We’re attending a financial conference here in Vancouver. Yesterday was actually the tenth anniversary of the Daily Reckoning. A group of readers took your editor to dinner and toasted him.

He was flattered… and grateful for the attention.

But we’re not kidding ourselves. Readers come up to us at conferences and tell how much they enjoy reading the DR. We wait for questions about Quantitative Easing, the Trade of the Decade, the Empire of Debt or other of our important themes. Instead, what they want to know about is:

“How’s your gardener doing? What’s Maria doing in Los Angeles? Did you ever figure out what happened to your missing cows…?”

Readers know what’s important. They want to know more about what really matters.

Still, we are foot soldiers in the lonely battle against economic claptrap; we must march on!

Yesterday came more evidence that the depression is over. The Dow shot up 188 points. From a technical point of view, if you believe that kind of thing, it looks as though the rally has farther to go. We recall setting a target of Dow 10,000. Perhaps we will get there.

Oil traded at $67 yesterday. Gold rose to $954 and bond yields on the 10-year T-note rose to 3.7%.

All of this sounds vaguely inflationary… and vaguely bullish. Besides, Goldman (NYSE:GS) stock is rising. And as we all know, what’s good for Goldman is good for the country.

Wait… we’re kidding… right?

Yes, we are kidding. What’s good for Goldman is generally bad for the country. Goldman makes money by separating investors from their money. Nothing wrong with that; someone has to do it. But the big banks are most profitable when speculation is rampant and debt is growing. That is, when people are going further and further into debt… and speculating on rising asset prices. We know you don’t really prosper by borrowing and gambling. But that doesn’t make casinos unpopular nor lenders unlawful. Bankers, like undertakers, benefit from human frailty. At least, they benefit as long as the government bails them out. Otherwise, they fall victim to their own human frailty.

But this is a minority opinion. Most economists disagree with us. And there are so many of them… if all the economists who disagreed with us were laid end to end… it would be a good thing. They believe that the economy is stabilizing… and on its way back to normal. Trouble is, ‘normal’ ain’t what it used to be.

Wall Street banks are making money, ‘tis true. But they’re not financing new businesses… or factories. They’re not aiding the process of capital formation nor allocating capital in ways that will result in new jobs and new industries. Instead, they are refinancing old debts… and speculating on zombie assets.

This will not increase the real wealth of the planet. Instead, money just changes pockets. Which, of course, raises an interesting question; where did all this money come from? If Goldman’s pockets are fatter, whose are thinner? If the four biggest banks earned a combined $11 billion in the last quarter… who did they take the money from? Who’s got that kind of money?
Meanwhile, we found out this week that the feds have wagered an amount equal to 170% of GDP in their attempt to bailout the world (more below). Part of that money was used to buy Wall Street out of the investments that they didn’t want. Which ones were those? Well, the ones that didn’t work out.

In other words, no wonder the banks are making money.

But while the banks are making billions, cometh another report from another sector – manufacturing. Caterpillar (NYSE:CAT) announced its results for the second quarter too. Profits were down 66%. In other words, while the banks were making money speculating with taxpayer’s money, Caterpillar was trying to make things and selling them to customers. Caterpillar not only makes things; it makes things that help other companies make things. Things with motors… big things… things that make noise and give off exhaust… things you use to dig holes and move dirt… things you need if you’re going to have a real economic recovery. Unfortunately for CAT, these things aren’t selling.

So what does this tell us? Well… it suggests that there is no real economic recovery at all. The real economy is suffering… sinking… and shutting down.

And more thoughts…

*** The banks are not earning their money helping Caterpillar expand. They’re making their money not because of a recovery, but because there isn’t one. In other words, they’re profiting from the financial stress of the early stages of a depression. There’s a post-crash bounce… and the government is sending a lot of money their way.

As for a real recovery – forget it. There’s no evidence of it. Unemployment is getting worse. Housing is still going down. Profits are going down. Those aren’t the things that presage a recovery… they herald a deeper, darker depression.

The depression darkens because people are not just being laid off – their jobs are disappearing. They do not get called back to work. Instead, they stay unemployed until they run out of unemployment benefits… and then the statisticians in Washington drop them off the unemployment rolls. Currently, the first batch of those people to reach the end of their benefits came this week. Last we looked, the Pennsylvania legislature was passing a law so they could continue drawing benefits for a few weeks more.

We’ve mentioned John Williams and his excellent service called Shadow Government Statistics. He looks at the numbers and figures out how they are twisted and tortured… and then figures out what they would be if they were treated properly. Currently, the unemployment rate nationwide officially is almost 10%. But if you computed the unemployment numbers the way they did back in the Great Depression, Williams says one in 5 people is out of work. In some places the figure is as high as one in four.

In other words, the unemployment numbers are already beginning to look like those of the Great Depression. But that’s true of almost all the numbers. They’ve all got a ‘30s era look to them. And if you stopped water boarding them, they’d tell a similar story. Almost all the indicators are worse than any we’ve seen since WWII.

Unemployment, trade, defaults, foreclosures, bankruptcies, prices, manufacturing… you name it and you have to go back to the end of WWII to find similar numbers. Of course, at the end of the war the wartime economy shut down. Millions of people who have been in uniform… or making tanks and airplanes… were suddenly out of work. Economists thought the economy would go right back into the Great Depression.

Instead, it boomed. Those soldiers and their families had savings. They had pent up demand – they hadn’t bought a new car in 10 years… they were young… they got married… they had children… they needed baby cribs and houses. We remember going to look at one of the first major suburban developments as a child – Harundale – in Maryland, built by the Levitt company…

…Horrible place. But you could buy a house for peanuts… on credit. And it set the pace for the suburban consumer credit expansion of the next half a century.

But what was normal for so many years is not normal any more. Now, consumers are paying off debt faster than any time since 1952. The government, however, is making up for them. Goldman may no longer be able to push more credit onto the public; but it can push one heckuva lot of debt onto the public sector. Wall Street firms helped households ruin themselves in the Bubble of 2003-2007. Now they’re doing the same for the government, helping the feds raise money on a scale never seen before in human history.

As we said… no wonder they’re making money. Too bad.

Source: The Real Economy is Shutting Down

These are just the latest in a growing series of central bank-sponsored interventions. Each time the Fed swings into action, it inches ever closer to the moral hazard of an outright bailout for Wall Street.

In fact, this is the closest the Fed’s ever come to Ben Bernanke actually dropping dollar bills from a hovering helicopter! Give him time – he’s working up to it.

For Once the Fed Actually Timed Things Pretty Well

The Fed has been widely lampooned for being “behind the curve” in coming up with creative solutions to the credit crunch. They’ve been accused of being either too slow, or too timid, in acting to relieve the crisis.

Last week the Fed’s timing was perfect in rolling out its plan to allow big banks and other “primary dealers” in the financial sector to swap their mortgage-backed securities (of highly questionable value) for high-grade U.S. Treasuries. This $200 billion credit swap has a term of 28 days. That’s just enough time to tide troubled financial firms over safely into the middle of April, after the books are closed on first quarter results on March 30!

In fact, the Fed is pulling lots of strings these days just to keep the financial system solvent. Consider the great credit ratings cover-up that’s currently taking place.

Rating Agencies Turn a Blind Eye to Wall Street’s Misfortune

A recent Bloomberg article details how the nation’s largest credit rating agencies have turned a blind eye to deteriorating credit-worthiness in Wall Street issued asset-backed securities.

“Even after downgrading almost 10,000 sub-prime-mortgage bonds, Standard & Poor’s and Moody’s Investors Service haven’t cut the ones that matter most: AAA securities that are the mainstays of bank and insurance company investments.” In fact, an estimated US$120 billion in sub-prime bonds – still rated AAA by the agencies – DO NOT meet the standard for such top ratings.

In fact, some of this AAA-rated debt has fallen as low as 61-cents on the dollar amid record home foreclosures and sky-rocketing default rates among similar bonds. According to one hedge fund manager interviewed by Bloomberg, “Downgrades of AAA and AA bonds are imminent, and they’re going to be significant.”

A look inside one of these bonds tells a frightening tale. A US$80 billion sub-prime asset-backed bond issued by Deutsche Bank in 2005 is still rated AAA by S&P and Moody’s. Yet, 18% of the mortgage loans in the security are in foreclosure.

Additionally, lenders have already seized 15% of the properties underlying the loan values for this security. Another 10% have been delinquent for more than 90-days.

Another Morgan Stanley Capital sub-prime mortgage-backed security has credit support of 64% relative to the number of delinquent mortgages loans in the pool. But the credit should be at least twice the delinquent mortgages to maintain a top rating.

Why This Junk Isn’t Rated As “Junk”

Technically, much of this so-called triple-A rated debt should have been downgraded long ago. So why hasn’t it? The simple answer is: Fear of too much “collateral damage.”

According to Bloomberg, “Financial firms own high-grade collateralized debt obligations, which package securities such as mortgage bonds and slice them into pieces with varying risk. As the underlying mortgage bonds are downgraded, those securities will also lose their ratings and tumble in value.”

There’s a huge potential “contagion” effect that would ripple through the financial system if Moody’s or Standard and Poor’s dared to downgrade these shaky sub-prime credits across the board. For instance, a bank holding US$100 million of AAA-rated sub-prime bonds needs just US$1.6 million in capital backing such a highly rated credit. – that’s a lot of leverage. And such leverage is fine, as long as the bonds remain triple-A rated.

Should the bonds get downgraded to below investment grade however, under global accounting rules, a bank must put up additional capital. In fact, it would take US$16 million in capital to back US$100 million in non-investment grade bonds.

That’s 10 times as much capital required in the event of a credit ratings downgrade. Wall Street just doesn’t have that kind of extra capital lying around. Bear Stearns found this out the hard way over the weekend. That’s why I expect the major ratings agencies, perhaps abetted by the Treasury Department and the Fed, to continue covering-up the true health of US$650 billion in outstanding sub-prime bonds.

Should these ratings get cut now, the consequences might be unimaginably bad for Wall Street. Think the “financial day of reckoning” that I mentioned last week.

A Nightmare in the Making

At the risk of sounding like an alarmist, I just have one question. What happens to confidence in the U.S. financial system (not to mention the dollar) when people wake up and realize these fairy tale markets (held up by fantasy ratings) turn into a nightmare?

The Fed is merely monetizing Wall Street’s mistakes yet again, while leaving future generations of taxpayers with an even bigger tab to settle, and higher future inflation to fight.

But there’s just no time for such ponderings now, we’re in the midst of a full-blown financial crisis after all. Damn the financial torpedoes, full speed ahead with the monetary printing press.

MIKE BURNICK, Senior Editor & Global Markets Analyst

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