Saturday, July 26, 2008

Two More Banks Bite the Dust

Just a couple of quick notes today.

The FDIC announced two more bank failures on Friday. Here is the information from the FDIC. :

"First National Bank of Nevada, Reno, Nevada, and First Heritage Bank, N.A., Newport Beach, California (owned by First National Bank Holding Company, Scottsdale, Arizona), were closed today by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (FDIC) was named receiver. The FDIC entered into purchase and assumption agreements with Mutual of Omaha Bank, Omaha, Nebraska, to take over all of the deposits and certain assets of the First National Bank of Nevada, Reno (also operating as First National Bank of Arizona, which recently merged into it), and First Heritage Bank, N.A., Newport Beach, California.

The 28 offices of the two banks will reopen on Monday as branches of Mutual of Omaha Bank. All depositors, including those with deposits in excess of the FDIC's insurance limits, will automatically become depositors of Mutual of Omaha Bank for the full amount of their deposits. Depositors will continue to be insured with Mutual of Omaha Bank so there is no need for customers to change their banking relationship to retain their deposit insurance.

Over the weekend, customers of the banks can access their money by writing checks or using ATM or debit cards. Checks drawn on the banks will be processed normally. Loan customers should continue to make loan payments as usual.

Of the 10 institutions that have failed over the past two years, this is the second time in which another bank acquired all of the failing banks' insured and uninsured deposits. Mutual of Omaha Bank's acquisition of all deposits was the "least costly" resolution for the Deposit Insurance Fund compared to all alternatives because the expected losses to uninsured depositors were fully covered by the premium paid for the banks' franchises.
As of June 30, 2008, First National of Nevada had total assets of $3.4 billion and total deposits of $3.0 billion. First Heritage Bank had total assets of $254 million and total deposits of $233 million."

My Take:

Its not a surprise that both banks are in the bubble areas of the housing market. If you live in a "bubble area" please make sure you to some research on your bank. We have had three bank failures in just the past week in these areas when you include IndyMac.

There will be many more bank failures so be careful!

Senate Passes Housing Bill

The housing bill was passed 72-13 in the Senate this morning. There is no stopping this bill now. Bush will sign on the dotted line and Moral Hazard will officially be crossed.

The taxpayer is now officially screwed. Its going to take a couple of generations to pay off this "bubble debt". This is a very sad day for America! Its extremely frustrating to see such a bullshit bill pass so overwhelmingly.

Congratulations pigmen! You were bailed out once again!

Lets see how the bond market reacts to the news next week.

Friday, July 25, 2008

Beware of Demand Destruction/Market Update

Good afternoon folks!

Well it was another Freaky Friday in the markets. We started off the day with good news in several areas. Consumer sentiment rose from its recent lows. GDP growth and new home sales were both better than expected:

"July 25 (Bloomberg) -- Orders for U.S. durable goods unexpectedly rose in June, and sales of new homes were higher than forecast, easing concern that the economic slowdown will worsen.
Bookings for goods made to last several years gained 0.8 percent and posted the first consecutive monthly rise since July 2007, the Commerce Department said today in Washington. New homes sold at an annualized pace of 530,000, exceeding the median forecast of 503,000 in a Bloomberg News survey. A private report showed consumer sentiment rose from a 28-year low."

My take:

Oil also dropped into the low 120's. After seeing the news this morning, I was expecting a rocket shot bounce back from the turbulence we hit yesterday. To my surprise, the DOW really never bounced. We were up about 100 points but then faded going into lunch.

The bulls must be feeling dazed and confused. 3 years ago this would have rocketed the DOW up 300 points by lunchtime. There is definitely a "crisis of confidence" that has hit Wall St. Is it the SEC? Bad economy? Financial shoes that continue to drop?

I think its a little bit of everything.

Demand Destruction

I want to spend some time on the big drop in oil prices the last few weeks. Oil has been dropping for one key reason: Demand destruction. Now one would think lower oil would be bullish for the markets. However, when its caused by demand destruction, you need to use this as a giant warning sign that the economy is in deep doo doo.

Think about this for a second. Putting gas in your car is a necessity. Almost all of us need to drive in order to work, pickup the kids, and buy groceries.

So I ask you a question. What in the hell is consumer spending going to look like in the next few quarters if people can't even afford to put gas in their car?

If they can't afford to put $50 in the tank then they definitely aren't going out and buying a $1200 plasma TV. Go walk into a Best Buy and look at the prices. They can't give the stuff away.

Been to a care dealership lately? You can get the deal of a lifetime on an SUV right now. Look at the Chrysler news that hit the markets today:

"July 25 (Bloomberg) -- Chrysler LLC, hurt by plunging prices for used sport-utility vehicles, said its finance unit will stop offering leases to customers on Aug. 1.

Dealers can still make leases obtained through independent finance companies, President Jim Press said today. Rising borrowing costs drove up consumers' lease payments, helping spur the shift, Press told reporters on a conference call.

Other automakers may have to join Chrysler as $4-a-gallon gasoline forces lenders to cut so-called residual values for leased SUVs and other vehicles at the end of their terms. Ford Motor Co. took a $2.1 billion second-quarter charge yesterday to write down leased vehicles owned by Ford Motor Credit."

Final Take:

So much for the days of leasing a car. The reason they need to stop leasing is they can't sell the SUV's after the leases are up. They are getting killed. I think the big 3 are all in deep trouble. This is the last thing Chrysler wanted to do because its a big chunk of their sales.

However, drastic actions must be taken when you are on the brink of going bankrupt. This is going to make it more expensive to buy a car because a car loan will be your only option unless you are paying cash. If you have an average credit score then your cost of a new car just went through the roof.

The credit crunch is going to impact everyone in more ways than most of us realize. Interest rates are going to go up on everything, and access to credit is going to be drastically reduced as the banks recover. This is going to suck the wind out of the consumer.

Another since of further financial woes was the S&P downgrade on Fannie/Freddie today:

"July 25 (Bloomberg) -- Standard & Poor's may downgrade the subordinated bonds of Fannie Mae and Freddie Mac, surprising investors who had anticipated the securities would be supported by any Treasury rescue plan
The potential cut would affect $19.2 billion of AA- rated subordinated debt at Fannie Mae and Freddie Mac, according to data compiled by Bloomberg."

Bottom Line:

The trade of buying stocks as oil drops is losing steam as signs of weakness continue to rear their ugly heads. Demand destruction in oil means you will be seeing demand dropping in all parts of the economy. In other words "If people ain't driving then they ain't spending!"

The timing of the Fannie/Freddie news was a signal to Congress by S&P. The way I see it, the ratings agencies are guessing equity holders might be screwed if this bill passes.

It just happens the vote on this bill is this weekend. I think the markets fired a warning shot to Congress. When you cross the line of "moral hazard", there are consequences.

Lets all hope that the Senate or Dubbya puts the kabosh on this dangerous legislation.

The SEC is Playing With Fire

Good morning everyone!

Quite a day yesterday wasn't it? Many are scratching their heads as they watched the violent move to the downside yesterday in the stock market(including myself).

The housing news was bad yesterday, but its been bad for two years so why did everyone so get so riled up and sell? Rick Santelli was complaining a lot about the SEC games and I think this story has legs.

The "tampering" of the markets by the SEC has created a huge "uncertainty" as to how stocks will trade as they change the rules on short selling.

If there is one thing the market does not like its uncertainty. I know its taken me out of the market. How can I play the game if I don't know the rules? I haven't made a trade since the SEC started with all of this crap.

Imagine how spooked traders will be tomorrow after seeing the financials free fall to their biggest one day loss in EIGHT YEARS just days after the new shorting rules on the financials kicked in. Do you go long? Do you go short? Who knows! The game has changed.

You think any trader is comfortable making trades now? Hell no. What happens to the stock market if they decide to take their money home and stop trading.

When there are no bids for stocks they drop!

Word on the street is many traders can't find any shares to short right now. They simply aren't available. Some companies have shares that are available to short and others mysteriously don't. No one has been able to figure out why. This just kills market confidence.

Now the SEC is trying to expand these rules to the entire stock market!

"By Karey Wutkowski and Rachelle Younglai

WASHINGTON, July 24 (Reuters) - The top U.S. securities regulator remains steadfast in a plan to broaden an emergency rule to curb abusive short selling despite opposition from the hedge fund industry and other short sellers.

U.S. Securities and Exchange Commission Chairman Christopher Cox told lawmakers on Thursday the agency would soon propose expanding the rule covering the shares of 19 major financial firms to the entire market.

"We have immediately pivoted to a broader rule making ... so we can extend this kind of procedural protection to the entire market," SEC Chairman Christopher Cox told a House Financial Services Committee hearing.

"I think very soon we will be in a position to issue a proposal on that," he said. The SEC could consider its next steps at the end of July or beginning of August.

The SEC is also considering other remedies to short selling abuses, such as requiring the reporting of substantial short positions, Cox told reporters after the hearing.

"At the hearing, lawmakers asked Cox why the agency did not reinstate the so-called tick-test rule on short sales, which was implemented after the 1929 stock market crash. Cox reiterated that studies have shown that the tick test is no longer effective.
In June 2007, the SEC repealed the rule, which only allowed short sales when the last sale price was higher than the previous price.

Cox said the idea of using a price test or some sort of circuit breaker to regulate manipulative short selling is a "subject currently under consideration by the commission staff."

Final Take:

Good idea Mr Cox! Lets spook the markets even more! Now I realize shorting has become abusive at times and power driving a company into BK has to be stopped. Something needs to be done about this.

However, attempting to paint such a broad stroke of regulatory power over the markets is a big mistake by the SEC. They are over stepping their boundaries just like the Fed is attempting to do with the Fannie legislation.

Here's an idea:

Why not just bring back the uptick rule? I think the market would handle it without a problem. Why? Because they traded with this rule in effect for almost 70 years. They know what to expect. It would create a sense of calm in the markets versus uncertainty. It would also at least partially reign in the shorts.

If you think you need to do more then that then increase your policing of the markets. I am sure its pretty obvious when the shorts are piling on a stock and driving it into the ground. This would keep the main rules of the game in tact which would entice investors to come back and make trades.

Bottom Line:

All of this meddling is increasing the risk of a major event in the stock market. The economy is already in shambles and investors look like they have seen a ghost.

When you decide to change the rules of the game in the middle of a rattled stock market thats trying to find itself, the risk of a crash increases dramatically.

Thursday, July 24, 2008

Wake Up America!

I advise everyone to watch this video. This is a great explanation on what happened in the housing market, and why the bailouts need to stop!

Wednesday, July 23, 2008

Mortgage Rates Hit a 5 Year High

I am officially calling today D-Day for housing as the president has now said he will not veto the housing bill. Rates will never be the same after this bill passes.

Rates have soared in the past week , and mortgage applications have plummeted in the last week as a result. Reports have applications down as much as 20% since rates started climbing.

A 30 year mortgage is now at 6.5% up from 6.14% a week ago. Jumbo mortgages have now hit 7.5% up from 7.1% last week. CNBC reported that this is a 5 year high for mortgage rates.

The effects of this housing bill are already forcing mortgate rates through the roof. Folks, Congress is putting the final nail in the housing coffin by passing this. The bond market is going schizo. The 10 year was sharply higher again today.

Congress will deeply regret passing this housing bill. We are less than two hours from the vote.

Sit back and enjoy the fireworks after it passes.

Tuesday, July 22, 2008

Bear Stearns Part 2

Just a commentary tonight

Haven't we seen this rally before? I feel like it is March all over again. The government sticksave is back.

The Paulson pump machine was in full gear again today saying the financial system is as strong as ever. Huh, really? Then why did Wachovia lose $9 billion dollars in a QUARTER.

Why did WAMU just announce a $3 billion dollar loss which was triple what analysts were expecting.

"July 22 (Bloomberg) -- Washington Mutual Inc., the biggest U.S. savings and loan, reported a $3.3 billion second-quarter loss as tumbling home prices left a record number of borrowers unable to keep up with mortgage payments. The shares surged 10 percent as the company announced it would cut costs.

The loss of $6.58 a share compared with net income of $830 million, or 92 cents a share, a year earlier, the Seattle-based company said today in a statement. The cost of uncollectible loans jumped 58 percent to $2.2 billion from the first quarter."

This is insanity at its finest. I hope the financials go up another 30%. It will create a nice shorting opportunity. Right now you simply can't fight the financial rally. The change on naked shorting combined with the stick saves has too much momo behind it. Plus, asI said before, these stocks are down 70-80%.

I am amazed that the government has somehow managed to talk everyone into believing they will bail everyone out again. Hello! Haven't we seen this before? Anyone remember Bear Stearns?

Look at what the 10 year rate has done in the bond market since Paulson announced legislation to backstop Fannie/Freddie(Image is from Karl Denninger's Market Ticker):

Final Take:

Wake up people! The government can't bail everyone out! Look at how the bond market has reacted even to the thought of trying to bailout the GSE's.

If this bill passes you are going to see a violent reaction in the bond market thats going to push interest rates up to levels not seen since the 1980's.

Imagine what this chart will look like if Paulson gets his way and the bill passes through Congress. If it does, 9% interest rates on mortages are right around the corner.

Bottom Line

There is only so much money to go around and the government can't save everyone. We can't print our way out of this because of the risk of severe inflation/hyperinflation. They are again sending the message that they can save everyone. There is no free lunch in life boys and girls.

If this was such a piece of cake for the government, then why is Paulson out EVERY SINGLE DAY selling this bailout to anyone who will listen?

I'll tell you why he is selling this so hard. Paulson sees the financial destruction that we are on the brink of reaching, and he is scared to death and doesn't know what else to do. Why do you think he pulled his right hand man out of Goldman Sachs this week to help him with this disaster.

Sometimes there are no good choices in life. Unfortunately, our economic mess is one of those times where you just need to bite the bullet and accept what has happened and deal with the consequences. All of this interevention is increasing the risk of an even worse event down the road.

These stocks are rallying based on a government stick save just like they were when Bear Stearns was "saved". We learned a harsh lesson about stick saves in May and June. Look at these bank losses and ask yourself if this rally makes any sense?

Buy financials at your own risk if this bill passes and its almost guaranteed to do so. "Moral Hazard" will officially be thrown out the window when it does. I would rather be late in buying financials versus being early when so much is at stake regarding our financial system.

Sometimes I am at a loss for words from what I am witnessing. Today is one of those days.

Wachovia Wipeout: $8.9 Billion Loss

All I can say about Wachovia is ouch! There is a lot going on in the markets today even though we are pretty much flat on the day. Oil is down, financials are struggling after Wachovia/Amex, and bond yields are rising.

Paulson is again out flapping his gums about Fannie and Freddie again today. Is everyone as tired of listening to this clown as I am? He realizes the economy goes down the toilet without Fannie And Freddie. As you can see below, the costs of backing these two bloated pigs are already seeping out even though Paulson refuses to admit it will cost the taxpayers anything. Yeah right.

GSE bailout $25 Billion and Counting

From Bloomberg:

"July 22 (Bloomberg) -- Treasury Secretary Henry Paulson's rescue package for Fannie Mae and Freddie Mac would probably cost taxpayers $25 billion, the Congressional Budget Office" said.

Quick Take:

I wonder what this number will look like after this housing crisis is over. I know one thing, its going to cost us a lot more than $25 billion!

Wachovia's Stunning Loss

This loss is much worse than I expected. They also slashed the dividend to .05/share. This loss rivals Merrill Lynch's $10 billion dollar hit last week. Remember folks, banks are leveraged much less than investment banks. Its hard to lose $8.9 billion in a quarter when you are a bank. You almost have to try to lose that much money.

This tells me Wachovia's underwriting had to have been horrific. Of course buying a subprime lender at the peak of the housing bubble sure didn't help these clowns.

Here is the Wachovia Story:

"July 22 (Bloomberg) -- Wachovia Corp., the U.S. bank that hired Treasury Undersecretary Robert Steel as chief executive officer two weeks ago, reported a record quarterly loss of $8.9 billion, slashed the dividend and announced 6,350 job cuts. The stock slumped as much as 10 percent in New York trading.

The second-quarter loss of $4.20 a share compared with net income of $2.3 billion, or $1.23, a year earlier, the Charlotte, North Carolina-based company said today in a statement. The loss included a $6.1 billion charge tied to declining asset values.

The writedown, job cuts and second dividend reduction in three months reflect Steel's response to the worst housing market since the Great Depression, which cost former CEO Kennedy Thompson his job after eight years. Wachovia has dropped more than 75 percent since it spent $24 billion two years ago to buy Golden West Financial Corp. just as home prices were peaking."

Quick Take:

Granted, these losses are terrible. However, you need to be careful here if you are trading financials. Many of these stocks are down 70-80%. Shorting them at these levels is a dangerous trade. You basically have to place bets that they are going to be zero's.

I would simply stay away from them at this point. There will be a time to go long on these stocks but I still think its early to be jumping in on the long side.

However, my estimation is the next trade on financials will be going long unless housing totally unwinds. This is why patience is needed here. The housing story is not played out yet as Fannie and Freddie hang in the balance.

When it is time to jump in, I would only go long by buying pools of banks because some of these dogs aren't going to make it.

Fed's Plosser: Fed needs to raise rates sooner rather than later

Plosser is out again today talking about fighting inflation. This is the second Fed president in the last few weeks warning of higher interest rates. As you can see below, the Fed is in a really tight spot:

"July 22 (Bloomberg) -- Federal Reserve Bank of Philadelphia Charles Plosser said the central bank should raise interest rates ``sooner rather than later'' to lower inflation and prevent price expectations from getting out of control.

``We will need to reverse course -- the exact timing depends on how the economy evolves, but I anticipate the reversal will need to be started sooner rather than later,'' Plosser, who argued against cutting interest rates in two Fed decisions this year, said in a speech today in King of Prussia, Pennsylvania. ``It will likely need to begin before either the labor market or the financial markets have completely turned around.''

Plosser joins Minneapolis Fed President Gary Stern, who also votes on rate decisions this year, in making the case for raising borrowing costs, a move Fed Chairman Ben S. Bernanke avoided discussing in congressional testimony last week. Record oil prices and rising food costs this year have increased investor expectations for the Fed to raise the benchmark interest rate."

Bottom Line:

We are pretty flat today as the market digests all of the earnings reports from the last couple days. Some companies did well last quarter. Caterpillar had a blowout number and far exceeded estimates.

Where we head going forward short term will depend a lot on how the Fannie/Freddie situation is handled. The bond market will have a lot to say about this.

One thing looks pretty certian. Interest rates are about to rise, and its going to hurt the economy as well as accelerate asset deflation. This is going to hurt, but its the only way out of this mess.

Monday, July 21, 2008

Earnings Disaster After Hours

Stocks were quiet today as many on Wall St. waited for the big earnings reports after hours. Unfortunately for the bulls, the reports were flat out ugly.

American Express

Apparently, American Express cardholders decided to "leave home without it" this quarter. Earnings came in at .56/share versus analysts estimates of .83/share. This is a gigantic miss. There guidance going forward was even worse. They refused to give any until the economy turns around! Yikes!

Here is the ugliness on Bloomberg:

"July 21 (Bloomberg) -- American Express Co., the biggest U.S. credit-card company by purchases, said second-quarter profit fell 37 percent on worse-than-expected consumer defaults. The shares dropped 9.6 percent in extended trading.

Profit from continuing operations was $655 million, or 56 cents a share, declining from $1.04 billion, or 86 cents a year earlier, the company said today in a statement. The average estimate of 17 analysts surveyed by Bloomberg was 82 cents. American Express abandoned its prior earnings forecast after saying conditions ``weakened considerably'' and it added $600 million to reserves for U.S. loan losses.

``They're like any other consumer lender right now, caught behind the 8-ball,'' Craig Maurer, analyst at New York-based Calyon Securities who rates the company ``buy,'' said in a Bloomberg Television interview. ``I don't think the environment's going to be helpful to the company over the next nine to 12 months.''

Quick Take:

Whats most concerning about this earnings miss is American Express is the card of the "wealthy". This tells me that even the high end consumer is starting to fall apart.

Stock Futures Tumbled after Hours on the AmEx/Apple News

July 21 (Bloomberg) -- U.S. stock futures tumbled after the close of U.S. exchanges, dragged down by lower-than-estimated earnings at American Express Co. and disappointing forecasts at Apple Inc. Treasury yields and the dollar also dropped.

American Express, the biggest U.S. credit card company by purchases, fell 11 percent from its 4 p.m. close after second- quarter profit trailed analysts' estimates by 32 percent. Apple, maker of the iPod music player, lost 6.5 percent after saying sales and earnings will fall short of projections. SandDisk Corp. tumbled 12 percent after reporting a loss."

My Take:

Amex will take its toll on the bank stocks tomorrow. The financials may be in deep trouble tomorrow as many regional banks report earnings including Wachovia. Regional bank earnings reports are expected to be horrific as bad loans continue to clog up the balance sheet.

I think we need to rename the quarterly earnings reports for financials. Every three months banks should report their quarterly "losses". We can call them earnings reports again in about 10 years when they have earnings again.

The I-Phone:

Just a couple comments here. I think this is an interesting example of the deflation that we are about to start seeing in all assets including tech. Everyone has seen the ongoing massive deflation in home prices.

It looks like Apple is the first tech company that sees deflation as the only way out of this. A great axample of this is the I-phone. The first Apple I-phone had a pricing point of $599 about a year ago. The newer faster 3G I-phone that launched last week was priced at $199.00.

A faster phone at less than half the price.

So how did consumers respond? Apple was expecting to sell about 500,000 phones the first weekend. They ended up selling over 1 million. Note to home sellers: Your bubble house is not going to sell at 2005 prices! If you price the home right, it will sell! Apple new I-phone is proof of this.

Apple is a smart company. They see whats coming. The lowering of earnings guidance is what hurt the stock today. Many blame lower prices on the I-phone and Mac as the main reason why their guidance had to be lowered going forward.

Kudos to Apple for stepping up and selling new technology at affordable prices. This will make Apple a stronger company in the long run. The companies that do not deflate will pay for it with crippled sales. Corporations need to face the reality of selling to a different consumer.

The New USA

Every other company better realize that deflation is here. If they don't, their sales are going to drop like a rock. Peter Schiff said it best this weekend: " Most of us have borrowed our way into Bankruptcy".

We have no disposable income after we pay our bloated mortgage payment in the face of higher inflation. Many are still paying off their credit cards after splurging on that $4000 65" HDTV. Oh and don't forget that Hummer that we financed with all of the "equity" that was borrowed in the form of HELOC loans.

There are already signs of a more simple standard of living as we pay off debts. The Hummer now sits in the driveway with a for sale sign on it because it only gets 9 miles to the gallon. Cruising the streets in the Hummer doesn't sound so fun when its cots you $10 roundtrip just to go the grocery store and back.

Another sign of deflation:

Look at how the summer movies are doing this year. Every weekend it seems there is a new movie that does $100 million during its first weekend. This week the new Batman movie broke the all time opening for a non holiday weekend by raking in $150 million.

Gee you think maybe because this might be because its the only form of family entertainment that doesn't cost you at least $100? The days of taking your family to a baseball game at $250 a pop are over. These million dollar athletes will be taking pay cuts as attendance begins to drop over the next few years.

The signs are everywhere folks. Look around and see how your friends are living. My guess is they are acting a little more frugal.

If you don't think this is going to murder our "consumer obsessed" economy then you need to rethink your position.

70% of our economy is based on the consumer. Sadly, all he can afford to do on a summer weekend right now is watch Batman battle the Joker.

Global Economy Hits Maximum Danger Levels

I will be on later today with an update on the market action. I wanted to share a great piece from the from Ambrose Evans-Prichard. He warns of a potential worldwide recession of epic proportions.

It appears Europe may fall into a recession before we do. It appears the "Global Growth" story is starting to fall apart. Our exports and cheap dollar have allowed many Fortune 500 companies to keep their heads above water.

Here is the piece in full. Its an excellent read:

"The global economy is at the point of maximum danger

By Ambrose Evans- Pritchard

Last Updated: 11:54pm BST 20/07/2008

It feels like the summer of 1931. The world's two biggest financial institutions have had a heart attack. The global currency system is breaking down. The policy doctrines that got us into this mess are bankrupt. No world leader seems able to discern the problem, let alone forge a solution.
The International Monetary Fund has abdicated into schizophrenia. It has upgraded its 2008 world forecast from 3.7pc to 4.1pc growth, whilst warning of a "chance of a global recession". Plainly, the IMF cannot or will not offer any useful insights.

Its "mean-reversion" model misses the entire point of this crisis, which is that central banks have pushed debt to fatal levels by holding interest too low for a generation, and now the chickens have come home to roost. True "mean-reversion" would imply debt deflation on such a scale that would, if abrupt, threaten democracy.

The risk is that these same central banks will commit a fresh error, this time overreacting to the oil spike. The European Central Bank has raised rates, warning of a 1970s wage-price spiral. Fixated on the rear-view mirror, it is not looking through the windscreen.

The eurozone is falling into recession before the US itself. Its level of credit stress is worse, if measured by Euribor or the iTraxx bond indexes. Core inflation has fallen over the last year from 1.9pc to 1.8pc.

The US may soon tip into a second leg of this crisis as the fiscal package runs out and Americans lose jobs in earnest. US bank credit has contracted for three months. Real US wages fell at almost 10pc (annualised) over May and June. This is a ferocious squeeze for an economy already in the grip of the property and debt crunch.

No doubt the rescue of Fannie Mae and Freddie Mac - $5.3 trillion pillars of America's mortgage market - stinks of moral hazard. The Treasury is to buy shares: the Fed has opened its window yet wider. Risks have been socialised. Any rewards will go to capitalists.

Alas, no Scandinavian discipline for Wall Street. When Norway's banks fell below critical capital levels in the early 1990s, the Storting authorised seizure. Shareholders were stiffed.

But Nordic purism in the vast universe of US credit would court fate. The Californian lender IndyMac was indeed seized after depositors panicked on the streets of Encino. The police had to restore order. This was America's Northern Rock moment.

IndyMac will deplete a tenth of the $53bn reserve of the Federal Deposit Insurance Corporation. The FDIC has some 90 "troubled" lenders on watch. IndyMac was not one of them.

The awful reality is that Washington has its back to the wall. Fed chief Ben Bernanke thought the US could always get out of trouble by monetary stimulus "à l'outrance", and letting the dollar slide. He has learned that the world is a more complicated place.

Oil has queered the pitch. So has America's fatal reliance on foreign debt. The Fannie/Freddie rescue, incidentally, has just lifted the US national debt from German 'AAA' levels to Italian 'AA-' levels.

China, Russia, petro-powers and other foreign states own $985bn of US agency debt, besides holdings of US Treasuries. Purchases of Fannie/Freddie debt covered a third of the US current account deficit of $700bn over the last year. Alex Patelis from Merrill Lynch says America faces the risk of a "financing crisis" within months. Foreigners have a veto over US policy.

Japan did not have this problem during its Lost Decade. As the world's supplier of credit, it could let the yen slide. It also had a savings rate of 15pc. Albert Edwards from Société Générale says this has fallen to 3pc today. It has cushioned the slump. Americans are under water before they start.

My view is that a dollar crash will be averted as it becomes clearer that contagion has spread worldwide. But we are now at the point of maximum danger. Britain, Japan, and the Antipodes are stalling. Denmark is in recession. Germany contracted in the second quarter. May industrial output fell 6pc in Holland and 5.5pc in Sweden.

The coalitions in Belgium and Austria have just collapsed. Germany's left-right team is fraying. One German banker told me that the doctrines of "left Nazism" (Otto Strasser's group, purged by Hitler) had captured the rising Die Linke party. The Social Democrats are picking up its themes to protect their flank.

This is the healthy part of Europe. Further south, we are not far away from civic protest. BNP Paribas has just issued a hurricane alert for Spain.

Finance minister Pedro Solbes said Spain is facing the "most complex" economic crisis in its history. Actually, it is very simple. The country was lulled into a trap by giveaway interest rates of 2pc under EMU, leading to a current account deficit of 10pc of GDP.

A manic property bubble was funded by foreigners buying covered bonds and securities. This market has dried up. Monetary policy is now being tightened into the crunch by the ECB, hence the bankruptcy last week of Martinsa-Fadesa (€5.1bn). With Franco-era labour markets (70pc of wages are inflation-linked), the adjustment will occur through closure of the job marts.
China, India, East Europe and emerging Asia have all stolen growth from the future by condoning credit excess. To varying degrees, they are now being forced to pay back their own "inter-temporal overdrafts".

If we are lucky, America will start to stabilise before Asia goes down. Should our leaders mismanage affairs, almost every part of the global system will go down together. Then we are in trouble."

Sunday, July 20, 2008

Is America Too Big To Fail?

Good afternoon!

I put this article in the must read category. It appears that some economists are becoming increasingly concerned that countries will continue to buy our debt.

As I described yesterday, there may be a day of reckoning where Russia and China say enough is enough and stop buying our debt.

So the question must be asked? Is America too big to fail? According to this article, the jury is still out. Here is the link to the International Herald Tribune piece.

Here are some of the highlights in the article:

"NEW YORK: In the narrative that has governed American commercial life for the last quarter-century, saving companies from their own mistakes was not supposed to be part of the government's job description. Economic policymakers in the United States took swaggering pride in the cutthroat but lucrative form of capitalism that was supposedly indigenous to their frontier nation.

Through this uniquely American lens, saving businesses from collapse was the sort of thing that happened on other shores, where sentimental commitments to social welfare trumped sharp-edged competition. Weak-kneed European and Asian leaders were too frightened to endure the animal instincts of a real market, the story went. So they intervened time and again, using government largess to lift inefficient firms to safety, sparing jobs and limiting pain but keeping their economies from reaching full potential.

Today, among strict adherents of laissez-faire economics, the offer to bail out Fannie and Freddie is already being criticized as a trip down the Japanese path of putting off immediate pain while loading up the costs further along.

For one thing, this argument goes, taxpayers - who now confront plunging house prices, a drop on Wall Street and soaring costs for food and fuel - will ultimately pay the costs. To finance a bailout, the government can either pull more money from citizens directly, or the Fed can print more money - a step that encourages further inflation.

"They are going to raise the cost of living for every American," said Peter Schiff, president of Euro Pacific Capital, a Connecticut-based brokerage house that focuses on international investments. "The government is debasing the value of our money. Freddie and Fannie need to fail. They are too big to save."

Using public money to spare Fannie and Freddie would increase the public debt, which now exceeds $9.4 trillion. The United States has been financing itself by leaning heavily on foreigners, particularly China, Japan and the oil-rich nations of the Persian Gulf. Were they to become worried that the United States might not be able to pay up, that would force the Treasury to offer higher rates of interest for its next tranche of bonds. And that would increase the interest rates that Americans must pay for houses and cars, putting a drag on economic growth.

Meanwhile, as American debts swell and foreigners hold more of it, nervousness grows that, someday, this arrangement will end badly. The dollar has been declining in value against other currencies. Some foreigners have begun to hedge their bets by buying more euros.

"Obviously, this is going to come to an end," Schiff said. "Foreigners are not charitable organizations, and they're going to demand that we pay them back."

No single country owning large amounts of dollar-based investments is inclined to dump them abruptly; nobody aims to start a panic. But fears have begun to grow that one day a country may get spooked that another is about to dump its dollars - and that could trigger pre-emptive panic selling.

"Foreigners could decide it's just not worth the risk and sell," says Andrew Tilton, an economist at Goldman Sachs. "The really dire scenarios have become a lot more likely than they were a year or two ago."

The central truth of that logic still seems to be apparent as the Treasury keeps finding takers for American debt.

So the government offers its rescue of the mortgage companies, and foreigners keep stocking the government's coffers. "They don't want the U.S. to go into the worst downturn since the Depression," Tilton says.

But all the while, the debt mounts along with the costs of an ultimate day of reckoning. Debate grows about the wisdom of leaning on foreign credit, and about how much longer Americans will retain the privilege of spending and investing money that isn't really theirs.

Bailouts amount to mortgaging the future to stave off the wolf howling at the door. The likelihood of a painful reckoning is diminished, while the costs of a reckoning - should one come - are increased.

The costs are getting big."

Final Take:

Its looking more and more like we are about to take the same path that Japan did when their housing market collapsed. The banks were allowed to walk around like zombies without being forced to open their balance sheets. Japan had no confidence in its stock market as a result and it collapsed.

How bad was the collapse? Japan's stock market dropped from 38,000 in the late '80s down to its current levels of around 13,000.

The best case scenario here is we continue to find buyers of our debt. However, there are no free lunches. We will be punished for doing so in the form of higher taxes and a weaker dollar. Our standard of living will also diminish as inflation rises because our currency will be so weak. This will then pummel the consumer.

Look at Japan's currency after taking the "hide the sausage" approach to their banking sytem and its failures. The Yen(Japan's currency) is the joke of the world. You may see the US dollar right beside it if we use Japan's gameplan to get out of our economic mess.

So what do you guys think? Is America too big to fail? I am starting to think this risk is a serious one that I may see in my lifetime if the bailouts don't stop.