RC
Stoneleigh,
I would argue that you have made a glaring omission in this summary. Namely, the role that China, Japan, and the members of the GCC have played in the liquidity bubble of the last decade.
Monetary policy influences the economy through four "channels." First is the money or interest rate channel of monetary policy influence. Higher interest rates raise the cost of funds which has adverse effects for home buying, consumer spending, and business investment. Second is the credit channel, which acts alongside the interest rate channel. Tighter monetary policy leads to a reduction in the supply of bank loans due to increases in perceived risk. Third is the wealth channel. Higher interest rates tend to lower the value of bonds and stocks, which lowers household net worth, leading to a weakening of consumer spending. Last is the exchange rate channel. Higher interest rates tend to strengthen the dollar, leading to a decline in the competitiveness of American products. Through the combined effects of these four "channels," monetary tightening leads to a slowdown in economic activity.
However, when the Fed tightened monetary policy 17 times between 2002 and 2006, raising interest rates from 1% to the current 5.25%, all of the above channels were essentially clogged due to the enormous and sustained purchases of U.S. debt by foreign central banks. There was no effect through the interest rate channel, since even as the Fed Funds Rate was increased, mortgage rates and other long term rates continued to decline, allowing households and businesses to continue their borrowing binge. There was no effect through the credit channel, since loans became far more available, rather than less available, as banks continued to relax their lending standards to both households and businesses. There was no effect through the wealth channel, since both stock and bond markets continued to soar (as well as real estate prices) leading households to feel more, not less, wealthy. And there was no effect through the exchange rate channel, since the dollar weakened considerably throughout the period of Fed interest rate hikes, leading to increased competitiveness of American goods, rather than decreased competitiveness. This was Greenspan's "conundrum."
In short, during the 2002-2006 period, the Fed became impotent, but instead of admitting, "I can't get it up," Greenspan declared that there was a, "conundrum." The enormous U.S. Financial Account Surplus (foreign central bank purchases of U.S. debt) is the mirror image of the enormous U.S. Trade Deficit. As long as the Trade Deficit exists, the Financial Account Surplus exists. And as long as both of these exist, one can argue, the world will be awash in credit. As Michael Pettis states on his China Financial Markets Blog,
By ignoring the true origin of the current liquidity binge, the U.S. Trade Deficit with the world, and placing the blame instead with the Fed, you are hiding the very real possibility that this liquidity binge may well continue after a brief, temporarily painful, setback. After all, the root cause of the liquidity and credit bubble, the U.S. Trade Deficit with the world, is still as strong as ever.
To your point wHoOps,
The Japanese monetary base has been allowed to double over short periods (i.e.: less than three years) three times. The last one from 2001 to 2003 -- that's 26% per year. That makes the Fed look like a bunch of sissies!
I doubt if the US consumers of last resort will be purchasing much from overseas for much longer. IMO their purchasing power is about to be abruptly cutailed. The exporting countries are going to end up with a huge overhand of productive capacity compared to much reduced demand.
Essentially, I think China is where the US was in 1929 - on the verge of a depression due to over-building almost everything and accumulating a massive pile of bad debt in the process. I think they're about to experience a set back at the begining of their emerging hegemonic dominance, as the US did and other emerging powers before them. I would argue that the US is where Britain was then, without the prospect of the cheap energy that cushioned Britain's fall from empire. I discussed this point in Entropy and Empire.
Stoneleigh says
" I doubt if the US consumers of last resort will be purchasing much from overseas for much longer. IMO their purchasing power is about to be abruptly cutailed. The exporting countries are going to end up with a huge overhand of productive capacity compared to much reduced demand.
Essentially, I think China is where the US was in 1929 - on the verge of a depression "
So are you agreeing with Whoops that the (your) deflationary scenario is dependent on china crashing?
Also the US consumption decreasing I guess is housing problems slowing the US economy.
BTW fascinating , great job on the financial issues.
I don't agree that my scenario depends on China crashing, although I think China will see a crash and that will make any kind of recovery much more difficult. I very much think that the liqidity crunch will be global. An awful lot of the financial 'toxic waste' ended up in Europe and Asia.
This article is a remarkable analysis of the current crisis. The author shows in an extremely clear way the complex interactions of real estate crisis + credit risk crisis + hedge funds strategies + credit derivatives bubble.
This is dynamite!
Thank You for this great article.
Pete Roll
Is there a similarity between my own financial collapse and the prospects for the western world. At the root of my bankruptcy was a disabling disease which cut my income. Working families in America have experienced paycut after paycut for nearly 30 years as investors have cashed in with more and more profit during the same time period. China has been letting us buy their goods on time for over a decade while OPEC has been doing the same for even longer. Could peak oil be the disabling disease which drives America over the edge? Without PO all these financial shenanigans would probably have little effect. It is the inability to produce and distribute enough goods to meet the monthly payments which matters. I reached a point where I could no longer do that. Have unfair trade practices put America in similar circustances?
How convenient for OPEC. They have an excuse if they don't come up with the production. Thus, they will talk about how much more oil they could have produced if they had spent N billion on development.
Cynical? Yep.
Any particular reason they decided to meet on Sept. 11th? OPEC is going to adjust their quotas downward to match whatever their member states can produce. There will always be some kind of excuse. If it's not toxic mortgages, they'll cite something else.
So the question is.... will banks allow people who were once home owners to remain as "stewards" of the property while they learn to grow food and use whatever land they have available?
There sure will be lots of Yellow School buses bringing former white collar workers into the fields again, eh? Without such policies and programs, people will be starving and killing one another.
I'd rather eat beans than one another.
www.lawnstogardens.com
Stoneleigh,
You certainly paint a stark picture. Any recommendations on where to place your assets to weather the storm?
Hi infp
I would think cash will be king and good to have about until, like Stoneleigh says, the fiat hits the fan in superhyperdooper inflation.
Another option is a good old sack of beans and rice. Souperman2 recommends that a dollop of lard to go along with them is a taste sensation ne plus ultra and who am I to gainsay him there? I have never known him to be wrong in matters of culinary delectation, l just love his hot dawg stew:)
and infp, come over to Stoneleigh's Roundup he serves very fine things like the above over there .
I have about 2 months of food on hand and about 3 months on the way.
Also just bought a radiation detector/monitor from Major Surplus n Survival. It was their last one. Get 'em while you can.
I guess chimp since it was the last one he will have to get it out of your dying hands?:)
BTW in the above posted by me re Roundup I was referring to Stoneleighs fine article here and not to Superman2's fine stew.
Hey just a thought, why not get a dog and buy it five months of food, everyone would be patting you on the head and saying "what a nice loony wee man, a little loose in the upper structures but so thoughtful buying his dog five months of survival food too".
That would give you ten months of food and a dog to eat too. I'm not sure what is good for taking the taste of dead dog out of ones mouth, but you have a great imagination so I am sure you will think of something.
Best wishes for culinary delights.
Matt,
Honest, I'm not standing on a soapbox right now. Sold it.
I do have a question though: when that geigercounter goes off beeping like a motherfukcer, what are you planning to do? Or to be more precise, I'm thinking you'd want to get moving, like an MF, and far away too, but how would you move 5 months worth of food and still be fast enough?
Santa Rosa is a tertiary target. Even if it's hit, there is a good chance of survival if you can move to the areas with less fallout. They idea we're all dead meat in an attack is myth.
The thing beeping like an MF is why I'm buying the thing. So you can use it to navigate to somewhere where its not beeping quite as loudly.
If things get as bad as I think they will, the stored food will be next to worthless. But if we get 6 months of another Great Depression prior to the nukes launching the food will have been a wise purchase. If the nukes drop tomorrow, then I will have purcahsed the food in vain.
BTW, Stoneleigh included a picture from the Great Depression in the article. Question for the non-doomers: How did the Great Depression end?
Answer: with most of European civilization in ruins and with a regional nuclear holocaust in Asia.
In other words, it took 2 nuclear bombs going off before the Great Depression was "solved." People here in the States forget that because in North America we had the post WW II cheap oil suburba blowout. But as you know, that's not going to be how things end a second time . . .
I'm curious: What makes people honestly think another Great Depression won't end similarly to the last one, particularly since we now have 20,000 nuclear weapons floating around, many in the hands of individuals who honestly believe they can win a first strike nuclear war?
The whole situation is 10,000 times worse than in 1929-to-1945 but people seem to think we'll get through this Great Depression with light rail* and letters to our congressmen.
(*No offense Alan)
Chimp--
That is good news (About Santa Rosa) because that is where I virtually live (in the spirit of the current virtual meltdown)---
I need to go to Kenwood to check my PO Box every couple of months, just to make it "official"------
Been drifting further North, as things seem more to my liking in Mendo and Humbolt---
Run with the hunted--
hightrekker
Perhaps hope will be as scarce as civilian gasoline deep post-Peak Oil. Desperate hopelessness can lead to "irrational" choices.
Creating hope and an internal problem to solve could well be a side effect of my plans. A different path. Thus my sign-off
Best Hopes,
Alan
Matt,
First of all I'm sorry for my smart ass comment a week or so ago about your not having an having an "Ah, Ha moment." It was a rough day. That being said, people should get ahold of the movie Testament for a fictional idea of how things might play out after a nuke where there is no blast but fallout. Want to be depressed? This is the one. But from a survival point of view, it offers many insights of how not to do it.
I'd also suggest that people watch The Edge. A hokey movie with some really important ideas.
Todd
Todd,
No need to apologize, I didn't even take it as an insult. And even if you did mean it as one, I've taken far worse degradation than could ever be thrown my way on these here internet(s) discusson. (I did graduate from a first tier law school after all. I'm accustomed to be degradation.)
Will check out the film although even I can only handle so much depressing info at once.
Rather than using fiction to get a grip on reality, why don't you read Cresson Kearny's Nuclear War Survival Skills,, a book written by Kearny under the direction of the US government while he worked at Oak Ridge National Lab investigating the problems of surviving nuclear war. It's available online for free now because Kearny believes this information still needs to be spread far and wide.
Or maybe try The Effects of Nuclear Weapons by Samuel Glasstone, which is THE reference on nuclear weapons.
I'd suggest reading a bit of fact rather than relying of fiction. Did you know that there was a blast shelter less than 100 meters from ground zero of Hiroshima that survived with no issues? This was a conventional blast shelter for use against conventional weapons. How can this be? Read Glasstone and learn. How do most people near the blast of a nuclear weapon die? Don't know? Maybe you should because it almost certainly won't be in a bright millisecond of light the way some people think.
"The greatest shortcoming of the human race is our inability to understand the exponential function." -- Dr. Albert Bartlett
Into the Grey Zone
I have 2 copies of Kearney's book sitting here on my desk. I went ahead and bought two copies as I want to have the print editions should the net/grid go down.
I don't need a gieger counter because Sebastopol is a nukular free zone.
Sebastopol = land of the million dollar hippie.
Half a league could be far enough, depending on the wind & terrain.
I'm just beginning to stock up :-( What a crappy time, business wise, to discover the need - things are really slow for me :-(
The key thing is to eliminate debt. After that, cash (and cash equivalents, such as short term treasuries) is king in a deflation. All manner of assets end up being offered for sale as people try to raise scarce and valuable cash. You wouldn't want to trust the banks with it though (you might want to look up the Argentine experience from 2001 to see why).
Treasuries should be a low risk option for quite a while. The dollar should benefit from a flight to quality as credit spreads widen and it'll be a long time before US treauries end up going the way of Russian GKOs from 1998.
If you have anything left after that, you could also think about investing in the necessities of life, or better yet the means to produce them.
Hi. Let me ask a naive question. When you say "short-term treasuries", what are these exactly? Is it a bond you can buy, or what? I have some I bonds which are issued by the govt and are theoretically cashable on demand, but they aren't transferrable. Could you give me a short explanation of how a regular person might shift some of their scarce funds into these? Thanks for a great piece...
Short term treasuries are simply government bonds with a short duration. There's no need to worry about having to sell them because the government owes you your money back every 30 (or 60, or 90 etc) days, and you decide whether or not you want to take it or roll them over for another term.
You don't earn much interest, but then we're moving into an era when the return ON capital will be much less important than the return OF capital. High yields mean high risk. Credit spreads (the risk premium over treasuries) are set to widen dramatically to reflect increased risk.
I wouldn't bet on Uncle Sam's credit-worthiness 30 years down the line (or want to be dependent on finding somone else who would, to take my investment off my hands), but I'd be comfortable with rolling over a short term commitment for the time being as the safest means to maintain liquidity. It would be much safer than trusting a hollowed-out banking system to look after a savings account IMO. The more direct control you have over your liquid assets, the better.
There are, however, risks whatever you decide to do monetarily, which is why I generally recommend investments in the the necessities of life, or better yet the means to produce or obtain them. Self-sufficiency is the best hedge against disruption. When money is scarce, it's hard to hold on to, although you need to try because having some is essential (you need to be able to pay property taxes for instance, even if you don't have a mortgage to worry about).
In Argentina they converted short term bonds into long term and then defaulted on them. In Russia they reissued the currency and made it difficult to convert from the old to the new so that the middle class lost their savings. In the US in the 1800s, people were sent to debtor's prison for non-payment of the high taxes that had been levied in order to pay those same people the interest they were owed on government bonds (see Manias, Panics and Crashes by Charles Kindelburger). There is risk everywhere. Depressions are unkind to almost everyone in one way or another, although a few may do very well.
Say, here's another naive question out of the blue. If Bernanke actually, literally wanted to drop money from helicopters or the equivalent to prevent deflation, how much would he have to drop? In dollars, and in tonnage? Would they need to drop nothing but thousand-dollar bills in order to keep up, or would they need to drop bigger ones? Would the drops mostly be done in red states, and wouldn't it be an interesting scene?
Not that the Chinese and others would be that sanguine about it, but I reckon they'll dump dollars at some point anyhow, and not from helicopters.
In wondering just how surreal things could get, I joked with my wife about them dropping new thousand-dollar coins which included radioactive waste - you'd have to spend it fast to survive, thus keeping an economy churning. I suppose other 'modifications' which could be made would be 200-year mortgages, or laws which would allow you to sell your children into bondage.
hmmm
Longer mortgage terms are characteristic of market tops, because they imply a very sanguine attitude to risk. As the current liquidity crisis develops into a real credit crunch (as I expect it to do), then mortgages are unlikely to available to most people at all. If they were then the term would probably be short and the rate of interest punitive, reflecting the resurgence of risk.
A credit crunch essentially means NO credit, unless one is wealthy enough not to need it anyway. As you can see, we're not there yet by any means - not when people can still merrily max out multiple credit cards or get 40 mortgages at a low rate. If you look at the graphic in the story on the from of a mania, I would say we haven't even reached the beginning of the bull trap phase. What we've seen so far is nothing but the tip of the iceberg. The signals as to the way this will develop are (IMO) all there, but we 'ain't seen nothin' yet'.
The US sent $12 billion in cash to Iraq, in the form of shrink-wrapped $100 bills, at a total weight of 363 tonnes. This is about 30.25 tonnes per billion, and it required C-130 transport planes. The Fed injected about $40 billion in 2 days. You do the math.
I can only conclude that Dr. Bernanke's remarks about throwing money out of helicopters were simply a metaphor for other solutions he'd use. If he were speaking literally-there's not enough cash, and certainly not enough helicopters. It would be merely a token gesture.
Stoneleigh--
Thanks for your great summary.
A few comments...
I believe it was last Saturday's WSJ which had an article about the difficulty and laxity in accounting for all of these hedge fund and derivatives transactions. If one mortgage gets owned by a dozen groups, how does one accurately account for that or when debt is sold and rebundled and sold again layer upon layer, at what point is the accounting lost? The article mentioned that the feds have done investigations and warned these companies and groups to keep more accurate accounting. This also becomes evident as I read through your descriptions of where we're at right now in this inverted pyramid situation. It seems it is potentially such an accounting mess that it reaches a point where it may be impossible to reconcile.
Secondly, I will quote an excerpt out of yesterday's front page WSJ story "Markets Crisis Tests Resolve of Fed, Officials" by Greg Ip, Deborah Solomon and David Wessel.
I certainly would like to see these protocols--each person gets a ten dollar bill and 2 loaves of bread and 1 gallon of gas...
And, lastly, I recall the majority of the Federal Reserve's board members resigning more than a year (not all at once, but over a relatively short time period), perhaps two years ago. I always wondered what triggered that. Just thought I'd bring it up during this uncertain time to see if anyone here knows.
WIDESPREAD PANIC and betting your azz
Well, so it goes....
Another bubble does what bubbles always do, and everyone acts surprised.
And don't kid yourself, they will be just as surprised when any one of the major bubbles in birthing burst later....just like chickens, they wake up in a new world everyday. The Chinese bubble? The Eurocurrency bubble, and best of all, the commodities and fuel bubble.....NOOOOO, their different, they will last forever.....the famous chant, "THIS TIME it's different."
So now, the panic sowers are at full screech, using such well known and authoritive sources as Wedbush Morgan (???) and "The Richebacher Letter" to prove beyond a doubt that the collapse had come, it's all over, as "the chimp" says, hoard food and radiation detectors (and what to do if it actually shows radiation?) (ilargi's post is a comedic masterpiece, picturing the chimp, Kunstler and Deffeye's trying to carry their old bones down the road with 5 months of food on their back....and to where?....maybe GW will let them into his off grid Texas bunker for a stay?) :-), hee, hee
But that's the spirit we need, FULL CAPITULATION. When the chimps advice is on the cover of "Money" and "Business Week" we will have taken the cure....
These are exactly the times that one has to ask him/herself, o.k., do I bet my azz on the collapse? Interestng question isn't it?
Because right now as we speak, people are also beginning to look for the bargains, and bet their azz on the recovery following the collapse, or setback, or recession, or bear market, or whatever you want to call it.
In central Kentucky, we are buried in new houses, and they are still to this day building like mad. One townhouse development I was interested in, I turned away from buying a unit in because it seemed too crowded, units packed in like chicken hutches in a factory farm. They have since added about 16 more units. The question is, who plans this stuff? Would they be worth anything to people of sense even in a good economy?
Our local big bank took another 6% percent hit on share price today, even though they do not have more than a percent of their total value in mortgage exposure, and are now at a 52 week low (and they have been flat anyway since 2002, never quite picking up their old steam after 9/11. Contrary to the popular picture of "boomtimes" many businesses still have not recovered) So why are they caught in this panic? Just general fear?
One of the biggest trainwrecks recently has been the IPO of Blackstone Group. But why? They have assets in some of the most promising growth industries, and they have some real estate holdings, mostly commercial, but virtually no exposure in subprime. After losing almost a third of their value on the IPO, they are now trading at a 2 to 1 price to earnings ratio. (!!!) This is the nature of WIDESPREAD PANIC (no, not the band, but their popular too), but it STILL HAS MUCH TO GO.
But the big money is waiting. The Buffet types, the big families, the old coupon clippers who leave the fvcking stock and retail credit markets alone simply because they are prone to these types of hysteria spells, are sitting off to the side, with cash to spare. They can afford to bet.....when the time is right. IT IS NOT YET NEARLY RIGHT.
They want this stuff at GIVAWAY prices. They do not want to pay even half of the value of the assets. They live by the rule, NEVER pay retail, or ANYWHERE NEAR IT.
The little investor can see this. The little investor knows they are being timed out again. And again this time, if they are carrying any debt, they may well be timed out of their home, through the use of the now almost godlike power of the credit rating and the variable rate. Remember the 1970's?, when people would just leave the key under the mat and walk away, with nothing. This is NOT new folks.
It has seemed that for a long time, the elites have hated the thought of masses being allowed to own their own home on thier own land. If we could drive them back to the slums, the chicken hutches of densely populated urban compounds, it would be easier to manage them, don't you think? (Read Kunstler for the philosophical justifications)
The little investor, trying to pay his mortgage, and with his money trapped in 401K's and IRA's and pension funds, has no power to move, to protect himself easily, to take advantage of the "crisis". But the big players with cash on the side will. Despite the rants against cash here on TOD, does it not interest you that the wealthy never turn it down? They will take your "worthless" dollars, down at the pawn shop, the rent to own stores, the "Get Cash for your paycheck now!" shops. They will take it one dollar at a time if they have to.
The other day, there was an article on Yahoo finance giving advice...."Why your child should have a credit card." And the band plays on. Tell the credit card company those "dollars" in interest they will take from you by the thouand are worthless.....see if that pig will fly.
I don't know about Chimps radiation detector, but we sure are in need of a bullshiit dectector. The advice to pay down debt NOW is excellent. if you can pay off your mortgage, DO IT.
I have managed to shave some 60% of my debt in the last year, and am basically living like a dog to finish off the rest. Air conditioning in Kentucky on a 98 degree day I am treating as a luxury. If I can hold my 1982 Benz Diesel together for another year (it's been a challenge I admit, and driving in an air conditioned car could be nice....:-), but the DEBT, especially the high interest debt has to go.
Make no mistake, this "crisis" is a set deal to do what it is intended to do.
And for the peakers, let's see whether you run out of the "worthless" dollars to buy that fuel way before the country runs out of fuel?
By the way, if your so sick of those worthless dollars, contact me. I will arrange shipment of them to my place......I need some to invest after the full capitulation is complete.
RC
Remember, we are only one cubic mile from freedom
Roger, why is it that everybody wants to go on a full bored apocolypse-o-rama about every third day on this site? Too many links to gold dealers? Everybody misses the last judgement and the chance to get raptured out of their tennis shoes?
Really,folks, your owing money is basicially your creditor's problem. Your banker probably needs a real job instead of approving credit card applications, maybe fixing bicycles. And if you fall out of the middle class at least you don't have to wear a suit at the office.
Bob Ebersole
How does that relate to the brewing crisis? I am given to understand that a major part of the problem is the large number of people who own neither homes nor land. And I imagine the manicured manor set just laughs at the plebes who are proud of their 2500sf houses on 3500sf lots.
I would argue the opposite (although partly just to be contrary). Urban neighborhoods pose a real threat of becoming strongly cohesive. And a sparser area with single-level buildings will show targets much better - "needle in a hay stack" isn't as effective as "needle in a needle stack". I'm pretty sure it was easier-to-manage urbanites at the "Battle of Bulls' Run", too.
please dont mention a 'brewing crisis', I've got enough to worry about already.
Yeah, nothing scares me like "Peak Beer".
really great article, thanks.
meanwhile, the analysts are out there trying to convince everybody that it's no big deal:
Wall Street Problems are Real, but This is Not a Credit Crunch
Don't know if you care to make any particular criticisms of this "everything is ok folks" view. Your article does a great job of presenting the other view.
cheers
Phil.
OXYMORON OF THE MONTH
Hedge Fund.
What do you want to bet they didn't say "everything is ok folks" all the previous times:
http://en.wikipedia.org/wiki/List_of_recessions
http://www.foxnews.com/story/0,2933,255141,00.html
http://en.wikipedia.org/wiki/List_of_stock_market_crashes
http://en.wikipedia.org/wiki/Business_cycle
(The Austrian School is particularly interesting)
I want to make it clear that I do not take the position that this coming recession (and it will come....when and how deep are always the issues) is in itself a terrible thing, or "the end of the world economic order" or anything of that nature. Let's always be honest, it COULD BE, but the odds are rather low of that, as they have always been.
Recessions are a normal part of the economic cycle. They serve a purpose, and they serve well those in a position to play the game well, and with the composure to play the game well. They can be brutal to those who are not well positioned (been there, done that).
Let me ask folks a few questions, and be honest:
Did you know there were this many "hedge funds"? How many are there actually? Who sets them up, who sets the guidelines for them?
Did you know there were this many so called "banks", and by that word I mean banks, credit unions, mortgage brokers refinance shops, secondary lenders, venture funds, Limited Liability Partnerships, credit card lenders, rent to own, pre paying check cashing stores, etc, who are all engaging in a supposedly "banking" function?
This is typical of a financial speculative boom run amuck. How much money in the U.S. is spent on "financial services" per year, per capita? I am willing to bet that it matches or exceeds what is spent in gasoline (again, I will speak for myself, what I once paid per year for interest payments dwarfed what I spent in Diesel fuel to get to work, and still exceeds it by some amount, and I commute 40 miles per day (both ways).
A nation (in fact, the developed world, because it is not just the U.S.) can carry that type of parasitic loss only so long, even in good times. For the U.S. carrying the massive financial parasitic loss, plus carrying a full blown war (we have been in the Iraq war as long as it took to win WWII, has anybody noticed?), and massive export of money for goods and energy.....gee, wonder where all the money went? Something has to give. The longer we put off this recession, the more it will hurt. Let's take our whippin' and get it over with.
Then can come the efficiency gains that our technology will allow, and with the pent up advances that we can then fund, REAL ADVANCES, not financial parasitism, the efficiency gains can be huge.
RC
Remember, we are only one cubic mile from freedom
Hi Thatsit,
That is exactly what they did say last time and many like myself believed them and lost a bundle. If the dot com had torn the wheels off this garbage cart of a economical/social nightmare it would have been the greatest investment I could ever hope for, rather than just a loss of a bundle.
Heres hoping we do better this time:)
.
I'm not so sure. I was hoping that I would be getting fewer refinance offers to throw away, including from my own bank, as these gyrations happened. I was finally getting around to filing my taxes (an accountant told me that extentions go to October now, but that is another story) and I needed the mortgage interest number to plug into the software I now use to avoid expensive math errors. I had put the bank's report in a safe place when it came in in February so I could not find it. I was busy in April getting ready to bend Steny Hoyer's ear about global warming which is why I set it aside and filed for an extention. So, yesterday I called up the bank to get the number. In the end I recalled my safe place so I didn't have to figure out a way to get a duplicate without a service charge, but it was nice that they were able to tell me over the phone what to plug in.
Today, I got a call from my loan officer saying that she'd heard that I'd called and did I want to refinance? I mean there is no way that I would want to do that at a higher interest rate so why did she call? I think there is a need to be doing deals. A credit crunch means that many people who do loans have nothing to do which means they don't get paid. So, what I think will be happening is that, for places where there is remaining equity and a good history of repayment, we'll be seeing a very agressive effort to get people to refinance. Bring interest rates down a couple of points, and you get a whole batch of new good credit loans that (fictionally) retire a lot of the debt in the troubled securities. Since the business of banks is to now churn credit rather than to provide credit a simple ploy would be to raise the retirement age by 3 years, boost annual social security benefits a tad and make 40 year 10% down mortgages with lower interest rates but the same or higher total interest the norm rather than the 20% down 30 year mortgage. A liquidity crisis hurts the banks' ability to always be doing a high volume of transactions so I think they'll find ways to counter this. States are already experimenting with 40 year mortgages. I think if Fanny Mae started going big into these, the rest would follow. This would also convert the ARMs after a bit so long as they are not too far in negative equity.
Then it is just a matter of getting the local politicians to work out ways to churn real estate more. More deals, more money to be made....
This is actually a perfect excuse to "fix" social security.
Chris
The view never changes unless your the lead dog!
Wolves lead and the sheep follow , guess what happens to the sheep , they get eaten......Gordon Geko wallstreet. Payoff your depts and act like the people who raised me do , these people were raised in the depression. Never a bower nor a lender be. Going through a divorce and raising two teenagers has been hard , but resisting the new ATV , boat , truck , car ,snowmobile , camper and paying off dept first is now starting to make me feel better.Grow some of your own food and you do not need take out or high priced meat very often.I was raised on canned beans and cheaper staples. At 48 I still remeber paying 16% interest on my first house , it is the younger generation who are in for a big wake up call. Just remeber more stuff does not make you happier and learn to conect with people for fun. Go to Cuba for a trip and see a very happy family centered people who are not burdoned with to much stuff.
PS when eveything goes down the tube , I will buy my toys at 10 cents on the $ hehehehehehe...........do they make a solar powered snow blower............
Solar in Alaska is an interesting thing. The resource is actually pretty good but very seasonal. If you pack your energy use into the summer say in a cannery, then it could make a lot of sense. Buildings that are summer use only can benefit as well. Alaska does not have a net metering law so you want to isolate the use of solar from the grid, but in Alaska the grid is not all that developed so there could be a lot of potential. There are electric snowblowers, but you won't have solar power when you most need to use one.
I'm glad you're pulling things together. I'm thinking that I'm somewhat insulated because my house is set up as two units while employment does not fluctuate so much where I live so a subprime crash means lots of renters who have jobs and lots of low cost properties to ride back up plus the refinance things I mentioned above. I think the effects will depend on local cirumstances quite a bit, especially the source of employment. Govenment tends to grow in a financial crisis so that seems to me to be a factor to consider.
Chris
The view never changes unless your the lead dog!
I live in whitehorse Yukon canada , not alaska and we have a dam that produces our electricity for the territory right in t0wn. What saves us is we are not conected to a grid to outside , so our energy can not be sucked off to the highest bidder.We are at the end of the supply line as far as food goes though , it hard to imagine what would happen if those trucks stopped rolling from down south. The good news is we have a lot of wild game to eat . clean air , water, fish and it is getting warmer very fast. If you look at a map we are 30,000 people in a hugh territory in the middle of now were and it is boomng here. Resource extration is booming as we are really the last frontier.Every day the $ I saved goes up buy selling my stock 3 weeks ago.........
Sorry I got the country wrong. Sounds beautiful. May you always time the market.
Chris
Where has all the money gone? Maybe these guys have it....
http://blogs.reuters.com/2007/08/14/blackstone-on-the-fundraising-trail-...
HSI -631.00
NIK -369.00
For those wanting a reference for Musashi's numbers, here is Bllomberg's Asia index list.
"The greatest shortcoming of the human race is our inability to understand the exponential function." -- Dr. Albert Bartlett
Into the Grey Zone
And for Thursday so far we have:
Asian markets are crashing, hard, so far for Thursday.
"The greatest shortcoming of the human race is our inability to understand the exponential function." -- Dr. Albert Bartlett
Into the Grey Zone
It is altogether too late for this country. The fascists and their traitorous supporters have sold us out and the house of cards is coming down. Pretty much anyone who voted for Bush in 2004 is in that category. They might as well give the right to vote to cattle.
For six years this administration has raped this country and concentrated immense wealth into the hands of a privileged few, gutting our institutions and the constitution. Fed policy has led to the subprime debacle, but it allowed those few to multiply the mortgage debt by a factor of 20 times the debt in housing.
This was the last rape of a once great nation facing decline. We have seen the decline of the dollar which has halved our buying power at the same time that the credit was loosened so that Americans could make ends meet through increasing mortgages and second mortgages. It was no consequence to the administration and their handlers, since they have seen the end on the near horizon since 1999. Each mortgage no matter how shaky or untenable in the long term, put 20X into the pockets of the few A manufactured “Pearl Harbor” (911) has allowed this administration to gut the treasuries and kill social services. And through executives orders that amount to the president making laws, Americans have been stripped of their rights and through fed policies have been driven to the level of indentured servants as the few have lined their pockets through the deaths of hundreds of thousands of innocents in Iraq as well as anywhere else that oil can be found.
At a level of cause and effect, the subprime debacle is not the cause. It is an effect that in turn has become a cause. The primary cause is and will be oil depletion. This year oil production is down 1.3 million barrels per day from last year. The global economy is contracting. In the last 2 weeks the US came up short by 11 million barrels of oil. Tomorrow, the oil inventory report comes out and if we have dropped another 5 to 6 million barrels per day there will be another blood bath on the stock market. If they can show an increase which is unlikely, then there will be a reset for a week till the next report comes out the following week. But the decline rate is increasing. Mexico announced three Fridays ago that in seven years they will be out of oil. Not declining, but gone. They are the #2 supplier to the US and they will no longer export to us within 3 years. That’s about 15% of our imports gone in 3 years. To give a scale, 5% reduction in 1973 resulted in oil prices that in today’s terms would be $100/barrel.
The markets have finally understood it, but too late. Big money is withdrawing their “hard-earned” capital. They are doing it so quickly that it would collapse the global markets except the national banks have stepped in to save the day. In the last 2 weeks, market capitalization has decreased by $3.7Trillion including today. National banks have dumped easy low interest money into the market to ostensibly provide needed liquidity, but it is a hoax. Last week the Bank of Europe and others threw about $200 Billion into the market to stabilize the situation, and on that day the market fell by 387 points. Each point represents about a $3 Billion lost in market capitalization. In the last couple of market days the banks have added an additional $200 Billion, and even so the DOW dropped more than 200 point today. We have lost a thousand points in the last 2 weeks. But the losses have been big money withdrawing their capital, that is to say that those few that have ruthlessly capitalized on the “War on Terror” have heard the fat lady sing and have drawn their wealth in out of the markets. The national banks are supported on the backs of the tax payer and so is no skin off their teeth.
This will turn into a run on the banks in the near future unless the torrent is somehow slowed. Oil depletion means that by the end of August the US will be below the 10 day safety band while we have been above it for the last year. The prices have finally reached a breaking point. By the end of the year there will be 0 days of buffer and shortages will hit the US. Shearson claims that oil could reach $100 a barrel by March, but statistics show that it is likely to be closer to $130 since institutions typically underestimate by 30%. But the meltdown of the US derivatives have left a very sour taste in the mouths of the foreign nations that have fueled the subprime debacle by buying US bonds based on mortgages that are proving to be rotten. The dollar could easily go through a complete collapse. Hyper Inflation or rather Hyper Stagflation.
Anyway, Global economic meltdown has temporarily been averted at the cost of the taxpayer once again, but it is a short lived reprieve probably only a matter of weeks. In Oct alone $50 Billion in mortgage defaults will lead to another $1 Trillion lost on the markets. In the coming weeks, I expect that many days the trading will be stopped because of loss limits, but we should still see several weeks where 1000 points are lost on the market. Next year will be very tough. Ultimately, by 2015 to 2020 the US population will drop to something less than 15 million (Liebig’s Law) and the world population will be under 2 Billion probably under 600 Million if you factor in war.
As a non american i have a question.
Lyndon La Rouche in his website EIR, states that the current world financiel/monetary system is now finished and will collapse.
I don´t know how to value his claims, because i don´t know who he is.
Can anyone moore in the know fill in the blanks?
All I knew is that LaRouche runs for President a lot:
http://en.wikipedia.org/wiki/Lyndon_LaRouche
Hi Swede
Thank you for having the interest and taking the time to post. I am always grateful for a European perspective, and I know others are too.
These are my own opinions, but its very possibly the most common one in the United States. La Rouche has a cult. He has been around since at least the early 1970's. His message is always the same. It is that the United States is collapsing because of what ever problem.Lyndon LaRouche is the only one who can save us, send donations, elect LaRouche for president.
He has always done this, and the US under George H.W. Bush even sent him to Federal Prison for tax fraud. His followers continued raising money and put him on the ballots from prison!
His followers are notorius for joining other movements then trying to take control of the meetings. I've seen them in action in movements as different as the anti-war movement and the Democratic Party, and have heard of them with the same agenda with theLibertarians and the Republicans. His people are very disruptive and all seem to have mental health problems I know that this sounds bigoted, but I'm sure you will hears the same from others here. I hope the spiders and cookies don't now get him on TOD, but if they do, its inevitable, nobody's fault.
I think he is a dangerous nut.
Bob Ebersole
Bob, I'll second your opinion of LaRouche! The guy is certifiable, and because of that attracts the attention of the media from time to time.
Hi OilmanBob
Thank you very much for that valuable information. I was already a little suspicious about his movement, but i could´t really know what to believe.
Do you perhaps know anything about "The global financial forecaster" Bob Chapman?? I read his free snippets, and listen a little on his radio show appereances. He claims that his service always has been right forecasting economical events.
BTW i believe, that we are in for a new great depression, and that soon the housing market here in Europe also will begin to collapse alongside with the speculative paper markets.
Personally i have invested 100% in physical Gold and Silver. The M3 in Sweden is also going berserk with 15-20% annually. Something is got to give.
Regards Kenneth
Edit: It should be "The international forecaster" Robert Chapman.
The thing is La Rouche is right that the US has been in slow motion collapse since about 1970-1975. Of course, he doesn't seem to connect this to the domestic oil peak. But most of these types don't as that's not sexy enough for them.
There is from time to time some good stuff on his site. As usualy you have to filter the crap from the non-crap.
Only in recent years has the idea that "we is in some big ass trouble here folks" began to attract a critical mass of the non-insane.
Well, yes the description and the causes of the coming collapse of the financial/monetary system by mr La Rouche seems logical, so he could be right there despite beeing kind of weird.
Well, looks like he is a bit eccentric and a loose cannon but the one thing that is for sure is that he is not owned by AIPAC. :-)
http://en.wikipedia.org/wiki/Lyndon_LaRouche
"Ultimatly, by 2015 to 2020 the US population will drop to something less than 15 million"
Everything you write seems right, then you come with this collossal die-off.
Could you describe how this die-off could happen??
War.
Plague, famine, war.
Famine is the easy way out. No destruction of the infrastructure, no emptying of the pipeline of raw materials, etc. Bet on somebody deciding to fight global warming using a basement nuke (basement nukes are big enough that they can't be carried on a plane, so massive destruction and fallout result), duct taped to a volcano. Instant "year without a summer". No harvest, no food, soon, no people.
Plague is next. The logistics pipeline empties because people hide in basements. No food, no oil, no repairs to machinery and infrastructure. Just a sudden shrink of the older and younger parts of the population. Not as easy as you think to kill people that way.
We can put the kids in the schools and keep things running while we look for a vaccine. Average age of America goes to 12, which ought to make things interesting.
Nuclear war gives us both the above, and huge firestorms destroying everything else, like factories, telecommunications, railroad switching centers, pipeline interchanges, refineries, etc. And if you survive, you get to spend the rest of your life rebuilding things. Depressing.
It was BaSE i was asking, but now you jump in with this doomer thing.
OK every thing can happen, but how realistic is your doomer scenario?? Like aliens from mars attacking us?
If the trucks stop rolling civil disorder becomes widespread within about seventy two hours. Won't happen everywhere all at once, will yield martial law, but look at Los Angeles after the King verdict for a taste of what will happen.
Ever drive through Colorado? Warmer winters don't kill spruce bark beetle and warmer summers dry out trees. Anywhere from 10% to as much as 50% of the pines visible from I-70 are dead. Take water bombers, helicopters, and 4x4 firefighting machinery out of the picture and a state sized firestorm is entirely possible. The whole mountain west faces these issues.
I don't believe in loose nukes in the lower forty eight(yet) and the triggering of a volcano with one is definitely Hollyweird's next big adventure movie.
A portion of that will come to pass more easily than we'd like to think. We'll see a taste of it if another big storm hits the Gulf Coast this season.
Hi Swede,
Mostly I was ranting, because afterall, who can predict the future? However in general, the process goes something like this.
Just prior to oil production US population was about 65 mllion people and farming could support this many without the miracle of high nitrogen fertilizers from natural gas and the effective set of pesticides that we get from oil, plus the use of diesel in all the heavy equipment used in modern farming. And of course people lived somewhat off the land.
Now imagine a distant future where there is no oil or natural gas, and the people are surviving on the food they can produce without the fertilizers and pesticides that we get from natural gas and oil. How many people is that? The biggest problems for those people will be the depleted soil, loss of resources, fouled water, and depleted oceans. It is not unreasonable to imagine that the population would be less than when they had an abundance of good land, water, resources and fish. So pick a number... something less than 65 million to start, say roughly half, or about 30 million. I felt it would be still less and picked 15 million. A reasonable book is "Overshoot" written in 1980, which took a look at this.
So now we have a target population of 15 to 30 million and a starting population of 300 million, the question is how do we get from now to that mythical future population of happy thriving Americans in a time without the benefits of oil and natural gas. How long are we talking about?
Congressman Bartlett had an interesting talk which gave a time estimate. It goes like this. In the 70's the world used as much oil as it had in all previous decades. In the 80's the world used as much oil. as it had in all previous decades including the 70's. and the same pattern followed in the 90's and is going on in like fashion in the 00's. What all this means is that once oil peaks, we have 10 years till virtually none is left.
I pick 2005 as the year peak oil happened, so in 10 years from then, in 2015, we will have reached our target population of 15 to 30 million, because we will be effectively out of oil and natural gas at that time. Of course to reach that target will require a healthy dose of lawfulness, and a willing self sacrifice for the common good by those other 270 to 285 million people that have to die by 2015.
Regards, Ben
Wow, it´s eight years from now. In Sweden we are nine millions, and clearly we can´t sustain that population. Before the oil age we were a couple of millions...
Goog God allmighty, this is unbelievable.
Also very handy for money repatriation and laundering one would think.
I thought this article was fascinating - its story of subprime lending in a California suburb:
http://www.ocregister.com/money/loans-camile-percent-1806121-subprime-loan
One guy sold his house for a hundred grand more than he paid for it two years later. But he is pissed off it took him two years to flip his house. Another guy pulled four hundred grand out of his house. He's going to give the house back to the bank but so what. Zamora thinks he's a genius for paying off his mortgage. He's an idiot. He has nothing. His neighbors pulled big bucks out of their houses and when his neighborhood is overrun with gangs hanging out in vacant houses, all property values including his will go into the dumpster.
The most insidious affect of Weimar style hyperinflation is that it makes fools out of savers and rewards the profligate. The social cohesion that makes a society work disappears.
Thank you for posting an article comprehensible enough that I can send the link to my relatives... and maybe they'll read it.
I've posted this link before on the oil drum, but I can't resist dragging it out once again: if you want to know more about our financial system, it's hard to beat the audio series The Wizards of Money. There are about 22 episodes, and the ones about Financial Risk Transfer and House Leverage at the Derivatives Casino are especially relevant here. But by all means listen to them all. I listen to them while cycling to and from work each day (admittedly, not the safest practice, but much of my hour-long route is low traffic).
Thanks for a very good read.