Today’s “legacy assets” are toxic derivatives; a decade ago it was gold reserves. Both are proving hard to shrug off, but for very different reasons. Both legacies also come thanks to previous central-bank history; the fossils remain only too livid today.

And 10 years from now, if not sooner, just how welcome will the current central bank must-have become – freshly printed government debt, bought with money that doesn’t exist until the central bank wills it?

Seeking first to defend against inflation and war, the West’s central banks built up huge reserves of the ultimate hard money –gold bullion– during the early-to-mid 20th century. Long before the turn of the millennium, however, these hoards grew to look quaint and expensive. Unyielding and relatively useless to industry, gold simply sat there, down in the vaults, costing money to store but returning no interest.

Who needed crisis-proof gold when Western Europe (if not the Balkans or Mid-East) was enjoying its first generation of peace-time in history? And who needed fine gold when the Nasdaq index of tech stocks was priced for 20% annual earnings growth over the next decade and more?

In short, who needed gold when we’d got Alan Greenspan, as the New York Times asked in May 1999. “The argument against retaining gold is that its day is past,” wrote Floyd Norris with uncanny timing, just two days before Gordon Brown’s Treasury announced its ham-fisted sale of half the UK’s gold bullion hoard.

“Once it was useful as a hedge against inflation that would hold its value when paper currencies did not. Now financial markets have their own sophisticated ways, using exotic derivative securities, to hedge against inflation.”

You could butter your toast with the irony. But it wouldn’t taste sweet or provide much nutrition. Whereas a further glance back at history might.

“With huge gold stocks available for sale, [governments] may discourage excessive price increases but naturally do nothing to prevent sharp decreases,” reported an investment piece for Medical Economics published in October 1977. (Our thanks to the author for finding and faxing it to BullionVault this week.)

“The government specter [over the gold market] can’t be expected to disappear quickly,” F.D.Williams continued, some 32 years ago. “Gold will continue to be part of many national reserves for a long time. The stocks are so large, they can’t all be dumped at once.”

Compare and contrast with today’s unwanted bequest – those toxic derivatives the US Treasury chooses to call “legacy assets” as if it played no role at all in producing them. Unlike state-hoarded gold, it only encouraged their creation; it didn’t want to look after the damn things. And quite unlike the market for state-hoarded gold, a ready stock of willing mortgage-bond buyers also looks unlikely to gather.

“The PPIP, which was beset by multiple delays as regulators tried to figure out the best means of removing many of the troubled assets from banks’ books,” as CNN reports, “is still not up and fully running yet.” It’s not been for lack of incentives. The $2 trillion Public-Private Investment Partnership, announced to much fanfare in March, offers huge leverage – entirely at tax-payer expense – plus some or other hold-to-maturity value to risk-cushioned investors, albeit as yet unknown. Private investment groups can use up to $1 of non-recourse loans, plus another dollar of Treasury finance, for every $1 they spend on taking toxic housing derivatives off the banks’ busted balance-sheets. Yet as a report published this week by the Congressional Oversight Panel put it:

“Whether the PPIP will jump start the market for troubled securities remains to be seen. It is also unclear whether the change in accounting rules that permit banks to carry assets at higher valuations will inhibit banks’ willingness to sell. Similarly, it is unclear whether wariness of political risks will inhibit the willingness of potential buyers to purchase these assets.”

Funnily enough, as the US authorities struggle to sell toxic debt, Western Europe’s Central Bank Gold Agreement has also stalled in 2009. This comes, however, despite prices and private-investor demand both holding near record levels. First signed ten years ago this September, back when no one at the New York Times, Economist, Financial Times or big central banks could see a use for the metal (simply owning this secure, liquid store of value is use enough, by the way), the CBGA capped annual gold sales and made them plain in advance for the coming five years. It aimed to avoid a repeat of May 1999, when the UK Treasury’s announcement drove prices down to what then proved their floor. In contrast to Washington’s PPIP, however, central-bank gold sales weren’t arranged in the hope of achieving maximum price, but merely curbing a rush for the exits instead. And as it is, they needn’t have bothered.

Gold prices have since risen three-fold and more against all major currencies, even while the 16 signatories to date sold almost one-fifth of their hoard in aggregate. Thus gold’s weighting in their reserves portfolio has doubled regardless, rising as gold outperformed all other assets from the start of this decade.

Hence the dramatic slowdown in central bank gold sales since the financial crisis began in August ‘07. Because it’s tough selling gold when its use becomes so clear, so present. Here in the fifth and last year of 2004’s renewed CBGA, “Net central banks sales likely to be in the order of 140 tonnes this year, down from 246 tonnes in 2008,” reckons London market-maker Scotia Mocatta. Yet the annual ceiling for CBGA sales currently stands at 500 tonnes!

The new agreement – just signed and due to commence on Sept. 27th – tips its hat to the facts, reducing that limit by one fifth. But who’s left to sell any way? Just as in the gold mining sector worldwide, the “easy metal” has already gone from West Europe’s vaults, pretty much emptying Spain, the UK and those excess Swiss holdings which maintained the Franc’s 100% gold-backing until the turn of this century. The two largest holders, Germany and Italy, continue to face down political calls for “mobilization”, refusing to yield one ounce so far despite signing all three agreements. France, the third largest owner, has pretty much sold the 600 tonnes from its hoard announced when it joined the central-bankers’ Cash4Gold party in 2005. That leaves only the International Monetary Fund’s 400-tonne sale, hardly enough by itself to meet the next half-decade’s 2,000-tonne limit.

Back at the Federal Reserve, meantime, tomorrow’s central-bank legacy – of freshly printed Treasury bonds bought with magic money from nowhere – continues to swell. Yes, the Fed’s stockpile of T-bonds may be smaller today than it was back in August ‘07 before the Great Inevitable broke, thanks to record Wall Street demand for the safety of Washington’s debt. And yes, the Fed isn’t quite collecting new bonds from the Treasury door directly, waiting instead a few days or so before picking them up (as Brian Benton, Chris Martenson and others have found) from those primary dealers who do bid at auction, rather than out-and-out monetizing the debt for all to see with its newly created cash.

And sure, private-sector demand for Treasuries continues to look so strong right now – what with overnight rates at 0%, plus the ongoing collapse of house prices, world trade and jobs creation – that the Fed says it will stop financing Uncle Sam’s spending in, umm, October rather than in September as previously stated.

But hoarding gold looked rather more sensible amidst the violence and misery of the mid-20th century, and no one at the Fed or Treasury guessed two years ago that they’d be offering leverage incentives to try and revive the market in mortgage-backed derivatives. When the global economy gets off the floor…or risk assets become more attractive to private investment…or China and Japan find they really don’t have any space left for US debt in their central-bank vaults, the market into which the Fed will want to sell its Treasury hoard will look very different to the market from which it’s currently buying.

Whether a decade from now, in 2010, or perhaps this fall – when the $300 billion of quantitative easing ear-marked for Treasuries is spent – trying to quit the Fed’s newest “legacy asset” could prove tougher even than finding ready buyers for today’s toxic junk. And given the soaring interest rates and potential US bankruptcy that in turn might trigger, spurred by whatever’s added to the Treasury’s $11.7 trillion of debt between now and then, perhaps buying gold will look a smart move to the Western world’s central bankers once more.

Regards,
Adrian Ash

Source: Gold Will No Longer Be a Toxic Derivative to Central Banks

“Investing in this market is like trying to take cheese out of a set mousetrap,” Chris Mayer begins today. “It’s very tempting to make a grab, but you are also fairly certain about what will happen if you do. The market’s 50% rise from its March lows is stunning. It’s like the cheese in the trap. But we also know that no market moves up like that for long. The kill bar is never far from such rallies.”

Check out Asia early this morning… you can almost hear that bar whipping through the air:

Today’s global stock sell-off really started on Friday, when the U.S. suffered its worst bank failure of 2009.Alabama-based Colonial Bank gasped its last breath late Friday. With roughly $25 billion in assets, it was the biggest bank failure since Washington Mutual back in September.

Like WaMu, the FDIC brokered most of Colonial’s burden onto another bank’s balance sheet. BB&T picked up the lion’s share. And just like the WaMu/JP Morgan deal, the FDIC greased the gears by including some kind of backstop provision. In this case, BB&T and the FDIC (read: your tax revenues) will enter a loss sharing agreement on $15 billion in shaky Colonial assets.

Colonial’s failure took a $2.8 billion chunk out of the FDIC’s deposit insurance fund. With just $13 billion left — at best — the fund is at its lowest level since 1993. Along with four other banks that failed over the weekend as well, the FDIC has closed 77 banks this year. One more and we’ve tripled last year’s count.
“The FDIC has been tardy in resolving banks and cleaning them up,” says Dan Amoss, “which will result in higher costs to the FDIC in the long run. Plus, with these ‘loss sharing’ deals (Colonial/BB&T), the FDIC is putting off the recognition of losses over a period of years, and its estimates of ultimate losses will likely be low, whether they’re ultimately absorbed by the deposit insurance fund or acquiring banks like BB&T.

“A perfect example is Integrity Bank in Georgia, which should have been shut down long before it was allowed to attract new deposits with high CD rates.

“Also, note to 5 readers: If your CD rates seem too good to be true, your bank may not be healthy, and you may have to deal with the hassle of not accessing your money while the bank is resolved.”

Dan has quite a knack for spotting bad banks. His Strategic Short Report readers bagged gains of 162% betting against Allied Capital, 220% on PNC Financial and the whopping 462% winner shorting Lehman Brothers. We just published his latest short-financial play… available to readers of The 5 for just $1.
Already anxious over Friday’s lousy U.S. consumer confidence number and Colonial’s failure, Chinese traders slammed the bid today on rumors that the Chinese government is going to tighten lending standards. No official word yet from Beijing, but rumor alone was enough to knock the Shanghai Composite down almost 6%. The Chinese benchmark is down 12% so far this month.
Thus, the foundation of the U.S. bear market rally is quickly eroding: The consumer is pulling back again, the banking crisis (as we noted Friday) is alive and well, and China — the world’s great hope for growth — is looking tired. Add all that up and the S&P 500 opened down almost 2% this morning.
“Investors might forget we’re in a bear market because investing this year has looked easy,” continues Chris Mayer. “Those who have missed out on the rally must be tearing their hair out. Their money burns a hole in their pockets.

“In fact, the evidence is that most investors have the attention span and patience of a field mouse. Here’s the average holding period for a stock on the New York Stock Exchange:

“What jumps out at you right away is that the average holding period is less than a year. That means that, on average, an ‘investor’ typically holds an NYSE stock for a matter of months. This is not investing, which is why I put the term in quotes. I don’t know what it is. Mindless gambling comes to mind.

“It’s no surprise that the last time we were down here was in the Roaring Twenties. We all know what that was the opening act for.

“This chart also speaks to a larger problem in the markets today — there are too few owners and too many renters. Just as in real estate, owners generally take better care of a property than renters. Why should it be different with companies?”

If you’re among the few long-haul investors left, you should team up with Chris. Check out his long-term “paycheck portfolio” here.
Commodities are under lots of pressure today, thanks mostly to Chinese investor anxiety. Oil’s down about $5 from Friday’s high, to $65 a barrel. Gold has fallen over $20 since Friday and goes for $932 an ounce as we write.
Thus, the dollar and U.S. Treasuries are today’s winners.The dollar index is up a full point, to 79.4. Bond demand has pushed the yield on a 10-year down 5 bps, to 3.5%.
Ben Bernanke is taking extra steps to save commercial real estate. The Fed announced this morning a three-six month extension of the Term Asset-Backed Securities Loan Facility (TALF).

The trillion-dollar program was set to expire at the end of the year. The Fed said today — conveniently, right before the market was about to open into a big sell-off — that it would bump the program back to June 31, 2010, for commercial mortgage-backed securities and to March 31, 2010, for other asset-backed paper. That should, in theory, encourage banks to securitize lots of new mortgage and consumer loans… the kinds they would avoid in a normally functioning free market. God bless the Fed!

The TALF has been in action since November 2008.
China’s sovereign wealth fund is preparing to buy up to $2 billion in U.S. mortgages. Having not felt quite enough pain from their Morgan Stanley and Blackstone investments, China Investment Corp. is rumored to be vying for a seat at the Public-Private Investment Plan — the yet-to-be-launched scheme the U.S. Treasury cooked up to get mortgage backed sectors off of U.S. bank balance sheets.
“We’re watching Far East telecoms,” Penny Stock Fortunes’ Greg Guenthner tells us. “Chinese Internet population is increasing at an astronomical rate, growing 42% last year alone, to nearly 300 million users, according to the China Internet Network Information Center. Now the government is setting its online ambitions toward the countryside, vowing to hook up every village with broadband lines by 2010.

“Still, the region’s penetration rate is only 17%, compared with 75% here in the U.S. The opportunities are boundless.

“Most of the time, backdoor plays offer the largest profits in growth industries like this one. Sometimes, however, a straightforward approach is your best chance at the quickest gains. This is one of those times.

“Take China Mobile, for instance. This telecom behemoth is the most obvious play in the region. In the last three years, the company doubled the number of subscribers and grew its bottom line 107%. That’s a rare feat for a $230 billion company.

“China Mobile’s growth is impressive, but it’s nothing compared with what a small-cap player can do in this field. There’s plenty of room to grow in the telecom industry of the Far East.

“That’s why we’ve been looking for under-the-radar Internet providers in Asia. And we just we found a beauty.”

Want the ticker? Subscribe to Penny Stock Fortunes here.
Japan has joined the ranks of recession-emerging nations. This morning, the Japanese government claimed the country’s GDP grew 3.7% in the second quarter. That puts an end to a five-quarter losing streak and the longest period of Japanese GDP contraction since World War II. As with Germany, France and Hong Kong last week, there’s little expectation for Japan to maintain this growth in the coming quarters.
Employees of the Chicago city government might be reading The 5 in their pajamas today. In a sign of the times, the city closed up shop to help close its budget gap. Running a skeleton crew will save ’em about $8 million a day
Last today, another strange reoccurring theme: Even the dead can’t escape the credit crisis.

An LA widow is auctioning her husband’s famous gravesite so she can afford the mortgage payments on their $1.6 million house.The deceased, Mr. Richard Poncher, is a relative unknown. But you might recognize the tenant immediately below his crypt:

At the end of the eBay auction — currently up to $4.5 million — Mrs. Poncher will rip her hubby out of his resting place and deed the crypt to the whoever the winner chooses. Before you fret for Mr. Poncher, we should add that he bought the place from Joe DiMaggio and insisted he be buried face down, in everlasting creepiness.

The new tenant will have to share Marilyn with Hugh Heffner, who has the crypt next to her reserved.
“Are you serious?” a reader asks. “How can this recession/depression possibly be over?” We enjoyed an overwhelming response to Friday’s issue, when we asked you to guess when the government/NBER would claim the recession is over.

“The causes of this man-made disaster have not been addressed and the same banksters-political class-financial oligarchy are still actively proceeding backward with their own hidden agendas. To quote Albert Einstein: “Never expect the people who caused a problem to solve it.” In other words, business as usual on the USS Titanic with its numerous enormous self-inflicted holes. Full speed ahead to the 1930s.”

The 5: We’re not suggesting it’s all sunshine from here on out. Here’s an example of someone who was closer to “pickin’ up what we were puttin’ down”:
“By my statistical analysis, the recession ended in May of this year; and that’s the good news,” he writes. “The bad news is that the DEPRESSION began in the following June. If anyone believes these smoke blowers at the gov’t and/or financial institutions (perhaps that’s redundant), they deserve what is upon us. It is not all sweetness and light. Bitterness and dark is the life we will lead until we restructure and begin the long pullback.”

The 5: Not a bad guess. Off the cuff, the average guess for when the government/NBER will officially declare an end to the recession is around November 2009. Most readers added that it won’t feel like it’s over for years to come. Lots of double-dip guesses too, which seems to make a lot of sense these days. And there were outliers, of course, which we’d be remiss not to share:
“2015,” a reader wrote. “No sooner — no way. Expect to defend yourself. It will get ugly.”
“It will officially end sometime in 2025-2028,” declared another.
“This depression should end technically around mid-2016 with the Dow under 1,000,” opined another. “So-called normalcy will not return until the mid-2020s. God only knows what this country will look like when it’s all over. Good luck to us all.”

Source: Global Sell-Off, Long Haul Investing, A Small Cap Opportunity, Commercial Real Estate and More!

It brings back the question, which has loomed dimly at the margins of America’s collective consciousness, as to whether we can get through the long emergency ahead without going through a wringer of domestic political convulsion. At this rate, sooner or later, anything identified with wealth could become a target for the wrath of the unemployed and foreclosed. The first rock that flies through an East Hampton window, or the first firebomb tossed into the lobby of Goldman Sachs Manhattan headquarters could ignite a chain of events that shoves all economic policy out of the political arena and quickly divides everyone at the center of power into armies out for blood.

What the nation — including President Obama — can’t seem to get through its head is that the USA has entered a period of epochal economic contraction. Instead of growth, as measured in conventional econometrics, we can only expect (in the best case) transformation to a different economy within the limits of real contraction. The president has got to stop promising renewed growth. While this would affect the perceived “standard-of-living” as measured in things like shopping mall sales and vehicle miles driven, it would not necessarily mean diminished “quality-of-life.” It would mean different ways-of-life for a lot of people — for instance, young adults who had expected lifetime employment as corporate executives but who, instead, find themselves ten years from now working at farming. We have an awful lot to get real about.

A genuine reorganization of the US economy seems beyond the ken not just of all US politicians but of the entire US news media and business leadership. A wonderful example a couple of weeks back was the idiotic press conference by General Motors marketing chief, Bob Lutz, who thinks he can revive the American Dream with electric cars. (By the way, this is pretty much the same thinking I encountered at the Aspen Environmental Forum among the Green celebrities.)

From a purely practical standpoint, the electric car is absurd. If they were produced on a mass basis, they would crash the electric grid — assuming that the masses could afford to buy them, which assumes a lot. We simply don’t have the electric generating capacity to run even one-quarter of the current car fleet on volts, and building the necessary nuclear or coal-fired power plants in five years is also an absurdity. (Don’t expect wind, solar, biomass, or anything else to pick up the slack.) If electric cars were produced as just a niche product for the elite (e.g. Goldman Sachs employees), they would soon provoke the resentment of the non-elite left to the mercy of the oil markets.

Anyway, America’s motoring dilemma has gone beyond the issue of how we power the cars — and even beyond the insanity of blindly maintaining our extreme car dependency per se. The continuation of Happy Motoring now hinges on two other big quandaries: 1. the likelihood that there will be far less capital available for car loans, and 2.) the likelihood that there will be far less government money for road maintenance. The problem of Peak Oil — and the prospect of price-jackings and shortages — is just the cherry on top.

By the way, for practical purposes Bob Lutz of GM is an employee of the US taxpayers now, since the US owns 60 percent of the “new” General Motors, so he must be considered a spokesman for national policy. Since a transformation of the US car fleet to electric vehicles is absurd, what would be an appropriate response to profound economic contraction? How about walkable communities connected by public transit? Why is that not a focus of the “new” General Motors? In 1941 the company made the transformation from cars to armaments in a matter of months; why can’t it produce the rolling stock for a renewed passenger rail system? Or trams? Is this not enough of a crisis? The answer is that there is no leadership in this direction. If President Obama declared this to be a policy objective, and stuck to it for more than one business day, he could drag the sleepwalking American public in this direction, and the rest of national leadership in government, business, and media with it.

This kind of thing is what prompts casual observers to wonder if the president is a cynical shill for business as usual, or a victim of the worst conventional thinking with no real vision, or just another clueless sleepwalking bozo with a charming veneer.

In circles that pass for “progressive” these days, the natives are getting restless. Their agitation seems pretty inchoate for the moment — still resting on vague, poorly-defined wishes for “change.” These vague promptings need to be focused on specific action that is realistic within the context of comprehensive contraction and transformation. A big piece of this would be the recognition that our suburban sprawl economy is dying, and that we now have to bend our efforts to reorganizing American life on the most fundamental physical terms. We have to inhabit the landscape differently, move around it differently, generate food out of it differently, and make things on it again. Whatever remaining real capital there is in the system can’t be squandered on cash bonuses for Wall Street employees.

Source: Wobble Time

[Note: For more of Mr. Kunstler’s inexhaustible work, including art, articles and links to his books, be sure to check out his webpage here.]

Yes, for those “old rockers” from the 70’s like me… That’s Uriah Heep, at their best!

OK… So, welcome to July! The last day of June was quite the volatile one to say the least! There we were waiting for the S&P/CaseShiller Home Price Index to print, and show that home prices were still down by quite a bit, when it did, it did, it printed at -18.12%… But! The media was all over that like a cheap suit, clamoring that the spiral down in Home Prices had come to and end! Which, may be true… But wouldn’t you want to wait to see if next month’s report confirms it? And… By the way… Since when does -18.12% fall in home prices beckon a rally? Yesterday, would be that answer!

So… The currency rally that was going on for a 4th day, was quickly wiped out, Ventures style… What? Don’t know who the Ventures are? Boy, you really missed a lot of great instrumentals! Any way, the euro sunk like the Titanic from a level of 1.4130 to 1.40… The iceberg that caused this mess was simply the fact that traders, etc. believe the U.S. is on its way out of this mess… Of course, they must not be Pfennig readers, because… They would have read yesterday how I detailed the monthly numbers and showed how even with the spiral down in Home Prices ending, it would take until 2011 before the Home Prices got back to zero!

But NOOOOOOO!!!! They couldn’t read it until late yesterday afternoon, because… Houston, we had a problem, with the Pfennig’s delivery yesterday… See, how I’ve mellowed? I’m not even going to rant about this… Instead, I’ll just remind everyone that whenever the Pfennig doesn’t show up in your email box, you can most likely find it to read on the Pfennig’s website, where you can view that “glamour shot” of me, and archives of the Pfennig! You can find it here: www.dailypfennig.com —- Hope that helps!

OK… Well… After the thrill is gone, and the dust settled on all that yesterday, the euro is leading the other currencies higher once again… Here are a few things that have caused a sell-off of the dollar overnight once again…

Not that I’m a fan of his… In fact, I don’t really care at all… But George Soros, normally has some interesting things to say, that end up being bang on… So here are a few one liners from a speech by George Soros yesterday… I believe this sounds very much like the things I tell you, have told you, and will continue to tell you…

SOROS SAYS SEES A “STOP-GO” ECONOMY GOING FORWARD
SOROS SAYS SELF-CORRECTING MARKETS IS A MISCONCEPTION
SOROS SAYS INFLATION FEARS WILL DRIVE UP RATES AS MARKETS REVIVE, CHOKING OFF GROWTH
SOROS SAYS CURRENT SUPER BUBBLE MADE POSSIBLE BY PAST INTERVENTION, EFFORT TO RESOLVE PREVIOUS BUBBLES
SOROS SAYS FORMER FED CHAIRMAN GREENSPAN REFUSED TO ACCEPT RESPONSIBILITY FOR STOPPING BUBBLES

And then there was Alice Rivlin, she of former Budget Director, and former Fed Reserve member, fame, had a few things to say to the House Budget Committee… Good stuff, but you have to wonder if anyone was paying attention! Here’s Alice!

“The long term budget outlook: impending
catastrophe”

“No one needs to remind this Committee that the outlook for the federal budget is worrisome indeed, scary. Long before the financial crisis and the current deep recession, this Committee was anxiously pointing out that current federal spending and revenue policies are on a risky, unsustainable course. Promises made under the major entitlement programs (especially Medicare and Medicaid) will increase federal spending rapidly over the next couple of decades, as the population ages and medical spending continues to rise faster than other spending. Federal expenditures are projected to grow substantially faster than revenues, opening widening deficit gaps that cannot not be financed.”

Hmmm… Sounds like me too! Is this “sound like Chuck day?” HA!

OK… Enough of all that, I don’t want anyone to get hurt, and I should have told everyone to put away the sharp objects before reading!

In other data yesterday, Consumer Confidence took a step backward, and fell in June to 49.3 from May’s figure of 54.8… Maybe those that were surveyed has just read Alive Rivlin’s talk to the House Budget Committee! Seriously though, this was a surprise, given the fat that the DOW gained 838 points in the 2nd QTR! At least, that’s what the Wall Street Journal said!

Today, we get a truckload of data starting with Challenger Job Cuts, and the ADP Employment Change. Those are followed by the ISM Manufacturing Index, Construction Spending, Pending Home Sales and Vehicle Sales… Not a lot of “major” data prints, but still stuff to check the pulse of the economy.

I was talking to my good friend, and an economics professor at a prestigious University, yesterday, and she mentioned that “this piece of data is questionable as to the inputs”… I said to her… “What piece of data isn’t questionable these days?”

OK… The “demand for high yield” was put on hold yesterday… But it will return, or at least I should say I think it will return… I don’t know for sure to say “it will”, so had better make the legal beagles happy… That’s funny! To say that they would be “happy” with me… They cringe, and get very uncomfortable every day when they read the Pfennig! HA!

But you know me… I’m just trying to provide Market Commentary, and other things that I think are important, well, important to me that is!

Like… A long time reader sent me a note yesterday, and said, “hey Chuck, did you see the story in the Wall Street Journal (WSJ) on Foreign Demand for Treasuries?” Well, I hadn’t and went immediately to the WSJ, and there it was… Tucked away in a corner so that no one would see it, if they weren’t looking for it… A story, by Min Zeng, titled, “Is Foreign Demand As Solid As It Looks?

These are the things that really TICK ME OFF folks, so stay with me on this… Basically, as we all know the U.S. Treasury Auctions have been getting “covered” easily recently… And foreign demand was listed as the reason… Which would have been the exact opposite of what I was saying about foreigners shying away from Treasuries…

Here’s the skinny… But I’ll let Min Zeng tell it, since he did the research and brought this to the public, even though it was tucked away so no one would notice!

“But in a little-noticed switch on June 1, the Treasury changed the way it accounts for indirect bids, putting more buyers under that umbrella and boosting the portion of recent Treasury sales that the market perceived were being bought by foreigners.

The new definitions are deep in the arcane world of Treasury auctions. The change involves buyers who place orders through primary dealers. Those had been counted as direct buyers, but as of June 1 they were classified as indirect buyers, making that group larger than before. Because investors view that group as being dominated by foreign buyers, they assumed foreign demand was higher.”

>>>> OK, back to me… Ahhh, so that’s what’s going on… The Treasury “moved the goal posts on us”… As Sylvester would say… That’s despicable! Why isn’t someone in Washington D.C. shouting from the roof tops about this? Oh, that’s right, they’re all in cahoots!

This is HUGE folks… So… When the markets were thinking that foreign demand was increasing, it was actually, as I had said, shying away from Treasuries! Which, if the market participants are thinking that as long as foreigners are “buying into our deficit spending” then the dollar will be on terra firma, but instead are getting “duped” by the U.S. Treasury, you would think that someone would have some xplainin to do… Right Lucy?

And here’s another thing that just ticked me off when I read it this morning… Recall, last week I told you about how someone in China was dissing the talk that China’s stimulus was working, and that China would not be recovering, which sent the Aussie dollar to the woodshed until this news had passed? Well… Talk about egg on their face! Here’s the skinny…

China’s manufacturing expanded for a fourth month in June… The official Purchasing Managers’ Index rose to a seasonally adjusted 53.2 in June from 53.1 in May… And just like here in the U.S. any reading above 50 is thought to show manufacturing is expanding… The manufacturing index in the U.S. is around 44, so… We DO have the tale of two economies…

In one corner, we have the Chinese who have spent about $585 Billion worth of renminbi in stimulus, and are seeing the results… Whereas in the other corner we have the U.S. who have spent… More money than you can shake a stick at, and are not seeing green shoots like they “think they are”, instead they see dandelions, and weeds!

And the currencies of Australia and New Zealand have responded positively to this news from China…

And since I’m talking about China, might as well check on the other members of the BRIC’s (Brazil, Russia, India and China) Brazil’s real just posted its best quarterly performance on record, and India was Asia’s 3rd best performing currency, and if you throw out the two currencies above India that are illiquid, South Korea, and Indonesia, India was the best performing currency in Asia in the second QTR…

And the people over at the Royal Bank of Scotland (RBS) believe that the rupee won’t stop here… RBS issued a research report calling for a record 11% gain by the rupee in the 3rd QTR… I bet this news is music to the ears of my colleague on the “other” newsletter that I write… The Currency Capitalist… (to find out more: https://www.web-purchases.com/CUC/WCUCJ900/landing) My colleague, Ashish Advani, at the Sovereign Society, has been saying the rupee would be a strong performer for months now!

Here’s something you might want to be aware of, regarding the New Zealand dollar / kiwi… About $4.5 Billion in kiwi Uridashi and euro kiwi bonds denominated in kiwi will expire next month… I’m told that this is more than 4 times the size of a usual monthly expiration of bonds. This could very well be the hoola hoop the Reserve Bank of New Zealand (RBNZ) is looking for, given their wish that kiwi would weaken…

Royal Bank of Canada’s Currency guru, Sue Trinh, says that kiwi weakness could be beneficial to Aussie dollars, as the Japanese are leaning toward Aussie over kiwi these days…

Sounds about right to me!

And then there was this… OK, you all saw that Bernie Madoff was given 150 years in prison… Did you see that his wife, Ruth, reached an agreement with the authorities to return all of her wealth except $2.5 million that she got to keep? The thing that I still don’t get is how there aren’t more people going down with the ship on this one… I’ve been in the back office of brokerage firms, ran a margin dept, etc. and know this wasn’t just Bernie and his accountant… There was a lot of wool pulled over many eyes… And this will be the next step in the investigation by the U.S. officials… To see, who else knew what… If a whole stable full of people aren’t found to have known, then I’ll be surprised…

Currencies today 7/1/09: A$ .8045, kiwi .6410, C$ .8640, euro 1.4050, sterling 1.6430, Swiss .9220, rand 7.7675, krone 6.39, SEK 7.6337, forint 192.50, zloty 3.1390, koruna 18.3315, yen 96.90, sing 1.4475, HKD 7.75, INR 47.90, China 6.8330, pesos 13.18, BRL 1.9515, dollar index 80.11, Oil $71.27, 10-year 3.54%, Silver $13.67, and Gold… $931.20

That’s it for today… So sorry about the tardiness of the Pfennig yesterday, but I can’t do anything about it when we have technical difficulties… You know that I get up before the milkman, and the paper man, to get here to write it… It wasn’t like I was dilly-dallying around and didn’t get it done until 5 in the evening! HA! I see that my little buddy, Alex, got a 2nd and 3rd in backstroke and freestyle respectively at his latest swim meet. Really long time readers might recall when Alex’s older brother, Andrew was a highly decorated swimmer, and I would write about his swimming records… And their sister Dawn, also was a medal winner as a young girl! So… It’s now up to granddaughter, Delaney Grace to carry on the swimming tradition! HA! Cards lose again… UGH! OK… Time to try to get this out the door, hopefully it will go without a hitch… But whether it does or doesn’t it won’t stop me from having a Wonderful Wednesday… How about you?

Source: The U.S. Treasury Moves The Goal Posts

“Are things getting worse or are things getting better?” we wondered aloud in yesterday’s edition of the Rude Awakening.

In today’s edition, we provide a few answers – well, not answers, really…just observations from you, the Rude readership. In the column below, we present a few real-world anecdotes from Rude Awakening readers. This narrow sampling of economic observations is hardly scientific, but it may be illuminating nonetheless.

Before we get into these real-world stories, let’s examine a couple of recent stories from Fantasyland – otherwise known as Wall Street. Seven of America’s largest banks repaid their TARP borrowings to the US Treasury yesterday, in the process providing one more occasion for hopeful investors to proclaim the end of the credit crisis. The details of the repayments were as follows:

• Morgan Stanley repaid $10 billion

• Goldman Sachs – $10 billion

• BB&T – $3.1 billion

• US Bancorp – $6.6 billion

• Bank of New York Mellon – $3 billion

• Capital One – $3.57 billion

• American Express – $3.39 billion.

Lost in the euphoric brouhaha over the TARP repayments was the dispiriting news that Standard & Poor’s had downgraded the credit ratings of 18 large American banks, including one of the seven that repaid its TARP loan!

Incredibly, the US Treasury deemed Capital One sufficiently healthy to repay its $3.57 billion loan while, at the very same moment, Standard & Poor’s downgraded the credit card firm to BBB – just two notches above “junk.” Standard & Poor’s also characterized the credit outlook for Capital One as “negative.”

We would not place much faith in the analyses of either the Treasury Department or Standard & Poor’s. But we are nevertheless fascinated by their conflicting conclusions. Maybe they’re both right. Maybe Capital One is in fine shape today, as the Treasury Department’s stress test implies. But maybe the credit card company will be in miserable shape tomorrow, as Standard & Poor’s downgrade implies.

As investors, we see these conflicting assessments of Capital One as a metaphor for the entire American financial sector. This sector is a hodgepodge of conflicting opinions, data points and risk/reward assessments. Both sides of every trade in the financial sector can point to some sort of fundamental justification. The buyers see a sector on the mend; the sellers see a sector in the mire.

Your California editor is not smart enough to know which assessment is correct; but he is fearful enough to recognize a potential tar pit when he sees one. So he’s got no problem watching others wade into the water while he remains back on the bank…at least for now.

Curiously, bank stocks have gotten worse, ever since the government told us things are getting better. Most finance company stocks have been performing poorly, ever since the upbeat headlines about the “stress test” results first crossed the newswires. The BKX Index of bank stocks has tumbled nearly 19% since the close of trading on May 8, the first trading day after the Federal Reserve announced the “better than expected” results of its stress tests on America’s 19 largest financial institutions.

The TARP repayment announcements did not alter the downward trend of the BKX. Since June 9, when the Treasury Department disclosed which banks may repay their TARP loans, the BKX Index has dropped 5%.

Apparently, the finance company sector of the stock market has shifted into the “good news is no longer good news” phase. The BKX’s dazzling 135% rally between March 6 at May 8 may have adequately “priced in” all the good news that is likely to emerge for a while from the financial services industry.

Furthermore, the conspicuous recent weakness of the BKX Index is probably not good news for the overall stock market, since financial shares have been leading the market – both to the upside and the downside – during the last year and a half.

To cite just one example of this phenomenon, between February 1 and May 31 of 2008, the BKX slumped 21% while the S&P 500 actually advanced 1%. But during the ensuing month and a half, the S&P fell 13%. The BKX initiated a similar “bearish divergence” in early December last year, as it tumbled 35% between December 5 at February 6. The S&P 500 barely budged during this timeframe, but fell 20% over the next 30 days.

Obviously, the most recent decline of the BKX does not guarantee a subsequent decline in the S&P 500. But neither does it give us a warm, fuzzy feeling. So let’s call the weakness of the BKX a warning sign. Heed the warning, if you are so inclined.

From Michigan, a reader reports:

Traveling thru some western and southern suburbs of Detroit for the first time since my cessation of employment at Chrysler showed some disturbing sights. Four of my old suppliers’ factories were either demolished completely, or in the final stages of demolition. This means the roughly 3-4,000 jobs won’t be returning at all.

The only “construction” I have seen in three years was a McDonalds restaurant, coincidently on the same trip. There you have it, four demolished factories that used to provide living wages, offset by a fast food place that provides minimum wage jobs earned by the sale of dollar meals.

PS. My relatives told me the McDonalds ran an ad for employment at that restaurant. Well over 2,000 desperate people showed hoping for a minimum wage job.

From Georgia, a reader reports:

Based on [what] I observe in my community – business either down or way down – and the information I hear from family, friends and acquaintances – major job losses – the green shoots bandied about in the press are not green shoots. They are really mushrooms growing on what is left of a rotting economy.

From Alabama, a reader reports:

Hi Y’all (haha), Houses are for sale and in foreclosure everywhere. My daughter, who is a student delivers newspapers in the summer, said that there are 54 homes vacant and for sale on her route.

The company I work for gave us a 5% pay cut 4 months ago, then 2 months ago they gave all full-time employees 2 weeks unpaid furlough, 2 days ago we were again advised that starting on the 29th of June we will be getting another 5% pay cut. A lot of hourly employees have been laid off and the salaried employees like myself are doing double duty. Half the people I know are unemployed and my teenage sons cannot find a summer job. My husband is a flooring installer and is contracted to the largest carpet store in the area. He has been there 12 years so he gets priority on work, which is 3 to 4 days a week and much smaller jobs than 2 years ago. His pay is about 1/3 of 2 years ago.

There are empty commercial buildings everywhere.

As for credit, I had several cards most did not have a balance, I was advised on 2 of them that they were being closed due to inactivity, on 2 that had balances I was advised that due to the economic situation that my interest rates were being raised. And one that had a very large credit limit but a small balance, changed by available credit to match the balance due, due to economic conditions.

From Texas, a reader reports:

Hello, I am a commercial property owner in a small town in East Texas. This property has been in my family for 50 years. I have been remodeling and building new retail space for the last 5 years. There is still additional bare land to develop, and currently, I am at 100% occupancy. “Mom and Pops” are my main tenants with 2-3 major corporations. I have held off from further development since last August to see what the new administration would do. I guess, I am one of the exceptions. Debt is low and the only reason I have any debt is due to a buy-out of a sibling and major renovation. I am cautiously optimistic. If other commercial market retailers get in trouble and reduce rental rates, it could adversely affect my position. The future of commercial real estate, according to your reports, looks dismal. I hope our area will be spared from the fallout, but anything is possible.

From Oregon, a reader reports:

Here in Portland Oregon, home of the second highest unemployment rate in the nation, jobs are scarce. Graduates are finding it hard to find jobs, even in “recession proof” areas like Healthcare. A year and half ago, an employer might receive 100 applicants for an open position, now he receives a thousand. Residential real estate is slow to sell, and most sellers are still in denial, not wanting to reduce their price. Not many for sale signs either, most are bravely waiting for the new recovery, sure to be just around the corner. Folks are still visiting the malls (less than usual, but still many) and carrying fewer bags. Scamps at the mall shut down just last weekend. The manager told me that they could not get the needed funding to continue operations. And one of the trendy cheap clothing stores also went out of business last month. Most others are still open, but offering big discounts. Lots of inventory in many of the higher end stores. Appears folks are going for the cheaper stuff. Starbucks is still busy, fancy drinks still in vogue.

From Nevada, a reader reports:

I’ll give you some “boots on the ground!”

Until yesterday, when I met with a bankruptcy attorney, I thought I could financially survive this debacle. But it doesn’t look like I can.

I live in Vegas, own a high rise condo at the Strip that is worth $125K less than the loans on it, am a 50% partner in an LLC that developed 4 fabulous warehouse buildings. Sold one a year ago but still have 3 warehouses for sale that have been sitting empty since built in January, ‘08, possess First Deeds of Trust with face value of about $500,000 that haven’t made any payments in over a year (just now starting to foreclose to get property that can’t be sold today) and are worth about 10-25 cents on the dollar (but have no idea when I will see it), have a $1M investment in a mezzanine loan on a high rise condo that is probably worth 30-40 cents on the investment dollar (but have no idea when I will see it), and of course I still have to pay my alimony, pay for my kids college and private high school education, not to mention my health insurance premiums (WHICH RECENTLY INCREASED 22% FROM LAST YEAR), auto insurance and every other daily expenditure to live. My retirement accounts are down 50% and my income from all sources has basically dried up (a few sales commissions and consulting jobs bring in some cash)…Bottom line is unless something happens quickly on the upside, I am in a bit of financial trouble.

The point is, there are probably tens of thousands, if not millions of people in the same overall trouble that I am in…and my story doesn’t make the headlines!!! Perhaps it will as my BK filings will ultimately be magnified by those thousands who soon will flood the system with such filings.

I know for a fact that there are no green shoots…everything is browning out! After talking to my bankers who are about to foreclose on my warehouses, from my attorneys who tell me I am not alone and some of the most successful and well known developers in town are in worse shape, and from my “friends” at Bank of America, who after 4 months of trying to get a loan modification so I can continue to live in my hi-rise condo told me “NO” twice, once from their internal “Loss Mitigation” division who said I don’t have enough income relative to my expenses to modify, and then from their “Obama Modification Plan” division because the bank had not sold my 2nd TD to FNMA, thus I don’t qualify, clearly the world I am living in is not improving.

I only wish the “spin machine” of Wall Street would turn into a “truth machine,” but I guess truth, integrity, transparency, etc. are not in our best interests!!!

Source: For Better or Worse

Treasury Secretary Geithner, we hereby dub thee “Turbo Timmy.”

As a number of you have informed me, the “turbo” moniker – as in, “doesn’t know how to use Turbo Tax” – has been around for a while now. With my many sources and ears on the street, I’m surprised I hadn’t heard it prior. (Or maybe it just went in one ear and out the other.)

Other honorable mentions in the SecTreas nickname contest include:

• “Tycoon Tim” (for serving his rich masters)
• “Torpedo Tim” (for threatening to sink the economy)
• “Little Timmy Geithner” (after a hapless cartoon character with wish-granting fairy godparents)
• “Lollypop Guild” Geithner (after the obscure Wizard of Oz character)
• Tim “The Beaver” Geithner (because his earnest, goofy manner has a “Leave It to Beaver” feel)

And then there was the following reader submission, which defies all description:

How about “All in, Tim” or IRONMAM “I Ran Over Nouriel Making Another Mistake” Or maybe tim, I can’t stop sucking Hank Paulsons A[**], Geithner. Tim, hey I got an idea Geithner. How about Tim the dollar killer? Gangster Tim? The 6 trillion dollar man? Tug boat tim? (No reason, it just rolls off the tongue) or maybe because he is printing boatloads of money? Tim the terrible? 2 face Tim? I don’t know, what do you think?

Tony

Tony, I think you gave me the best laugh I’ve had all week.

No Laughing Matter

It’s good to start off this piece with a little humor, because the storm clouds are about to roll in.

I’ve looked over the details of the new Geithner “rescue plan” announced earlier this week. I’ve read everything I can get my hands on and plowed through the proverbial “stack o’ stuff” pertaining to the topic. And after a fair bit of reading and thinking, here is what I have come to conclude:

• As it has been presented, there is no way this so-called “rescue plan” can work.
• If the Geithner rescue plan is implemented honestly, it is almost certainly doomed to failure.
• If the plan is an elaborate ruse, however – that is to say, a sneaky scam… a con job designed to fool the public into seeing what isn’t there and believing what isn’t true – then it just might actually work.

This whole deal is more twisted and distorted than a room full of funhouse mirrors, so it will take some effort to explain my thinking. It’s important, though, so stick with me here.

First off: To understand why the Geithner plan can’t work as advertised, we have to understand the nature of the problem that Turbo Timmy is trying to solve. To that end, I will use an analogy that you should easily be able to grasp.

Meet Franky Flipper

We have all heard how the crux of the problem relates to “toxic assets” buried deep in bank balance sheets. But what does that mean exactly?

To get a mental picture, let’s rewind to the heady days of the housing bubble. Remember when “flipping” was all the rage? There was even a popular show called “Flip This House” on A&E. (I just did a quick Google search, and apparently the show is still going. Amazing!)

The basic idea behind flipping a house works like this:

• Franky Flipper buys a house for a low down payment – say, $10K down on a $150,000 property.
• Franky cleans up the joint and sells it at a markup – say $180,000 ($30K more than he paid for it).
• In this example, Franky’s total investment is $10,000 down, plus effort and materials spent fixing up the house. (We’ll leave out interest payments to keep it simple.)
• If we assume Franky spent $5,000 on time and materials – cleaning the place up himself – his total investment is about $15K (fix-up cost plus down payment). So if he sells the house for $30,000 more than he paid for it, that represents a quick 100% profit – $15K in, $30K out. Franky doubled his upfront investment, thanks to the power of leverage.

You can see why the “flipping” concept looked so attractive against the backdrop of a relentlessly rising housing market. Ordinary joes could do this without a lot of time, effort or money. (Many ordinary joes did.)

But it got out of hand when Franky Flipper started reasoning like this: “If low down payments are good, then ZERO down payments must be better!”

When the down payment drops all the way to zero, the theoretical return on investment shoots through the roof. And if there are no fix-up and repair costs – as is the case when flipping brand-new properties as opposed to old ones – the theoretical return approaches infinity.

Franky Gets Wiped Out

You remember what happened next in the great housing saga… the Franky Flippers of the world went nuts, and nobody tried to rein them in. (Hell, the media and the government all but egged them on. But that’s another kettle of fish…)

At the height of the bubble, there were any number of stories – you saw them – of uber-aggressive flippers leveraging a portfolio of 10 or 15 different properties, all purchased with no money down, against a single stream of income amounting to $50,000 or less. Everyone just went crazy. You had school teachers, bus drivers and traffic cops all playing the cookie-cutter suburbia version of Donald Trump.

Going back to our friend Franky Flipper… let’s say that Franky has $300,000 in the bank. He’s doing pretty decently for himself – and he also has a hotshot sales job – but $300K is all the cash he has for now.

Franky also has a $3 million portfolio of 10 homes – average purchase price $300K each – all purchased on generous lending terms with no money down. (Rather than fixer-uppers, these are all new homes or soon-to-be constructed homes bought on “spec.”)

You’re with me so far, right? You can see how a relatively average joe like Franky could go out there and buy 10 new houses at the height of the housing bubble, courtesy of stupid lenders and the zero down phenomenon, figuring he will sell all those houses at a profit and make a mint?

The plot thickens… for whatever reason, Franky loses his job at the luxury auto dealership. Lexus sales are down and he hasn’t been hitting his quota, let’s say – too much stress taking him off his game – so he’s out.

Without the cash flow from his job to make his monthly mortgage nut, Franky has to sell all 10 houses – $3 million worth of real estate – before he can get square and put his life back on track.

But here’s the kicker: Because Frankie has a $3 million leveraged portfolio and only $300,000 in cash, it only takes a 10% decline in real estate values to wipe him out.

Franky paid an average $300K for each of those 10 houses. So if the average price falls by just 10%, $30K times 10 equals $300K equals all the cash Franky has left. Any real estate decline beyond 10% leaves him insolvent (effectively bankrupt).

You see how that works? If you buy an asset (like a house) with lots of leverage relative to your capital base, and that levered asset falls by even a modest price percentage, it can be enough to wipe you out. This is true for everyone. It doesn’t matter if you’re Donald Trump or Joe Blow or Gigantic MegaCorp. Leverage is leverage, and it’s a double-edged sword for all.

Drinking Their Own Kool-Aid

So why did I just walk you through all that? After all, it isn’t the real estate flippers who are getting bailed out here – it’s the big dumb banks with their dumb toxic assets.

Here is why we went through it: Because the big banks in trouble now are in the exact same situation as Franky Flipper.

Whether it’s 3 million, 3 billion or 3 trillion dollars we’re talking about, the math is still the same. Whether it’s a straight-up mortgage note on a house or a more exotic form of “mortgage-backed security,” the leverage issue is the same.

It’s pretty ironic, really. Those of us with good sense had a cynical belly laugh at the madness of the flippers when the stories started hitting the wires. “You mean there’s a guy in Vegas who bought 14 houses on a $35K income? What a maroon!”

And you would think the bankers, of all people – the clean and sober belt-and-suspenders types who did the lending – would be smarter than the jokers they lent to. If real estate speculators were hot-to-trot gamblers, then the banks were supposed to be more like “the house,” i.e. the casino.

(No well-run casino would ever give its clientele enough rope to hang the house, by the way. That’s why the high roller tables always have posted limits. To refer to banks as “casinos” then is to actually give casinos a bad name.)

At any rate, there was no sobriety to be found anywhere. The big banks went just as crazy as Franky. After a time, the bankers drank their own Kool-Aid and started believing all that crap being shoveled out to the punters about how home prices never go down and any home-related risk is a good risk.

And so the banks decided to load up on super-risky mortgage-backed assets themselves, leveraging up their own books to the moon,with all the zero-down exuberance of a Franky Flipper… and they did it in mega-size fashion. We’re talking multi-trillion large here.

And now the banks are screwed, and staring down the barrel of insolvency (”bankruptcy” to schleps like Franky) because the value of their overleveraged loan portfolios (to the tune of trillions) has tanked, and that’s how we got to where we are with this whole “rescue plan” business.

Turbo Timmy’s Tough Problem

We can take the analogy further, so let’s do it.

Say that Franky Flipper is a good friend of yours – he got you a great deal on your Lexus, maybe – and you just happen to be a government official.

For whatever reason, you have decided that Franky Flipper must be saved. The situation looks bad, but you are a loyal pal, and you don’t want Franky to go bust under any circumstances if you can possibly save him.

So in your capacity as a government muckety-muck, how do you save your friend?

In an honest world, there would just be no way to save Franky. His liquid assets ($300,000) are only a tenth of his liabilities ($3 million worth of mortgage notes), and the value of his illiquid assets (the homes he owns) has gone into the crapper along with the real estate market.

Barring a miracle, Franky is toast. Apart from a windfall cash infusion out of the blue – the death of a rich uncle maybe – there is no way to make the math work. There’s just no way to save Franky’s bacon… and the same is true for the banks as they exist today.

See, the toxic garbage sitting on banks’ books right about now looks as attractive to potential buyers as a half-finished mega-mansion with a bulldozer out front, tucked way in the back of a deserted cul-de-sac, in the middle of some nameless, empty, ghost-town subdivision 30 miles due east of Tumbleweed, Arizona. You wanna live there? You wanna invest there? I don’t think so. Does anyone else in their right mind? I don’t think so.

With me so far? Analogy holding up? Let’s keep going…

Geithner’s brilliant solution – the thrust of the “rescue plan” that juiced Wall Street this week – is to bring private investors into the toxic asset mix, in a “public-private partnership” between Wall Street and the government… and then, via that public-private partnership, to buy up all the bad assets from the banks (with a huge helping of taxpayer-funded leverage).

Just imagine Turbo Timmy saying the following (as a giant light bulb goes off over his head):

“Hey! Here’s how we can solve Franky Flipper’s problem. We’ll just get other real estate investors to buy the 10 houses off him… and we’ll convince those other investors to do it by offering them sweetheart deals on leveraged loans and limiting their total risk to a small down payment only. Franky sells off his housing portfolio, the private investors get a deal, and everyone is happy. Hooray!”

Now… do you see why this plan can’t possibly work? Here it is in plain English:

• Franky is so leveraged, even a 10% haircut on the value of his portfolio is enough to wipe him out. (Remember, he only has $300K cash against $3MM worth of mortgage notes.)
• No real estate investor in his right mind would buy Franky’s houses at just 10% off. To keep their investment protected, they would need more like 30% off… or 40%… or maybe even 50%.
• Therefore, there is no way both parties’ interests can be satisfied.
• For Franky to get a price he can live with – one that doesn’t wipe him out – the new investors have to pay far too much. For the investors to get a price that they can live with – one that makes sense to them as investors – the bid price has to fall far too much, making Franky toast.

That’s why all this shiny happy stuff about a public-private partnership is total baloney. The banks are just as bad off as Franky Flipper. If the toxic assets in question were sold at anything approximating their true value, the banks would be wiped out.

Shockingly, the word is that players like Citi still have huge piles of assets on their books marked close to “bubble valuations” like 90 or 95 cents on the dollar. That’s nowhere close to the real value. It’s like Franky Flipper pretending that the half-built spec house 30 miles outside Tumbleweed – a house more likely to be torn down for scrap than to ever see someone living in it – is still worth 90% of what he paid for it.

And again, the much-touted “private investors” being invited into Turbo Timmy’s plan have no reason to pay anything but fair prices (i.e. extremely low prices) to the banks for these assets, because private investors are not stupid as a general rule and will want to protect themselves against risk of loss.

So, in a nutshell, the whole private-public partnership thing is Mission Impossible. The natural interests on both sides – of the banks and the putative investors – are way, way, waaay too far apart.

And that means Turbo Timmy’s brilliant rescue plan is DOA… dead on arrival.

Unless, of course, the whole rescue plan is just a complicated scam… a con, a shell game, an elaborate ruse designed to hoodwink the public.

More to come….

Source: Turbo Timmy’s Sneaky Scam (Part One)

All the old mechanisms that enabled our way of life are broken, especially endless revolving credit, at every level, from household to business to the banks to the US Treasury.

Peak energy has combined with the diminishing returns of over-investments in complexity to pull the “kill switch” on our vaunted “way of life” — the set of arrangements that we won’t apologize for or negotiate. So, the big question before the nation is: do we try to re-start the whole smoking, creaking hopeless, futureless machine? Or do we start behaving differently?

The attempted re-start of revolving debt consumerism is an exercise in futility. We’ve reached the limit of being able to create additional debt at any level without causing further damage, additional distortions, and new perversities of economy (and of society, too). We can’t raise credit card ceilings for people with no ability make monthly payments. We can’t promote more mortgages for people with no income. We can’t crank up a home-building industry with our massive inventory of unsold, and over-priced houses built in the wrong places. We can’t ramp back up the blue light special shopping fiesta. We can’t return to the heyday of Happy Motoring, no matter how many bridges we fix or how many additional ring highways we build around our already-overblown and over-sprawled metroplexes. Mostly, we can’t return to the now-complete “growth” cycle of “economic expansion.” We’re done with all that. History is done with our doing that, for now.

So far — after two weeks in office — the Obama team seems bent on a campaign to sustain the unsustainable at all costs, to attempt to do all the impossible things listed above. Mr. Obama is not the only one, of course, who is invoking the quest for renewed “growth.” This is a tragic error in collective thinking. What we really face is a comprehensive contraction in our activities, especially the scale of our activities, and the pressing need to readjust the systems of everyday life to a level of decreased complexity.

For instance, the myth that we can become “energy independent” and yet remain car-dependent is absurd. In terms of liquid fuels, we’re simply trapped. We import two-thirds of the oil we use and there is absolutely no chance that drill-drill-drilling (or any other scheme) will change that. The public and our leaders cannot face the reality of this. The great wish for “alternative” liquid fuels (bio fuels, algae excreta) will never be anything more than a wish at the scales required, and the parallel wish to keep all our cars running by other means — hydrogen fuel cells, electric motors — is equally idle and foolish. We cannot face the mandate of reality, which is to do everything possible to make our living places walkable, and connect them with public transit. The stimulus bills in congress clearly illustrate our failure to understand the situation.

The attempt to restart “consumerism” will be equally disappointing. It was a manifestation of the short peak energy decades of history, and now that we’re past peak energy, it’s over. That seventy percent of the economy is over, especially the part that allowed people to buy stuff with no money. From now on people will have to buy stuff with money they earn and save, and they will be buying a lot less stuff. For a while, a lot of stuff will circulate through the yard sales and Craigslist, and some resourceful people will get busy fixing broken stuff that still has value. But the other infrastructure of shopping is toast, especially the malls, the strip malls, the real estate investment trusts that own it all, many of the banks that lent money to the REITs, the chain-stores and chain eateries, of course, and, alas, the non-chain mom-and-pop boutiques in these highway-oriented venues.

Washington is evidently seized by panic right now. I don’t know anyone who works in the White House, but I must suppose that they have learned in two weeks that these systems are absolutely tanking, that the previous way of life that everybody was so set on not apologizing for has reached the end of the line. We seem to be learning a new and interesting lesson: that even a team that promises change is actually petrified of too much change, especially change that they can’t really control.

The argument about “change” during the election was sufficiently vague that no one was really challenged to articulate a future that wasn’t, materially, more-of-the-same. I suppose the Obama team may have thought they would only administer it differently than the Bush team — but basically life in the USA would continue being about all those trips to the mall, and the cubicle jobs to support that, and the family safaris to visit Grandma in Lansing, and the vacations at Sea World, and Skipper’s $20,000 college loan, and Dad’s yearly junket to Las Vegas, and refinancing the house, and rolling over this loan and that loan… and that has all led to a very dead end in a dark place.

If this nation wants to survive without an intense political convulsion, there’s a lot we can do, but none of it is being voiced in any corner of Washington at this time. We have to get off of petro-agriculture and grow our food locally, at a smaller scale, with more people working on it and fewer machines. This is an enormous project, which implies change in everything from property allocation to farming methods to new social relations. But if we don’t focus on it right away, a lot of Americans will end up starving, and rather soon. We have to rebuild the railroad system in the US, and electrify it, and make it every bit as good as the system we once had that was the envy of the world. If we don’t get started on this right away, we’re screwed. We will have tremendous trouble moving people and goods around this continent-sized nation. We have to reactivate our small towns and cities because the metroplexes are going to fail at their current scale of operation. We have to prepare for manufacturing at a much smaller (and local) scale than the scale represented by General Motors (NYSE:GM).

The political theater of the moment in Washington is not focused on any of this, but on the illusion that we can find new ways of keeping the old ways going. Many observers have noted lately how passive the American public is in the face of their dreadful accelerating losses. It’s a tragic mistake to tell them that they can have it all back again. We’ll see a striking illustration of “phase change” as the public mood goes from cow-like incomprehension to grizzly bear-like rage. Not only will they discover the impossibility of getting back to where they were, but they will see the panicked actions of Washington drive what remains of our capital resources down a rat hole.

A consensus is firming up on each side of the “stimulus” question, largely along party lines — simply those who are for it and those who are against it, mostly by degrees. Nobody in either party — including supposed independents such as Bernie Sanders or John McCain, not to mention President Obama — has a position for directing public resources and effort at any of the things I mentioned above: future food security, future travel-and-transport security, or the future security of livable, walkable dwelling places based on local networks of economic interdependency. This striking poverty of imagination may lead to change that will tear the nation to pieces.

Source: Debt Drought Kills Consumerism

The bearish camp is pointing towards Japan and claiming that asset prices will not rebound for many years. According to these folks, corporate earnings will continue to decline and unemployment will rise to much higher levels. So, the bears have concluded that global financial markets will stay depressed for the foreseeable future. It is my observation however that in post-war history (with the exception of the previous recession when stocks were grossly overvalued) stock markets have always commenced a new bull-market prior to the end of each recession.

The current U.S. recession commenced late last year, so it has already lasted for more than a year. The average post-war US recession lasted 10 months making this downturn more severe. With the exception of the Great Depression, the worst post-war recessions occurred in 1974 and 1982. Both of these lasted for 16 months, making them the worst recessions since World War II. Now, if we were to assume that the current recession continues well into 2009, this would imply that stock markets will probably bottom out over the coming months.

We must remember that the financial markets are a discounting mechanism and with prices down significantly from their highs, most of the negative news seems to be already factored in today’s prices. In the past few months, some nations have been brought to their knees, the entire investment banking industry has been decimated, homebuilders have taken huge losses and now auto-makers are facing bankruptcy! For sure, such circumstances are not signs of a major top; rather they are usually associated with the bottom of the business cycle. So, liquidating positions and taking losses during such a pessimistic environment would be a big mistake. On the contrary, the ongoing liquidation of all assets is providing long-term investors with a fantastic buying opportunity. Accordingly, over the past couple of months, I have deployed all of my personal surplus cash reserves into the markets. Now, I concede that it is possible that prices may continue to drift lower in the short-term, but the recent market action suggests that we may have reached an important low. Unfortunately, I cannot state with certainty as to whether or not last quarter’s low will turn out to be the ultimate low for this bear-market. However, I do know that investors who deploy capital in commodity stocks and bullion today, will probably be sitting on huge profits in 5 years from now.

At present, the markets are extremely oversold relative to their moving averages and investor sentiment is awful. In this environment, I anticipate a multi-month rally in commodities, related stocks and precious metals. Conversely, at the same time, I expect a decline in the U.S. dollar, Japanese yen and U.S. Treasuries. All of these assets appreciated considerably during the liquidation phase and they will come under pressure when the tide changes.

The main reason why I do not foresee deflation (decrease in the supply of money) is due to the fact that the contraction in credit arising from deleveraging is being more than compensated by the money-pumping actions of the various governments. In the past year alone, the Federal Reserve has expanded its balance-sheet by a whopping US$1.2 trillion! Moreover, thanks to Mr. Bernanke’s cash injections (quantitative easing), reserve balances have sky-rocketed from roughly US$5 billion to almost US$600 billion in roughly 3 months (Figure 1)!

Figure: Lift off in bank reserves – helicopters being primed?

Source: Federal Reserve Bank of St. Louis

Furthermore, it is interesting to note that the Federal Reserve (money-printer extraordinaire) has now started to inflate the supply of money. Over the past few weeks, the Federal Reserve has injected roughly US$300 billion into the banking system without a proportionate increase in its non-banking liabilities via deposits by the US Treasury. In simple terms, what this means is that the Federal Reserve is now increasing bank reserves without the US Treasury removing an equivalent amount of money from the system. Usually, when the Federal Reserves provides surplus reserves to its member banks, the US Treasury borrows this money from the market by issuing bonds; thereby offsetting the inflationary impact of the Federal Reserve’s monetary injections. However, this is not what is happening now and this has inflationary implications. Essentially, the Federal Reserve is now creating money ‘out of thin air’, debasing its currency and sowing the seeds for sky-high inflation.

At present, commercial banks are hoarding this cash, but I expect this newly created money to seep through the economy over the following months. When that occurs and credit starts flowing again, business activity will pick up and prices will start appreciating.

In the past few weeks, we have received numerous queries from anxious investors who want to know if we are heading into deflation. Obviously, we don’t know what will happen in the future, but for now, data shows that all the deflation hype is absurd. If you have any doubt whatsoever as to whether we are facing inflation (expansion in the supply of money) or deflation (contraction in the supply of money), you need to look no further than Figure 2 which highlights the rate at which various nations are inflating the money supply. There is no doubt in this writer’s mind that deflation is out of the question when the money supply is expanding at such a frantic pace. For the sake of clarification, I must state that what we have witnessed over the past year is not deflation but a contraction in asset prices due to forced liquidation (non-availability of credit).

Figure 2: Inflation is the problem

Source: The Economist

Now, you may be wondering why there is so much talk about deflation these days when inflation (expansion in the money-supply) is the real issue at hand. There are two reasons for this:

First and foremost, you must remember that banks are in the business of lending and the central banks’ prime objective is to manage inflationary expectations. So, Mr. Bernanke and his comrades are paid to keep a lid on the public’s inflationary fears. Accordingly, a ‘deflation scare’ is engineered ever so often, so that they can continue with their long-term stealth inflation agenda without raising too many eyebrows. Secondly, the establishment needs to advertise a ‘deflation scare’ so that the central banks can slash interest rates. If inflation rather than deflation was perceived as the legitimate threat, then the Federal Reserve would not get away with near zero interest-rates.

In summary, I am of the view that the set-backs in our preferred areas (energy, miners, agriculture and bullion) will prove to be temporary and these assets should outperform the broad market once the recovery commences. Finally, it is worth noting that silver and platinum are now unbelievably oversold and they should rally hard and outperform gold over the following months. Accordingly, I would recommend buying some silver and platinum bullion at these levels.

Source: Sowing the Seeds

Humor me. Let’s crunch those numbers.

Those gold certificates have a book value of about US$14 billion, if you include special drawing rights and coin holdings ($1.7 billion). Even if you revalued this inventory, it would still total less than $300 billion, or 12% ofthe Fed’s total assets. So far, that’s a weak defense against our allegations. And it only goes downhill from there. Assuming it still got the goods at all, a lot has changed in just three months. In August, this gold had a market value that represented over 30% of the Fed’s assets.

Back then, additionally, U.S. Treasury securities still made up half the Federal Reserve’s asset base.

Today, however, in a very short space of time, the market value of both of these assets together comprises just 30% of the central bank’s total assets. It is fruitless to discuss what makes up the rest of its “portfolio,” because whatever it is, it is of lesser quality — aka higher risk.

His proposal was interesting, however, for other reasons. In case you missed its inference, the idea of a revaluation in gold reserves on the Fed’s balance sheet is to boost confidence. It is but a keyboard stroke away, a technical matter. Most analysts already take gold’s market value into account anyway.

Still, two outcomes of such a revaluation occurred to me over and above the obvious, I think.

The first: It would align the Fed’s interests with gold prices — by increasing gold prices, it would boost the value of its balance sheet, for instance.

Second, it would inflate gold’s perceived importance — an endorsement of sorts, in the eyes of the Fed. The public and the market would have to reassess their fundamental outlook about the importance of gold, too.

On the surface, Gramley’s proposal aims at making the Fed look like some kind of gold standard bank. But in fact, this kind of thing, especially if it were spun out in reaction to a crisis of confidence, might be so bullish for gold that it sinks the Fed.

If Bernanke were smart, he would want that gold to disappear off the balance sheet without notice.

But let’s forget about what would be bullish for gold and point out what in fact is the fear of deflation.

The Great Reinflation Update

In December, the Fed shoveled another couple hundred billion new Washingtons into the banking system, out of its many open windows. B-r-r-r!

Its balance sheet expanded to over $2.3 trillion as of last week’s report, which came out the day after it decided to cut rates to nothing. My guess is that we’ve seen nothing yet. You thought “cheap money” was bad. This is the era of FREE money. This stuff grows on trees. You don’t even need choppers. Already, despite the intensity of the deflation rhetoric, the money supply numbers continue to point the other way — toward the Great Reinflation. Or should we say “because” of the intensity of the deflation rhetoric!

This week’s money supply numbers suggest the alleged credit freeze continues to thaw.

After stagnating with little or no growth, stuck at under $1.4 trillion over the past four years (since the Fed began hiking rates in 2004), even as the Federal Reserve started cutting rates in 2007 again, U.S. M1 has grown by over $130 billion, or 10%, since August alone. That’s when it stopped sterilizing its “liquidity” injections. But this kind of growth in three months is a record. Percentage-wise, too.

Most of that growth, moreover, is occurring in checkable (demand) deposits. U.S. M2 is growing at almost $100 billion per month, and it is approaching a 9% year-over-year growth rate — its strongest growth since early 2002, midway through the Fed’s last reinflation effort (2001-03).

Most of that growth is occurring in money market fund holdings.

The definitions of money supply that I put stock in suggest that the banking system is inflating deposits at roughly5% year over year, but of special significance is that this growth rate is picking up now.

It certainly is not as robust as the narrow measures of money or the Fed’s balance sheet.

But it is not deflation.

I promise to keep looking for it, nevertheless.

Source: The Great Reinflation

This from Taipan Daily:

U.S. Treasuries look so lousy here that shorting them has become the “obvious” trade. But there is more to this mystery than meets the eye, as Justice explores…

Jim Grant nailed it in a recent Financial Times piece. Known for their “risk-free return” in more normal times, Grant observes that U.S. Treasuries (or USTs for short) now offer “return-free risk.”

Treasury buyers, in other words, choose to lend to Uncle Sam for free these days… or, worse still, to pay for the privilege. As 2008 draws to a close, USTs are an asset class with no yield to speak of… microscopic upside potential… and plenty of room for a downside break.

“Return-free risk” indeed.

But here is what bugs me. Buying Treasuries is such a plain-as-day dumb move that shorting Treasuries has now become the “obvious” trade.

It seems too easy… I don’t trust it. Sometimes a trade really isthat simple. But more often than not, that which appears “obvious” in markets turns out to be a trap.

So what are the missing puzzle pieces here?

OPEC’s record-setting January 1st production cut is poised to become the greatest price-fix in the history of commerce. Here are all the details — plus the one petroleum play that could land you realistic gains of 19,000% if you get in before The Fix takes effect…

Covering Their Assets

The first thing to note is that there are few truly “dumb” buyers out there. Anyone scooping up Treasuries at these nosebleed heights has their reasons.

End-of-year accounting is one factor. A number of money management firms may be parking their dollars in short-term Treasuries as a conservative move. When the final 2008 statements go out, these firms want to present an image of prudence. So they’re willing to take a short-term hit on that parked money for the sake of appearances.

The foreign asset mix is another big factor. Foreign investors were huge buyers of “agency” securities over the years – bonds and notes issued by the likes of Fannie Mae and Freddie Mac.

Now foreign investors are trying to dump those holdings as fast as they can. They no longer trust these “agency securities,” but they have few good places to park the cash. So what are they doing? Swapping out their “agency” debt for the safest stuff they can find in a pinch.

The New York Times chart above tells the story. In a piece titled “Foreign Investors Trade Safe for Safest,” Floyd Norris writes:

More foreign money came into Treasuries in October — almost $91 billion — than in any previous month.

Most of the money — $56 billion in October — has gone into Treasury bills rather than into longer-dated bonds and notes. That flow helped to push down interest rates on bills to historically low levels, sometimes even a bit below zero, as investors sought complete safety.

King Kong Waiting in the Wings

There could be another reason, too, as to why the shorts haven’t piled into USTs yet. That reason is the Fed.

With the Fed Funds target now in a “range” of zero to 0.25%, the Fed has no more ammo on the rate-cutting side. The chamber of that particular sixgun is empty.

But Ben Bernanke isn’t worried about being out of bullets, as you know, because the Fed has so many “alternative measures” available for juicing the economy.

Those alternative measures include buying Treasury bonds.

If the Fed feels the need, in other words, they could buy hundreds of billions worth of USTs at a clip in order to keep interest rates low. The Fed has further expressed willingness to move as far out along the curve as necessary. Two-year, ten-year, thirty-year… all are fair game for a Bernanke buying binge.

The Fed’s bond-buying option is both a promise and a threat. It’s a promise in respect to keeping interest rates low for “a considerable period of time.” It’s a threat to all those investors who want to keep their money hidden in a mattress – or some rough equivalent thereof – rather than putting it back to work in the economy.

“The policy will work if applied with sufficient ruthlessness,” writes Martin Wolf of the Financial Times.

That ruthlessness could include ramming and jamming the bond market like nobody’s business if bond prices fall (and rates conversely rise) to a greater degree than the Fed’s liking.

The Dollar Speaks

If the Fed were indeed to put a huge bid in the treasury market, how would they do it?

The mechanics would no doubt be convoluted. Bernanke would probably dream up a fresh entry for his growing seven-letter acronym collection in order to describe the new bond-buying “facility.”

But, at the end of the day, the smoke-and-mirrors accounting has to come out in the wash somewhere. In this case, a Fed bond-buying binge would put the market awash in a tidal wave of new dollars. (Bernanke would have to put dollars into the hands of the private sellers he is buying bonds from.)

The sinking in of that reality – the Fed’s willingness to prop up bonds with printed dollars – might explain why the U.S. dollar index just saw its biggest six-day decline in history.

According to Bespoke Investment Group, the dollar’s recent eight-percent-plus drop was the largest ever, besting the previous 7.48% record set in September 1985.

Short-Term versus Long-Term

Based on end-of-year accounting factors and a supply-limited window of foreign investor buying, USTs could be a good candidate for a quick, sharp break (much like the dollar’s swift fall) early in the 2009 calendar year.

An aggressive put option trade – near-term firecrackers relatively close to expiry – could be one way to play this. If done right, it’s the kind of trade where you either lose the small amount you invested or make five times your money in a fingersnap.

If I were to make a short-term play like this, I would do it with money I could afford to lose – probably no more than one or two percent of my total trading account. And if the trade paid off, I would take the money and run at the first sign of stabilization (rather than waiting around for the Fed to bid bonds up after the break).

The other way to look at Treasuries is with a decidedly patient, long-term view.

In the medium term, the Fed’s action profile is decidedly bond-positive and dollar-negative: they want interest rates low and exports strong, which favors strong bonds and a weak currency.

In the longer term, though – once the Fed’s near term issues have been resolved – Treasuries could be setting up for a historic multi-year decline… the sort of epic, drawn-out move in which new trend-following fortunes can be made.

A Treasury Bond Mystery and a Currency Clue