When China announced a new array of stimulus measures earlier this month, this very important plan was overshadowed by China Premier Wen Jiabao’s concerns about the United States’ quickly growing debt load.

“We have lent a huge amount of money to the United States,” Premier Wen said. “Of course we are concerned about the safety of our assets. To be honest, I am definitely a little bit worried. I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”

China has cause to be concerned: As of December, the most recent figures available, China held $727.4 billion in Treasuries – about 26% more than the $578 billion in U.S. government securities the Asian giant held at the end of 2007. More than half of China’s nearly $2 trillion in foreign currency reserves are tied up in U.S. Treasuries and notes issued by other affiliated agencies of the U.S. government – including beleaguered mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE).

However, the value of U.S. Treasuries has dropped steadily since the government began selling record amounts of debt to finance its economic stimulus packages. Investors have lost an average of 2.7% in 2009, according to Merrill Lynch & Co. Inc.’s U.S. Treasury Master Index.

China’s leaders “are worried about forever-rising deficits, which may devalue Treasuries by pushing interest rates higher,” JP Morgan & Co. (JPM) analyst Frank Gong told The Associated Press. “Inside China there has been a lot of debate about whether they should continue to buy Treasuries.”

And as the U.S. debt soars as the government works to halt the worst financial crisis since the Great Depression, China’s concerns about this country’s growing deficits – and its creditworthiness – are escalating in kind.

Depending upon how it did so, were China to stop buying U.S. debt – or even worse, to start dumping it – the economic fallout could be widespread, and perhaps even catastrophic:

• The U.S. dollar would drop 15%-20%.
• U.S. stocks would get hammered.
• Inflation would spike and interest rates on Treasuries would jump into the 8% range.
• And the economy would end up flat on its back – where it would stay, with no rebound on the horizon.

Detailing the Deficit

During the first five months of the 2009 fiscal year, which began Oct.1, the U.S. budget deficit hit a record $764.5 billion. Last month, President Obama outlined a $3.94 trillion budget plan that would take the deficit to $1.75 trillion by the time the fiscal year ends Sept. 30. The plan then calls for a $1.17 trillion deficit for fiscal 2010.

As currently projected, the U.S. budget deficit is forecast to run at about 12% of gross domestic product (GDP) – even worse than the perennially anemic Japan, where the deficit is running at 11%. And the debt picture is certain to get worse.

The Treasury Department has the government’s printing presses running overtime just to finance the $787 billion stimulus passed by Congress earlier this year. And in order to pay for all the stimulus, bailout and fix-it plans that are being put in place to arrest the U.S. economic decline, the U.S. government is assuming a murderous amount of debt: Over the next decade, the Congressional Budget Office projects that the White House budget will run $9.3 trillion in deficits.

That’s $2.3 trillion more than the Obama administration had forecast. But even the CBO projection could prove way too low: It assumes that the U.S. economy – after declining 1.5% this year – will turn around an advance at a racy 4.1% clip in both 2010 and 2011, a forecast that seems far too rosy, given the depths that the U.S. economy appears to have reached.

And that brings us to China.

Enter the (Red) Dragon

During the past several years, government-operated “sovereign-wealth funds” (SWFs) from virtually every major economic powerhouse around the world had been on a global shopping spree, buying up assets and bidding up prices as they did so.

China was no exception.

So when worldwide financial-asset prices began to slide – and then to nosedive – China abandoned many of its riskier holdings, choosing to boost its stockpile of U.S. Treasury securities. That underscores one marketplace truism: Despite Premier Wen’s reservations, the market for U.S. debt is the only market large enough, liquid enough, and stable enough to accommodate China’s large-scale investments.

That’s forced China to engage in a kind of global investor activism – although, so far, most of that activism has been aimed at one country: The United States.

About one-fifth of China’s currency reserves were tied up in Fannie and Freddie debt last fall when the two mortgage firms were placed under government conservatorship, The Washington Post reported.

In fact, as Money Morning detailed back in September as part of its ongoing investigation of the bailout of the U.S. banking system, that U.S. government decision to take control of Fannie and Freddie was driven not by worries about the fading U.S. housing market, but by concerns that foreign central banks in China, Japan, Europe, the Middle East and Russia might stop buying our bonds.

China clearly made its risk concerns known at that time, adding to the sense of urgency U.S. officials felt to make a move. Today, as U.S. debt continues to mount at an obscene rate, financial and economic risks also escalate. This could lead to a spike in inflation and interest rates – a double-whammy that could cause any recovery that’s under way to sputter and stall. That duo of higher inflation and interest rates could also hammer bond values, including the Treasuries held in such large quantities by China. So it’s no wonder the risk concerns China articulated back at the time of the Fannie and Freddie takeovers go double or triple now.

Indeed, when Premier Wen unveiled the spending measures earlier this month, he made the point of saying that China should seek to “fend off risks” by further diversifying its reserves.

“We have already adopted a guiding management policy of diversifying our foreign exchange reserves, and at present our foreign exchange reserves are safe overall,” Wen said. “Our first principle in managing foreign currency is averting risk. We have always adhered to the principles of foreign currency security, liquidity and maintaining value, and implemented a strategy of diversification.”

When it comes to U.S. government debt, that strategy will take one of three forms, and will have the following potential effects:

1. Quietly threatening to stop purchasing (or even threatening to “dump”) U.S. Treasuries, a form of “back-channel” communications that can generate results (just look at how China forced the U.S. government to place Fannie and Freddie in conservatorship). Because this is back channel, it stays out of the marketplace, so long as the U.S. government finds some ways to appease Chinese investors by somehow reducing risk.

2. Quietly slowing or stopping its purchases of U.S. government debt. If China does this effectively and systematically, the fact that it’s cutting back on purchases doesn’t surface until the plan is executed. If China is able to pull this off – and it faces long odds to do so – the fact that it’s cutting back on U.S. debt doesn’t roil the markets too badly, especially if it doesn’t leak out until after the fact.

3. Publicly dumping U.S. debt. Self-explanatory in nature – and also the most unlikely, if it wants to maintain its “friendly” status with the United States – this is the worst-case scenario, and is the one that ends up with the dollar and the stock market getting stomped. If China chooses this route, it’s also essentially cutting off its nose to spite its face. The reason: By publicly dumping U.S. debt, the Treasury market will also take a beating – meaning China’s remaining U.S. debt holdings would take a haircut of 20% to 30%.

The Marketplace Realities

International demand for long-term U.S. financial assets actually fell in January, reflecting China’s smallest net purchase since May, Bloomberg reported.

International investors sold a net $8.4 billion in U.S. corporate debt in January, the report showed. Net foreign purchases of Treasury notes and bonds were a net $10.7 billion in for the month, after purchases of $15 billion a month earlier.

Few analysts believe China will abandon its Treasury holdings altogether, as that would hammer the dollar, hurt the value of its debt holdings and ruin its political relationship with the United States.

Besides, it’s becoming increasingly clear that Beijing wants a voice in Washington.

Yu Yongding, a former advisor to the Bank of China said last month that China should seek guarantees from the U.S. government that its holdings won’t be diminished by “reckless policies.”

Premier Wen echoed that request last week when he called on the United States to “honor its promises and guarantee the safety of China’s assets.”

“I think what they’re trying to say right now is, ‘Don’t take any steps that would impair our ability to access your market,’” Auggie Tantillo, executive director of the American Manufacturing Trade Action Coalition, told The Post. “The Chinese are starting to flex their muscles, they are becoming more powerful commercially and economically, and they want us to know it.”

The very possibility that China and other foreign countries would stop buying U.S. bonds already was enough to prompt the U.S. government to take control of foundering mortgage giants Fannie Mae and Freddie Mac.

Source: The Three Ways China May Deal With Growing U.S. Debt

The Federal Home Loan Bank system, a government sponsored enterprise like Fannie Mae (FNM) and Freddie Mac (FRE), has been called a shadow Fed, and is another part of the”shadow financial system” that’s been a central player in the ongoing financial mess we’re continuing to battle.

With several of the 12 Federal Home Loan Banks now losing money, their impaired ability to lend to their member banks or pay dividends may increase financial-system stress and insolvency. That has the Fed and the FDIC very worried.

And with good reason.

The FHLB system allows member banks to borrow cheaply, to use proceeds for purposes other than originally intended, to mask regulatory capital inadequacy, and ultimately to leverage U.S. taxpayers by adding to the burdens of central bank and the FDIC.

Questions regarding government backing, moral hazard, conflicts of interest and whether the Home Loan Banks inadvertently abetted the banking crisis need to be addressed immediately.

The Blueprint of the Home Loan Banking System

The Federal Home Loan Bank system, established by Congress in 1932, is a wholesale cooperative of 12 regional banks with locations in Atlanta, Boston, Chicago, Cincinnati, Dallas, Des Moines, Indianapolis, New York, Pittsburgh, San Francisco, Seattle and Topeka. It was designed to address several specific problems.

In 1932, for instance, there was no secondary market for residential mortgages, thrifts originating mortgages had to hold them until maturity. If a thrift was “loaned up,” meaning there was no more depositor funding available for mortgage lending, potential borrowers were turned away. The Home Loan Banks were chartered to make loans, known as “advances,” to member banks, after taking in their existing mortgages as collateral.

Originally, only thrifts, savings-and-loan associations, savings banks and insurance companies were allowed to be members of the Home Loan Bank system. The Financial Institutions Recovery Act of 1989 opened the FHLB system to commercial banks, credit unions and other depository institutions with involvement in the mortgage business. In 1999, the Gramm-Leach-Bliley Act increased membership reach by loosening participation criteria and lifting the cap on the amount of other real estate assets – such as commercial real estate loans – that members could post as collateral.

As of September 2008, according to the latest figures available on the FHLB’s Web site, the system has 8,154 member institutions, $1.429 trillion in assets, and has extended $1.012 trillion in advances – which has resulted in $88 billion in mortgage loans. The fact that the FHLB hasn’t updated its assets and advances to reflect activity through the end of the year may be more a failure to be timely than it is a hint that there are problems afoot. Still, given that we’re in the midst of the worst financial crisis in modern history, updated data on membership, assets, advances and mortgage creation, should have been a priority.

The Hidden Costs of Cheap Money

The problem begins with the FHLB’s easy ability to raise the money it lends to members.

The FHLB funds itself by issuing debt instruments across the world’s capital markets. But because the FHLB is a government-sponsored enterprise (GSE), the debt it raises is not only a joint obligation of the regional Home Loan Banks, it is also considered an obligation of the United States government. The de facto government backing means an investment grade AAA rating from all the major rating agencies. And that means that the FHLB can borrow at a very narrow spread over Treasuries – in other words, cheaply.

Perhaps if FHLB members just used borrowed capital to facilitate mortgage lending in their respective regions, the fallout would’ve been localized. But in a 2007 U.S. Federal Reserve report, “Federal Home Loan Advances and Commercial Bank Portfolio Composition,” authors W. Scott Frame, Diana Hancock and S. Wayne Passmore determined that the banks were, relatively speaking, no longer fulfilling their primary purpose. The authors concluded that:

• Capital advanced by the Home Loan banks is “just as likely to fund other types of bank credit as to fund single-family mortgages.”
• Unexpected changes “in all types of bank lending are accommodated using FHLB advances.”
• Some banks “appear to have used FHLB advances to reduce variability in commercial and industrial lending in response to macroeconomic shocks.”

There are two problems with members borrowing cheaply and easily from the system:

The first issue is one of moral hazard. Not having to rely on core deposit growth or pay higher fees to attract deposit capital through CDs, member banks, able to borrow freely, are less constrained in their efforts to grow. The lack of any “risk premium” imposed by the FHLB on members doesn’t differentiate good borrowing members from suspect borrowers and actually may incentivize some banks to take greater portfolio risks.

The second problem is that many banks may actually be using these loans to mask capital inadequacy. There have already been some egregious examples of FHLB advances propping up sick institutions.

From the end of 2004 to the end of last year, IndyMac Bancorp Inc. (OTC: IDMCQ) increased its borrowings from the San Francisco Home Loan Bank to more than $10 billion, an increase of 500%. At the time IndyMac failed, that money accounted for a third of IndyMac’s liabilities. In November, when asked why the Home Loan Bank helped keep IndyMac afloat, FHLB spokesperson Amy Stewart told MSNBC.com that “it’s not our role to cause a liquidity problem for a member institution.”

Not one to be denied a place at the FHLB trough, Countrywide Financial Corp., as it was reeling from mortgage losses in 2007, borrowed $51 billion from the Atlanta Home Loan Bank branch, which U.S. Sen. Charles E. Schumer, D-N.Y. accused CEO Angelo Mozilo of using like a “personal ATM.” But the winner, so far, has been Washington Mutual Inc., which the FDIC says tripled its FHLB advances to $58.4 billion – or almost 20% of its assets – before it collapsed.

Problems Looming?

At a time when global financial leaders are working hard to end the banking crisis and restore confidence in the still-functioning institutions, insolvent banks that are actually being propped up by FHLB advances pose a devastating possible threat to these objectives. Potentially insolvent banks pose an overwhelming threat to the FDIC, and virtually none to other member banks that may inadvertently be abetting insolvency.

The FHLB has never suffered a loss on any advance. Because advances are “collateralized claims,” they have a senior position under U.S. bankruptcy law. FHLB claims are repaid before other claims, including those of the FDIC.

In its November cover story, “Banks on the Edge,” Bloomberg Markets magazine quotes Tim Yeager, a former Fed economist who is now a finance professor at the University of Arkansas at Fayetteville, as saying: “The Federal Home Loan Banks cannot effectively control or monitor the risks that are in these institutions.”

That’s not a problem for the FHLB, according to John von Seggern, president of the Council of Federal Home Loan Banks, a lobbying group for the FHLB.

“We’re not the regulator, our role is to be the liquidity provider,” he told the magazine.

But liquidity loans are a big problem for the FDIC. According to that same Bloomberg article, FDIC Chairman Sheila C. Blair said “we really get a double whammy. We have a beef with excessive reliance on Federal Home Loan Bank advances.”

It stands to reason that if FHLB advances spell trouble for the FDIC, they spell even more trouble for the Fed and the U.S. Treasury Department, which will inherit the problem and be forced to bail out the FDIC when its dwindling deposit-insurance fund is exhausted.

In fact, the government is not only worried about funding the FDIC, it is so worried about the potential solvency of Federal Home Loan Banks that on Sept. 7 – the day after then-U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. announced the bailout of Fannie Mae and Freddie Mac – he quietly extended a secured line of credit to the FHLBs – “if needed.”

The time of “need” may be nearing. At the end of February, the Federal Home Loan banks of San Francisco, Pittsburgh, Boston and Chicago reported write-downs on heavy losses on mortgage securities, and some banks had net losses. The Pittsburgh bank reported a loss of $187.9 million for the fourth quarter; the Boston bank reported a loss of $73.2 million; and the San Francisco bank reported a loss of $103 million for the quarter – a major swing from the net profit of $231 reported in the comparable quarter the year before.

Just last Wednesday, according to The Seattle Times, the Federal Home Loan Bank of Seattle announced it took a fourth-quarter net loss of $241.2 million, and said it took a $304.2 million charge for impaired securities on its balance sheet. In addition to its statement that full-year results will be posted by March 31, the bank said it failed to meet a regulatory capital requirement at the end of last month and that because of its capital deficiency it is disallowed from paying a dividend or repurchasing its capital stock from members. Members rely on dividends and their ability to sell back capital stock to their district banks to additionally bolster their own balance- sheet capital. The F ederal H ome L oan banks of Atlanta, Pittsburgh and Indianapolis have already suspended or delayed dividends, the newspaper reported.

No one really knows what might happen if all of the system’s financial dirty laundry is aired, given how many banks are being propped up by FHLB advances. For the member banks reliant on that capital, the graver concern is what might happen if FHLB funding dries up. If that’s the next shoe to drop in this ongoing financial crisis, the worry is that an entire leg – the banking system – comes with it.

New and stronger regulations – and absolute transparency – are necessary to wean banks off these “easy-money loans” from the Federal Home Loan Banks and “hot money” from brokered deposits, the FHLB’s other evil twin.

Like a flash-fire in an untouched part of the woods, just as fire crews have finally gotten a series of deadly wild fires under control after months of battling, a crisis and scandal in a heretofore untouched portion of the U.S. financial sector could have a demoralizing and devastatingly damaging impact on the long battle to subdue the financial crisis – just as it seems some gains have been made.

With the opportunity to act before this fire really gets started, let’s not waste weeks or months in debate. The time to act is now. We need to “Just Do It.”

Source: “Shadow Fed” Casts a Shadow Over the Solvency of the U.S. Banking System

Here’s a curious development that may be worth watching: Bloomberg is suing the Federal Reserve.

Last week, we took a look at the Fed’s bulging $2 trillion balance sheet. And if you’re a long-suffering 5 Min. reader, you know our futile recounting of the weekly Fed lending programs… all the abbreviations and acronyms: TAF, TSLF, PDCF, CPFF, TARP, etc.

Well, the folks at Bloomberg dared to do the right thing last week: demand the Fed tell us where this money is going. With few exceptions (namely, the TARP, Fannie, Freddie and AIG), the Fed lends in secrecy. They’ll say how much they dole out each week, but never name names. Nor will the Fed reveal the specific loan collateral they’re now accepting, or their valuations of these toxic assets that no one else will buy.

Bloomberg is tapping the Freedom of Information Act to try to force disclosure. Good luck.

In the meantime, the Fed has given American Express carte blanche access to the array of Fed lending programs. Like Goldman Sachs and Morgan Stanley, the Fed will allow AmEx to call itself a “bank holding company” so it can gain access to both the Treasury’s TARP bailout and the Fed’s lending facilities.

The Fed fast-tracked AmEx’s application after it reported a 24% decline in third-quarter profit and said it will fire 10% of its employees. Hmmmn…

Let’s see, what else is the government doing with your money? Oh, here’s one…  Fannie Mae revealed a $29 billion quarterly loss yesterday.

Under the guidance of the government, Fannie lost $9 billion in housing-related losses, and then another $21 billion after the group altered its accounting practices. That must have been some alteration.

Fannie’s new executive team also warned that they will likely tap into the government’s $100 billion backstop next year. But if the company continues on its current trajectory, says CEO Herb Allison, “or to the extent that we experience a liquidity crisis that prevents us from accessing the unsecured debt markets, this commitment may not be sufficient to keep us in solvent condition…”

In other words, as with the restructured loan AIG and the Fed announced yesterday, Allison’s warning $100 billion probably won’t be enough to save Fannie’s bacon.

Are we detecting a pattern here?

“The credit crisis is even affecting the world’s ability to produce food,” warns Chris Mayer.

“It’s harder for farmers to get credit for next season’s crop, especially farmers overseas. They need fertilizer, seed, fuel and more. The net effect might be lower planting of key grains even as world inventories of these grains hover near historic lows. Bloomberg reports that global inventories of corn, wheat and soybeans are the second lowest they’ve ever been since 1974.

“All the while, the credit crisis threatens next year’s crop in many critical grain-growing regions. In Russia, for example, cash-starved banks have cut off funding for the industry. The head of the Russian Grain Union says, ‘Many farmers probably won’t be able to borrow money for the spring sowing.’ This is important because Russia is no lightweight in the grain division. It produces 9% of the world’s wheat, for instance.

“Even if demand growth for grains slows, it’s not likely that those low global grain inventories will improve. PotashCorp CEO William Doyle presented the nearby chart (‘Tight Grain Markets’), which might seem a little busy, but I think it shows you how much of a hole the grain markets are in. For instance, the five-year average growth rate in grain demand is 2.6% per year. Even if grain demand fell to 2% per year, we’d still need record production to keep grain inventories from falling further.

“I think the future is still bright for agriculture and all that it entails. I think the fertilizer companies look cheap again.” For a few worth looking into, see: The Endless “Paycheck Portfolio”

The credit markets are still showing some signs of improvement. The London Interbank Offered Rate (Libor) dropped again this morning. The three-month rate for banks to lend U.S. dollars to each other fell to 2.18%, from 2.24% Monday — less than half the 4.82% during the worst of the crisis a month ago.

But that’s far from an all-clear signal. The Fed’s target rate is 1%.  And the overnight Libor increased slightly again last night, to 0.35%, above Monday’s record low of 0.32%. Also, the Libor-OIS spread is still at 1.69%… a mite higher than the 0.1% back in September.

Starbucks announced today a venti-sized problem. Its profits had plummeted 97% from the third quarter of 2007.

For all its corner locations across this hot, flat and crowded globe, the company managed to book just $5.4 million in profits in the third quarter, awarding investors with a penny per share. The company said much of the increased expenses over the past three months came from closing 600 stores…

No, we prefer our coffee with a little anarchy on the side. Lately, we’ve been required to bring our own mugs to Red Emma’s. Otherwise, they won’t serve us.

The global package humper DHL bowed out of the U.S. market yesterday. The German-owned company said it will kick nearly 10,000 employees to the curb here in North America and exit the domestic-only shipping services.

Good thing we still have the American-owned, Memphis-HQ’d FedEx, huh? Yeah, that’s right… TEAM AMERICA! I think you know what that means.

Oops… the U.S. Postal Service is downsizing too. The government agency says it’s looking into 40,000 employee layoffs — or about 6% of its work force. “Just what we need, isn’t it?” we paraphrase Jay Leno, “40,000 disgruntled Postal employees?”

The commodities market showered love all over China’s $586 billion stimulus package we mentioned yesterday.

But then traders had second thoughts. “Hmmmn…” they seemed to say, “if the Chinese stimulus packages is as ‘successful’ as the U.S. variety, well, there’s not too much to get excited about.”

Just as quickly as they came back in vogue yesterday, commodities are out of style today.

Oil, for example, is back down to $59 a barrel — a new 18-month low. China gave oil a $6 boost early yesterday, but all gains were erased by the N.Y. Merc Exchange opening today.

Oil’s autumnal decline has landed like a salty finger in a frothy beer in the UAE: The Dubai stock market has fallen flat. Stocks are down 16% over the past two days… 7% today alone.

You’d think that the La-La Land of the “world’s biggest” everything, 24/7 air conditioning, Mercedes in every garage and super-sized (super-leveraged) building projects would be hit hardest during this global retraction… but up until this week, Dubai’s been showing remarkable resistance.

Booms this big always end in tears. Caveat emptor.

“The signal of oil supply constraints could become much louder after tomorrow,” forecasts Dan Amoss. “On Nov. 12, the International Energy Agency (IEA) will publish a very important report. Few media outlets have mentioned it yet, but it could have a huge effect on the 2009 stock market.

“This report, the World Energy Outlook 2008, will contain a thorough field-by-field analysis of production trends at the world’s 800 largest oil fields. Hopefully, the IEA will finally lay to rest the widespread misconception that oil producers can ramp up supply at the flip of a switch.”

The Financial Times recently secured an early draft of the IEA report. If you didn’t catch that sneak peak, here’s the gist: The WEO report will likely say that output from the world’s oil fields, even the most established and reliable, is declining faster than expected. This problem will require, according to the FT’s preview of the report, ‘a significant increase in future investments just to maintain the current level of production.’

“When the final draft of this report is published,” adds Dan, “its key conclusions will probably flood the media airwaves. An annual decline rate between 6-9% will spur trillions of dollars of new investment over the next decade.

“Depletion of the existing oil supply base — as an investment theme — may finally get the attention it deserves.”

Gold is getting slammed now, too. The spot price shot up almost $20, to $765, yesterday, but gave back all of its gains by the end of the session, and is even lower today. An ounce is going for $725 this morning… and falling.

The dollar index reversed trends yesterday and is quickly approaching a one-month high, trading at 86.6.

Thus, its competitors are getting a swift kick in the business end of their trousers. The euro is down 2 full cents, to $1.25. Ditto with the pound, down to $1.54.

And oh, the poor loonie… the Canadian dollar’s been suffering some huge swings lately as oil gyrates. It’s on the wrong side of that trade today, down more than 5 cents from yesterday’s high, to 83 cents.

The yen is hangin’ tough around 97.

The excitement over China’s stimulus package quickly fizzled yesterday in the world’s stock markets, too. Traders were high on the plans coming out of the Far East in early trading and pushed the Dow up over 150 points. But the buzz wore off as news from the likes of GM, AIG and Circuit City hit the wire. The Dow ended down nearly a percent. The S&P 500 and Nasdaq fared even worse, falling 1.2% and 1.8%, respectively.

Today, AmEx, Starbucks, Toll Bros. and Las Vegas Sands have added to the pall. The Dow continued down at the opening… a 250-point loss out of the gate. It’s still there as we write.

“It was very interesting to read your remarks,” notes a reader. “‘Why don’t [U.S. car manufacturers] just make cars people want?’

“Gee… why didn’t someone think of that before?  The American car industry did just that, built large SUVs and trucks that people wanted. That was the only way the companies could produce a profit, considering the cost of labor and benefits that were once heralded by our very own government as the wave of the future for all domestic companies.  Laws were passed protecting the unions, which still ensure pay and benefits for two full years even if a plant is shut down.  There is no way our domestic manufacturers can compete with cheaper imports, facing that kind of uneven playing field.

“Go into manufacturing facilities and look at the percentage of import vehicles, purchased at much lower prices, and then ask the poor individuals facing layoffs from overseas manufacturers why their jobs are at gone. They will look at you with blank stares on their faces.  Go to Japan. They will not drive an American vehicle, not because of price or quality, but because of loyalty to their own brands. Get real!!

“Yes, we probably will see the Big Three become the nonexistent three, along with all the banks and investment bankers. But it will not be because of poor quality; it will be because of unfair trade practices and inconsistent, displaced American loyalties.”

The 5: And poor quality… the hangover from planned obsolescence. We’re still driving a 1994 Honda Civic with over 200,000 miles on it. It needs very little maintenance, and when I turn the key, it starts. What can be more American than exercising a right to choose which product to buy?

The fact that high gas prices drove sales from 18 million cars down to 12 million cars in less than two years helps prove our point. The auto industry is too big, bloated and regulated to shift gears with market demand. Management has little recourse but to lobby for a bridge loan from another bloated, ill-fitting, wealth-leeching behemoth while they get their act together.

“Here in Michigan,” writes another, “we were making cars and trucks people wanted until high oil prices and the mortgage fiasco froze credit markets and reduced the American economy to a crawl. What’s the cause of high oil prices? Lack of a coherent energy policy that Washington has had more than 30 years to fix. How much time does it need?

“What’s the cause of the credit freeze? Primarily toxic mortgages loaned by bankers (with a gun held to their head by Bill Clinton in the late 1990s) to people who couldn’t pay them back. Include the banking industry and government-approved lending practices that rivaled the Chicago commodity market in terms of leveraging on-hand deposits and it was just a matter of time before the house of cards fell.

“Now add to this witch’s brew federal government regulation of the auto industry and a lack of right to work laws, which has enabled the UAW to hold OEMs hostage for health and retirement programs that foreign OEMs don’t have to pay. Since when does government know how to build anything except a pyramid of debt? Is it any wonder that the foreign car companies locate in the Southern U.S. and avoid unionized northern states like the plague?

“I’ve worked in this industry for more than 30 years. The people I know work their butts off but are hamstrung by the government and the unions. If the auto industry in America dies, the government will have killed it, and 10% of the nation’s economy will die with it.  For those who want the auto industry to die, be careful what you wish for. A nation without a manufacturing base is a third-world nation with no future.”

The 5: Amen to that. We covered your sentiments exactly in Empire of Debt.

Source: Sue the Fed, Dubai in Trouble, Coming Food Crisis and More!

Fannie and Freddie, the nation’s two-largest mortgage holders, will target loans in which borrowers are 90 days or more delinquent, and have high loan-to-income ratios, Bloomberg News reported. The companies may offer homeowners reduced interest rates and longer terms of as much as 40 years to trim monthly payments. By rewriting the terms on some overdue loans, homeowners won’t have to pay more than 38% of their monthly income on housing payments, officials from the U.S. Treasury Department and the Federal Housing Finance Agency said at a news conference in the nation’s capital yesterday.

It’s the government’s most aggressive move yet in its battle to reverse the rising tide of mortgage defaults and home foreclosures, MarketWatch.com reported.

“Foreclosures hurt families, their neighbors, whole communities and the overall housing market,” said James B. Lockhart III, director of the Federal Housing Finance Agency. “We need to stop this downward spiral.”

The plan centers upon Fannie and Freddie because they are than operating under a government conservatorship, and because the two entities own or back roughly $5 trillion in loans, CNNMoney.com reported. The federal government took over the two government-sponsored enterprises back in September – not because of worries about the fading U.S. housing market, but because of concerns that foreign central banks in China, Japan, Europe, the Middle East and Russia might stop buying our bonds, a Money Morning investigative report showed. Fannie Mae on Monday reported a third-quarter loss of $29 billion.

The initiative expands efforts by the Hope Now Alliance, a group that U.S Treasury Secretary Henry M. “Hank” Paulson Jr. helped create last year. Hope Now is made up of investors, advocacy groups, and mortgage lenders and servicers such as Citigroup Inc. (C) and Wells Fargo & Co. (WFC). The past success rate for “curing” delinquent loans with modifications similar to what was proposed yesterday was about 50% for both prime and subprime mortgages.

“With such broad adoption, this new protocol will be a standard for the industry to quickly move homeowners into long-term sustainable mortgages,” Neel Kashkari, the U.S. Treasury’s interim assistant secretary, and the architect of much of the housing legislation aimed at easing the U.S. real estate crisis, said in a prepared statement.

MBA Chief Economist Jay Brinkman conceded that “we realize that a number of those can’t be saved because of the borrower’s situation. But if we can save half of them, that’s a good result.”

While a number of major banks – including Citigroup, JPMorgan Chase & Co. (JPM) and Bank of America Corp. (BAC) – have announced loan-modification programs in recent weeks, those financial institutions hold only a fraction of the nation’s mortgages compared with Fannie and Freddie.

Federal agencies have been slow to present their own plans to modify the loans of millions of “at-risk” homeowners – despite calls from congressional representatives and harsh criticism from housing advocacy groups. Those critics want the government to take a more direct role in preventing foreclosures.

Under the new program, mortgages on owner-occupied homes that are at least 90-days past due with a loan-to-value of 90% or more will be eligible for the streamlined modification, MarketWatch reported. Homeowners who are “underwater” – owe more on their home than it is worth – will be eligible. However, homeowners who purposefully default on their mortgage to get a modification will not be eligible. Borrowers who want to know if they qualify should contact the company they make their payment to each month – called the “servicer.”

To encourage them to take part in this program, these servicers will be paid a fee of $800 to modify loans.

Even with this program, the borrower ultimately still will be responsible for paying the full amount of the principal borrowed. The program is only designed to defer payment on part of that principal to make the monthly payment affordable, experts say.

Lockhart said the program would apply to loans guaranteed by Fannie or Freddie, including prime, Alt-A and subprime mortgages. Other kinds of loans may also be covered. Lockhart urged the private-label mortgage industry to adopt the modification plan as well, MarketWatch reported.
The program will start by Dec. 15.

Moody’s Economy.com (MCO) forecasts that even with loan modification programs, 1.6 million Americans will lose their homes this year either in a foreclosure or distressed sale, and another 1.9 million are projected to lose their homes in 2009, CNNMoney.com said.

Source: Government Rolls Out Long-Sought-After Anti-Foreclosure Program

HA! Had you there for a minute! The dollar rallied once again, when the deep, dark, dangerous clouds returned, and the risk takers that had come out of the woodwork on Friday, disappeared, which left the currencies hung out on the line. Gold rallied $10, which is really counter-intuitive to the risk takers disappearing and the dollar rallying… But it did, and I’m not here to argue about that!

As I said yesterday, the data cupboard was bare with no data to report Monday… With today being a holiday, we won’t get our next glimpse of the awful fundamentals data until Wednesday. In the overseas version of a data cupboard, the German Investor Confidence, as measured by the think tank, ZEW, surprised on the good side, with the index rising in October… This index had been on the slippery slope for the past few months. The news is that the index rose because the European Central Bank (ECB) stepped to the plate a couple of weekends ago, and made good contact with the financial meltdown in Europe.

Again… Let me say this loud and clear, folks… There’s a HUGE difference in Central Banks that provide liquidity… One does so from a position of strength like the ECB and China… and the other does so from a position of weakness (the Fed)…

But the good report isn’t doing anything to help the euro this morning, as the overnight stock markets didn’t fare too well, which has led to U.S. index futures being off… And all that means a rotten trading day, thus keeping the risk takers on the sidelines, and the dollar being the king of the hill…

And… All this means the Japanese yen is back on the rally tracks! I see this morning where BNP Paribas says that their Elliott Wave chartists believe yen will trade to 96.85 in the next week… Of course you know me folks… Trends are what move currencies… Charts merely tell you or give you an excuse as to why a currency moved in that trend. In this case… We all know that while the deleveraging is going on during the credit market squeeze, that dollars and yen are the only two currencies to gain (Chinese renminbi goes back and forth)…

Back here in the Good Old U.S.A…. The accountants over at Fannie Mae announced that the $100 Billion pledge to them “may not be enough”… This announcement came after Fannie posted a record $29 Billion loss and confronting more difficulty in issuing and refinancing debt. I guess the folks at Fannie thought, Shoot Rudy, if AIG can go back for second helpings of bailout funds, then we can too! I think we should all get used to this, as I said when all the original plans to bail out these firms were announced… These bailout funds are going to be like cocaine to these needing bailouts, and they are going to need more and more…

And the Wall Street Journal reported this last night that… “The Federal Reserve said Monday it will allow American Express to become a bank-holding company, saying “unusual and exigent circumstances affecting financial markets” justified a fast approval of the company’s application. The surprise move would give American Express access to new low-cost financing from the Federal Reserve.”

Before it’s all said and done, we’ll all be one big happy family, no make that dysfunctional family of “bankers”… Shoot, they may as well bring the automakers into the fold too, they need some of the low-cost financing from the Fed too! I could really go off on a tangent here… But, I’ll keep it on a even keel, as it’s not like there’s anything I can do about all this, so why get to upset with all these dolts!

So… The bad fundamentals, no make that awful fundamentals, continue to mount for the U.S. to deal with… But before we can deal with the awful fundamentals, we have to deal with the credit markets squeeze… No ifs, ands or buts… If we can get the lending going again, and I’m not talking about to individuals, I’m talking about between banks, and with Corporations, then the focus will return to the fundamentals… That’s my story and I’m sticking to it!

You know… One thing that I talked about last summer, and was even quoted in the Wall Street Journal talking about, was the fact that with the low interest rates in the U.S. the dollar had replaced the Swiss franc as a funding currency in the carry trade… And since then, the borrowing rates in the U.S. have gone even lower… But Carry Trades are not too popular at the moment, with risk taking on the sidelines… So the affect on the dollar at this point is mute. But, this explanation helps with the “reason the dollar is rallying”… I’ve explained more times than I care to that with Carry Trades unwinding, the “funding currency” which was sold short, gets bought to cover the short position, and so, just like Japanese yen, the dollar rallies…

And while I’m on the weird things going on in the U.S. I thought I would give you a snippet of a letter that Ted Butler (no relation, that I’m aware of) sent out regarding what he feels is manipulation of Silver. Here’s the other “Mr. Butler”…

“This week, I received a copy of a letter, dated October 8, sent from the CFTC to a California Congressman, Gary G. Miller. It discussed allegations of a silver market manipulation because of the data in the monthly Bank Participation Report. The data in that report for August showed that one or two U.S. banks held a massive short position in COMEX silver futures of 33,805 contracts, or more than 169 million ounces. This is equal to 25% of annual world mine production, and was up more than five-fold from the prior month’s report. After this position was established, silver prices fell more than 50%, in spite of a widespread shortage in retail forms of investment silver.”

So, there you go! Ted Butler believes he has the proof of manipulation in Silver, but what’s the Gov’t going to do about it… Ahhh… As one of my all time faves, Edwin Starr, sings… Nothing, absolutely nothing, say it again!

There was an article posted on CNBC’s website yesterday that listed Companies here in the U.S. that are announcing layoffs… This was not a pretty scene folks… But if you want to check it out, click here… http://www.cnbc.com/id/27645929

Yesterday, I told you the “news of the weird” with the announcement by the Fed that the guy who was responsible for risk management at Bear Stearns, the now defunct Bear Stearns I might add, was hired to head the group that overseas the purchase of the toxic waste bonds by the Fed… This to me is akin to putting the fox in control of the hen house! Any way… A long time reader sent me a note regarding this announcement… “I read somewhere about this appointment in several places last week on the web. One “source” actually suggested perhaps he was hired just to keep his mouth shut as who would better know how really toxic the traded paper is and what really lies out there?”

OK… You know me, I’m not one to put speculation in the Pfennig, especially when it appears on a website… But, this really struck a chord with me (probably cmaj7 my fave chord!)… And it appeals to my conspiracy theory blood… Let’s just hope it’s not even close to the truth!

I hear that the major oil companies that are attempting to get Oil out of the oil-sands in Canada, have decided to halt the spending there. For those of you not familiar with these oil-sands in Canada… These are the world’s biggest energy reserves outside Saudi Arabia. Getting the oil out of the ground here is a real problem and costly, and with the price of Oil dropping since July, the oil companies drilling here, have decided to cut back on the costs… I don’t understand this decision, as this IS the time to drill!

Currencies today 11/11/08: A$ .6685, kiwi .5830, C$ .8385, euro 1.2740, sterling 1.5575, Swiss .85, ISK 182, rand 10.1825, krone 6.90, SEK 7.875, forint 210.50, zloty 2.2050, koruna 19.89, yen 97.75, baht 34.94, sing 1.4980, HKD 7.75, INR 48.10, China 6.8250, pesos 12.88, BRL 2.2050, dollar index 86.02, Oil $60.30, Silver $9.97, and Gold… $739.15

Well, I would just like to say Thank You to anyone that reads this letter that is or was in the service for this country… And Thank You to those that are no longer with us to read the Pfennig. Sure hope your Tuesday is Terrific…

Source: Veteran’s Day

More from Investor’s Daily Edge:

Equities aren’t the only markets acting strangely these days. The bond markets are acting even stranger.

For both bond and equity markets the cause of this strange behavior is the same: Piecemeal government actions in the U.S., Europe and Asia culminating in massive intervention.

The U.S. government is trying to nurse the economy back to health. And like a doctor who has a pill for anything that ails you, the U.S. government is trying to find a cure for practically every ailment afflicting the economy.

Sometimes when you’re on a lot of medication, you don’t know if it’s the symptoms or side-effects which are causing the most pain.

One thing is sure, the government has flung open the doors of its heavily stocked pharmacy and has emptied its shelves on the poor economy.

And when the meds don’t work, they simply put the targeted patients on life support – as they did with Freddie, Fannie and AIG.

Well … except for that one patient that got away … Lehman Brothers. At the time the government more or less said, “We can’t save them all.”

Now the government is more or less saying, “let’s save them all.”

No wonder the markets are confused. These government prescriptions are having all kinds of confusing side-effects…

Like when the government decided to lend to banks in return for asset-backed commercial paper. Investors were soon favoring the higher-yielding asset-backed debt of these banks over corporate and European bank debt which did not enjoy such government backing.

It’s no coincidence that the European bank crisis began to accelerate about this time.

And when the FDIC guaranteed bank deposits of up to $250,000, money-market funds cut back their investments in short-term commercial paper and held on to more money for themselves. Why? They feared that savers would begin leaving money-market accounts for safer (but lower-yielding) government-backed bank accounts

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The government may have eased the concerns of bank customers, but for a time it helped make credit markets even tighter.

Every time the government gave the economy a remedy that worked in theory, more unforeseen symptoms appeared.

Now we have an economy reeling from both the original causes of the crisis – reckless lending by banks and interest rates that were way too low – and some very clumsy moves by the government.

You can tell from the markets’ crazy swings that it doesn’t know what to make of all this.

And, sure you can argue that it’s created some bargains in the stock market – a lot of companies are going at half price.

But with money still tight and revenues falling off, the key question for these companies isn’t how cheap they are, but how much cash they have. In other words, can they survive without having to sell all the furniture?

The bond market is also obviously affected by concerns over survival. The price of corporate junk bonds has fallen to record lows.

On the other hand, bank bonds are selling like hotcakes. Can you guess why? Yep, it’s the government stepping into the breach once again. To help banks raise much-needed capital, it has guaranteed bank bonds.

You hear of lots of money pouring into the safety of Treasuries. That’s fine. That’s bond investors reacting to risk. That’s NORMAL.

But lots of money is also fleeing Freddie and Fannie bonds into government-guaranteed bank bonds. For decades Freddie and Fannie bonds were the safest bond investments next to Treasuries. And, then, on September 7th, the government announced its promise to safeguard Freddie and Fannie’s $3 trillion bond market.

So what’s happening now is very ABNORMAL.

Freddie’s and Fannie’s bonds get about a percentage point more in yield than Treasures. Investors liked getting the extra yield while accepting very little risk.

But why settle for those yields when you can get even better ones from bank bonds. Not only that, you can also get a government guarantee that is just as strong if not stronger than the ones covering Freddie and Fannie.

So investors are selling off Freddies and Fannies and going to greener pastures sprinkled with government manure (all you have to do is hold your nose). That naturally has driven down the price of Freddie and Fannie bonds while raising their yields.

And that’s great news for a group of companies which invest almost exclusively in the bonds of Freddie and Fannie.

They’re very conservative in using leverage but they do use it. Then they simply apply the time-honored formula of borrowing low and investing high. Freddie and Fannie bonds give them more than enough spread to enable these companies to give their investors up to 8-10 times more money than your current savings account is probably earning. Plus, there are no minimums and no extra charges or fees to pay.

A couple of the companies that are investing in the debt of Freddie and Fannie and other GSEs are MFA (NYSE:MFA), and Anworth (NYSE:ANH). The long hand of Uncle Sam is making them and companies like them big winners.

Source: Boring Bonds Offering Great Deals

The Federal Deposit Insurance Corp. said in a statement it will take over operations of IndyMac, which will open for business on Monday as IndyMac Federal Bank. The thrift – the fifth U.S. bank to fail so far this year — had total assets of $32.01 billion as of March 31.

Much of IndyMac’s business was built on Alt-A single family mortgages, which were often made to borrowers with poor credit. As the secondary market for these loans collapsed, IndyMac’s financial condition became precarious.

“Often made to borrowers with poor credit.” Didn’t that worry anyone, even slightly?

“It’s bye, bye boomland,” said Bill Bonner in The Daily Reckoning on Thursday, the day before federal regulators shut down IndyMac. Investors should be aware that even U.S. Treasuries are no longer a safe haven…

Most of yesterday’s [Wednesday's] hard fighting took place in the financial sector.“Fed Sees Turmoil Persisting Deep Into Next Year,” saith the New York Times .

The New York press tells us that Steve & Barry’s, a clothing retailer with 200 stores, has filed for Chapter 11. And Fannie Mae and Freddie Mac got walloped again. The two Mississippi Companies [a reference to the government-chartered company in 18th century France that dominated a huge bubble, went broke and practically bankrupted the nation] desperately need to raise money. But even though the two are backed by the U.S. government and clearly “too big to fail,” investors are being a lot more grudging with their money these days. Fannie had to pay 74 basis points over the Treasury rate to get cash, much more than in the past. Freddie’s stock dropped to $10. Fannie’s hit $15. Both traded as high as $60, if we recall correctly.

IndyMac is in the news too. The big mortgage lender specialized in Alt-A loans – a step up from subprime, but apparently not a very big step. The shares traded at $50 in 2006. Yesterday, they were marked down to 44 cents.

Bloomberg tells us that Wall Street debt is being “downgraded by derivative traders.” They know the stuff better than anyone, of course.

What is surprising – to us, anyway – is that they aren’t downgrading government debt. We believe the credit cycle has turned. After a quarter century of falling yields, it looks to us as though yields have formed a major, triple-bottom. Which is to say, bond prices, (remember, they go up as yields go down) have hit three successive peaks, more or less at the same altitude, in 2003, 2005 and again in 2007.

But if we’re on the downward slope, so far it’s a gentle one. We looked yesterday and found the 10-year T-note yielding all of 3.88%.

We have to pause a minute and draw breath. What are bond buyers thinking? Of safety, surely. They see this latest assault of deflation – with falling stock prices all over the world…with Wall Street collapsing…the Fed nervously holding the key rate at 2%…oil slipping, possibly topping out – and they look for a hole to jump in. What better hole than U.S. Treasuries…dug deep by the full faith and credit of the U.S. government and denominated in the almighty dollar?

Well, ahem…that there is the problem. The hole may be deeper than they think.

Conventional wisdom holds that inflation will not be a lasting threat. The experience of the last quarter century is that short bursts of rising prices are soon replaced by another longish period of stable ones. But this was the period when the Chinese and Wal-Mart were lowering prices on manufactured goods…when labor rates were held down by the influx of millions of people into the modern economy…and before the cycle of commodity prices turned up. This was also the period in which interest rates were falling…and almost infinite amounts of money were available to increase consumer spending and production. That period is over.

Nevertheless, millions of investors expect it to continue. They believe that a cooling world economy will bring the forces of inflation back to their barracks and that they can go on collecting 3.88% coupons without feeling like chumps.

Who knows? Maybe they’re right. Still, we think they are morons. Even if they turn out to be right, the margin of safety on U.S. Treasuries is so razor thin they’re bound to cut a vein.

The real issue for us here at The Daily Reckoning is how the world ends. The world as we know it…Boomland…the world of constantly expanding credit and rising asset prices…is finished, we think. Does it end with a bang or a whimper? Does it end with the bang of inflation? Or the whimper of dying prices?

“Both” is still our best guess.

The New York press tells us that Steve & Barry’s, a clothing retailer with 200 stores, has filed for Chapter 11. And Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) got walloped again.

The two Mississippi Companies [a reference to the government-chartered company in 18th century France that dominated a huge bubble, went broke and practically bankrupted the nation] desperately need to raise money. But even though the two are backed by the U.S. government and clearly “too big to fail,” investors are being a lot more grudging with their money these days. Fannie had to pay 74 basis points over the Treasury rate to get cash, much more than in the past. Freddie’s stock dropped to $10. Fannie’s hit $15. Both traded as high as $60, if we recall correctly.

IndyMac (NYSE:IMB) is in the news too. The big mortgage lender specialized in Alt-A loans – a step up from subprime, but apparently not a very big step. The shares traded at $50 in 2006. Yesterday, they were marked down to 44 cents.

Bloomberg tells us that Wall Street debt is being “downgraded by derivative traders.” They know the stuff better than anyone, of course.

What is surprising – to us, anyway – is that they aren’t downgrading government debt. We believe the credit cycle has turned. After a quarter century of falling yields, it looks to us as though yields have formed a major, triple-bottom. Which is to say, bond prices, (remember, they go up as yields go down) have hit three successive peaks, more or less at the same altitude, in 2003, 2005 and again in 2007.

But if we’re on the downward slope, so far it’s a gentle one. We looked yesterday and found the 10-year T-note yielding all of 3.88%.

We have to pause a minute and draw breath. What are bond buyers thinking? Of safety, surely. They see this latest assault of deflation – with falling stock prices all over the world…with Wall Street collapsing…the Fed nervously holding the key rate at 2%…oil slipping, possibly topping out – and they look for a hole to jump in. What better hole than U.S. Treasuries…dug deep by the full faith and credit of the U.S. government and denominated in the almighty dollar?

Well, ahem…that there is the problem. The hole may be deeper than they think.

Conventional wisdom holds that inflation will not be a lasting threat. The experience of the last quarter century is that short bursts of rising prices are soon replaced by another longish period of stable ones. But this was the period when the Chinese and Wal-Mart (NYSE:WMT) were lowering prices on manufactured goods…when labor rates were held down by the influx of millions of people into the modern economy…and before the cycle of commodity prices turned up. This was also the period in which interest rates were falling…and almost infinite amounts of money were available to increase consumer spending and production. That period is over.

Nevertheless, millions of investors expect it to continue. They believe that a cooling world economy will bring the forces of inflation back to their barracks and that they can go on collecting 3.88% coupons without feeling like chumps.

Who knows? Maybe they’re right. Still, we think they are morons. Even if they turn out to be right, the margin of safety on U.S. Treasuries is so razor thin they’re bound to cut a vein.

The real issue for us here at The Daily Reckoning is how the world ends. The world as we know it…Boomland…the world of constantly expanding credit and rising asset prices…is finished, we think. Does it end with a bang or a whimper? Does it end with the bang of inflation? Or the whimper of dying prices?

“Both” is still our best guess.

Source: The End of the Boomland Economy

We are sitting here this morning, in our office, looking at a fat woman – stark naked – sleeping on a couch.

Of course, how rich people spend their money has always been a source of interest and entertainment. That an apparently sane and sensible man like Roman Abramovich spent $33,641,000 for the painting of the “Benefits Supervisor Sleeping,” must also be a comfort to the poor. At least, they don’t have to look at it.

But the world of money is a world of wonder…today, as everyday. We could begin today’s reckoning wondering why the rich are so eager to part with their money, for example…or why the poor are so eager to have it; they can see that it clearly impairs one’s judgment and degrades ones tastes.

Instead, we will wonder why those who constantly praise the virtues of capitalism seem to have so little faith in it.

What brings this wonder to mind is the latest legislation to clear the Senate Finance Committee. Congress is preparing to improve the way capitalism functions, by authorizing the Federal Housing Administration (itself an improvement of an earlier Congress) to insure $300 billion worth of home mortgages. Up until now, federal housing agencies could work all sorts of mischief; you could argue that without the implicit guarantees of Fannie Mae and Freddie Mac, or the explicit efforts of these quasi-public companies to create a huge market for derivatives based on mortgage finance, the whole housing bubble would never have occurred in the first place. Now – if this legislation becomes law, that is – new mischief is about to appear on the scene. The FHA will be empowered to help patch up America’s housing bubble.

The goal, said Senator Chris Dodd, is to keep people in their homes. He did not mention that these are the same homes whose owners demonstrably cannot afford them. Nor was he especially concerned that his meddling with the corrective machinery of capitalism was likely to throw a monkey wrench into the gears. Instead, like God on the 6th day of creation, he looked upon his handiwork and thought it was pretty good.

Everyone is perfectly happy to let capitalism do its stuff – as long as they like the results. But cometh a correction and all of a sudden the press is full of whining pundits and meddling politicians. Every correction brings forth new improvements until there are so many of them the system collapses under the weight. That why we have revolutions and bankruptcies, after all, to blow away the accumulated impediments.

And that is why the emerging markets have such an advantage. In many ways, people swing their arms and their hammers more freely in, say, Russia or China than they do in the United States of America or Britain – simply because there is nothing to stop them. These countries have already had their moments of violent desperation…their bankruptcies…and their revolutions. Both tossed out their entire economic systems in the late ‘80s and early ‘90s. They’ve been rebuilding – fast – ever since. The leeches haven’t had a chance to get their suckers attached.

America’s war against Iraq had its roots in many improving impulses. According to John McCain and Alan Greenspan, however, the taproot sank into Iraq’s oil fields; America wanted to secure its access to cheap oil, they say. Unfortunately, this program – like all government meddling – backfired. The price of oil was only $25 a barrel when the war began in September of 2003. Yesterday, it hit $130 a barrel. And the war itself is expected to cost the nation $1 trillion or more. For all its efforts, the US secured the most expensive energy in world history. (And then pushed food prices up to their highest levels in modern times too – keep reading…)

China, meanwhile, decided to take the capitalist road. Instead, of using military force to get oil, it simply bought it on the open market. It has sent its agents to secure, peacefully and honestly, long-term contracts for oil and the other natural resources it needs to feed its ravenous economy. Its buying is driving up prices for everything. But what would you expect?

Meanwhile, having completely failed in the Mideast, America’s improvers turned to the Midwest. Yes, dear reader, if we can’t get oil from the sands of the Gulf and Mesopotamia, we will squeeze it out of our own farmland. At least, that was the promise of the program to subsidize the production of ethanol. Capitalism could not be relied upon to fill America’s energy needs, said the kibitzers.

Capitalism had already pronounced its verdict on corn-based fuel: it was a bad idea. Later, environmentalists came to the same conclusion; it actually caused more damage than petroleum. But the US Congress, in its majestic wisdom, saw something in ethanol that capitalists and environmentalists had missed – campaign contributions and votes!

And so it came to be that a large portion of the US corn crop is diverted into fuel tanks. And so it comes to be that a large number of the world’s people – including Americans themselves – find their food much more expensive than it used to be.

And more thoughts…

*** In Haiti, people are eating mud.

We’re not making this up. There’s a photo of a miserable woman making mud cakes in Port-au-Prince, in yesterday’s Daily Telegraph newspaper.

For the benefit of readers who wish to cut their food budgets, the Telegraph gives us the recipe: you simply mix clay with salt and vegetable fat and lay it out in the sun to cook – like mud pies. Then, you call them “biscuits.”

Last time we looked, mud was not one of the main food groups recommended by dieticians. But all over the world, poor people have to make do with what they can find. Rice is the staple food in Haiti, and it’s trebled in price in the last year, says the Telegraph. Other grains are not far behind. Since January of 2007, wheat has gone up 200% and corn 150%.

Desperate poor have already rioted in 34 countries this year. The ghost of Thomas Malthus, if he bothers to read the paper, must be saying “I told you so.” Malthus predicted that population would grow faster than food supplies. Millions of people would starve, he predicted. Now, it looks like he might have been too optimistic. He died in 1834. Since then, a series of happy events and technological developments greatly increased the supply of food…while war and family planning reduced the number of mouths to be fed. Now, it appears that the gains from mechanization, bio-engineering, chemistry and land clearing may have reached their limits. We may soon reach “Peak Food”…the point at which the world can produce no more food. But the human population – especially the part of it that doesn’t eat at the Tour d’Argent in Paris – keeps growing. Experts predict that the world’s population will grow by 3 billion people over the next 40 years – a 50% increase. Where will the world get 50% more food? At what price? Who knows…but one thing is sure: there will be plenty of opportunities for the world-improvers to make things worse.

Flush with British pounds at a 27-year high against the dollar, they poured something like $4.6bn into US real estate, according to data from the Association of International Property Professionals (AIPP).

Now the pound’s slipped back, but so too have Florida house prices. So cue Fannie Mae to target British holiday-makers.

“Homes Available in USA,” says a Google advert – visible only to web surfers inside the UK it would seem – from the US-government backed mortgage agency.

If you’re inside the fifty states, most likely you won’t find it. Which would only be tactful.

“Affordable housing opportunities,” says the ad. “Find a holiday home in America.”

There are plenty of “holiday homes” to choose from in the USA right now, not least on Fannie Mae’s books. Single family homes in Miami, Florida, for example, start at just $45,000. The last time a first-time buyer in Britain could snap up a starter home for that price – around £23,000 – was 1991.

Even then they had to buy far outside the “hot spots” of London and the South-East. At least 150 miles away, in fact. The last reported sighting of a London home costing less than $50,000 equivalent was back in 1985. Today the average apartment in the UK capital costs six times as much.

But hey, that’s inflation for you! And flicking through the huge range of cut-price real estate now on sale at Fannie Mae today, three things about the decade-long inflation in real estate prices now imploding on both sides of the Atlantic continue to amaze us here at BullionVault.

First, the sheer volume of foreclosures sweeping the former hot spots of America. Second, the size of house price “discounts” about to hit the United Kingdom. And third, how-in-the-hell anyone ever thought subprime mortgages sounded like a good idea.

As the chart above shows – courtesy of Janet Yellen of the San Francisco Federal Reserve – late payment rates on subprime US mortgages stayed above 9% even when the cost of borrowing sank to a four-decade low (and stayed there) between 2002 and 2005.

Teaser rates of just 1% interest, in other words, left almost one-in-ten subprime borrowers unable to meet their monthly mortgage bills. So the profits assumed by “resetting” those rates to 7% and above two years down the line were never going to show up.

As in not ever. Any bank day-dreaming otherwise deserves euthanasia, let alone bankruptcy.

What they’re getting instead, however, is a fresh dose of money from the Fed. The US central bank is actively creating a market in mortgage bonds, accepting these illiquid assets as collateral against loans of highly liquid US Treasury bonds.

Will the money thus released to the banks find its way back into US house prices? Whatever happens on your street in 2008, subprime lending as a financial product is dead – if not for good, then at least for now. Issuance of residential mortgage-backed bonds collapsed by 95% during the first three months of this year, according to data from SIFMA, the securities association. The futures market expects a further 25% drop in US house prices, notes Janet Yellen of the Fed, based off the price for Case-Shiller index contracts.

And now the UK property crash has finally turned up as well – a mere three years after everyone thought it would – the chances of British holiday-makers supporting the Florida real estate market look pretty slim too, despite Fannie Mae’s advertising dollars.

Source: Turning Sub-Prime Misery Into Vacation Homes