The Apotheosis of Deal Making

For Ben Bernanke and the Fed these have been bare knuckle flying days. Never has the dominant central bank moved so radically into a new orbit as has the US Fed this year. Conversely, for the Media this launch into monetary outer space has been greeted with the kind of yawn that might have been reserved for a weather balloon.

Never mind the Bear Stearns rescue that was done so hastily that it appears no one bothered to insist that JP Morgan Chase return future windfalls estimated to be in the billions against guarantees the Fed made to get the deal done in a weekend. The Bear deal did close to end out a very perilous week and what looked like a potential domino game of other falling investment houses --Lehman Brothers was most named as the next-- was stemmed, at least for the time being. This respite, coupled with recent moves up in the markets and the dollar, has gained Bernanke street creds and has kept the flak to a minimum, and directed mainly by capitalist purists, long used to not being listened to. Politically, it also has served as leverage for those who would rescue the millions of underwater adjustable mortgage holders.

While it's true that the Fed's rescue of an important "investment house" crossed a bright historical line, it was also widely recognized that the banking world itself has changed so radically in the last decades as deal making has replaced the sweat and toil of agriculture and manufacturing, that the commercial banks and the investment houses overlap in the kind of credit issued and the kind of paper they accept either as "insurance" or "assets" to back their financing of deals. And it wasn't just Bear and Lehman Bros. etc. who were taking enormous losses, it was also the world's largest "commercial" banks; i.e, Citi, Deutsche, UBS, HSBC, etc. who were announcing multibillion write-downs as far as the eye could see.

The lesson to be drawn is that the Fed and the key European central banks (ECB, BOS, BOE,) have made it abundantly clear that no rash of bad deal making, no matter how egregious the imbalances created are, will be allowed to fail. The Bear deal made headlines, that couldn't be helped but a much more radical plan to create a superfund for bad debt that could go to $800 billion by year's end passed unnoted!

TAF, the Fed's Superfund for Toxic Waste

Last December 17, the Fed announced that it was about to offer US Banks (This was later expanded to include the Bank of Switzerland and the European Central Bank) a deal that they couldn't (and wouldn't) refuse. In exchange for the highly discredited --we prefer the word, toxic--mortgage backed securities on their books, the Fed would offer the banks at face value highly secure US Treasury notes. This deal was called TAF, or Term Auction Facility. In exchange, the Fed charges only 2% --slightly below market, that is, for paper that would probably mark to market at an average discount of 20%-- in interest.

In essence, to get around reserve rules and allow the banks to keep lending, the Fed is taking them off the hook for the bad paper they issued and bought and for the collateral they received from hedge funds that were gambling in the real estate bubble that was fueled by these mortgage backed securities. Remember, the mojo that fueled the rush to lend anybody standing (Chicago voting rolls had better actuaries) with the dough to get into their dream house, came directly from the red hot mortgage backed security and credit swap markets that looked great on the balance sheet of the hedge funds, generated huge annual bonuses for the poo-bahs, and eventually spread as far as the coffers of small towns on the banks of the Norwegian fjords.

So, once again, now that the party is over, the bonuses banked, the private jets furbished and the summer and winter palaces built, the Fed has rushed in to sweep up Wall Street's left over garbage. However, quite significantly, since this was a very big party, even the limits of the US Federal Reserve may be stretched by the time this plays out.

The Fed had been buying up Treasuries for over a hundred years and before this latest rescue operation now in full stride, it had managed to accumulate a war chest of over $800 billion. It's more than a little notable, that by early May, they had already drawn down that pool by more than $150 billion.

In May, Bernanke and crew decided to double down on their bet when they realized that this was not just a mortgage crisis but instead a major debt crisis that includes consumer and student loans as well as automobile credit. To meet the threat that Americans might start walking away from their gas guzzlers and piles of credit card debt, they agreed to expand the definition of eligible paper beyond residential and commercial mortgage backing to anything with a rating above AAA/Aaa asset backed securities. Remember, one of the sub plots of the whole greedy asset-backed security mess, was the way the bond rating agencies decided to jump into the party by trading good ratings for expanded business. In this pool, AAA/Aaa could mean practically anything, even used cars!

Bernanke's big bet is that the failure in the real estate markets will have begun to normalize by the end of the year. And for this to happen he has managed to buy time by putting his $800 billion stake on the table where everyone can see it. For the moment, this has had a calming effect on the stock market and even has slowed the decline of the dollar.

By the end of the year, this hiatus may look more like a pause between storms and if housing prices continue to fall, job losses accelerate and consumers pull way back , it's quite possible Bernanke will have blown the entire pool of Treasurys built up over a century in just a single year. Little wonder, then, that he has given his own encouragement to Congress to move in its rescue of the little guys struggling to hold onto their houses. Too many empty houses on the market could tip the balance.

But there are headwinds that could counter the stimulus that comes from artificially low interest rates, government supported mortgages and a giant green light for bankers to continue to lend. For one thing, a majority of the houses that need rescuing are located in exurban locations. Commuters from these locations where just about everyone has a long commute, often driving the de rigeur SUV or pick-up are getting doubly clobbered as they fill up their tanks and do the weekly supermarket run. Also, a number of the most vulnerable no-money-down mortgage holders were working in the then booming construction industry. In order for prices to even bottom out, new building will remain at a standstill for a long time to come. The combination of a slowdown and the kind of inflation that hurts consumers most, also spells trouble for the commercial building market as company's shrink their staffs. The Fed and Congress's best efforts may not be enough to convince people to keep paying for homes, much less cars, they can't and never could afford.

In CreditWorld, Leverage is King

Most Americans not only do not have savings but most have accumulated large amounts of plastic debt as they attempted to live better even while struggling to keep up wages and pay for health care, fuel and food prices that have only accelerated even as jobs get harder to find.

By lowering interest rates to artificial levels for the second time in five years --to make its TAF subsidy less conspicuous?-- the Fed is also telling savers that they are losers in this new economy. There is little wonder that people who sat on the sidelines while their neighbors were tapping their houses like ATM's now see themselves as the losers. In CreditWorld, it's obvious that Aesop's Tales get flipped upside down.

We have been in bubble mode back since the Keating Five. Since then we have had a succession of bubbles all fanned by Fed policies. We can offer some ideas on what the Fed will sacrifice next to keep the party going one more time.

The Dollar Has No Clothes

Where the buck stops and starts, erosion of the world's preeminent store and measure of value, the US dollar, can serve as a metaphor for the way we grok an expanding, inter-related sphere of critical but slow boiling crises like: energy, health care, population, food, water, climate change, human rights, personal freedom, trade imbalance, wealth division; etc.

FUD and Band-Aids

The dollar is, after all, merely the material meter with which we value all our goods and labors. And yet the precipitous shrinking of this measure, of anywhere between 50 and 150% over the last decade against basic materials has all but escaped mention in the agenda-driven, zeitgeist whirlpool we call the Media. Obviously, once again, it serves no one's agenda to call attention to this inconvenient happening just as it appears to serve no one's interest to understand the consequences of peak oil in an energy driven world economy.

We can offer some "politicized" explanations for the inconvenience, like the cost of a long war to folks who want to expand it to Iran, the war's impact on the price of oil, the insistence on borrowing from foreigners holding excess dollars-- to offset government deficit spending and soak up the overhang from the trade imbalance, the fostering of easy credit needed to jack up the consumer component of the economy to over 70% even as wages stagnate and manufacturing and services are outsourced, the fudging of the CPI to grossly hide inflation and the loosening of controls on how the financial sector can create money.

Here in Dymaxia, we have no magic ways to tap into pools of truth. We are as unarmed as you, dear reader, to insist on what gets talked about on the loud megaphones that, when blared, reach everyone. So, when we try to discern agendas; we mainly revert to the "who stands to gain" approach.

In TV-land we notice there are rarely analysts who insist that borrowing a trillion dollars to fight a war has a negative affect on the value of our currency. There are rarely analysts who make plain that the war in the Persian Gulf is about the control of the flow of petroleum even as it is so completely obvious it sometimes shows up as a slip of tongue by some soon to be sorry politician. There are rarely analysts who make clear that it has been Iran, that has been the greatest beneficiary of our sorry adventure in Mesopotamia. It even took forever for anyone to note that Bush's brain was running on empty even though nobody had ever heard him successfully string three words together.

Time Outs are Ugly

The blogosphere, with all its cacophony, is the repository of an enormous pool of gray matter and hands-on knowledge. One only need think about Wikipedia, warts and all, to grasp its potential to gather information in a cooperative endeavor. But for all its vitality it is a David in the face of a massive Goliath. The whole sorry run-up to the war and the fool me twice rant on the success of the Surge has shown just how a repetitive Media acting in unison can drown out wiser voices.

China, as well as many other more or less totalitarian regimes, has gone further in managing to suppress activity on the Net. Likewise, here in this country, the major internet service providers (led by AT&T and Verizon) have been waging a legislative battle to gain control of the Internet's pipes they manage and parse them into fast lanes (for paid media stuff) and slow lanes (for everybody else). Advocates for Net Neutrality understand that the speed in which a web page, or say, a YouTube clip, is delivered to a browser can ultimately have a major impact on users' preferences for competing info sources. Lest we forget, here's a brief list of YouTube moments that have, for better or worse, had significant weight on this election: Jeremiah Wright's "God Damn America" rant, Hillary's Bosnia misinformation episode, Allan's Macaca Moment (yes, he was an insider conservative pick), McCain's confusion over Sunnis and Shiites, etc.

Ultimately, a sure sign our experiment in democracy is failing is when citizens continue to vote against their best interests. There is, it seems, one tried and true way to make this happen, through cacophony and confusion that elevates wedge issues far above their significance and neutralizes inconvenient facts and truths. Imagine pointing out to people that the price of gasoline or their basic foodstuffs hasn't really gone up so much as the dollars we use to pay for them have gone down. Imagine how that would affect the mass psychology! Instead the story line goes: India and China are now getting richer and they are buying up all our excess petrol, rice and corn. Shouldn't we be wondering how this cosmetic explanation gained such mainstream currency?

Peak Oil?, When's the Last Time You Heard About Peak Oil?

The great issue of our moment, is the nonrenewable fuel crisis. It shapes the most fundamental aspects of our government policies in enormous ways that then need to be obscured by those who would allow us down this --for them very profitable-- path towards the most momentous crash this civilization has ever known. If you look at the War as an extension of our status-quo oil policy, and the cost of maintaining that war at its present inconclusive level and the cost of borrowing to sustain that and factor that in as a direct subsidy to petroleum, the price we really pay per barrel goes ballistic. Now, add in the cost of keeping the Persian Gulf open for shipping, the naval and air power, control and command structures for the region and all the unintended consequences that grow out of our preoccupation with keeping the spigots open, then factor in the burgeoning cost of global warming, not to mention road building and maintenance and you are talking about the greatest subsidy in our history for an ultimately declining industry that will, by the definition of its finiteness, only fail us if we insist on remaining addicted to its supply.

What is worse, as long as we insist upon basing our energy mix around imported oil, we are sending more dollars out of the country into the coffers of the very same countries we feel most threatened by! This, we submit, is collective insanity of the first order and it it doesn't convince you, dear reader, that something very fundamental in the way we process information in this country is entirely broken, then, we suppose, you are reading this for laughs.

Corn to Ethanol, a Metaphor for our Time

It might take chutzpah and confusion to get here but once in Washington, the real money is in the FUD and band-aid businesses: take the current economic crisis-- the product of serial bubbles and across the board excess borrowing from the government down to the lowliest citizen. As a remedy for these excesses, the President announces, without worrying how it might be paid for, that he is sending everybody in the country a check that he promises is sure to kick-start a new recovery to the "slowdown", Congress funds a way for communities to buy up foreclosed properties, the Fed has its back window open soaking up the financial waste products on the books of the major banks and brokerages and it's printing presses running over-time to serve up cheap (when you factor in inflation, interest rates are now negative) money for the next bubble, farmers are paid to turn corn into ethanol even if the process absorbs as much energy as it produces and food shortages pop up around the world, and the Presidential candidates promise programs or further tax cuts, with no way to pay for them. "Got a Problem?, we'll lower a tax!

You might think that this money for nothing, kicks for free approach to solving what is essentially a borrowing crisis, might have raised the curiosity of those who tell the national narrative. How, they might ask, have we found ourselves in the position of facing lower salaries for workers, rapidly rising food prices, gasoline prices that might have showed up in some SUV driver's nightmares a few years ago, and a dollar that is so anemic that travelers abroad have taken to complaining they can't afford un Grand Mac not to mention a coffee and croissant. Watched or not, pots will come to a boil, and now it seems we have come to one of those moments where the steady stream of bubbles in the weak dollar kettle can't be ignored. Of course, as they ignored the rise of CO2 in the atmosphere and its effects, or the decline in ordinary peoples' earning power over the years, the pundit class continues to prate, as if they were playing pin the donkey's tail on their own asses.

Connecting the Dots

First off, there's the unavoidable price at the pump that's brought one of the least enjoyable aspects of traveling in Europe to our own pump islands. You no longer have to imagine paying over 120 bucks to fill up your tank; it's enough it seems to make some people want to give up a job that requires a 150 mile daily commute in their Tundra, if they could only find another. No wonder then, that people are tucking the keys under the Hummer's driver side mat and walking away from that 5000 sq. ft. dream house now 20 or 30% under water, with heating and cooling bills to match.

For that matter, has anyone noticed that while the price of gas was going up, the value of the US dollar was somewhat symmetrically falling when measured against food staples, raw materials, precious metals or even other trading partner currencies like the Euro or Yen?

Of course, we are not on a gold standard, that is, there is no official link between the metal and the dollar but quite curiously we can see that even though the price of oil is actually quoted in dollars, the sellers of that black liquid are getting no more today, if measured in gold, then they did five years ago.

Once upon a time, there were, in more primitive days, political positions that would argue in favor of a weaker or stronger currency. Populists, remember William Jennings Bryant and his famous Cross of Gold speech, would argue for the government to soften its golf restraint to print more money to stimulate growth, Conservatives, with notions of protecting their net worth, argued against the notion. Later it was said that a cheap currency protected both industry and worker by cheapening exports and making imports more costly. Significantly, it was Richard Nixon who broke off the last link between a precious metal --in this case, silver-- and the dollar, thereby making the American printing press, the world printing press. Today, a weak dollar benefits the balance sheets of multinationals who can shift resources in and out of markets and magnify the "growth" of foreign profits by converting them, on paper, at least, into cheaper dollars. For instance, last month, it was Ford's turn to show a profit abroad that magically out-totaled its losses in the US.

For those of us who measure our spending ability in dollars, it is hard today to make the argument that a less valuable dollar has some beneficiary impact. The old saw that currency devaluation acts as a stimulus for export trade has a very hollow ring to a society that has outsourced most of its manufacturing capability to other parts of the world. A low dollar may be helping China and India to establish markets in the "strong" Euro and Yen zones but it has done little or nothing to offset the ever growing trade deficits being run up in this country.

Curiously, outside of Ron Paul's run, none of the present candidates talks about the impact of the dollar's value on all us and so while broadly "the economy" is perhaps the major issue, the role our currency plays appears to get short shrift. Paul, though somewhat coherent, probably has done little to broaden the discussion. By putting a lot of focus on the gold standard, which only rewards gold producing countries, and combining that with an unreal role for government, Paul turns off most progressives and fiscal conservatives who might otherwise be repelled by a weak dollar policy that punishes all of us with savings and earnings in dollars while rewarding multinational corporations that can hedge their holdings abroad and further gimmick earnings.

There are many reasons why the weak dollar has been shut out of the national political discourse by both parties; it's just plain inconvenient since: it makes our assets less valuable in a global economy, it makes it advantageous for players outside the dollar zone to purchase US assets, it tilts corporate power to companies that can do a large part of their business outside the dollar zone and most importantly, it boosts the prices of staples and raw materials where there is global demand. Like the recent rise in oil prices vis à vis the dollar, the same thing is happening with the price of rice, corn and wheat, the basic food staples the world depends upon. And like petroleum, the food story has a raft of causes. Being somewhat simple in nature and style, we here in Dymaxia, will make the argument that the price of food, like the price of copper, or platinum or uranium has followed closely the ascent of the price of oil (and, of course, the symmetric decline of the dollar).

It's the Dollar, Stupid

We are left to wonder why the two Democratic candidates have not seized on the weak dollar as an argument against McCain and his supply side bromides that will lead to further deficits as far as the eye can see. One supposes they are afraid of being ridiculed the way Paul was made to suffer. Ultimately, this may be a mistake because there is a visceral component to the issue. We in this country are being beggared in order to protect global hegemony for our great global corporate entities. In fact, this is actually and certainly, a potent enough issue, if past currency crises are examples, to be successfully used as an argument for pay as you go government!

Many of the most successful investors over the last six years have bet against the dollar. They looked at the supply-side (debt-fueled) script that Bush was intent on playing out, they looked at the historically unprecedented shift of manufacturing capability out of the US to Southeast Asia that insured an ever increasing trade deficit, they looked at the ensuing shift in demand for basic commodities including food and energy, they looked at the laissez-faire postures coming out of Greenspan's Fed, and finally, once underway, they concluded that the cost of the Iraq War, particularly as it was funded off the books, would further weigh on the dollar, the world's reserve currency.

We are far from our Zimbabwe moment --the rest of the world is paying a price for the weak dollar and will ultimately intervene to support it-- where it takes a wheelbarrow of currency to buy a loaf of bread but we are beginning to see some weird distortions: the price of basic foodstuffs has climbed throughout the world. This is partially due to weather changes, they say --the rice crop in Australia-- and partially due to increasing demand, particularly in Southeast Asia, and partially to the use of corn for ethanol production but also to the decline of the value of the dollar. The US is a major grain producer, a weak dollar would indicate that grain becomes cheaper when purchased outside the dollar zone. This is not the case, of course. Instead, like oil that is also denominated in dollars, food grain prices have climbed as currencies in the raw materials exporting parts of the world have not followed the US dollar down, countries like Canada, Australia and New Zealand.

Because so much of our food is packaged, manufactured product, the raw material component price has not had such a startling impact as say, the price of corn has had on Mexican families who rely on the grain as a key part of their diet. There have been demonstrations in a number of countries beyond Mexico including most recently violence in the streets of Haiti. It is possible then to foresee troubled times around the globe because of a devaluation in the US.

As we've also often noted, paradoxically, the oil rich Arab states, the Chinese and the Japanese have a vested interest in supporting the dollar regime, even as it appears to be falling apart. This is because they are major holders of the dollar in the coffers of their banking systems. They could precipitate a world financial crisis that would make the present leveraged banking crisis feel like a warm breeze in the eye of a hurricane. To be sure, they are all working overtime trying to figure out the least destabilizing ways to lower their dollar positions. We can look for the Chinese, say, to be out seeking stakes in entities that own and control raw material assets and distribution.

Another factor driving the value down is our artificially low interest rates. Money from abroad that might normally flow into the US for safe harbor bond purchases, will instead go to places where interest rates are higher. Today, the rates set by the governing central banks in Europe, Australia, New Zealand and Europe are about where the US was before the Fed rushed in with its record setting cuts. Low interest rates make it cheap for companies to borrow and thus stimulate business activity. What's dismissed is that low rates hurt savers and retirees who have managed to be thrifty and are now living off those savings, even as much as a cheap dollar does. Together, there is a double whammy of inflation and wealth erosion.

Miraculous Recovery

There are some out there who are already heralding that we are on the brink of recovery in the US, even as we are just entering into this Recession. After all, the stock market has performed well this month and the unemployment figures don't seem so bad. Our guess is that unemployment and job loss will be revised upward in the future as they are measured by means that tend to obscure the facts at the outset and end of cycles.

What that would mean is that the financial system has managed to absorb $100's of billions in bad paper, that construction workers who have lost their jobs have some how ended up on their feet, that ordinary Americans, no longer able to borrow against their houses, are bellying up to the bar and paying more for gas and food and still yet are able to keep the 70% of our economy that depends on their consumption on track for growth, that continuing job losses in manufacturing are being replaced elsewhere, that interest sensitive savers are able to absorb the hit of low returns, that high diesel costs are not driving up retail costs and that continuing job shrinkage --we need 150,000+ new jobs per month just to keep pace with population growth-- are all being overcome by some miraculous happenings off the radar somewhere.

Lately, of course, moral hazard has become in the popular press something associated with the ongoing financial crisis. Roughly defined, it invokes the requirement that investors, fully rewarded for their wins, must also pay the whole price for their haircuts. And so, it's not bad behavior, per se, that must be reckoned to the full but behavior that results in material loss, wanton or not. In this latest crash there has been no shortage of the usual caddish behaviors: salespeople were spiffed to get customers into financially disadvantageous loan agreements, borrowers faked their personal financial data, rating agencies put their AAA imprimaturs on toxic paper, bankers created an insatiable demand for loans they could package and pass on, "counterparties" cleaned up writing default swaps they could market, regulators looked the other way, brokerages shorted the securities they themselves issued to their own customers, hedge funds borrowed heavily to get their bets into the game, bankers made extreme loans to hedge funds, bankers created off the-book entities to issue suspect paper, etc.

And, of course, when this rash of bad behavior went from endemic to epidemic, the usual calls for government intervention went out, first by the general public when foreclosure signs began to sprout in their neighborhoods like mushrooms in a rainy Fall and then in the weightier pages of the WSJ and FT when it became clear that the great investment houses, themselves, had been left swallowing their own toxic waste and melting into the ground like a serial Three Mile Manhattan, London and Basil. As fast as the Fed and the ECB pumped "liquidity" into the markets, the faster the banking system seemed to fuse to a halt. Something more radical than winners and losers was occurring, hence the concerted move to a bail time-out for the whales left flapping on the beaches.

For the cynics here in Dymaxia, it came as no surprise that the bailouts would extend well beyond the former limits of the commercial banks all the way to the free-market precincts of the hedge fund industry. After all, by definition hedge funds are highly leveraged entities that do their borrowing from their willing commercial and investment banker brethren. We also remembered Ben Bernanke's famous "helicopter" speech in which he vowed to keep the government printing presses going day and night to supply whatever money might be needed to keep the system off (or on, we couldn't recall) its knees.

To ourselves, laying down the editorial pages of the Wall Street Journal, we mused, moral hazard is about as quaint a notion today as the characters in Austin's Sense and Sensibility might have appeared to Choderlos de Laclos, the author of Les Liaisons Dangereuses, had he lived long enough to contemplate them. In the end, it was the chronicler of another gilded age that seemed more appropriate, and so we deferred to the much maligned Marquis de Sade for our contemporary standards for hazardous morals.

As we noted in our last posting,
Pushing on a String of Discontent: Bernanke's Tale: Bernanke's Tale, the Wall Street executives who led their companies so deeply into this quagmire, would surely not admit, even under oath, that the good performance their companies produced as the pyramid scheme unfolded, and for which they were so richly rewarded by cash and stock option bonuses, had little or nothing to do with the hard landings their companies were experiencing today. "Who could have predicted," their chorus lamented, "that the unprecedented growth in home equity and home ownership, would have resulted in a bursting bubble?" And like all farces that recount the foibles of the Gods, economists, the regulators and the mainstream press, echoed in polyphonic tone from across the stage, "who would have predicted"?

And so, in keeping with the moment's theme of decadent farce and moral hazard, we asked rhetorically, will those entities that are now rushing in to save the remnants of Bear Stearns (it was too late for these guys who, it appears, were so swimming in toxic waste that a special $29 billion fund had to be set aside by the Fed to soak it up) and most recently Lehman Brothers (they've already availed of $4 billion in back-up spare change) be asked to take back some of the bonuses that were paid out to top executives during the recent up years?

The answer, of course, is that it will take another round of heat, at least, before anyone begins looking for a couple of high level guys for some communal bloodletting. After all, James Cayne, the Chairman and CEO at Bear Stearns, we hear from those same journalists who continue to insist on calling that company's forced by-out, a non-bailout, has paid dearly for the loss of equity he suffered. His shares, they remind us, went for $10 a piece when just a couple of years ago they were trading at $171. We are, by this light, supposed to suffer for the good chap who like a Long Island Nero, played bridge while his firm and his bonus shares sank into the clutches of the goodly fiends at JPMorgan Chase.

Quaint, we say, because today's gilded age has funneled so much wealth into the hands of this super class that counts its yearly earnings not in the hundreds of millions but in the thousands of millions of dollars even while the tax rates paid by this über group are less than those paid by the lowest wage earners. Last year, a tepid attempt by Congress to reckon hedge fund manager earnings as taxable earnings was quickly shunted to that special place on Capitol Hill where all high minded efforts go to be stored, like Walt Disney's body, for a better day.

Speaking of which, the distortions created by economic policies that hide the cost of war, rely on declared and hidden deficit spending, encourage plastic-based consumerism, personal credit extension, negative real-term interest rates to discourage saving, and money printing dollar devaluation are now emerging like the dead from the earth on Judgment Day: basic commodities, like food and energy costs ripple upward even as economic activity slows, the banks, unsure of the value of their own securities, refrain from lending and wages continue to fall for the vast middle even by normal definitions-- measured against wages in the Euro and Yen zone, the loss in buying power for the average American over the decade has accelerated in a way that is astounding.

The housing bubble, the ultimate, live today, pay tomorrow spree, where anybody could borrow as much as he wanted, was the antidote to the sinking of American economic hegemony. And yet there is also a Main Street equivalent to the moral hazard story that has appeared, like a throwback to some cloth coat Republican era, both in George Bush's and John McCain's rhetoric as they have been forced to grasp the systemic and political implications of a housing bubble meltdown: never mind the dastardly builders, loan brokers and debt packagers, what about all those obnoxious speculators you used to run into at every wedding, first communion and bar mitzvah party? All of them had just successfully flipped a whole bunch of condos somewhere or other, turned their log cabin into a country manor house and had all become safely installed in their suburban equivalent of Monticello. Are these the guys who need to be bailed out of all their flimsy loan deals?

As for those Members of Congress who are supposed to be working to get aid to all the poor folks who just happened to get sucked into the housing frenzy at the wrong moment or through devious paper sleight of hand (remember those spiffs that pulled brokers toward selling loans with trap doors built in) , we wish them the best or luck. They will need every ounce of backbone they can stiffen, or, not only will the lion's share go to the same scoundrels who partied on the way up (NYTimes on the Senate version,
Big Tax Breaks for Businesses in Housing Bill) but also to the shareholders of the two big once quasi governmental agencies that were designed during the New Deal to save housing during that desperate period, Fanny Mae and Freddy Mac. The proposal on the table would build in government backing to expand Fanny and Freddy's capacity to lend to soak up bad mortgages designed to spin out of control with a new crop of fixed-rate models to homeowners even if their present houses are already underwater.

Beyond the personal debacles, a falling housing market that might lose up to 40% of present value is predicted to cause the kind of Main Street financial chaos that would spread beyond containment. Of course, the new plan would require the Federal Government to provide guarantees for all these new underwater loans in case homeowners just plain decide to walk away from their homes in search of greener pastures. It needs to be noted that here, once again, the backstop is going to be the already battered dollar, and the recipient agencies, though hybrids of a sort (Fannie, for instance, uses its quasi status to avoid paying local property taxes for its headquarters in DC), these are private stock issuing entities just emerging from bookkeeping scandals that fortified private industry level salaries and bonuses for their executives.

You already know that the US finances a very expensive war by printing dollars off the books (which no doubt explains why billions of them have just disappeared into the Mesopotamian underground) runs a built in deficit that grows from year to year and buys ever more from abroad. The Federal Reserve is providing hundreds of billions to backstop a financial system that has taken shock one, the blowback from the sub-prime crisis but may soon face the prospect of seeing the loans and counterparty paper issued to "insure" the equally speculative business of highly leveraged buyouts come a cropper as well. This Recession is like the new year, hardly a baby still. Prolonged recessions can be trouble for a number of corporations under normal circumstances but for leveraged buyouts paying out enormous debt loads, a few bad quarters can be as toxic as the sub-primes were for leveraged financial giants like Bear and Lehman Bros.

We recall that up to a short while a ago, LBO's, or leveraged buy-outs, were all the rage on Wall Street. Last week, one of them, Linen and Things, with 17,000 employees around the country, announced they were shutting their doors. With gas prices expected to hit $4 a gallon this summer ( it's already there in some places, while the Diesel fuel that truckers rely on has already passed that line across the country), building activity down, and the price for food hitting the roof, it's hard to believe that Linen and Things will be the only stretched out retailer to bite the dust. As the Chinese currency, the RMB is inevitably pushed up to counter the worldwide inflation in raw materials, the price of retail goods in the US will have to move with it, despite what the round smiley face signs at the end of the aisle tell us.

Those who argue that this Recession still has a long way down to go, certainly have more than their share of arguments and data to back it up. Watch out!

In other words, while we were staging this most excellent pyramid game, no one complained about a hundred million here or there, not even our stockholders; so now why shouldn't we be paid a little extra for managing the hard times we are going through? In effect, "you really want to know where the bodies are buried, then get real!"

But for just a moment, never mind the titans at the top of the world, that mentality works on regional levels as well.  Here in Washington, a local marvel at the crest of another bubble when the capitol region was fast becoming a tech Mecca, Friedman, Billings, Ramsey, or FBR as it's known, have been on a nearly consistent losing streak that has seen practically every investment they've undertaken this millennium, lose money. Just recently their board announced that they (the founders) were awarding their top executives (themselves) a massive bonus-- one supposes to keep themselves in place so they can do even more damage.

Here's what Steven Pearlstein, a columnist at the Washington Post had to say on that account in his Friday column:

"But for pure chutzpah, nothing tops the recent announcement that, following a year in which the company posted an operating loss of $740 million, Billings and three other top executives were awarded bonuses and stock grants worth $30 million, at the time equal to nearly 9 percent of FBR's market value."

The Ultimate Bear Trap

But, of course, last Friday was different. it marked a clear point of demarcation, as the government moved from mere propping and backstopping to the next big step in this menacing financial unraveling. Friday saw hundreds of billions pledged for the first phase of a pure and simple bail-out for one of Wall Streets bare knuckle gangs. The Fed was now taking mortgage backed securities no one else wanted as loan collateral, albeit for 28 day loans, not for a commercial bank, as comes under its mandate, but instead to ward off the collapse of a brokerage and trading business that specialized in mortgage-back finance.

As you no doubt remember there was an incident back last summer when a couple of hedge funds managed by Bear Stearns -- Wall Street's fifth largest investment and clearing businesses-- that had borrowed large sums of money to invest in (actually, soak up paper sitting on Bear's books) mortgage-backed securities, ran into a reef.  See our piece, The Big Crack

It was the first major extrinsic sign that the great easy money home lending bubble was about to burst.  Of course, anybody looking should have foreseen this outcome as the pyramid scheme finally ran out of suckers, in this case some of Bear Stearns own high worth customers.

Every so often there comes a point when a downdraft causes Wall Street and Main Street to collide: right then down on Main Street people's wages were standing still even while they were gobbling up high priced homes for themselves that had doubled or trebled in price over the course of a few short years.  The easy lending had also fostered a pack of players looking to "buy" (no money down, no questions asked) and flip neighboring properties as they came on line. And if you wanted to know how, all you had to do is look at the ads in your local paper or even check your mail every day. There was no shortage of banks and brokers who were bending over backwards to lend you money against the accrued value in your own house as they urged you to buy a newer, bigger one.

But never mind the collateral, the money kept getting easier: first, you didn't need any money down, so you could borrow up to 100% or the purchase price, then you didn't need to pay back any of the principal, then not even at the going opening mortgage rate for the first couple of years and finally, you only had to pay off the teaser interest part of the loan.  Finally, the word got out that you didn't really need to prove you had a job or reliable income to get a loan, you could just make up an income figure and move the family into your Mac-mansion as fast as you might get a pizza delivered there.

The Huge Sucking Sound from Wall Street

There was, it seemed, an uncannily huge demand to underwrite these mortgages no matter what shape or form they came in, and it came all the way from the heights of Wall Street. For, with the ink still wet on the loans, they'd be immediately taken off the hands of the issuing banks and, with a special kind of magic known only to these financial wizards, crammed into some three-letter financial gadget (ABS, SIV, CBO, CLS)  that would pack them together with a mix of other peoples' loans, and send them off as fodder for this new, largely unregulated and soon-to-become massive, shadow banking system.

The Fed's easy money policies, laissez faire attitude and the tsunami of new dollars being created by trade-deficit recycling, had, it seems, been turned into a great demand for paper that paid even just a percent or two more than the safe stuff and so a profitable bundling business turned into profitable underwriting businesses and bundles were sliced, diced and rebundled in secondary and tertiary derivative markets and sold to anyone who wanted to lay down cash or step up to the window and borrow to leverage their bets. Investors around the world were rushing into the hedge funds that were pulling off these tricks, ready to pay the fund managers up to a third of the paper profits in fees for the privilege.

At the end, there was even a perverse echo of the previous bubble, the hedge fund doing an IPO; cherry on the cake: to leveraged buy-out companies like Blackstone and the Carlyle Group. Carlyle Capital, a spin-off of highly successful defense industry investor Carlyle Group (more below) took the scheme of borrowing heavily to buy mortgage-backed paper as a business model and brought it to the stock market. They issued an IPO on the Carlyle name, registration in the Isle of Guernsey, selling shares to the public through the Amsterdam Exchange! Other such highly leveraged companies went into the market selling bonds or creating further derivatives. Last summer, just before the first crack occurred, Bear Stearns, themselves, tried to palm off another load of their own toxic paper, to a subsidiary they were trying to hastily bring public.  They didn't get it launched until it was too late, thereby saving a whole bunch of suckers their money until, one assumes, the next Ponzi moment.  

Smart Guys, Smart Money

But now, this Ides of March we are just beginning to see the leading edge of the worst effects of this splurge in mindless highly leveraged bet making. What may be mind-boggling is that the so-called smartest guys, the ones who had to know what kind of toxic crap they were creating, buying, insuring, lending against and selling, so flooded the market that they got caught up eating their own dog food trying to make it still look palatable. Time-wise, it's hard not to parallel this with the exploits of Elliot (Ness) Spitzer who had boosted his career by slapping down Wall Street's greediest no-gooders.  The same week that finished with gritty, uncooperative (they had balked at joining the other big investment firms in the LTCM bail-out in the 90's) Bear Stearns finding itself in the ignominious position of being on its knees before a rival bank, JPMorgan Chase, Spitzer would have to quit as New York's Governor because money and electronic tracking traps, he himself had souped up to use on others, would, in a federal investigation, ensnare the enforcer himself, pants down.

In contrast to the "irrational exuberance" that characterized the last crash--  this time the tectonic plate has moved much further than the precincts of stock touters and patsies. This time, the folly occurred far outside the grasp of the regulators-- and it is spreading to impact ordinary home and car owners, folks on fixed incomes, municipalities, bridge and tunnel authorities and the states, themselves, who all reside way beyond the precincts of the giant global banks and investment houses.

After all, when you normally hear about margin calls, it's the banks and brokerages requiring their clients to put in more capital to back up their bets. This time around, it's the banks themselves that are hearing the margin calls.  They are being asked to "mark to market" all of this Byzantine three-letter asset-backed paper they have on their books as collateral. The only problems is, that having lost confidence in their own holdings, this time there is no market to mark to. Trading has slid to a near halt.

So guess who has opened up a window to accept the toxic waste? Why it's our very government sending in the cavalry, with bushels of ordinary people's tax dollars. That same no-good government, if you read the editorial page of the Wall Street Journal on most ordinary days, that is supposed to be standing aside and letting the private sector do it's magic.  Never mind the deficits already on the government's books, never mind the money being thrown into the endless War, the Federal Reserve now stands at the ready to suck up the waste product of greed with yet more borrowed money. And so, in this nasty tale, so sinks the dollar ever further.

Since the  fiasco of 1929, when borrowed money underlying the stock bubble brought the developed world economy to its knees,, there have been rules in place that limit a bettor's ability to borrow money to buy securities.  In recent years, the onset of leveraged and highly leveraged hedge funds has driven something of a major loophole into these rules.

There were, obviously, no such rules, only practices, in place when it came to the mortgage business at a time that the Federal Reserve was pushing interest rates down, down, down to soften the landing of the Tech Bust.

Greenspan's Legacy, the New Shadow banking System

One of the great ironies of this present and particularly alarming crash --they seem to come back to back at greater frequency--  is how avoidable it might have been had not we come to a particularly dangerous fork in the ideological setting that led up to what now is clearly going to be more than a mere "two quarters and out, garden variety recession" that the majority of economists can somehow still project. Here in Dymaxia, we often excoriate the mainstream press for their birds on a telephone wire, reflexive reporting.  Economists, seem to have invented the phenomenon. No single societal group seems to be more consistently wrong at every turn, even in their rear view mirrors. 

At their historic crest, the mood in the dominant party back in 2000 was to eliminate regulation wherever possible and to generally roll back any public protection that might have been created since the mid-Depression Roosevelt years. Unfortunately for that movement, we were in the aftermath  of the Enron debacle and it was all too crystal clear that, despite all the regulation in place, it was still possible to game the stock market big time. That wasn't the moment that Congress could be seen thinking of getting rid of the market police at the Securities and Exchange Commission, rather they begrudgingly toughened reporting standards with Sarbanes Oxley.

But the guy sitting inside the Fed, the man who'd gained palpable clout for how he'd managed the Tech Bust (by bringing interest rates down to near zero), was Alan Greenspan, an acolyte who had once literally sat at the feet of novel writer, Ayn Rand, an icon of a newly invigorated Conservative movement that was striving to restore, in Randian terms, the power of the individual over that of the collective.

Anything less than a purposely anesthetized Federal Reserve Governor, would have smelled a rat, when, in a moment of low inflation, housing prices started to take off wildly. For a boom to turn into a bubble you need a blind regulatory eye, the promise of ever rising prices to suck more and more people in and plenty of freshly printed, readily available money to lend them. The promise goes something like this: "Buy now, even if you have to borrow everything you can plus some, because this time next year you'll be able to sell, get everything back plus a profit and move on to the next killing."

Bubbles are something we will always have, as long as there's a natural dose of greed around.  But as night follows day, there will be busts, too. Fear, will sooner or later rear its head. The smart money is supposed to get in early and out of the way when the bubble begins to crash.

Ironically, central banks, like the Fed, came into being to ensure that the inevitable crashes didn't pull perfectly innocent participants going about their day to day business in the banking system into some extraneous financial world wreckage. They are there to regulate, to make rules to thwart bubbles and backstop only to protect the innocent bystanders. For such, the Fed is mainly limited to using its hold on interest rates to slow or quicken the economy, to keep things on a smooth course.

Unlike its predecessor, the Tech pyramid, the impetus for the Housing Bubble, however, can be almost entirely laid at the doorstep of the Fed, itself. The Fed quite significantly has the power to require banks to manage their lending practices.  Greenspan, it's clear, decided not to get in between the banks and their more risky business partners, including the completely unregulated hedge fund industry, even as it knew that the once hard walls separating banks and the brokerage business had been freshly pulled down.  The theory, no doubt being that savvy adults, bankers included, ought to know what they are doing and take the up as well as the down consequences for their actions.  Consequence, after all, is the cornerstone of laissez faire capitalism.

In Greenspan's zeal to unleash the unregulated hedge fund industry even as commercial banks were spreading into the investment world, he managed amnesia regarding one of the main tenants of the Austrian School that he professes adherence to, and that has to do with the printing of paper money with nothing "real" behind it.  The modern Fed is in the business of printing money with nothing behind it, no inconvenient bars of gold no silver, no nothing.  And now, in this Spring of discontent, it seems, it is also in the business of mitigating the consequences of bets gone horribly wrong.

Credit, Credit, Everywhere but not a Drop to Drink

This latest pyramid, we all know, started in the mortgage industry as homeowners were given the opportunity to trade in older more traditional mortgages for loans that had lower introductory interest rates. The kicker was that these older loans demanded a 20% down payment and over time further equity built up as the monthly payments included principal as well as interest. It's a cliché but also a truism that house's have traditionally served as a ordinary folks' largest and most important piggy bank, not, as in our present paradigm, it's ATM machine. The Fed could have cut the bubble off at its knees by taking a hard stance on the lending rules and the valuation of the derivatives that were being issued to fuel the worst excesses, the excesses that have actually brought the financial system to its knees. When questioned, Greenspan, from his pinnacle, repeatedly said he saw no intrinsic peril in the practices.

Yesterday, the government agency that measures such things, made public that for the first time since the end of World War II -- in the shadows of the Great Depression, that is-- Americans own less of their houses than do the banks and other lenders.  It came in 51% to 49%.  So much for the piggy bank and so much for the household! The conversion to a nation of debtors in just a short period was complete.

For those unhappy folks whose house now is worth less than they owe on it, there is another kind of choice: Do I hang around and struggle to pay off a mortgage, set to bump upward in many cases, or just walk away?  For a lot of folks with nothing in and facing ever scarier job prospects, this is a no brainer.  And so more houses go onto the market and prices in surrounding neighborhoods start to drop as well.  This second wave is ushering in a new chapter where companies that have borrowed on the basis of ABS-type bundles of these prime mortgages are also being called in to put up more solid collateral. Clearly, the problem has begun to spread in a number of directions. And worse for all the innocent bystanders, the Fed, in it's policy of hastily lowering interest rates, the public be damned, merely spits against the wind, yet, all the while, sewing the seeds of the next big distortion, sure to take root from interest rates that in real terms --that is, after you take inflation into account-- are already negative.

Of course, while the banks were inundating home owners with loan offers, they were also chasing every living American to open up a new line of plastic credit debt.  If you were maxed out, no worry, just consolidate --6 month teaser rate-- and come play with us, they beckoned. American families now owe an average of $28,000 in credit card debt, often with interest rate tags of over 20%, not to mention penalties if they miss a payment.

Then there's the added glow that a bubble or pyramid scheme brings to the players early in.  But this last bubble driven expansion had a weird hue to it from the start, all its own. Americans, even as their jobs were being shipped abroad, were borrowing and spending at a rate never before seen in our history, and mainly for stuff no longer made by them.  It's no exaggeration that we now  don't even question that 70% of our economy is based, not on what we make but on what we consume, nor do we second guess the massive trade imbalance that has ensued. The American consumer, it is said, is the engine that fuels the entire world economy. 

And for the world, that ought to be very bad news.  While every day consumers were borrowing, and the shadow banks were leveraging in the billions, they were being matched in spades by their own Government as it refused to tax for its own spending needs and even set the trend by running a major war --$12 billion a month-- off the books. This government borrowing together with the trade deficit has in just one Administration pushed down by half the buying power of the dollar, especially in Europe and Japan but most significantly in the Middle East, where the oil is. Consumers are now pouring money down the Exxon and Shell funnel to Arabia even before they can even get to Wal*Mart and Target for their little contribution to the Chinese dream. Never mind, the Spender in Chief encourages them to go out and spend. Got problems, he says, just save my tax cuts, and I'll send you a check in the mail.

A feeble dollar makes us all poorer but it is yet another gimmick governments use to stimulate business.  In the old model, a cheap dollar would have led to higher exports thus stimulating the domestic economy. But in a service economy where manufacturing has largely been sent abroad, there's nothing extra to sell. Goods, and particularly raw materials, from abroad get more expensive in dollar terms and before you know it you have a systemic inflationary force.  It should be noted, that the Fed is betting that a slowing economy will take care of that inflation by pushing down demand.  In other words, even as the Fed is pushing the pedal to the metal, it's betting that its mainly going to spin the wheels. That mud, it seems, is being thrown into the eyes of all those who predict this will be a two-quarters and out event.

Japan, a mega-industrial power you don't hear much about these days, has been in a state of low or no growth for over twenty years despite the fact that the Bank of Japan --their version of the Fed-- has kept interest rates a near real-term zero over most of that time. The government refuses to force the banks to clean the mountains of bad debt they accumulated in their own stock bubble way back in the 80's. Still, Japan runs an annual trade surplus with the US of over $80 billion, holds over a $trillion in reserves, and their people save at a healthy rate.  Their population continues to age and they appear culturally unable to absorb foreigners to replace their work force.  Could America's brand of borrow and bail out, create our own version of a limping giant?

Saving has totally disappeared as a concept in the US.  With houses now tapped out, university costs soaring and the education gap between high earners and the stagnant middle class ever widening, the coming generation, routinely emerges from college and graduate school with tabs in the hundreds of thousands of dollars. Working folks have to dread a medical event that can throw them into even deeper debt.

What the housing bubble did was temporarily mask the hard truth of falling manufacturing jobs and the wages and benefits that came with these often unionized jobs. Easy lending combining low (initial) payments and very loose requirements had a major impact.  Many people --depending where you live, of course-- saw the values of their homes rising by 10 or 20 percent per year as all the churning encouraged people to "trade up". The activity also brought in speculators who saw how easy it was to buy houses on margin and flip them as prices soared.

For the Administration, this was no-questions-asked territory.  It was being hailed as the result of lowering taxes on the wealthiest players in the game even as they were wracking up the biggest pay-offs of their careers. By the no-tax theory, increased activity brings increased tax revenue and the whole thing pays for itself.  So never mind, the growing domestic deficit and never mind the equally ballooning foreign trade deficit.  In the end, it would all shake itself out. And if it didn't, well that would be the problem of the next Administration, and the debt that of the next generations.

Now that this is starting to spin out of control, everyone with their own skin in the game is running the other way. No one trusts what's on the other guys books so no one is loaning despite the Fed's best efforts. Present Fed Governor Bernanke is printing money as fast as he gets interest down.  But that's like trying to stop the flow of water by putting your hands into a stream.

To attack the problem of mortgage backed securities as collateral, the Fed has announced that it will lend to banks and accept, in exchange the toxic collateral that no one else will take.  For this it has made available the sum of $400 billion dollars, which, is half the amount the Fed holds for all market intervention it makes. But that was earlier in the week, before it was forced to intervene in saving Wall Street's 5th biggest firm, Bear Stearns. This Bear Stearns rescue marks the first federal bail-out of a major bank since, yes, since, the Great Depression! To close the deal that saw JPMorgan Chase take Bear Stearns for less than the building it owns and occupies is worth, never mind the $80 billion it claimed in assets just last November, the Fed agreed to scoop up $30 billion in further toxic waste. Clearly, the skin they, the Fed, have in the game is other people's money, in this case the taxpayer's.

But that's not all that happened in this week.  In a clear echo of the Bear Stearns crack, a leveraged hedge fund started by the investment bank giant, Carlyle Group, was being called to put up more security against the $22 billion it too had borrowed to get into the mortgage security margin play game.  And so a few million here and another 100 million there and before you know it, additional billions of dollars are coming off of balance sheets of the world's great financial institutions in write-downs. In the end, the Carlyle Group decided to let technically separated Carlyle Capital sink into bankruptcy rather than pay out a billion to save it's own good name.  That decision shook all it's Wall Street lenders, including Bear Stearns where it may have been the straw that broke the camel's back.

Perfect Storm, Yet?

It's been estimated there are still more than $100 billion in write-downs to come in the area around mortgage paper alone.  Last time out, we wrote about something as obscure as the CDO's and CLO's,  called credit-default swaps, or CDS's.  This is a gargantuan insider "insurance" market that is fairly unregulated.  It is estimated to total the staggering sum of $45 trillion.  If this market should start to unravel, it is impossible to predict where the outcome might lead. And sure enough, in the noise around the collapse of Bear Stearns, there is already talk of failing CDS's. No doubt this is where the Fed has placed itself as counterparty to shield JPMorgan from god knows what else.

As we've noted, the aftershocks coming from the sub-primes has spread into what are traditionally boringly safe markets like the ones for municipal bonds. The sub-prime fiasco has also called into question the reliability of a lynch pin of the system, the credit rating agencies, which, for greed of their own, were willing to bestow their highest AAA imprimatur onto mortgage-backed securities, including some with a tranche or percentage of sub-primes in the mix. 

What's poisoning the municipal bond market, that cities, states and their agencies use to finance their projects, is the state of the so-called monoline insurers who cover the risk of municipal bonds by selling insurance on the basis of their own AAA credit ratings.  These insurers have nearly gone belly up because they too jumped into the CDO and CLO security game, providing added cover to the toxic waste products. Now the municipalities issuing bonds to cover things like stadiums, bridges, sewer systems, etc. are having a hard time convincing investors that the insurance they hold to ensure their AAA rating will actually cover them. Investors who could rely on the ratings and the insurance, are now forced to try to figure out which water company is more solvent than say, the nearby sewer authority.  As a result, mundane bond auctions have been failing for weeks on end.

There is more of the pernicious circular dynamic here since these very municipalities depend on property taxes and user fees to pay off their bonds.  As their property bases shrink as people walk away from underwater mortgages, the very income the municipalities need to pay off their debt is called into question; hence investor apprehension.

On this very shaky weekend, the thought occurred to us: what if some other unexpected jolt --our proverbial black swan-- were to hit this truly unprecedented situation, a 9/11 type event or a pandemic episode like the Avian Flu, or a run on the dollar as foreign banks moved to Euros or Yen? 

Moral Hazard

We are now at the point we predicted it would all come to: where the Fed is putting up public money to bail out the greediest layer of society, the guys whose bonuses are in the millions, who set up their shell companies in the Caribbean to get out of paying taxes on profits, who treat their salaries at the Bush capital-gains rate.  The guys who, as Warren Buffett put it, pay less in taxes than their secretaries do.

For every $billion the Fed puts up to suck up the excess waste, will players have to pay a special tax on the bonuses they took home while the party was roaring? We wager not!

And will the Fed in  it's zeal to bring interest rates down find some way to compensate regular folks for the little bit of interest they are losing on their savings?  After all, seniors present and future are encouraged to save so they will have something to live on in retirement.  Low interest rates, like pushing on a string, may stimulate some movement but it's just as likely to be as distorting as it is in Japan where housewives are said to borrow Yen at the low rates to invest in high interest places like Australia and New Zealand.  The hedge funds call this activity the carry trade and it is ready to make a comeback at a fund near you, soon.  

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.

We got back to the States two weeks ago, in time to hear the weekend bloviators indicate almost unanimously that Hillary Clinton had wrapped up the Democratic presidential nomination.  Only on the following Monday when an ABC Washington Post poll came out of Iowa were they stunned into realizing that all of their hot air and spin had to be revised.  Somehow, Iowans --the folks who actually will be making up their minds in 5 weeks-- had, like their credit cards, maxed out on Hillary's message of a return to the good old days. 

What Don't They Miss?

Pundits, of course, travel on other peoples' credit cards and sometimes even get to dine and rub shoulders with the Great Gatsby crowd that have had a great run these last few years. For them, the sound and smell of little people's mortgages going up in smoke is as far away as one of Jupiter's liquid moons. Nothing it seems can divert their eyes from the talking points coming across the transom, not even the unseemly multibillion dollar panhandling in Arabia of giant financial institutions --Bear Stearns, Merrill Lynch, Citibank, Bank of America, HSBC, to name a few- as stoppers to the hundreds of billions of dollars in write-downs they are taking for holding derivatives (many of their own making-- that were somehow supposed to have allowed them to sprinkle fairy dust on the toxic waste they'd bundled into tidy CDO's, CLO's, MBS's, etc.)  (For a lot more detail on this alphabet soup mess, please have a look at our July 27 piece The Big Crack )

That trillions of dollars have flowed out of the US and into the coffers of sheikdoms small and large, friend and foe, as well as to our East Asian allies and rivals is something best left to the money men to figure out, it seems.  Even when great banks teeter on the brink, and CEO's are forced packing, we hear nary a peep out of the political and media class.

Does anyone among the poobahs and sages wonder how it is that nearly all these so-called sophisticated money men, and their peanut counters in the back room bought so heavily into their own waste product?  Or in the more convoluted case of Goldman Sachs, shorted the lousy paper they were selling to their best customers (even while the present Secretary of the Treasury was still leading the firm)?

Hardy, though Paul Krugman, the Princeton economist and New York Times columnist, who does do his own thinking, had a simple way of nailing it; greed in the corner office in a political environment that has put the foxes in full control of the henhouse. Krugman has made the Enron-revisited point that none of the CEO's who've lost their jobs as the multibillion dollar losses of the subprime crisis have hit the fan, has had to give back his golden parachute going forward or the obscene, bonus-based, pay packages they collected during the years they were ginning up the phony mortgage market and creating the mountains of bad paper --they secretly called "toxic waste"-- their institutions and stockholders are now forced to swallow and that is shaking world financial markets.

The Farce Begins

The Friday November, 30th Wall Street Journal reports that the Bush Administration --the same guys who advocated that Social Security should be replaced by private investment accounts in the markets-- is in the process of negotiating with the banks with an end result that is sure to mean --even if its hidden in the deal-- that the taxpayers will soon be subsidizing the banks as well.

Here's a good pundit question to be asked: Will the Democratic Congress ratify a deal designed to help the banks and the holders of some of the many balloon mortgages that are scheduled to blow up as rate increases kick-in, without asking that at least some of those bank and hedge fund executives who have pulled in billions of dollars in bonuses for the last few years to give back any of their bonuses and commissions, in return for a rescue of their scams?

We, here in Dymaxia, are willing to bet that the question will hardly arise before it gets buried like a lead pipe in a toxic waste dump.  After all, this sitting Congress already has a record on hedge fund bonus money; i.e., they continue to allow it to be called "capital gains" by the hedge fund moguls, so it can be taxed at 15%, half the rate the folks who sweep their offices pay on their earnings!

But bank sub-prime paper mega-write-downs (see the E*Trade deal where $3 billion in CDOs was turned overnight into $800,000, for instance)   also strike at lots of folks who have pensions invested in the banking industry not to mention bank stocks in their mutual fund portfolios. In the case of Citigroup (CIT), alone, shareholders have, since the beginning of the year, lost approximately two thirds of the value of their holdings, or more than $80 billion dollars. In E*Trade's (ETFC) case, shareholders have lost more than three-quarters of their holdings.

CIT is, or was, of course the world's largest financial institution. In desperation, to stay above water it negotiated a deal in which it promised to pay its rescuer, the Abu Dhabi government, 11% interest on the $7.5 billion cash injection it received this week. In today's world where very big money accrues even to individuals if they're in the right place, $7.5 billion probably doesn't sound like a lot to a pundit's ear.  It was, it turns out, enough to buy nearly 5 percent of our biggest bank.  Importantly, for the gulf state oil sheikdoms, it represents probably only a few-day flow of petrodollars; here, it seems, the pundits and the petro-billionaires can agree!

Trillions of dollars, of course, is real money even in Washington where they print the stuff.  No one knows where it all goes except when big purchases become visible like the Chinese attempt to buy a large oil company with significant reserves or when the management of our major ports goes on the block. What the Citigroup deal points out is that these outside government and quasi-government players in the Gulf States (including Saudi Arabia, of course), China, and Russia are likely to continue to gain clout as the major tectonic shifts of the current crisis continue to shake the banking system.

Now, imagine for a minute that subprime mortgage based money creation was not an anomaly and that there are parallel but even larger fault lines still to come into play!  Impossible, you say?

Here's the way it works when the Fed and the regulators are betting on the private sector to regulate itself: banks and their proxies earn immediate money by lending time bombs that don't go off for several years; bigger banks and hedge funds earn money on these foolish loans by packaging them and turning them into respectable derivatives they sell without, in many cases having to pay a middle man or market fee directly to their customers; rating companies profit by this new business stream and give out their imprimatur of a high credit ratings to this paper now three steps removed from the original loan; other banks and insurers serve as counterparty guarantors, buying and selling the obligations as investment grade to their customers or hold as reserves, thereby "spreading the risk" eventually around the globe.

Are Junk Bonds the Next Junk Bombs?

When it became clear last summer that the entire world banking system had been gaming itself as the US home mortgage bubble reached gargantuan proportions, politicians and their sock puppets looked the other way, spouting the usual nonsense about the core economy being sound.  Neither party could see perils without an equal mix of good news in dealing with the crisis.

Now that the problem has spread beyond the growing rash of foreclosures (these only affect ordinary people and are thus ..........) and to the foundations of the major banks thereby threatening pension funds and even bank deposit holders, the problem still gets less notice by the commentators than the daily swings of the Dow Jones Index.  It's almost as if on the day the twin trade towers fell, the stock market stayed open and went on to gain a couple of hundred points so the headlines read: "Despite Early Fall, Markets up on Gains in Scrap Metal, National Security and Office Building Prospects".  The Dow Jones Index now seems to be the only gauge the media use to measure events on the ground.

Official Blindness

Pundits are an important component of the information flow, since they shape public opinion; so how they get spun matters much. Politicians, we know, who get out in front of public opinion face ridicule and sudden death, which is probably why there are mere nuances of differences in the platforms of all the Democratic candidates, minus say, Kucinich and for all the Republican's, Ron Paul. The pundits, as we noted, tend to read each other, hoping, one supposes, that one among them knows something. The rest of the time they rely upon being fed thought aids by the lobbyists and other operatives, the guys who earn the big bucks in Washington.

Unlimited Dollars All Around

Public money used to have meaning in Washington until Ronald Reagan intuited that debt, in our new economy, had become as American, say, as a wallet full of credit cards. Take the 5th year of the Iraq Occupation. The United States continues to spend off budget nearly 10 billion dollars a month on Iraq, or, in annual terms, nearly one percent of our entire annual gross national product.  To make this palatable, the Administration has raised no taxes but preferred to merely further run up our national debt, something it has been doing across the board without much pushback, anyway.

As we've often pointed out here in BlowBack, since Bretton Woods, the US has had a built-in cushion that allowed it to spread its debt practically cost free around the world. The privilege, a massive type of seigneurage, was made the base of a system in which dollars printed here and spent to buy foreign goods and services often don't show up for payment but instead get held by other countries as a Reserve Currency  It's a great benefit that any country would be envious of; nonetheless, there can be too much of a good thing; the system has been allowed to perpetuate right into this massively financial global era, allowing trillions of dollars to build up outside the country in the last few years as China and petrodollar debts mounted geometrically.

Now that there are these trillions of dollars out there, it doesn't take a perfect storm scenario to imagine what kind of an avalanche a real crack here --say, a major bank or brokerage going under, might set off! China and oil producing nations, should more bad paper start to unwind, might be tempted to cut their losses and try to recycle those dollars into "real" investments, like shares, say, in hat in hand banks or teetering corporations or in the holders of natural resources..

It now looks like one indirect result of the Iraq adventure will be the future dismantling of Bretton Woods.  Since Bush took office the dollar has lost more than half of its value if gold, oil or other raw materials, including food grains) are used as a counter value. 

Our pundit class, of course, never mentions the actual financial cost of the occupation, even as many of them advocate stretching it out as far as the eye can see, once again imagining that the US can go on printing dollars indefinitely just like in the good old days.

But this level of obliviousness, unreality and folly is, of course, hardly limited to the falling dollar, the collapsing mortgage market, the strains showing in the banking system from Citibank to E-Trade or even the looming recession.

CDS, the Next Dominos, Junk Bonds and Counterparts

To get to the Perfect Storm scenario, another shoe might have to drop and it looks like junk bonds may very well be the next subprimes:

This week, we read a compelling piece on where the next big crack might occur, thanks to the research of Ted Seides, as republished by John Mauldin in his Nov 26th "Outside the Box" weekly e-letter.  Seides  entitled his essay The Next Dominos, Junk Bond and Counterpary Risk. In his article, Seides makes the point that the total amount of derivatives issued by the financial institution bundling mortgage debt, pales in comparison with the amount of deriivatives (CDS) that are in circulation, built not on mortgages but around corporate Junk Bonds, which, he points out, are by definition are high risk vehicles.

According to Seides, there are $45 trillion (yes, trillion with a T or more than three years of US GNP) of these derivatives sitting on the balance sheets of financial institutions around the world. He also makes the searing point that there are no reserves (or counterparts, as he calls them) to back these CDS's up. The issuing banks and hedge funds are the guarantors and they have not been required to set any countervailing funds aside to support the paper they've issued.

Here are a selection of attention-grabbing quotes from Seides piece that, unfortunately does not appear to be available on line, yet:

........

.....

.....

Does this all sound familiar?  It should if you've followed the sub-prime debacle!

The Black Swan in the Room

We take our lead from Nassim Nicholas Taleb, mathematician, empiricist and trader, who can be fairly ranked as one our worthiest contemporary anti-pundits. NNT, as he likes to refer to himself is, most recently, the author of The Black Swan, The Impact of the Highly Improbable.  In this book and others, Taleb argues that contrary to the thinking of the punditry, or all those who would predict the future based on the norms of the past, randomness plays a much greater role in the outcome of history than is even vaguely appreciated by those whose world is routinely described by the bell curve of probabilities. For Taleb, it's not just that backward looking statistics lie but when it comes to seeing what might lie ahead, they are as useless as an ice cube in hell.

The Black Swan is, of course, his metaphor, for something that is totally unexpected  (by all, but those close to it, and even they often don't realize the true extent --remember Watson, the founder of IBM predicted there might be a market for four of his machines!) until it is actually developed and injected into the system. In the world of mediocrity, the land of the pundits and politicians, there are no black swans but, as NNT points out, we do not live in "Mediocristan" but instead in "Extremistan". Taleb, of course, can easily point to a string of even recent developments that have appeared "unexpectedly" that have radically and irreversibly changed the way the world functions, from central processing computer chips to the Internet, to mobile phones, (to, yes, the subprime loan debacle that was on no MSM analyst's radar up to just a few months ago), etc.

Mediocristan or Extremistan?

As we've said often in these pages, it sure doesn't look like Mediocristan out there as we watch the markets jerk up and down like vaporetto commuters in Venice, even as we watch the bailouts big and small at banks all over the globe and as we mull over all those unregulated hedge funds --the new counterparties-- going after "absolute profits" for themselves and their clients.

In Mediocristan it all shakes out, reason trumps greed and the beat goes on,,lati lati do!  

If you haven't noticed, Alan Greenspan, the former Fed chief has been as busy as a hero in a Univision telenovela as he makes the circuit plugging his new book. Greenspan, once one of the most powerful men on earth, has returned to private citizenry and is taking the opportunity to make a few bucks off of his outsized notoriety while he repels charges made at him from left and right.

Like an Iranian poobah, Alan has taken it upon himself to categorically deny the reality of his responsibility for any of the myriad financial crises left in his wake. Did Alan have anything to do with the lame dollar that won't even get you a postage stamp in Rome, or the billions poured down the Iraq quagmire (much gone missing, BTW), or the monstrous US domestic and trade deficits, or 20 years of stagnating middle class wages in the wake of blind-eye trade policies, or the soaring price of oil, or the retreat of the US on the world development stage or the Tech Boom and Bust or the Housing Boom and Bust or the threat of trillions in phony paper derivatives busting or....... you name it?

The answer, of course, is, NOT!.  The Mago of the Fed whose every pause could shake markets from Shanghai to Chicago argues that in fact he was hardly listened to.

His advice to Bush to go into Iraq to ensure the flow of oil? Well, he did say it but he believes the administration when they say it had nothing to do with their own reasons for negating the UN Charter and launching a preemptive war of occupation.  As for his support of the Bush tax cuts for the top echelons? Well, according to Alan that support was given with a number of caveats regarding spending.  Unfortunately, he laments, no one in the Republican controlled Congress or the White House listened to him and when he finally began raising Fed fund prices to force up long term rates that would impact mortgage rates? .... Well, the markets just did not take the Fed's lead, despite the 100's of PhD's on its payroll.   

Celebrity and the Media  

Books, of course, sell best if they contain some juicy insights into the real thinking of those wizards who finally come out from behind the draperies.  In Alan's case, it's his take on Administration spending and the reasons for war that have particularly stuck in the craw of his former conservative allies who, after successfully lobotomizing the media, have been busily running the country into the ground while making sure nobody is really noticing.

The Exes

They don't need their ex-generals telling everybody about their screw-ups and they certainly don't need their ex-Fed Governor moving key economic blunders into perspective in his rear-view mirror.  Hand it to Alan that he has been willing to go on just about every talk show that would host him from Democracy Now to Fox News.

We live in a top down media world that allows ample room for the great to paper over their worst mistakes and in some cases to handily point the blame elsewhere. Needless to say, the Oracle of Constitution Ave. is no fool and is quite aware that he, in his capacity as Chief Guru, has very well served what he can't help implicitly acknowledging to be one of the worst administrations in our long history.

Greenspan has presided economically over one of the most transformative periods in our economic history.  He has encouraged free trade even if it is highly unfair trade, he has aided and abetted the running up of deficits that in this one administration have created more debt than in all prior administrations combined, he has blessed tax cuts that were earmarked for the wealthiest strata and his interest rate policies have fanned bubbles that most benefit the financially agile and plugged in.  During the same period the working segment of the US population both in manufacturing and services has seen weak job growth (in services with losses in manufacturing jobs)  no growth in real wages and a crippling loss in benefits, particularly health and pension benefits, the same benefits  that Greenspan now warns are about to drag the entire economy down.

It's here where the Mago has to do his heaviest tap dancing and he takes on the task by putting on a halo and a twinkle.  He is, he says, quite worried that great imbalances in wealth will come to undermine the stability of our political system. The founders, he decries, didn't find a solution to that problem. Quite astonishingly a number of highly sophisticated interviewers of the Rehm, Rose ilk let him get away with that one. The corrosiveness of great inequality in the Greenspan Age?  Well just blame it on the founding fathers!

Dianne Rehm even noted that he had something in common with John Edwards on his protestations regarding the great inequalities in our society, as if Greenspan single handedly has not had more to do with these inequalities than any other member of this Administration or Congress!

In other words, forget about the Fed dropping interest rates to below zero in real terms and the resulting housing bubble, import bubble and finally in a currency crisis that is still in the early stages of unfolding as we write this. Greenspan has said adios, has moved comfortably to the sidelines, his legacy papered over, he hopes, for all to hear.

Alan protests that he is also keenly worried about our loss of civil liberties although he makes it clear (he long ago mastered the art of having as many hands as a Hindu god) that personally he thinks that Cheney and Rumsfeld, whom he has known since his Ford Administration days, are honorable men.  Someone, he worries, ingenuously, is stealing our most sacred liberties but how it is coming about, he can't really say.

Destilando Petroleo

But where Alan has had his biggest pushback (and "resonance", also among the liberal blogosphere as Charlie Rose was ready to derisively point out) has been in his candid comments on the Iraq War and petroleum.  Forget the conservative bellyaching over the deficit, it didn't affect their love for Reagan, who paved the way on this, it's on the oil and Iraq paragraphs in his book that the maestro touched the real third rail of the Bush presidency. 

Alan, as good a weaver as can be in a very tight circle, is not a great open-field runner, it turns out.  He pauses, he staggers and he hems and haws to draw breath when he should be juking. But on the question of the world's energy supply, the significance of a bottleneck at the Straight of Hormuz and the potential for incredible disruption that the narrow supply line has become, Alan is uncharacteristically straightforward.

He did, he says, encourage Bush to invade Iraq because he perceived Saddam Hussein to be intent upon the goal of putting a stranglehold on the world's major supply of energy. Greenspan worried, he says, that Saddam Hussein would purchase a stray nuclear device, say from a hoisted stockpile of the ex Soviet Union.  And so, when asked, he says, he urged on military action.

In his Diane Rehm interview, which came after Cheney came out of hiding to blast him in the Wall Street Journal over his Iraq oil remarks, Greenspan demurred, claiming not to have any real clout in the matter.  Nonetheless he then went on to reiterate his warning that the oil supply was of major concern to him in his past official position and today as a citizen. Interestingly, when asked by Rehm if he felt the same about Iran today as he did about Saddam then, Greenspan offered that he thought the situation in Iran was more nuanced with what he saw as a counterbalance of political forces there, something that didn't exist in Iraq.

Mirror, Mirror on the Wall

What then becomes most obvious in all this is our utter inability through the media spectrum to deal with our most pressing issues even when they are staring us in the face and even when decidedly non-blogger guru's like Alan Greenspan lay them out on the table front and center.  In all the interviews we tuned into, Greenspan was allowed to back away, in face of the Cheney refutation in the Wall Street Journal from any interpretation of his words that might be taken as providing a real motive to the old boy oilmen for going in and planting  160,000 US troops on top of an alleged 112 gigabarrels --according to a Wikipedia entry this puts it as the third largest proven reserve after neighboring Saudi Arabia and Iran-- of untapped oil.  To put that in perspective, today's largest producer, Saudi Arabia presently produces 4 gigabarrels --again from the same Wikipedia article--  per year and may have already tapped much of the oil it claims to still have under its sands.

$80 a Barrel Oil

Here's it is:  In 2007 and to no one's surprise the amount of oil being consumed is exceeding the amount being discovered.  We are, and have for half a century, been pulling down world reserves to the point that we have probably used up more than half of all the oil we are ever going to be able to extract at a reasonable cost even as folks in large population countries like China and India look forward to buying their own energy guzzling versions of the American way of life.

What's also not being really noted is that the price of oil is at an all time high in dollar terms, having passed $80 dollars a barrel. For months the dollar has been falling in the face of rising oil costs and that is putting further strains on the world economic system that still relies on the dollar as the ultimate reserve currency.

And so the US Federal Reserve, has a very tricky role to play in all this.  They have the responsibility of keeping the economy on track while avoiding either a rapid jump or drop in prices. Since the dollar has a special role as a reserve currency it is held by foreign governments around the world to shore up their own currencies. The Fed works best when foreign central bankers and the major private financial sector players go along with the concept that what is good for the US economy is good for the world economy. If too many private sector bankers see holding dollars as too costly a position to justify (remember, that as short a time as less than a decade ago you only needed 80 cents to buy a Euro and that today that same Euro will cost you over 1 buck forty-three, it's hard to see how anyone can be happy holding a sinking currency that could go into free fall should the Fed lower rates quickly to hold off the looming recession in this country), than central bankers either have to lower rates in their own countries in the face of inflationary forces that would be fanned by this, or have to go into the market and soak up the dollars that are being shed by the private sector.  Needless to say, there is no central bank in the world, including the Fed that could stem that move if the bankers and speculators, including the very hedge funds that Greenspan continues to believe are benign forces, start to smell the big profits associated with dollar blood in the water.

The Golden Goose Theory

The world's largest economy, the US, and the world's fastest growing economy, China, are still joined at the hip.  As the US dollar goes down we and the Chinese, pay more for oil that is now only nominally being priced in dollars but appears to be following hard currencies as they revalue against the floundering greenback.

This means that more and more of China's cheap dollar profits are being sucked out by the petroleum producing countries and the big distributors whose profits also climb with dearer petroleum. This is putting a heavy strain on the Europeans who don't want to be priced out of certain global markets, like automobiles, aircraft, wines, etc. by the strong valuation of their currencies. And then there's the giant question; will the Chinese and Saudi governments continue to prop up the dollar cum golden goose?

Oil and the American Century

As early as the 1960's a leading oil industry geologist, M. King Hubbert, began talking about peak oil (check out our Blowback article, Twin Peaks). The term has come to loosely signify the moment when there is less petroleum in the ground than has already been extracted. In the US, the world's leading consumer of petroleum, peak oil occurred, as Hubbert correctly predicted, some time in the mid 1970's. Since then the US has progressively expanded the percentage of oil it imports versus the amount developed domestically.

Despite the decline in local production, the US, followed by Great Britain remains by far the dominant player in the world oil industry. US companies provide the bulk of the service industry that discovers, develops and builds drilling capacity, the pipeline and shipping backbone of the distribution system and the downstream refining and marketing capacity that defines the world energy system.

Oil has been at the base of a great amount of the wealth held by leading American families, including of course the Bushs, and it is no coincidence that the growth arc of American military and political might closely parallels that of our dominance of the energy industry. 

As long as the world economy continues to grow, the demand for energy will grow apace. The great question of our time is what form future energy supplies will take and who will control that supply. Compared to its two present main rivals, coal and nuclear, petroleum appear to have clear advantages: simplistically, coal is dirtier and nuclear much more potentially toxic.

But oil's great advantage over electricity from the above sources is that it can be autonomously carried from place to place quite safely. In other words, if cars, airplanes, etc. could store enough electricity in a breakthrough battery, say,  to cover their expected ranges, electricity would suddenly emerge as a serious rival, though climate questions would remain regarding how the electricity was produced.

Oil's other great advantages: its incumbency first and foremost and its relatively competitive price, would be sorely challenged should someone announce tomorrow a new battery technology that promises durability and range and to reduce the size and weight of the electric storage to that of say, a full tank of gas. Today's hybrids would quickly turn into tomorrow's plug-ins.

There are a number of ways for electric energy to be produced efficiently without further endangering the environment; first among these is probably the conversion of ocean  and tidal movement into electricity as well as the potential of wind and solar to be developed in highly distributed settings.

Oil presents the same quandary that mainframe computers did for security 50 years ago when the government started looking around for something less central and therefore less vulnerable to a single strike.  That government funded effort, as we all know, led to the development of the highly distributed network that came to be called the Internet.

The giants of the petroleum industry (EXXON, Shell, BP) know all about peak oil, they also have understood the implications of expensive petroleum. They also know what happened to IBM once smaller servers were introduced. They know that as long as they continue to bring relatively cheap oil onto the market and box out the speedy development of alternative technologies, current market trends might be stretched out another 20 or 30 years until the new technologies --that they intend to fully control-- inevitably force a turning point. No doubt they are already planning for that shift in their business strategies. But there is also no doubt in the minds of