The Oil Drum

In the US, as one door has closed on subprime lending, another has opened on credit card debt. Actually living within one's means doesn't always seem to be an option, for some due to poverty and for others due to greed. Either way, the debt hole Americans (and Canadians, and the British) are collectively digging themselves into is getting deeper by the day, and they start young.

As losses mount, the role of mortgage fraud, by both borrowers and lenders, and also potential securities fraud, is being revealed. The litigation is only just beginning, but be prepared for a storm of legal action and recriminations. The ratings agencies are looking vulnerable to European action as their ratings enabled the sale of bad loans to European institutions, under conditions of conflict of interest.

Signs of stress are spilling over from the world of high finance to the real economy, where trucking and shipping are feeling the slowdown. Meanwhile Canada (several months behind the US) is still seeing a booming housing market, but for how long?

With frozen ABCP (asset-backed commercial paper) apparently about to spawn a litigation nightmare in Canada, huge bank writedowns in the US and Europe, bank closures, a lack of interbank lending, large-scale ARM readjustments, exploding credit card debt, a growing surge in foreclosures, and homebuilders further depressing real estate prices by selling off their inventory for whatever they can get, one could be forgiven for wondering why global stock markets seem so unconcerned.

Some aggressive speculators - cushioned by the moral hazard of central bank liquidity injections - may be prepared to throw caution to the wind in overextending the trend, but others are waiting in the wings, well placed, through bets in the derivatives market, to profit from its eventual reversal. In a market at the peak of a mania, where rampant speculation drives volatility for short-term gain, arguably the best place to be is out of the game.

This is a Finance Round-Up by ilargi.

We have a 'luxury' problem today. Not only was Thursday Stoneleigh’s birthday, at least 4 articles deserve our top spot. And there’s much more.

Highly regarded finance writer Mike ‘Mish’ Shedlock has a list that looks like “Peak oil survival guide Part 1”:

Drowning in Debt - How do we protect ourselves?

• Don't Buy Stuff You Cannot Afford (classic SNL video)
• Have a Years' Worth of Living Expenses in Cash
• Buy Food On Sale
• Consider Wants vs. Needs vs. Affordability
• Reduce Leverage
• Consider Retirement Plans
• Challenge Traditional Thinking

And this House testimony by Robert Kuttner is a must read:

The Alarming Parallels Between 1929 and 2007

Your predecessors on the Senate Banking Committee, in the celebrated Pecora Hearings of 1933 and 1934, laid the groundwork for the modern edifice of financial regulation. I suspect that they would be appalled at the parallels between the systemic risks of the 1920s and many of the modern practices that have been permitted to seep back in to our financial markets.

Tighter credit regulations? It’s only gotten worse!:

Subprime Delinquencies Accelerating

Subprime mortgage bonds created in the first half of 2007 contain loans that are going delinquent at the fastest rate ever.

“It’s shocking what you see,'' said Kyle Bass of Hayman Advisors LP. “Anything securitized in 2007 has got to have the worst collateral performance of any trust I've seen in my life.''

And the icing on the cake:

The Death Of Investment
_{THE GREATEST STOCK MARKET MANIA OF ALL TIME}

By comparing how swiftly money passes through stocks in relation to both gross domestic product (GDP) and total stock market capitalization, we can see how the relative importance of the stock market rises and falls over the course of the last 80 years.

Quite obviously, in 1929, nothing was more important than stocks and when the corresponding mania peaked, trading was 133% of gross domestic product stock market and 228% of total stock market capitalization. In 2000, trading was 328% of gross domestic product and 203% of total stock market capitalization, a mania fully equivalent to the madness of the "Roaring Twenties."

Today, trading is 326% of gross domestic product and 237% of total stock market capitalization. For all intents and purposes, the current environment represents the greatest velocity of trading ever seen. However, by the end of the year, we expect that the current stats will be far more extreme, a bizarre circumstance that lends itself to only one description - a continuing stock market mania, the greatest mania of all time.

From July to August, in the span of just one month, the New York Stock Exchange reported that the monthly total for dollar trading volume had risen 21.7%. Share volume surged 29.7%. The number of trades soared 39.6%. The sheer speed at which our capital markets are evolving and metamorphosing is frightening.

The theme of investment is for all intents and purposes, dead.

An inflationary future is becoming conventional wisdom, but, as consensus takes time to develop, the stronger the consensus, the later it is in the trend. A consensus is a backward-looking phenomenon of little use - except as a general contrarian indicator - in detecting the inevitable discontinuities that can abruptly and painfully invalidate all one's assumptions.

We have lived through a long period of inflationary credit expansion, and regard it as normal, but credit expansion is a self-limiting condition. Credit bubbles are merely the rediscovery by a new generation of the powers of leverage (see for instance A Short History of Financial Euphoria by Galbraith, Manias, Panics and Crashes by Kindleberger or Financial Armageddon by Michael Panzner). Every credit bubble that ever existed has eventually deflated, and this one will be no different.

We have essentially already reached the limit of debt serviceability that brings an expansion to an end. We are already seeing the tightening of credit standards, the refusal of banks to lend to one another, the frozen commercial paper, the bank runs, the redefinition of what constitutes a store of value, the rejection of financial alchemy, the debt defaults that reduce the money supply, the falling prices in the housing market, the lack of confidence - which together unmistakably herald deflation. Central banks can do nothing more than paper over the cracks for a short time, at the cost of aggravating the eventual impact of deflation.

Time to Aim High?

I salute Wasik for pointing out the sham that the CPI is. However, it is because of the debasement of the dollar and distortions in the CPI that the Fed has practically forced risk down everyone's throat. But one must be cognizant of herding behavior that has nearly everyone thinking exactly like he is and the Fed wants. Aim high. Shoot for the moon. Do or die. You are losing money by saving. Buy assets. Only fools save. In the long term, stocks always go up.

The problem is that aiming high is synonymous with increasing risk. Up till now, risk taking has been rewarded. But what happens when everyone does the same thing? More to the point, what happens when everyone does the same thing for 20 years or longer? Eventually, risk gets so unappreciated that various asset classes go to the moon....

....Essentially, the same advice given for real estate (you cannot buy too much home, home prices always go up) is now being touted for stocks. There is an amazing belief in the Fed's ability right now to control the business cycle, as well as price stability. It's not warranted. At this stage of the cycle in a slowing economy, with rampant overcapacity, a tenuous job climate, and no real reason for businesses to expand, the odds are that aiming high is precisely the wrong thing to do.

This is a Finance Round-Up by ilargi. An Energy and Environment Round-Up will follow over the weekend.

Et tu, Canada?

There's a country just south of here that pretends to be the world's richest economy, but in reality seems headed for the Halliburdened poorhouse. Et tu, Canada? Depends on where you look.

The papers' front pages show Prime Minister Stephen Harper, knowing there's no opposition left to speak of, though he leads a minority Cabinet. Stephen, too stiff to even play golf, shuffling the greens with Tiger Woods for a photo-op. Then a broad media smile: an alleged record federal budget surplus ($13.8 billion). To top it off, the new King of Nadamaskakas magnanimously hints at tax cuts. Little detail: it's $35 per person per year, less than 10 cents per day. But it sounded good at first, right, tax cut? Bienvenue à la politique.

In the finance pages, a different take: lax laws have allowed trusts, funds and your pet parakeet to issue non-bank commercial paper (ABCP), to the tune of $40 billion (bank ABCP: $80 billion more). On August 16, the biggest gamblers tried hard to change this from short-to long term debt. Turns out, that won't fly: nobody can even figure out where it is or what it's worth. Caught in their own trap.

Québec's massive Caisse de Dépot pension fund holds $20 billion worth of it, a sizable chunk of their $240 billion portfolio, and that's just their domestic toilet paper. Our advice: Keep the day job. Till you're, like, 95. Your pension has been gambled away.

About that federal budget surplus: Canada's federal debt is $467 billion. Which, to our untrained eye, means the term "budget surplus" is the victim of acute and intense inflation. Harper actually said on TV that the surplus will be used to pay off the debt. On our untrained calculator, that would take, at the current rate, a negligible 33.8 years, or until 2041, providing no new debts are incurred, and inflation stops dead in its tracks. But we kid you not, at the moment of writing this, Harper's on TV, saying he does this for future generations.

To finish off this sunny newscast, while TD Bank raves about the tar profits, despite royalty reviews, Big Oil has launched the first lawsuit against Canada under NAFTA law. We'll see much more of that, soon, as in the Alberta royalty revision plans. Send your kids to law school.

_source

The week after we saw bank runs in the UK, a measure of calm has returned to the markets thanks to a combination of central bank bailouts, government deposit guarantees and interest rate cuts. For all that heavy intervention, one derivatives market expert warns that we are still at the beginning of the beginning of the credit crunch.

On the Canadian energy scene, the debate over the Alberta oil and gas royalties review continues. Alberta, which has lower royalties than comparable jurisdictions, wants its fair share, but that could affect Ottawa's tax take. Investors concerned about the royalty issue seem keen to extract themselves from tar sands investments. With the Canadian dollar at parity with the US dollar for the first time since 1976, there are concerns about the ability of the Canadian economy to adapt and compete.

Concerns on the climate front center on the potential for methane-powered runaway warming thanks to new research on the Paleocene-Eocene Thermal Maximum. The direct relationship between carbon offsets and increasing child labour in the third world is also worth highlighting.

Are we headed for an epic bear market?

One of the world's leading experts on credit derivatives, Das is the author of a 4,200-page reference work on the subject, among a half-dozen other tomes. As a developer and marketer of the exotic instruments himself over the past 30 years. He seemed like the ideal industry insider to help us get to the bottom of the recent debt crunch -- and I expected him to defend and explain the practice.

I started by asking the Calcutta-born Australian whether the credit crisis was in what Americans would call the "third inning." This was pretty amusing, it seemed, judging from the laughter. So I tried again. "Second inning?" More laughter. "First?"

Still too optimistic. Das, who knows as much about global money flows as anyone in the world, stopped chuckling long enough to suggest that we're actually still in the middle of the national anthem before a game destined to go into extra innings. And it won't end well for the global economy....

....When you add it all up, according to Das' research, a single dollar of "real" capital supports $20 to $30 of loans. This spiral of borrowing on an increasingly thin base of real assets, writ large and in nearly infinite variety, ultimately created a world in which derivatives outstanding earlier this year stood at $485 trillion -- or eight times total global gross domestic product of $60 trillion.

Canada's economy is moving and shaking. The loonie reached parity with the US dollar for the first time since the Gerald Ford presidency. But don't be fooled: it's not the Canadian economy that does so great, it's the US that sinks ever further ever faster, and the rest of the world is sinking with it, including Canada.

The long-awaited report on the royalty rates for the Alberta tar sands was published, and it recommends raising the royalties significantly. Both the industry and the business-friendly media in Canada cry foul, and worse. Just a few months ago, Shell said their tar sands operation was immensely profitable, but now the tune has changed.

Some voices say raising the royalties reeks of too-big government, and comparisons with Hugo Chavez fly everywhere. But those same voices do want the government to pay for the Mackenzie Valley pipeline.

Go here for the full report.

Caracas on the Bow River

Tim Hearn, chief executive officer of top oil sands producer Imperial Oil, said any additional royalties would harm companies already facing sky-high labour and construction costs for their projects.

“I'm not in a position today to say whether we've reached a tipping point or not because I can't tell you,” Mr. Hearn said. “But there's enough things working against us that if all this stays in place as is, there will be an effect in the industry, clearly.”

A former oil executive who was on the review panel lashed back at energy executives, saying they should concentrate on better managing their own businesses and contain cost increases rather than “whining” about higher royalties.

“I don't have any sympathies,” said Sam Spanglet, who ran Shell Canada Ltd.'s oil sands operation before retiring several years ago. “[Alberta is] still going to be very competitive. I feel very confident.”

Some Calgarians were angry, with one broker e-mailing his clients with the subject line: “Caracas on the Bow River,” comparing Alberta with Venezuela and its socialist President Hugo Chavez, who expropriated oil assets this year.

“If [the report is] enacted, investment decisions will be impacted … [the report] reads a bit like a Chavez-style manifesto,” Steve Larke, a Peters & Co. Ltd. broker, said in the e-mail.

Today's Round-Up focuses on disappearing acts. First, out of $12 billion in $100 bills that were physically flown from the New York Fed to Baghdad, $9 billion are missing. Second, more of life on earth is vanishing - the updated Red List of endangered species shows a large increase in species in critical condition.

In the world of finance, the next month is full of key moments, where debts will have to be covered, paper of various sorts matures, hedge funds will need to fork over lots of cash to investors who want out, and take-over deals will come under scrutiny. It looks like trillions of dollars could disappear from the markets before the end of the year.

And Greenspan had no idea. None. Now there's a mystery.

Billions over Baghdad

_{Illustration by John Blackford. By Peter van Agtmael/Polaris (desert), Konstantin Inozemtsev/Alamy (money)}

Between April 2003 and June 2004, $12 billion in U.S. currencymuch of it belonging to the Iraqi peoplewas shipped from the Federal Reserve to Baghdad, where it was dispensed by the Coalition Provisional Authority. Some of the cash went to pay for projects and keep ministries afloat, but, incredibly, at least $9 billion has gone missing, unaccounted for, in a frenzy of mismanagement and greed. Following a trail that leads from a safe in one of Saddam's palaces to a house near San Diego, to a P.O. box in the Bahamas, the authors discover just how little anyone cared about how the money was handled.

Hidden in plain sight, 10 miles west of Manhattan, amid a suburban community of middle-class homes and small businesses, stands a fortress-like building shielded by big trees and lush plantings behind an iron fence. The steel-gray structure, in East Rutherford, New Jersey, is all but invisible to the thousands of commuters who whiz by every day on Route 17. Even if they noticed it, they would scarcely guess that it is the largest repository of American currency in the world.

On Tuesday, June 22, 2004, a tractor-trailer truck turned off Route 17 onto Orchard Street, stopped at a guard station for clearance, and then entered the eroc compound. What happened next would have been the stuff of routineprocedures followed countless times. Inside an immense three-story cavern known as the currency vault, the truck's next cargo
was made ready for shipment.

With storage space to rival a Wal-Mart's, the currency vault can reportedly hold upwards of $60 billion in cash. Human beings don't perform many functions inside the vault, and few are allowed in; a robotic system, immune to human temptation, handles everything. On that Tuesday in June the machines were especially busy. Though accustomed to receiving and shipping large quantities of cash, the vault had never before processed a single order of this magnitude: $2.4 billion in $100 bills.

(See also the Energy and Environment Round-Up for September 7th below.)

For all those who think that the world's central bankers have the developing credit crunch contained, look at the liquidity crisis in asset-backed commercial paper (ABCP), which is currently affecting Canada worst of all. ABCP is an impenetrable mish-mash of mortgages, credit card receivables, car loans and other miscellaneous debt that institutions were quite happy, until recently, to use as a convenient place to park short term cash. Within a month that has seen a severe attack of risk aversion, it has gone from safe to toxic, with the result that liquidity has dried up almost completely.

In Canada, banks are trying to put together a deal that converts $35 billion of non-bank short term paper, that could no longer be rolled over, into 5-year floating-rate notes, but the credit default swaps (which can be, and were, used as vehicles for naked speculation) are a huge problem. Does the deal remind anyone of the Argentine financial crisis - where short term bonds were converted to long term (and then later defaulted upon)?

Those who think the situation contained might also look to Europe at the increasing gap between base rates and three-month interbank lending rates (Libor). That gap is now at its widest for 20 years, reflecting uncertainty and distrust as to the risk exposure of other banks, and the hoarding of cash. Interbank lending is breaking down, despite the efforts of the ECB and the Fed to restore confidence.

Is there really nothing to worry about?

ABCP investors could lose half their money

The vast majority of about $35-billion of non-bank ABCP is backed by risky bets on credit default rates that are now so far underwater that investors could be looking at losses as high as 50 on the dollar, said Edward Devlin, Canadian portfolio manager for highly respected California-based bond fund manager Pacific Investment Management Co. LLC....

....Commercial-paper markets around the globe have been struggling with fallout from the subprime mortgage crisis in the United States, but the situation is worst in Canada.

"It's the one country where people couldn't get their money back," Mr. Devlin said. "There's a whole group of people who bought commercial paper [thinking it was liquid] and now they find they can't get their money back."

The developing credit crunch is looking less contained by the day, despite the recent bounce in the equity markets. The interconnectedness of global markets really becomes apparent when contagion threatens to spread.

Following on from the Montebello SPP summit, Naomi Klein brings us an interesting twist on the right of protestors to be heard - surveillance as the new participatory democracy.

More commentators are weighing in on the question of Newfoundland oil royalties, while a pipeline capacity shortage looms in Alberta and potential conflict brews in BC over coal bed methane.

Top 25 Quotes on the Credit Crisis of 'O7

The U.S. economy, once the envy of the world, is now viewed across the globe with suspicion. America has become shackled by an immovable mountain of debt that endangers its prosperity and threatens to bring the rest of the world economy crashing down with it. The ongoing sub-prime mortgage crisis, a result of irresponsible lending policies designed to generate commissions for unscrupulous brokers, presages far deeper problems in a U.S. economy that is beginning to resemble a giant smoke-and-mirrors Ponzi scheme. And this has not been lost on the rest of the world. - Hamid Varzi, International Tribune