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Saturday, January 31, 2009 6:20 PM

Hazardous Lending and Lax Collection Practices

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One of Minnesota's largest and oldest community banks, Forest Lake's Mainstreet Bank gets FDIC order to change.

Mainstreet Bank of Forest Lake, one of Minnesota's largest and oldest community banks, has received a cease-and-desist order from the Federal Deposit Insurance Corp., alleging "hazardous lending and lax collection practices."
My Comment: If hazardous lending and lax collection practices are grounds for cease and desist orders, then about 1000 notices ought to be flying out of FDIC headquarters right now, starting with Citigroup (C), Bank of America (BAC), Wells Fargo (WFC), and even some newly created bank holding companies like GMAC.
Like many community banks, Mainstreet is getting stung by loans it made to developers and builders during the real estate boom, when property prices were going nowhere but up. Now, those loans are souring at an alarming rate, and banks that hold the loans are being ordered by state and federal regulators to clean up their lending practices.

The FDIC claims Mainstreet operated with policies and practices that "jeopardize the safety of its deposits." The 105-year-old bank, which has nine branches in the Twin Cities area, operated with an excessive level of delinquent loans and did not keep an adequate allowance for loan and lease losses, according to a 23-page order, issued Dec. 12 and made public Friday.
My Comment: The whole freaking system is insolvent. There is nothing special about Mainstreet. What is special is the perhaps 10-20% of the banks that did nothing stupid but are being punished for it. FDIC insurance has CD money flowing to the crappiest of crappy banks.

One way to tell if a bank is crappy is to look at the CD rate. If it is way above normal, then assume it is involved in way above normal risk.
Out of commercial real estate

A Mainstreet spokeswoman said Friday that the bank is moving quickly to address the FDIC's concerns. It has temporarily stopped making loans to real estate developers, and will focus instead on consumer and business loans.

"It's back to our core, which is community banking," said Karen Greisinger, chief marketing officer. "All of our products are still in place. We're still making loans. But we're just moving away from that segment -- commercial real estate."
My Comment: Now there's a fantastic plan. Mainstreet made hazardous loans on commercial real estate and now wants to return to its core business of making hazardous loans to consumers smack in the face of a soaring unemployment rate.
In Minnesota, the delinquency rate on commercial mortgages and construction loans made by state banks rose 84 percent in the third quarter of 2008 from the same quarter a year earlier, according to Foresight Analytics, a California real estate research firm.

"It was the residential housing market that burst first," said Jennifer Thompson, a financial analyst with Portales Partners. "But all these home builders borrowed from someone, and those loans are starting to crack, too."

As of Sept. 30, an alarming 37 percent of the bank's construction and land loans were more than 30 days past due -- nearly four times the national average, according to Foresight.

About 100 Minnesota banks have more than four times their total capital in commercial real estate -- a level at which heightened scrutiny from examiners may be warranted, according to the FDIC.
Let's translate that last sentence so that it reads properly: "As many as 100 Minnesota banks may be doomed to fail having engaged in hazardous lending and lax collection practices centered around commercial real estate".

A tsunami of commercial real estate failures is coming. And when it comes to "lax collection practices", you either have the money or you don't. All the debt collectors in the universe cannot squeeze blood out a bankrupt turnip.

Mike "Mish" Shedlock
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3:08 PM

Case Shiller and CAR Analysis January 2009 Release

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California Association of Realtors C.A.R. Data

The following chart is from my friend "TC" who has been monitoring California Association of Realtors (C.A.R.) and DQNews data. C.A.R. data contains resale single family residences and new homes. DQNews data contains resale single family residences and new homes.

click on any chart in this post for sharper image

Median nominal prices in CA are now down 53% according to CAR and 48% according to DQNews - and those declines are in 19-20 months!

Case-Shiller is a more accurate way of looking at home prices than median prices. Case-Shiller data follows.

Case Shiller January 2009 Release

Inquiring minds are considering the Case Shiller Home Price Release for January 2009.

Home Price Declines Continue as the S&P/Case-Shiller Home Prices Indices Set New Record Annual Declines.

New York, January 27, 2009 – Data through November 2008, released today by Standard & Poor’s for its S&P/Case-Shiller1 Home Price Indices, the leading measure of U.S. home prices, shows continued broad based declines in the prices of existing single family homes across the United States, with 11 of the 20 metro areas showing record rates of annual decline, and 14 reporting declines in excess of 10% versus November 2007.

The chart above depicts the annual returns of the 10-City Composite and the 20-City Composite Home Price Indices. Following the lead of the 11 metro areas described above, the 10-City Composite matched last month’s record decline of 19.1% and the 20-City Composites set a new record, down 18.2%.

“The freefall in residential real estate continued through November 2008,” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s. “Since August 2006, the 10-City and 20-City Composites have declined every month – a total of 28 consecutive months.

The chart above shows the index levels for the 10-City Composite and 20-City Composite Home Price Indices. It is another illustration of the magnitude of the decline in home prices over the past two years.
Please see the original article for more commentary and tables on the data.

Case-Shiller Declines Since Peak

The following charts were produced by my friend "TC" who has been monitoring Case-Shiller Data. Although individual cities topped at varying times, the top-10 and top-20 city composites peaked in a June-July 2006 timeframe.

Case-Shiller Declines Since Peak Current Data
Correction: The column below that reads 2009 should say 2008.

click on chart for sharper image

Case-Shiller Declines Since Peak Futures Data

click on chart for sharper image

"TC" writes:
The Nov 2008 Case-Shiller data continues to accelerate to the downside. The 10 and 20 city index show declines from their peak in excess of 25% and the bubble cities (along with Detroit) all have declines in excess of 30% with Phoenix having the largest percentage drop of -43% and San Francisco having the largest price drop at $351,000+.

It is important for readers to know that Case-Shiller uses a Repeated Sales Methodology (RSM) which provides the most accurate housing data available. Additionally, as requested I've added two columns titled "Price Level" which show both the last time prices were at the current level and what price level prices are projected to decline to based upon the CME Futures market.

The most extreme bubble city decline is once again San Francisco which is at prices last seen in May 2002. However, the most extreme overall city is Detroit which has now reverted to prices last seen in Aug 1997.

This additional data is even more interesting when you look at the projected trough months. For example, Los Angeles is expected to trough in Nov 2010 at prices last seen in Jan 2003. However, those Jan 2003 prices are an amazing 44% higher than LA prices were in Jan 2000. Consequently, we can certainly go a lot lower and it appears that even the Futures market may be too optimistic about when this market bottoms.

Lastly, the sheer number of negative quarters in every city continues to amaze as 14 of the 20 cities have now experienced 9 or more consecutive quarters of prices declines!
Thanks "TC"

Those wanting to see still more graphs of housing and other data should take a peek at another fine post by Calculated Risk called January Economic Summary in Graphs.

My take is unemployment is going to soar in 2009 along with foreclosures, credit card writeoffs, and bankruptcies. Those will add to the inventory problems. Thus it is extremely unlikely that housing bottoms anytime soon.

And as much as housing prices have declined, take another look at the second chart in the news release above. Imagine where prices will be if they fall back to 2003 levels or worse yet 2001 levels. Moreover, why shouldn't prices fall back that far? Finally, how many are prepared for it, if indeed that were that to happen?

Mike "Mish" Shedlock
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Friday, January 30, 2009 6:40 PM

January ends with grim news on stocks, jobs, shipping

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The stock market decline that started over a year ago picked up some steam in the Worst January ever for Dow, S&P 500

It was the worst January ever for the Dow industrials and S&P 500, according to Stock Trader's Almanac data.

The Dow lost 8.8% and the S&P 500 lost 8.6% in the month.

The Nasdaq's loss of 6.4% was eclipsed by last January's loss of 9.9%. That 2008 loss was the worst in the tech average's history, going back to its inception in 1971.
As goes January so goes the year. Or so they say.

Cargo Plummets 22.6% in December

The International Air Transport Association is reporting Cargo Plummets 22.6% in December
The International Air Transport Association (IATA) released international scheduled traffic results for both December 2008 and the full-year.

In the month of December global international cargo traffic plummeted by 22.6% compared to December 2007. The same comparison for international passenger traffic showed a 4.6% drop. The international load factor stood at 73.8%.

For the full-year 2008, international cargo traffic was down 4.0%, passenger traffic showed a modest increase of 1.6%, and the international load factor stood at 75.9%.

“The 22.6% free fall in global cargo is unprecedented and shocking. There is no clearer description of the slowdown in world trade. Even in September 2001, when much of the global fleet was grounded, the decline was only 13.9%,” said Giovanni Bisignani, IATA’s Director General and CEO.” Air cargo carries 35% of the value of goods traded internationally.
Nearly 6% of world’s boxships laid up

The picture is grim for container ships as well as Nearly 6% of world’s boxships laid up
The number of containerships laid up is growing very fast. According to French maritime consultant AXS-Alphaliner, 255 ships, equivalent to 675,000 teu in capacity (5.5% of the global containership fleet), were laid up as of January 19 this year. It projects that the volume of containerships on standby will jump to the equivalent of 750,000 teu in early February this year, accounting for 6% of the entire global boxship fleet.

Since the week before Christmas - just one month ago - the number of ships idling has grown by 90 or 255,000 teu.

Worse is to come. Alphaliner estimates that new build deliveries in 2009 will represent 14% of the current fleet. Another 12% will join in 2010. Despite continued scrapping, the weak demand trends will fall well short of absorbing this net new capacity. Compounding the problem, as pointed out by Alphaliner, is that current bunker prices are reaching the point where the popular coping practice of "slow steaming" becomes uneconomical. In short, the idle fleet will expand considerably.
Harbours fill with surplus ships

Harbormasters are rejecting ships as Harbours fill with surplus ships
Boatowners are likely to encounter many more laid-up merchant ships around the UK due to the credit crunch. Harbours and anchorages in several parts of the country are filling up with surplus ships as owners lay-up their vessels.

The lay-up area at King Harry Ferry on the River Fal is already so full of dormant ships that Carrick harbourmaster Andy Brigden has had to reject a request to accommodate a further fleet of seven vessels. Southampton, meanwhile, has become the temporary home of four large ships totalling over 300,000 tonnes, and it is reported that additional moorings will be laid to accommodate further arrivals.
French workers march on 'Black Thursday'

In France, A million workers march on 'Black Thursday'

(Jean-Paul Pelissier /Reuters)

About a million French workers staged a one-day strike yesterday and hundreds of thousands took to the streets in a show of force against President Sarkozy and his handling of the economic slump.

The stoppage, mainly by public sector workers, closed many schools but failed to paralyse public transport as the strikers had hoped. The Paris transport system remained about 75 per cent normal. But quiet stations and roads around the capital and other cities showed that many people had stayed at home for what had been billed as “Black Thursday”.

Mr Sarkozy’s Government played down the “day of mobilisation” as relatively routine by French standards. “This was by no means exceptional in terms of a public sector stoppage,” said Luc Chatel, the Cabinet Minister who acts as government spokesman. “It was about the same as in May this year and in 2006.”
Index shows economic activity decreased further in December

The Chicago Fed National Activity Index shows economic activity decreased further in December.
The Chicago Fed National Activity Index was –3.26 in December, down from
–2.78 in November. All four broad categories of indicators made negative
contributions to the index in December.

The three-month moving average, CFNAI-MA3, increased slightly to –2.40 in December from –2.56 in the previous month. With recent revisions, the three-month moving average reached its lowest value since 1980 in November. December’s CFNAI-MA3 suggests that growth in national economic activity was well below its historical trend. It also indicates little inflationary pressure from economic activity over the coming year.

The production and income category of indicators made a large negative contribution of –1.32 to the index in December, following a contribution of –1.06 in November. Total industrial production declined 2.0 percent in December after decreasing 1.3 percent in the previous month. In addition, manufacturing capacity utilization declined to its lowest level since 1983—at 70.2 percent in December from 71.9 percent in November.
General Motors To Invest $1 Billion of TARP Funds in Brazil

US Taxpayers are creating auto jobs in Brazil as General Motors to Invest $1 Billion in Brazil Operations
General Motors plans to invest $1 billion in Brazil to avoid the kind of problems the U.S. automaker is facing in its home market, said the beleaguered car maker.

According to the president of GM Brazil-Mercosur, Jaime Ardila, the funding will come from the package of financial aid that the manufacturer will receive from the U.S. government and will be used to "complete the renovation of the line of products up to 2012."

"It wouldn't be logical to withdraw the investment from where we're growing, and our goal is to protect investments in emerging markets," he said in a statement published by the business daily Gazeta Mercantil.
Riot Fears In China

As the global economy sours, China fears riots will spread as boom goes sour
Today millions will leave the cities to return to their rural family homes for the new year celebrations. But this year Beijing hopes the newly jobless revellers will stay there - to prevent a fresh wave of unrest in the cities.

They surged into the grimy streets around the factory: first scores, then hundreds, then more than a thousand, as word spread and tension loaded the stale, grey air. The boldest overturned a police van and smashed up motorcycles, then tore through the building destroying computers and equipment. The mood was exhilarated, angry and frightened.

"It happened so quickly ... There were maybe 500 involved and another 1,000 watching them. People were yelling: 'It's good to smash'," said a witness.

But the riot late last year at the Kai Da factory in Dongguan, amid the grim industrial sprawl of the Pearl River Delta, was not an isolated incident. It was one of tens of thousands of protests, many erupting from the same mixture of economic grievances, resentment of police and swirling rumour.
Property tax revenue plummets with home values

Adding to the growing list of California woes, Property tax revenue plummets with home values
California could pay the price for the foreclosure crisis for years to come, thanks to Proposition 13, the 1978 voter initiative that caps property taxes.

As banks feverishly dump foreclosed homes at cut-rate prices, and as neighboring homes change hands at similar bargain-basement rates, those amounts are enshrined as the new basis for determining property tax until the homes are sold again. Under Prop. 13, that basis can rise a maximum of just 2 percent a year, even if the home is worth significantly more. The consequence is likely to be a revenue crunch for the public services funded by property tax revenues.

"This is going to have a long-term impact on the state budget and on local budgets," said Jean Ross, executive director of the nonpartisan California Budget Project in Sacramento. "It means that even after the economy recovers, state and local government budgets will not recover fully."

Gus Kramer, Contra Costa assessor, puts it in stark terms.

"It's going to be an absolute economic disaster in Contra Costa County and surrounding areas," he said. "Everyone thinks this is like the last recession with values going down and that when they come back there will be a resurgence - but it's not going to be like that. It will be years before (the tax roll) recovers because all these people are selling (distressed) homes, banks are selling at deep discounts, values are going down from 50 percent to 75 percent. The people buying them will hold onto them for five, six, seven years. The tax base is not going to recover anytime soon."
Ford Burns Through Cash, Seeks Deal With Bondholders

In what may amount to an exchange of worthless shares for worthless bonds, Ford May Seek Distressed Debt Swap With Bondholders
Ford Motor Co., the only U.S. automaker shunning federal loans, may seek to exchange its unsecured debt with bondholders “in the coming months” as it burns through cash in the longest U.S. recession since the 1980s.

There is “little chance” that Ford, which depleted $21.2 billion of cash in 2008, will pay unsecured debt holders back at par, Kip Penniman Jr., an analyst at Montpelier, Vermont-based KDP Investment Advisors Inc., wrote in a report today.

Ford, the second-biggest automaker, on Jan. 29 reported a worse-than-expected $5.9 billion fourth-quarter loss, capping what was the worst annual performance in its 105-year history. The company said it would tap a $10.1 billion credit line to increase cash reserves.
Utah's MagnetBank closed without an acquirer

It's Friday so this news cannot be unexpected: Utah's MagnetBank closed without an acquirer
Utah's MagnetBank became the fourth bank failure of the year on Friday, and the Federal Deposit Insurance Corp. was forced to directly refund depositors after being unable to find another institution willing to take over its operations.

It marks the first time the FDIC has been unable to find an acquirer for a failed bank in nearly five years, according to FDIC spokesman David Barr.
"This bank did not have an attractive franchise value, and not many retail deposits or core deposits," Barr said. The FDIC had conducted an extensive marketing process for the bank's assets, he said.

The closure marks the fourth bank failure of 2009 and the 29th since the start of the credit crisis.
80 proof, not recession proof

The Seattle Times is questioning conventional wisdom in 80 proof, not recession proof for liquor industry
Drinking away your troubles? Possibly. But chances are you're doing less of it, and you're imbibing at home.

The alcohol industry is often thought of as "recession proof," but the spirits industry said Friday that its business softened last year, with revenue growth slowing and spending shifting away from bars and restaurants.

Revenue reported by liquor suppliers rose 2.8 percent from the previous year to $18.7 billion in 2008, according to the Distilled Spirits Council of the United States. That's slower than the 6 percent average annual growth rate since 2000. Volume grew 1.6 percent, also below the 2.7 percent average growth of recent years.

That there is even still growth shows the spirits business is "recession resilient," said council president Peter Cressy, but not immune to the pressures of the economy.

"It is absolutely not recession proof," Cressy said. "There's no question the fourth-quarter softened substantially."
Economic Plunge Worst Since 1982

Obama says it's a continuing disaster as the Economy's new plunge is worst in quarter-century
Battered by layoffs, debts and dread of worse to come, shoppers clutched ever tighter to their wallets in the final three months of 2008 and thrust the economy into its worst downhill slide in a quarter-century. Americans cut spending on everything from cars to computers, and it's only getting worse so far in the new year.

All told, the economy staggered backward at a 3.8 percent pace at the end of last year, the government said Friday. And the tailspin could well accelerate in the current quarter to a rate of 5 percent or more as the recession churns into a second year and consumers and businesses buckle under a relentless crush of negative forces.

Spending cutbacks hit everywhere last quarter. Shoppers chopped spending on cars, furniture, appliances, clothes, food, transportation and more. Businesses dropped the ax on equipment and computer software, home building and commercial construction. And overseas sales of U.S.-produced goods and services tanked as foreign buyers grappled with their own economic woes.

It's "a continuing disaster" for the nation's families, declared President Barack Obama, making what has become an increasingly urgent daily pitch for his $819 billion stimulus package to revive the economy.
Auto Fleet Sales Off to Slow Start

An automotive hurricane is hitting the industry. Low fleet demand gets '09 auto sales to slow start
A steep drop in sales to rental car companies and other fleet buyers is expected to weigh heavily on carmakers when they report their January sales results Tuesday. It remains to be seen whether injecting government cash into automakers' financing arms helped consumers make up the difference.

"It is an automotive hurricane moving through this industry," said Jim Farley, Ford Motor Co.'s marketing chief, at last weekend's National Automotive Dealers Association convention. Farley predicted a big drop in business from fleet buyers, which are keeping their current vehicles longer to pare costs.

Fleet sales -- big-volume sales to customers like rental car companies and municipalities -- typically account for about 20 percent of industrywide sales, but analysts expect that to be down sharply in January. Rental car companies have taken a big hit as consumers and businesses slash their travel budgets in the economic downturn, and the companies are holding onto their old cars rather than buying new ones.

"Our demand is down double-digits," said Richard Broome, spokesman for rental car company Hertz Global Holdings Inc. "So the need for new cars is less now than it would be in most years."

Many U.S. auto plants have been closed all month, with some shut down as long as eight weeks, said Jesse Toprak, executive director of industry analysis for the auto Web site Edmunds.com. He predicted industrywide fleet business fell 50 percent from January 2007.

"I think there's a lot of pent-up demand," Toprak said. "Consumers postponed purchases in the marketplace for the last year or longer, and once conditions start stabilizing in the economy, we're going to start seeing those postponements become reality."
Pent Up Demand? Let's look at the jobs picture before discussing pent up demand. Unemployed persons are not prone to buy cars.

Job cuts exceed 100,000 for the week

CNN Money is reportingJob cuts exceed 100,000 for the week
In a brutal week for the job market, an assortment of companies across various industries announced more than 100,000 job cuts.

The bulk of the job loss news occurred on Monday, when several major U.S. companies announced sweeping job cuts, pushing the day's total to more than 70,000.

Pfizer (PFE, Fortune 500), the leading drugmaker in terms of annual pharma sales, and Caterpillar (CAT, Fortune 500), a heavy equipment manufacturer based in Peoria, Ill., each said they would cut 20,000 jobs. These are the biggest reported eliminations among U.S.-based companies.

Boeing (BA, Fortune 500) announced its massive layoffs on Wednesday. The Chicago-based airplane manufacturer said 10,000 workers, including 4,500 previously announced reductions, would lose their jobs. The company blamed this on dwindling demand for its aircraft.

The U.S. economy lost 2.6 million jobs in 2008, according to government reports. This includes 21,137 mass layoffs, a seven-year high. In a mass layoff, 50 or more workers are laid off at a time.
Pent Up Demand?

Yes there is a pent up demand, not for autos, but rather for cash.

Mike "Mish" Shedlock
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12:18 AM

Global Crisis Destroys 40% of World Wealth; Bailout to Hit $4 Trillion

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The world Economic Forum is reporting Global crisis 'has destroyed 40pc of world wealth'

The past five quarters have seen 40pc of the world's wealth destroyed and business leaders expect the global economic crisis can only get worse.

Steve Schwarzman, chairman of private equity giant Blackstone, said an "almost incomprehensible" amount of cash had evaporated since the financial crisis took hold.

"Business will be very different," he added.

His comments came on a day of the World Economic Forum characterised by the gloom of its participants and warnings that the crisis will endure for some time. News Corp chief executive Rupert Murdoch kicked off the meetings by warning that the atmosphere was worsening – despite global economic confidence plumbing the lowest depths on record.

"The crisis is getting worse," he said. "It's going to take drastic action to turn it around, if it can be turned around, quickly. I believe it will take a long time."
Indeed, business will be very different. This is the back side of Peak Credit and its twin sister Peak Earnings.

Inflationists simply do not understand the destruction of bank credit accompanying in conjunction with the decline in asset prices. Nor do they understand the changing attitudes towards debt. This is a once in every 3-4 generational occurrence. Hardly anyone alive has experienced anything but inflation all their lives until about a year or so ago. A rude awakening is at hand.

Pimco Says U.S. Must Buoy Asset Prices for Recovery

Oce again Bill Gross misses the mark by a mile. Please consider Pimco Says U.S. Must Buoy Asset Prices for Recovery.
Policy makers must stop declines in asset prices to revive the U.S. economy in 2010 and curb rising unemployment, according to Bill Gross, co-chief investment officer of Pacific Investment Management Co., the world’s biggest bond fund.

“You can’t bail out everyone, yet economic recovery is not possible unless certain critical asset sectors are not only reliquefied but rejuvenated in price,” Gross wrote in his February investment outlook posted today on the firm’s Web site. “An economic recovery is dependent upon commercial real estate prices stabilizing and more retail stores staying open for business in the months and years ahead.”

Policy makers should purchase municipal bonds, commercial mortgage-backed securities and investment-grade corporate bonds as a “necessary step towards eventual economic revival,” Gross wrote.
It is impossible for government to stop the decline of asset prices except by owning every one of them. Prices will fall to their natural level regardless of intervention.

What Gross is essentially asking for is for the government to guarantee above market prices for the assets PIMCO owns.

Darling Lines Up The Tools

On the other side of the Atlantic Darling Gives BOE Authority on Asset Purchase Fund
The U.K. government gave the central bank authority to spend 50 billion pounds ($71 billion) on bonds and commercial paper and paved the way for the central bank to lift money supply as interest rates keep falling.

Chancellor of the Exchequer Alistair Darling directed Bank of England Governor Mervyn King to buy investment-grade securities as a way of unfreezing financial markets. The bank’s Monetary Policy Committee also will consider using the fund to stimulate the economy, though it will need permission to act.

Britain’s recession is deepening as banks ration credit, shrugging off seven cuts in the central bank’s borrowing costs. The policy, set out in letters between the central bank and the Treasury, marks a first step toward so-called quantitative easing, where governments increase the money supply to reduce its cost and prevent a downward spiral in the economy.

They’re getting all the tools lined up,” said Matthew Sharratt, an economist at Bank of America Corp. in London. “All you need to do is stop the sterilizations to increase money supply. The mechanics are being set up to move into quantitative-easing proper. It is a rising probability they may be forced into further down the line.”
As I commented in Fed Adopts "Throw The Kitchen Sink" Policy
Flooding the market with words and throwing the kitchen sink at the problem will not stop the impending wave of failures. In cases of tools vs. tsunamis, the tsunami will win every time.
And after the kitchen sink, it's straight down the drain thereafter.

The Ever Rising Cost Of The Bailout

Does anyone remember when the cost of the bailout was supposed to be $500 billion? Then $1 trillion? Then $2 trillion, then a whopping leap to $3.6 trillion. It's time top up the taxpayer ante once again.

Fortune Magazine is reporting Bank bailout could cost $4 trillion
Banks don't have enough capital to fix their problems, which means the Obama administration may need a lot more money to clean up the financial mess.

The cost of the bank bailout is likely to be much higher than $700 billion.

While the Obama administration hasn't asked Congress for more money yet, some experts warn that government spending on support for struggling financial services companies will ultimately reach into the trillions of dollars.

"The amount of working capital you'd expect the government to take into this would be around $3 trillion to $4 trillion," said Simon Johnson, a senior fellow at the Peterson Institute for International Economics and author of its Baseline Scenario financial crisis blog.

But calls for a comprehensive response from the government have increased in recent weeks following the free fall of bank stocks.

The KBW Bank index has dropped 35% in January after a 50% plunge in 2008, as investors worry that the government may be forced to nationalize some banks -- and wipe out shareholders in the process. Shares of Citigroup (C) and Bank of America (BAC) have been particularly hard hit.

"The big banks are a hope trade right now," Johnson said.

Johnson said the government could get warrants in banks receiving assistance that would convert to common shares once the government sells them. He also said the government could hire private equity managers to oversee the assets the government takes on -- and sell them when the time is right.

These arrangements, he said, should allow the Treasury to extract some gains for taxpayers when the economic free fall ends and the banking system starts to recover.

Some observers believe asset values are so depressed right now that as long as the government has a well designed plan that restores investor confidence, taxpayers should profit from the financial bailout

"I think we have seen prices fall to a point where the government could very easily make money, though I'd be very happy if we end up breaking even," says Gary Hager, president of Integrated Wealth Management in Edison , N.J.
I am sorry, there simply is no hope for the "Hope Trade". Citigroup, Bank of America, Wells Fargo, etc are gigantic black holes that will suck in every dollar available. All taxpayers will get, if anything, are a few quarks that escape.

Colin Barr, senior writer for the story goes on to say "If the history of previous banking system rescues is any guide though, there's also a good chance that removing toxic assets from bank balance sheets could leave taxpayers with a significant tab."

Had Barr written "near certainty" instead of "good chance" and I would have rung the bell and given him a cigar.

And in talking about a possible RTC style bailout, Barr concludes "But whatever method the aggregator bank uses, it could mean significantly higher startup costs than the RTC had. So expect to see the Obama administration coming back to Congress for more money...soon."

Ding, ding, ding, we have a winner. I am ringing the bell for Barr's final conclusion. That unfortunately, is the sad state of affairs.

Murray Rothbard vs. Tim Geithner

Inquiring minds are considering a 1984 classic by Murray Rothbard entitled Wall Street, Banks, and American Foreign Policy.
Commercial bankers, engaged as they are in unsound fractional reserve credit, are, in the free market, always teetering on the edge of bankruptcy. Hence they are always reaching for government aid and bailout.
My friend "BC" just pinged me with ... The banksters hold the marked cards, the politicians are the dealer, and the taxpayers are the patsy in this game. Of course the banks are not just 'teetering' anymore. They have actually gone bankrupt.

Mike "Mish" Shedlock
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Thursday, January 29, 2009 6:14 PM

Deals of the Week

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Inquiring minds are reading about "Deals of the Week" in Five Things You Need to Know: Banana Republic. Let's take a peek.

1. Change Comes Hard

This morning I was rudely greeted by two bizarre news headlines; bizarre because they were written about roughly the same thing, yet presented two diametrically opposed thoughts.

The first was from the New York Times: Geithner Sets Limits on Bank Lobbying

The second was from the Wall Street Journal: Geithner's New Chief of Staff is Former Bank Lobbyist

What in the hell? Seriously? That used to be something you would only read in a local broadsheet while waiting on a sweaty tarmac to flee a collapsing South American dictatorship.

Yes, change comes hard in all senses of the word.

2. Deal of the Weak

As if to underscore the reality of a the ongoing structural shift in consumption taking place, the Wall Street Journal "Deal of the Week" in commercial real estate this week is the sale of one of Cincinnati's largest malls by Simon Property Group (SPG) for $20 per square foot.

According to the Journal, the average price nationally for malls is around $134 per square foot.

"To be sure, the property is in sad shape," The newspaper noted. "Some 40% of its non-anchor retail space is empty."

Expect more "Deals of the Weak" to follow in the months ahead.
Day in and day out, Kevin Depew writes one of the best columns on the web.

Please take a look at his post if you are a following gold. In point 3, Kevin has charts of "Two views of Gold", one in Euros, the other in dollars. His take, there's reason for caution. My take? I still like gold here. Compromise: Perhaps gold does well in real terms (what it buys in terms of other assets) but remains range bound in nominal terms.

As for "more deals coming in the months ahead", why here's a deal to consider from two days ago. ....

Regulators Are Demanding A Deal

Please consider Suburban Federal Savings Bank told to sell
Federal banking regulators have told Crofton-based Suburban Federal Savings Bank that it must be sold by Friday or face a possible government takeover.

The 53-year-old thrift has been trying to recover from losses on soured real-estate loans. In documents filed last week, the Office of Thrift Supervision ordered Suburban to merge with another institution or accept "appointment of a conservator or receiver."

If Suburban were to be seized, it would be the first bank to fail in Maryland since 1992, the tail end of the savings and loan crisis.

The bank had about $33 million in bad loans as of Sept. 30, about eight times its capital.

If neither Suburban nor the government can find a buyer, the FDIC could take receivership and try to find one or more parties to buy pieces of it. "The desire is to have a whole bank transaction, where the healthy institution takes over the failed institution ... so they've acquired a franchise," said FDIC spokeswoman LaJuan Williams-Dickerson.

Bert Ely, a banking consultant in Alexandria, Va., said it will difficult to find a buyer for Suburban. "It's absolutely amazing they're still open," Ely said. "The capital at the end of September was almost exhausted."
Here's the deal. Deal: Sell Yourself. No Deal: The FDIC takes you over. That's the deal. More deals coming. ... Soon.

Good Bank Bad Bank Deal Is A Bad Deal

Institutional Risk Analysis is discussing The Big Banks vs. America: A Roundtable with David Kotok and Josh Rosner.
The term "bad bank" is being tossed around Washington dinner tables this week, a sign that the situation facing the largest banks is reaching a boiling point. It is amazing to us to see how little people understand the choices facing us with the big banks, how narrow those choices truly are and how the numbers in terms of losses are so BIG that they will ultimately force us to do the right thing.

Remember that the entire banking industry stands in front of the taxpayers in terms of loss absorption at the FDIC, so you can understand why the smaller banks in the industry are SERIOUSLY PISSED OFF at the large banks and their minions in the Obama Administration like Tim Geithner and Robert Rubin. Oh, and don't forget Chairman Ben Bernanke and the entire Fed board of governors. These leading officials are increasingly talking the side of the large banks in the battle over limited financial resources, a fact that is causing the community bankers to rise in anger. Stay tuned.

Roundtable: David Kotok & Josh Rosner

For additional perspective on this issue, The IRA spoke last week to Josh Rosner of Graham Fisher & Co and David Kotok of Cumberland Advisors:

The IRA: The basic question everyone's asking is what do we do with the big banks, particularly C and BAC and the growing tension between the cost of supporting the big banks w/o a resolution and the rest of the industry, which is being resolved according to the law. You can see our discussion of the issue and our view of loss rates above.

Rosner: First, I am very cautious about making loss estimates because your loss number could be very low. I can actually draw a scenario that gets us well above that level of charge offs, especially if we assume worsening macro conditions and their further impacts on ADC books, corporate defaults and other areas outside of the structured exposures.

Kotok: The motivation of keeping big banks alive is driven by a desire to avoid another Lehman on the Obama watch. I hear people saying that we cannot have another Lehman, therefore we cannot permit a failure. ... It is the Lehman failure and the contagion that is driving this policy.

The IRA: Well this just confirms that nobody in Washington understand the problem. As we have heard from many people in the industry who did the diligence on Lehman, there was no way for a private buyer to do the deal, so bankruptcy was the only choice w/o a very large, several hundred billion public bailout. The fact that the Fed and Treasury professional staff support this type of idiocy, over tinme, will destabilize the political consensus in this country behind an independent central bank. We might as well just make the Fed part of Treasury now.

Kotok: It looks to me as well that we now have Paul Volcker saying that we cannot tolerate another Lehman failure. Maybe Chris has some thoughts on this?

The IRA: My conversations with Chairman Volcker are OTR unless he says otherwise.

Rosner: I think what you are going to see is, on the one hand, the Fed, Treasury and OCC put together a proposal for a continuing or institutionalization of the "insurance wrap" approach used with C and BAC. This is a useless approach, in my view, and as we saw in the case of C because it created greater market confusion.

The IRA: Nobody in the Congress or the White House wants to acknowledge that the policy prescriptions coming from the Fed and Treasury are badly flawed when it comes to bank solvency. The market liquidity measures have had success, but the "save the big banks" approach by the Fed is just more of the same nonsense that cause the problem in the first place.
The Institutional Risk Analysis is always a good read. This one was exceptional. I recommend reading the entire article to see the letter from the reader that inspired the post, as well as more of the roundtable discussion.

"Black Swan" commented earlier today, his idea of what is driving Geithner. "There is only one reason Geithner doesn't want to nationalize the banks. It would destroy all the stock wealth of his bankster cronies now running these banks, and would force them out of their financial engineering jobs and personal fiefdoms. Geithner will do everything possible to not force banking's elite insiders to have to go out in the working world amongst the commoners."

Regardless of the motivation, one look at the IRA article suggests something that I have maintained for quite some time. This may not be a issue of "too big to fail", but rather the combined losses may be so great that it's a case of "too big to bail". Nonetheless, expect them to try, and expect lots of damage to our economy when Geithner does try. That unfortunately is the deal.

Mike "Mish" Shedlock
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5:47 AM

Geithner Discusses Nationalization In $2 Trillion Bailout Proposal

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Barney Frank once again is leading the way in a mad rush to do something, even though his track record in such cases is a perfect zero. Please consider Lawmakers Weigh Bad-Bank Plan

Top U.S. House and Senate Democrats are taking a wait-and-see approach to the Obama administration's potential plan to create a "bad bank" to buy up toxic assets, though there remains a sense of urgency for policy makers to put something in place fast.

"It has to be done quickly," said House Financial Services Chairman Barney Frank (D., Mass.), when asked Wednesday about the concept. "There are a variety of ideas, and this is something they should focus on."

There has been increasing chatter in Washington that policy makers plan to dedicate some portion of the roughly $350 billion remaining from the TARP to buying up troubled assets. The approach could be twofold: allowing the government to purchase the assets through a "bad bank" and then guaranteeing the assets against further losses.

The bad-bank portion of the program could involve the government creating an entity to purchase the assets from financial institutions, while raising money by selling government-backed securities.

Shares of banks and other financial companies jumped in response to the reports of the plan. Wells Fargo & Co. shares were up more than 25% in afternoon trading. Shares of two banks that have required two bailouts from the government, Citigroup Inc. and Bank of America Corp., were up more than 15% and 10%, respectively.

The rescues of Citigroup and Bank of America could provide a partial model for policy makers. In both cases the government, and by extension taxpayers, are on the hook for billions of dollars of potential losses after the banks take the first hit. The Citigroup rescue alone included protection for more than $300 billion in assets.

Mr. Frank said one benefit of creating an entity to buy up the assets would be that the government could be more aggressive in dealing with foreclosures. Because a major portion of the toxic assets the government would likely own are mortgage-backed securities, it would give policy makers leverage when trying to implement foreclosure-mitigation plans that have been stunted by MBS investors unwilling to agree to rework the terms of struggling mortgages.
It has to be done quickly

How many Barney Frank nightmares do we have to endure just because they "Have to be done quickly"? Frank himself is bitching about how Pauslon spent the first $350 billion. Yet time was of such essence he helped ramrod the bailout bill through Congress, then complained about the results.

Another Day, Another Bailout

In yet another waste of taxpayer money U.S. Moves to Bail Out Credit Union Network
In the latest effort to prop up a sector of the finance industry, federal regulators on Wednesday guaranteed $80 billion in uninsured deposits at the powerful institutions that service the nation's credit unions -- a maneuver that shows how the economic crisis continues to ripple across the U.S.

Regulators also injected $1 billion of new capital into the largest of these wholesale credit unions, U.S. Central Federal Credit Union of Lenexa, Kan., after the firm on Wednesday posted an unexpected $1.1 billion loss for 2008. U.S. Central serves essentially as a main clearinghouse for the others in the network. ... Rest By Subscription
New Bank Bailout Plan Could Cost $2 Trillion

Inquiring minds are reading how the New Bank Bailout Plan Could Cost $2 Trillion
Government officials seeking to revamp the U.S. financial bailout have discussed spending another $1 trillion to $2 trillion to help restore banks to health, according to people familiar with the matter.

President Barack Obama's new administration is wrestling with how to stem the continuing loss of confidence in the financial system, as it divides up the remaining $350 billion from the $700 billion Troubled Asset Relief Program launched last fall. The potential size of rescue efforts being discussed suggests the administration may need to ask Congress for more funds. Some of the remaining $350 billion of TARP funds has already been earmarked for other efforts, including aid to auto makers and to homeowners facing foreclosure.

The administration, which could announce its plans within days, hasn't yet made a determination on the final shape of its new proposal, and the exact details could change. Among the issues officials are wrestling with: How to fix damaged financial institutions without ending up owning them.
My Translation: Officials are wrestling with how to privatize the gains and socialize the losses.
The aim is to encourage banks to begin lending again and investors to put private capital back into financial institutions. The administration is expected to take a series of steps, including relieving banks of bad loans and distressed securities. The so-called "bad bank" that would buy these assets could be seeded with $100 billion to $200 billion from the TARP funds, with the rest of the money -- as much as $1 trillion to $2 trillion -- raised by selling government-backed debt or borrowing from the Federal Reserve.
My Comment: It is idiotic to force banks to lend because few credit worthy borrowers have no reason to borrow.
The administration is also seeking more effective ways to pump money into banks, and is considering buying common shares in the banks. Government purchases so far have been of preferred shares, in an effort to both protect taxpayers and avoid diluting existing shareholders' stakes.
My Comment: Protect the taxpayer? There is no one between the sun and Pluto who believes the taxpayer is being protected. When can we stop this ridiculous charade?
A Treasury spokeswoman said that "while lots of options are on the table, there are no final decisions" on what she described as a "comprehensive plan." She added: "The president has made it clear that he'll do whatever it takes to stabilize our financial system so that we can get credit flowing again to families and businesses."
My Comment: There may be a bunch of options on the table, but not a single one is viable.
Treasury Secretary Timothy Geithner said Wednesday that he wants to avoid nationalizing banks if possible. "We'd like to do our best to preserve that system," Mr. Geithner said. But given the weakened state of the banking industry, with bank share prices low and their capital needs high, economists say the government probably can't avoid owning at least some banks for a temporary period.
My Translation: Geithner is doing his best to wreck what little semblance of capitalism we have left. Geithner is the worst of Obama's picks.
But buying common shares raises the likelihood that weaker banks will become largely government-owned. Bank share prices are so low that any sizable government investment in a bank would give the U.S. effective control of it.

Another option under discussion is insuring some of the assets against further losses. That is the route the U.S. has taken in its rescues of Citigroup Inc. and Bank of America Corp. Insuring the assets would limit the amount the banks could lose but wouldn't remove the securities and loans from their books. The government would cover any losses in the assets' value beyond agreed-upon levels.

Charles Calomiris, the Henry Kaufman Professor of Financial Institutions at Columbia University, said that approach is preferable since it leaves the assets in private hands while giving investors confidence to put money into the institution.

"You have to eliminate prospective stockholders' concern that there's a bottomless hole at the banks," Mr. Calomiris said. "Getting them off the books solves that problem, but insuring against the downside would have a huge positive effect and might end up costing nothing."
Charles Calomiris is yet another socialist clown looking to socialize the losses and privatize the gains straight into the hands of the recklessly greedy bank executives that helped create this mess. This appears to be yet another Terminal Case Of FIV.

Only a complete fool could think that guaranteeing debt while having no stake in the gains might cost nothing.

Mike "Mish" Shedlock
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5:44 AM

CRE Tax Bills Due, Will Anyone Pay?

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In a harbinger of things to come, Austin officials are nervous about tax bill for 10 office buildings

Local tax officials are concerned as uncertainty looms over whether Austin's biggest office landlord will be able to pay $17.8 million in property taxes that are due Monday.

The money is due from Thomas Properties Group Inc. and Lehman Brothers, which, along with the California State Teachers' Retirement System, own 10 office buildings in Austin, including the Frost Bank Tower downtown.

Thomas Properties has gone to court in an attempt to force Lehman Brothers Holdings Inc. to release money from a $100 million revolving loan to pay the property tax bill. But the lawsuit is entangled in Lehman Brothers Holdings Inc.'s complex bankruptcy case in New York, and it's not clear when the Thomas matter might be resolved.

City and county budget and tax officials have met twice in the past two months to discuss the outlook for tax collections generally, as well as the potential impact if the Thomas Properties/Lehman money isn't forthcoming, said Dusty Knight, chief deputy of the Travis County tax assessor/collector's office.

"This could very majorly impact all taxing jurisdictions in the county," Knight said. "Their budgets are contingent on getting the money in a timely manner. If it takes four or five years to get it back, it could affect this year's budgets drastically."
The commercial real estate mess is just beginning. Uncollected tax bills are going to soar, and many small to mid-sized regional banks heavily into commercial real estate are headed for bankruptcy.

Mike "Mish" Shedlock
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Wednesday, January 28, 2009 3:46 PM

Fed Adopts "Throw The Kitchen Sink" Policy

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The Fed is using all the tools it has available including a threat to buy long dated treasuries to break the downward spiral of the economy.

The Federal Open Market Committee kept its interest rate target in a range of zero to 0.25%, as expected. Rates will need to stay close to zero for "some time," the statement said.

The lack of action on interest rates was expected, as was the FOMC's statement that rates were likely to stay low for a considerable length of time.
All of the action in the statement was related to the Fed's continuing efforts to flood the financial system with money.

The Fed has adopted a "throw the kitchen sink" approach to combating the downturn, which is being fueled in part by weak banks.

"The Fed stands ready to buy anything that anyone suggests might help. The sky is the limit," said Mike Englund, chief economist at Action Economics.
Buying longer-term Treasurys would be a new tool in the Fed's arsenal to repair financial markets. Some economists worry that buying Treasurys would cause foreign investors to lose their appetite for the securities.

"If the Fed commits itself to a policy of artificially depressing the returns on Treasury securities for an extended period, it will force investment committees around the world to reconsider their portfolio allocations to the U.S. Treasury market as an asset class," wrote Lou Crandall, chief economist at Wrightson ICAP in a note to clients.

The Fed said was "prepared" to buy Treasurys "if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets."
Full Text of FOMC Statement

Interested parties may wish to read the Full FOMC Statement as listed below.
The Federal Open Market Committee decided today to keep its target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

Information received since the Committee met in December suggests that the economy has weakened further. Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending. Furthermore, global demand appears to be slowing significantly. Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight. The Committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant.

In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. The focus of the Committee's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets. The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Committee will continue to monitor carefully the size and composition of the Federal Reserve's balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Dennis P. Lockhart; Kevin M. Warsh; and Janet L. Yellen. Voting against was Jeffrey M. Lacker, who preferred to expand the monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs.
Flooding The Market With Words

The more unconventional the Federal Reserve's policy becomes, the more it feels the need to explain itself. So the Fed flooding the market with words.
In its statement on Wednesday, the Federal Open Market Committee didn't change policy at all. It kept its interest rate target with a whisker of zero percent; it said rates would be low "for some time"; it vowed to continue buying mortgage-backed and asset-backed securities; and it said once again that it was prepared to buy longer-term Treasurys if warranted. Nothing new.

What was new in the statement was the explanation the FOMC gave for these unconventional moves. The Fed can't lower interest rates any further, but it can do a lot to grease the wheels of commerce. Most of the statement was an explanation for why the Fed thinks the grease is necessary, and a few details on what brand of grease they intend to employ.

The result was the longest and most detailed FOMC statement on record. The typical FOMC statement covers about 300 words; this one weighed in at 474.

The FOMC repeated its commitment to use "all available tools" to bring the economy back to life. They went into great length about the tools they've got in the box, including a promise to buy longer-term Treasurys if they think that would help.
All that detail could be counterproductive. It may look like the Fed is doing some fancy footwork, but all they are doing really is bailing as fast as they can.
FDIC May Run ‘Bad Bank’ in Plan to Purge Toxic Assets

Bloomberg is reporting FDIC May Run ‘Bad Bank’ in Plan to Purge Toxic Assets.
The Obama administration is moving closer to setting up a so-called bad bank in its effort to break the back of the credit crisis and may use the Federal Deposit Insurance Corp. to manage it, two people familiar with the matter said.

FDIC Chairman Sheila Bair is pushing to run the operation, which would buy the toxic assets clogging banks’ balance sheets, one of the people said. Bair is arguing that her agency has expertise and could help finance the effort by issuing bonds guaranteed by the FDIC, a second person said. President Barack Obama’s team may announce the outlines of its financial-rescue plan as early as next week, an administration official said.

“It doesn’t make sense to give the authority to anybody else but the FDIC,” said John Douglas, a former general counsel at the agency who now is a partner in Atlanta at the law firm Paul, Hastings, Janofsky & Walker. “That’s what the FDIC does, it takes bad assets out of banks and manages and sells them.”

Bank seizures are “going to happen,” Senator Bob Corker, a Tennessee Republican, said in an interview after a meeting between Obama and Republican lawmakers in Washington yesterday. “I know it. They know it. The banks know it.”
Everyone knows a tsunami of bank failures is coming. Flooding the market with words and throwing the kitchen sink at the problem will not stop the impending wave of failures. In cases of tools vs. tsunamis, the tsunami will win every time.

Mike "Mish" Shedlock
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1:05 AM

Bankers' Worst Nightmare Materialize

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Amidst soaring chargeoffs and ever increasing job layoff announcement, Bankers' Fear of Unemployment Materialize.

Bankers' worst nightmare is the unemployment rate climbing toward 10%, a level at which credit losses could balloon unpredictably because of high defaults among people with previously strong credit histories.

Right now, bank balance sheets don't appear in a position to deal with unemployment moving sharply higher from its current 7.2% rate.

Building up bad-loan reserves to deal with a 9% to 10% rate could produce enormous losses and pulverize capital when banks are trying to preserve the thin cushions they have. And fear of rising unemployment could deter lending when the government wants banks to expand credit. True, the Obama administration's stimulus plan could reduce unemployment expectations. But right now, banks are hoisting their joblessness forecasts.

Last week, consumer lender Capital One Financial increased its unemployment forecast to 8.7% by the end of 2009, from its previous expectation of 7% by midyear. And Capital One added that it is building more-severe unemployment scenarios into lending decisions.

Also last week, Kelly King, chief executive of regional bank BB&T, said unemployment of 8% to 8.5% is "kind of manageable," but 9% to 10% would "have a dramatic impact on our scenarios."

Why the trepidation of going above 9%? Take a regular credit-card book. Past data show that a percentage-point increase in unemployment leads to roughly a percentage-point rise in the charge-off rate, the amount of defaulted loans written off at a loss.

But as unemployment exceeds 9%, bankers think charge-offs will start to increase by more than the increase in unemployment. The reason? A high rate could cause an unprecedented wave of defaults among prime borrowers, who tend to have bigger loan balances.

"The situation is so extreme and beyond what we've seen in past cycles that management teams are becoming reluctant to predict the relationship between unemployment and credit losses," said Kevin Fitzsimmons, analyst at Sandler O'Neill & Partners.
House of Cards

The Washington Independent notes that Analysts Fear $1 Trillion Credit Card Market Could Be Next Crash. Please consider House of Cards.
Even as the subprime mortgage fallout continues its ripple effect across the economy, fiscal storm-watchers have an eye on the next gathering cloud: nearly $1 trillion of consumer credit card debt. Defaults are up; in November, the percentage of charge-offs — money card issuers give up on ever collecting — rose to 5.62 percent. According to some economists, that percentage could double before this current downturn is over. The bearish RGE Monitor predicts the default rate could rise as high as 13 percent, eclipsing the previous high-water mark of a 7.85 percent in the first quarter of 2002.

This is bad news for the banks and third-party investors that hold this debt, as well as for consumers hit with the double-whammy of rising unemployment and restricted credit. Americans are relying on their credit cards to an ever-increasing degree. In 2008, the average credit card balance was $11,212, according to CardTrak.com. Compare this to 15 years ago, when the average credit card debt was a comparatively paltry $4,306. Factors like California’s plan to delay income tax refunds and long-jobless workers running out their unemployment benefits don’t help the situation, either. With no silver-bullet solution in sight, economists and analysts are nervous.

Credit card companies have already started to batten down the hatches by cutting cardholders credit limits and raising interest rates. “What institutions are doing now is circling the wagons,” said Dennis Moroney, research director, bank cards, at finance-industry research firm TowerGroup.

Additional retrenchment looks inevitable. Although about half of all credit card debt has been repackaged and sold as securities, it’s a much smaller pool of capital than the mortgage securities market, so a rise in default rates probably won’t cause the kind of systemic domino effect that the mortgage collapse triggered. It will, however, make third-party investors much more reluctant to purchase such debt — and risk getting burned — in the future. With mounting default losses on their own books, banks will have to raise more capital to meet their reserve obligations. Like a retailer trying to unload Christmas paraphernalia on December 26, they’ll have to slash prices if they want to attract buyers. As a result, consumers — especially those with blemished credit — are going to have difficulty securing loans or lines of credit.

In addition, the banking industry contends that new regulations passed by the Federal Reserve last month will give them no choice but to sharply curtail lending — putting at risk the consumer purchasing power that drives 70 percent of spending in the U.S.
Notice how that only now regulations will sharply curtail lending. Here is an easy prediction. Lending will eventually get to be as ridiculously tight at the bottom as it was ridiculously easy at the top.

Credit Squeezed

In an ironic twist of fate, extremely poor credit risks may be getting a better shake than prime borrowers as card companies step up efforts to recoup what they can from members as noted in Credit Squeezed.
Credit card issuers are using a host of measures to make sure customers make their payments and fees keep coming in, now that banks are feeling as squeezed as their financially pinched consumers.

Some card issuers are clamping down on late payments and grace periods as they near new, stricter credit card regulations that go into effect in July 2010, consumer advocates say. Some lenders also are working out payment plans and, in certain cases, lowering interest rates for delinquent customers who are having a hard time keeping up with their bills.

The industry also is bracing for sweeping changes approved last month by the Federal Reserve to revamp rules governing penalty fees and rates. Among other things, card issuers will be required to send a bill at least 21 days before the due date so consumers have time to make payment before getting slapped with a late fee. And bankers won't be able to raise rates on existing balances unless a payment is more than 30 days late.

"They see the writing on the wall, and when these rules take effect, their ability to impose penalty rates and penalty fees are going to be so greatly curtailed that in the interim period they'll be aggressive in trying to impose fees to the letter of the law that's in the account agreements," said Ben Woolsey, director of marketing and consumer research at creditcards.com.

With economic conditions deteriorating, card companies are stepping up their collection efforts in hopes of recouping what they can from consumers. They're also taking more telephone calls from cash-strapped customers.

Discover Financial Services has hired staff to respond to customers seeking help and launched a section on its Web site where cardholders can find more information on getting payment assistance.

American Express is calling card members in earlier stages of delinquency and offering payment plans that offer "flexibility around the interest rate, fees and plan length."

And Bank of America is waiving fees and reducing interest rates on monthly payment programs. Last year, the bank said, it modified nearly 700,000 credit card loans.
Be Careful Of What You Ask

That's a good 2 page article by the Baltimore Sun.

What we are seeing is the unwinding of extremely favorable banking regulations towards much tighter lending restrictions. Loose regulations that bankers asked for and received under Bush are now backfiring big time. Such is the nature of the Fed, Congress, and the credit cycle. The solution is not regulation, but sound monetary policy and the elimination of fractional reserve lending.

Mike "Mish" Shedlock
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Tuesday, January 27, 2009 3:32 PM

Fed's "Homeownership Preservation Policy" Doomed To Failure

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The Fed is doing everything humanly possible it can to make matters worse. Please consider Fed Adopts Policy to Modify Mortgages, Stem Home Foreclosures

The Federal Reserve will ease terms on residential mortgages acquired in the rescues of Bear Stearns Cos. and American International Group Inc., seeking to stem foreclosures.

The Fed policy is targeting borrowers who are 60 days or more overdue on loan payments and covers modifications of interest rates and payment plans. The program uses the Fed’s authority in the $700 billion Troubled Asset Relief Program and was released today by the House Financial Services Committee.

“It reflects the understandable desire of the Federal Reserve to have some cooperation” with the Obama administration, House Financial Services Committee Chairman Barney Frank told reporters today in Washington. “This is a very big deal.”

The Fed’s “Homeownership Preservation Policy” lets the central bank or its agents “promptly” review applicable mortgages to determine whether the borrowers should be offered a loan modification, the document said. Qualified borrowers must be at least 60 days late on their payments.

The policy applies to the residential-mortgage assets the Fed acquired in its rescues of Bear Stearns in March and AIG in September.

The Fed will distinguish between loans in which the central bank may hold only a fractional interest along with other investors, the Fed said. It will encourage the servicers of those residential mortgage-backed securities “to implement a loan-modification program that is consistent with this policy,” according to the document.
The Fed's "Homeownership Preservation Policy" will not preserve many homes, but it will encourage homeowners to get 60 days late. For now, the policy only pertains to AIG and Bear Stearns loans, a very small subset of loans. When the policy fails, as it will, expect the Fed to expand it to other areas. Every failed policy to date has been expanded. This one will be no different.

Mike "Mish" Shedlock
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Monday, January 26, 2009 11:03 PM

Return Of The Three-Day Work Week

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In the UK, government sources say shorter hours would be preferable to mass unemployment: Britain is facing return of three-day week

The prospect of the three-day week returned to haunt Britain yesterday as it emerged that ministers are considering paying firms to cut hours in order to survive the recession.

Tens of thousands of businesses are already planning to scale back working hours this year in an effort to stay afloat. But as the country comes to terms with the reality of a recession, it emerged that the Government is looking at compensating employees, through their firms – thereby drawing comparisons with the shutdowns of the 1970s.

While the move would safeguard jobs, it would mean that the financial crisis is on a much larger scale, further undermining confidence in the economy with the suggestion of Britain grinding to a halt.

Major firms such as JCB have already downed tools for one day a week and are considering moving to a three-day week, with state help, if the recession gets worse. The firm's chief executive, Matthew Taylor, said that he is pressing Lord Mandelson, the Secretary of State for Business, to introduce compensation for workers if their hours are reduced.
Taylor wants everyone to work three days and the government pay for the extra two. Is this supposed to be a viable plan?

‘Soviet’ Britain swells amid the recession

The Times online is reporting ‘Soviet’ Britain swells amid the recession.
PARTS of the United Kingdom have become so heavily dependent on government spending that the private sector is generating less than a third of the regional economy, a new analysis has found.

The study of “Soviet Britain” has found the government’s share of output and expenditure has now surged to more than 60% in some areas of England and over 70% elsewhere.

Experts believe the recession will tighten the state’s grip still further as benefit handouts soar and Labour directs public sector organisations to create jobs to soak up unemployment.

In the northeast of England the state is expected to be responsible for 66.4% of the economy this year, up from 58.7% when a similar study was carried out four years ago. When Labour came to power, the figure was 53.8%.

Across the whole of the UK, 49% of the economy will consist of state spending, while in Wales, the figure will be 71.6% – up from 59% in 2004-5. Nowhere in mainland Britain, however, comes close to Northern Ireland, where the state is responsible for 77.6% of spending, despite the supposed resurgence of the economy after the end of the Troubles.

Even in southern England, the government’s share of spending is growing relentlessly. In the southeast, it has gone up from 33% to 36% of the economy in four years.

The state now looms far larger in many parts of Britain than it did in former Soviet satellite states such as Hungary and Slovakia as they emerged from communism in the 1990s, when state spending accounted for about 60% of their economies.

“It’s not that the public sector in the northeast is too big, it is that the private sector is too small,” said Malcolm Page, deputy chief executive of One North East. “The decline of traditional industries in the past means we need to establish more big private-sector companies in the region.”
The government's share of spending is about 50%. And to top it off , JCB wants it to increase. When does the 3 day week start here?

Mike "Mish" Shedlock
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Sunday, January 25, 2009 10:44 PM

Peter Schiff Was Wrong

Mish Moved to MishTalk.Com Click to Visit.

There are numerous YouTube videos, articles, and references to Peter Schiff being "right" rapidly circulating the globe. While Schiff was indeed correct about the US imploding, most of the praise heaped on Schiff is simply unwarranted, and I can prove it.

First, let's start with a look at the claim being made. Peter Schiff concludes many of his articles, books, etc. with the following statement.

Mr. Schiff is one of the few non-biased investment advisors (not committed solely to the short side of the market) to have correctly called the current bear market before it began and to have positioned his clients accordingly.
Highlight in red is mine.

I would like to see some proof of that statement. Specifically I would like to see the average returns posted by EuroPacific clients for 2008.

I have talked with many who claim they have invested with Schiff and are down anywhere from 40% to 70% in 2008. There are many other such claims on the internet. They are entirely believable for the simple reason Schiff's investment thesis was flat out wrong.

I have an actual portfolio statement from one of Schiff's clients at the end to discuss, for now let's discuss the main points of Schiff's thesis.

Schiff's Overall Thesis

  • US Equity Markets Will Crash.
  • US Dollar Will Go To Zero (Hyperinflation).
  • Decoupling (The rest of the world would be immune to a US slowdown.
  • Buy foreign equities and commodities and hold them with no exit strategy.

Schiff was correct about point number 1 above. The US equity markets crashed. That was a very good call. Unfortunately, his investment thesis centered on shorting the dollar in a hyperinflation bet, and buying foreign equities rather than shorting US equities.

Furthermore, Schiff made no allowances for being wrong and had no exit strategy whatsoever.

What happened in 2008 was that foreign equities sold off much harder than US equities, and a strengthening US dollar compounded the situation.

In other words, Schiff failed where it matters most: Peter Schiff did not protect his client's assets. Let's take a look how, and more importantly why, starting with charts of various foreign indices.

click on any chart in this post for a sharper image

$SSEC Shanghai Stock Exchange Weekly

$NIKK Tokyo Nikkei Weekly Chart

$TSX - Canada TSX Weekly Chart

$AORD Australia ASX Weekly Chart

$SPX S&P 500 Weekly

2008 Equities Bloodbath

2008 was a global equities bloodbath. Clearly there was no decoupling. The Shanghai index (China), Nikkei (Japan), TSX (Canada), AORD (Australia), and virtually every world equity index collapsed along with the S&P 500, the DOW, and Nasdaq in the US.

Many, if indeed not most, foreign equity markets did worse than the US indices. The Shanghai index fell from 6124 to 1665, a whopping 72.8% decline top to bottom.

Let's investigate why this happened, starting with the decoupling thesis itself.

Global Decoupling Thesis

Please consider this excerpt from the Little Book of Bull Moves in Bear Markets, page 41:

"I'm rather fond of the word decoupling, in fact, because it fits two of my favorite analogies. The first is that America is no longer the engine of economic growth but the caboose. [The second] When China divorces us, the Chinese will keep 100% of their property and their factories, use their products themselves, and enjoy a dramatically improved lifestyle."

I mentioned decoupling many times previously but declared it officially dead on January 22, 2008 in Global Decoupling Myth Shattered In Equity Selloff. There are some interesting charts on currencies in that post as well.

Here is a snip from Tail Wags Dog Theory Blows Up written November 1, 2008.
Tail Wags Dog Theory Blows Up

At every peak there are always ridiculous predictions. In the dotcom bust, it was all about the "gorilla game", the "new economy" and "click counts". When the Shanghai Stock Index rose from 998 to 6124 in about two years, we heard the same sort of thing about growth in China. Instead of click counts, the theory in vogue was called decoupling. China was supposed to be the 800 lb gorilla with insatiable demand for commodities and perpetual growth for the next decade.

That decoupling theory was based on the belief that the US no longer mattered, that China demand was self-sustaining, that China could grow forever with no problems, etc. Such beliefs eventually became a religion.

The tail does not wag the dog no matter how many people think otherwise.
Let's explore decoupling by looking at manufacturing, employment, and capital flows.

Global Manufacturing Contracts

Please consider US Manufacturing Orders at 60 Year Low, China Contracts 5th Straight Month.

  • China’s manufacturing contracted for a fifth month.
  • European Manufacturing Contracts At Fastest Pace On Record.
  • Russian Manufacturing PMI Shrank the Most on Record.
  • U.S. Manufacturing Shrinks as Orders Hit 60-Year Low.

That's not decoupling, that's a worldwide recession.

Millions of Chinese Struggle to Find Jobs

In the wake of a global slowdown, Chinese export shrink, civil unrest is a worry, and unemployment is rising as noted in Xinhua says there will be more unemployment and social revolts in 2009.
State council adviser Chen Quansheng, warns that unemployment is much more serious than portrayed by the official statistics. According to Chen, so far at least 670,000 small industries have been closed, leaving 6.7 million people unemployed, but this number refers only to registered workers. But there are millions of people working in the underground economy, coming from the countryside, who are being fired and are forced to return to their villages without any unemployment benefits.

The academy of social sciences is also warning about the worrisome number of firings. In 2009, the government will have to create work for at least 33 million people, including migrants, young people seeking their first jobs, and new graduates.
The odds of China finding work for 33 million workers without printing vast amounts of money are slim.

Hot Money Outflows Exacerbate Chinese Problems

Inquiring minds are reading Monetary conditions might exacerbate the Chinese adjustment by Prof. Michael Pettis.

Synopsis: Chinese monetary policy has locked the country into a dangerously pro-cyclical trap. Hot money flowed into China and pushed the economy into overheating. Those inflows have reversed sharply, perhaps by as much as $100bn last quarter, equivalent to around 8% of Q4 GDP. These outflows are causing a credit contraction and an even sharper economic slowdown at exactly the worst possible moment.

One Tail Cannot Wag Six Dogs

Those hot money inflows were all part of the global credit boom that is now unwinding. Much of China's boom centered on exports. Now that the US consumer has thrown in the towel, a key question arises:

Can China expand enough to make up for the contraction in US and European demand given that the two economies are more than six times the size of China?

The answer to that last question is an emphatic no. One tail cannot wag six dogs.

Here is another way to look at it. The US is the world's largest economy. Housing had already weakened but commercial real estate had not. US retail stores and malls were being built at an unsustainable blowoff pace and those stores were crammed with goods coming from China and Japan.

The decoupling theory was that loss of the US consumer would not matter to the commodity producers like Canada and Australia or the manufacturers like China and Japan. How could any economist have thought that? Many did. Schiff was one of them.

Peter Schiff on 2009-2010 USA Hyperinflation

Here is a partial transcript of a Schiff Audio On US Hyperinflation
The whole idea is to get out of the US Dollar. It is on the verge of collapse. The people who don't get out of the US dollar are going to be completely broke and that is obvious. Look at what Ben Bernanke did. Interest rates are zero. Money is free.

Bernanke is going to run up printing presses as fast as he can. This is pure inflation Latin American style. This is hyperinflation; this is Zimbabwe; this is the identical monetary policy of the Weimar Republic.

I am just as convinced that people who have their money in US dollars are going to be just as broke as people who have their money with Madoff.

I do not know how much time you have. With the dollar dropping 5% a week at this point, could it snap back? But what if it keeps falling? What if it's down 5% next week? And 5% the week after that? And then what if it drops 10%? and another 10%? At some point a year from now the dollar could be dropping 5% a day.

The inflation rate in Zimbabwe is over 100 million percent a year.
Hyperinflation or Hyperventilation?

Schiff asks "But what if it keeps falling? What if it's down 5% next week? And 5% the week after that? And then what if it drops 10%? ...."

That was quite some rant, enough to scare many who listened. Schiff is indeed very charismatic.

He never bothers to ask, "What if it doesn't?" The answer was not so pretty for his clients. The simple fact of the matter is Schiff was wrong where it mattered.

Schiff has been ranting about hyperinflation for years. The dollar is substantially higher now than it was at the start of 2005. His explanation for the recent rally is there is no "real demand" for dollars, it's just deleveraging.

I agree that deleveraging is indeed happening.

But why is deleveraging happening? The answer is everyone herded into anti-dollar plays based on decoupling and hyperinflation theories that did not pan out. Those trades are now being forcibly unwound. The bulk of the carnage is likely over but the losses have been immense.

Unlike Schiff, I called for this US dollar rally.
On November 9th, I went neutral on the dollar as the US dollar index came close to hitting my target.

In 2001-2002 the US$ index peaked at 121. Since then there was a massive flight out of US dollars into anything else. That flight continued into 2008 even though the fundamentals were changing.

The fundamentals of China and the commodity producers were simply not very good once the US consumer threw in the towel.

Schiff simply did not see this coming.

US the Next Zimbabwe?

Schiff continually compares the US to Zimbabwe. Such comparisons are silly. Please consider Zimbabwe to launch 100 trillion dollar note.
Zimbabwe's central bank will issue a 100 trillion Zimbabwe dollar banknote, worth about $33 (22 pounds) on the black market, to try to ease desperate cash shortages, state-run media said Friday.

Prices are doubling every day and food and fuel are in short supply. A cholera epidemic has killed more than 2,000 people and a deadlock between President Robert Mugabe and the opposition over power sharing has dampened hopes of ending the crisis.

Hyperinflation has forced the central bank to keep issuing new banknotes which quickly become almost worthless. There is an official exchange rate, but most Zimbabweans resort to the informal market for currency transactions.
Does that sound like anything that is happening or is going to happen in the US? I think not.

However, let's assume for a moment that hyperinflation is going to happen. Where then could one get the most bangs for their buck to take advantage? The answer to that question is in real estate, where one can buy on 5% down. Nowhere else can one easily get such leverage.

Note that there has never been hyperinflation in history where real property declined in value. Therefore, if Schiff really believes in hyperinflation, he ought to be suggesting that his clients buy houses.

However, Schiff thinks housing prices will continue to crash. So do I. And if they do, you can kiss hyperinflation theories goodbye.

EuroPacific Thoughts on the Financial Crisis

I do not expect every advisor at every company to think alike, but I did find these Thoughts on the Financial Crisis by Andre Sharon, Consulting Research Analyst for Euro Pacific Capital rather interesting.
What Now?
Only three possible outcomes:

1. We inflate to the level of the debt, i.e. we "fulfill" debt obligations, but in mini-dollars
2. We take the hit, cleanse the system of excesses and move on. Result: deflation, bankruptcies, high unemployment, etc...
3. We disinflate veeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeery slowly, like Japan. Won't happen: the American psyche won't take 16-odd years of no growth. Different cultural mindset: you can't prick a balloon slowly here.

My guess: combination of 1 and 2. I would hope for a bias towards 2. Terrible for many, but healthier for the system long-term. Schumpeter's concept of creative destruction trumps Keynes, in my book. That's life, and progress, with all its faults and flaws.
My pick is a combination of 2 and 3 (2 is not by choice but rather by force) for reasons explained in Brink of Debt Disaster.

But what I find interesting is that a Europacific advisor believes that Keyensian economics can be trumped (I do as well, Japan proved it), but also that Andre Sharon at least in part is calling for "Result: deflation, bankruptcies, high unemployment, etc..."

I would advise Schiff to toss his hyperinflation theories out the window and listen more to his research analyst. However, Schiff cannot and will not change because he has two books calling for hyperinflation.

On the other hand, I can change. I called for deflation and it is here right now. I do not have to wait for it. The only debate is how long it lasts.

At the appropriate time, I expect to transition my stance towards a stagnant slow growth period in which there will be inflation but not by a lot. In such a scenario, the US would hop in and out of recessions for up to a decade, much like Japan.

Time will tell whose model is correct. I reserve the right to change my model. It's too late for Schiff to change his. The damage has already been done.

Closer Look At Currency Fundamentals

The US economy is clearly in shambles. However, when the US dollar index crashed to 70 the dollar was priced as if the US alone was in trouble. That was hardly the case. Europe, China, Australia, Canada, the UK, are in shambles as well.

On August 8 2008, Trichet Put the Spotlight on the Euro, Dollar by saying economic growth in Europe would be "particularly weak". That was a clear signal all was not well in the Eurozone. Most, including Schiff ignored the signal.

Although the US had a massive housing bubble, so did Spain, Ireland, and other parts of Europe. Also note that European banks invested in US mortgage debt.

Finally, European banks invested heavily in Latin America and the Baltic states. The US did not make those mistakes.

The credit crunch now threatens the sacrosanct

On January 19 2009, New Europe reported The credit crunch now threatens the sacrosanct.
Last October, the ECB signed a currency swap agreement with the Swiss National Bank. The obvious purpose was to support the solvency of the Swiss Franc. The reason why the franc needed support was that the country’s banks had undertaken huge obligations in foreign currencies, which exceed the Swiss national income, probably by many times. Who knows how many? Last week this agreement was renewed and extended in volume.

The case is similar with Iceland. That tiny country was one of the richest and most reliable in the world, a kind of small Switzerland. But Iceland’s banks were found at the beginning of credit crisis to have huge obligations in foreign currency. When the banks started to go insolvent the government of Iceland stepped in and nationalised them.

In the case of Switzerland - along with the ECB - came the American central bank, the Fed, to support the solvency of the franc with foreign swap agreements. Who on earth wants the Swiss banks to fail? In short, nothing has been settled in the credit crunch crisis and the entire world continues to support those who created the problems in the first place.
Think the Swiss Franc is a safe haven? I don't.

So what about the Euro? Here are a few headlines to ponder.

Germany Faces Worst Post-War Economic Decline


Germany is facing its biggest economic downturn since the Second World War with Chancellor Angela Merkel's government saying Wednesday it expects Europe's largest economy to contract by 2.25 per cent this year.Germany's Economics Minister Michael Glos and Finance Minister Peer Steinbrueck released the latest data on Wednesday, revising their prior 2009 forecast down sharply from last October's prediction of 0.2 percent growth.Since then, German exports have declined precipitously and are expected to be down 8.9 percent for the year.

Berlin Sees No Limits to Economic Intervention


As part of her efforts to combat the economic crisis, German Chancellor Angela Merkel is increasing the state's influence in the market, buying holdings in banks and bailing out individual industries and companies.Is Germany turning into a planned economy? Only a few weeks ago, Chancellor Angela Merkel spoke out against "arbitrary, unfocussed economic stimulus programs" and large-scale government intervention in the real economy.

Trichet Vision Unravels as Italy, Spain Debt Shunned

On January 16, 2009 Bloomberg reported Trichet Vision Unravels as Italy, Spain Debt Shunned
European Central Bank President Jean-Claude Trichet’s vision of economies converging behind the shield of a shared currency may be unraveling.

The gap between the interest rates Spain, Italy, Greece and Portugal must pay investors to borrow for 10 years and the rate charged to Germany has ballooned to the widest since before they joined the euro. The difference may grow further as Europe’s worst recession since World War II hurts budgets and credit ratings across the region.

Diverging bond yields hurt Trichet’s argument that the ECB’s inflation-fighting mandate ushered in an era of stability for nations that once suffered rampant price growth.

They also make it tougher for the ECB, which cut its key rate to a record yesterday, to set one benchmark for all 16 euro nations. That may delay recovery as governments try to fund stimulus plans.
Monetary union has left half of Europe trapped in depression

Ambrose Evans-Pritchard at The Telegraph is writing Monetary union has left half of Europe trapped in depression.
Events are moving fast in Europe. The worst riots since the fall of Communism have swept the Baltics and the south Balkans. An incipient crisis is taking shape in the Club Med bond markets. S&P has cut Greek debt to near junk. Spanish, Portuguese, and Irish bonds are on negative watch.

Dublin has nationalised Anglo Irish Bank with its half-built folly on North Wall Quay and €73bn (£65bn) of liabilities, moving a step nearer the line where markets probe the solvency of the Irish state.

A great ring of EU states stretching from Eastern Europe down across Mare Nostrum to the Celtic fringe are either in a 1930s depression already or soon will be. Greece's social fabric is unravelling before the pain begins, which bodes ill.

Each is a victim of ill-judged economic policies foisted upon them by elites in thrall to Europe's monetary project – either in EMU or preparing to join – and each is trapped.

In Lithuania, riot police fired rubber-bullets on a trade union march. Dogs chased stragglers into the Vilnia river. A demonstration outside Bulgaria's parliament in Sofia turned violent on Wednesday.

Latvia's property group Balsts says Riga flat prices have fallen 56pc since mid-2007. The economy contracted 18pc annualised over the last six months. Leaked documents reveal – despite a blizzard of lies by EU and Latvian officials – that the International Monetary Fund called for devaluation as part of a €7.5bn joint rescue for Latvia. This was blocked by Brussels – purportedly because mortgage debt in euros and Swiss francs precluded that option.

Spain lost a million jobs in 2008. Madrid is bracing for 16pc unemployment by year's end.

Private economists fear 25pc before it is over. Spain's wage inflation has priced the workforce out of Europe's markets. EMU logic is wage deflation for year after year. With Spain's high debt levels, this is impossible.

Italy's treasury awaits each bond auction with dread, wondering if can offload €200bn of debt this year. Spreads reached a fresh post-EMU high of 149 last week. The debt compound noose is tightening around Rome's throat. Italian journalists have begun to talk of Europe's "Tequila Crisis" – a new twist.
On page 157 of Little Book of Bull Moves in Bear Markets, Peter Schiff writes "The Euro could possibly replace the United States dollar as the world's reserve currency."

I suggest a breakup of the Eurozone has a greater chance than that. While I agree that US dollar hegemony will end eventually, ideas that the Euro will replace the US dollar as the world's reserve currency are farfetched.

Looking far ahead, there may not be any one reserve currency per se. Ideally we will return to a gold standard but at the moment that does not seem particularly likely either.

So what about Australia? Can it decouple?

Australia is one of Peter Schiff's favorite countries for investing. Please consider Aussies hit by 50yr record wealth decline.
CommSec equities economist Savanth Sebastian says that is the worst fall in records dating back to 1960.

"It's no doubt that it will have a big impact on consumer spending going forward adding further downward pressure after we saw those job losses in terms of full-time employment," he said.

"So it suggests that for the Reserve Bank and for the government further stimulus will need to be on the agenda."
That additional "stimulus" is the same thing Schiff rails about in the US every time he speaks. The whole world is stimulating now.

Australia Won't Hesitate To Stimulate

Australia Treasurer Wayne Swan says Australia’s government won’t hesitate to stimulate the economy further should the need arise amid the global recession.
“We will not hesitate to take whatever further action is necessary to support growth and jobs,” Swan, 54, said in speech notes received via e-mail. “Major financial institutions, some of which have withstood world wars and the Great Depression, have either collapsed or been bailed out.”
Australian Dollar Monthly Chart

The Australian dollar is one of Schiff's favorites. "While other countries are creating inflation, Australia's central bank is raising interest rates to keep inflation in check." page 161

Australia May Cut Interest Rate Below 2%

Former Reserve Bank Governor Fraser suggests Australia May Cut Interest Rate Below 2%.
Fraser, Reserve Bank of Australia chief during the nation’s last recession in 1991, said policy makers may reduce the overnight cash rate target to less than 2 percent from 4.25 percent now. The bank’s board gathers for the first time this year on Feb. 3.

“This recession will be deeper and longer than the last recession in 1991,” Fraser said in a phone interview today from his home near Canberra. “The Reserve Bank could go below 2 percent; they will go as low as they need to and a further stimulus from the government will be required.”
Australia started reducing rates at the fastest rate ever in 2008, culminating with a surprise cut of 100 basis points in December. More rate cuts are coming.

One of the biggest drivers for currencies is relative differentials in interest rates, as well as expectations of future increases in interest rates differentials. The Fed is not cutting any more so future rates cuts in Australia may increase the unwinding of various carry trades (borrowing in dollars or Yen, and investing in Australian dollars or Euros).

Peter Schiff did not see or simply ignored the ramifications of the unwinding of various carry trades. All gains in the Australian dollar have been wiped out since 2003.

US$ Trading Range Theory

China, the UK, the Eurozone, Canada, Australia, and Japan are all slashing interest rates. And every country above is printing like mad. Finally, European banks are in dire straits because of bad loans to the Baltic states and Latin America on top of bad investments in US mortgage backed securities.

Schiff simply ignores those problems, or worse yet is not even aware of them.

Given the severe stress everywhere, and given the race to zero interest rates by all, the odds favor a wide trading range rather than a collapse of the dollar. Hyperinflation is simply not in the cards, at least for the US. Ironically, China or Russia is at far greater risk.

What About Commodities?

The following is from a chapter in his book called "Hot Stuff" on page 105.

Schiff writes: "What I want you to take away from this chapter is the knowledge that there is extraordinary excitement in commodities, which are in the early stages of a historic secular bull market." ...

$CRB Commodities Monthly Index

"There is extraordinary excitement in commodities."

Indeed there was. However, the time to invest in anything is not when there is extraordinary excitement but rather when there is no excitement at all.

When there is no excitement, the likelihood of investing safely for a long period increases. The above chart shows what happens when you invest for the long haul during periods of high excitement.

The Little Book of Bull Moves in Bear Markets nailed the exact cyclical peak in the commodities boom. Ironically, the subtitle to his book is "How to Keep Your Portfolio Up When the Market Is Down".

Peter Schiff was wrong about deflation.

There is no debate (at least there should not be a debate) that the US is in deflation. The conditions in the US are exactly what one would expect to see in deflation. The score is a perfect 15 out of 15. Please see Humpty Dumpty On Inflation for details.

I believe I know Schiff's rebuttal. He will talk about soaring money supply. Yes, money supply is indeed soaring, but destruction of bank balance sheets is happening faster. He will counter that it is money that matters, not credit.

History proves otherwise, but I willing to debate on the basis of money supply alone.

Base Money Percentage Change From A Year Ago

Using monetary expansion alone, one would conclude there was massive inflation during the great depression, starting in 1931!

Any definition that suggests that there was inflation in 1931 is silly. Some might counter, as one person recently did "It's not silly. When gold was confiscated by FDR and then revalued 70% higher in dollar terms, was this not inflation?"

My reply is "During the Great Depression, the purchasing power of the dollar went up vs. everything but gold. If the purchasing power of gold vs. the dollar is the sole judge of the inflation-deflation debate, then deflation ruled from 1980 to 2000, a ridiculous proposition."

It is important to pick definitions of inflation carefully. A definition based on money supply and credit successfully predicted interest rate trends, stock prices, the price of gold, housing, and numerous other things.

A definition of inflation based on the CPI failed miserably in predicting interest rates.

A definition based solely on an increase in money supply failed miserably in predicting interest rates, the recent strengthening of the US dollar, gold's decline from 850 to to 250 between 1980 and 2000, and numerous other things.

Soaring money supply simply is not proof "Big Inflation Is Coming" just as it was not proof that "Big Inflation" was coming in 1931. There cannot possibly be any other logical conclusion when confronted with the data.

Is Peter Schiff Early?

Some will claim that Schiff is simply "early". However, from the perspective of the Little Book of Bull Moves In Bear Markets, Schiff was 5 years too late.

To be fair, he was talking about commodities and foreign equities long before that, but as is often the case, such books come out at a time of "Peak Excitement". Schiff's book was the ultimate contrarian indicator.

Let's Return to Schiff's Investment Thesis.

Schiff's Investment Thesis

  • US Dollar Will Go To Zero (Hyperinflation).
  • Decoupling (The rest of the world would be immune to a US slowdown.
  • Buy foreign equities and commodities and hold them with no exit strategy.

12 Ways Schiff Was Wrong in 2008

  • Wrong about hyperinflation
  • Wrong about the dollar
  • Wrong about commodities except for gold
  • Wrong about foreign currencies except for the Yen
  • Wrong about foreign equities
  • Wrong in timing
  • Wrong in risk management
  • Wrong in buy and hold thesis
  • Wrong on decoupling
  • Wrong on China
  • Wrong on US treasuries
  • Wrong on interest rates, both foreign and domestic

That's a lot of things to be wrong about, especially given all the "Peter Schiff Was Right" videos floating around everywhere. The one thing he was right about was the collapse of US equities and no part of his investment strategy sought to make a gain from that prediction.

Peter Schiff concludes many of his articles, books, etc. with the claim he saw this coming and "positioned his clients accordingly".

Fortune Magazine Examined The Hype

Peter Schiff: Oh, he saw it coming

'Dr. Doom' became a star by predicting last year's market meltdown. And now his 2009 forecast is even scarier.

Schiff did not invest for doom; he invested for a bull market that did not exist. He was wrong where it mattered most, protecting client assets. For this amazing feat, people think of him as a star.

An Actual Schiff Portfolio

click on chart for sharper image

The above statement is from a person who claims to have additional portfolios invested with Schiff over the past 2 years. In total (not just this portfolio), my contact says he invested $70,000 and is now down to $27,000. That is a loss of 61%.

I have talked with another person who claims to be down 72%, and many others who claim 40% or more.

Schiff's entire invest thesis seems to boil down to "Buy and hold foreign stocks, foreign currencies, and commodities, come hell or high water, and hold on to them." Hell has arrived for those following Peter Schiff's philosophy.

Perhaps I have stumbled on the worst of Schiff's portfolios. There is one way to find out.

I challenge Schiff to post the average returns for his clients on a year-by-year basis, just as Sitka Pacific does. That is the only way to see just how right (or wrong) his investment thesis is.

Sitka Pacific vs. Europacific Philosophies

Rather than take a rigid position as to what the market "should do", Sitka Pacific Capital Management tries to position itself for what the market is doing. At times we may like a particular stock group, commodity, or currency, and at other times not.

We do not think this is a good time for buy and hold strategies for either foreign or domestic stocks or currencies. Moreover, we certainly do not think it was prudent to put 100% on foreign stocks and currencies, with virtually no exit strategy if wrong.

We do feel a long-term position in gold on a percentage of assets is a reasonable proposition.

Schiff's slogan is "Because There's A Bull Market Somewhere. TM" but for a year he failed to find one with the exception of physical gold. Ironically, one of his most hated asset classes (US treasuries), had one of their best years in history.

Sitka Pacific Strategies

The two key strategies at Sitka Pacific are called Hedged Growth (a long-short, primarily domestic strategy), and Absolute Return (a global strategy that can invest in domestic stocks, foreign stocks, gold, and currencies, hedged at times with inverse index ETFs).

Absolute Return may at times bear some resemble to Schiff's strategy but we are not dogmatic about it. If we do not like market action in stocks and commodities, we are on the sidelines and heavy in cash or treasuries.

Absolute Return had a 34% position in long dated treasury ETFs in 2008, now well less than half that after cashing out.

Chart of Hedged Growth Since Inception

click on chart for sharper image

Note the .17 correlation to the S&P 500 in Hedged Growth.

Correlations run from -1 (perfect inverse, think inverse ETF) to +1 (think buying every stock in the S&P). Zero is no correlation. A correlation of .17 is very low. What it means is the strategy is not dependent on market direction. Many hedge funds make that claim, but the average hedge fund got lost well over 20% in 2008.

Hedged Growth achieves its performance by picking a basket of stocks long and a basket of stocks short. Market direction, inflation-deflation debates, interest rates, etc., simply are not a concern for this strategy. The idea is to pick a winning basket of good stocks vs. poor stocks on a relative basis.

The most we ever put on a short position is 1.7%, and we only take a position in liquid issues. We never add to short positions. This is for risk management purposes.

Absolute Return Since Inception

click on chart for sharper image

The chart shows a monthly correlation to the S&P at .36. That is a low number, which is a good thing.

The chart also shows we had a significant drawdown between June and October. That drawdown was based primarily on an expectation that gold and gold miners would diverge from the market on a seasonal trend. That seasonal pattern did not happen. We are not going to get everything correct, but no one else will either. We made much of that drawdown back in late November and December while hedged growth was flat.

One additional thing I would like point out is that none of our strategies was net short in 2008. Our most cautious stance is market neutral. Thus, we were neutral to long the whole year, and our two key strategies finished solidly in the green even though the S&P finished down 38.5%.

90+% of Sitka Pacific accounts are either Hedged Growth or Absolute Return.

To lay everything out in the open, we also offer Commodities Focus (a portfolio of commodity related stocks and ETFs). Commodities Focus does not hedge and will tend to track a blend of energy stocks and mining stocks. It was down 34.5% on the year. Only 2% of our clients are in this strategy, approximately ½% by total asset value.

Commodities Focus is best suited for those who want anti-dollar plays for a hedge or for those with a very long time horizon as opposed to boomers headed into retirement with their nest egg.

We also offer Dividend Growth for IRA clients who cannot short. Dividend Growth is similar to Hedged Growth, except it may or may not hedge. When it does hedge, it uses inverse ETFs as opposed to shorts. Dividend Growth was down 4.6% for the year, a good achievement compared to the S&P 500 which was down 38.5%.

Gains Needed To Get Even

10% - 11%
50% - 100%
70% - 233%

If you are down 10% you need to gain 11% to get back to where you were, at 50% down you need a 100% gain to get back to even, and at 70% down you need a 233% gain to get even. This is why risk management and capital preservation is paramount.

Boomers significantly down hoping to get back to even may find it will take a decade or more. Those close to, or already in retirement, simply do not have a decade to make up for losses. That is the problem with buy and hold strategies.

Buy and hold was wrong nearly everywhere, but especially for those in or approaching retirement.

Client Letters

We post our client letters online, on a 2 month delayed basis. The letters come out sooner if you subscribe. Subscription is free. Interested parties may Register For Sitka Pacific Monthly Newsletters. Subscribe at the bottom of the linked-to page.

In the wake of various scandals, a certain question invariably comes up.

How Sitka Pacific differs from Madoff, hedge funds, and mutual funds.
  • We are not a hedge fund.
  • We offer managed accounts.
  • The accounts are in investors names.
  • Statements are from a brokerage house not us.
  • We cannot manipulate earnings because we do not produce the statements.
  • We have no access to investor funds.
  • If someone sends us a check made out to us, we send it back. As a strict rule, we never handle client money.
  • We have no exit penalties and no exit restrictions.
  • Someone can close their account for any reason at any time and can even do it without telling us. If you do not like how we are trading your account, you can close it.
  • We do not use leverage.
  • We often have high cash positions.
  • Clients can see every trade we make. This is unlike hedge funds where you typically cannot see anything, or mutual funds where all you see is a snapshot at the end of the month.
  • We have trading rights to accounts; all other aspects of the account belong to the client.
  • Your account is not commingled with any other account.
We are the very opposite of hedge funds or mutual funds.

High Risk, High Reward Strategies

Placing everything one has on anti-dollar bets is a type of high risk, high reward strategy. There is little room for error, especially if there are no risk management controls, which Schiff does not seem to have. "The whole idea is to get out of the US Dollar. It is on the verge of collapse. The people who don't get out of the US dollar are going to be completely broke and that is obvious. ...people who have their money in US dollars are going to be just as broke as people who have their money with Madoff."

Such arguments can easily be construed as "fear tactics". Listen to the previously mentioned Schiff Audio On US Hyperinflation and make your own determination. While it is certainly prudent to have some diversification, it is not prudent, in my opinion, to bet the farm on a complete hyperinflationary collapse of the US dollar that did not occur and in my estimation won't, at least for a long time.

Undiversified, unhedged portfolios may succeed spectacularly. They also risk catastrophic loss. Many who rolled the dice on Schiff's philosophy came up snake eyes: a catastrophic loss that depending on the exact portfolio, may take a decade or longer to recover.

Where To In 2009?

The question as to where the market is headed comes up all the time. The truth is, no one really knows. However, we see no real value here. Fundamentally stocks are not cheap. Earnings are sinking, unemployment is rising, and this was the biggest debt bubble in history. Logic dictates the biggest bubble should be followed by the biggest crash.

To pick a range for a bottom something like 450-600 on the S&P 500 would seem about right. If so, that is quite a drop from here, and one would certainly want to be hedged if that happens.

However, if the market starts to behave like there is some value now, we will change our tune.

We strongly doubt the dollar will crash, but we will take notice if it breaks out of its trading range. We do like gold here but that can change. Commodities may have bottomed. We doubt stocks have. Foreign stocks may outperform but remember they were clobbered more in 2008.

We are not permabears or permabulls, nor do we daytrade. We review and reposition our strategies monthly, but if something noticeable happens mid-month, we try to react to it.

Unlike Schiff, we attempt to position our clients for what the market is actually doing, not what we think it ought to be doing. The distinction is paramount, especially when such thinking just might be wrong.

Mike "Mish" Shedlock
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