Everyone also knows that some of the key culprits behind this financial mess were the credit-rating firms like Standard & Poor’s and Moody’s Investors Service, which assigned top-tier “AAA” ratings to investments that were actually backed by subprime mortgages and other toxic debt.

Whether it was collusion or incompetence almost didn’t matter: The firms claimed that the credit ratings they issued were constitutionally protected free speech. With this First Amendment shield, S&P, Moody’s and others said they were protected from lawsuits or other liabilities.

But that’s about to change.

A federal court judge in New York last week stripped the ratings firms of that defense, a decision that could expose the companies to billions of dollars worth of liabilities from investors who were burned by the faulty ratings.

Let’s legal case involved three specific firms – two firms that rated collateralized debt securities, and an investment bank that sold the debt. Those three companies were:

• Standard & Poor’s, which is owned by The McGraw-Hill Cos. Inc. (NYSE: MHP).
• The Moody’s Investor’s Service unit of Moody’s Corp. (NYSE: MCO), which is 19% owned by Warren Buffett’s Berkshire Hathaway Inc. (NYSE: BRK.A, BRK.B).
• And Morgan Stanley (NYSE: MS).

This particular case had been brought against Moody’s and S&P by Abu Dhabi Commercial Bank PJSC and Washington State’s King County. The case involved losses suffered from an investment in a structured investment vehicle (SIV) called Cheyne Finance. Although the debt securities Cheyne issued were backed in part by subprime mortgages, they received ratings as high as “AAA.”

In return for the high rating, the companies received higher-than-normal fees.

The $5.86 billion Cheyne Finance SIV went bankrupt in August 2007. The plaintiffs claimed fraud. The suit is seeking class-action status on behalf of investors who were burned when Cheyne was forced to dump securities it had issued between October 2004 and October 2007.

Since lawyers for the plaintiffs say the ruling could be applied to any deal involving SIVs, it could have a substantive impact. Before the financial crisis caused the value of these asset pools to plummet, experts estimate there were $350 billion to $400 billion worth of SIVs in existence.

“There certainly will be other cases filed – that’s the future impact of this decision,” San Diego attorney Patrick Daniels told The Wall Street Journal.

Moody’s and S&P had sought a dismissal, citing their First Amendment protections. But U.S. District Court Judge Shira Scheindlin ruled on Sept. 2 that securities ratings that were distributed to a small group of investors don’t warrant the same First Amendment protections that are afforded to the widely circulated ratings of corporate bonds.

Judge Scheindlin acknowledged that ratings constituting “matters of public concern” are typically protected from liability. That’s especially true when the ratings are distributed to the general public. But it wasn’t the case here.

“Where a ratings agency has disseminated their ratings to a select group of investors rather than to the public at large, the ratings agency is not afforded the same protection,” Judge Scheindlin ruled.

The ruling will likely be appealed. And it could end up in front of the U.S. Supreme Court.

The case spotlights the biggest problem with the business of rating securities: The ratings firms are paid by the issuers to rate them.

When you get right down to it, ratings firms are in business not to rate but to make money for themselves by rating issuers and their securities. The surprise isn’t that the obvious lack of objectivity fostered abuses in the credit-rating process – it’s that the problem took so long to come to a head. The complexity of mortgage-backed securities (MBS), collateralized mortgage obligations (CMOs) and collateralized debt obligations (CDOs) only exacerbated the investor risk.

The decision received widespread media attention. But it’s only half the story.

And the media missed the other half.

In an ironic twist that transforms the credit-rating firms into legal sacrificial lambs, the U.S. Securities and Exchange Commission (SEC) has in recent weeks acknowledged its own failure to protect the public from the same ratings firms that the federal agency mandates that investors rely upon.

This admission – combined with the legal assault on the constitutional protections ratings firms are used to hiding behind – could threaten the ratings firms’ very existence. It not only will further fuel investor ire, it could also provide litigants with additional needed legal ammunition. The ratings involve tens of billions – if not hundreds of billions – of dollars of failed securities.

A series of internal reviews by the SEC – one reaching back to last year – has highlighted some of the abuses.

About a year ago – in July 2008, to be exact – the SEC concluded a 10-month examination of the ratings industry that uncovered “poor disclosure practices and procedures guiding the analysis of mortgage-related debt and insufficient attention paid to managing conflicts of interest.”

According to the report, there was an obvious degree of knowledge and complicity in playing the ratings game.

E-mail exchanges between analysts at “unnamed” ratings firms back this up. In one, an analyst said the firm’s ratings model didn’t capture “half” of the deal’s risk, but said that the security “could be structured by cows and we would rate it.” In a Dec. 15, 2006 missive, a manager wrote that the ratings industry was creating “[an] even bigger monster – the CDO market.”

Confided the manager: “Let’s hope we are all wealthy and retired by the time this house of cards falters.”

In July of this year, in testimony to Congress, SEC Chairwoman Mary Shapiro said she supported proposals to impose liability standards that would make it easier for investors to sue credit ratings firms. That’s a bit ironic given that the SEC is charged with supervising the ratings firms.

According to the internal investigation conducted by the Office of Inspector General, the SEC failed to exercise its duties as the nation’s watchdog of the same credit ratings firms that many large investors are forced to trust.

By law, certain investors must rely on the ratings of a handful of companies, known as  “Nationally Recognized Statistical Rating Organizations,” or NRSROs. In many cases, the NRSROs determine what are “eligible” or “appropriate” investments. And it’s the SEC that determines who is, or who can be, an NRSRO.

For instance, most state insurance regulators say that insurance companies can only invest in assets that carry one of the top four credit ratings. And it’s the NRSROs that certify those ratings.

Similarly, money-market funds can only invest in the highest NRSRO-rated securities.

Countless institutions – public and private, domestic and international – rely on rules that determine what assets are acceptable investments. And that acceptability is determined by financial due diligence and the resulting credit ratings – as determined by SEC-certified rating agencies.

It’s not clear that any of this is really protecting investors, according to a Feb. 15, 2008 “Review & Outlook” piece in The Journal. Drexel University Finance Prof. Joseph Mason took a look at CDOs that were “Baa” (an investment grade rating) by Moody’s. His finding: They were 10 times more likely to default than equivalently rated corporate bonds.

In that same article, an S&P spokesperson was asked if they actually examined the mortgage debt that made up the investment pools that make up a CDO.

The spokesperson’s answer was not confidence-inspiring: “We are not auditors; we are not accounting firms.”

Source: The Credit Rating Firms Are Running Scared – It’s About Time

I guess those were the good old days, before the credit crisis renewed the world’s faith in the dollar.

Today if you take one look at the chart of the U.S. Dollar, the only thing you see is strength.

This is a chart of the U.S. Dollar Index ($USD) which charts the dollar’s strength against six major currencies. The first thing that you’ll notice is the dollar’s 22% move from 71 to around 86.

But the second and more interesting development is a new bullish diversion.

A bullish diversion occurs when an indicator such as the Slow Stochastic is showing a move from overbought (80 or above) to neutral (50 – 80)… while at the same time the stock does not really drop in price.

If you’ll notice, the Slow Stochastic has been dropping since the middle of January. Yet the stock price has remained virtually flat. This is a bullish diversion in its purest form.

Typically when you see this happening, it gives you an early indication that prices will move higher. If this bullish diversion is right, then we could very well see the dollar rally past its peak at 88 and go past 90 by the end of the year.

For you FOREX bugs out there, taking a long-term bullish position in the dollar should pay you greatly by the end of the year.

Geithner painted the picture of the latest U.S. recovery attempt in broad strokes, outlining the “key elements” of his proposal:

• Promoting greater transparency and stricter oversight of both established and new financial stability programs.
• Providing capital to institutions in desperate need of a cash infusion.
• Committing up to $1 trillion to support consumer and business lending.
• Addressing the housing crisis and reducing foreclosures.

Geithner was critical of the previous administration’s handling of the crisis, saying previous attempts to support the economy were “not comprehensive or quick enough,” and that “the spectacle of huge amounts of taxpayer assistance provided to the same institutions that helped caused the crisis added to public distrust.”

Hoping to rectify this, the first step of Geithner’s plan calls for stricter oversight of taxpayer funds.

“The American people will be able to see where their tax dollars are going and the return on their government’s investment,” the Treasury Secretary said. “They will be able to see whether the conditions placed on banks are being met and enforced. They will be able to see whether boards of directors are being responsible with the taxpayer dollars and how they are compensating their executives. And they will be able to see how these actions are affecting the overall flow of lending and the cost of borrowing.”

This information will be made available on a new Web site: FinancialStability.gov.

As far as addressing the crux of the current financial crisis, Geithner described three new programs aimed at strengthening the nation’s banks and jumpstart lending.

First, banks that seek financial assistance will undergo a “carefully designed comprehensive stress test” that will determine which institutions are most in need of capital. Those institutions will then be given access to funds from the Treasury, but only if they agree to specific terms named by the government.

In crafting his plan, Geithner reportedly rebuffed calls from some of President Obama’s top advisors to implement more austere restrictions of executive compensation and dictate to banks how to spend the rescue money.

Geithner instead opted for economic incentives to encourage lending, arguing that stark, interventionist measures would be more expensive in the long-run and ultimately undermine the government’s credibility, The New York Times reported.

Geithner also announced the creation of a Public-Private Investment Fund, which will buy up many of the toxic assets that have bogged down banks’ balance sheets. This fund, which has also been referred to as a “bad bank,” will be jointly managed by the Treasury and the U.S. Federal Reserve and bolstered by financing from private investors.

“By providing the financing the private markets cannot now provide, this will help start a market for the real estate related assets that are at the center of this crisis,” Geithner said. “Our objective is to use private capital and private asset managers to help provide a market mechanism for valuing the assets.”

The fund is expected to spend about $500 billion initially, and could easily expand beyond that.

The third and final measure intended to revitalize credit markets involves a vast expansion of the Federal Reserve program for consumer and business loans.

“Working jointly with the Federal Reserve, we are prepared to commit up to $1 trillion to support a Consumer and Business Lending Initiative,” Geithner said. “This initiative will kickstart the secondary lending markets, to bring down borrowing costs, and to help get credit flowing again.”

In the U.S. financial system, 40% of consumer lending has historically been available because people buy loans, according to Geithner.

In addition to these measures, the Fed and the Treasury will commit $50 billion to reduce mortgage payments for homeowners facing foreclosure. A legislative proposal giving bankruptcy judges more authority to modify mortgages on terms more favorable to borrowers will also be renewed.

“As house prices fall, demand for housing will increase, and conditions will ultimately find a new balance,” Geithner said. “But now, we risk an intensifying spiral in which lenders foreclose, pushing house prices lower and reducing the value of household savings, and making it harder for all families to refinance.”

“The President has asked his economic team to come together with a comprehensive plan to address the housing crisis,” the Treasury Secretary added. “We will announce the details of this plan in the next few weeks.”

Source:  Geithner Unveils TARP Overhaul

Yesterday, we received some really awful data here in the U.S. but the dollar rallied… This just shows to go you that the Trading Theme of rewarding the dollar every time the data shows more deeper, darker, and dangerous times for the economy. What this does, is send the “risk takers” hiding behind rocks, and afraid to come out of the locker, they are as nervous as they can be… And no, it’s not because they’re wearing an itsy bitsy yellow polka dot bikini! It’s because the waters for them are rough when the Trading Theme is in place.

With no risk takers, the currencies just don’t have any support… Except for… Drum roll please… Japanese yen! I’ve explained this phenomenon so many times in the past 6 months that I just can’t get myself to do it again this morning, but you know the story… Risk takers leave, unwind their “risky trades” and this all benefits yen… The yen is trading within spittin’ distance of an 87 handle this morning… WOW! And to think people laughed at me for the last couple of years when I said this would all happen… That the carry trades would eventually unwind, and the high yielders would get sold, and Japanese yen would get bought thus producing a rally for yen…

Yen would tease us, and go to 105, 104, and then back to 110, 115… But I held true to my thoughts that the next leg down for the dollar would be VS the Asian currencies led by Japanese yen.

OK, so the dollar has the other “non-yen” currencies on the run going into the weekend. The data yesterday had a lot to do with this, so let’s review what printed yesterday…

First of all, we had the Weekly Initial Jobless Claims… OMG! The forecast was for 542K Jobless Claims to have been filed last week… But the number was actually 589K! OUCH! That’s crazy folks, nearly 600K people filed unemployment papers last week! First of all, these last two reports (last week was 527K), show that the drop below 500K in the previous two reports were not an indication of any kind that layoffs had bottomed, instead this was caused by the holidays, as I said at the time… A Head Fake as we call it in the markets… I think that this number is going to be maintained in the next few reports too, unfortunately!

Then we had the Housing Starts and Building Permits data… Housing starts for December collapsed to 550K, a new record low. Building permits for December also collapsed to a new record low of 549K. These two pieces of data go back a long way (1959)… You have to go back to 1991 for Housing Starts to show this kind of weakness and even then they were higher than this print… And you would have to go back to 1975 to show this kind of weakness in Building Permits… And again even then they were higher…

This, to me, is the adage that you’re gonna get what’s coming… The massive overbuild of houses in the U.S. in the past decade was bad enough… But then we had the massive credit crisis… I saw a headline somewhere that said the U.S. McMansions, were being “right-sized”…

There are scheduled data prints today… I think we probably need a day to recover from those three reports that printed yesterday!

OK… The tax cheater… Oh, that reminds me of the local guy here that had a big hit back in the 60’s called “The Cheater”… Bob Kuban and the In-Men… Haven’t you heard about the guy, known as the Cheater? He’ll take your money and then he’ll lie and cheat on his taxes…

HAHAHAHA! Our soon to be brand spankin’ new Treasury Secretary, a.k.a. “the cheater” Tim Geithner is already going after the Chinese… I know why he’s doing this right out of the starters blocks… He’s trying to get everyone to get their minds off his personal problems with the IRS, the agency that he now heads! Now… Here’s a memo from me to “the cheater”… Ahem… I would think the Chinese are now laughing their socks off, at least the old Treasury Secretary didn’t have skeletons in his closet, or at least we didn’t know about them!

Now, here’s a guy with little credibility, in the eyes of the Chinese (I believe), telling them that “President Obama believes you are “manipulating” its currency”… Here we go again folks… Blaming the Chinese for our problems… When we should be getting down on our knees and thanking them for buying all our debt the past decade… OK… This has gone on enough, time to go to something else, I could feel my blood pressure rising, and I’m not in the mood to be in that frame of mind today!

The Fed’s FOMC meet’s next Wednesday… I don’t expect the Fed to go the remaining 25 Basis Points (1/4%) to zero, as there’s no reason for them to use the last arrow in their quiver, no matter how small that arrow is… Besides, they’ve done all this cutting and have little to show for it. I think it would behoove them to sit back and give the previous rate cuts a chance to work… That is if they are going to work… Remember, it’s been my stance, that it’s not a case of the cost of credit causing the credit crisis, it’s a case of the lack of liquidity causing the credit crisis… So… In my mind… I didn’t see the need to cut rates all along, and especially not to near zero! But, the longer we’re here at near zero, the better my call for soaring inflation by 2010 to have a chance to come to fruition!

And the beat goes on for the pound sterling… Every day, there’s more and more reason to not touch pound sterling with someone else’s 10 foot pole! The Gloom and Doom is everywhere in the U.K. and analysts, and pundits are lining up to take their turn swinging the stick at the U.K. piñata… The selling of pound sterling has gotten so strong that it is now carrying over to the euro on the crosses… The euro has to deal with being sold on the crosses, and is the main reason the euro is flirting with falling below 1.28 as I write…

And after those last couple paragraphs, I’m going to go to the Big Finish on a good note, and talk about Gold… You know… You can’t always think just about Gold’s relationship with the dollar… Yes, I know, we’re all, for the most part, dollar based investors, so that’s all we care about… But you see there’s more when you pull up the carpet… For instance, earlier this week I talked about how Gold and the dollar were rallying… Well, a look under the carpet tells us that Gold is rallying even more against the Russian ruble… So, knowing this, we can better understand the Gold and dollar rally at the same time. I hope you’re with me on this, as I really don’t know a better way of explaining this relationship…

So… Gold looks as though it will end the week with a weekly gain… I have to say that all this dollar strength is beginning to get pretty questionable, and THAT could be another reason for Gold’s strength. Oh, and it’s up $15 this morning!

Currencies today 1/23/09: A$ .6425, kiwi .5180, C$ .7920, euro 1.28, sterling 1.3570, Swiss .8570, rand 10.35, krone 7.0840, SEK 8.4120, forint 226.25, zloty 3.4525, koruna 22, yen 88.10, sing 1.5080, HKD 7.7570, INR 49.25, China 6.8490, pesos 14.20, BRL 2.3520, dollar index 86.52, Oil $42.84, Silver $11.50, and Gold… $873.60

Source: Gold Ends The Week Strong!

Said Bernanke: “This disparate treatment, unappealing as it is, appears unavoidable. Our economic system is critically dependent on the free flow of credit, and the consequences for the broader economy of financial instability are thus powerful and quickly felt.”

In other words, credit is the lifeblood of our economy, and the continued operation of credit providers is actually an issue of national security.

In truth, not all economies run on credit. But over the last decade, the United States became a bubble economy that needed unlimited credit to keep from collapsing. In a legitimate economy, it is not credit that fuels spending and investment, but simply income and savings. It’s too bad our Fed chairman does not understand the difference.

That American families now routinely rely on credit to make every-day purchases is a habit that needs to be broken – not encouraged. What we need in America is more restraint and less indulgence.

For example, Americans in the current economy should not go into debt to buy new cars. Given the level of debt that weighs down the typical family, Americans should defer such purchases until they have paid down existing debt, or have replenished their savings to the point where they can afford to pay cash. Until that time, Americans should continue driving their old cars. In the meantime, the untapped savings could be made available to local businesses that would use it to finance badly needed capital investments.

But such a drastic reversal in financial culture represents the kind of change that no one in the outgoing or incoming White House administrations appears willing to consider. By providing perpetual support to lenders that have bankrupted themselves through bad loans, the government merely guarantees that bad economic behavior will continue.

Credit is indeed vital to an economy, but it does not constitute an economy within itself. The important thing to remember is that credit is scarce, and is limited by the stock of savings. Obviously, savings loaned to one individual is not available to be loaned to another until it the outstanding debt is repaid. If it is never repaid, the savings are lost.

Loans to consumers not only crowd out more productive loans that might have been made to business, they have a far greater likelihood of ending in default. In addition, while business loans increase our capital stock and lead to greater productivity, loans made to consumers are merely spent, and do not create conditions that will make repayment easier.

When businesses borrow to fund capital investments, the extra cash flows that result are used to repay the loans. When individuals borrow to spend, loans can only be repaid out of reduced future consumption.

One of the reasons we are in such dire straits is that consumers have already borrowed and spent too much. Many did so based on the false belief that ever-appreciating real estate would ultimately provide the means to repay their debts and finance their lifestyles. Now that reality has finally set in, why should the spending spree continue?

The fact that our gross domestic product (GDP) – 70% of which is consumption-driven – is currently contracting should not surprise anyone. In fact, such a contraction is long overdue and the government should not do anything to interfere.

In trying to perpetuate the illusion, the government wants to revive the spending spree that has led us to this disaster. But how can such actions possibly help? How will more debt improve the economy? Wouldn’t our circumstances be vastly improved if we paid off some of our debts and replenished our savings? Wouldn’t we be in better shape if instead of buying more stuff we concentrated on producing it?

The unpleasant reality is that years of bad monetary and fiscal policy have encumbered our economy with debt and undermined our industrial capacity. The sooner we can begin to repair the damages, the sooner we can right the ship. If instead we merely administer more of the same, the ship will sink in a sea of inflation.

Source:  Is the U.S. Bailout Perpetuating the Credit Bubble?

Dear Mr. President-Elect:

The people of the United States have spoken. Their collective voice resonates loudly and overwhelmingly in praise of your vision and promises for America the beautiful.

Over the many voices, the chorus of a common refrain resounds: There is nothing we as a people cannot do if inspired by confidence in our president, honest and transparent democratic government, and equal opportunity in pursuit of our happiness.

Fundamental to our pursuit of happiness is confidence in the viability, integrity and safety of our capital markets institutions. The public’s confidence and reliance upon these institutions to create employment opportunity, to provide protection of the many from the greed of a few, and to shepherd our savings and nation’s wealth have been dangerously undermined. The internal threat to our way of life and future is the crisis of confidence we face in restoring manifest integrity, safety, and viability in our economy.

With the mandate of the people you have an opportunity to override the self interest of entrenched politicians, the inordinate influence of lobbyists and the disturbing greed of vested interests. The old walls of crony capitalism are held together by self-serving, self-policing and self-destructive regulatory bodies. The inability of the present system of regulation to deal with the complexities of expanding capitalism and protect us from inordinate concentrations of systemic risk has been tragically demonstrated. It is time that the crumbling walls of regulation are replaced with a new singular, transparent, effective and dynamic regulatory apparatus. I believe the attached outline for such an apparatus serves as a prospective model towards engineering effective regulatory architecture.

Upon your inauguration and ascendancy to the highest and most powerful office on earth, your message and promise of change will resound and echo throughout the world. There may be no better change to make than to repatriate confidence in the American capitalist model and dispel the crisis of confidence gripping our nation by immediately exercising your mandate to change the regulatory apparatus essential for economic growth. Change is your promise, and God willing, it will be your legacy.

Congratulations on achieving the American presidency. The whole world is with you.

Sincerely,

Shah Gilani

***

Money Morning Plan for Engineering an Effective Regulatory Architecture

Overview: The United States must engineer a new transparent, non-partisan, “systemic-centric,” economy-oriented regulatory apparatus that facilitates innovation in capital formation, product efficacy, public protection and open, fair and equal market access.

I. General Architecture:

1. The United States Economic Council: Establish The U.S. Economic Council under the Executive branch. Council members will consist of:

• U.S. Treasury Secretary (Chairman of the Council).
• Chairman of the Federal Reserve Board.
• President of the New York Federal Reserve Bank.
• Comptroller of the Currency.
• Chairman of the FDIC.
• Chairman of the Federal Association of State Insurance Commissioners.
• Chairman of the U.S. Capital Markets Commission.

The U.S. Economic Council would oversee and have both approval and veto power over all rules and regulations established by the U.S. Capital Markets Commission. The Council would represent the U.S. in global regulatory agreements and disputes.

B. The United States Capital Markets Commission: Establish a six-member U.S. Capital Markets Commission, consisting of:

• Chairman of the Capital Markets Commission.
• Equity Markets Commissioner.
• Credit Markets Commissioner.
• Commodities Markets Commissioner.
• Derivatives Markets Commissioner.
• Currency Markets Commissioner.

II. Specific Guidelines:

Market Commissioners: Market Commissioners would be respected industry professionals with demonstrable records and expertise in their respective market segments. Market Commissioners would be elected by a vote of those they regulate, where eligible voters would be determined by registration of individuals pursuant to licenses to transact business in their respective market disciplines. Holders of multiple licenses in different market disciplines would be free to vote per each pertinent license.

Market Commissioner Terms and Pay: Market Commissioners terms would be for two years and staggered. Market Commissioners would be limited to two terms. Market Commissioners would not be paid but exercise their duties as public servants.

Chairman of the Commission: The Chairman of the Capital Markets Commission would be elected by a vote of the U.S. Economic Council, and would be an established and recognized “academic” who wasn’t already actively involved in any market segments, for at least five years.

Commission Chairman Terms and Pay: The Chairman would serve a four-year term. The Chairman would be limited to three terms. The Chairman’s pay would be market based.

III. Operation:

The U.S. Capital Markets Commission would blend the offices, personnel and resources of the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Financial Industry Regulatory Authority (FINRA) and all peripheral regulatory bodies.

The Commission would have regional offices run by career-oriented regulatory professionals. Individuals holding an executive – or in any way a judicial – position with the ability to make or influence findings of guilt or innocence, or to levy any fines or penalties in any matter, before any jurisdictional body empowered by the Commission, would be ineligible to be hired or compensated by any company or individual subject to Commission rules or regulations for five years subsequent to their Capital Markets Commission employment.

The Commission would be funded by fees and transaction charges levied upon regulated companies, markets and individuals. The Commission would establish a rules-based – vs. a principles-based – architecture. The Commission would incorporate:

1. A transparency committee.

2. A products committee.

3. A ratings committee.

4. A licensed persons committee.

5. A public-trust committee.

6. A fair and orderly markets committee.

7. A systemic markets oversight committee.

8. An international regulatory coordinating committee.

The mandate of the U.S. Capital Markets Commission would be to establish market efficiencies and opportunities enforced by rules and regulations for transparency in product creation, ratings integrity, market fairness, public protection and systemic-risk mitigation.

Source: An Open Letter to President-Elect Barack Obama: How a Regulatory Makeover Can Fix the Financial Crisis

Editor’s Note: This is the third installment of a three-part examination of deregulation, and how it helped spawn the U.S. credit crisis. In this capstone installment, Gilani outlines a plan for rebuilding the nation’s regulatory safety net.

Poor Adolf Merckle. The tycoon must have been down to his last billion or so. He was “broken” by the credit crunch, says the Financial Times. He wrote a farewell note and stepped in front of the 7:38 Express on its way to Munich.

As far as we know, the worldwide meltdown has claimed as much as $30 trillion dollars, according to one figure we saw, but relatively few lives. That makes it a comedy…not a tragedy.

Too bad for Herr Merckle. He didn’t appreciate the humor of it.

Yesterday was a bad day for investors. They are all expecting a recovery. Instead, the patient got sicker…the Dow fell 245 points. Oil slipped down nearly $6. And gold? Et tu AU? Yes, gold fell too – down $24.

So, here is a good place to take up our guesswork about what is going on in the world’s markets and what we should expect.

It all seemed too simple, a few days ago. It was. Too simple, that is.

The world’s markets have begun a major correction. The world’s governments – led by the United States – are determined to stop it. They want people to spend like there was no tomorrow. But people are acting like every day is tomorrow. Instead of spending, they are beginning to save.

Then comes news that vacancies in malls are at a 10-year high. Malls are places where consumers buy stuff. The days of stuff-lust are over. Ergo, less retail space is needed.

But if they buy less stuff, fewer people are needed to sell stuff…to make stuff…to move stuff…to count stuff and so forth.

“Pink slips pile higher,” reports the Associated Press. Employers cut nearly 700,000 jobs in December. The total for last year, when the final counts are made, is expected to be about 2.4 million. But the job losses have barely begun. It was only at the end of 2008 that most businesses realized they were in trouble. The real job losses will come this year.

The unemployment rate in November was about 6.7%. In December, it was said to be around 7%. If you put into the number all the people who have given up looking for work, the figure would go to about 12%. But even that will seem like full employment after the tsunami of job cuts hits this year.

Since so many Americans live without substantial reserves – savings – the pressure on Misters Obama and Bernanke to ‘do something’ will increase. What can they do? Spend money.

“US deficit set for post-war record,” reports the Financial Times. Reports today tell us that Obama says deficits will go “over $1 trillion.” One estimate put it at $1.2 trillion for ‘09. We’ve seen others at $1.5 and even $2 trillion.

What they are trying to do is two things: replace private spending with public spending…and cause consumer prices to rise.

But replacing private spending with public spending, alone, is a task that would have staggered Hercules. In the past, the U.S. consumer could be counted on as the planet’s chump of last resort. He didn’t have any money. Still, when an economy slumped, he nevertheless kept spending – buying on credit. Gradually, the whole world economy came to rely on him. But now he’s stopped borrowing; in the last 12 months net consumer lending has collapsed. With neither more income nor more credit he has had to stop buying. And without buying from the U.S. consumer, the world economy is dying in a ditch.

Of course, U.S. rescue teams are on the scene. But if the U.S. government is going to save American households, it practically has to save every gadget maker in China…every call center in India…every rubber plantation in Malaysia…all the wine makers in Bordeaux – all the industries and jobs that relied on U.S. consumers. Otherwise, prices fall.

Even the United States can’t afford a bailout of this magnitude. Trillion-dollar deficits won’t be enough. Martin Wolf, in the FT, quotes a report from Levy Economics – “even with the application of almost unbelievably large fiscal stimuli, output will not increase enough to prevent unemployment from continuing to rise through the next two years.”

With rising unemployment the pressure to ‘do something’ grows. And the feds redouble their efforts. And this is where we find the basic logic our forecast:

In the fight against the global financial illness, the feds can’t cure the patient. All they can do is to deliver larger and larger doses of their quack medicine – until the patient dies.

*** A few days ago, this seemed so obvious, we worried that it was too obvious. Mr. Market doesn’t reward people for doing the too-obvious thing. He sets them up. Then he destroys them. He always seems to find a way.

The Barron’s survey told us that Wall Street’s strategists all believe stocks will go up in ‘09. The only question is how much. The bulls think they’ll go up and keep going up. The bears think they’ll go up…and then go back down again.

And currently, there’s more money on the sidelines – waiting – than there is in the game. U.S. money market funds now exceed the amount in equity funds, for the first time in 15 years. According to the dominant view, this money is just itching to get back in the game and score a major victory. Battered in ‘08…it wants to get even in ‘09. This attitude, we hasten to point out, is not what you find at the end of a bear market…it’s what you find at the beginning of one. People still think that they will make money in stocks – it’s just a matter of time! And how much!

Will Mr. Market give these people what they expect? Or what they deserve?

We don’t know, but we see two possibilities:

The first is that there is no significant rally. Instead of going up, a torrent of bad financial news washes stocks further downstream in the first quarter. There, they will stay for the next 5, 10, or 15 years…until they give up all hope of ever making any money in the stock market.

The second possibility is that stocks do rally…strongly enough that that money now on the sidelines comes back in – just in time to get wiped out by the next major leg downwards.

*** If we were in an earlier phase of the imperial cycle – such as we were in 1920 – we would ride out the bust…liquidate the mistakes…and bounce back stronger than ever.

But this is 2009…not 1920. The empire is now old and tired. It has been burdened with so many fixes, rules, privileges and safety nets it cannot compete in many key industries. It is also heavily in debt…and running a trade deficit and a public deficit that sink it further into debt each day.

At this stage, Americans do not boldly face the future…they want protection from it. And so the feds flex every flabby muscle trying to hold it back. Of course, no one can stop the future. Birds gotta fly. Fish gotta swim. And the future’s gotta happen.

All the feds can do is to make it happen in a different way. Almost certainly a worse way. More tomorrow…as we keep thinking…

*** We also promised, yesterday, to tell you how you could escape… Americans already have a huge burden of private debt. Now, their government is adding an even huger new burden of public debt. How are you going to get out of this stalag of debt? What will happen to it? What effect will it have on your investments?

Hmmm….our answers will have to wait another 24 hours…we’re out of time for today.

*** This year marks the 50th anniversary of Cuba’s revolution. How things change! As a note in the Financial Times reminds us, a half century ago a young lawyer took charge in Havana while an old general ruled in Washington. Now a young lawyer takes charge in Washington while an old general tries to hold on in Havana.

Source: Global Financial Illness

• It’s official: The United States has been in a recession since December 2007, the National Bureau of Economic Research said yesterday (Monday). Already 12 months into it, this recession is longer than eight of the 10 recessions the U.S. has experienced since World War II, CNNMoney reported. Should it continue past the June 2009, it will be the longest.

• U.S. Federal Reserve Chairman Ben Bernanke said the central bank could buy long-term Treasury securities to help revive the economy. “This approach might influence the yields on these securities, thus helping to spur aggregate demand,” he said in a speech yesterday (Monday) in Austin, Texas, Bloomberg reported.

• A report from JP Morgan Securities (JPM) predicts the U.S. Federal Reserve will lower its benchmark federal funds rate to 0% and hold it there at least until the end of 2009. The current rate is 1.0%, and many analysts predict the Fed will lower it to 0.5% at its December 15-16 meeting, Reuters reported.

• Pilgrim’s Pride Corp. (PPC), the largest U.S. chicken producer, filed for Chapter 11 bankruptcy protection after four consecutive quarters in the red fueled by rising grain costs. The company is the poultry supplier to Wal-Mart Stores, Inc. (WMT) and Kentucky Fried Chicken, a subsidiary of Yum! Brands Inc. (YUM), Bloomberg reported.

• The U.S. credit-card industry could pull back more than $2 trillion of credit lines over the next 18 months due to risk aversion and regulatory changes banking analyst Meredith Whitney said yesterday (Monday). “Already, we have witnessed the entire mortgage market hit a wall, and we believe it will, for the first time ever, show actual shrinkage over the next few months,” she wrote. The credit card market will be 18 months behind the mortgage market and will begin to shrink by mid-2010, Whitney said.

• Light, sweet crude for January delivery yesterday (Monday) fell $5.15, more than 9%, to settle at $49.28 a barrel on the New York Mercantile Exchange. Reports showing declines in both manufacturing activity and construction spending also contributed to the decline.

• Johnson & Johnson (JNJ) said yesterday (Monday) that it would buy cosmetic-product and breast-implant maker Mentor Corp. (MNT) for $1.07 billion. J&J will start a cash tender offer for $31 per share – almost double Mentor’s Friday closing price of $16.15 a share.

Global Investing Roundups, Tuesday, December 2nd, 2008

The astonishing news to me was that the Fed has pledged to plow $540 billion into the money market, which is composed of very short-term debt, which is, as I already said, pretty astonishing since the total money market is about $3.5 trillion, and which has had (according to Doug Noland in his Credit Bubble Bulletin) “a y-t-d expansion of $423bn, or 16.8% annualized”. And in an odd bit of symmetry to the just-pledged $540 billion, he goes on to report that “Money Fund assets have posted a one-year increase of $566bn (19.1%).” And now they need half a trillion dollars? Half a freaking trillion?

And since we are talking about things that are astonishing, get this: Total Fed Credit jumped by another $63.2 billion last week! I was going to try and add up the astonishing amounts of credit that the Fed has cooked up in the past month or so, but I am so Scared Out Of My Freaking Mind (SOOMFM) at what I might find that my hands are shaking too much to handle a calculator. That’s my excuse, anyway, and it’s a lot of work, besides.

Naturally, being the lazy little coward that I am, I decide to simply abandon the task and instead run like a scared little rabbit to the Mogambo Bunker Of Invincibility (MBOI) while I still have enough coordination in my hands to lock and bolt the door, adjust the Security Settings to “Repel Boarders” and put a slice of pizza in the microwave with which to calm my Frazzled Freaking Nerves (FFN) at all this monetary expansion.

Afterward, I remembered that I had intended to add up all the credit that those filthy bastards at the Federal Reserve have created lately, and I shuddered anew at the prospect of the work involved, and of what I would find.

But there is something in the Cosmic Force that wants me to see this, as Doug Noland’s Credit Bubble Bulletin was still on my computer, and there, big as life, I read not only that “Federal Reserve Credit expanded another $63.2bn to a record $1,803bn”, but that this latest whopping glop of credit from the Fed has reached “a historic 6-wk increase of $915bn.” Yow!

Almost a trillion dollars of new credit in 6 weeks! Gaaaahhhh! My hands now mysteriously clenched into Mogambo Fists Of Outrage (MFOO), I am forced to clutch a pencil between my teeth and try to laboriously calculate that if $1,803 billion in Federal Reserve credit is up $915 billion in 6 weeks, then the percentage change is, ummm, wait a minute, ummm, carry the one, ummmm, well, the percentage change is, ummm, well, who the hell cares what the damned stupid exact percentage is when you can just freaking LOOK at the problem to see that TFC has about doubled? Yow! A 100% gain! In 6 weeks!

My brain is staggered! In 6 lousy weeks, all of the total credit in the banking system created by the Fed since 1913 was almost instantly (poof!) doubled! Gaaaahhhh! We’re freaking doomed!

This is the second worst news possible, right behind finding out that getting married and registering your marriage at the county clerk’s office makes it some kind of a binding deal that has ramifications and duties far, far beyond what I was prepared for, and I thought she would work and I would stay at home and watch TV all day. Maybe play a little golf and do some “social” drinking. That kind of thing.

It sure as hell didn’t work out that way, and when the kids started coming it got a lot worse, which is ALSO something that nobody tells you about beforehand!

But this monetary expansion thing is the stuff of nightmares, too, and one day soon you will wake up screaming in the middle of the night, bathed in sweat, jolted out of a nightmare of financial misery and suffering that is all but unimaginable even to Dante, and you finally realize, “Hey! These morons at the Fed and Congress with their ridiculous neo-Keynesian, permanent-stimulus theories and econometric stupidities are killing me by killing my money by creating so much of it! What is the only correct economic theory and who can I sue to get my money back?”

The correct theory is, since you asked, the Austrian Business Cycle Theory, as perfectly explained at Mises.org, and reinforced by Milton Friedman who perfectly explained that “Inflation is always and everywhere a monetary phenomenon”, which means that you, as the citizen who is forced to use an abused fiat currency, is doubly screwed; prices are going up faster than wages, particularly food, and you can’t sue anyone.

In fact, an argument can be made that inflation in food prices is already here, as from Florida we get the news that the Department of Families and Children handled 1.3 million calls about getting food stamps last year, and already this year the number of calls has doubled!

And don’t get me started on foreclosures, falling earnings, falling employment, insane levels of money and credit creation, or the horrors of inflation, because then I will also get started yammering about how gold, silver and oil have got to be the biggest bargains out there right now, and trust me when I tell you that you do not want to get me started!

Source: Nightmares of Financial Misery

According to the newspaper report, this program would be the most sweeping and direct government initiative aimed at home-loan borrowers since the financial crisis started last year. As proposed, the federal government would incur half the loss on a home loan if the mortgage company that controls the loan agrees to lower the borrower’s monthly payment for at least five years. On any given loan, the mortgage company would reduce the payment borne by the homeowner by writing off part of the loan balance, reducing the loan’s interest rate or changing other loan terms, sources told The Times.

The newspaper said it could not name the three senior officials who provided details of the plan because it was still being worked out.

The plan – which would be part of the $700 billion banking-system rescue plan the government approved early this month – would cost $40 billion to $50 billion, with the money being used to cover future losses on loans that are deemed eligible for federal support.

U.S. Treasury Department and Federal Deposit Insurance Corp. (FDIC) officials are collaborating on the proposal and an announcement may be made sometime soon. FDIC Chairwoman Sheila C. Bair – a leading proponent of such a plan – publicly discussed the possibility a week ago.

Bush Administration officials clearly want to stabilize the U.S. housing market, but that’s easier said than done. Even at a time when roughly one in every 10 mortgages was either delinquent or in foreclosure – as was the case this summer – companies have been highly reluctant to aggressively reduce payments for two key reasons:

• They’re afraid the borrowers might default again.
• And they fear that the buyers of mortgage-backed securities might sue.

By offering to incur half the losses, federal officials hope that the U.S. housing market – and the accompanying market for mortgage loans – might finally settle out, which could also ease the financial crisis even as it provides a bit of a boost to the U.S. economy.

There’s one key challenge, however: If the economic slump ultimately ends up being deeper and longer-lasting than anyone right now predicts, the housing program could end up being much more expensive than planned – dumping still more unexpected debt onto the U.S. balance sheet.

Treasury Department spokeswoman Jennifer Zuccarelli told The Times that it would be premature to discuss a plan that policymakers were still working on.

“As we said last week, the administration is going through the White House policy process to look at ways to reduce foreclosures, and that process is ongoing,” she told the newspaper. “We have not decided on a particular approach.”

Source: Bush Administration Proposing Plan to Bail Out Delinquent Homeowners