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Saturday, February 28, 2009 5:32 PM

Who Bears the Burden for a $3 Trillion Mistake?

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Citigroup plunged 39% on Friday to $1.50, a price last seen in 1992.

The plunge was in response to a Citigroup U.S. Accord on a Third Bailout that will convert the government's preferred shares to common, thereby diluting existing common shareholders and exposing US taxpayers to more losses.

Citigroup Inc. and the federal government agreed to a third rescue that will give U.S. taxpayers as much as 36% of the bank but expose their ownership stake to greater risk from the recession and housing crisis. The deal will punish existing shareholders of Citigroup, who will see their stake diluted by 74%, and likely do little to change the awkward relationship between federal officials and management of the New York company.

Depending on how many current holders of Citigroup preferred stock agree to a similar move, the company's tangible common equity could surge to $81.1 billion from $29.7 billion at Dec. 31. That would reverse the recent slide in tangible common equity -- a gauge of what shareholders would have left if the company were liquidated -- that fueled a downward spiral in Citigroup shares.

The conversion leaves taxpayers exposed to the risk of greater losses. The government's preferred holdings had stood ahead of common stock in Citigroup's capital structure, meaning they were less likely to lose value if the company's woes continue to mount. In addition, by converting much of the U.S. stake to common shares, Citigroup won't have to pay the hefty dividend payouts that were attached to the preferred stock.

"The government is bending over backwards to not go along the lines of nationalization," said Bernie Sussman, chief investment officer of Spectrum Asset Management, a unit of Principal Financial Group Inc. that manages about $6.9 billion in assets. "They had the alternative to completely zero out the common stock."
Mysterious Plans Revisited

Let's take a look one more time at Krugman's article Mysterious plans
What Treasury now seems to be proposing is converting preferred to common.

[Mish: No longer a proposal but a done deal]

It’s true that preferred stock has some debt-like qualities — there are required dividend payments, etc.. But does anyone think that the reason banks are crippled is that they are tied down by their obligations to preferred stockholders, as opposed to having too much plain vanilla debt?

I just don’t get it. And my sinking feeling that the administration plan is to rearrange the deck chairs and hope the iceberg melts just keeps getting stronger.
Shared Sacrifice

I had the pleasure of meeting Michael Mandel, chief economist for BusinessWeek, at a economic conference sponsored by the Kauffman Foundation last Thursday and Friday. I spoke with him at great length about the preferred conversions at Citigroup.

Mandel advised what was happening could be found in column he wrote last October called Shared Sacrifice Will Ease the Credit Crunch.
Over the past four years the U.S. private sector has borrowed an astonishing $3 trillion from the rest of the world. The money, directly and indirectly, came from countries such as China, Germany, Japan, and Saudi Arabia, which ran huge trade surpluses with America. Foreign investors trusted their funds to U.S. financial institutions, which used much of the money for mortgage loans.

But American families took on a lot more debt than they could comfortably afford. Now no one is sure how much of that towering sum the U.S. is going to pay back—and all the uncertainty is roiling the financial markets.

The Washington bailout debate boils down to this question: Who is going to bear the burden of the $3 trillion mistake?

Will low- and middle-income borrowers have to cut back on spending to pay their mortgage bills? Will taxpayers have to chip in big bucks to pay for defaults on those debts? Or will Washington act in a way that imposes large losses on foreign investors—in effect, repudiating some of the debt? The best outcome is shared sacrifice among borrowers, taxpayers, and foreign investors—but that result may be politically difficult to achieve.
Too Big to Bail

The next piece of the puzzle can be found in the Institutional Risk Analyst article Too Big to Bail: Lehman Brothers is the Model for Fixing the Zombie Banks.
Remembering that half of the liabilities of C, BAC and JPM are funded out of the bond markets and not via deposits, it should be clear to one and all that the US taxpayers are not in a position to subsidize the bond holders of these three banks, representing some $1.5 trillion in debt, if the deposits of these banks are to be protected. Some people, indeed, many people believe that we must avoid another Lehman Brothers type resolution where bondholders take a loss, but to us the only scenario where depositors of C, BAC, JPM do not take a loss is if we haircut the bond holders.

There are no easy answers here, but the guiding principle left by the Founders that bankruptcy be used to quickly and finally resolve insolvency is instructive. In that sense, Lehman Brothers is the ideal example, not something to be avoided.

What is required in Washington is an adult conversation, between the US government on the one hand and the holders of the bonds of the largest banks on the other. Many of the bond holders of the large banks are foreign governments, central banks and investment funds and not a few of these sovereign names are in really serious financial difficulties. Since the receiverships for Lehman Brothers and Washington Mutual, where bond holders took a near total loss, these foreign investors have been vocal in demanding that US taxpayers protect them from further harm.

But to deflect these cowardly, expedient arguments, the US government must be willing to lead by example to show that there really is only one way to restore confidence in zombie banks: use receivership to wipe out the common and preferred shareholders, conserve the deposits and sell the good assets to new investors, and then restructure the remaining operations of the bank to maximize recovery to the bond holders and other creditors.
Frogs Slowly Boiled In Order

Finally, in The Great Repudiation Revisited, Mandel mentions the above Institutional Risk Analyst article and concludes "At some point the bondholders are going to have to take a big haircut."

We can now see that the plan is to slowly boil the frogs in order. In other words, the government preferred shareholders need to be wiped out first in a manner that offends foreign investors the least. That manner was to wipe out US government (taxpayer) preferred shares along with foreign governments common equity and preferred positions.

The next frog to be boiled will be after Citigroup fails the stress test. At that point, there will be no way to avoid "an adult conversation" between the US government and foreign bondholders.

Meanwhile, the government is avoiding an outright nationalization of Citigroup hoping to avoid pressure by foreign governments for the US to make good on a full repayment of bank bonds. If the government limits its stake to 40% or less, US Government guarantees of bank debts may be skirted, or at least postponed.

Tying it all together, what's really happening has nothing to do with the announced plan to boost banks' TCE, tangible common equity. Rather, the plan is to repudiate the bondholders, step by step, boiling each frog in order, hoping to minimize the fallout from foreign bondholders.

Mike "Mish" Shedlock
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Friday, February 27, 2009 9:55 AM

Mervyn King, Governor of the BOE Sings an Old Time Classic: It's Impossible

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Mervyn King, the Governor of the Bank of England is singing a classic Perry Como tune It's Impossible.

It's impossible, tell the sun to leave the sky, it's just impossible
It's impossible, ask a baby not to cry, it's just impossible
Can the ocean keep from rushin' to the shore? It's just impossible
If I had you, could I ever want for more? It's just impossible
For to live without your love--It's just impossible

Please sing along with Perry Como while reading Mervyn King: 'Impossible to say' how much capital needed to shore up banking system.

Mervyn King, the Governor of the Bank of England, has said it is "impossible to say" how much capital will be required to shore up the British banking system.

Mr King said it would take "many months" to establish the scale of toxic assets held by banks, and the scale of problems would change depending on the international economic outlook.

"That is not something that is easy to do or can be done quickly," he told the MPs. "It will require a much longer and more detailed assessment contract by contract."

"How much capital banks will need in the end is impossible to tell," he added.

But he also suggested public borrowing was too high as the UK entered the crisis and that had affected the Government's response to it. "I do think public debt matters. We get to this crisis with levels of public borrowing which were too high and that made it difficult," he said.

But, he added, that was a "million miles" away from the idea that Britain in any way resembled somewhere like Zimbabwe.
I happen to agree with King that it is impossible to say precisely how much is needed to shore up banks, not just in the UK, but the Eurozone, US, China, Ireland, and Australia as well.

Meanwhile, back in the US, a different tune is playing. That tune is called "Yes We Can". My rebuttal is Dear Mr. President, With All Due Respect ....

Looking ahead, Mervyn King thinks it's impossible, yet Bernanke Rejects ‘Anything Like’ Bank Nationalization before the results of the much ballyhooed "stress test" is even complete. This is like building a bridge without knowing what load the bridge needs to carry. Well maybe the bridge does not collapse, but I would not want to be the first to cross it in a cement truck.

And let's be honest about this. There is a lot of cement on the balance sheets of banks. How much? It's impossible to say with any degree of certainty, which is why mistrust of banks is so high, and the plan of Bernanke and Geither is so misguided.

Mike "Mish" Shedlock
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Thursday, February 26, 2009 10:57 PM

Dear Mr. President, With All Due Respect ....

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Dear Mr. President, I read your New Era $3.6 Trillion Budget Proposal. I also listened to your speech Tuesday night. You made a great campaign speech. However, the campaign is over. You won. And the reason you won is you offered hope as well as a promise of change.

With all due respect Mr. President, Tim Geithner and Ben Bernanke are offering the same policies as President Bush and Secretary Paulson. Those policies are to bail out banks regardless of cost to taxpayers. Mr. President, it's hard enough to overlook Geithner's tax indiscretions. Mr. President, it is harder still. if not impossible, to ignore the fact that neither Geithner nor Bernanke saw this coming. Yet amazingly they are both cock sure of the solution. Even more amazing is the fact that solution changes every day.

With all due respect Mr. President, Geithner and Bernanke are a huge part of the problem, and no part of the solution and the sooner you realize that the better off this nation will be.

With all due respect Mr. President, your budget proposal is the same big government spending as we saw under President Bush. The only difference is you promised more spending and bigger government, while President Bush promised less government and less spending and failed to deliver on either count.

With all due respect Mr. President, it is impossible to spend one's way out of a problem, when the problem is reckless spending.

With all due respect Mr. President, you and Congress want to force banks to lend when banks (by not lending) are acting responsibly for the first time in a decade. Mr, President can you please tell us who banks are supposed to lend to? Do we need any more Home Depots? Pizza Huts? Strip malls? Nail salons? Auto dealerships? What Mr. President? What? And why should banks be lending when unemployment is rising and lending risks right along with it?

With all due respect Mr. President, we were hoping your administration would not carry on the war mongering policies of your predecessor. Instead we see amazingly that you Seek $75.5 Billion More for Wars in 2009. Mr. President, do we really need another $75 billion for wars? Was there nothing in the military budget that could be cut?

With all due respect Mr. President, The United States spends more on its military budget than the next 45 highest spending countries in the world combined; The United States accounts for 48 percent of the world's total military spending; The United States spends on its military 5.8 times more than China, 10.2 times more than Russia, and 98.6 times more than Iran. Isn't that enough Mr. President?

With all due respect Mr. President, the downfall of every great nation in history has been unsustainable military expansion. Mr. President, the US can no longer afford to be the world's policeman. You act as if we can. Mr. President, can you please tell us how we can afford this spending?

With all due respect Mr. President, Fannie Mae Reported A Fourth Quarter Loss Of $25.2 Billion. Can you please tell us where you draw the line on taxpayer bailouts of Fannie Mae? Freddie Mac? AIG? Mr. President is there a line anywhere, on anything? If there is, we would appreciate knowing where it is.

With all due respect Mr. President, how can you talk about reducing the budget deficit while proposing the biggest budget in history?

With all due respect Mr. President, how is it possible to talk about reducing health care costs while proposing to increase the health care budget?

With all due respect Mr. President, you have talked about "hard choices". Can you please tell us what hard choices you have made other than to throw money at every problem? Sure a few programs have changed but Bush orchestrated the biggest Medicaid/Medicare package in history and you upped it. You upped military spending. You criticized McCain for cutting programs that amount to peanuts, and all you can find to cut out of the budget is peanuts.

With all due respect Mr. President, your "Era of New Responsibility" is nothing more than a continuation of the Bush administration Era of Irresponsibility. Mr. President, we hoped for more and deserved more. Yet, behind the charade of campaign messages of hope and change, we essentially see the same fiscal irresponsibility and misguided policies as before. Oh sure Mr. President, your budget priorities have shifted a bit, sadly the irresponsible spending did not.

Mike "Mish" Shedlock
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11:14 AM

Durable Goods Orders Plunge; Weekly Claims Soar

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A double shot of bad news was released today with durable goods orders plunging and unemployment claims soaring. Please consider Durable Goods Orders Drop for Sixth Consecutive Month.

Orders for U.S. durable goods fell for a record sixth consecutive month in January, signaling companies are cutting back on spending as customers worldwide retrench.

The 5.2 percent drop was more than twice as large as projected and followed a 4.6 percent decrease the prior month, the Commerce Department said today in Washington. Comparable data began in 1992. Excluding transportation equipment, orders fell 2.5 percent.

“Businesses are cutting back everyplace they can in order to survive the recession,” said Tim Quinlan, an economist at Wachovia Corp. in Charlotte, North Carolina. “The slowdown in business spending at the end of last year apparently picked up speed at the beginning of the year.”

Demand for non-defense capital goods excluding aircraft, a proxy for future business investment, plunged 5.4 percent after falling 5.8 percent the prior month. Shipments of those items, used in calculating gross domestic product, dropped 6.6 percent.

Orders excluding defense equipment decreased 2.3 percent and bookings for military gear dropped 35 percent.

Transportation equipment demand slumped 13.5, with autos down 6.4 percent for a second month. Commercial aircraft orders surged 82 percent following a 59 percent drop.

Today’s report showed orders for metals, machinery and computers also dropped. Only communications gear and aircraft advanced.

Tight credit and a global recession indicate demand for aircraft is likely to slump in coming months. Boeing Co., whose new 787 Dreamliner is now almost two years behind schedule, said Feb. 19 it lost another order for the plane in the prior week, bringing total cancellations to 33.

“Cancellations are especially affecting aircraft makers and other heavy industries like mining as customers feel the credit pinch,” said Brian Bethune, chief financial economist at IHS Global Insight in Lexington, Massachusetts.

Today’s report also showed order backlogs dropped and companies cut stockpiles. The 0.8 percent decline in inventories was the biggest since September 2003. Unfilled orders fell 1.9 percent, the most since January 2002.

Smaller backlogs indicate manufacturing will be slow to recover even after the economy gains traction.
Weekly Claims Hit 667,000

Inquiring minds are investigating the latest Weekly Unemployment Claims statistics. Here are the grim details.
In the week ending Feb. 21, the advance figure for seasonally adjusted initial claims was 667,000, an increase of 36,000 from the previous week's revised figure of 631,000. The 4-week moving average was 639,000, an increase of 19,000 from the previous week's revised average of 620,000.

The advance number for seasonally adjusted insured unemployment during the week ending Feb. 14 was 5,112,000, an increase of 114,000 from the preceding week's revised level of 4,998,000. The 4-week moving average was 4,932,250, an increase of 89,250 from the preceding week's revised average of 4,843,000.

The best numbers to watch are the 4 week moving averages because they smooth out minor week to week fluctuation noise. The numbers are ticking up substantially. A year ago the numbers were bad, and they are far worse now.

Signs are in place suggesting another 500,000 jobs or more will be lost in the next monthly BLS jobs report.

Mike "Mish" Shedlock
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1:44 AM

Bernanke's Boiled Frog Plan To Recapitalize Banks

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Bernanke has fired yet another misguided missile to stabilize the banking system. His new program is called the Capital Assistance Program and supposedly it will restore confidence in banks and get them to lend. Here is a description of the program:

The purpose of the CAP is to restore confidence throughout the financial system that the nation's largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers.

  • Capital provided under the CAP will be in the form of a preferred security that is convertible into common equity at a 10 percent discount to the price prevailing prior to February 9th.
  • CAP securities will carry a 9 percent dividend yield and would be convertible at the issuer's option (subject to the approval of their regulator).
  • After 7 years, the security would automatically convert into common equity if not redeemed or converted before that date.
  • The instrument is designed to give banks the incentive to replace USG-provided capital with private capital or to redeem the USG capital when conditions permit.
  • With supervisory approval, banks will be able to request capital under the CAP in addition to their existing CPP preferred stock.
  • With supervisory approval, banks will also be allowed to apply to exchange the existing CPP preferred stock for the new CAP instrument.
CAP Facts

1) Amazingly CAP fact sheet states the securities will yield a 9% dividend. However, any bank troubled enough to need the CAP is likewise too troubled to be able to pay a 9% dividend. Banks can't get a 9% return on borrowed money everyone knows it. Instead, expect preferred shares to be converted to common at inflated prices.

2) Digging a bit deeper into the fact sheet we see the "Conversion price is 90% of the average closing price for the common stock for the 20 trading day period ending February 9, 2009."

Think February 9 was selected at random? Think again. The first box in the charts below is the 20 days ending February 9. Compare to what has happened since.

Citigroup Chart For February

click on chart for sharper image

Bank of America Chart For February

click on chart for sharper image

Bernanake Reassures Investors

The CAP plan White Paper goes on to say ...

"By reassuring investors, creditors, and counterparties of banking institutions--as well as the institutions themselves--that banks have capital in a sufficient amount and quality to withstand even a considerably weaker-than-expected economic environment, the CAP instrument should improve confidence and increase the willingness of banking institutions to lend."'

Those assurances amount to a promise to continually stick it to taxpayers, no matter what the cost.

Citi Near Deal to Boost U.S. Stake to as Much as 40%

The Wall Street Journal is reporting Citi Near Deal to Boost U.S. Stake to as Much as 40%.
Citigroup Inc. may announce a deal with the U.S. as soon as tomorrow that could raise the government's stake to as much as 40 percent, the Wall Street Journal reported, citing unidentified people familiar with the matter.

The deal may cause Citigroup to sell part of the company's stake in Grupo Financiero Banamex, the Mexican bank, because Mexico prohibits companies with a more than 10 percent ownership by a foreign government from running a bank in Mexico, the newspaper said.
Based on the above, expect taxpayers to be forced into supporting Citigroup at substantially above market prices. Remember, taxpayers are on the hook for $300 billion in debt guarantees for which we got a lousy $7 billion in preferred shares. Those shares are about to be diluted further.

Bernanke Rejects ‘Anything Like’ Bank Nationalization

It appears the nationalization train has run into a brick wall, perhaps because there was never any agreement as to what "nationalization" means. Let's tune into Bernanke Rejects ‘Anything Like’ Bank Nationalization.
Federal Reserve Chairman Ben S. Bernanke said while the U.S. government may take “substantial” stakes in Citigroup Inc. and other banks, it doesn’t plan a full- scale nationalization that wipes out stockholders.

Nationalization is when the government “seizes” a company, “zeroes out the shareholders and begins to manage and run the bank, and we don’t plan anything like that,” Bernanke told lawmakers in Washington today.

In the case of Citigroup Inc., the government may end up with a “substantial” share of the lender’s stock, he said. Oversight of the company would be accomplished through regulators and by exerting “shareholder rights,” Bernanke said.

The Treasury Department, Federal Reserve and other banking regulators said in a joint statement on Feb. 23 that they stood ready to pump more capital into banks, or convert some of the government’s outstanding preferred shares into common, to prevent their failures. The stress tests are scheduled to begin today, according to that statement.

“We will see how their test works out, and we will see what evolves,” Bernanke said. “If in fact they have to convert even the existing preferred into common, then there could be a more substantial share of ownership of Citi by the U.S. government.”
Somehow taking a a “substantial” share in banks and injecting more money over time is nothing "like nationalization".

Mysterious Plans

Very seldom do I completely agree with Krugman. In fact, this is the first time that I can recall. Please consider Mysterious plans
I’m trying to be sympathetic to the various plans, or rumors of plans, for bank aid; but I keep not being able to understand either what the plans are, or why they’re supposed to work. And I don’t think it’s me.

So the latest is that we’re going to convert preferred stock held by the government to common stock, maybe.

Here’s my stylized picture of the situation:

What Treasury now seems to be proposing is converting some of the green equity to blue equity — converting preferred to common. It’s true that preferred stock has some debt-like qualities — there are required dividend payments, etc.. But does anyone think that the reason banks are crippled is that they are tied down by their obligations to preferred stockholders, as opposed to having too much plain vanilla debt?

I just don’t get it. And my sinking feeling that the administration plan is to rearrange the deck chairs and hope the iceberg melts just keeps getting stronger.
Tangible Common Equity for Beginners

Inquiring minds are reading Tangible Common Equity for Beginners.
The initial government investments in Citigroup, back in October and November, were in the form of preferred shares. Between the two bailouts, the government put in $45 billion in cash and got $52 billion in preferred stock (the $7 billion difference was the fee for the guarantee on $300 billion of Citi assets). That preferred stock was designed to be much closer to debt than to equity: it pays a dividend (5% or 8%), it cannot be converted into common stock (so it cannot dilute the existing shareholders), it has no voting rights, and it carries a penalty if it isn’t bought back within five years. In fact, it is hard to distinguish from debt, except perhaps for the fact that, if Citi defaults on it (cannot buy the shares back) we don’t need to worry about systemic instability, because the government can absorb the loss. As preferred stock, these bailouts boosted Citi’s Tier 1 capital, but not its TCE.

Because of the newly perceived need for TCE, the bailout plan under discussion is to convert some of the preferred stock into common stock. Citi wouldn’t actually get any new cash from the government, but it would be relieved some of the dividend payments (currently close to $3 billion per year), and of the obligation to buy back the shares in five years.

The trick is deciding what price to convert the shares at. All of Citi’s common shares today are worth around $12 billion, so if you converted $52 billion of preferred shares into common, the government would suddenly own over 80% of Citi. (In the conversion, you divide the value of the preferred stock you are converting by the price of the common stock, and that yields the number of common shares the government now owns.)

The Geithner team is still continuing the Paulson policy of avoiding anything that looks like nationalization, so the talk is that the government ownership will be capped at 40%; that means the government could only convert about $8 billion of its preferred stock. There will probably be some clever manipulation of the numbers to say that the preferred stock is actually worth less than $52 billion, or that it should be converted at a higher price than the current market price of the stock.

(This seems like a blatant subsidy to me, since new investors buying large blocks of stock in a public company typically pay less than the current market price.) There is also talk of trying to get some of Citi’s other preferred stock holders to convert as well, because the more they convert, the more common shares, and hence the more the government can have without going over the 40% limit.
The Amazing, Shape-Shifting Convertible Preferred

Minyan Peter has an interesting take in The Amazing, Shape-Shifting Convertible Preferred.
I have been asked whether there was anything in Chairman Bernanke’s speech yesterday that changed my outlook on the prospects of nationalization for some of our largest financial institutions. In a word: “No.”

Knowing that there are teams of professionals on Wall Street dedicated to giving new hybrid securities cute names, let me suggest that the government henceforth refer to these incremental investments as “Maybetorily” Convertible Preferreds - as in, maybe they're straight preferred stock, maybe they're common stock, maybe they're gone altogether - it all depends on how bad the economy gets from here.

How these Maybetorily Convertible securities can in any way provide the impetus for further private-sector investment into the common stock of our banking system confounds me. As I see it, if implemented, existing common shareholders have at best the same upside they previously had, with exponentially larger downside.

So rather than throwing the frogs (banks) into nationalizing boiling water immediately, the government is going to place them in a tepid bath and watch, suggesting, at least this week, that while they may have to turn up the temperature a little bit (“temporarily”), no one will ultimately get burned.

Maybe, maybe not.
I'm sticking with my version of the story: The Fed Is Clueless and Banks are Zombified.

The only reason banks are not on an "out-of-control course to nationalization" is Bernanke is on an "out-of-control" mission to rescue banks regardless of what it costs taxpayers. The Fed clearly has no idea what it is doing and is making things up along the way.

Mike "Mish" Shedlock
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Wednesday, February 25, 2009 11:36 AM

Bernanke Admits Fed Is Clueless and Banks are Zombified

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Inquiring minds are asking "To what extent is the Fed is in the dark?"

Amazingly Bernanke answered that question today in Congress with complete candor. All you need to know is how to translate his statements. Please consider Bernanke tells Congress Fed knows what it is doing.

Federal Reserve Board chairman Ben Bernanke tried to assure Congress and investors that federal regulators are not grasping at straws in the response to the financial crisis.

"We're not making it up," Bernanke told the House Financial Services panel.
"We're working along a program that has been applied in various contexts."
"We're not completely in the dark."
My Translation:

"We're making it up as we go along"
"We have no idea what we are doing so the program changes every day"
"We are completely in the dark"
Bernanke is trying to reinforce his message to Congress that the Fed and the Obama administration now have at least the outlines of a bank rescue plan in place that will show results over time and that banks are not on an out-of-control course to nationalization.
My Comment: The only reason banks are not on an "out-of-control course to nationalization" is Bernanke is on an "out-of-control" mission to rescue banks regardless of what it costs taxpayers.
Bernanke assurance Tuesday to the Senate Banking Committee that the federal government doesn't want to nationalize the nation's largest banks was cited as a major factor in the stock market's rebound. Bernanke said regulators would ensure than banks did not turn into zombie banks.
My Comment: Now Bernanke wants to take credit for a one day relief rally as if correlation was causation. Furthermore, it's impossible for banks to turn into Zombie banks. They are already Zombie Banks, kept alive by the blood of taxpayers as explained in Bernanke's Hide and Seek Delaying Tactics.
Bernanke said that the government was prepared to inject capital to fix holes in the banks caused to the sudden sharp drop in their assets. But the size of the holes remains an open question.
My Comment: If the size of the holes is "an open question" then so is the amount of taxpayer blood needed to rescue them.
Rep. Barney Frank, the Massachusetts Democrat and chairman of the House panel, told members to curb their anger for the cost of the bailout. He said that it was impossible to send all culprits in the crisis to the gallows.
My Comment: For starters we should send the Fed, Geithner, and Barney Frank to the gallows.
Another interesting point from the first day of the hearing was that the idea that the Fed was planning to buy long-term Treasurys has moved to the back-burner.
How long before that idea is back on the front burner? No one knows because the Fed is making up the rules of the game day-by-day.

As Bernanke clearly said... "We have no idea what we are doing. We're completely in the dark, making things up as we go along."

Mike "Mish" Shedlock
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3:11 AM

German, Japanese Exports Plunge

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In conjunction with falling consumer demand for auto and electronics, Japan’s Exports Plunge 46% in a Year.

Japan’s exports plunged 45.7 percent in January from a year earlier, resulting in a record trade deficit, as recessions in the United States and Europe smothered demand for the country’s cars and electronics.

The shortfall widened to 952.6 billion yen ($9.9 billion), the Finance Ministry said on Wednesday in Tokyo. It was the biggest deficit since 1980, the earliest year for which there is comparable data. The drop in shipments abroad eclipsed a record 35 percent decline set in December.

Exports to the United States tumbled 52.9 percent from a year earlier, and shipments to Europe also posted big declines. The collapse is likely to force Japanese companies to keep firing workers and closing factories, worsening an economy that shrank the most in 34 years last quarter.
German Contraction Driven by Export Slump

Bloomberg is reporting German Economic Contraction Driven by Export Slump.
German exports slumped in the fourth quarter, causing Europe’s largest economy to contract the most in 22 years.

Exports dropped 7.3 percent from the previous quarter and company investment in plant and machinery declined 4.9 percent, the Federal Statistics Office in Wiesbaden said today. Companies are scaling back production and cutting jobs as global growth grinds to a halt and demand for exports wanes. The German government expects the economy to contract 2.25 percent this year, its worst performance since World War II.

Volkswagen AG, Europe’s biggest carmaker, said sales dropped 21 percent in January from a year earlier, while deliveries at Bayerische Motoren Werke AG, the world leader in luxury autos, fell 24 percent. MAN AG, Europe’s third-largest truckmaker, said it will cut costs further and extend reductions in employees’ working hours after declining sales caused fourth-quarter profit to plunge by almost half.
European Truck Sales Plunge 35%

The European Automobile Manufacturers Association is reporting European Truck Sales Plunged 35% in January as Slump Deepened.
European heavy-truck sales plunged 35 percent last month, more than double the drop in December, as the global recession ravaged the region’s main markets.

Manufacturers sold 20,068 trucks weighing 16 metric tons or more in January, compared with 30,755 a year earlier, the Brussels-based European Automobile Manufacturers Association said in a statement today.

Spain and the U.K. led the slump among larger western European markets, with declines of 76 percent and 40 percent respectively. The U.K. turned negative from a 13 percent increase in December. Germany, where business confidence hit a 26-year low this month, suffered a 28 percent January drop.

Truck sales have waned as the global financial crisis erodes demand for the transportation of goods, causing Daimler AG, Volvo AB and MAN AG, Europe’s top three manufacturers, to cut thousands of jobs. Sales plunged 58 percent in the 10 eastern countries that joined the European Union in 2004, with Poland, the biggest, suffering a 76 percent decline.

Purchases of vans weighing less than 3.5 tons tumbled 37 percent in January to 114,664, while demand for vehicles exceeding 3.5 tons, including heavy trucks, fell 33 percent to 27,336, according to the ACEA. Registrations of new buses and coaches declined 16 percent.
Toyota Cuts January Vehicle Production by Most Since 1987

When demand drops, output follows. Toyota Cuts January Vehicle Production by Most Since 1987
Toyota Motor Corp., Japan’s biggest automaker, slashed global production last month by the most in more than two decades as the recession and a credit crunch decimate demand for new automobiles.

Toyota’s output fell 43 percent to 413,285 vehicles in January. Honda Motor Co.’s production dropped 33 percent to 226,551 vehicles and Nissan Motor Co.’s slid 54 percent to 145,286 units, the companies said separately today.

Japanese carmakers are cutting output and earnings forecasts as slowing economies and rising unemployment in their largest markets deter consumers from buying new vehicles. Toyota’s domestic output is being reduced by half this quarter, compared with a year earlier, as exports plunge and it heads for its first operating loss in 71 years.

“Things will get worse before they get better.” said Ed Rogers, chief executive officer of Tokyo-based hedge fund adviser Rogers Investment Advisors Y.K. “Nobody is buying cars -- there is a global freeze of commerce.”

Honda’s global production decline in January was its biggest since at least 1999, as exports to the U.S. fell 62 percent in the period, the company said.

Nissan, which posted its biggest production decline since at least 1984 last month, estimates domestic output will tumble 16 percent to 1.06 million vehicles this fiscal year. Nissan last month said its U.S. plants will build vehicles only four days a week indefinitely.

The automaker’s total exports fell 62 percent last month, the most in at least 38 years. Exports to North America slid 85 percent.

Mazda Motor Corp., Japan’s second-largest car exporter, said global production fell 63 percent to 45,548 units in January.

Fuji Heavy Industries Ltd., the maker of Subaru-brand cars, said global production fell 32 percent to 31,654 vehicles in January. Suzuki Motor Corp., Japan’s second-largest minicar maker, said global production fell 20 percent to 177,085 units.
Without jobs there is little reason to believe this economy is close to turning around. Yet, stimulus plan or not, there is simply no reason for jobs to pick up any time soon. I expect another half million jobs will be lost in each of the next couple months.

The key is consumer attitudes towards debt and spending have changed, and those attitudes are not changing back. Expect a long, deep recession no matter what Obama and Bernanke do.

Mike "Mish" Shedlock
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Tuesday, February 24, 2009 1:30 PM

Bernanke's Hide and Seek Delaying Tactics

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The ever changing model of nationalization took another leap towards a resolution of sorts today. Bernanke's new plan amounts to a game of hide and seek, hoping the mess resolves itself over time. Please consider U.S. Will Take Bank ‘Ownership’ Stakes Only as Losses Climb.

The Treasury will buy convertible preferred stock as needed in the 19 largest U.S. banks after stress tests to determine how much capital is needed to address losses in a “worse” case scenario, Bernanke told lawmakers at a Senate Banking Committee hearing today. The shares will be converted to common only as the extraordinary losses happen, he said.

“It doesn’t have an ownership implication until such time as those losses which are forecast in the bad scenario actually occur,” the Fed chief said. Bernanke also said that the so- called stress tests that regulators will run on the 19 banks will look at potential losses over a two-year horizon if the economy worsens.

Bernanke’s remarks come after some investors expressed concern that the Treasury’s capital-injection plan would hurt banks’ shareholders and lead to government ownership stakes. The chairman added that it will be up to Treasury Secretary Timothy Geithner and the Obama administration to determine whether more bailout funds will be needed from Congress.

“How much more we’ll have to do depends on the state of the banks, it depends on how the economy evolves and it depends on the margin of safety we think we want to have,” Bernanke said today. He separately warned that “if we don’t stabilize the financial system, we’re going to founder for some time.”
My Translation: "The banking system is going to flounder like a fish out of water for quite some time."
The stress tests “will look at the balance sheets and the capital needs of each of our 19 largest $100-billion-dollar-plus banks over the next two-year horizon,” Bernanke said in response to a question from Senator Robert Corker, a Tennessee Republican.

The assessment will use “both a consensus forecast -- where we think the economy is likely to be based on private sector forecasts -- and an alternative which is worse,” Bernanke said.

The purpose of the reviews isn’t to provide a “pass” or “fail” grade for banks. Instead, the government wants to ensure that banks can meet their obligation to lend even if the economy worsens, he said.
My Comment: The purpose of the "stress test" is to pretend something is being done when it isn't. No one can possibly believe any announced results. Neither the Fed nor the Treasury has any credibility at this point.
Regulators won’t let banks “hide anything” as they look at how lenders have valued their assets, and will ensure that firms are using “appropriate models” for mark-to-market accounting, Bernanke said.
My Translation: "Regulators let banks hide everything for years. Regulators will continue to let banks hide everything for years to come. This is what we mean when we say 'appropriate models'. Of course, Citigroup will not be required to bring $800 billion or so in SIVs off the balance sheets back on its balance sheet. Furthermore, we intend to do nothing about ridiculous assumptions on the marked to fantasy prices of level 3 assets on the balance sheets of every bank. Hopefully these delaying tactics will buy banks the time they need. We realize this is unlikely to work, but what the hell? Right now, this game of hide and seek is our only prayer."
“We’re going to do a tough evaluation,” the central banker said in response to a question from Senator Richard Shelby of Alabama, the Senate panel’s ranking Republican.
My Translation: "We’re going to do a complete whitewash and hope the market buys it".

The game Bernanke is playing will allow the Fed to slowly bleed taxpayers to death by 100 tiny cuts. Each cut will all the Fed to inject taxpayer blood (capital) in drips to the banks while pretending the cancerous patient is in good health. Meanwhile, Bernanke is hoping the taxpayer will not notice. This is essentially the same model that left Japan's economy stagnating for over a decade.

Mike "Mish" Shedlock
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3:47 AM

14-year Commercial Real Estate Supply In China

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Inquiring minds are reading Beijing's Olympic building boom becomes a bust.

Reporting from Beijing -- "Empty," says Jack Rodman, an expert in distressed real estate, as he points from the window of his 40th-floor office toward a silver-skinned prism rising out of the Beijing skyline.

"Beautiful building, but not a single tenant.

Beijing went through a building boom before the 2008 Summer Olympics that filled a staid communist capital with angular architectural feats that grace the covers of glossy design magazines.

Now, six months after the Games ended, the city continues to dazzle by night, with neon and floodlights dancing across the skyline. By day, though, it is obvious that many are "see-through" buildings, to use the term coined during the Texas real estate bust of the 1980s.

By Rodman's calculations, 500 million square feet of commercial real estate has been developed in Beijing since 2006, more than all the office space in Manhattan. And that doesn't include huge projects developed by the government. He says 100 million square feet of office space is vacant -- a 14-year supply if it filled up at the same rate as in the best years, 2004 through '06, when about 7 million square feet a year was leased.

"The scale of development was unprecedented anywhere in the world," said Rodman, a Los Angeles native who lives in Beijing, running a firm called Global Distressed Solutions. "It defied logic. It just doesn't make sense."

The government spent $43 billion for the Olympics, nearly three times as much as any other host city. But many of the venues proved too big, too expensive and more photogenic than practical.

The National Stadium, known as the Bird's Nest, has only one event scheduled for this year: a performance of the opera "Turandot" on Aug. 8, the one-year anniversary of the Olympic opening ceremony. China's leading soccer club backed out of a deal to play there, saying it would be an embarrassment to use a 91,000-seat stadium for games that ordinarily attract only 10,000 spectators.

The venue, which costs $9 million a year to maintain, is expected to be turned into a shopping mall in several years, its owners announced last month.

A baseball stadium that opened last spring with an exhibition game between the Dodgers and the San Diego Padres, is being demolished. Its owner says it also will use the land for a shopping mall.

All around the Olympic complex, there are cavernous empty buildings, such as the main press center for the Games, that still await tenants.

A shopping arcade that stretches for a quarter of a mile across the street from the complex is empty, the storefronts papered over with signs reading "famous stores corridor."

"They wanted to build 'the world's biggest this' and 'the world's biggest that,' but these buildings have almost zero long-term economic benefit," economist Huang said.

Moreover, the makeover of Beijing for the Olympics led to an estimated 1.5 million residents being evicted from their homes, according to the Geneva-based Center on Housing Rights and Evictions.

In this vibrant capital city of 17 million, there is an insatiable demand for housing, yet prices remain far out of reach of most residents. American-style free-standing homes are being advertised for more than $1 million in gated communities with names like Versailles, Provence, Arcadia and Riviera. Within the Fourth Ring Road, a beltway that defines the central part of the city, two- and three-bedroom apartments are offered for $800,000 in compounds named Central Park and Riverside.

"These are like New York prices, but we are Chinese. We don't have that kind of money," said Zhang Huizhan, a 55-year-old businessman who owns a Chinese furniture factory. He has been looking for five years for an apartment for him and his wife within their budget of $150,000.

The average salary in Beijing is less than $6,000 a year.
"Harina R" writes I was in China for the Olympics and was astonished at how many building were empty. It was all too obvious.

In response to Inside China: A Sculptor's View "Steven H" writes:
Hi Mish

I was in China in Spring 2008. I agree with what you wrote. Most development projects build 3 to 6 buildings simultaneously, most of them at least 30 stories tall. As we drove around China, there would almost always be a cluster of these
buildings going up, within eyesight distance through the smog.

They thought the migration to the cities was so huge that all this capacity would be needed. It's not.

Steven H.
China's jobless return to countryside

Reuters is reporting China's jobless migrants loath to return to countryside
The parched farmlands of central China hold no future for Li Honglin, but she is trapped there until word comes from a clothing factory far away on the coast where she used to work.

Li's boss promised to call her back to her job as a sewing machinist when the factory resumes full production. It's not clear when that might happen, though, as China's garment exports have been decimated by the economic downturn and orders are thin.

Wearing tight pants and high-heel shoes studded with rhinestones, Li stood with her parents and elderly neighbors as they played mahjong late into the afternoon by a dusty road about an hour's drive from Henan's provincial capital, Zhengzhou.

"Almost all my friends have already gone back to the big cities, but I'm not rushing out. You need to have a job to live in the city. It's too expensive to get by without one," she said.

"It's no good. I had found work by this time last year but I've had no opportunities, nothing, so far this year," said Zhao, Xichang, standing by a hand-painted sign that advertised his skills as a driver at a job market in Zhengzhou.

Long lines of migrants, mainly men in rumpled suits, snaked down the street just a few minutes' walk from the train station, each with a sign like Zhao's. There were chefs and drivers, electricians and builders, plumbers and handymen.

A wrinkled man in a cloth cap sat at a corner table, charging half a yuan ($0.07) to paint job-wanted signs for the illiterate.

Rumors spread about where there might be more work. One man said Beijing. Another scoffed, saying he had left the capital because its economy had turned sour.

"People here barely have enough to eat. And it's going to be bad for society if the situation doesn't improve," Zhao said. Not that there would be protests, just unhappiness, he quickly added.
China's insatiable demand for commodities we all heard about was nothing but a global crack-up boom, a byproduct of cheap money everywhere. Ironically, right at the height of the boom, many thought $200 oil was in the cards and hyperinflation was just around the corner. It wasn't then and it isn't now.

And with wages being what they are in China, there is no hope that China can fill those real estate vacancies at a profit, if indeed at all. Signs point to a crash in China's GDP (assuming it hasn't already). Alternatively, China will overheat if it attempts to grow at the same pace. Either way, there is more pain for China and the world economy right around the corner.

Mike "Mish" Shedlock
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Monday, February 23, 2009 6:56 PM

Cancel The Card; Reap The Rewards.

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For some American Express cardholders, membership has $300 worth of privileges: AmEx is paying card holders to close their accounts.

American Express Co (AXP), battered by mounting credit card losses, is offering $300 to a limited number of U.S. card holders who pay off their balances and close their accounts, the company said on Monday.

"We sent the offer out to a select number of card members," said Molly Faust, a company spokeswoman. "We are looking at different ways that we can manage credit risk based on the costumers overall credit profile."

The company did not say how many card holders would receive the offer and did not disclose the total of their card balances. Card holders have until the end of February to accept the offer and must close their accounts in March or April. Each card holder will receive a $300 pre-paid American Express card.

American Express, often seen as catering to relatively wealthy customers and companies, has been expanding its credit card business in recent years by reaching out to a wider range of clients. But that strategy has backfired. The company's earnings tumbled in the fourth quarter as credit losses jumped and debt-burdened consumers slashed spending.

In addition, American Express reported last week that credit card delinquencies rose in January more than analysts expected, as U.S. unemployment increased and the global economy deteriorated.
American Express needs to reconsider some of its trademarked slogans.

Revised Slogans

  • "Don't Leave Home Without It" needs to become "Don't Leave Home With It".
  • For our Canadian friends, "Ne Partez Pas Sans Elle" needs to become "Ne Partez Pas Avec Elle"
  • "Lifetime Membership" needs to be changed to "Lifetime Membership Maybe"
  • "Use The Card. Reap The Rewards" is clearly outdated. "Cancel The Card; Reap The Rewards" more accurately describes the current state of affairs.

Indeed, "Membership Has Its Privileges", a $300 bonus bonanza to anyone politely asked to leave.

Mike "Mish" Shedlock
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12:32 PM

Purposeful Joint Lie by the Treasury, Fed, FDIC

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A magic bailout of Citigroup and Bank of America is underway. Supposedly this bailout will not require any new capital. Details can be found in a Joint Statement by the Treasury, FDIC, OCC, OTS and the Federal Reserve on the economy.

A strong, resilient financial system is necessary to facilitate a broad and sustainable economic recovery. The U.S. government stands firmly behind the banking system during this period of financial strain to ensure it will be able to perform its key function of providing credit to households and businesses. The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth. Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments.
My Comment: Clearly, the US Government will continue to bail out insolvent banks no matter what it costs taxpayers.
"We announced on February 10, 2009, a Capital Assistance Program to ensure that our banking institutions are appropriately capitalized, with high-quality capital. Under this program, which will be initiated on February 25, the capital needs of the major U.S. banking institutions will be evaluated under a more challenging economic environment. Should that assessment indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital. Otherwise, the temporary capital buffer will be made available from the government. This additional capital does not imply a new capital standard and it is not expected to be maintained on an ongoing basis.
My Translation: "This new capital will not cost anyone anything. It will be dispensed by magic fairies and recovered at a later date. We cannot share exactly how this magic works because under the rules of the magic ministry, we would be stripped of our magic hats and lose the rights to dispense magic if we did. Trust us. This is the proverbial free lunch that everyone says does not exist. However, like magic pixie dust, it does exist, it really does."
Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory. Previous capital injections under the Troubled Asset Relief Program will also be eligible to be exchanged for the mandatory convertible preferred shares. The conversion feature will enable institutions to maintain or enhance the quality of their capital.
My Comment: The market cap of Citigroup is $11.5 billion. The market cap of Bank of America is $20.3 billion. How does a Government guarantee $400 billion of Citigroup and Bank of America debt and inject another $75 billion in preferred convertible shares without costing anyone a dime and without requiring any new capital? Why, magic pixie dust of course.
"Currently, the major U.S. banking institutions have capital in excess of the amounts required to be considered well capitalized. This program is designed to ensure that these major banking institutions have sufficient capital to perform their critical role in our financial system on an ongoing basis and can support economic recovery, even under an economic environment that is more challenging than is currently anticipated. The customers and the providers of capital and funding can be assured that as a result of this program participating banks will be able to move forward to provide the credit necessary for the stabilization and recovery of the U.S. economy. Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands."
Anyone who believes the joint statements by the Treasury, FDIC, OCC, OTS and the Federal Reserve may as well believe in magic pixie dust. I believe the statements to a purposeful joint lie.

Mike "Mish" Shedlock
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Sunday, February 22, 2009 9:10 PM

Citigroup Begs To Be 40% Nationalized

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Citigroup is in deep trouble. Its share price is $1.95 and the market is recognizing what I said a year ago: "Citigroup Is Insolvent". Of course it is not just Citigroup that is insolvent, the entire global banking system is insolvent.

Nonetheless, Citigroup pretends otherwise.

Inquiring minds are reading Citi presses officials to take 40% stake.

Citigroup is pressing the US government to agree on a new capital injection that would increase the authorities’ stake in the troubled bank to about 40 per cent but stop short of an outright nationalisation.

People close to the situation said Citi executives had been in discussions with regulators during at the weekend over a plan that would enable the government and other shareholders to convert up to $75bn of preferred shares into common stock.

According to its proponents, the injection of common stock would bolster Citi’s capital base while at the same time allaying market fears of a nationalisation. Under the plan, first revealed by the Financial Times last week, Citi could also try to raise fresh equity with a public share offering. The aim would be to keep the government stake to no more than 40 per cent or at least below 50 per cent, said people familiar with the plan.

People familiar with the plan said it would hinge on the price at which the government and other shareholders, which include sovereign wealth funds and Prince Al Waleed, convert their shares as well as how many of its $45bn-worth of shares the government converts.

Top Government Officials – who are trying to establish seeking a want a more strategic and less ad hoc response to the crisis – were and are anxious to avoid if possible the type of Sunday night crisis announcement that became a staple for Hank Paulson for ’s crisis management at the Treasury last year.

The Treasury said secretary Tim Geithner would “preserve a financial system that is owned and managed by the private sector”.
Citigroup Is A Black Hole

Citigroup is a black hole, sucking in every dollar thrown at it and it still wants more. No amount seems enough to save it. Taxpayers have already guaranteed a whopping $300 billion dollars worth of Citigroup debt. Now, two months later, Citigroup is begging for still more capital, pretending that will save it.

Tim Geithner's Brain Is A Back Hole

Not only is Citigroup a black hole from which no taxpayer dollars can escape, but Geithner's brain is a black hole from which no intelligent thought can escape.

How the hell can you preserve a system this way? The answer is you can't. Nonetheless the Obama administration tries to end bank nationalization talk.
The White House on Friday insisted it's not trying to take over two ailing financial institutions, even as stocks tumbled again. On Wall Street, talk of nationalization of Citigroup Inc., and Bank of America Corp., prompted investors to continue to balk, worried that the government would have to take control and wipe out shareholders in the process.
Spare me the sap.

Geithner is attempting to bail out his banking buddies, no more, no less, and he does not give a damn what it costs taxpayers to do so. And while everyone and their brother has hopped on the Nationalization Train (please see The Nationalization Train Has Left The Station), I think there are at a bare minimum a half dozen questions that need to be addressed first (please see Nationalization Revisited).

Citigroup is struggling to remain independent even as it knows full well, that without still more government intervention, it is worthless. In fact, Citigroup is less than worthless because without more taxpayer cash infusions it cannot survive.

To hell with Citigroup. Bust it up and sell it. It's the best possible outcome for everyone involved.

Mike "Mish" Shedlock
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6:13 PM

Taxpayers To Get Raped In Public-Private "Partnership"

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CNBC is discussing Crafting a Bank Plan...No 'Lehman Weekends'

While markets appear to be waiting for the hammer of government to come crashing down on the nation’s two largest banks, several government officials in interviews with CNBC on Sunday described a process in the works that is far more deliberative.

Some details will be made available this week, but parts of the plan will take weeks, months and even more than a year to play out as the Obama administration puts together a program that they hope will return banks to long-term health.

What is clear is that they are specifically trying to avoid “Lehman Weekends,” referring to the furious efforts in September when Lehman Bros. went bankruptcy and AIG was bailed out. Officials stressed that there were no separate meetings going on surrounding Bank of America or Citigroup specifically and that the two banks would be treated under the broad plan now in the works.

Neither bank has asked for increased government assistance and one official said such assistance is not needed at this time.

Officials would not rule out increased or even outright government ownership of large banks at the end of the process, but they say their intent is to avoid that outcome and that it is anything but certain. They say the government does not want to be running these companies.

If the banks end up in government hands, officials say, the intent would be to get them into private hands quickly and do so in a way that is not much different from how the Federal Deposit Insurance Corp. currently resolves bank insolvencies, which typically take place over the weekend. The extent of government ownership, they say, will depend on the size of the losses at the banks, the access of banks to private capital and how the recession plays out.

Said one high-level official, “I think the market is missing that the whole intent of this process is to show that the banks have enough capital for even worse outcomes than we currently envision and to show there’s a program in place to give banks access to that capital if they need it.”
My Comment: What the nameless high level coward really means is: "It is obvious that the banks do not have enough capital and there's no program in place yet to give it to them. Furthermore the amount is too large and we are scrambling like mad fools to get something in place."
Several officials conceded that they have done a poor job in explaining the process to markets and that markets have, understandably, spun the darkest possible outcomes in the absence of information.
My comment: What they need to do is tell the truth. Here is a good statement for to kick off a truth telling campaign: "The banking system is insolvent".
New details on the so-called bank stress test could be made available as soon as tomorrow, officials say. This process will gauge bank capital levels under worst-case economic scenarios than are currently seen. Details on those scenarios are likely to be made public on Wednesday.

Officials say there will also be some information about the “capital-access program” that will explain how banks can obtain government capital in the event of worst-case economic scenarios. Separate details of the public-private partnership will also be made available soon, but the timing is less clear.
My Comment: $400 billion has been guaranteed to Citigroup and Bank of America alone, so what's with this "In the event of worst-case economic scenarios" nonsense?
The key misunderstanding in markets, officials believe, is how the public-private partnership will work and the way that new government capital, in the form of mandatory convertible preferred shares will become common equity.
My Comment: How the hell can there be a "misunderstanding" where then has been no announcement?
One official said the public-private partnership will be voluntary so there will not be no mandate that banks offload assets at a loss. The official added that additional government capital will go into the banks as mandatory convertible preferred. Those shares remain preferred until realized losses and capital needs trigger conversion to common. As a result, the official said, the government may end up with a large stake in a given bank over a period of time, but it won't happen overnight.
My Comment: Voluntary for who? It sounds to me it will not be voluntary for taxpayers who will have this crammed down their throats.

Look for taxpayers to get raped in this "public-private partnership".

Mike "Mish" Shedlock
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Saturday, February 21, 2009 1:46 PM

Watch Those Home Owner's Insurance Policies

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Here is some practical advice from "Richard R" about the amount of insurance you may be holding on your home. Richard writes ...


We just got our homeowners insurance policy from a company who took government money and voila, presto, the value of our house went up! Our plain-Jane ranch home has under 2400 sq ft, vinyl siding, asphalt shingle, gravel driveway and 2 car garage with no outbuildings or hot tubs. It was valued at $697,000 replacement cost without the land.

By questioning and reviewing the house it was reduced by their own formulas to $492,000 replacement cost. This is probably high but not crazy for Southern Connecticut.

Difference in policy premium is almost 25%!

I can't imagine what the difference might be in Las Vegas where 4000 sq ft homes that sold for 1.3mm now routinely go for $395k...

Have a great weekend.


Thanks Rich!

Please check your policies and make sure you are not overpaying!

Mike "Mish" Shedlock
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Friday, February 20, 2009 6:39 PM

Obama administration tries to end bank nationalization talk

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The stock market is acting as if banks will be nationalized even as the White House tries to end bank nationalization talk.

The White House on Friday insisted it's not trying to take over two ailing financial institutions, even as stocks tumbled again. On Wall Street, talk of nationalization of Citigroup Inc., and Bank of America Corp., prompted investors to continue to balk, worried that the government would have to take control and wipe out shareholders in the process.

Citigroup fell 20 percent, while Bank of America fell 12 percent in afternoon trading but also came off their lowest levels.

"This administration continues to strongly believe that a privately held banking system is the correct way to go, ensuring that they are regulated sufficiently by this government," White House press secretary Robert Gibbs said when asked about nationalizing the banks.

"That's been our belief for quite some time, and we continue to have that," Gibbs said.

When a reporter suggested Gibbs could do that by saying point bank that Obama would never nationalize banks, Gibbs would not make that statement, but emphasized: "I think I was very clear about the system that this country has and will continue to have."
Bank Nationalization Fears

CNN Money is reporting Bank Nationalization Speculation Prompts Confusion, Fear.
Speculation about possible bank nationalization by the U.S. government is driving down shares in the sector Friday. However, there's plenty of uncertainty of what nationalization would actually look like.

Nationalization gives the U.S. government the power to control banks. That power could mean anything from taking control of the public shares to replacing existing management, installing a new board of directors and setting corporate strategy. But the lack of clarity surrounding nationalization has created confusion on what's the best path the federal government should take.

"One of the problems in talking about nationalization is there is very little consensus on what the word means," Yves Smith, author of the popular "naked capitalism" blog, wrote in a recent post. "I strongly suspect that the advocates and opponents may have a lot more common ground than they realize."

There are several questions that need to be addressed before nationalization can seriously be considered, said Michael Shedlock, an investment adviser for Sitka Pacific Capital Management. They include what happens to the government guarantees of bank debt and whether both stockholders and preferred shareholders will be wiped out in a nationalization scenario.

"Unless and until those questions are answered, we cannot know to what extent taxpayers are at risk," Shedlock wrote on his blog.
Citigroup closed at $1.95 trading as low as $1.61. Bank of America closed at $3.79 having traded as low as $2.53.

Regardless of what Obama says, the market doubts these banks survive.

Mike "Mish" Shedlock
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10:18 AM

Inside China: A Sculptor's View

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I have been exchanging emails with Bill Hopen, a sculptor who frequently travels to China, often for months at a time. Bill writes ....

I've been to China a lot Mish, spent many months at a time there for the last eight years. China is already in a massive overcapacity real estate bubble. They are building three apartments for everyone that is lived in. Most apartments are empty and those that are rented do not come close to paying the interest on the loan.

There are huge department stores with products loaded on the shelves and staff everywhere and no one is shopping! Staff outnumbers customers five to one. It's surreal. They are ready, waiting for a great wave of shopping to come, but no wave is coming.

Eventually this "borrow and build" economy will be a pop heard round the world. China runs on construction, build build build, but there is no reason for that many places and spaces and big mall businesses with no consumers.
I asked Bill to fill in some more details about the cities he visits. Bill writes ...
The Shanghai/Pudong/Hongchow area,(30 million population) is mostly where I go, work, live for months at a time. I correspond with my expat friends who live there even when I'm back stateside.

I also have first hand knowledge about Lon Gong, in the Wenzho area (China coast across from northern Taiwan). It is one of those miracle cities that went from a near zero population fishing village to 300,000 in a few years, all fueled by farmers who made and or bought looms and created a textile center weaving blankets for world export.

My comments were about apartments in Shanghai. Middle class folks (e.g. a doctor makes about $20,000 a year) will often buy one apartment one to live in and one as "investment". Sound familiar? The extras are mostly empty, or renting for much less than 6% interest on the money to buy the unit.

We rented a luxury two floor roof top terrace apartment (20th floor) in a gated compound with gardens, sculpture, playgrounds, walkways, waterfalls, bamboo fish ponds, fountains, and underground parking for $800 a month! The apartment is fully and nicely furnished with beds HDTV, kitchen dishes...everything.

The guy we rented from said he would sell it for $650,000. This was a normal price judging from many "bargain" offers in the windows of many area Realtors.

The typical real estate secured interest rate was 6 to 6 1/2%, so that's at least $36,000 interest per year, yet we were able to negotiate a rent of $800! And there were lots of apartments available. People would approach us with incredible deals. You could tell they were hurting, had bought extra apartments and were struggling with paying the mortgages, and were desperate for any help from any rent they could get.

There simply were not enough foreign renters with US corporate salaries as they assumed there would be. I'm a hippie artist type, not a corporate executive. And how much rent can you get from a Chinese doctor who earns maybe $20,000 a year?

We would go shopping in these giant shopping center places, full of stuff, wow! Goods had very high prices, but no one buying; there were no bags in "shoppers" hands, and no one was checking out. Store staff standing around outnumbered shoppers.

Ai Qiu (my wife) and I went to store after store like this and had this eerie feeling like it was a stage set as opposed to a real money making business venture.

Year after year there are more places that go down and a new one sprouts up. However, it's all the same. There are no shoppers so there is no way is this a business making money. It reminds me of the "Field of Dreams" concept. "if you build it they will come", except the mythical rich consuming Chinese or foreign shoppers haven't shown up yet, nor do I don't think they'll ever show up.

The Shanghai skyline is like that too. Look at the highrises! There are more square feet of commercial office spaces being built in Shanghai every year than exist in all of the island of Manhattan! A brand new Manhattan sized city business district added to this city each and every year on top of the existing hi-vacant buildings.

I have no contacts in banking or real estate but I can imagine the implosion/bankruptcies are beginning to occur. China's a year or so behind the Miami condo market.
I asked Bill how he met his wife, Ai Qiu. Bill writes ...
I met Ai Qiu in 2000/2001, she was a sculptor working in Shanghai China, I was a sculptor from USA. We now sculpt together in both countries. We sell works in China that we have sculpted and cast in the USA, and we work on sculpture for USA that we sculpt and cast in our studio in China. Most of our work that is produced for USA and European collectors are cast here in West Virginia, a small third world country nestled within the eastern mountains of the USA. As far as I can tell, West Virginia is completely unaffected by the world's current economic woes except that Chevy pickup trucks are cheaper and you can't ever retire.

Ai Qiu has 4 younger sisters and her parents living in China. We have three children, so there is a lot of family visiting. Our kids have time with their grandparents and aunts. The extended family model in China is wonderful. Working and living in China is a great experience for us all, professionally and familialy.
Bill Hopen The Sculptor

Inquiring minds are exploring the Bill Hopen Gallery.
Here are a couple of my favorites.

Bill Hopen at work.

I asked Bill for some final thoughts. Bill Writes...
I love China, I have met the most earnest good and hardworking people there. They are so optimistic with the growth of their new economy. Within living memory of 50-60 year old Chinese like Ai Qiu's father is the hard times of the 1960's when 20-25 million people starved to death. I've heard the stories. Things were much worse than our 1930's depression stories that my parents told me. There's big difference between going to bed hungry and starving unto death.

I think if poor times were to come, the resourceful, tough, patient, communal, hard working Chinese lower classes would do just fine compared with urban Americans. China is not a socialist country like USA. If you get sick and need oxygen in the hospital and you cannot pay for it, with cash, you may die. It's the same with food and hunger. In America we have one poor indigent person for every nine working and making it. In China its flipped. You have nine poor people working for $5 a day, maybe even $2 a day, for every well-to-do middle class $20K per-year person. It's a very Darwinian, Dickens-like capitalist world, perhaps like US in 1880.

I think the Chinese believe the growth will go on forever and everything will be great. They are hard working, frugal, productive, they save and reinvest. I wish them the best but I fear the worst coming to their newly built shining cities.
Thanks Bill. Wishing you Ai Qiu and your family the best.

Mike "Mish" Shedlock
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Thursday, February 19, 2009 11:18 PM

Nationalization Revisited

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Previously I expressed some thoughts on nationalization in The Nationalization Train Has Left The Station. Greg Mankiw suggests wait a minute, this is just nomenclature as the FDIC shuttering banks would itself be nationalization.

Yves Smith at Naked Capitalism discusses this in Greg Mankiw in Favor of Nationalization (and Tries to Clean Up Nomenclature).

One problem I have is that no one is laying out the details of what should happen. Does Mankiw's nationalization equal Roubini's or Greenspan's? Let's explore that question with a look at Mankiw's Nationalization, or Pre-privatization?

If the government is to intervene in a big way to fix the banking system, "nationalization" is the wrong word because it suggests the wrong endgame. If banks are as insolvent as some analysts claim, then the goal should be a massive reorganization of these financial institutions. Some might call it nationalization, but more accurately it would be a type of bankruptcy procedure.

Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, "Go away, you have been zeroed out." The debt holders are told, "Congratulations, you are the new equity holders." Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!

I am sure there are a host of legal issues here. The government cannot blithely walk into banks and tell them they are insolvent when the banks are saying (pretending? hoping? praying?) otherwise. But as bank regulators, the feds have more leeway with banks than they would with other types of business enterprise. How much leeway is an issue beyond my ken.
Unfortunately, Mankiw does not offer many details other than suggesting equity holders will be wiped out and bond holders get the assets.

Questions That Need Addressing

1. Are all US government guarantees of bank debt null and void? They should be. At a minimum, taxpayers are currently on the hook for $300 billion of Citigroup's debt and $100 billion of Bank of America's debt.

2. Are we going to end up creating another banks that is "too big to fail" out of this mess?

3. Will stock holders and preferred shareholders both be wiped out?

4. In a normal bankruptcy process one might expect to see significant changes in management. Will the nationalization process allow the clowns who wrecked these banks to stay in control? For how long? Under what capacity? And what person or committee gets to decide those questions?

5. Will the CDS liabilities be wiped out in entirety regardless of consequences? Clearly they should because otherwise taxpayers will be footing the bill. Unless this is spelled out I suspect measures will be taken to protect Goldman or whoever else is on the right side of those CDS and derivative contracts.

6. What kind of bidding process will be put in place and in what timeframe for the assets of the banks? Who decides and why?

When someone says they are in favor of nationalization, those are the questions that are in play that need to be addressed, for starters. There are likely many other questions that I missed. Unless and until those questions are answered, we cannot know to what extent taxpayers are at risk. I would like to see Nouriel Roubini and Greg Mankiw address those questions, otherwise we may be comparing apples to planets. Without answers to those questions,I strongly suspect taxpayers will be left holding the bag.

Mike "Mish" Shedlock
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8:44 AM

Fiat World Mathematical Model

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In a fiat world, money is printed into existence by the central bank - in the United States the Fed. Given there is nothing backing up this money, it is inherently worthless. However, one can think of as real. It was printed (even if only electronically), therefore it exists.

In addition to the previously mentioned money supply, fractional reserve lending allows credit to be extended by banks and financial institutions on top of that inherently worthless money. Indeed, banks and financial institutions have leveraged credit to base money at ratios of 30-1, 50-1 or even higher.

It's pretty amazing if you think about it: Credit is extended with 30-50 times leverage on inherently worthless paper.

Ponzi Financing

Borrowers have to pay interest on the amount borrowed. However, the interest and the debt cannot possibly be paid back except by an ever expanding Ponzi scheme of lending. That scheme can last only as long as everyone believes the debt can be paid back and the market value of that debt keeps rising.

It's a faith based system in which banks extend loans and hold the credit on the books (or in many cases off the books in various structured instruments). The banks are thought of as being well capitalized as long as the value of credit on the books in relation to their reserves meets some ridiculously low minimum set by the Fed.

This is how the system works, using the term "works" loosely.

Day of Reckoning

The day of reckoning comes when asset prices start falling, defaults soar, and the value of credit on the books starts plunging. That day of reckoning has arrived.

And if leverage is high enough, as it was with Bear Stearns and Lehman, the institutions are wiped out overnight. Citigroup (C), Bank of America (BAC), Fannie Mae (FNM), Freddie Mac (FRE) and AIG are essentially in the same position of Lehman except the taxpayers via the Treasury are funding the bailouts.

Deflation Economics

Conditions today are essentially the same as during the great depression. I talked about this in Humpty Dumpty On Inflation. When I wrote that piece, I listed 15 conditions one would expect to see in deflation and the score was a perfect 15-15. I recently added a 16th: bank failures. Click on link to see the conditions table.

Those who stick to a monetary definition of inflation pointing at M2, M3, MZM, or base money supply, as well as definitions that involve prices are selecting a definition of inflation that makes absolutely no practical sense.

It is the destruction of credit, coupled with the fact that what the Fed is printing is not even being lent that matters, not some Humpty-Dumptyish academic definition that has no real world application!

I have long been arguing that we are in deflation based on the following definitions: Inflation is a net expansion of money and credit. Deflation is a net contraction of money and credit. In both definitions, credit needs to be marked to market.

Mathematical Model

I can express the above mathematically.

Fm = Fb + MV(Fc)

Fm = Fiat Money Total
Fb = Fiat Monetary Base
Fc = Fiat Credit, the amount of credit on the balances sheets of institutions in excess of Fb

MV(Fc) is the market value Fc

Inflation is an expansion of Fm
Deflation is a contraction of Fm

If only base money was lent out (no fractional reserve lending), MV(Fc) would equal zero. The equation ensures we do not double count credit in Fm.

MV is a function of time preference and credit sentiment (ie. Belief that one can be paid back). As long as that belief was high, banks were willing to lend.

Because (at the moment) Fc (credit) dwarfs Fb (base money), the system can only hold together as long as there is belief credit can be paid back and as long as there are not defaults. Needless to say, the perceived belief that Fc can be paid back is under attack, both by rising defaults, and by sentiment. That is why MV(Fc) is collapsing.

In other words, the mark to market value of credit is contracting faster than base money is rising.

What About Deposits?

Some may point out that base money is not the only real money out there. Deposits are real.

Actually most deposits are fiction, borrowed into existence via an accounting entry and lent out with the miracle of fractional reserve lending time and time again. Moreover, savings accounts have zero reserve requirements and the bulk of checking accounts which are supposed to be available on demand are swept nightly into savings accounts so that they too can be lent out.

However, the FDIC guarantees those deposits up to the FDIC limit, now at $250,000 per account. Because of FDIC it might seem that deposits up to the guarantee limit should be accounted for in the above equation. One could do that by adjusting the right side of the equation to allow for FDIC guarantees. This would result in a peculiar formula of adding credit extended with 30-50 times leverage on inherently worthless paper to guarantees promised on that which does not really exit.

From a practical standpoint however, the economy seems to be acting as if base money and FDIC guarantees are irrelevant and the only thing that matters is the market value of credit.

Let's explore why that is using a magical printing press as an example.

Magical Printing Press

Assume for a moment you invent a magical printing press. Your machine can print hundred dollar bills so good that the US Treasury cannot distinguish them them from the real thing. The bills are perfect in every way. Now assume you print $5 trillion worth of those bills and bury them in your back yard. Is this inflation? Surely not. Would it be inflation if $5 trillion in bills were spent and entered the economy? You bet. The key then is not how much the Fed prints, the key is how much of that money makes its way into the economy.

Please consider this audio with Austrian Economist Frank Shostak on Mises on September 30, 2008 discussing recent actions by the Fed.

Will this printing create [price] inflation? This is dependent very much on what money will do next. If banks will not lend and banks sit on that cash forever and ever like the great depression because the risk is too high and the banks do not know if the lending will end up in good assets or bad assets, and because banks are in so many bad assets now they probably will not lend at all.

That is the observation that Murray Rothbard made, that during the Great Depression that banks have chosen not to lend because the risk of accumulating bad assets was far to high. So they were sitting on massive reserves. That is what is developing right now.

A good example is what happened in Japan in 2001-2002 where the Bank of Japan pumped 300% at one stage and lending continued to collapse. I expect similar things to happen here. If lending will not increase we can conclude this will not be inflationary.
I agree whole heartedly with Shostak and suggest we are following the Japanese model. This has been my thesis for years.

Don't Ask, Don't Sell Policy

The Fed tries to hide the contraction in the market value of bank credit by its Don't Ask, Don't Sell policy. See Fed and BOE Shell Games to Bailout Insolvent Banks for more discussion of the aggregator bank shell game and the Don't Ask, Don't Sell policy.

Many point out that base money is rising at an amazingly high rate. However, as we have seen, base money is irrelevant until the money is lent. The key issue is that the market value of credit is collapsing at an amazing rate.

This is deflation.

One can choose to say in strict Austrian terms there is no deflation because money supply is rising. However, the money supply theory falls flat on its impractical face when it comes to accurately explaining what is happening in the real world.

The inflation model simply does not fit. Conditions one would expect to see during inflation, stagflation, hyperinflation, and disinflation are nowhere to be found.

The US shows 16 symptoms of deflation for the simple reason deflation is at hand.

Confusion due to delays?

Steve Saville chimes in on the The Inflation-Deflation Debate with a thesis that suggests there are lengthy and variable time delays between changes in the monetary trend and changes in prices. Let's take a look.
For many years we have been expecting inflation (growth in the supply of money) and nothing but inflation as far as the eye can see, but there have been times, such as the past 12 months, when we have felt more affinity with deflation forecasters than with most other inflation forecasters. The reason is that monetary inflation, when measured correctly, was minimal during the first half of 2008 and during the two preceding years, thus setting the stage for a US$ rebound and large price declines in the investments that had been bid up to astronomical heights.

Based on our observation, a lot of confusion on the inflation/deflation issue is caused by the lengthy and variable time delays between changes in the monetary trend and changes in prices. It will often be at least 2 years before the effects of a major change in the monetary trend start to become apparent in the prices of commodities and everyday goods and services. Consequently, during the first 2 years of a new monetary inflation cycle the outward evidence will often point to deflation (even though the inflation threat is rising), and for 2 years following the END of an inflation cycle it will seem as if the inflation threat is growing (even though it is falling). ...

Current Situation

We agree with much of the analysis presented by the well-known deflationists. The main point of contention revolves around the ability of the monetary authorities (the Fed and the Treasury in the US) to keep the total supply of money growing. Our view has been, and continues to be, that the Treasury-Fed tag team has the power to promulgate monetary inflation under almost any economic circumstances and will use this power. The bond market could eventually impose a practical limitation on the government's ability to inflate because increasing the money supply becomes counter-productive once the bond market begins to anticipate rapid currency depreciation, but if price-related evidence continues to favour the deflation view over the coming year then this limitation will not arise anytime soon.

The case is not yet closed, but the evidence presented to date supports our view. For example, the monetary base has expanded at an astronomical pace over the past five months. Mike Shedlock has attempted to counter this by pointing out that a sharp increase in the adjusted monetary base (AMB) also occurred during the early 1930s, but the St. Louis Fed's updated long-term chart of the AMB shows that the recent increase has been many times greater than anything during the 1930s. In any case, the overall monetary situation today could hardly be more different to the early 1930s. During the early 1930s the Fed increased the monetary base, but the total supply of money plunged.
Discussion On Points Of Contention

I agree wholeheartedly with Steve Saville that the Fed can print money at will. However, getting banks to lend is another thing indeed as the following chart of Reserve Bank Credit shows.

Reserve Bank Credit

click on chart for sharper image

Simply put, the Fed cannot force banks to lend or consumers and businesses to borrow. Congress can force the issue with TARP funds and other so-called "stimulus" measures. Then again, writeoffs of bad loans are going to increase at a massive rate, especially credit card defaults and foreclosures in conjunction with rising unemployment.

What About The Lag Theory?

Saville states "a lot of confusion on the inflation/deflation issue is caused by the lengthy and variable time delays between changes in the monetary trend and changes in prices."

Another way of phrasing Saville's theory is that growth in credit (and prices) follows the creation of money, with a lag. This is the money multiplier model.

Money Multiplier Lag Theory Is False

Please consider commentary from Steve Keen’s Debtwatch, Roving Cavaliers of Credit.
Two hypotheses about the nature of money can be derived from the money multiplier model:

1. The creation of credit money should happen after the creation of government money.
2. The amount of money in the economy should exceed the amount of debt, with the difference representing the government’s initial creation of money.

Both these hypotheses are strongly contradicted by the data.

Testing the first hypothesis takes some sophisticated data analysis, which was done by two leading neoclassical economists in 1990.

If the hypothesis were true, changes in M0 should precede changes in M2.

Their empirical conclusion was just the opposite: rather than fiat money being created first and credit money following with a lag, the sequence was reversed: credit money was created first, and fiat money was then created about a year later:

There is no evidence that either the monetary base or M1 leads the cycle, although some economists still believe this monetary myth. Both the monetary base and M1 series are generally procyclical and, if anything, the monetary base lags the cycle slightly."

Thus rather than credit money being created with a lag after government money, the data shows that credit money is created first, up to a year before there are changes in base money. This contradicts the money multiplier model of how credit and debt are created: rather than fiat money being needed to “seed” the credit creation process, credit is created first and then after that, base money changes.
Solid Evidence Credit Is Created First

Solid evidence that credit is created first and reserves later can be found by reviewing Fannie Mae’s and Freddie Mac’s Financial Problems, an article written July 15, 2008.
To make certain that the GSEs have adequate funds to cover potential losses, OFHEO (like all financial regulators) imposes capital requirements. At the end of 2007, the two GSEs had a $24.8 billion surplus over the regulatory capital requirement of $58.4 billion; they had a surplus of $50.8 billion over the risk-based capital requirement of $38.8 billion.

These amounts can be compared with the combined retained mortgages portfolios of $1.434 trillion and the $3.501 trillion in MBS that the GSEs guaranteed for a total of $4.934 trillion.

The regulatory capital surplus amounted to 0.50% of the $4.934 trillion and 1.03% of the risk-based capital surplus. If the GSEs were to face losses in excess of their income by these percentages, they would be forced to either reduce their capital requirements by selling mortgages and MBS from their portfolios or to raise new capital from investors.

The Secretary of the Treasury is authorized to lend the GSEs $2.25 billion each, but this is more a symbolic amount than a total solution. Based on Fannie Mae’s issuance of $1.588 trillion in short term debt in 2007, the $2.25 billion would have lasted less than 12.5 hours. Based on the $598.6 billion issued of short term debt that Freddie Mac issued in 2007, the $2.25 billion would have lasted just under 33 hours.
Fannie Mae's capital surplus was 0.50% on close to $5 trillion in assets. In other words, Fannie extended credit at will with virtually no reserves behind it. The Treasury provided reserves later, after Fannie and Freddie imploded.

Base Money Yet Again

Steve Saville points out that recent increase in base money has been many times greater than anything during the 1930s. Steve is correct as the following chart shows.

click on chart for sharper image

Note that the pattern leading up to the great depression and the pattern before the latest spike are nearly identical. There is no other similar pattern on the chart. And most certainly the recent spike as Saville points out is unprecedented.

Base money is indeed soaring. However, so is debt.

USA Money Stock Measures and Debt

Here are some more charts and commentary courtesy of Steve Keen’s Debtwatch.

Measured on this scale, Bernanke’s increase in Base Money goes from being heroic to trivial. Not only does the scale of credit-created money greatly exceed government-created money, but debt in turn greatly exceeds even the broadest measure of the money stock—the M3 series that the Fed some years ago decided to discontinue.

Bernanke’s expansion of M0 in the last four months of 2008 has merely reduced the debt to M0 ratio from 47:1 to 36:1 (the debt data is quarterly whole money stock data is monthly, so the fall in the ratio is more than shown here given the lag in reporting of debt).

To make a serious dent in debt levels, and thus enable the increase in base money to affect the aggregate money stock and hence cause inflation, Bernanke would need to not merely double M0, but to increase it by a factor of, say, 25 from pre-intervention levels. That US$20 trillion truckload of greenbacks might enable Americans to repay, say, one quarter of outstanding debt with one half—thus reducing the debt to GDP ratio about 200% (roughly what it was during the DotCom bubble and, coincidentally, 1931)—and get back to some serious inflationary spending with the other (of course, in the context of a seriously depreciating currency). But with anything less than that, his attempts to reflate the American economy will sink in the ocean of debt created by America’s modern-day “Roving Cavaliers of Credit”.
I agree with Steve Keen in regards to money vs. credit, with credit being far more important, at the present time. Furthermore, rising unemployment is only going to exacerbate the problems of imploding credit. Expect to see massively rising credit card defaults, foreclosures, and walk-aways, all on account of unemployment that is soaring.

Finally, it is important to consider the role of attitudes going forward. Attitudes affect the willingness of consumers to take on debt and banks to extend it.


  • Boomers are heading into retirement. A significant portion of their retirement plan (home prices) has already been wiped out. Another portion of boomer retirement plans is being wiped out in the stock market crash. Toy accumulation is out. Fears of insufficient saving is in.
  • Boomers will be traveling and spending less than they planned.
  • A secular shift to frugality and risk aversion in all age groups has begun. Signs are everywhere.
  • The lend to securitize model at banks is dead. So are toggle bonds where debt is paid back with more debt, and a myriad of other financial wizardry schemes.
  • Children who have seen their parents wiped out in bankruptcy or foreclosed on are going to have a completely different attitude towards debt than their reckless parents did. Expect to see more frugality from parents and their children alike.

What About Zimbabwe?

In Zimbabwe, credit does not exist. You simply cannot walk into a bank and get a loan. Nor would anyone in their right mind deposit money in a Zimbabwe bank as part of a saving program. The money would be worthless in a month.

In the US credit is not being extended for a different reason. Banks are not afraid of being paid back with cheaper dollar, banks are afraid they will not be paid back at all. Cash is being hoarded by banks and consumers alike. This is the opposite of what happened in the Weimar Republic and what is happening now in Zimbabwe.

Global Stimulus Kicker

There is yet another kicker to this model. And that kicker is the Eurozone, the UK, Japan, and essentially every county on the planet is all attempting some sort of stimulus plan or other. This is bound to cause a major distortion at some point, as no country has anything remotely close to an exit strategy for this. What kind of distortion and when cannot be certain because we are indeed in uncharted territory, worldwide.

Political Will vs. Consumer Psychology

What happens next depends somewhat on the political will of the central banks and politicians. However, it depends more on the psychology of the borrowers. If consumers and businesses refuse to spend and instead pay back debts (or default on them along with rising unemployment), the picture simply is not inflationary, at least to any significant decree.

The credit bubble that just popped exceeded that preceding the great depression, not just in the US but worldwide. Thus, it is unrealistic to expect the deflationary bust to be anything other than the biggest bust in history. Those looking for hyperinflation or even strong inflation in light of the above, are simply looking at the wrong model.

At some point the market value of credit will start expanding again, but that is likely further down the road, and weaker in scope than most think.

Mike "Mish" Shedlock
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