So with some historic irony, one year and two weeks after Lehman Bros. bit the dust, another debt-burdened, credit-reliant, potentially “too big to fail” institution is looking to either stick its bondholders with a raw deal or enter sudden bankruptcy. We won’t pretend to know exactly how this one will end, but the market has certainly voiced its opinion:

Heh, and of course, Goldman Sachs (NYSE:GS) has a horse in this race. They stand to make about a billion bucks if CIT goes into bankruptcy — the fruits of a smartly designed loan agreement. Hank Paulson, despite his GS pedigree, didn’t make such a deal when he put $2.3 billion in TARP funds on the line… a CIT bankruptcy would mean a near-total loss of taxpayer bailout loans.

CIT is one of the biggest lending sources for small- and medium-size business in America… what happens to this recovery when this well runs dry?

With or without CIT, “The real job creators in the U.S. economy, small businesses, will not expand hiring as expected,” forecasts Dan Amoss. “There are many reasons for subdued hiring plans; an emerging reason to avoid expansion and hiring will be heightened expectations that tax rates will soar in the future to pay for out-of-control government spending.

“So I expect over the next several months, mainstream pundits and forecasters will start worrying about tepid hiring, even as the pace of job losses slows. As we ‘lap’ the 2009 corporate cost cutting by early 2010, and top lines fail to rebound, earnings estimates will have to come back down. I’m amazed at how many sell-side analysts are modeling V-shaped recoveries in 2010 earnings. Most stock prices are disconnected from reality…

“The labor market is dealing with a structural imbalance fueled by government-sponsored housing and credit bubbles. Many will call for the government to ‘solve’ this labor market problem, which will cause a new type of market dislocation. By early 2010, some will push for the federal government to start hiring the chronically unemployed in ‘New Deal’ types of programs.”

Source: The Lehman of 2009

On one hand, the $130 billion he spent on acquisitions – FleetBoston Financial Corp., MBNA Corp., LaSalle Bank Corp., Countrywide Financial Corp., Charles Schwab Corp.’s (Nasdaq: SCHW) U.S. Trust private banking unit and Merrill Lynch – that more than tripled the size of Bank of America, making it the largest U.S. lender both by assets and deposits.

On the other, his open-wallet policy and the example it set forth almost perfectly encapsulates the boom, bust and nascent rebound of the U.S. housing and banking crisis – which later became the financial plague that devastated markets all over the world.

In the second half of 2007, the extent of the U.S. housing crisis began to crystallize when Countrywide’s freewheeling subprime-lending policy irreversibly sank the nation’s largest home lender. Lewis moved in and acquired the troubled lender for $4 billion the following January, and in doing so, he put Bank of America on the hook for Countrywide $1.5 trillion loan portfolio.

In the second half of 2008, the extent of the how much havoc the destruction of investment banks and brokerage firms would wreak upon the world became clear. The vortex of it was Sept. 15, the day the Lehman Brothers Holdings Inc. (OTC: LEHMQ) declared bankruptcy and Bank of America agreed to pay $29 billion for world’s largest brokerage firm, Merrill Lynch, which probably would have failed had it not found a partner.

Lewis’ spending got Bank of America into this mess. The question now is whether continued  spending – using the $45 billion bailout courtesy of the U.S. Treasury’s Troubled Asset Relief Program (TARP) – will get BofA out of it.

And Lewis seems to acknowledge both in the news release announcing his voluntary departure.

“Bank of America is well positioned to meet the continuing challenges of the economy and markets,” Lewis said. “We are in position to begin to repay the federal government’s TARP investments. For these reasons, I decided now is the time to begin to transition to the next generation of leadership at Bank of America.”

Lewis naturally defends his actions just as much as critics chide him for them.

“Their loan portfolio is horrible looking and it’s not going to be easy for them,” Mike Williams, research director at Gradient Analytics in Scottsdale, Arizona, said in a Bloomberg News interview before Lewis announced his departure. “They would have been better off without the Merrill and Countrywide acquisitions over the next few years.”

Money Morning Contributing Editor Martin Hutchinson, a leading banking expert, says that Bank of America has a very difficult journey ahead of it.

“Lewis followed [predecessor CEO Hugh] McColl’s strategy of expanding BofA by acquisition,” he said. “The trouble is that his last 2 deals were both lousy. Countrywide was at the epicenter of all that was bad about housing finance, and that was obvious in January 2008, when he bought it. Just a terrible deal.”

In fact, Hutchinson believes there’s only one viable option for Bank of America.

“BofA will have to be broken up, but may need to be sorted out by a liquidator/ the government,” he said.

Spinning Merrill

The Merrill merger was perhaps the defining moment in Lewis’ tenure, and he Lewis has played the victim and hero of the saga.

Lewis testified that U.S. Federal Reserve Chairman Ben S. Bernanke and former U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. pressured him not only to move ahead with a merger with Merrill Lynch despite reservations, but also to stay quiet about the mounting losses at the crumbling investment bank.

And in a note to employees announcing his departure, he took credit for the fact that Merrill has contributed 24% to the Bank of America’s first-half profit, boosted trading and investment-banking revenue, Bloomberg reported.

“I am gratified that even some of the critics of our acquisition of Merrill Lynch have come to acknowledge how well the deal is working out for our clients,” Lewis wrote. “This journey has been a rocky one and not for the faint of heart, but perseverance is paying off.”

But to the rest of the world, Lewis was most often seen sitting under the hot light of probes by Congress, the U.S. Securities and Exchange Commission (SEC) and New York’s attorney general all trying to determine if Lewis misled investors about Merrill’s losses and bonuses.

And even if shareholders agreed with Lewis’ decisions, they didn’t prefer him to be the company’s face. In April, shareholders voted 50.34% in favor of stripping Lewis of his chairman title.

Changing of the Guard

When Lewis steps down from his post Dec. 31, he joins the ranks of fellow financial firm executives – James Cayne of The Bear Stearns Cos., Charles Prince of Citigroup Inc. (NYSE: C), Stanley O’Neal of Merrill, Kennedy Thompson of Wachovia and Richard Fuld of Lehman Brothers, John Thain of  Merrill Lynch – that resigned, many in disgrace, either during or in the aftermath of the global financial crisis.

Among the survivors, Lloyd Blankfein, CEO of Goldman Sachs Group Inc. (NYSE: GS), and Jamie Dimon, CEO of JPMorgan Chase & Co. (NYSE: JPM).

Bank of America said it will find a replacement by Lewis’ last day, and media outlets have already began making lists of possible successors.

Among the names frequently mentioned:

• Brian Moynihan, head of Bank of America’s consumer and small business banking unit.
• Sallie Krawcheck, former Citigroup Inc. (NYSE: C) CFO and president of Bank of America’s global wealth and investment management unit.
• Tom Montag, former Merrill executive and head of Bank of America’s corporate and investment banking unit.

An outsider might well be the best choice, says Money Morning’s Hutchinson.

Lewis is “leaving a company that no human being could manage, with vast problems, and far too broad a franchise,” Hutchinson said. “North Carolina retail bankers haven’t a clue how to run a top international investment bank like Merrill and vice versa. There’s nobody available to succeed him that can do the job.”

Source: Boom, Bust and Rebuild: Bank of America and the Kenneth Lewis Legacy

Here’s a hint:

The House put the kibosh on the first rendition of The Emergency Economic Stabilization Act of 2008 — Former Treasury Sec’y Hank Paulson’s three-page request for a $700 billion blank check for his buddies on Wall Street.

“Investors” threw a tantrum, crashing the Dow 777 points — its biggest point loss in history. Approximately $1.2 trillion in Wall Street shareholder value was wiped out, also a record. This day a year ago, the real market pain began. The S&P fell about 20% over the next two weeks.

The House eventually passed a package — aimed at cleaning up “toxic assets” on big Wall Street balance sheets, but also rife with pork barrel spending. A year later… the stock market has recovered, Congress has spent plenty o’ money, but has anything been done to stave off future CDO or mortgage-backed calamity? No.

Time and clever accounting have put us deservedly back to square one… right? Or as Addison argues in his latest investment report, is this the “biggest financial swindle in world history, engineered by none other than Wall Street and Washington, DC.”

Source: What Happened to Toxic Assets?

It all started back in 1991, when J. Aron & Co., Goldman’s commodities-trading division, recommended that a large institutional client invest about $100 million in commodities.  The vehicle “du-jour” was Goldman’s own investment vehicle, the Goldman Sachs Commodity Index (now the S&P GSCI Commodity Index).

The GSCI is a 24-commodity dollar-weighted index, comprised of 70% energy (oil and natural gas), 8% industrial metals (aluminum, copper, lead, nickel and zinc), 3% precious metals (gold and silver), 14% agriculture (wheat, corn, soybeans, cotton, sugar, coffee and cocoa) and 4% livestock (cattle and hogs).

Goldman was to take the other side of the bet, meaning that should the index rise, Goldman would have to pay equivalent returns to the investor.  In order to hedge, J. Aron needed to institute similar positions in the futures markets for those commodities.

But the plan had one wrinkle in it.  At the time, the U.S. Commodity Futures Trading Commission (CFTC) – the agency that regulated the commodities sector – placed position limits on certain agricultural commodities, like wheat, corn and soybeans.  Other commodities weren’t subject to these same limits.  Yet it was necessary to hedge all the commodities concerned in order for this investment arrangement to work.

So with a large chunk of new business at stake, J. Aron asked the CFTC to grant it an exemption.  Goldman contended that it was not a speculator, but was instead a true “hedger.”

The upshot: In October 1991, J. Aron was granted the sought-after exemption.

Inspired by J. Aron’s success, other members of the commodities-trading oligopoly followed suit, and soon had similar exemptions in hand.

The Global Commodities Boom

In the 18 years that followed the exemption grants, the commodities sector was all in all a pretty orderly place. Between 1990 and 2002, in fact, commodities prices essentially traded sideways.

Unfortunately, that stability wasn’t to last. Like a greyhound that sets out after the hare after having been penned up for too long a stretch, commodity prices started to surge – and ended up doubling over the next six years, albeit in a relatively orderly fashion.

Finally, last year, a market that had been simmering for far too long finally came to a full-fledge boil – and last summer boiled over. Food prices soared, intensifying inflationary fears here in the United States while prompting the leader of the United Nation’s World Food Programme to warn that a “silent tsunami” of hunger was threatening to span the globe.

It seems, though, that the actual boiling point was reached last summer when oil went into a near-vertical climb, surging 63% in just five months, and hitting an all-time high of $147 a barrel last July. Given that oil is in many ways the most relevant commodity to the general public (think fuel for transportation and heating), the new record price touched off a media feeding and prompted projections that crude oil could be headed for $500 a barrel.

As commodity prices were shooting skyward, however, U.S. stock prices saw their already-steep descent turn into a nearly vertical plunge – thank to a worsening of the deepest financial crisis since the Great Depression.

As a result of that crisis, the world’s largest banks, insurance firms and brokerages have been forced to take nearly $1.5 trillion in writedowns, Bloomberg News reported. Because of that and some other related problems, U.S. Treasury Secretary Timothy F. Geithner is pressing Congress to somehow restrain the $600 trillion worldwide derivatives market.

And that has set the stage for a showdown that pits the regulators against the speculators.

What Gensler Wants …

As the spotlight has increasingly been focused on Goldman in the last couple of years for its trading prowess, it’s been suggested on many occasions that the investment bank must be benefiting from some sort of a “special” relationship with the federal government.

The suggestion is understandable on several levels.

Only a month ago, for instance, when Goldman reported its financial results for the second quarter, the investment bank’s trading results helped it record all-time-record profits of $3.44 billion – a good 50% above what experts had been forecasting for what had been expected to be a “blowout” quarter for Goldman.

The stunning profit results once again reminded observers that Goldman Sachs alumnae seem to have a “knack” for landing in positions of high influence.
Former U.S. Treasury Secretary Henry M. “Hank” Paulson Jr., who held that position under former U.S. President George W. Bush – where he was widely viewed as the mastermind behind many of the bank bailout programs conceived last fall – was once the chairman and CEO of Goldman Sachs.

While he was serving as Treasury secretary, Paulson’s office calendar says he called Goldman Sachs Chairman Lloyd C. Blankfein roughly 24 times the week that the federal government opted to bailout out busted insurance giant American International Group Inc. (NYSE: AIG). Remember, had AIG been allowed to collapse, Goldman would have been left holding the biggest of all bags, because of the oversized bets they’d made on AIG’s financial insurance.  Paulson, it seems, would have none of that.

The “Six Degrees of Goldman Sachs” doesn’t end there, either, as the many connections show. Geithner, the current Treasury secretary, was mentored by Goldman alumnus John Thain [the last chairman and CEO of Merrill Lynch before it merged with Bank of America Corp. (NYSE: BAC)].  Plus, Geithner just chose Mark Patterson, formerly a lobbyist for Goldman, as his top aide.

And don’t forget about Gary Gensler, the newly installed head of the CFTC whose resume includes a 20-year stint at Goldman Sachs. But interestingly – perhaps even ironically – Gensler’s new job pits him directly against Goldman, as the CFTC looks to rein in what some consider to excessive speculation.

During hearings held in July and August, attended by representatives from both Goldman Sachs and JPMorgan Chase & Co. (NYSE: JPM), Gensler commented that the CFTC “must seriously consider setting strict position limits in the energy market.” He also indicated that his staff had been instructed to determine “every authority available to the agency” to guard the interests of the public as well as the markets.

What Goldman Should Get

In its defense, Goldman has argued that setting position limits on trading commodities is likely to prove harmful, as restricting access could affect liquidity.  (Highly liquid markets, or “deep” markets with large volume, are considered to be more fairly priced).

Steven Strongin, a managing director at Goldman, recently told a Senate hearing committee that “attempts to regulate volatility have rarely – if ever – succeeded.  Yet they often have unintended and significant consequences.”

Although commodities trading accounts for a considerable part of Goldman’s revenue – some estimates place it at about 8% to 9% – making it a target for would-be reformers, Strongin’s cautionary words should serve as a warning to back off for one simple reason.

He’s right.

Because of the exemption granted to the trading houses, institutional investors have been better able to provide commodity diversification to their portfolios, thereby minimizing some asset and inflation risks.
United States Oil Fund LP (NYSE: USO) and the United States Natural Gas Fund LP (NYSE: UNG) – two ETFs that are among the largest such products in the world.

Though very popular, such exchange-traded funds (ETFs) as the United States Oil Fund LP (NYSE: USO) and the United States Natural Gas Fund LP (NYSE: UNG) could also be affected.  They currently boast large volumes in the 12 million and 40 million units traded/day, respectively. That means that a limitation on futures positions – let alone an outright prohibition – would work against the best interests of individual investors.

Even producers and refiners of petroleum products could end up being squeezed, as well. These oil-sector players sometimes hedge risks by calling on the large commodities traders who can provide them with custom trades on demand.  The dealer then turns around and wisely hedges its own risk.  Now, doubt is being cast on the ability to perform these transactions.
So we know that Goldman, along with JPMorgan Chase) and others – as the largest owners of derivatives – have a lot to defend.
But there’s actually an even-bigger-picture view that argues against regulation – of any kind.

Who Needs Rules?

Government oversight, intervention, and insurance schemes usually lead to problems – often really big problems.

A simple example should be enough to make my point.

Just think back to what happened last year to mortgage giants Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE).  It doesn’t take an accounting degree to figure out that, by having their loans government guaranteed, management had no incentive to follow cautious lending practices.

After all, why should they?  When a base salary is certain, a bonus is tied to sales or growth, and there are no consequences for bad results, why not take on more risk and just shoot for the moon?  If you hit it out of the park, your bonus swells.  If you strike out – even so badly that you even make “Mighty Casey” look like Henry Aaron – and you lose really badly and your company loses big, even to the point of bankruptcy or outright collapse, you still get your base salary.

Where’s the incentive to manage your risks?

In the case of a bank, there’s no incentive to be careful with depositor assets when the Federal Deposit Insurance Corp. (FDIC) is your bottomless backstop.

Clearly, the government does not always know better.

And that brings us back to Goldman Sachs.

Goldman Sachs: Unplugged, Unfettered, Unregulated

In the debate about regulating the commodities markets, I come down on the side of Goldman, reasoning that a free market – left unfettered – knows best, since the forces of supply and demand will ultimately price things fairly.

Inside an economic system as highly developed as that of the United States, everything operates at a level of complexity that no single person – let alone a government bureaucracy – can operate, or even fine tune. And as soon as anyone begins to tinker with it, there are always going to be unintended consequences.  Which leads us back to the question of regulation.

According to Prof. Kent Moors, a noted global oil consultant, only a small portion of a commodity’s price, at any given point in time, can be attributed to speculators.  He believes that speculators they are necessary to provide liquidity and that, in the end, the benefits speculators provide cancel out any of the negatives often ascribed to their marketplace activities.

If regulations with real “teeth” – in this case, position limits on energy futures – are actually put in place, U.S. financial leaders will end up playing the economic equivalent of Whac-A-Mole – an unwinnable game, and a dangerous one, at that.

While the final result is difficult – if not impossible – to picture, here’s my best guess: The financially lucrative, economically prestigious and strategically important commodities-trading business won’t fold up and disappear – it will just move to another country, where it’s better treated, and even nurtured.
Perhaps it will end up in Asia, as has been the case with so many other important businesses during the past couple of decades.  And that, once again, will end up costing America jobs – these jobs high-paying and prestigious – at the worst possible juncture.

According to commodities guru Jim Rogers – who is frequently quoted here in Money Morning – “the three commodity exchanges in China are booming.  Dalian trades more soybean contracts than Chicago does already, and that’s with a blocked currency [and] a closed market.  Can you imagine what’s going to happen if and when they open that market up to foreigners?  It’s going to explode.”

So as you think about “big bad trading firms” such as Goldman Sachs, and commodities speculators, remember the necessary role they play.  And realize that restrictive regulations will end up being bad for consumers, investors, and the same free markets we should be defending.

Source: How Over-Regulating Goldman Sachs Will Lead to Higher Oil and Commodity Prices

The Dow slipped a bit yesterday – only 39 points. Everyone is watching. They want to see how far this rally carries on. Many think it is more than a bear market bounce; they think it is for real.

The prevailing opinion is that quick action by the feds avoided a more serious meltdown. Ben Bernanke says he was working to prevent a “second great depression.”

And now that the crisis is past, the economy is slowly climbing out of its hole. The second quarter showed GDP falling at 1% per year in the US… rather than the 6.4% rate recorded earlier in the year. Housing sales have perked up. Oil is trading above $71 – a sign of renewed economic activity. And gold seems to be getting ready for another assault on the $1,000 mark – a sign of growing inflation pressures.

At least… that’s the way the world sees it.

Here at the Daily Reckoning, we look… we squint… we wipe the fog off our glasses and try to tear the scales off our eyes. What do we see? We see a financial world gone mad.

Or, perhaps we should say… a financial world that has still not recovered from the Bubble Madness of 2002-2007.

One bubble begat another. We have previously reported that the bubble era was over. Because the machinery that made it possible – the bubblelized financial industry – was broken. Well, we were only half right. The finance sector has exploded. Bear Stearns was sold for peanuts. Lehman Bros. went broke. Merrill was forced into a shotgun wedding with the Bank of America (NYSE:BAC); with Hank Paulson holding the firearm. JPMorgan (NYSE:JPM) is still in business. So is Goldman (NYSE:GS).

But now we know that even Goldman might have gone under if Paulson – ex-Goldman man – had not engineered a stealth bailout. He brought the feds in to save AIG, and in the process he saved his old alma mater too… AIG’s biggest trading partner, Goldman Sachs.

And now Goldman is in the news almost every day. It reported spectacular trading results for the quarter, lifting the entire world stock market. What’s good for Goldman must be good for the whole world economy, investors reasoned.

Then it was reported that Goldman made its money in a variety of ways – none of which had anything to do with providing genuine service to the economy. Goldman made a fortune on the feds’ own money-raising, it came out. And then it came out … Goldman was making billions by trading at lightning speed — clipping investors for fractions of pennies each time a transaction passed through the markets.

The Italians think Goldman runs their country. They’ve got the top three posts in Rome… Premier Romano Prodi is an ex-Goldman guy. So is the headman at the Treasury. And the chief of the central bank too.

They think Goldman is like a cult… a semi-secret society of insiders with the power to rule the country – surreptitiously. Like the free masons… the Jesuits… or the Illuminati.

Goldman has its boys in important posts in the US too – but not at the same level as in Italy. Tim Geithner is not a Goldman graduate. Neither is Ben Bernanke. But both have plenty of in-put from ex-Goldman associates, colleagues and handlers.

We confess an interest – we have relatives working at Goldman. But we doubt that Goldman rules the world. Just look what they said and did over the last couple of years; they had no more idea of what was going on than anyone else. No, they don’t rule the world… but they do manage to persuade it in their direction from time to time…

During the bubble years, they urged consumers, bankers, and investors to borrow… to speculate… and to ruin themselves. Naturally, Goldman made out like… well… like a bandit.

And now Goldman guys urge the government to ruin itself too. Yes, dear reader, the bubble age is not quite over. Now, there’s a bubble in government debt… Here too Goldman makes money like a bandit. The more the feds borrow… the more debt there is to buy and sell. And the more the feds stimulate… the more acts of reckless speculation there are to finance.

And the more money Goldman makes… the more politicians the firm is able to buy. Of course, they welcome campaign contributions.

And of course, Wall Street is spending record amounts in lobbying. But the real appeal is the lure of being able to join Goldman itself… of being able to spend some time in Washington… pushing business Goldman’s way… and then cash in big by joining the firm and getting a piece of the action…

*** There are two big bubbles now. There is the familiar one in federal government debt. The other is the Peoples’ Republic of China.

Andy Xie says China is a ‘giant ponzi scheme’ fed by new investors hoping to get rich. Of course, the China story is an attractive one. China’s growth rate is spectacular. Even in a worldwide financial meltdown… and the biggest depression since the ‘30s… China is still growing at greater than 8% per year – or so the figures tell us. New cities are still being built… at a breathtaking pace.

Stocks on the Shanghai exchange are up 80% so far this year. China has the biggest pile of cash on the planet — $2 trillion worth. And it has more bright, well educated engineers, accountants and economists than anywhere else… In fact, it has so many economists trained at Western universities, it is almost sure to blow itself up…

Maybe this is the Chinese Century. Maybe it is not. Either way, it seems inevitable to us that the Chinese bubble economy is going to pop. Banks are lending 3 times as much as they lent last year. You can’t increase lending at that rate and still maintain credit quality – if there was any in the first place. A lot of buildings are going up that won’t find tenants. A lot of factories are expanding that won’t find customers. A lot of speculations are going on that investors will later regret. That’s just how a bubble works!

Mr. Xie says, for example, that the cost of property in China is about the same as in the US. But wait, the average income in China is only 1/7th what it is in the USA. How can the Chinese afford American prices? Well, they can’t. They’re all betting on the greater fool theory – that they can pay any price, because some greater fool will come along and pay more. Trouble with that is that the Greatest Fool of All finally shows up… and then the whole structure collapses.

*** Barron’s says that “The Greenback is Broken.” True, the dollar has been losing ground as the stock market gains it. Yesterday, it took $1.44 to buy a euro.

“I was amazed at how expensive everything is in Paris,” said son Will. “You go into a shop to buy a few groceries… You expect to pay about $12. Instead, the bill comes to $40. Or, you stop to have a cup of coffee and a croissant. It costs you $10. I don’t know how you can afford to live in Paris…

Will lives in Buenos Aires… with frequent visits to in-laws in Florida…

“You know, it used to be so much cheaper to live in Buenos Aires than just about anywhere. But now, I think the prices are about the same as in Florida. Everything seems so cheap in Florida. And you can make some very good deals on property…

“Remember that house that I bought in 2006. You warned me not to do it. But right after I bought it people were coming to my door asking if they could buy it. One guy offered to write a check for $600,000. Then another guy offered $675,000. I began to think I really had something hot.

“Of course, then the market crashed. Now, I’m thinking of selling it for $300,000 – if I could find a buyer.

“But that’s in South Florida… only about an hour up the coast from Miami. There are places in the US where things are really, really cheap. In Iowa, maybe… Arkansas… Michigan. You can get a nice house for less than you’d pay for a garage in Paris. From that standpoint… the US seems like the place to be. You can live so cheaply. And fairly well… but quality of life is another thing… ”

The dollar is low… America is cheap. Barron’s is probably wrong about the buck. It’s not broken – not yet. Our guess is that it will rise when stocks crash this fall.

*** We’ve thought a lot about quality of life. It is not a constant, fixed thing we conclude…

There are only three main decisions you make in life – what you do; who you do it with; and where you do it. Typically, these decisions are made without much real thinking – which is probably the best way. They are not things that lend themselves to thought… but to feeling. Pity the more man who marries a woman after a prolonged and logical thought process. The poor sap is doomed. His head may be in the game, but his heart will drop the ball. The next thing you know, he will be in divorce court or therapy.

Likewise, the decision about where you live is not one that is readily subject to logical analysis. You like a place because you like it… And you may like it for a variety of reasons that defy analysis. There’s no accounting for tastes, as they say.

Living in rural Iowa probably wouldn’t suit us. We don’t have the stomach for it. We couldn’t draw enough nourishment out of such lean meat. We need more stimulation.

We like Paris for the street scenes. Everywhere we look, we see something we like to look at – people, buildings, shop windows, streets, bridges, river boats… Same thing out here at our summer place. We work in an octagonal office that sits in the park. No matter what window we look out of we see something that pleases us. A stone barn with a red barrel tile roof. Those big limousine cattle grazing in the field. And there’s the house itself… a conglomeration of a fortified farm house from the middle ages with a Renaissance-style faux-chateau cobbled onto it in the 19th century. And there is our grandson… 16 months old… playing in the gravel…

… wait… what’s he doing? Uh oh… he’s eating the gravel…

Gotta run…

Source: Goldman…Goldman…Goldman…

About six months ago, Goldman itself was on its hands and knees looking to get a part of Hank Paulson’s $700 billion TARP fund. Back then, Goldman posed a “systematic risk” to the system. Handily, the firm’s former CEO happened to be Treasury Secretary. And Goldman was granted bank holding status and TARP rescue money lickety-split.

Back in the last depression, the Pecora Commission went straight for bankers’ gonads. Examples were set. Bigwigs were forced to resign. And landmark legislation was put in place (think Glass-Steagall) to keep the “banksters” in their place.

These days are different. Washington seems less keen to go after their pals on Wall Street or ask too many awkward questions. Instead, the pols are rejoicing in Goldman’s record profits and desperately trying to forget about all those billions in tax dollars they recently handed over to the nation’s top bankers.

Of course, not all bankers are created equal. And former Goldman Sachs CEO and then Treasury Secretary Hank Paulson had no intention of extending your hard-won tax dollars to just any old bank.

Goldman’s competitor Lehman Brothers needed cash too. It had earlier claimed to be “too big to fail” and a “systematic risk.” But the feds were having none of it. Bank holding company status was withheld. And Lehman brothers, like Humpty Dumpty, “had a great fall.”

(Oddly, or perhaps not oddly at all, considering the established close ties between Goldman Sachs and Washington, Lehman’s demise has greatly helped Goldman. The reduction in competition has greatly benefitted Goldman’s bottom line.)

So what is Goldman doing with the money? Well, we hate to break it to you, folks, but it’s not saving it for a rainy day. According to Barron’s, having saved roughly $600 million by issuing FDIC-backed debt with yields reflecting the government’s guarantee, Goldman has managed to set aside some $11.4 billion for compensation in this year’s first half. This works out to an annualized $770,000 “for each chief, cook and bottle-washer at the firm.”

Of course, saving for a rainy day is something a bank might do if it knew that it couldn’t rely on its connections in the upper echelons of government (and taxpayers’ generosity) should things get a little hairy again down the line. Or as Bill puts it less prosaically: “like a welfare queen in a pink Cadillac, it spends every penny, confident that it can lean on the feds next month as well as the last.”

But surely, some would say, Goldman’s bumper quarters mean the banking crisis and the economic crisis are over. Surely it’s now time to rush back into stocks, switch on Cramer and let the money start rolling in again. Perhaps, dear reader, perhaps. But as always, things aren’t quite what they seem. This from Bill in yesterday’s Daily Reckoning:

But now, look. After all our whining and complaining about the bailouts – they must be working, right? The big banks are making money again… big money. And that must mean the economy is on the mend. They’re lending… they’re speculating… they’re rolling the dice and… hallelujah… a pair of boxcars!But wait. Ken Lewis of Bank of America says, “Profitability in the second half of the year will be much tougher than the first half…”How come?

Because the banks’ core business is actually getting worse! The core business of banking is lending to people who are capable of paying it back – out of earnings. If the borrower is counting on higher house prices…or higher stock prices… to allow him to refinance on better terms, the lender is asking for trouble. Prices may go up… or they may go down. And if they go down, down goes the lender’s collateral too… and his hope of getting repaid.

The banks made big mistakes in the bubble years. And now they’re paying the price. But so far, they’ve only made the first installment payment. Subprime loans started going bad two years ago. Then, people began losing their jobs… and loans of all sorts were in trouble.

There is no sign that this process is over. Instead, it is merely proceeding in good order… just as you’d expect.

California lost another 65,000 jobs in June. And in Pennsylvania, 17,800 people are running out of jobless benefits. This group is on the cutting edge of a huge new trend – people not only unemployed, but out of unemployment benefits. One estimate says there will be more than half a million of them nationwide by the end of September. You think they were cutting back on spending last month? Let’s see what they do in October. And let’s see what happens to their debt… those Alt-A, jumbo, and prime mortgage loan…

… and let’s see what happens to credit card debt…and to commercial loans too. There’s a report that New York commercial properties are running up towards a 23% vacancy rate… Shoppers not shopping… stores and restaurants closing their doors… unemployment going up – sounds like the depression might not be over yet…

Paulson’s remark came in response to Lewis’ request for a letter from Fed Chairman Ben Bernanke, acknowledging the government’s insistence that Bank of America acquire Merrill Lynch, despite the brokerage firm’s mounting mega-billion-dollar losses.

This one little phrase probably tells you everything you need to know about Henry Paulson, the man who put the “secret” in Secretary. And this one little phrase certainly tells you everything you need to know about the structure and actual objectives of the bailout campaigns Paulson orchestrated.

Specifically, the Paulson bailouts sought to divert hundreds of billions of taxpayer dollars toward Wall Street finance companies, and to do so as secretly as possible. In the name of “systemic risk,” the former Treasury Secretary dispensed hundreds of billions of dollars to the likes of AIG, Citigroup, and his former employer, Goldman Sachs, without ever seeking or receiving a single vote from an elected official. Thus, as it turns out, the only system genuinely at risk during Paulson’s tenure was the American system of honest and transparent financial markets.

The initial bailout facilities were created and implemented by Paulson and Bernanke, two unelected officials. And none of the initial bailout schemes ever faced scrutiny from elected officials, much less a formal vote. Even though some of the subsequent bailout programs, like the TARP, did face a vote in Congress, the Treasury Secretary continued to champion numerous ex-legislative activities, like the backdoor bailout of Goldman Sachs through the $170 billion bailout of AIG, and the shotgun takeover of Merrill Lynch by Bank of America.

According to the February 26th testimony of Bank of America CEO, Ken Lewis, before New York State Attorney General, Andrew Cuomo, Paulson strong-armed Lewis into completing the Merrill takeover, without disclosing to B of A shareholders that Merrill’s losses were much larger than publicly disclosed.

“Lewis testified that he asked Federal Reserve Chairman Ben S. Bernanke to ‘put something in writing’ regarding the US government’s plan to support pack of America’s acquisition in view of Merrill’s mounting losses,” Bloomberg news reported yesterday. “After Bernanke said he would consider the idea, Paulson called Lewis and said, according to Lewis, ‘First, it would be so watered down, it wouldn’t be as strong as what we were going to say to you verbally, and secondly, this would be a disclosable event and we do not want a disclosable event.”

Inconveniently, non-disclosable events are also illegal events. “Paulson kept the Securities and Exchange Commission, which is responsible for making sure companies disclose material information to their investors, in the dark, according to Cuomo,” Bloomberg news continued. “The allegations [by Cuomo] suggest Paulson and other policymakers may have resorted to breaking securities laws in order to protect a fragile financial system…”

Do the ends justify the means? Yes, if you’re a muckety-muck at Merrill Lynch or Goldman Sachs. No, if you’re anybody else. Paulson’s groundbreaking lawbreaking facilitated the survival of institutions that deserved death, in the process amassing trillions of dollars of fresh liabilities for American taxpayers who deserved to be left alone.

The adverse effects of these criminal acts extend far beyond annoying your California editor. For one thing, bailing out incompetent executives enables the incompetent executives to continue their incompetent behavior. For another thing, lavishing hundreds of billions of dollars upon ailing, functionally bankrupt companies, promotes a web of deception and illusion that impedes the healing process that would lead to a bona fide recovery.

If you hand $10 billion to any bankrupt company in America, that company will seem healthy for a while. The truth of the matter is that the Paulson bailouts, along with subsequent multi-trillion initiatives, have injected various finance companies with short-term stimulants that produce an image of health, while leaving the underlying disease untreated.

The resulting fraud is that diseased corporate entities appear to be recovering. They can pretend they are A-OK once again, while the top brass at these companies can pretend they no longer require government assistance – certainly not any of that dreaded TARP money that imposes limits on obscene executive compensation.

Eventually, as a result of all these falsehoods, investors begin to imagine that they actually see what the finance companies’ CEOs pretend to see. And before you know it, you’ve got a great big rally in bank stocks, fueled by nothing more than deception, hype and hope.

Is your California editor being too hard on the Wall Street boys and girls? He thinks not…and neither does his colleague at the Australia Daily Reckoning, Dan Denning:

“So the banks have returned to profitability have they? If that were true, bank balance sheets would also be recovering. But that’s not true.

“The big three banks reporting recently – Citibank, Goldman Sachs, and JP Morgan – all reported huge revenues from their trading desks. As we reported last week, Goldman’s $6.6 billion in trading revenues was not only 70% of total revenues, but it was also a ten billion dollar improvement on a $4 billion loss in the fourth quarter.

“JP Morgan reported nearly $5 billion in revenues from trading fixed-income securities. And Citigroup reported $4.69 billion in fixed-income trading. In fact, all of Citigroup’s other major operating segments reported declining revenues for the quarter. Its global credit card revenues fell by 10%. Consumer banking revenues were down 18%. And Citi’s Global Wealth Management revenues were down 20%.

“But something magical happened in the fixed-income trading group for Citi. If you dig into the quarterly report, you’ll learn that fixed-income trading revenues were boosted by a net $2.5 billion positive CVA on derivative positions, excluding monoclines, mainly due to the widening of Citi’s CDS spread.

“That takes some sorting out. A CVA is a ‘credit value adjustment.’ As you can learn here, it’s the credit risk premium of a derivative contract. Once you sort it out, you learn that Citi ‘made’ $2.5 billion on a derivatives position designed to profit when the companies own credit default swaps spreads widen.

“Or, in plain English, Citi profited because it made a bet that the cost of insuring itself against a default would go up. The credit default swap market is the place where you can bet on the credit worthiness of a firm, or, essentially, the chance that a firm might default on its bonds. Citi appears to have reported a $2.5 billion trading gain in the fourth quarter precisely because the market thought the company stood a good chance of failing (hence the widening CDS spread).

“As far as we can tell, if you use this kind of perverted logic, the closer Citi gets to bankruptcy, the more money it would ‘make’ on its derivatives. That shows you how bogus the quarterly number was. The company reported declining revenues in its core banking and lending activities. But thanks to fixed income and this handy $2.5 billion CVA, the company was able to report $1.5 billion in net income.

“Also, don’t forget that all of the banks benefitted from what financial sector analyst Meredith Whitney called back door financing.” Whitney described what amounts to Fed-sanctioned front-running of the fixed income market by the banks. The Fed publicly telegraphed its intention to buy $750 billion mortgage-backed securities from Fannie Mae and Freddie Mac and $300 billion in U.S. Treasury bonds. And that was AFTER it announced in late November of last year it would be wading in as a buyer for all agency bonds to support the U.S. mortgage market. In other words, the big banks were able to take positions in the exact securities that they knew the Fed would be buying. Huge profits were not guaranteed, just highly likely.

“Since the financial statements of the banks don’t break trading revenues out a line item basis, it’s hard to say how much money each bank may have made by frontrunning the Fed’s actions in the bond market.

“But from the looks of it, what we have here is a kind of back door subsidy to bank profitability provided by the Fed. First quarter earnings were strongly boosted by an increase in the valuations of mortgage-backed securities that went up with Fed buying. Before you get all excited about the recovery in financial stocks, you may want to keep that in mind.”

And let’s also bear in mind, dear investor, that the AIG bailout may have contributed mightily to Wall Street’s enormous trading profits in the first quarter. According to a widely circulated theory to which we alluded in the March 19, 2009 edition of the Rude Awakening, Paulson bailed out AIG so that AIG could bail out Goldman Sachs and other ailing Wall Street firms.

Whether directly or indirectly, intentionally or unintentionally, the federal government enabled the big Wall Street banks to produce billion-dollar profits in the first quarter. Certainly, the federal government will attempt to repeat the performance in the second quarter. But we suspect the jig is up. We suspect the trading profits of the first quarter were one-off events that will not become two-off events.

As a result, we suspect that finance company earnings will resume their downward trajectory throughout the rest of the year, as adverse real-world trends swamp government-subsidized trading profits.

The truth is that banking profitability is not actually recovering, and neither is the economy. And that means that every stock market rally rests on shaky ground. The nearby chart tells the tale…or at least most of the tale.

Foreclosures have become nearly as numerous as home sales. Unless and until the two lines on the chart above begin to diverge, rather than converge, a recovery in the finance sector will remain a deception, a recovery in the economy will remain a false hope and a recovery in the stock market will remain a dangerous illusion.

And one final thought: Would America be any worse off if Paulson had simply told the truth?

Source: The Recovery That Isn’t

With the old “drinking from the fire hose” routine being extra intense as of late, and Tuesday being a rare travel day for yours truly, I haven’t had time to digest the finer points and nuances of Tim Geithner’s new bank plan just yet. I’ve got my stack of stuff printed out, though, and should have a proper state of fulmination worked up by Friday.

Here’s my quick take: Clearly the market liked the plan, based on Monday’s action – or maybe the market just liked ANY semblance of a plan – and just as clearly a number of commentators did not. Paul Krugman hated it, for example. So did the guy over at LOLFed.

And by the way, speaking of Tim Geithner – how come he hasn’t picked up a nickname yet? Ben Bernanke has “Gentle Ben” and “Helicopter Ben”… Hank Paulson had “Hammerin’ Hank”… even the Prez has “Barackstar” and “No Drama Obama.” I keep thinking of Timmy from South Park (Timmay!), but that’s probably not appropriate given the recent news flow.

Probably the most surprising comment, as relating to the Geithner bank plan, came from John Authers over at the Financial Times. I like John Authers – by and large he tends to be sharp and clearly knows his stuff.

And that’s why this comment from Authers at the end of a recent “Short View” video segment made me sit up and take notice:

If this plan works as hoped, then it’s quite probable we’ve seen the bottom of the whole bear market. If it doesn’t, then we probably haven’t.

Yowza. When you think about it, that’s quite a statement.

And by the way, if you ever wondered what the bears leaving town might look like, now we have a mental image (courtesy of www.englishrussia.com):

to the airport, comrade!

Since putting a bear in the back of a taxicab might strike you as slightly irrational behavior, this feels like a good segue point into today’s main topic.

Swaying to the Beat

I recently finished a wonderful little book called, Sway: The Irresistible Pull of Irrational Behavior, by the brothers Ori and Ram Brafman.

The inside jacket flap promises that Sway will “change the way you think about the way you think,” and in some regards it does just that.

The jacket goes on to summarize:

Drawing on cutting edge research from the fields of social psychology, behavioral economics, and organizational behavior, Sway reveals the many dynamic forces that influence our personal business lives, including loss aversion (our tendency to go to great lengths to avoid perceived losses), the diagnosis bias (our inability to reevaluate our initial diagnosis of a person or a situation), and the “chameleon effect” (our tendency to take on characteristics that have been arbitrarily assigned to us.

For all that, it’s actually quite a breezy little book. The contents do deliver on all that is described above, but it comes in the form of stories and anecdotes written in plain English. I found the whole thing very light and engaging – almost like an extended Vanity Fair article turned into a book.

Pants-Wearing Monkeys?

As a trader and an investor, I have always been fascinated by the human condition – in particular, the reasons why people think and do odd, perplexing, and sometimes flat-out dumb things.

Over the years, too, I have been on a quest to find out the “why” behind a true statement from one of the greatest traders of all time, Jesse Livermore, who observed: “A speculator must fight a lot of expensive enemies within himself.”

This is undoubtedly true. But how come? (Good news: the fight is winnable, but it takes time.)

Some, like blogger and money manager Barry Ritholtz, think we are all just a bunch of “pants-wearing monkeys” (himself included). Others simply shrug and accept that deep irrationality in certain areas is just part and parcel of the human condition.

But the reason I found Sway so engaging a read is because the Brafman brothers do a very good job, again, of explaining the “why” behind some of the oddball things humans do.

Or to put it another way, randomly irrational behavior is not all that interesting because there’s very little you can learn from it. But if certain surface-level irrational actions actually make logical sense as phenomena once you dig down to the roots – i.e. if there are underlying patterns and reasons as to why people act as they do – then those patterns and reasons are probably well worth finding out.

Further Down the Rabbit Hole

If you’re a fan of this type of thing – human psychology, behavioral economics and what not – then I think you would enjoy Sway. As I say, it’s a relatively light, fast, breezy read, with a lot of funny stories and some fascinating anecdotes too.

Going deeper: If you consider yourself a budding connoisseur of the rational (or should I say irrational) mind, you can also take things further with a book that is less fun, but perhaps even more enlightening: Influence: The Psychology of Persuasion by Dr. Robert Cialdini.

Here is an excerpt from an Amazon review of “Influence” I penned many years ago:

[In his book Influence: The Psychology of Persuasion] Professor Cialdini takes a refreshing look at the frailties of the human mind, and his conclusions are a reminder of how damningly automatic a human response can be.

He illustrates how the behavioral / cultural conditioning we receive from birth, designed to make us functioning members of an orderly society, also creates exploitable weaknesses within our psychological frameworks.

These weaknesses are compelling (and permanent) because the patterns are so ingrained; we can’t short-circuit them without short-circuiting beneficial social behavior patterns also….

As a trader, I bought this book to hone my understanding of human psychology and various influences on the decision making process, in the hope that Cialdini would shed a light on the complex emotional processes that lead to buying and selling. He surely did.

And for the Truly Hardcore…

If you’ve already read Influence, and you think Sway sounds like just another Malcolm Gladwell-style coffee-table-slash-beach-read book – which it kind of is, not that there’s anything wrong with that – then maybe you’re a candidate for the really hardcore stuff.

If so, you might want to check out Psychology of Intelligence Analysis by Richards J. Heuer Jr.

This one is available on Amazon.com, but you can also get it free from the CIA.

Do I mean that CIA, as in, the Central Intelligence Agency? Yep… apparently it’s required reading for analysts (or was at one time). The CIA keeps a free copy of the book online here. Obviously there’s nothing breezy or easy about this one, so be forewarned.

If you pull any good insights from these tomes, or have some good “brain food” selections of your own to share – or, heck, if you just know a good nickname for poor ol’ Tim Geithner – let me know: justice@taipandaily.com.

Source: The Irresistible Pull of Irrational Behavior

Poor Warren. He’s down to his last $25 billion. And Bill Gates can barely hold his head up; his pile has shrunk to barely $18 billion.

And do a Google search of “AIG outrage” and you will get 621,000 hits.

Alas, being rich isn’t as easy or as much fun as it used to be.

The rally paused yesterday. The Dow lost 7 points. It could be over. More likely, it will run for a few months. Gradually, people will come to think that this is the real thing. They’ll begin to imagine that it is 2003 all over again. Of course, it’s not…this market has nothing in common with the Great Rebound of 2003-2007. (More below…)

Oil traded at $47 yesterday; it is slipping toward the $50 level. And the dollar is slipping around too – it is losing ground against the euro, now trading at $1.29/$. But it is mostly steady against gold, which seems to like the $900-$950 range…for now.

AIG is today’s main story. Everyone is appalled, outraged…or apoplectic about it. First, we under-reported the amount in bonuses paid out. The real amount is $450 million, says the Wall Street Journal…and one member of Congress charges that many bonuses were disguised as other things…and that the real total is more like $1 billion.

The average lumpenvoter has no idea how bailouts work. He was willing to believe that giving Wall Street hundreds of billions in taxpayer money would somehow make his house go up in price, but now that he sees how it really operates, he is ticked off about it. He may not understand macroeconomics, but he knows chicanery when he sees it.

Under pressure, AIG revealed what it did with the bailout money. It came as no shock to us to discover Goldman Sachs at the top of the list of recipients. Goldman’s main man was in the room with the feds – the only representative of Wall Street – when the decision was made to rescue AIG. What’s more, the feds’ main man at the time – Hank Paulson – also used to be the top honcho at Goldman (NYSE:GS). So the fix was in. The government gave money to AIG and AIG gave it to a long list of speculators – including Goldman.

This seems perfectly natural to us. If we’d been in on the fix we would have steered some of the loot our way. But the politicians are feigning shock and horror. Senator Grassley even said AIG management should “resign or commit suicide.” He later calmed down and said he didn’t mean it.

But we would have simply edited his remarks, giving the schmucks at AIG a last chance to exit with honor: “Resign AND commit suicide, in that order.”

Barney Frank added that “maybe it’s time to fire some people.” Why not? The feds own 80% of the insurance giant now. Go ahead; fire all the people you want. That’s about the only pleasure a real capitalist has left to him. Reach out…and fire someone today!

Elsewhere in the news, the economy continues to deteriorate. Industrial production fell 1.4% in February. And credit card defaults are at a 20-year high.

Misters Smoot and Hawley seem to still be on the federal payroll. The news this morning is that they began a trade war with Mexico and the Mexicans have already retaliated. That’s all we know about it…

But back to the tribulations of the rich…

First, Mr. Market is downsizing fortunes – fast. In the last 12 months, the average rich person has probably lost half his wealth. Not only did he own millions worth of stocks and real estate…he was also among the privileged few to get into good deals on derivatives, SIVs, hedge funds and private equity. Many of those complicated and conflicted assets have been wiped out completely. Or, maybe he was unlucky enough to count Bernie Madoff as a friend.

Second, what Mr. Market doesn’t take, Mr. Politician is looking at. All over the world, plans are afoot to increase his taxes…and close down his tax havens. President Obama has already revealed his plans to soak the rich. Every other group will come out even…or better…from Obama’s tax proposals. But the rich are going to be saturated…marinated…soaked to the bone.

And third, the poor rich guy has become a pariah. He doesn’t get invited to charity events anymore – or even to join the guys after work for a beer. Europeans have always distrusted rich people. But in America, a rich man used to be respected – just because he was rich. People asked his opinion on politics…on fashion…on art. He was presumed to be an authority on all things and was generally treated with respect…even deference.

But now rich are seen as chumps, losers, incompetents and malefactors. Even Americans look at rich people and think they must be either stupid or corrupt.

“Le secret des grandes fortunes sans cause apparente est un crime oubli , parce qu’ il a t proprement fait.” said Balzac. Which has been paraphrased to “Behind every great fortune lies a great crime.” Of course, he was referring to France, where it is has probably always been true. Money is dirty in France. But in America, money was supposed to be clean…innocent…honest and forthright. The richest man in town always sat in the front pew in church and stood for election to local office.

But come the depression and even the rich suffer. And unlike the starving urchins, unlucky widows and innocent orphans, no one cries a tear for the rich. Here at The Daily Reckoning we always take the side of the underdog…and always support the lost cause. So when we think of the rich…those darling people with their Italian suits…German cars…and Swiss bank accounts…our cheek gets a little moist. For we – and we alone – still admire and respect the rich. Of course, the rich are human beings too – just like the rest of us. And yes, dear reader…we still despise them as much as anyone else. When it comes to intelligence or moral rectitude, they are probably no better than the lower classes, though probably no worse. But we still admire and respect their money. Their money is no better either – but they have more of it.

Now over to Baltimore, where Addison at The 5 Min. Forecast gives a St. Patty’s Day look at the Emerald Isle:

“What’s the difference between Iceland and Ireland? ‘one letter and six months,’ or so goes a joke making its way around the Internet,” writes Addison.

“Aye, on this St. Patty’s day the Emerald Isle is suffering the mother of all hangovers; the embodiment of a boom gone bust.

“With official unemployment now over 10%, GDP shrinking at a 6.5% clip, a proper housing crash and a 10% federal budget shortfall, Ireland has seen it’s glory days crumble into one of the Eurozone’s most beaten down economies.

“Ratings agencies are on the verge of downgrading Ireland’s sovereign debt, which will assuredly make the whole matter even grimmer.

“The opening joke is so pointed,” Addison continues, “Irish Finance Minister Brian Lenihan is now on a global PR tour to help rekindle the world’s love of shamrocks and Guinness. Despite Lenihan’s denials, many expect the IMF to swoop in and become Ireland’s banker of last resort.”

Back to Bill in Paris…

It’s NOT 2003. Just in case you had any doubts.

You remember 2003? After a phony recession in ’01-’02 came a phony boom in ’03-’07. Stocks had driven into a ditch following the crash of the NASDAQ. The Dow had fallen down to about 7500. And then, when it looked like they were going nowhere for a long time…along came Alan Greenspan’s friendly towing service. In a jiffy, he winched the economy back onto the road…and it was soon flying along at the fastest speeds every recorded. The Dow went all the way to 14,000 and beyond…before crashing into a stone wall.

And now the financial media is on “bottom watch.” No, we’re not talking about the kind of bottom watching you do on a Brazilian beach…we’re talking about looking for the end of this bear market.

“Are stocks and oil bottoming,” asks a headline at Seeking Alpha.

“How will we know…” when we hit the bottom? Asks the New York Times.

The answer: we will know when we no longer want to know.

For the moment, we believe we are beginning a classic rebound. The news seems to have turned positive…along with the weather. It’s sunny and warm in Europe this morning. And investors are focusing on the positive.

“IMF poised to print billions in global quantitative easing,” says a headline in London’s Telegraph.

All over the world, the feds are working the pumps. And investors are watching their little boats begin to rock. If history is any guide, this rebound will recover 20% to 50% of what was lost. Then, the bottom – so recently spotted and revered – will fall out.

This is not 2003. In 2003, there was no collapse of the financial sector…banks didn’t fail…major companies didn’t face bankruptcy…consumer spending didn’t fall…house prices didn’t collapse…savings rates didn’t go up…capitalism wasn’t called into question…there were no tax rebates…there were no bailouts…not even a stimulus plan (though the feds did spend much more money…and the Fed did cut rates to 1%).

This time it’s different. This is not a recession. Not even a phony recession. It’s a very real Depression with a capital D…and all that goes with it – including whole industries that go broke, a credit crunch, a big drop in consumer spending, a huge political shift toward socialism, interest rates at zero, falling prices, and widespread bankruptcies – both of households and companies.

In 2003, a quick cut in interest rates – along with a boost in federal spending – produced a fast turnaround. Within months, prices were rising again. Consumers didn’t even pause…they kept spending and borrowing all the time. This time, the world has never seen stimulus efforts of such huge magnitude – and still no real uptick. This time, consumers are running scared…they’re losing their jobs and closing their wallets. This is the real thing. It won’t end quickly…or easily.

Here’s a calculation for you. The amount of excess debt in the United States is about $20 trillion. That’s the difference between the usual level debt – about 150% of GDP – and today’s level – about 350%. That $20 trillion in surplus debt probably has to disappear before a true growth cycle can begin again. The best way is simply to let nature take her course. Much of it would be written off in a few months. But the feds won’t let that happen. They’re doing all they can to prevent assets from getting marked down…and to prevent debt from getting written off. So far, they’ve committed $11.7 trillion to the fight against debt deflation.

So instead of writing it off, it will have to paid off…or ultimately, inflated off.

Currently savings rates have risen from zero to about 3% of GDP. That’s about $420 billion per year put to paying down the debt. Let’s see, at that rate, how long will it take to erase the $20 trillion in excess debt? Hmm….about 47 years!

Until tomorrow,

Bill Bonner
The Daily Reckoning

Source: Where the Bailout Money is Really Going

The sound bite that got all the play yesterday was this: “What I’m looking at is not the day-to-day gyrations of the stock market, but the long-term ability for the United States and the entire world economy to regain its footing. And, you know, the stock market is sort of like a tracking poll in politics. You know, it bobs up and down day to day. And if you spend all your time worrying about that, then you’re probably going to get the long-term strategy wrong.”

Leave aside the particulars of his economic policy, and that’s a fair enough statement.  But then, what prompted him to say this in the next breath?  “On the other hand, what you’re now seeing is profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal if you’ve got a long-term perspective on it.”

This sounds like someone trying to have it both ways: “I don’t give a flip about the stock market… but you know what, there are some mighty good buys out there right now.”  Mixed messages, if not necessarily a blatant contradiction.

There, in a nutshell, is the reason the S&P has tanked 30% since Election Day, and roughly 13% since Inauguration Day.

The scholar Robert Higgs sums up this phenomenon with the delicious expression, “regime uncertainty.”  It’s when investors choose to sit on whatever money they have rather than put it to work creating wealth, because they have no idea what the rules are going to be day to day.  Higgs applied the term primarily to the New Deal, but we’re seeing the phenomenon at work today.

We see it when the administration chooses to run up record deficits, but then Tim Geithner says it’s “crucial” to bring deficits under control.

We see it in every speech Geithner gives about the shape of TARP II, in which the parameters change as quickly as those of TARP I under Hank Paulson.

We see it in Geithner’s commitment to go after “tax cheats,” a declaration shorn of any self-awareness or irony.

Conventional wisdom has it the broad stock market won’t recover its losses for three to six years.  But if this administration continues to take its cues from the New Dealers, we’re looking at another 16 to 23 years.  Figure it this way: The Dow finally returned to its 1929 levels in 1954 — a 25-year gap.  Assume the market topped in 2000 and the 2002-07 runup was a bear-market rally, then we’re looking at a recoup of the losses by 2025.  If the top came in 2007, then it’s 2032.  A “long-term perspective” indeed, Mr. President.

And if the president is focused on P/E ratios, perhaps he should ponder this: If P/Es are near historical norms right now, and if Q4 earnings are about to take a major hit, doesn’t that imply P/Es are about to grow?  And prices will have to fall further to come back in line?  Just asking.

Source: Regime Uncertainty