And Warren Buffett came out saying he’s buying equities again. All the while, the dollar is sitting at an 11 month low, and gold touched $1006 this morning.

As I perused the underground, I came across a piece by Jeff Harding of the Daily Capitalist that I had to share. He begins by asking, “how has the playing field for our economy changed and how will those changes affect our future? The answer to these questions will determine the future of the world’s economies.”

He then outlines the 7 mega-trends that will dictate our economic future. We’ve touched upon many of these ideas in previous issues. But here they are:

• Megatrend No.1. The culture of consumption is broken and won’t return to former levels. This is the key to everything.
• Megatrend No.1. The culture of consumption is broken and won’t return to former levels. This is the key to everything.
• Megatrend No. 2. Consumers will continue to increase savings to prepare for retirement.
• Megatrend No. 3. Declining U.S. consumer demand will continue to negatively impact the world economy.
• Megatrend No. 4. Deflation will continue for some time.
• Megatrend No. 5. Home ownership rates will decline to more historical levels of, say, around 66%, down from the high of 69% during the boom, which will keep a lid on home prices.
• Megatrend No. 6. Government stimulus and recovery programs only delay recovery and deepen the pain for workers.
• Megatrend No. 7. Massive federal deficits will double the national debt, result in higher taxes, and will act as a permanent drag on the economy.

If you have a chance, you should check out the piece in full. It is jam packed with facts and figures that will give you something to chew on for breakfast, lunch and dinner.

So where do these trends all lead?

All cycles eventually bottom out and growth resumes. The timing of any recovery is impossible to predict and for the most part it depends on what the government will do (or, hopefully, not do). The more the government interferes with the recovery process by propping up bankrupt banks, by manipulating the economy with fiscal and monetary stimulus, by creating a huge national debt, and by increasing taxes, the longer it will take.

With commercial real estate in serious decline, deflation will continue, and we’ll see more bank failures. While we may see a “bump” in GDP in Q3 and Q4, the liquidation of commercial real estate assets and other debt will accelerate. At some point, deflation will stop, and asset prices will find a bottom, as housing is starting to do now. My view is that the post-deflation economy will remain sluggish with high unemployment for some time. I believe that, unlike Japan, we will eventually see inflation.

There are significant differences between our economy and Japan’s and the comparison to Japan in the 1990s may not be entirely applicable here. The Japanese were reluctant to let banks and companies fail, but, despite a few notable exceptions, we aren’t. This is a necessary requirement for recovery, and we are better at “creative destruction” than are the Japanese.

Also, we have a more dynamic culture of entrepreneurship than Japan, making us more responsive to a recovery. However, the main difference is that Japan’s debt was largely financed internally due to their very high savings rate in the 1990s (about 14%). While our savings rate will continue to grow, I do not believe it will keep up with rising federal deficits, and we will need to finance our national debt on the international markets. This will drive interest rates up and put pressure on the dollar.

Then I believe inflation will assert itself as banks renew the lending cycle. I believe the Fed will maintain its loose monetary policy in order to keep interest rates down to stimulate growth. Governments always find it expedient to create inflation to give people the impression that the economy is growing. The problem is that inflation will depress the formation of real savings necessary to finance growth, and like the 1970s, we’ll see stagnation and inflation (”Stagflation”). If inflation gets out of hand, then, for a while we may see price and wage controls.

After that, who knows? Cut the money supply as Paul Volker did, and drive up interest rates and bring on a new recession? Continue to inflate? That’s too far in the future and politicians don’t think that far ahead.

The goal of the FED, as with all central banks, is three-fold: (1) to protect the largest
commercial banks from their depositors, who occasionally exercise their contractual right to withdraw currency (the ungrateful cads); (2) to control entry of newcomers into the bankers’ cartel (interlopers); (3) to keep the stock market from collapsing in a panic, thereby persuading depositors to withdraw currency.

With the Federal Reserve System’s latest proposal, presented to the public by Secretary of the Treasury Henry”Goldman Sachs” Paulson, the FED is asking the United States government to make it the Great Protector of Capital.

Think of the bank run scene in “It’s a Wonderful Life.” Ben Bernanke wants us to view him as kindly Jimmy Stewart, handing out his honeymoon money to save the family
business from fearful depositors who want their money back. Sorry, but the best I can mentally conjure is an image of Donna Reed with a beard.

The Federal Reserve System has always been presented to the voters as the lender of last resort, the provider of the national safety net. But because of the now-admitted
fragility of the present leveraged financial system, the FED has become the deal-doer of first resort. When the New York FED intervened on Sunday, March 17, to cobble together an emergency deal for J. P. Morgan Chase to buy out Bear Stearns’ investors for $2 a share (the price had been $10 on March 15 and $68 on March 11), the New Domestic Order was made visible. The FED, not the capital markets, will set prices of financial institutions whenever the FED’s bureaucrats deem this necessary.

Anyone who says that the FED is not using its government-granted monopolistic power over money to protect the capital markets from the now-unpleasant effects of the
FED’s actions under Alan Greenspan deserves to be a Bear Stearns investor.

MORAL HAZARD AND UNCLE SCROOGE

“Moral hazard” is the phrase that describes one negative effect of guaranteeing the survival of a group of companies or an entire industry that have made bad investments, but which are then bailed out by the government or its licensed agent, the Federal Reserve System.

What is this negative effect? To promote future high-risk loans or investment strategies that offer above-market rates of return because of this risk.

The decision-makers, knowing that their rich uncle has previously guaranteed that several large firms were not allowed to go bankrupt, now pursue investment strategies
which they would not pursue if they believed that they would be held fully accountable for their actions. Senior managers see that their peers were bailed out. They think,
“We will be bailed out, too.” Uncle Sam is the rich uncle. And also Uncle Ben –
not the rice fellow: the FED fellow.

There is another Uncle with a lot of money: Uncle Scrooge. Uncle Scrooge was never dumb enough to offer his nephew Donald an insurance policy for Donald’s schemes to
make money. If he had, he would have found himself handing out a lot of money.

Uncle Scrooge understood the effects of insuring profit-seeking schemes by people who have been given security from their own mistakes. How do I know what Uncle Scrooge thought? Because I knew him personally. Well, not quite. I knew his advisor.

For many years, the man who wrote the story lines for the Uncle Scrooge comic books was Vic Lockman. He was a professional cartoonist. Back in 1969, he published a
cartoon booklet on the Federal Reserve System, “The Official Counterfeiter.” That booklet deserves to be posted on some website, or lots of websites.

Uncle Scrooge had a vault full of gold coins. So does the Federal Reserve System, or so we are told. Uncle Scrooge owed his coins. The FED holds gold bullion bricks
as a reserve for a part — a fixed part — of the money supply of the United States. It does this on behalf of the United States (it says here). That gold may still be in the vault at the New York FED, or it may not. Members of Congress do not know, nor do they know what, if anything, is in the vault at Fort Knox. Congress is assured that the gold is there. By whom? By the handful of Treasury and Federal Reserve bureaucrats who have access to these vaults.

So, with gold as a reserve — we hope — and with government debt as a reserve, and with mortgages handed over to the FED by banks and financial institutions in exchange for Treasury debt, the Federal Reserve System regulates America’s money supply, or tries to.

It now wants to regulate far more than the money supply. It wants to regulate the institutions that lend or invest large chunks of the nation’s money supply. Why? Officially, because of the fragility of the financial system. That, at least, is the implication of Secretary Paulson’s published statements. The financial system was not seen as fragile in July, 2007, but it is now. On the contrary, the system was said to be A-OK in July, 2007, but not now. Everything is different today.

It isn’t different, of course. It is the same. What is different is that what was always implicit has now become explicit: the threat of falling dominoes. If the proposed legislation passes — and it will — things will be even more different in the future.

BAD MORTGAGES? LET’S WRITE MORE!

Recently, a memo issued by Wachovia Bank indicated that it would no longer make high-risk loans to home buyers. This sounds to me like locking the barn door after the horses have escaped. The memo got leaked. Then an amazing thing happened.
Wachovia’s response was neither to confirm nor deny.

You think, “Wait a minute. Why not confirm it? Why not admit that making high-risk loans is a bad policy?” Because Wachovia is regulated by the United States government. It must be very careful about refusing to make high-risk loans.

There is a bank lending policy called red-lining. Banks in the past refused to make mortgage loans in neighborhoods where there is a past record of high default rates. This policy is today illegal. The Federal government subsumes it under racial discrimination.

It’s not that red-lining was aimed at the Sons of Tonto. It was aimed at high-risk neighborhoods. And, because birds of a feather are said by the U.S. government
never to flock together, it’s illegal to discriminate against birds of a certain color.

We know that zip code marketing is very profitable. The Claritas company has broken the United States into 66 different neighborhood types: income, age, education, etc.
These are tied to nine-digit zip codes. It sells this information to marketers who want to plan sales campaigns for certain products.

Claritas has been doing this for years. How? Because birds of a feather really do fly together. Response rates to direct-mail solicitations do differ in terms of zip codes, right down to all nine digits.

Wachovia is still making loans called option ARMs. These loans involve an offer to a borrowed to pay less per month than is required to repay the loan. Each month, the
money left unpaid is added to the loan’s principal. Then, at some contractual trigger price for principal, the loan’s monthly payment jumps. The borrower may have to pay twice
what he had been paying. He may pay even more than double.

Why would anyone agree to accept such a loan? Two reasons: (1) he expects his income to rise sharply in the next year or two; (2) he is a person who does not read or
understand contracts and also believes in something for nothing. Here is a description of who might reasonably take such a debt.

Option ARMs are best suited to sophisticated borrowers with growing incomes, particularly if their incomes fluctuate seasonally and they need the payment flexibility that such an ARM may provide. Sophisticated borrowers will carefully manage the level of negative amortization that they allow to accrue.

In this way, a borrower can control the main risk of an Option ARM, which is “payment shock”, when the negative amortization and other features of this product can trigger substantial payment increases in short periods of time.

http://www.GaryNorth.com/snip/532.htm

We are now in a recession. The number of people who can expect big increases in their income next year is a small and declining figure. But Wachovia is still making
option mortgages. But aren’t option ARM’s the most vulnerable to default
of all mortgages? Yes.

So, Wachovia has a big problem. (1) It wants to make more of these loans; (2) it does not want to get prosecuted for red-lining. This led to the memo. On the one hand, Wachovia made no bones about its desire to continue to make option ARM loans. Where? In California. California? Where housing prices are plummeting? Yes.

Certain markets looked more risky than others. So, in these markets — Caucasian, middle-class places like Riverside County, where I lived for a decade — Wachovia
decided it might be wise to cut back on such loans. You and I know what happens to internal memos. They get leaked. But high-level people write memos never catch
on. So, the “Los Angeles Times” got a copy and published a story on it. The memo identified 17 counties where property values have fallen so far that the bank would no
longer write new option ARMs.

When asked to explain this memo, a bank official refused to comment. The policy is merely “under consideration.” The memo was sent “prematurely.” This is a tried and true response to embarrassing memos that probably goes back to Middle Kingdom Egypt.

http://www.GaryNorth.com/snip/533.htm

The present subprime mortgage crisis has been in full swing since August, 2007. Why in March was Wachovia still making these loans — in California, Missouri, or anywhere
else? This rule comes to mind: “When you’re in a hole, stop digging.” Why isn’t Wachovia honoring it?

I don’t know about you, but my assessment is that option ARMs are really bad ideas today. I first heard of these loans 30 years ago. They were not called option ARMs. They were called backward-walking mortgages. They were written by sellers of homes who wanted to take back those homes after a hopeful buyer defaulted on his loan. It was an interim program to get a house sold when the seller expected the house’s price to rise. He wanted a buyer to occupy the house. A renter usually does not take care of a house as carefully as a buyer does. So, house sellers used backward-walking mortgages to get a down payment out of a person who was virtually guaranteed to default. The person moved in, took care of the house, and was evicted right on schedule.

No one ever sold a house with a backward-walking mortgage if he expected the house to fall in price. So, I understand Wachovia’s concern with 17 counties in California. Frankly, I think this concern applies to 3,000 other counties in the United States.

But I don’t understand this aspect of the deal. Wachovia, unlike a seller of a home who is in the business of buying and selling homes, does not want to foreclose. Wachovia is not in the house-flipping business, except as a lender to house-flippers — a bad idea these days. Wachovia presumably makes loans that it wants borrowers to pay off. Then why does it still write option ARM loans?

My guess: because it can get more borrowers to sign the loans than if the borrowers understood that the loan contract they are signing is a backward-walking mortgage.
They want borrowers now. They don’t care about foreclosures tomorrow. They expect enough borrowers to keep paying. I think they are wrong. But I don’t make policy at
Wachovia.