In 1987, which is now more than twenty years ago, I published a book with James Dale Davidson. Some people still remember it for its title, Blood in the Streets, taken from a remark of Nathan Rothschild in 1815, at the time of Napoleon’s hundred-day gamble that ended in his defeat at Waterloo. “The time to buy,” said Rothschild, “is when blood is running in the streets.” The book arose out of our commentary in Strategic Investment.

The book attracted a good deal of attention at the time because it forecast the 1987 crash, which is still the largest fall in one day’s trading on Wall Street. I was in New York when the 1987 crash occurred. I remember an Australian broker observing that he had fought in a foxhole in Vietnam and that he found the 1987 crash more frightening.

Certainly we are experiencing a time of panic now, but there have been panics before. Some of them, like 1987, have had a benign outcome, with a recovery in the months following the panic. James Davidson and I did not forecast the post-1987 recovery; we expected a recession. The recession of the early 1990s duly came, but it was only a recession, not a crash. Even the ending of the dotcom bubble in 2000 did not produce a crash and certainly did not produce a depression.

The collapse of the U.S. housing and mortgage bubble has proved much more worrying and has already destroyed the independence of Bear Stearns, Merrill Lynch (NYSE:MER), A.I.G. (NYSE:AIG), Lehman Bros (NYSE:LEH), Fannie Mae (NYSE:FNM), Freddie Mac (NYSE:FRE), and, in London, Northern Rock and HBOS, with various levels of loss for the shareholders.

When we were writing Blood in the Streets, we did foresee the significance of the housing market. There is a section, in the book titled The Coming Real Estate Crash. Indeed we were able to identify in 1987 several of the weaknesses of the world’s political economy. It is not much help forecasting a crash twenty years ahead of its happening, but there are elements in the analysis we then made which turned out to be valid when the crash occurred. The 2008 crash comes as a natural consequence of long-term systemic failures.

Blood in the Streets was written fourteen years before 9/11. We did specifically refer to the threat to the twin towers in a subsequent book, The Sovereign Citizen. There is also a paragraph in Blood in the Streets in which I think we can take some legitimate pride:

“No V-day over terrorism. Disorder today is far more threatening because of the collapsing scale. As the margins of American power recede at the periphery, the raw power of these groups rises. So does their ability to disrupt arrangements they do not like. They cannot be stopped, as World War II was stopped, by forcing the surrender of a large-scale network of command. There is no single chain of command that has the authority to stop terrorism. Nor can anyone negotiate a compromise to meet demands of many of the small groups now wielding military force.”

We did foresee the significance of real estate and terrorism as factors that might undermine the stability of global finance. We also expressed concern about the reliability of the interbank market. “The danger of rapid deflation is more acute than it was in 1929. Why? Look no further than the geometric growth of the $700 billion interbank lending market. Each day U.S. banks are involved in interlocking transactions that total as much as $700 billion. This is the banking equivalent of having hundreds of trapeze artists swinging through the air — to what everyone hopes will be a safe landing. If even one bank failed to make good on its commitments, the whole criss-crossing show could come tumbling to the ground. This means that a liquidity crisis and a loss of confidence could contract credit almost instantly — on a far wider reach than in the past.” That is a fair description of what has been happening in the last thirteen months.

We correctly foresaw the bail-out of weakened banks, and the losses for their shareholders. “Remember that a bail-out of the banking system, which the authorities will surely attempt in the event of a debt collapse, does not necessarily mean a bail-out of bank holding companies or shareholders. Depending upon the political climate and administration at the time the music stops, there might even be a de facto nationalisation of major American banks — an outcome less far-fetched than it might seem. In a time of crisis, the government may be the only entity large enough to save the vulnerable banks.” Only the Federal Government was big enough to rescue A.I.G.

The U.S. real estate market, terrorism, debt, interbank lending and nationalisation of U.S. banks have all figured in the development of the present crisis. We did not get every issue right, but we did identify in 1987 the underlying insecurity of the global financial system. What we failed to foresee was the timing of the crisis. We saw its vulnerability, and pointed accurately to its weaknesses, but we did not see that so unstable a system could survive for twenty years of rapid economic and technological change. Will the Central Banks now be able to restore confidence after the events of last week? It will be some months, perhaps years, before we know the answer to that question.

Regards,
Lord William Rees-Mogg

Source: Forecasting the Crash

It is a government’s duty to provide its people with opportunity. So we must thank Alistair Darling for giving us with his wise words on Saturday what has to be the easiest money-making opportunity of the year: to sell the pound as soon as the markets opened on Monday. Not since Northern Rock a year earlier has such an obvious trade presented itself.

I said in MoneyWeek’s New Year predictions for 2008 that I wouldn’t rule out a sterling crisis later in the year. That moment is looking more and more likely. If it is the government’s intention to devalue sterling as quickly as possible, it’s hard to see how they could improve on the job they’re doing.

Then again they may just be incompetent.

The story behind the pound’s devaluation

Let’s start with some charts of sterling. Two pictures that each tell a thousand ugly words. The pound against the euro:

And against the dollar:

The downturn accelerated in October-November 2007, shortly after Gordon Brown announced that he would not be holding a November election. The horrid realisation must have dawned on forex traders that we had three more years of the bloke and they began hitting the sell button. But it was an orderly decline. ‘He can’t last three years, surely?’ they thought.

Then as August began, the grim reality hit home that not only was he coming back from his holiday, but that he had no intention of resigning, despite dire Scottish election results. We had what is known as a mad rush for the exit, punctuated by a brief moment of respite as somebody won another gold medal, then downwards into the abyss.

Just as you thought you could take a breather last Saturday – perhaps watch a bit of footy or take a stroll by the river – Darling has his Road-To-Damascus-Meets-Trisha moment and onwards and downwards went the pound.

Anything that you, me or my Aunt Joan own which is denominated in sterling has lost 15% of its value in a year in currency alone.

Devaluing sterling effectively devalues the Government’s debt, so you might think for a second it’s deliberate. But you know deep down it isn’t. It’s that old Labour favourite: incompetence.

The Government can’t hope to save the housing market

Do they honestly think they can save the housing market? With this new £175k stamp duty threshold, I feel sorry for anyone who is struggling to sell a property currently valued at £250k. Before you can say party political broadcast, they’re going to be getting a whole load of offers at £175k, plus some cash for curtains and white goods.

Interest-free loans to help low earners to get on the housing ladder! If they’re low earners, why are you trying to get them into debt? That is highly irresponsible, is it not? How will they pay that debt back? They might go on to become high earners, yes, but then they might not – and with this lot in charge of the economy the latter is more likely – and what then? This is imprudent lending – the very cause of the problem.

Read the full article

Source: How House Prices Could Fall by 75% from Here, in Gold Terms

Turns out – would you believe – that the Newcastle-based lender, a pioneer of 125% mortgages and one of the most dominant lenders right at the peak of the market in early 2007, is getting clobbered by much higher-than-average default rates. Surprise, surprise!

Sarcasm aside, the Rock is just the tip of the iceberg, if you’ll forgive the slightly mangled metaphor. The rest of the UK banking system, or certainly the bit that isn’t effectively bust already, is getting set to slam down the loan window shutters as it runs shorter and shorter of money.

It all promises to be a very unhappy 2009 for borrowers…

Northern Rock is suffering much higher-than-average default rates

There’ve been probably more column inches within the last year devoted to the sorry Northern Rock nationalisation saga than to any other company in the country, so I’m not going to add to them by talking about the right and wrongs of what the financial authorities did or didn’t do.

We’re stuck with it. But if anyone’s looking for any further evidence that offering 125% mortgages is a completely brainless idea, particularly if the lenders responsible proceed to scatter their cash around like confetti, the latest news serves that up on a plate.

It turns out that from what The Telegraph calls “previously unseen documents” that Granite, the £40bn so-called ‘off-balance sheet securitisation vehicle’ which holds many of the mortgages issued by the Crock, is anything but rock-solid.

Payment arrears of 90 days or more on mortgages on Granite’s books rocketed by two-thirds between this year’s first and second quarters, according to the credit monitors at Standard & Poor’s. That adds up to £508m-worth of dodgy home loans, even though rival banks saw relatively small increases in delinquencies. What’s more, repossessions soared by 163% between the first and second quarters, again much worse than virtually every other lender.

The loan-to-value (LTV) ratio is another potential disaster. Average LTVs were 77% for Granite compared with 60% typically elsewhere, with almost 30% of Granite’s loans at LTVs of 90%. That means a large chunk of borrowers will soon be dropping into negative equity territory as the housing market gets worse.

Today’s Nationwide survey said that UK home values have already plunged 10.5% over the last year after a further 1.9% fall in August, while the Bank of England’s governor Mervyn King this month forecast “a significant adjustment” downwards in house prices.

Read the full article

Source: Northern Rock, Yet More of Your Cash Down the Drain

But by keeping interest rates below the rate of inflation for three straight years starting in 2002, the Fed created a bubble in the housing market. That bubble has now popped, leaving in its wake a severe liquidity crisis.

Now big banks won’t lend without the backing of government bonds, and the Fed continues to inflate money supply. All good news for gold, says Adrian…

So Alan Greenspan – former chairman of the Federal Reserve – thinks this equals the Great Crash, if not out-bads it.

“It’s getting increasingly evident that this is a once-in-a-century type of phenomenon,” he told the ever-fragrant Maria Bartiromo in an interview with CNBC this week, “not the standard type of liquidity crisis that we have seen in the past.

“It’s verging on the issue of solvency.”

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To gauge the true scale of this crisis, Greenspan went on, just consider the fact that it took sovereign credit to stabilize first the U.K. and then U.S. financial systems. When Northern Rock went belly-up last Sept. and then Bear Stearns (NYSE:BSC) blew up this spring, Treasury bonds had to be lent out like adjustable-rate home loans circa 2006, covering short- term black holes with government debt.

Without these loans of government bonds, the banks simply wouldn’t lend to each other. They needed securitized tax payments to gain the credibility needed for raising new funds in the market. Short of offering government debt to put up as collateral, they found the cost of borrowing money – when they found any money to borrow – simply too high to bear.

“It’s still very evident from [inter-bank lending] spreads that we have not gotten closure yet,” Dr. Greenspan continued, pointing to the ongoing premium charged for loans backed by anything other than sovereign credit. So to fix the problem – or at least tease it out for months if not years – clearly the world needs more government bonds for the big banks to borrow and put up against cash loans in the market.

“It’s essentially, fundamentally the price of homes in the United States which are determining… the ultimate collateral of mortgage-backed bonds, pretty much around the world.”

Looking ahead, he concluded that “we’re still nowhere near the bottom of the home-price thing” – the word “thing” standing in for “crash…collapse…crisis…deflation” and all the other phenomena Greenspan must still believe can never apply to real-estate prices.

As key contractor, if not the architect, of today’s pan-global banking crisis, he chose to keep U.S. interest rates way below the rate of inflation – making debt pay and savings a suck of real value – for three years straight starting in August 2002:

That period marked the first run of sub-zero returns paid-to-cash since the inflationary ‘70s, back when loose money worldwide led to a bubble in prices that needed 20% interest rates to revive the world’s faith in the dollar.

The start of this decade also saw the gold price – dormant-to-dead ever since the U.S. took that strong medicine at the start of the ‘80s – double inside five years.

“First warning,” as Marc Faber wrote in his Gloom, Boom & Doom Report of Sept. ‘07, of trouble ahead.

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“Ultra-expansionary U.S. monetary policies with artificially low interest rates led to bubbles all over the world and in every imaginable asset class. The price of gold more than doubled in nominal terms and against the Dow Jones Industrial Average.”

So why didn’t gold take a dive when Greenspan’s successor – Ben Bernanke – tip-toed his way back to 4% real rates of interest in late 2006…? Because early gold buyers never believed the Fed would succeed in keeping rates there. With housing now a political issue – and home ownership a god-given right for even the flakiest debtors – the first sign of trouble would cause a collapse in real rates, destroying the value of money in the hope of achieving “Reflation Part II.”

Hey, it worked after the Tech Stock bubble blew up. Why not again? And faced with a much greater crisis, or so Ben Bernanke believes, he’s managed to out-Greenspan the Maestro… pushing real U.S. interest rates way down to minus 3% and worse.

Take gold as a marker of stress, and the true extent of today’s crisis becomes clearer still. Bear Stearns’ firesale to J.P.Morgan (NYSE:JPM) in mid-March – which required an open-ended loan of $29 billion from the Federal Reserve – saw gold jump to $1,032 per ounce. We think it’s a signal that Alan Greenspan ignores it.

“Central banks, of necessity, determine what the money supply is,” as he told Congress in a 1999 hearing. “If you are on a gold standard or other mechanism in which the central banks do not have discretion, then the system works automatically.

“The reason there is [now] very little support for the gold standard is the consequences of those types of market adjustments are not considered to be appropriate in the 20th and 21st century. I am one of the rare people who have still some nostalgic view about the old gold standard, as you know, but I must tell you, I am in a very small minority among my colleagues on that issue.”

Today, almost a decade later, the Federal Reserve and its peers across the world are trying to prevent the money supply from shrinking again. That was the fear amid the “Deflation Scare” of 2002, which caused the Fed to ordain sub-zero rates, creating not only the bubble in housing but also the collapse of true money values against oil, food and pretty much all raw materials.

The world’s nostalgia for gold, in response, has seen it treble in price vs. the dollar and more than double against the Euro, Yen and British Pound. But the cheerleader for cheap money when running the Fed, Alan Greenspan, points instead to government bonds when gauging the size of today’s crisis. A true policy wonk, Greenspan thinks only of political bailouts to protect the system, rather than considering how private investors might choose to protect themselves and their wealth.

Heaven knows they won’t get any help from Bernanke’s repeat of the Maestro’s “reflationary” error.

Source: Sorcerer’s Apprentice

It probably won’t be long before the US government nationalizes General Motors (NYSE:GM), says Bill Bonner in The Daily Reckoning.

Who’s really responsible for bringing down the likes of Fannie and Freddie? Look no further than the US government’s over-active dollar printing press, says Bill…

In the news last week was word that the Argentines are taking back their national airline – Aerolineas Argentinas. Back in the heyday of privatization – led by economists from the University of Chicago – they sold it to a Spanish group. But now the Iberians can’t seem to make a go of it – not with oil over $130 a barrel – so the Argentines are re-nationalizing it.

What is the likelihood that the heirs to Juan Peron will do a better job of running an airline than a private company? You might put the same basic question to Gordon Brown. What are the odds the Labor Party will run Northern Rock better than private owners? And in the United States of America – almost 30 years after the Reagan Revolution – the federal government is effectively nationalizing the biggest and most important financial institutions in the world, Fannie Mae and Freddie Mac.

Between the two of them, Fannie and Freddie hold almost half the entire nation’s mortgages – equal to about a third of the US GDP. It probably won’t be too long before General Motors is nationalized too. Someone is going to have to pay GM’s pension bill. Even if the company isn’t nationalized, its health and pension obligations probably will be. But can America’s Republicans and Democrats do a better job of running a mortgage company or an auto company than card-carrying capitalists?

On the evidence, maybe so.

Milton Friedman warned that if you put government in charge of the Sahara there would soon be a shortage of sand. But the heirs to Friedman have some explaining to do. The smartest of them have crashed airlines, busted banks and wrecked builders.

They’ve ruined businesses so simple that even a half-wit could have made a profit. Fannie and Freddie couldn’t win at their business, even though the deck was stacked in their favor from the very beginning. And the Friedmanites’ beloved markets – which are supposed to “look ahead” and anticipate trouble before it happens – must have shut their eyes years ago. They walked out into the blazing desert without a map or a hat; no wonder they’ve been acting strange.

To many of the world’s politicians and opinion mongers, the evidence of the last 12 months has proved what they always suspected – that capitalists are greedy s.o.b.s. But we would have spotted them that… and readily conceded that they are often morons too. Still, a system in which people get what they’ve got coming is infinitely better than a system in which people take only what government gives them. That’s the essential difference between capitalism and socialism: one yields to Armani-clothed fraud; the other to cheap-suit force. Both have their moral failings. But one is wicked; the other is merely dumb.

Want to know who caused Aerolineas Argentina’s bumpy ride… and who’s responsible for bringing down Fannie and Freddie? Follow the money. Before 1971, in the Bretton Woods monetary era, major economies used the dollar as a reference of value. The greenback was a North Star – helping businessmen and investors find their way. The U.S. dollar was reliable because it was tied to gold, which the U.S. Treasury promised to deliver to any country at a rate fixed at $42 an ounce. Then, on August 15, 1971, the U.S. Treasury reneged. Egged on by modern economists, the last link with gold was cut. Governments, investors and businessmen could still look to the dollar as a point of reference, but good luck to them. This disgraceful mischief caused even the stars to wobble.

Since then, the U.S. government could print almost as many dollars as it wanted. Arguably, it printed too many. For something – perhaps it was too much cash and credit in circulation – led American homeowners to think house prices would rise forever.

They over borrowed, homebuilders overbuilt, and Fannie and Freddie – even with all their Ph.D. economists on the payroll – over-lent. And something – maybe it was the same thing – caused the price of oil to rocket upwards 400% in the last five years. The airlines hadn’t seen that coming either. So, the big lenders and the high fliers are in trouble.

Those are only two of a long list of today’s troubles that can be traced…directly or indirectly…to the world’s monetary system of the last 37 years. Businessmen, consumers and investors respond to financial signals. If interest rates are set too low, they tend to borrow too much. If the money supply expands too rapidly, they expand too rapidly too.

To make a long story short, a bubbly supply of cash and credit led to bubbly markets. The U.S. and major foreign stocks market bubbled up to all-time highs in January 2000; then they headed down. In inflation adjusted terms, most never recovered. Then, in 2003, it was housing’s turn… followed by emerging markets… and lately, oil and commodities.

Sure, the capitalists are greedy. And sure, many of them make mistakes. But with feds rearranging the heavens, it’s a wonder they didn’t wash up more often.

Source: Lovable, Moronic Capitalists

The Fall of Northern Rock

The book is peppered with confessions of ignorance. He picked up not a single warning signal from the beginning of the debacle to the end. In early 2007, he thought nothing could stop the bank’s “fantastic progress”. When the share price started to fall later in the year, he assumed, along with his colleagues, that the media, jealous of the bank’s previous successes, had “it in” for it.

Walters knew little of the bank’s funding methods and was “blissfully unaware” that the sub-prime crisis in America might threaten Northern Rock – as, indeed, were his bosses, who launched a new discount tracker for buy-to-let investors in August 2007. And even in early September, just before all hell broke loose in Newcastle, he was busy flying off for a holiday in San Francisco with, as he says himself, very little idea of “what was really going on behind the scenes”.

It all seems rather extraordinary given that, although he wasn’t exactly a board director, Walters was head of commercial lending for the Leeds office, and given that even the most junior of financial journalists and analysts across the City had a very good idea of exactly what was going on behind the scenes.

Still, compare it with this week’s debacle – the profits warning and bungled rights issue at Bradford & Bingley (B&B) – and it doesn’t seem so odd after all. It looks like a mixture of total lack of awareness and mild stupidity is par for the course across the UK banking sector. Just like Northern Rock, B&B has clearly spent the last few years in total denial – refusing to accept that the housing market was in a bubble and hence fuelling the fire of its own destruction by providing the credit to keep the bubble growing.

And just like Northern Rock, senior management appeared to be blissfully unaware of the all-too-obvious risks to their business. At the start of this year, even as volumes – the canary in the coal mine to the housing market – collapsed across the country, B&B announced that it was relying on growth in its buy-to-let business to keep things going. Whoops.

But just as delusional as the bankers are those who were still holding B&B shares on Monday when their bad news at last appeared. Who didn’t know about the credit crunch? That buy-to-let in Britain is bust? That falling house prices and rising mortgage rates always lead to arrears and defaults? And who had forgotten that bubbles always end in corruption (B&B also announced on Monday that they’d lost £15m to mortgage fraud)? You might want to check one of them isn’t running your pension fund.

Source: Make Sure You Check Who’s Running Your Funds

Before we dive in, let’s have a quick refresher.

The Rock owes the Bank of England rather a lot of money (£27 billion). They’ve also got the European Commission on their back. It’s bad form, in a private market such as banking, to have one player who’s backed by a government. It’s just not cricket.

All of which goes to explain the following extract from the Rock’s website:

As you may be aware, one of our primary business objectives is to repay the Bank of England loan, as quickly as possible. We aim to achieve this over the next three to four years, through the creation of a smaller, more focused, financially viable mortgage and savings bank, which will ultimately be returned to the private sector.

Today we see another mini milestone on the road to the Rock becoming “a smaller, more focused” operation.

A lot of Rock mortgage customers are coming to the end of fixed rate deals. Ordinarily, lenders are keen to retain business, and it’s often easier for borrowers to remortgage with the same bank. But, of course, the Rock is in the process of creating “a smaller, more focused, financially viable mortgage and savings bank”.

So a metaphorical gangplank has been erected between the Rock and the good ship Lloyds TSB. Rock customers coming off fixed deals will be able to switch to Lloyds. If they don’t like that, they can try and find a deal they like in the wider market. Or they can stay with the Rock, but at much higher rates.

Our research director Theo Casey explains the deal with the aid of a handy six-point plan:

1. Northern Rock customers will receive Lloyds’ pamphlets and brochures on various mortgage deals.
2. Customer chooses the one they like and calls the Rock.
3. The Rock tells customer how much it’ll cost.
4. Customer says yes.
5. Lloyds TSB checks customer credit, gives thumbs up or thumbs down, and sends off the contract.
6. Customer signs contract. Bang!

“Can you believe it?” he asks. “The Government’s five-year-plan to halve Northern Rock’s mortgage book is spoon-feeding up to 180,000 customers to Lloyds!”

All well and good for Lloyds. But where does it leave Northern Rock, a bank which we’re all underwriting through our taxes?

Not in a happy place, I’m sorry to say. It all comes down to Point 5. Lloyds (quite reasonably) has the power to prevent bad business coming onto its mortgage book. It seems fairly obvious that it will.

So there’s a very realistic prospect that “our bank” will end up losing our best customers, while retaining the bad.

Add in the fact that the European Commission wants the Rock to speed up the process. That means there’s a great likelihood that too much profitable business will be lost before the Rock’s management can create a “financially viable” institution. Which in turn decreases the likelihood of the Rock ever being returned to the private sector.

We’ve been sold a dummy. The Government knocked up a plan that I’m convinced, in the fullness of time, will prove to be totally unworkable.

But by then this shower won’t be around to take the flak, will they?

And this week’s award for least surprising news goes to…

The Bank of England’s Monetary Policy Committee. It left rates on hold at 5% this lunchtime.

While the last two decisions generated a bit of interest, in a will-they-won’t-they sort of a way, this one was a foregone conclusion. Even I didn’t mention it yesterday, and I love this sort of thing.

Now we’ve got a whole new month to watch the next round of the Data Fight — that interminable process by which we see obscure reports competing for column inches and the attentions of policymakers.

One day we’ll see headlines of the “Oh My God, We’re Having A Recession!” variety, while the next we’ll see “Blimey! Inflation!”

What’s a Bank of England to do? For today, nothing, which was probably sensible.

Next month? Well, they’re gonna wait and see which kind of bad data comes out on top in Round June.

The story behind the story of the commodities boom

“We’re in a population bubble,” writes a reader. “If we wait for Mother Nature to reduce our population she will not do so very kindly. Better that we reduce our numbers ourselves.”

Garry White completely agrees. “Population,” he once told me, “Is the elephant in the room. It’s driving the markets, it’s the reason for the food crisis — yet politicians are scared to talk about it.”

For Garry, population growth is the ‘story-behind-the-story’ when it comes to explaining the boom in commodities. It’s not just that there are more people. It’s also the fact that many of them are richer, and therefore consume more.

Unlike many commentators, Garry doesn’t believe we’ll see a catastrophe in food… at least not imminently.

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“A pay-off bigger than we ever imagined!”

Manraaj Singh came bouncing into this morning’s meeting. He stood at the head of the table, a gleam in his eye, and waited for a hush to descend. Then, with a twirl of his moustache, he announced his big news.

“My copper play,” he said, “is on the verge of a huge pay-off. This is the Big One!”

It’s no wonder he’s pleased! Manraaj’s play is up 110% since recommendation. (Past performance is not a reliable indicator of future results).

Not only that, but Manraaj tells me he’s looking at ANOTHER great copper investment in a different part of the world. .

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Until tomorrow

Ben Traynor

Source: Lloyds TSB To Grab Northern Rock’s Best Customers

This we all know. But what if all goes wrong? What if the people the bank lends to don’t pay them back? What if too many savers want their deposits back? Basically, what if the bank runs out of cash?

Northern Rock posed this question last year. As well as using deposits, the Rock also topped up its lending from the money markets. But then the money markets seized up, and it was game over.

So the question was asked – what should be done now that it’s all gone wrong? It stumped the powers that be. The FSA, the Government, the Bank of England – they all scratched their heads. They scratched and they scratched, for several months, until they’d worn holes in the tops of their heads.

A bank is a private business. A bank that runs out of money, like any business that fails, can expect to go bust.

But, as we all know, that didn’t happen with Northern Rock. Once the head scratching was over, Northern Rock was nationalised. This marked a major deviation from the way private enterprise is supposed to work.

So now, the Treasury is drawing up plans for something called the special resolution regime (SRR). The idea is that in future the SRR would swiftly liquidate a failed bank, strip it of its assets and appoint new executives. Just as would happen with a failed business in any other sector.

But there’s a problem. Who will run the show? The FSA didn’t come out of the Northern Rock crisis very well. But the regulator would no doubt argue that its past performance should not be taken as a reliable indicator of the future.

Bank of England governor Mervyn King has reservations. He suggests there could be reluctance on the part of the FSA to pull the trigger if another bank fails. His reasoning is that this would be an admission of failure on the part of the regulator who allowed said bank to fail in the first place.

But the FSA counters that involving the Bank with a final decision would mean it would also inevitably become involved in monitoring, duplicating the FSA’s role.

Personally, I don’t really care who wins this little turf war. If I had to pick a side I’d go for the Bank. Call me a traditionalist.

A more fundamental question is how on earth have we got into this situation? As noted above, a failing bank should… well, fail. Adam Smith’s Invisible Hand is supposed to allocate the spoils of business to those most deserving. Those who get it wrong get less… if they get it really wrong they get nothing.

But the workings of the market have been gummed up by regulation. That and political fear (runs on banks don’t look good on the telly. Better do something, quick!)

It’s this political fear that creates moral hazard. The banks knew the Government would never risk letting them fail. So they were happy to take big risks.

Now an institution, the SRR, is being created to effectively force punishment upon banks that mess up.

Welcome to the age of the Visible Hand.

Hold your nerve, Merv!

Hurrah! It’s the day before the Bank of England’s Monetary Policy Committee (MPC) meets to decide what to do with interest rates.

Because I’m a sad man, I set up our very own Fleet Street Daily shadow MPC. Better-looking than the official MPC, our committee comprises seven wise men, one wise woman and Glenn, a bloke from Grimsby.

And my, was it close! A five-four split in favour of a quarter-point cut.

Not that this is what we expect the Bank will do. Nor necessarily what it should do.

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“And there’s also talk of US interest rates rising,” adds colleague Frank Hemsley. “That would put sterling in serious trouble! Especially if the Bank of England cuts our rates.”

Indeed. A weak pound would make imports – including food and energy – even more expensive. Meaning more inflation, and pressure to put rates back up if the Bank adopts a US Fed-style aggressive rate cutting policy.

Personally, I’d favour keeping rates on hold. Businesses and consumers are rational. They see the economy is struggling, and they’ve changed their behaviour accordingly. This is why each day we see new ‘bad data’. Cutting the base rate by a quarter-point will do little to change prevailing sentiment.

What it will do, though, is further undermine the Bank’s reputation as an independent inflation fighter. So I’m hoping the Bank stands firm and leaves rates where they are. It won’t be popular, but being popular is not the Bank’s job.

Cracking above 40,000 Deutsche Marks Per Kilo, the price of gold – when converted back from the Euros that German investors now clutch – promptly sank almost 14% from that 27-year top.

In the ensuing sell-off (to date) it bottomed (so far) at the equivalent of €561 per ounce on Tuesday. (You’ll note the caveats. The last real sell-off took the Euro gold price right down to a 20% loss.)

But our deep mistrust of technical analysis has failed to beat our fat crayons again. Because the gold market low (so far) coincides precisely with another key level in the metal’s long-term ascent:

The big “cathedral top” of May 2006…

The mainstream British and European press ignores pretty much all investment news by screwing its eyes tight and hoping the public won’t mind. Which we don’t, as a rule.

It takes some kind of mania to shake the mass of so-called “savers” to demand prices on tap (tech stocks at the end of ’90s; real estate until summer last year). Only a genuine scandal leads the press to wheel out a half-decent analysis (Enron, Northern Rock, Bear Stearns).

So it was disquieting to find gold splashed across the London media last month. Just as in May 2006 – the last blow-off top – the shiny yellow stuff even made an appearance in the tabloids, on radio and on breakfast TV. And the last time gold made headlines on the BBC news, any British, French, German or Italian investors choosing to buy gold lost one fifth of their money inside a month.

From 12 May 2006 to mid-June, the price vs. the Euro sank from €561 down to €450 per ounce. It took fully 18 months to recover that level, breaking it decisively at the very end of 2007.

And your crayon doesn’t need blunting to match that top with this week’s low (to date). So for now at least, that level – of €561 per ounce – marks the bottom of the latest plunge to clear weak hands out of the gold market.

Standing almost 14% below the new 27-year high hit on March 3rd this year, that former line of what professional chartists call “resistance” might just prove to be what they’d say is “support”.

If not, it will become “failed support” – the failure being the market’s fault, of course, rather than any error by the analyst or his thick wax crayon.

Adrian Ash
for The Daily Reckoning Australia

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Given the attention focused on how creditworthy our banks are, some may well be tempted, as The Daily Telegraph’s Stephen Ellis notes, to “stuff it all under the mattress”.

However, that is not only rather risky, but also should be unnecessary, thanks to an investor safety net – the Financial Services Compensation Scheme (FSCS) – which pays out if a bank or building society holding your cash goes bust.

At first glance, the scheme is pretty simple; if a bank goes bust and a customer is unable to recover a cash deposit via the normal liquidation process, then they are entitled to claim 100% of any amount up to a maximum of £35,000. So far, so reassuring. However, there are some quirks to be aware of.

First off, the £35,000 applies per person and not per account. So if you have two accounts with a single bank, say a current account and an online savings account, the balances are combined to test the £35,000 threshold. Also, some banks, such as HBoS, have a single Financial Services Authority (FSA) registration for all of their operations – including the likes of Intelligent Finance, Birmingham Midshires, Halifax and Bank of Scotland. That means you only get a single £35,000 claim to cover balances across the whole group. So a cautious investor should limit single deposits to £35,000 and, ideally, spread them across different banks.

It’s also worth noting that the scheme only pays out if your bank is FSA-authorised. You can check this on the FSA Register, or call them on 0845-606 1234. Be aware too that certain banks, such as Bank of Ireland, ING, Landsbanki and Fortis, get their primary authorisation to operate here from local regulators rather than the UK FSA. Although you would still be entitled to claim from the FSCS should the local scheme pay less than £35,000, the process may take longer, given the complexities of dealing with two different regulators.

If this all sounds like a lot of homework for a simple cash deposit, remember that the Government’s bail-out of Northern Rock suggests a major UK bank is unlikely to be allowed to fail, so the FSCS may never be tested. That’s perhaps just as well, given that under new FSA rules from 1 April it can only raise a maximum of £4bn a year in funding, hardly enough to cover all the deposits in a major retail bank.

But if you still have doubts, consider investing with the Government-backed National Savings Bank instead. One savings product stands out if you don’t mind locking up your cash short-term – index-linked certificates. Running for three or five years, the investment limit for each is £15,000. They each pay tax-free interest at 1.35% above the retail price index (a key measure of inflation) currently sitting above 4%. For a higher-rate taxpayer that’s equivalent to a gross annual return of just over 9%, with your deposit guaranteed by the Treasury.