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October 03, 2008

Time for the US Department of the Portfolio

Department of the Portfolio

"This sucker could go down", quoth the President,

Quoth the Secretary of the Treasury, "Nevermore". 

The Vice Presidential candidate peers through her trademark glasses and exclaims: "Putin rears his head and comes into the airspace" while grown Congressmen change their votes because of the tone of a speech by the Democratic leader. Hold you Nose! Everybody kinda sorta agrees that maybe throwing a trillion unfunded dollar sponge to soak up the (toxic) waste will somehow unplug the overflowing toilet. We've got "cow patties with marshmallow centers", car wrecks galore and the greatest inflation of unfortunate metaphors in the country's history.  This truly is a national nadir commensurate with the waning days of the eight-year Bush reign. 

Heartland Wisdom

$85 billion, that's your money. I mean, it's all of our money. I don't know where they get it. It's really interesting. They just print it or something.

Mayor Richard Daley Jr.

Too Big to Fail, or Uncreative Capitalism

The Fed and the Treasury move blindfolded across the countryside followed by a gaggle of lobbyists shouting out the path from behind the trees. In their wisdom they have quickly created three large supernational banks, surely too large to fail.  So much for the creative destruction of capitalism that the fundys love to invoke. "Take a sharp left to that $25 billion carmaker bail-out then....."

This is truly a test of the power of the US Treasury's virtual printing presses. The immediate crisis will be averted if only enough money can be beamed at it fast enough.

The taxpayer response should be simple enough: Equity, interest, fees, whatever, we want our money back with interest. Give us a new agency: The Department of the Portfolio, with requirements to report back to us every three months. All profits go the Social Security Trust Fund

Bail-outs Are US

We're used to seeing the media lunging at the meme du jour like a flock of pigeons on a telephone pole. Their target line being the trail of talking points sprinkled like a string of directional clues through the semi-dark labyrinth they forage in. Each nibble, of course, leaves them more clueless as to the real way out.  But there's solace, there will always be new bread crumbs.  Lunch is assured.

Candidate in a Telephone Booth

We've been having a like spectacle among the political leaders with one party's candidate suspending all campaigning as he emerges from telephone booth and leaps into a situation he knows virtually nothing about. His hope, it seems, is that by some odd chance he will manage to get the politics right, thereby winning the favor and respect of the citizenry readying to cast their votes. It's hard for us to tell if this is a strategy or a tactic but in any case it is meant to appear decisive.... at least, up to the point he has to make a decision. Unfortunately for this gray-haired chap, whose left eye may just be sagging under the strain, he found himself, with no legs, unblinkingly leaping into the mother of all political and economic quagmires.

Sorry but folks out there have little clue how this whole mess came about but they sure don't trust what their leaders are telling them, particularly those leaders who were spoon-feeding them up to just a week ago a taste of  "the fundamentals are sound".

Beam Me Up A Virtual Depression, Hank

We know, of course, that the fundamentals are NOT sound and moreover that they have not been sound for a very long time, so long, in fact, that the most dynamic underpinning of the private sector house of cards has all but collapsed. We've reached a point in the evolution from molecules to bits, where only outliers dare dispute that what's good for Wall Street is good for America. We are a country that has gone into the Transporter Booth only to be fleeced as our money is beamed around the world in bits and bytes. The transporter is located in the south end of Manhattan Island and must be saved.  If not, of course, the whole sucker just might go down. Thus, in typical eloquence, are we rallied on by our leader.

Real Time Central Planning

By beaming those dollars to all round edges of the globe, Wall Street genius has managed, in Greenspan's words to "spread the risk" so thoroughly that there is no one left willing to take any of it, ergo the urgent plea to the Congress to crank up the printing presses. It is the ephemeral soundness, the vibrating beams of money we know is in the ether, that still makes this a virtual depression rather than the kind that sends folks into public bread lines. The next phase, the one that is being passed in Congress today is to further spread the risk out to every single taxpayer in perpetuity as an ever larger chunk of the ever more virtual budget goes not to arms or wellbeing but to debt service, the province of which is controlled by, well, Wall Street, of course. In a virtual depression; we are much more likely to see the citizenry on their way to the grocers with real time credit limits being reevaluated on their plastic between the time they enter the store and leave.  We'll be kept abreast on our iPhones.

The Wal*Marts of Treasury Bonds

Another way to look at it is to view the US economy as it manufactures fewer hard goods replacing that lost productive activity with the production of Treasury Bonds.  Quite simply, we can assume that as the world economy falters there will be a rush to US Treasury bonds. And the good news is that business is jumping, so this week, even as the US economy dangled on the breach, the smiling yellow face went up and US T Bills flew off the shelves. The oil bubbling Russian stock market, for one, simply collapsed, Asians saw German and French road-kill, sold off Euros and the Yen, setting off a rush for dollars! Rates dropped to 1/20th of 1% on short term T-Bills.

For those customers with too many dollars around the world, and derivatives they couldn't move limit-free on E-bay, there is a happy outcome to all this.  The Treasury Secretary, tired of merely spawning M&A deals in a down market, has moved to Washington where money need only be printed. He now rolls out the greatest deal of all time, an $800 billion whopper. Doors open bright and early next Monday morning, the line forms in front of the White House, forget the lead boxes, just bring the toxic waste.

We call this a virtual depression because its fundamentals are hidden in plain site: there is now a seemingly endless all too real war being fought on borrowed money, one that has coincidentally cost up to now approximately $800 billion. Another major factor, is the supply of imported petroleum costing hundreds of billions. This money is sent East to gadget maker and oil producers alike who must re-circulate it, into something other than the now proven toxic collateralized debt objects  and the Agencies issued by Fannie Mae and Freddie Mac.

We have turned the country's principal market into one vast junk money market with headquarters in Washington: Employees around the country, throw off your assembly line gear and don the uniform of the big banks.  In virtual America you'll be flipping  T-bills for minimum wages until someone here can figure out how to gin up the next bubble.

A vast moat of debt is being built around the capital for the next Administration to grapple with.  In it, Paulson is creating an ever deeper pool of US T-Bills and one can imagine, as the mechanics of the bail-out get put in place, new classes of Agency bonds backed, once again, by the full faith of the US government. Conceivably, with a little help from Congress, Paulson will have kicked the ball down the field until that ever looming day, the virtual dollar, itself, faces collapse. What has been beamed away will reappear.

Bernanke et al. know that the dollar manufacturing monopoly provides an enormous cushion,  years, at least. Monopolies don't break easily. Unfortunately, the endless War will not go away, that's the clear logic of Iraq and Afghanistan where costly troop deployments, will have to be augmented by even more costly (aid) giveaway programs. After all, spreading dollars like manure worked in Anbar Province. Obama's hands are tied before he even gets there. This is Bush's parting gift, he thinks, while all he has really done is pull the cloak off the virtual dollar machine, the great transponder.

The (Private) Debt Party is Over?

Meanwhile, back in that part of the USA outside the Beltway, where molecules still make sense, the party is temporarily suspended. The bad news folks is that, like in 1932, the bottles empty, we've bubbled out. We have, after all, been tripping the light fantastic from bubble to bubble since the 70's and given the costs piling up for real world War and the onset of shockwaves from Peak Oil,, the end of this one has had a fate, perforce, no better than Steve Fossett's.

It will take years to dig out from under a borrowing blizzard that has been going on for decades.  This is not just bad residential and commercial mortgages but leveraged buy-outs, credit card debt, auto loan debt multiplied thousandfold by layer upon layer of big bets in the shadow banking system. While the Administration was keeping the cost of the War off the books and running up steeper and steeper official budget deficits in synch, the public was doing its bit on the helium of borrowed money and spiked smoke in the stock and housing casinos. Such is leverage in every day spiked Bubble World.

Human Nature, or Leveraging Leverage

Had the borrowing frenzy been restricted to the above confines, we'd be in the process of winding down from a serious binge but there'd be only the usual casualties, the hogs, the foolhardy, and the suckers.  Over time we'd work our way out of it. But this is a different story that has been brought on by the accelerating logarithms of what's come to be called the shadow banking system. Ultimately. what goosed the lending frenzy was a financial industry where the hogs had gobbled up the pigs. These porcine magos took all manner of loans, good, bad and otherwise, and bundled them and sold them as CDO's or MBS's or Swaps or whatever device they could use to pile leverage on top of leverage. To be quaint, they labeled them "toxic waste" and like their smokes from another generation they consumed them with even more gusto.

Importantly, in a souped up low interest environment, they found they could move these "securities" that paid very little better than T-Bills at enormous margins. In a creative flurry, equal they imagined to the one that brought us the Internet, they took to bundling the bundles themselves into various classes of so-called derivatives, quantifying so-called tranches of loans into various levels of risk for anyone who wanted to make believe he understood them.  And as this market grew, they created a class of insurance policies they called credit default swaps, designed to back up the derivatives. We wrote a few months ago that the CDS market totaled  the astounding sum of $57 trillion, though lately we've heard it calculated at 62 trillion (no one really knows) or, 4 years of the total US economy! We concluded that it was little more than a Vegas kind of side bet industry since there was no open market for the swaps nor were there any requirements for set aside reserves.  It was, every hog for himself.  We also predicted it would end up in the taxpayer's lap!

Meanwhile the regulators in Washington were no where to be found.  Greenspan's Fed did not raise its rates to slow things down nor did it urge Congress to institute new rules that might curb the activities of the security issuers by requiring transparency, marketability or reserves to back up their promises.

In order to keep this market going, long after every not so eligible borrower had exceeded their ability to ever pay back their loans, the banks began eating more and more of their own toxic waste, trading more and more of the stuff among themselves to the point, today, that they no longer trust the books of any of their counterparties or peers.  Today's bailout sponge is meant to take all of this massive mess off their hands 

The reason we have seized up is that there are no markets to trade these derivatives and swaps and no way to know what they are worth given that no one knows what the underlying loans look like or how they are actually backed up. For this, and a host of other suspicions, the banks have stopped lending to each other making it hard to satisfy their legitimate customers. 

Washington Truce and Consequences

Back in the 1980's the Reagan Administration introduced what has turned out to be one of the two basic seeds of destruction for the modern Republican Party. For Reagan, who promised to "get government off the backs of the American people", the Administration would embrace a theory called supply side economics (the other seed, of course, is the creation of a Christian fundamentalist base that can get ecstatic with having the likes of a Sarah Palin as President) as a substitute for the prevalent Keynesian approach that both parties had adopted, as Richard Nixon famously said. Hitherto, conservative orthodoxy had been closely associated with a cloth coat, business-like fiscal conservatism intent on balancing the budget.

Put, perhaps too simply: for Keynes, the government had a roll in stimulating the economy in a crisis through the creation of infrastructure: money put into highways, bridges, parks, etc. directly generating jobs and economic activity while contributing to the common wealth. For supply-siders, the individual taxpayer becomes the net beneficiary since the government, in essence, finances its projects through debt rather than taxes, something that Reagan's Republican primary opponent, George HW Bush, dubbed "voodoo economics". Supply-siders argued then and still try to make the case that by leaving the taxpayer off the hook to spend and invest as he/she wishes, economic activity is stimulated and over time limited level tax revenues actually increase. This was a wondrous no-pain solution for the wealthy that better fit the mood of Americans moving from the Rustbelt to the South and West. For high bracket Americans, it was "the shining light on the hill". Unfortunately, for future generations it was debt service.

It was a novel idea that also had its roots nourished by an emerging rightward libertarian tilt of the party whose proponents also advocated truly risible nihilistic thoughts of "starving" government of its lifeblood, through choking the tax stream. Reagan would abolish government social programs --for instance, it was at one time committed to abolishing the Department of Education-- while greatly increasing the Defense Department budget. In the end, Reagan left office with the largest non-wartime deficit in history; nonetheless, his presidency was seen, particularly among his co-conservatives, as a success, and the basis of a winning coalition. Since then Republicans have never looked back on this smorgasbord  of voodoo economics and politics that would have horrified many of their Eisenhower era colleagues.

For a bookend, the hapless Bush II who never ran a profitable business, of course, does the same thing, only with no-blink attitude.  He greatly expands the Defense budget through his new endless War and Homeland Security, he puts little or no restraints on government growth or on the mega-pork-barrel spending of a Republican Congress and he cuts taxes on high earners well below the levels Reagan wrangled out of the Democrats. There is no longer any doubt he will leave office having run up more debt than all the previous presidents combined, with the exception of Franklin Roosevelt, who merely had to dig the country out of the Great Depression and finance the Second World War. Ironically, he will, as a result of the Wall Street Bail-out Bill,  also be associated with the largest government takeover of private assets in the country's history.

The End of the Bretton Woods Era?

What Reagan had inadvertently tapped into --and what makes the theory of starving the government so risible-- was the built-in advantage the US had over its trading partners, the almighty reserve currency, the now virtual dollar. Since Richard Nixon had delinked the dollar from silver, the dollar had become strictly a piece of  paper backed up only by the credit and faith of the US government. It was in old parlance a "fiat currency" that also happened to be, by international agreement, acceptable as a reserve currency for central banks around the world, with the same status as gold. The US printing press would become the engine churning out decades of debt absorbed by a willing South Asia Middle East. 

Back in 1999, as the Wikipedia puts it: "shortly after George W. Bush was elected president, Congress and President Clinton were trying to pass a $384 billion omnibus spending bill, and while the debates swirled around the passage of this bill, Senator Phil Gramm clandestinely slipped a 262-page amendment into the omnibus appropriations bill titled: Commodity Futures Modernization Act."

What Gramm and the banking lobby behind him accomplished with this Act combined with a preceding Gramm-Leach-Bliley Act removing the bounds between thrifts, investment houses and insurance companies that governed the financial industry since the 1930's, provides the stage for the present meltdown on Wall Street. The Act quite specifically opened the door to a whole new classes of completely unregulated investment vehicles we're calling the shadow banking system. Gramm, of course, is the same unfettered market fundamentalist who had been John McCain's campaign head and chief economic guru until he had the misfortune to speak his mind on TV a few weeks ago.  As we all remember, he got in trouble for saying that the American economic problems were psychological and that Americans who saw it differently were whiners. Another enormous irony: should McCain be elected, Gramm may by his Secretary of Treasury and therefore in charge of spending the money that Congress has just allocated.

Revolutionizing the Debt Republic

It's pretty easy to guess why all these financial wizards could play make believe with trillions of dollars: quarterly profits on Wall Street boost investment house stock prices, enriching option holders and annual profits feed into enormous bonuses for those fortunate enough to be in the game.  So, for several years this decade, as the housing market pushed upward investment house stocks soared and paydays on Wall Street were the envy of the world. It would not be uncommon for a middle level executive to take home an 8 figure bonus.  These were heady times and the Bush tax cuts meant that less would go back to the government coffers and the more to penthouses, second and third homes and breakfasts at Tiffany's and the pockets of armies of lobbyists and political donations to the pliant. Are we whining yet, Evita?

Billions of "excess" dollars flowed into the shadow banking system as exemplified by the plethora of hedge funds that sprang up like mushrooms around the big Investment Banks. For hedge funds there were no limits on leverage, they could borrow as much as the Merrill's etc. would lend them and the Gramm Act had removed reserve restrictions on these guys as well. Mighty Bear Stearns fell partially on the weight of its lending to its own in-house hedge funds. Where restrictions did apply, the created entities called special investment vehicles, or SIVs to skirt the laxly enforced rules on public companies. After all, the SEC was now being run by industry lobbyists weaned on Enron accounting.

Off With Their Heads!

For those yearning for the public stripping of wealth, the symbolic guillotine, the place to start might be with the hedge fund managers who not only pulled billions off the top of their funds as they gamed the derivatives game but also found a highly questionable loophole that allowed them to declare their managerial fees as capital gains, rather than wages, thereby paying a lower tax rate than the guy who emptied their wastepaper basket, as Warren Buffet famously pointed out. A simple IRS ruling under the next administration might be made to apply to this billion dollar loophole  So far, we've heard no one call for this one.


Of Bubbles and Bail-outs:  The Saga Continues

$85 billion here and $400 billion there and $800 billion there and before long you are talking about real money: and so, alas, this story only gets worse. Yes, Lehman Brothers was allowed to crash on its own but even there in the background the Fed was making moves to goose up its lending capital and is now accepting not only bad paper but the collapsing stocks of the other investment houses as collateral for its back window short term loan facility that not too long ago was restricted to the thrifts it oversees and which must maintain verifiable reserves. Paulson's transparently phony line in the sand on socializing loss at Lehman didn't stay visible even for the 24 hours it took to blow off AIG.

Enron Accounting Goes to Washington

For 6 years Bush has been able to keep the annual $130 billion cost off the books as he fights his "temporary" war.  No surprise, then, when Paulson let it slip that he wasn't going to put the $29 billion he laid aside for Bear Stearns on the books, either. Our point, as this virtual depression started to unwind last year has been that when this story of unbridled lending fueled by insane greed got to the end, the taxpayer would pay and pay big.  We have no doubt that eventually the government will find it necessary to directly intervene in the national housing market to stabilize prices there too as well, after all it is at the very root. 

A real bail-out of the housing market will indeed cost real money, much more than the $1 trillion already pumped in, and on the books, or off, depending on how transparent or eventually profitable the results are --are we getting laughable?--  taxpayers will be paying for it for years to come. There are also reasons, given the takeover of Fannie Mae and Freddie Mac, to believe we may have actually already doubled the national debt by the time this crisis finally blows over.

The Deficit is not the Deficit is not the Deficit 

What we are seeing this month of September is the meltdown of the entire Wall Street elite of independent investment banks either through merger with big old style banks or through collapse as in the case of Lehman Bros, that waited too late to make a deal.

Not every one of the regulated thrifts is going to make it through this meltdown (117 were already on the regulator's watch list even before the collapse of Lehman, Wamu, Wachovia and AIG). It was also very likely, as the unwind plays through, that the FDIC, the agency that insures depositors' money, would run out of cash.  It didn't take too many IndyMacs to get to that stage.  The Senate, in its version added on this facility for the Treasury as well, in exchange for the "temporary" raising of insurance limits to $250,000 per depositor. FDIC is funded by the banks in normal times. The $250K limit will no doubt be made permanent despite the objections of the banking lobby.

It's the Mortgages, Stupid!

Well, maybe not just the mortgages and the national housing market. But continuing lower prices for houses is at the core of much that's gone on so far. But the profits brought on by the issuing of a pyramid of paper based on these loans also extended to all manner of commercial and consumer loans. Mortgages and house prices are particularly insidious because they amount to the plus and minus side of Americans' largest class of assets. If your house is worth less than you owe on it then you are probably underwater all the way around.  After all, on the minus side, most Americans have carried credit card debt, and auto loans, not savings accounts. Where mortgages look particularly bad in the coming year is not so much in the sub-primes that were so flimsy that many collapsed at the first downdraft and are being cleared off the books.  But many ordinary Americans with better that bottom of the barrel credit and looking to move up, or simply to refinance their credit card debt-- took out something called Alt-A mortgages that didn't require strict income documentation and that were characterized by very easy terms during the first couple of years. These Alt-A's or "liar loans" were more than the majority of  loans issued in 2006 and many will require refinancing in the coming months. That's bad news in a declining market because borrowers will  face significantly higher monthly payments on houses they cannot sell for anything near what they owe. How many just walk away depends very much on just how low prices on these houses go. House prices during the Great Depression fell over 30%,  Depending on how you  measure it, we may have reached about half or two thirds of that grim statistic but no one can guarantee that 30% is a magic number. The ratio of debt to savings that Americans customarily carry today was nowhere to be seen back in those more innocent days; home ownership was more limited and job mobility hardly existed.

These increased loan payments are coming due just as the job market begins to crumble. In the past decade wages had remained below growth levels but there were jobs.  Now, those jobs are starting to disappear.  This is bad news for already shaky families who may no longer have a choice about staying in homes that are underwater.  They may have to move to where the jobs seem to be, despite school and community ties.

After all, in the days of easy credit, homeowners were  bombarded with offers to refinance, in other words, use their houses as ATM ;machines every time they maxed out their credit cards or wanted that bigger SUV flashing across their TV screens  Ah for the life of off the road, clean family fun, or sex drugs and rock n' roll or great adventure.  In that world, you could, with no money down, drive all the way to the top of the most pristine mountain peak and gaze out at a pollution free world with nary another SUV in sight or drive up the swankiest night club in town in your V-8 Ram tough.

Such is the magic of the American dream, as easy as flipping your keys to the parking valet!

Or Maybe, It's the Taxpayer, Stupid!

It's hard to mark just when we morphed into our present system of jobless, bail-out capitalism, was it the Saving and Loan bubble when everybody and his brother opened a bank with a lending window marked: No Developing Country Will Be Turned Away? Since then the series of bubble and busts have followed one another like Atlantic hurricanes in September.

Like those single-eyed monsters, the intensities and trajectories can be different but damage is left in the wake for the clean-up. FEMA gets called in and taxpayers foot the bill. Hurricanes, of course, are acts of nature, while economic bubbles are acts of human nature. Still, in the end, it's the taxpayer, stupid! --we'll resist the temptation to reverse the word order, or shedding a tear for that matter.

Many people marvel at the breadth, scope, flexibility and velocity of the world economic system as it shifts trillions of dollars from Hong Kong to London to Tokyo to New York in a 24 hour cycle. And it truly is a marvel but like any very large and constantly changing system it is open to ever more sophisticated forms of manipulation.

For some it's a necessary mechanism of doing business, a streamlined way to finance and pay for their every day business transactions.  But for many more, it is an opportunity, a way to game a few basis points more out of their capital investments. And it is this very greed that is at the bottom of every bubble.  It's easy to say that if losers don't get to pay for their greedy mistakes, another bubble will be on the way even before this one is wound down. But bubbles are much easier to stimulate than hard work, productivity and inventiveness, the stuff of real growth.

Alas, Say it Ain't So!

In the end, the ultimate target is always the ordinary gamer who gets sucked into the pyramid scheme just as it begins to hit its height and who is destined to get burned as the scheme begins to collapse. But often, perhaps to prove their existence, the Gods of Fear and Greed see to it that the very perpetrators of the scam get caught up in their own webs and end up taking the biggest falls of all.  And so, welcome to Bail-out World, where they get to use the leverage of their power and wealth to drag in those who stayed completely clear of the whole process and never dreamed that it would be their money that would be used to get the big guys off the hook.

The mantra of course is "too big to fail".  It explains why those who profess the religion of maximum gain for those who invent, work hard and risk, find it necessary to "suppress"  their own core belief in moral hazard for the "good" of society. During the brief time-out, everyman will now be allowed, for the greater good, to step in and once more mop up the blood on the floor.

Last month, as the Treasury Department stepped in to bail-out Fannie Mae and Freddie Mac, we may have just witnessed the largest one-day Federal takeover in US history but certainly only the prelude to this tragicomedy. 

The Tragedy of Fannie and Freddie

Like all Atlas-like epic fiascos there is a long and complex story with many more sinners than saints for main characters across the generations. In the end there is a complete failure of the system as a cynical move was made by Greenspan's Fed to shift the bubble away from the stock market after the tech bubble blew up.

In 2002, the extensive lowering of interest rates in the wake of the tech bust and 9/11 actually priced money at a negative interest rate. Banks and investment houses were encouraged by the Fed to get into the game, mortgage rates fell to historic lows and homeowners were encouraged to refinance, take cash, trade up,  take on second homes and to take a plunge into real estate speculation. The flourish in activity had the effect of driving up housing prices the same way the stock market soared during previous bubbles. As housing prices rose much faster than people's salaries, encouragement in moving up hinged on the proposition that house prices would continue to move up for the foreseeable future. Greenspan assured Congress in public testimony that there was nothing to fear from rising home assets, no irrational exuberance, this time around in this Fed induced and abetted bubble.

Wall Street, on an unfettered lending and borrowing binge of its own, roared into the game by greatly widening the market for sub-prime and Alt-A mortgages through the issuance of all manner of derivatives based those mortgages.  But as we noted, it was just too profitable a game to voluntarily put the brakes on.  If ever there was a need for adult supervision, it was here. It is, of course, just another gambling at Ricks, moment when politicians exclaim they were caught unawares.

 Meanwhile in Washington, the GSE's, that is, those hybrid privately owned Government Sponsored Agencies, commonly known as Fannie Mae and Freddie Mac, who were the backers of most ordinary mortgages issued in the country, were basically frozen out of this new market for bundling sub-prime mortgages into securities, by their own regulators. Undaunted, they found a climate in Washington ready to open the ways for them to get around their own regulations by getting leave to buy up the Wall Street derivatives to hold as their required reserves. And they borrowed heavily, leveraging 60 to 1, to get at the "profits" in this burgeoning market. Needless to say, as hybrids that made them public or private when it suited, they had grown accustomed to paying their own executives massive bonuses as well, based on the same short-term criteria as Wall Street. As a Washington creation with roots back to the New Deal, they had become masters in the game of lobbying and thus in getting their way no matter the Administration.

The Bell Tolls for Fannie and Freddie

Of course, sooner or later, someone would have a reality moment and sell off some of the growing mountain of toxic waste.  That finally occurred with a couple of hedge funds run by one of Wall Streets most savvy and ruthless bond trading houses, Bear Stearns. When people began to pull money out of the funds back in summer 2007, the managers were forced to offer up their securities to the market and when Bear, itself, wouldn't fully step in, there were no other takers. Then, Bear Stearns, themselves were forced quite publicly to only sorta back up their own funds,  letting the more highly leveraged one slosh noisily into oblivion.. The emperor's clothes had now to be hung out to dry. With the sweep of a wand, less than 7 months  later, venerable, savvy, Bear, itself was toast and banks all around the world were nervously digging into their balance sheets to determine just how much waste product they were holding. True they had hedged up by buying things called credit default swaps to insure against losses but they now were forced to take a hard look at who it was that had issued these totally unregulated insurance policies and just how much in reserves there were to back them up. Bear's hasty demise, greased by Paulson's Treasury, told the sad story.

Credit ratings, based on the possible toxic reserves, were suddenly being reevaluated.  Reserves were based on the face value of securities with no market and the regulations required they be marked to market, or priced at what they might actually bring in a sale. Many swap and derivative agreement also had clauses in them that required issuers to firm up reserves as their credit ratings were downgraded.  This set off a spiral, as the entire financial world began to grock that there was no real market for the derivatives of the swaps. Mark to market, or give a real value to a security, had no meaning and too much meaning at the same time.  SEC regulations required this accounting.  The commercial banks would be forced to begin making real write-downs of billions in losses to meet their requirements. The operative word was "write downs' but these were losses that had to be put on the balance sheets. It was a signal to the other banks that their best customers might just be insolvent.

A Hosing in Housing

Meanwhile back at the subdivisions of California, Nevada, Florida, etc., as those houses in real America went into foreclosure, it drove the price of surrounding houses down as well. People who had been convinced that they could borrow beyond their means for houses they couldn't afford now found themselves owing more than their houses were worth.  Many of them had no choice but to pack up, leave the keys under the mat and take off. Home builders found themselves with developments full of unsellable houses worrying about the cost of plugging roof leaks and cutting down weedy front lawns. Their stocks tumbled as did the stocks of the big banks as it became clear they were holding mountains of debt based on an inflated value of the same sinking home market. For a while, there was denial then a belated effort by some of the big regulated banks to unwind their worst losses. Along the way IndyMac bank suffered the first public run since the 1930's as it shut its doors. The spectacle was taking an ugly turn.

Government Bail-Out Phase 1, a mere $29 billion

The problem was becoming national and then international.  Each quarter major banks around the world would announce the write-off of billions of dollars, $10 billion for USB, one quarter, $8 billion for Merrill Lynch, another. Foreign buyers were invited in to take big pieces of these International financial trophies. And then one winter weekend Bear Stearns fell off the cliff. The losses were mounting into the hundreds of billions and the Asian and Arab nouveau riche bowed out.

Here then was Treasury Secretary Hank Paulson, a Wall Street poobah, himself, announcing a deal in which the old, hard knuckled investment house that had assured every one that it was fully capitalized, would be sold off over a single weekend before markets in Asia opened on their Monday morning.  It was highly unseemly, not only wasn't there adequate capital, the entire $multibillion firm was actually less than worthless, an estimated $29 billion less than worthless! Paulson took $29 billion out of the Treasury, and gave it to JP Morgan to make the problem disappear.  And for a while, the markets quieted down.  The crisis was averted! But now there was the potentially politically damaging spectacle of a Republican Administration using public's money to shore up Wall Street, the paradigm of excess, while millions of Americans were facing foreclosure on their rapidly devaluing homes and collection agency calls on their lump sided plastic debt.

Are We Whining Yet?

For years the Wall Street wing  of the Republican establishment has wanted nothing more than to stick a stake in the heart of the two largest (when combined) financial institutions in the United States, Fannie Mae and Freddie Mac. And then  when the housing bill passed Congress before the summer recess, Treasury Secretary Paulson, a Wall Streeter himself, was given the green light to do the deed as part of a what then appeared probable bail-out of the two hybrid giants. Still, he hesitated, there was too much at risk to the broader economy.

And yet, it had become clear to knowledgeable folks who looked over their holdings that a collapse at Freddie and Fannie was inevitable.  There was a tactical question as to whether they could hold out until after the election, which seemed to be  why Paulson and the Administration kept holding back from doing the deed. A financial crisis as large as a Fannie and Freddie collapse, would certainly turn the public's attention back to the economy and probably spark the big run on the banks.

It's Not Just Housing, Stupid!

But in a tightrope act, the Treasury under Paulson was active in other pre-election areas as well. Towards the middle of July, the dollar suddenly jerked upward and the price of oil moved in the opposite direction. Until then, for months, the dollar had been trading in a range between 1.55 and 1.60 Euros.  As we write this, it has gone down well below 1.40.  Meanwhile, oil, which peaked near $140/barrel has fallen back to less than $95. It was as if, somewhere way behind the damask, the Administration had decided they had to bring the price of oil down before the election and had set in motion the gears that force the dollar up. By doing this, they would with the benefit of a little lag time, sacrifice gains made in exports, for what would be an immediate stop to the oil price bubble that had powered the speculation market in the early summer.

At first the strengthening of the dollar and the even bigger drop in oil prices appeared to provide a boost for the US stock market already reeling from the sub-prime mortgage crisis, but which had reached a bottom in the middle of July just as the price of oil peaked. Then the sucker started to go down!

AIG and then what?

For mortgage lenders and a number of banks and investment houses of all sizes, the subprime debacle has been an ongoing disaster. Two of the largest lenders in the market, had already gone belly up, and many observers believe that the nation's largest bank, Washington Mutual would soon follow suit. Morgan Stanley, one of the last of the 4 independents seemed likely to go the way of Merrill Lynch, in some shotgun deal and that might even have dragged down the last, Goldman Sachs, Paulson's own alma mater.

Credit, Credit, Everywhere and Not a Drop to Drink

This --the latest chapter-- in what has come to be our first virtual Depression-- was breathtaking in the number of ironies that got rolled up into what is still unfolding as the greatest rescue package of all time..

In retrospect, it might appear to more sanguine viewers that the consolidated goal of the Bush Administration, its Fed and the bankers became to strip Americans of their one asset, their house, and turn it into spending money. With a little luck, they might also have succeeded in diverting social security into Wall Street's maws.

There was a rather lengthy list of major players in the scheme all with their own, sometimes coinciding, sometimes antagonistic agendas:  There was the Administration that was intent upon replicating and outdoing the Reagan years by running up the national debt; there was Alan Greenspan's Federal Reserve that was equally intent upon experimenting with substantial deregulation of the financial markets and stimulating growth through low interest rates, there was Wall Street, with its bonus system of big insider payoffs, ready to pick up the Greenspan's challenge of "innovating" and new types of unregulated investment entities we'll lump under the rubric of hedge funds; there were the commercial banks that were being rolled up into giant national financial entities as banking laws were repealed; there were the building and building supply industries, obvious beneficiaries of a residence construction boom; there were foreign governments running enormous trade surpluses with the US looking for creative ways to park their dollars,  there were millions of Hispanics ready to risk all to cross illegally into the country for low wage building jobs, there were the mortgage brokers who sold the loans; there were, of course, the homeowners who could tap their equity and, sometimes, move up and eventually lots of new homeowners who were offered deals on homes that might never have dreamed to get into, the flippers, or the speculators who jumped in to fire the upward pressures on the market as house prices spiraled higher, and now, of course, the guy who thought he was staying clear of the shenanigans, who's just getting the mop up bill.

Pigs Get Fat While Hogs Get Slaughtered (Tom Delay quoting Texas wisdom)

The trouble with virtual depressions is that they always leak over into the real world. Recent government moves have proved once again that while the gains may be private, the risk must be socialized; on that both political parties are in agreement as are all the governments in the G8. All that bad paper sloshing around the world financial system will eventually be absorbed by the governments and the great international banks themselves, when it suits them, as the price they pay to soak up pesky competitors. The next couple of years will be full of sound and fury as the politicians realize they will have no choice but to pull out all the stops to stabilize the housing market as a first step. This will not be a pretty tug of war nor a shining day for moral hazard. But in financial crises as in war, the truth is always the first casualty.

The taxpayer, alas, will not get his Department of the Portfolio.




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Posted by dymaxion at 04:30 PM

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January 23, 2008

Move Over Subprime , It's Primetime for Credit Default Swaps

As if, after centuries of debacles, we needed proof that greed and fear will trump rationality in the affairs of men big and small; once again, we are peering down that precipice of folly called "the market knows best". This Gilded Age that even the Enron debacle couldn't derail has now come to crash. And oh, by the way, the rest of us will be left to swab the blood and piece together the remains.

Last month we warned that the second shoe is about to drop as subprimes move off the front pages to make room for something more obscure but potentially even more toxic, called credit default swaps or CDS's. And once again, as with the problem of the subprime mortgage disaster extending far beyond the problem of millions of people unable to make their home payments and the falling home prices of their neighbors but rather to the mountain of three-letter (CDO, CLO, SIV, etc..) financial rigmarole that the banking system and the shadow financial system generated on top of the mortgages, the failure of billions of dollars in CDS's and their derivatives, will rain down on all of us.

Remember, banks in China, Singapore, even a few small towns in Norway and some of the biggest world-straddling financial institutions are all still trying to figure out how much they lost buying the toxic waste their bond development arms so profitably generated in the pyramid scheme that led up to the latter stages of the subprime crash. Financial institution balance sheet losses, alone, are conservatively estimated to be in the range of $250 billion when all the off-book transactions are brought into the open as write downs..

Counterparty, What's a Counterparty?

Unfortunately, as they say on prime time, there's more to come, folks: the credit default swaps --insurance policies with little money behind them-- are whole new episodes still to be played out.  And when it's all done the major economies of the world will have thrown further billions in taxpayer money at the various debacles.  Only the scoundrels who conceived of the pyramid and spread the bets around, will be left with their fortunes intact; for, if we've learned anything at all, we know that the bailouts will be seen as necessary to keep the system from crashing entirely and the guys who walked away and the guys who were supposed to be regulating them will be off laughing, no doubt conspiring on the next bubble.

It might be sobering to note that there are estimated to be $45 trillion in CDS's in circulation as we write this, that, in case you're not counting, amounts to approximately 3 years worth of the entire US economy! CDS's are designed to act as insurance against the default of specific junk bonds, bundles of bonds or, their derivatives, and in a further twist, of the same companies that issued the insurance swaps in the first place. They have existed in a market outside of, but impacting the bond insurance traditionally issued by the monoline companies to guarantee corporate and municipal bonds and the complex rating system that determines the interest rates that companies and municipalities end up paying as they rotate their borrowing sometimes on a weekly or monthly basis.

But as CDS's took off even the sleepy monoline insurance business got a hit of cocaine in the last few years and got into the more lucrative business of using their AAA credit ratings to issue insurance on the CDO's that Wall Street was using to finance the subprime mortgage bubble. As a result nearly all of the major bond insurers (Ambac and MBIA, are the leaders) are now facing bankruptcy, unable to take on the financing needed to cover their obligations without so diluting their capital that takeover vultures will rush in right behind the capital injections.  This is still to be played out as bailouts get structured (here's a Marketwatch article).

In the meantime, with the money spigot left wide open by the Fed, the vast majority of squirrelly bonds issued by Wall Street was "junk" rated and thus out of the realm of the regular insurers --who,  by the way, are also required to keep a certain amount of reserves on their books to back up the insurance or lose their vaunted credit ratings--  and so a whole new range of players stepped in to fill the void with these CDS's.  The issuers, whether hedge funds or off-the-book brokerage house and bank financed companies, created mountains of new paper insuring, as we noted, not only the derivative products but the derivatives that were derived from bundling derivatives (you wonder who would have bought into this game?). These new insurers, or counterparties, as they're called on Wall Street, were totally unregulated, existed outside the realm of the already overly loose playing ratings agencies, and thus had no real obligation, other than their own guarantees, to keep any reserves on hand.  And, of course, as quickly as the hedge funds were able to amass piles of cash, they could disappear as investors smelling the coming debacle, pulled their money out.

Like the subprime mortgages that were issued by people who were paid to write them but who carried no risk should they go bad, the CDS writers and the brokerage houses that moved their paper guarantees had little to worry about and plenty to gain in the short term. The clearest description of what a CDS is came in some of our reading last week.  The author --who will have to go without credit as we forgot to pencil in a note-- called them something akin to side-bets that viewers of a sporting event make between themselves along the side-lines.  CDS's, it turns out, were bought and sold by participants who were not holding the underlying securities that were insured.  In that way they opened the door to speculators who might be trying to short the derivative, junk bond or CDO, etc. markets.

In free market theory all this activity would be beneficial to the overall market as it spreads the risk or at worst, would be detrimental strictly to the players on the wrong side of a bet. 

According to this line of thinking, you've got supposedly shrewd and savvy people managing other supposedly smart, shrewd and savvy people's money making their own bets on how things will play out.  This "hedging" or "speculative" activity, depending on the bettors perspective, is theoretically supposed to allow more granulated approaches to larger market forces thus smoothing out discrepancies that might otherwise disproportionately tilt them. Unfortunately, as we are once again about to see so tragically, it doesn't work that way when the guys who start the pyramid game get to walk away Scot free leaving people who never ever heard of a hedge fund, much less, a CDS to pay the piper!  That's where we are today as markets around the world tumble and the Central Bankers and politicians scurry to print more paper, this time in the form of legal tender, thus diluting everybody.

It's Pay Up Time

The big problem with the CDS's is that losses involving this paper may total another $250 billion or perhaps much more, according to the calculations of people like Ted Seides (see our last piece, The Next Big, Big Crack)  Junk bonds by their very definition, are bonds issued by entities with weak balance sheets.  They pay higher interest because there is a higher probably some of them fail.  Historically, these defaults run in a range, depending on the relative financial health of the issuer,  from about 2.8% to 4.7 % in normal times. With the pool of junk bonds expanding over the last few years in a borrowers market when investors were willing to buy just about anything sporting even a small risk payoff (in fact the premium between Treasury's and junk had never been narrower), there's lots of room for future failure. It's also obvious that in a recession the percentage of failing companies increases significantly and therefore the number of failing bonds increases.  It may, with a deeper than normal recession looming, then be much more that an average failure rate for low rated junk of  4.7% over the next couple of years, if so the losses would be nearly $1/2 trillion just in CDS's. And once again, no one knows who the counterparties are and where they could possibly come up with that kind of money (we can guess with great certainty, they can't) and, more importantly, who is holding all these CDS's that are likely to sink to pennies on the dollar. Imagine the big banks going through another round of hat-in-hand begging for cash injections around the globe.  Any takers for side bets on whether the governments will step in?

Now comes the US recession and an ongoing crisis in the world financial system still trying to swallow the subprime debacle's losses and we can now foresee the failure of numerous junk bond issuers.  As those bonds fail, investors will turn to the CDS issuers to cover the defaults. And, of course, the issuers of those guarantees will be nowhere to be found, their gains tucked handily out of reach in offshore havens that require no reporting and no taxes.  No wonder the Fed and the Treasury Secretary have gone into panic mode!

 Meanwhile, the so-called US or world recession will deepen as the authorities begin to dig deeper and deeper into their rescue strategies. Nobody, except maybe the GOP candidates, will be lauding the free market system as it becomes time to start wiping the blood off the floor.  Stock holders and investors will be the first to be hit but certainly won't be the worst victims of the folly that let $45 trillion in insurance be issued without any reserve requirements.  Interest rates will be forced down affecting older Americans whose incomes are tied to them, families with large credit card debt will default, governments will struggle with lower tax revenues and begin cutting programs designed to protect their taxpayers, good jobs will be lost at an even faster pace then during the "good times' of the last 4 years. As Wall Street insider and serial bull, Mort Zuckerman, so out of character, put it on the weekly John McLaughlin Show, we're looking down the barrel of the worst recession since 1929.

The already wounded large banks will struggle once again to cover the next round of losses brought around by the CDS debacle and new and larger pieces of America will go on fire sale to those private and "sovereign" entities sitting with their coffers stuffed with dollars that have been passing so quickly through Wall*Mart, Exxon, etc. conveyor belts on their way East. The CDS debacle will be this chapter's Black Swan.

That's why nobody thinks the $150 billion stimulus plan proposed by the President with Congress on the bandwagon is going to do more than a peashooter aimed at a tsunami. Just as sharply lower interest rates in the US will only accelerate the race out of the dollar thus fueling a new round  of strange distortions down the road.

Bush, it looks like, will finally get to truly exceed his father. The 2nd Bush Recession, potentially the worst since 1929, on top of the series of debacles around the world of this regime, and a bleeding dollar will put the nail in the coffin of the Reagan Revolution. The party of domestic deficit spending, unfettered trade policies in the face of enormous dollar trade deficits, moving social security money to Wall Street, off the books war spending, and the dogmatic unfettering of the activities of the world's pyramid scheme guys, will likely come to an end.  Already you can see it coming apart as the so-called social conservatives get fleeced at the gas pump on their way to jobs or homes that might not be there next month, the defense hawks contemplate unending $trillion, force-draining occupations of Iraq and Afghanistan and the fiscal conservatives see their savings eaten away by a diluted dollar.

Imagine a country with high unemployment, millions of personal bankruptcies and foreclosures, bailed out banks and brokerages and a social safety net in tatters; now think about the lip licking, fire-sale vultures waiting in the wings to swoop in, who have gotten away with the loot thanks in part to egregious tax loopholes that not even a Democratic congress had the guts to close.  If that doesn't make you mad, nothing will.

Posted by dymaxion at 02:21 PM

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January 08, 2005

Off With Her Head!


`A cat may look at a king,' said Alice.  `I've read that in some book, but I don't remember where.'

Tut, tut, child!' said the Duchess.  `Everything's got a moral, if only you can find it.' And she squeezed herself up closer to Alice's side as she spoke.

In Alice in Wonderland the Queen calls for the lopping off of Alice's head even before her trial begins. Here in Bushworld, there's an added element to the topsy-turvy world view; for simplicity sake, let's call it class warfare.

For four years the policy has been to pump a kind of economic silicone into the body politic by running deficits designed to extend out the day of reckoning for the excesses of the 90's.  Rather than paying for that puffery, we've gone into a situation of chronic deficit spending.  Hell, we even fight costly wars ($150 billion so far) while lowering taxes.  Deficits, of course, are papered over by the issuance of government debt in the form of Treasury notes.  Since Social Security (or payroll) taxes continue to run a surplus --the projection is that this surplus will continue until at least 2018 at current rates-- one of the ways the deficit is paid for, is by government borrowing of Social Security payroll tax receipts..  That's because there is no lockbox.  What's actually serves as the lockbox is a ledger noting the same debt that sits in the vaults of of private and government central banks all over the world; i.e., debt that is backed up by the good name and faith of the government of the United States through Treasury notes.

It is estimated that at present payroll tax rates the Social Security fund will not run into trouble until the year 2052.  So, you have to ask yourself why an Administration that never mentions the present growing deficit its tax cuts have brought about, that hardly bats an eye as the country continues to run up huge foreign debt in its current account by importing far more than it exports (the present imbalance is over 650 billion a year and growing, as we outsource most manufacturing), has somehow seized on the perils of 2052 to focus its economic policy agenda.

Can you smell the rat, yet?  The people who whisper in Bush's ear have found a way to beggar future generations for what will be at best only be a short term tookus lift for the stock market and a giant windfall for the brokers who get to manage the private accounts the administration proposes.

To understand what happens, it's important to see how the proposal would impact the present system.  As we said above, basically the payroll taxes collected today are used to cover the SS checks sent out today.  The surplus in collected receipts, is redirected to cover deficits in the Government's general fund.  The Government then issues IOU's in the form of T-notes back to SSA. And that's counted in the national debt.

What Bush is proposing, instead, is that a portion of the money covering today's payouts be instead diverted and put into private savings accounts that would allow younger workers to invest in the stock market rather than in a guaranteed future fixed income check the system, as is, provides.

As a result, multiple billions of dollars (depending on the specifics) would be diverted from the SSA and sent to Wall Street, where it could purportedly bring in higher returns and "give young workers a stake in the ownership society". The manner in which we cover this massive diversion of  funds from the system, is still up in the air but because the Administration has already promised it will not raise payroll taxes , it will either be added to the national debt with the stroke of a pen in the dark of the night or will be covered in some other more mysterious way. One idea being floated in Washington is that some juggling of the way cost of living raises designed to keep SS payments in line with inflation might be legislated as part of the plan.  In other words, the benefits of those collecting already, despite promises to the contrary, will be slowly shaved away to back private savings plans that could eventually founder if the markets remain bearish. And flounder it might, for a long time to come.

Despite all the extreme makeovers of the last four years, the stock market remains in limbo.  Deficit spending, uncovered war spending, low interest rates, the devaluation of the dollar, the normal quirks of Mr. Market,  have all had the same effect: of putting off the inevitable. And the inevitable is that stock market valuations have been and still remain way above the historical norm no matter how you figure them.  The Wall Street pumpers will always tell you that this time around it's different but the fact is that valuations always come back to the norm which historically, is somewhere, in P/E ration terms, from 16 to 10.  That ratio today is at around 27.

There is no exception, markets always come back to the norm, and for good measure, usually continue on past it, up or down.  We have still not shaken out the excesses of the tech boom, despite the bust, and are therefore still in the process of doing so.  Historically, that could take more than a decade (it took from 1929 to 1949 and 1966 to 1982 the last two times) or it could happen faster with a major retreat but eventually, despite momentary head fakes and jukes, the market will find its norm.

In Silicone Valley East (Washington, DC) the ugly duckling always becomes a queen, at least for a day.  The motto, of course, is whatever it takes to get re-elected.  No one in Washington ever worries about the long term.  When they do, it's time to hold onto your wallet.  The Social Security reform being put forward has nothing to do with Bush's retirement --that's laughable, though he did cite it yesterday in his speech on the subject-- and everything to do with a scheme to prop up the markets with new government-guided cash injections into the stock market taken straight out of payroll taxes. 

If fund manager bonus checks can be compared to tookuses, you can see them kissing them already.  Just attend one of the many fund raising inaugural dances scheduled for Washington this month.  One thing is sure, the fat cats will be having a ball.  



Posted by dymaxion at 12:55 PM

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January 28, 2004

Buy and Hold?

In an economic world that appears more precarious than at any time in the last 65 years, there's no shortage of risk. And so, for the sake of --should we say-- fun, we decided to move a jaundiced eye towards where we fear the greatest risks may be hiding, while knowing full well that the gods, like the audience at the local Cineplex, always seem to prefer a surprise ending, or a disaster flick, over what's reasonable and predictable.

We also know from hard experience that risk should be avoided when possible even in the best of times and, when accepted, should pay high premiums.

So, with safe returns --from both long and short-term interest rates-- hovering at historical lows and every indication that the Fed will hold them that way until at least until they can have no effect on the November elections and a dollar that has lost nearly 25% of its value in the last 12 months, there is somehow increasing pressure to take on the risk of either highly valued stock, REITs, commodities, bonds or even the currency markets.

There are plenty of analysts (hypesters and pumpers) out there who are ready to tell you that we have reached a virtuous moment in which booming asset prices; stocks, gold, housing, you name it, a depreciating dollar, rising corporate profits and easy credit for the indefatigable American consumer against a backdrop of very low inflation rates have somehow laid the groundwork for a real recovery.

For these guys, it's not too late (for you) to get into the market, which in some cases is up 50% from the bottom it hit back in 2002.  Jobs, they argue, are sure to follow and an improving job market will trigger further spending, savings, taxes and profits.  According to this analysis, we have rounded the corner and, having dodged the bullet through a heavy dose of government goosing are now heading for the next real boom. For these experts, the siphoning of jobs and manufacturing know-how to China and India, is the counterbalance that keeps prices in the stores low and thus dampens the usual inflationary pressures caused by distorted government and trade deficits and a depreciating currency.

The skeptics, of course, see a quite different picture: stagnant or sinking wages, reduced benefits, sinking dollar, government debt growing without any real prospect of moderation, widening trade deficits only marginally mitigated by the dollar devaluation, consumer debt now reaching 90% of GDP, job creation happening abroad in Eastern Europe, and mainly Asia. They also see a very deceptive inflation rate that undervalues things like the quickly rising costs of education, housing, healthcare and state and local taxes. By our reckoning --we of course count ourselves among these worrywarts-- it is only a matter of time before either some chain of events sets off the process or the ball of yarn starts to fall apart on its own no-shortage of internal tensions.

So --while always genuflecting to the aforementioned cinemaphiles, mind you-- let's conjure up the kinds of events that might cause the center to spin apart? Then, in an act of further hubris, we'll try to gauge what the possibilities might be.

We think that most people would agree that another terrorist attack of the magnitude of 911 would, depending on its strategic targeting, set off a wave of devastating economic setbacks as fear and physical destruction take their toll. Think, say, a dirty bomb attack on one or several city centers --we know al Khaida likes to stack its hits-- or, say, a bioweapon that hits humans or even the food supply. 

And the risk?  Again, we don't claim to know, but according to our neighbor Tom Ridge, something like this may be nearly inevitable.  We do know that the Soviets and others have had sophisticated germ and chemical programs and that both the know-how and the materials are out there and possibly, along with nuclear waste, for sale. Can we depend upon our intelligence organizations or border police to keep them out?  Again, knowing what we do about the number of people that infiltrate the borders every day and the lack of control in ports and even certain airports, we have to guess that someone with money, an undercover network and knowledge --sound familiar?-- could smuggle in the wherewithal to pull off a major attack.

Could that same gang have sleeper cells in this country ready to act?  Again, knowing what we do, it would seem to be a given; having had a 10 year head start, that there are likely guys already deeply embedded into this society who are only waiting to get the substances and the plans to go.

Another possibility is the outbreak of a worldwide epidemic like SARS.  How likely is that? Well, we know that SARS came close to getting out of the bottle just last year and we can  see today, with the Bird Flu, another example of a disease that just might totally overwhelm the system.  A worldwide epidemic could easily bring the economic system to a grinding halt.

To us, that alone would argue against any scenario in which an investor sinks a large percentage of  her capital into stocks or even bonds. In other words, there seems to be little room left on the upside and a whole bunch in the other direction.  Bonds, of course, have no where to go but down. Unless you believe interest rates will go negative.

So, let's say that everybody with a choice ought to be thinking about limiting exposure to risk even more today than usual.  If you believe that buying and holding stocks was the way to go last century --the American Century-- (it still wasn't) then you have probably long ago stopped reading this.

There's a strong contrarian argument out there that commodities are the way to go forward, at least, long term. According to this line of thinking, goods like oil, copper, titanium, gold are in limited supply and that as China and India grow their economies and 3/4 of the world's population gradually become consumers of electronic goods, scooters and automobiles, commodity prices as a class will rise even as demand in the industrialized countries stays flat.

Gold, of course, is that special commodity that will remain in relatively short supply while holding its historic role of ultimate storage of value.

But there are downsides on commodities.  A stagnant world economy on the brink of a deflationary spiral as more and more factories in Asia go on line, could drag commodity prices down and ultimately slow growth in Asia once again.  Economies, as we know, tend to move in fits and starts, booms and busts....and China, with all its upside, will be no exception.

Bear in mind also that petroleum and gold prices can be manipulated by political wills in ways that other markets won't be. In the case of gold, there is always the chance that behind the scenes the central bankers find it necessary to dump gold as a feint to slow the slide of the dollar.  As for the price of oil and the dependency that all players in the global economy have on it, countries will see oil prices as too strategic to be held to the whims of Mr. market.

On the other side, the major upside that is, should there be a serious crisis both gold and oil will inevitably shoot upward no matter what stop gaps are put in place.

So, all things considered, there is a little downside in a basket of commodities.  The central banks will try to hold the dollar from going to much further down and some will try --as if there weren't enough market pressures-- to "influence" China to move the RMB up to take some pressure off the dollar.

That brings us to currencies.  The real question out there is not whether the dollar will strengthen but whether it will stay pretty much where it is and only move slowly further down. The Fed made it more than clear today that they were going to hold down rates here --with a little juke move where they dropped the not really significant words "considerable period" from their outlook-- as long as it takes.  Once again, this week, Fed Gov. Bernanke raised the specter of a deflation crisis: <>.  So we have the possible losing battle scenario of the Japanese and perhaps next the Europeans busily throwing away their money buying up dollars as fast as we can print them.

But what the Europeans, the British and the Aussies won't do is lower their interest rates for fear of losing control of their economies.  And so the dollar has no where to go but further down despite the jawboning and head-fakes of the last couple of weeks.  The big question is whether there will be some kind of currency war if the US pushes too hard and further whether the Chinese will continue to throw good money at US Treasury and Agency bills as vendor financing to keep the status quo.  Should they decide they no longer have to worry about loss leaders and to keep more of their money for investment at home or stow it more safely in euros, then the seams could come apart.

Bottom line:  very little downside risk in deposits in strong currencies paying higher interest rates. In other words, there is an opportunity to store money in high interest paying denominations.

We also think that despite the high valuations, the general flimsiness of the asset bubble in general and the heavy state of consumer debt, that with much less upside potential the stock markets are unlikely to fall precipitously on their own weight this year.  That is, without some tsunami-like chain of events.  We say that because low savings account interest rates (and, shall we say, greed) are driving salivating unwashed investors back into markets that they may have had more appendages than their fingers burned in just a few years ago. Also, the money supply --M3-- which had started to slow on its own accord in November and December, will be boosted further by the Fed that will continue to keep the pedal to the metal at nearly all costs leading up to September.

As Warren Buffett is reported to have said: "throw a trillion dollars at any problem and you're sure to get some results."  The government will continue to spend on homeland security, on Iraq and further military and country-building efforts, while fazing in further tax cuts.  All of that borrowed money will filter into the economy where further borrowing fueled by low interest rates, will multiply the impact.  A cheaper dollar should also have short-term stimulating benefits: foreign goods (did anyone say Airbus?) will get more expensive while US made goods will cost less on the world market. Fewer Americans will take their vacation money to Europe and more Europeans will see bargains in visiting this country, etc.

So, we could easily be wrong about the above scenario, but let's look at what might cause the wing beat in the forest that leads to the tsunami.  For us, of all the great tightrope walking situations out there, from the above terrorist scenario to the possibility of serious setbacks in Iraq to cheap-dollar-instigated general slowdowns in Europe and Japan, to a jobless muddle-through recovery at home, the great currency imbalance seems to offer the greatest risk. 

The Fed thinks they have this under control since cooperating Group of Seven governments and the IMF have their hands on most of the levers.  But there is that little sticking point of the upcoming election: judging by the interest of voters in Iowa and New Hampshire, the continuing bad news out of Iraq, Bush just may seem beatable on the twin issues of jobs/economy and rebuilding Iraq.

The President, with the helping hand of the Fed, will pull out all the stops.  But where to go?, surely interest rates can't go any lower and it's questionable whether anyone would notice if they did.  The Congress can't vote an emergency tax giveaway that would take place a couple of weeks before the election. So??????  That leaves further currency manipulation.... and that might just set off a crash course that ends in driving the Chinese out of the US bond markets.    



Copyright 2003 Richard Mendel-Black All Rights Reserved

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Posted by dymaxion at 04:40 PM

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January 09, 2004

The Mysteriously Shrinking Silicon Valley or Whatever Happened to the Real Growth Engine?


  • The Never-Ending Dollar Dip Creeps on like Chinese Torture

  • Gold Prices Keep Moving Up

No surprises from these quarters regarding the above two headlines.  But the raft of headlines coming out of Washington and Silicon Valley yesterday and today got our attention: We hear from the San Jose Mercury News that a group of Silicon Valley luminaries plans to visit Washington in the coming months hat in hand.  What do they want: More money in subsidies and tax breaks for tech R&D and, get this, carte blanche when it comes to exporting tech jobs abroad. With extreme chutzpah, Craig Barrett, Intel's CEO said the request would amount to about a $30 billion dollar subsidy for the high tech industry.  He compared it to the amount of money Congress doles out to agriculture, in his words "a Nineteenth Century industry".

Is this the same decidedly libertarian Silicon Valley that we knew oh so few years ago? Tramping back and forth from DC every couple of weeks, we found it hard to make people even want to know what their representatives were cooking up over here.  So now, how can we help but wonder what happened to this once proud (to a fault) industry.  Back in those days, we used to hear that when it came to the real things that made America grow, the East Coast was irrelevant.  The twin engines of American growth, high technology and the media industry were solidly settled in the West.  And with their Convergence, --you'll remember this word-- the synergy would be earth shattering.

We remember hearing the story repeated by a colleague about a co-executive, in the supreme hubris of the moment, arguing before a group of executives a the country's leading bricks and mortar publisher, that the reason the relatively insignificant company --a couple of hundred employees--  they were both working for was valued in the market at a higher price than the publisher and a number of the nation's other greatest companies with hundreds of thousands of employees, was because "the market got it!"  In other words, a stock market valuation of $6 billion for a company with no paying customers, was the true measure of its economic value. 

Ever since then, you might note, he, and I should say, we, have become more and more convinced that much to our chagrin the market doesn't get it at all.  He goes on to recall actually shuttering one day when a working-stiff friend of his told him over a couple of drinks that he had just made a big bet on the stock of this company when it was selling for nearly $100 a share.

The market does get something. It does indeed!  And hopefully, if you're reading here, it won't be yours!

But we are talking about Silicon Valley today and the high tech engine that drives this country's growth: And so we also remember hearing from these same Valley wags that the Japanese, once everybody's bugaboos, were now toast. You remember that expression, too. In Part 2, we will take a look at what's going on with Silicon (and Silicone) Valley and those cooked Japanese.

We have, of course, spent much energy in previous blogs expounding why we think the present bubble is a bubble, and an "echo bubble", at that. Besides the symptomatic collapsing dollar, the widening trade and government deficits, the lack of (real and not too real) job generation, all of which we have belabored with the obsession of a little kid crying, "see, mama, he's not wearing any clothes", what's really got us is the most important question of all:  "Where's the growth engine?"

No, we don't believe we can stick our fingers in the job leak dike and stop companies from farming back office, programming and R&D jobs to India where they can do the same stuff for a fifth of the price --and have it ready by the time business opens over here.  Anybody who understands the power of that much maligned Internet and infrastructure of the global economy, knows that there's nothing that can stop this kind of activity.

But the spectacle of Carly Fiorina and Craig Barrett et al. coming to Washington DC to plead for Congressional blessing for this unfortunate blowback of the Internet revolution, well, that makes me think that, perhaps, Silicon Valley looks a lot more like the Rust Belt than the promised land.

According to the economists who know, the the early 21st Century world, it seems, will continue to rely on the American consumer to power its growth.  Now, can anybody out there figure out where that valiant consumer is going to get his next good paying job?  Surely not at Wal-Marts.

To be continued:  Steve Jobs and Bill Gates, hold onto your hats!


Copyright 2003 Richard Mendel-Black All Rights Reserved

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December 30, 2003

The Fog of War or Hold on to your Wallet


As 2004 approaches investors should bear in mind a few salient trends and keep a sharp eye on cracks in the structure of things.

First off, it's human nature for some of us to be optimistic, especially on the eve of a New Year.  It's what keeps us going in the face of heavy odds.  And so we shall try, while keeping in mind that all the optimism, faith and trust in history that we imagine permeated the inhabitants of Bam, Iran couldn't keep their walls from crashing down.  To make a point, it’s easy to see that Bam literally had a structural problem: non reinforced masonry being particularly susceptible to the kinds of swaying movements produced by earthquakes.  And yet, Bam had a long historical record on its side, since it was a very ancient city and unlike, say, Pompei, no such disaster had befallen it before.

And so, even as we look ahead, we won’t entirely lose sight of the possible tectonic movements of the vast monetary imbalance we so mundanely term the US current accounts deficit, which today is measured in little more than a gradual shift in dollar value of assets worldwide. No one knows (and I wager that includes Alan Greenspan) whether the daily erosion of $1.5billion mainly to the Far East is little more than a cyclical ebb and flow or whether there are more dire movements brewing in the mindseye of the market gods.

We wonder how a consumer driven economy --nearly 70% of GDP results from consumer activity-- can be sustained as those very same consumers steadily lose decent paying jobs (2.5 million in the last 3 years).  Not to worry, say the chattering class," the ingenuity of the American people has never failed before. Jobs get lost and new jobs get invented."

How, we wonder can a debt-ridden public continue to rack up even more debt (per family non-mortgage debt averages nearly $8,000, up 7-fold since 1960) when real wages hold steady or even decline. For George Will on ABC yesterday, there was little to worry about. For George, "losing your job nowadays is just not such a big deal anymore."  We have to wonder when George got this insight.  It's hard to imagine he's run into any laid-off factory workers as he made the round of Washington cocktail parties this Christmas season, talking points at the ready.

Now, if the consumer weren't such a critical part of the economy; and if, instead, savings were being poured into new plants and equipment in this country (not Asia) then George might be right.  But, we're afraid here, that indeed we have become a country of consumers spending dollars we haven't yet earned that flow mainly into the hands of entrepreneurs and poorly paid workers living half way around the world. But, to worry, we will try not.

The dollars, of course, are cheap to print and are backed with nothing more or less than the good faith and credit of the United States of America. Foreigners are welcome to invest those dollars back into our economy and up to now they have continued doing just that even though they could earn more interest –not to mention gains-- if they converted them to say, Euros or the Aussie dollar. In fact rather than earning less than 4.3% on a 10 year T-Bill, in dollars that have lost nearly 40% of their value in the last few years, these same investors might have found better ways to recycle them.  But, perhaps they haven’t yet noticed.

We, as Bill Bonner of the Daily Reckoning likes to echo Blanche in saying, "are living off the kindness of strangers."

And then, of course, there is that little matter of the domestic deficit.  Our government in its own lack of kindness to generations to come, insists on creating more spending programs while collecting fewer taxes, with the neat result that we are running deficits as far as the eye can see of more than a half trillion dollars per year.  But, of course, we only pass those down to our children.

And then there is that even littler matter of the reconstruction of Iraq in the face of popular hostility among those who would benefit from our generosity. How much will it really cost us now that we know that there is little chance Iraq's vaunted oil reserves will come back on line any time soon?

But just as the American consumer is undaunted in his never ending quest for more gadgets and SUV's, so too is the American stock market investor in the face of valuations to earnings ratios that are normally only seen at a bubble's peak.

This  time it’s different, we are reassured.  Not because things are structurally so hot, no one would really argue that.

And so that brings us to our newly invented election year theory.  Perhaps the American investor in his great wisdom is betting on the following scenario: with George the Second’s future at stake the Fed will not do anything to raise interest rates even if it means letting the dollar sink to around $1.50 to a Euro. China and Japan will support this by continuing to recycle at a loss because they have everything to lose should the dollar crash (their reserves are in US dollars, not gold) and the Europeans will stand idly by clasping their collective hands in wonderment of how their socialized economies had gotten so rich without having to give up any of their paid holidays or social benefits. Meanwhile, US multinationals will report higher profits as they measure their European business in fattened Euros and that will improve P/E ratios and….. you get it.  The bet is that prices will hold still, interest rates will remain low, Americans will continue to run up debt and a lowering dollar won’t rock the boat.

Meanwhile, Saudi Arabia (and the rest of the OPEC) will stand still and keep pricing their oil in sinking dollars because they know first hand what happens when you cross the Bushes.  And US manufacturers will finally have a price edge over their ritzy Euro-competition and they’ll finally start hiring American workers at top wages!

Yes, this is an election year, Virginia, and the amount of hyping and huffing and puffing on the sidelines will make the usual legions of Wall Street hypesters seem like a bunch of bookies in the face of the Parimutual. Why just yesterday we heard from Bush’s former chief economic advisor, Larry Lindsey, that "Tax rebates are the antidote to lower wages." 

This may indeed be the year in which we turn around, start creating real jobs, bring down the the foreign and domestic deficits and defy the law of gravity when it comes to stock prices.

Our advice: Hold on to your wallet!



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December 11, 2003

Nothing Like the Good Ol’ Bank of Japan

Gold, and particularly gold mining stocks have fallen back over the last few days, and in the case of the mines, the reaction has been fairly drastic. Even as the price of yellow stuff climbed to a record $411 an ounce, there was a sell off in the mining stocks, which, after all, have increased in price much faster than the metal itself (there’s a logic to this, since the price of extraction remains flat, the mines’ profits begin to rise with each bump up in the price of the end product). 


According to Reuters, the fall off in price reflects an anticipation of end-of-year maneuvering as traders lock in profits.  The dollar has also stopped its crazy skid and actually moved back up a penny or so from its low with the Euro.  It seems the Bank of Japan has been soaking up dollars from the world market in order to keep the Yen at a price that allows them to not loose market share to countries whose currencies are locked to the dollar, namely, of course, China.  Not so, for the Brits’ Pound, which continues to climb.


The Brits, it seems have been borrowing and spending nearly as fast as their Yank cousins according to a report out from the Bank of England today, which puts household debt at historic highs.  The difference, it seems, is that Blair is not up for re-election this year and the adults there have decided to do something to slow things down by raising interest rates on government bonds which are now in the 10-years some 60 basis points higher than US T-Bills.  Risk-adverse money –it seems there are a few of us still around—has been flowing there like the melting of the glaciers at the North Pole.


Of course, in the US, we have invented a new kind of recovery, one in which fewer people do more business.  At the height of the greatest government cash push in history (all, BTW, borrowed from the future), jobless rates once again were up this week.  What will Alan Greenspan do next?  Who knows what Carl Rove will cook up!


In Japan they went so far as to have negative interest rates –which in real terms is what we have in the US—in which they paid people to borrow.  Unfortunately, the strategy backfired as it served to drive down prices, thereby encouraging the thrifty Japanese to put off purchases in anticipation of even lower prices the following year.


Not to worry about the Americans, though.  It seems we bought even more SUV’s this November than last.


Bush, of course, caved first to the Europeans on steel when they had him by the balls:  they had targeted retaliatory steps against products coming from key electoral states.  The dirty secret there, anyway, was that the tariffs were keeping steel prices artificially high thus raising costs for American manufacturers and actually costing more manufacturing jobs than they were saving steel jobs that have no future in any case.  I hope you followed that!


Then he caved to the Chinese on Taiwan on a little issue like democracy.  Maybe even he has finally realized that if the Chinese ever wise up and start spreading their reserve assets around, the whole pyramid scheme on which he has bet his re-election will come tumbling down.  And that’s the rosy outlook on DW today.  So, I wouldn’t make any medium or long-term bets long on the dollar.  Meantime, I think I will run to the cash machine and pull out Euros today while the getting is, well not exactly good, but better than, say, $1.25, which is likely to soon be the situation.  Thanks BOJ!


Bucky Balls


Now, a word for our godfather, Buckminster Fuller:  Bucky’s legacy, as incorporated in his invented word, Dymaxion, emphasizes the non-static nature of reality and secondly the power to be derived from the infinite simplicity that is the essence of Nature’s grand design.  Standing in the Pantheon, as impressive a testament to the enormous advances the ancient Romans made in architecture –the brick and mortar dome is actually larger than the cast iron one on the Capitol in Washington—you can lean your hand against the massive stone pillars weighing thousands of tons that hold up the structure.  Compare that to Bucky’s best known structures, the geodesic domes that can be fitted together, even for large structures with fewer people and in less time than it would have taken to move just one of the Pantheon’s granite pillars from the quarry to the city.  It’s hard to imagine the size of the crews that worked on these ancient monuments but the dynamic is the force of a great institution –in this case, the most powerful state ever known on earth.


Bits and bytes have for all practical purposes no friction as they pass through copper and fiberglass conduits at nearly the speed of light.  As the number of users and uses increases, the costs diminish.  The great machines of the corporate media, like the columns in the Pantheon, adsorb massive infrastructure and personnel resources.  For such, they need to behave like the great empires of the past.


In the Dymaxion world, change is inevitable, information is crunched into something useful, spin turns static, talking heads become so many trophies on the screen, like marble heads in a mausoleum.


The real infrastructure of the web is as light and malleable as the lines of code that support the communication and distribution system.  We look forward to seeing what these dynamics are going to bring together but I am confident that the need to cut through the bullshit is so enormous that given the kind of persistence and optimism that characterized the original Dymaxion man, this will become a valuable and cherished resource.







Copyright 2003 Richard Mendel-Black All Rights Reserved


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December 08, 2003

It May Be Too Early to Say that a Peak has been Reached in World Stock Markets but Then Again

Monday December 8, 2003


  • A Cold Wind Sweeps Across World Markets


  • Dollar back down to $1.22 for 1 Euro, 11 Year Low against the Pound


  • Gold at $408 per ounce


  • It May Be Too Early to Say that a Peak has been Reached in World Stock Markets but Then Again


Major Asian and European markets are all down today as are Dow and NASDAQ futures.  This comes on the heels of US employment figures that came out last Friday.  In order to just stay even with new entrants into the job market, the US needs to add over 150,000 new jobs per month.  Instead, only 75,000 new jobs were added in November according to the latest report and for the 40th straight week, there were critical losses in manufacturing jobs.  What that means is more jobs at Wal-Marts at the minimum wage and fewer quality slots.  Meanwhile, the jobless numbers were said to have declined as in the previous couple of months.  Our suspicion is that any decline in the jobless figures has more to do with people giving up and no longer seeking work than any positive reason.  Remember that literally incredible gain in productivity that came out earlier in the week? Could it really be more production on the backs of fewer employees?


All this comes despite the greatest binge of debt spending in the nation’s history --outside of World War II, that is-- and the fastest decline of the dollar in recent memory.  Now that the tax cuts have worked their magic in consumer spending and 13 interest rate cuts by the Fed have helped impoverish a good portion of retired Americans who depend on a safe and steady return on their safe government backed investments, what we have to show is a bump up in activity that hasn’t been reflected in business spending or, more importantly, hiring.


How, you might ask, does a consumer society deep in personal debt continue to spend, spend, spend, when few good new jobs are being offered.  The only excuse for reckless fiscal and current account policy is that it eventually jump-starts the economy.  What we have got is a steaming hot stock market full of overvalued stocks and maybe, though, we hope not, an economy that acts like a diesel engine in sub-zero temperatures.


Meanwhile the gold bugs have at least temporarily taken a sigh of relief as the shiny metal pushed its way over $400 and never looked back.


Tomorrow, I want to muse on how important high technology and particular, intellectual property, are to the US economy.  But today, one more reality check on consumer activity in this corner of Old Europe.


Here in Italy, today is a holiday.  Which one it is, I can’t say but everybody else seems to know.  I’m not sure there is a pertinent investment lesson to be drawn from the Rome experiment in cutting off all traffic but it is certainly worth noting.  For those of you who haven’t had the pleasure, Rome has been built not in a day but on over two thousand years of ups and downs.  The old or “Historic Center” covers a good 15 square miles of mainly winding cobble stone passages, alleys and streets.  Every powerful family –usually belonging to a reigning Pope—has its own palace or two with accompanying fountain and square.  The more imposing take up large city blocks, causing everybody else to detour around them.  Every important cardinal felt impelled to build his own memorial by adding a church or two to the scene so that in this limited area often one finds one large dominating church on a square facing one or two other smaller ones.  Having up most blocks, you’ll find a smaller church or ruin; there is no city like this in all the world!


When I first lived here some 30 years ago, it could have been said that the traffic problem was so bad that the addition of one more car threatened to bring the city to complete gridlock.  Of course, where there is gridlock there is also massive pollution often abetted by the sweet, soft Mediterranean climate the city enjoys.  The Romans are by nature a flexible crew used to muddling through problems, if at all possible.  After all these years, they have come to the conclusion that it’s better to “magna, dormi, fa l’amor” or eat, sleep and make love, than to get overly worked over by anything but the most pressing problems.  And so, things tend to happen gradually.


So, it seems, has the traffic problem.   You can imagine the downtown merchants in the beginning screaming that they would lose all their customers if they couldn’t somehow drive into town.  And the single metro line into town was taking centuries to build since every time they moved a foot or two forward they would hit another archeological find and have to stop everything until the scientists had their say.  Rome is, after all, built right on top of the ancient city whose walls, at its height, pretty much match the dimensions of today’s more baroque and neoclassical central city.


Yesterday was the second shopping weekend of the holiday season and special in that it was part of a three day holiday weekend when everyone is out getting their gift purchases done.  It was a cold, rainy Sunday –in contrast to the mild days we’ve been having for the last couple of weeks—and yet the city was swamped by pedestrians.  Not only were the main shopping streets, around the Corso, Fratina, Condotti chic streets swarming but everywhere you went people were out five across and strolling about.  You might have thought it was at the absolute height of the tourist season and half the tourists in the world had all descended on the Eternal City, as they like to call it, I suppose for its proximity to the Holy See.  But no, these were just shoppers!


This means that if you live in the old city, you might as well forget using your car during weekend days, even though you have a special permit that gives you the right to move in and out.  For everybody else, it’s public transportation or a long walk from one of the underground garages placed around the walls.  But what has been a long and cautious story is starting to really take off.  Clearly, the merchants and restauranteurs --even more numerous than the city’s churches—have nothing to complain about.  In fact, every day it seems new stores and restaurants, bars, wine bars, pubs are opened.  This is no place for a big box mentality; the businesses have to survive in spaces that were often reserved for storage at the ground floor of the old buildings where artisans once labored or the rats held sway.  Needless to say that rents and housing prices here have flown off the charts.


The city is now finally cracking down on the millions of scooters that still have the right to come in at will.  For them, there will be inspections and exhaust level testing to cut down on pollution.  Walking in the wake of their fumes, you would no doubt say it’s about time.


The lesson to be drawn here is that people like to get out and walk, to see and be seen and, of course, dressers that they are, nobody likes the process more than the Italians. Meanwhile, we couldn’t even get into any of our popular, economic restaurants last night without a reservation.  The Old Europe may be poised to come out its recession and without the artificial pumping that has gone on in the States.  This may be a good thing for the US because demand in Germany and yes, France, could spark some kind of surge that so far has been lacking.  Wouldn’t that be the ultimate iron for George II and his Rummy friends? 







Copyright 2003 Richard Mendel-Black All Rights Reserved


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December 02, 2003

The Proboscis Closest to Your Heart



The Bet on commodity index funds, like stock index funds, which have the advantage of requiring very little overhead –after all, there are few trading costs involved in maintaining the portfolio’s balance since it’s rare for companies to be added or removed from an index—is now being offered by a few companies They are designed to rollover a fixed percentage of holdings based on the weighting the fund presets for key raw materials like petroleum, precious metals, coffee, pork bellies, etc. 


For most investors, and I use the term in contrast to “traders”, the buying and selling of various trades for commodities can be a daunting task.  Traders tend to both leverage their bets by using very generous margins and to hedge them by buying both sides of a play.  The trick, often, is not to guess a price direction so much as spot a price anomaly that is bound to break in one direction or the other.  At least, that’s the way it is supposed to work. 


Some of these trades are purely technical; others are based on macroeconomic factors.  As investors, it is important to be nimble enough to jump on opportunities where they might arise but we are mainly looking at macroeconomic factors in making our betting decisions.


The question here is whether a pure commodities play is a hedge against an overvalued stock market and a falling dollar.  The answer should be yes except that a stagnating economy and drying demand –the buyproducts of a fall in stock markets and the more general economy—will also affect commodity demand.  Some people are betting that internal growth in India and China will propel demand for commodities even if the global economy falls back to stagnation and delation.


Is the China story that big?


Sometimes, the opportunity lies right under our noses.  For instance, I like to collect old family style cameras and used to pick them up mainly at tag sales and flea markets.  Then came EBay and the range of choices increased enormously.  No longer was I looking at one or two cameras in a month’s time, instead, on any given day I could see 20 or 30 being offered on line.  What’s more, since the offers were so consistent, I could sit back and watch a few auctions to establish a price range in which they seemed to be valued.  Before that, I was subject to the whim of the seller who might guess anything when it came to the object in question. Of course, that sometimes worked to my buying advantage but it also was annoyingly frustrating trying to convince somebody that a, say, $50 camera, could be bought for $15 on most Sundays.


EBay ended all that.  It soon became clear that there was a market for these outdated but still quite common objects and that there were more or less desirable ones to be sought based on rarity and aesthetic considerations.  An amazing window had been opened up for butterfly collectors of all stripes!


Before long I was becoming great friends with my mailman, not to mention the UPS and FedEx drivers on my beat.  Furthermore, despite everything you heard about the pitfalls of doing business on the Internet, it became clear that most of the sample of people I dealt with delivered what they said they had in a fairly prompt manner at the price determined by the auction.  Sure, it was hard doing transactions without credit cards and intermediaries like Paypal but somehow, even with check payments that had to be first cleared before shipment, the packages would stream to my address.


To make my point, here was a system that was working big time.  And it had sticking power because once you hit a certain magic number of buyers and sellers the value of EBay to its overall community increased exponentially.


These were the days when there were any number of so called pure internet plays out there and there was much more chatter around, say, Amazon or WebMD, than there was on this flea market auction site where Piz box collectors were known to congregate.


But over the long haul and even through the valley of the shadow of death that opened in March of 2001 like the Red Sea being parted once again by Moses, EBay has been a winner.  This is not by any means a recommendation to buy EBay today since even they have their macro growth limitations and a very high valuation already built in.  But to say, when you start ordering the equivalent of your DVD’s from Netflix and the service turns out to function pretty well, then just maybe you might want to consider plunking down a bet.  Just 6 months ago, they had a valuation of little over $60 million dollars.  Since then, that has more than doubled to circa $1.2 billion.  Just a year ago you could have bought a share of Netflix for less than $10.  To get one today, you’d have to plunk down more than 5 times that.  So maybe it’s too late for them.  But keep your eyes out for those things that are right in front of your nose.  Sometimes the proboscis closest to your heart hides more than you think.






Copyright 2003 Richard Mendel-Black All Rights Reserved


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November 28, 2003

Information Vs. Knowledge


The facts roll across the bottom of your screen, the newspaper summaries roll into your e-mailbox, the custom search pages fill with articles of all types.  You can easily spend your entire day watching prices and volume and trend lines flash across another screen while talking heads pump up and pump down in a corner reserved for gab. Do you really think any of this will make you a smarter investor or one whit wealthier? Maybe.


My goal is quite the opposite.  What I am seeking are not the momentary byte grabbers who seem to fly along with every trend but instead those of us who have been on the inside, who know how easy it is to manipulate and who have a general distrust for anything that is being presented on a platter to the lumpen consumer.


Yes, the US economy is on a roll.  We have all heard the good news.  Yes, all the indicators are pointing to a repeat of the boom we saw in the 90’s.  So why am I so skeptical?  In the 90’s there was something going on; hyped, hyperhyped, superhyped? Yeah, but still there was a fervor that captured the whole world’s imagination.  Japan, the champion had hit the skids and the new guy standing tall was the US, no longer weighed down his fat girth and rust belt but newly robust in his information age, Silicon Valley superhero robes.


We had reached a new age and all the world was jealous.  We got it, they didn’t.  We were in our cubes from 8 in the morning to past midnight building the virtual world of the future while they were fighting for shorter workweeks and subsidized villas on the Cote D’Azur.


Information and Eyeballs were the new currencies.  Still, the old one, the dollar grew stronger and stronger as smart money from all over the world flowed into our financial markets—the cleanest, best managed, best run companies in the cleanest best-managed markets in the world.  It was quite a moment and the Euro, the symbol or a new Europe fell from its original 1 Euro= $1.18 to I Euro = $.80.  People from all over the world quit their jobs and came to Silicon Valley for the great gold rush.  An IPO a day, then two or three a day.  How could you not remember? 


And guys like Warren Buffett?  Well, they just didn’t get it.  And guys like me, crowing “bubble”.  Chicken Littles we were.  Why wouldn’t you want to price some start-up that was losing money by the buckets-full at three times the value of General Motors?  Information was money. Remember!  How could you forget?


But really, something was happening. New businesses were being born and some of them would stay around and change a lot of people’s lives.  Imagine, say, collecting just about anything without EBay to set the real price and availability.


The Internet is a communications environment like nothing to go before it and most of us cannot imagine living without it always on in the background and foreground.


So what, I ask rhetorically, is it that is fueling this present boom and if things are so great this week, Thanksgiving week, why is the dollar going down like a one-eyed prostitute in Bangkok?  Okay, you’re right. Unkind language.  But still, why if everything is so hunky dory are interest rates staying down, the dollar crashing and the markets shrugging?


Could it have to do with the fact that we have an election year coming up and some of the least principled political leaders in our much-besmirched history?


Short the dollar, friends.  I, who’d like to see my assets rise vs. the rest of the world, instead of drop like soaked bread in a goldfish bowl, just can’t see things turning around anytime soon.


I think that is based on knowledge, not just information, folks.  But maybe you know different.  Maybe Alan Greenspan is going to push gold down as a symbolic way to weigh down the Euro.  I don’t see it but I hear some of you saying it.


Remember, among certain folks, gimmickry beats discipline every time.







Copyright 2003 Richard Mendel-Black All Rights Reserved


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November 27, 2003

Gold’s Glass Ceiling



Gold’s Glass Ceiling


There is widespread paranoia among goldbugs that some entity close to the US government quietly intervenes in the gold market when it reaches some invisible price target only known by those who foster the conspiracy.  Several years ago, the glass ceiling number was $300 per ounce.  Now that we are close to $400 the same kind of resistance seems to have been built into the markets.  Several times in the last two weeks the price of the yellow shiny stuff started to cross $400 only to fall back.  Once again, yesterday, it looked for a while like the momentum was building for a strong move across the goal line only to see late afternoon faltering.


Gold, as you know, has no monetary value outside of a few coins that are minted in South Africa and Canada but it has traditionally been an anchor on which all but a few monetary systems remained tied to.  Those paper or “fiat” currencies in the past that broke all links with gold or silver have consistently ended up on history’s abundant monetary trash heap. 


Politicians without the restraints of something real, will turn on the printing presses to save their skins.  This is nothing new.


Commodity traders will tell you that gold is a weak commodity trade since even when sold it is little consumed by industry (jewelry is sold by weight and value add, so the gold stock remains even after it is “used”) and has little other demand.  Production, though relatively small, they will tell you, is sufficient to meet that demand.  Even when it is hoarded as a safe island for investors, it remains intact, and can enter back into the market any time the price rises high enough for investors to make a profit.  Furthermore, it is a lousy investment compared to stocks and bonds, they will say.


So why would any government intervene by selling gold, since after all, all of the main holders of gold (the central banks) have pledged to stop selling in the open market?  Is it psychological?  After all, nobody, in the US, that is, seems to even notice how far down the dollar has fallen in the last 12 months –it now takes $1.19 to buy 1 Euro—so why would the price of gold have any psychological impact on American financial markets?  I can’t say that I know and I am betting that gold goes over $400 and climbs above its last high of many years ago, of $416.  The question then is, will it keep on going or is it merely following the Euro, Pound, etc. up as the dollar goes down?


One thing is for sure, the dollar will continue to fall and gold will probably move in the opposite direction.  So, does gold have some mysterious tie to the value of the dollar that someone in power may feel needs to be manipulated?  We’ll see, soon enough.




Copyright 2003 Richard Mendel-Black All Rights Reserved


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Posted by dymaxion at 05:40 PM

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