Smashing Capitalism and The Law of Unintended Consequences

Well I’m in Greece and I’m gathering info for a number of posts, but will write on that subject upon my return. Have seen a lot of building projects underway here leading me to assume there was lot’s of speculation. I will post some photos as well.

In the mean time here is an article that can be filed under ‘The Law of Unintended Consequences’.
Vern

Global capitalism will survive the current credit crisis; already, the
government has rushed in to soothe the feverish markets. But in the long term, a
system that depends on extracting every last cent from the poor cannot hope for
a healthy prognosis. Who would have thought that foreclosures in Stockton and
Cleveland would roil the markets of London and Shanghai? The poor have risen up and spoken; only it sounds less like a shout of protest than a low, strangled,
cry of pain.

The rest of the article - Smashing Capitalism

I'll be gone for a couple of weeks

I'm heading down to Greece to have a look around and see how their housing market looks. I will try and get a surface view of their economy as well and post on what I see.

I will have intermittent internet access and will try and post from there.
Vern

How Does the Fed Inject Money into the Economy? A Primer

I asked yesterday how repos worked and got this from my friends over at patrick.net.
Thanks guys, Vern

From The Wall Street Journal on line:
How Does the Fed Inject Money into the Economy? A Primer

The Fed garnered attention last week by adding billions of dollars to the money market to relieve upward pressure on interest rates. How do these operations work? Here’s a primer.

The Fed influences growth and inflation by controlling short-term interest rates. It controls those rates in turn via its monopoly over the supply of reserves to the banking system.

All banks in the U.S. are required by law to set aside a portion of their demand deposits (such as checking deposits) as reserves. These reserves can be either currency in the vault, or reserves on deposit at the Federal Reserve. Banks can use reserves at the Fed to settle transactions with each other. Numerous factors affect the level of reserves: funds disbursed for new loans, funds coming in from loan repayments, clearing of checks with other banks, tax payments to the federal government, federal disbursements such as for social security. On any given day, some banks will have more reserves than they need, and others less. Those with an excess lend to those with a shortfall in the federal funds market. The Fed manipulates the federal funds rate by manipulating the supply of these reserves.

Its principal means of doing this is via open market operations. To put downward pressure on interest rates, the Fed would buy securities in the open market from a designated dealer (primary dealer). The Fed pays for the securities by crediting the account of the dealer’s bank at the Fed. The bank now has more reserves than it needs, and so it lends them out, pushing down the federal funds rate. This operation results in an expansion of the Fed’s balance sheet and thus the money supply. However, the Fed is not principally targeting the money supply but the short-term interest rate, which ripples out to all borrowers and lenders. To raise interest rates, the Fed sells securities to dealers.

The Fed has two principal types of open market operation. A permanent operation is conducted to adjust the Fed’s balance sheet to what it believes is the normal, long-term need for currency and reserves. To do so, it either buys (or, more rarely, sells) Treasury securities and adds them to its portfolio. A temporary operation is in response to short-term fluctuations in the supply and demand for reserves. To supply additional reserves, the Fed conducts a “repo” or repurchase operation. It offers to supply a fixed quantity of funds to primary dealers for 1 to 15 days in return for collateral consisting of either Treasurys, bonds issued by Fannie Mae or Freddie Mac (called agency bonds), or mortgage backed securities issued by Fannie Mae, Freddie Mac or Ginnie Mae. At the end of the repurchase agreement, the dealers repay the money with interest and the Fed returns the securities. The opposite operation is called a reverse repo. Last Friday’s repo was unusual in that the Fed encouraged dealers to submit only MBS as collateral, the first time it has done so since at least 2000 (after the Sept. 11, 2001 terrorist attacks, it did conduct a similar “single tranche” auction but that time accepted only Treasurys as collateral). It may have done so to help dealers finance their holdings of MBS, or possibly to avoid aggravating a potential shortage of Treasurys in dealer inventories that might be needed for other collateral purposes. The Fed only said it did so for “operational simplicity.”

Why might such a temporary operation be necessary? The federal funds rate could rise above the Fed’s target for several reasons: either unexpected high demand for reserves, or restricted supply. The precise reason for last week’s rise in short-term rates remains unclear. It may be that European banks, some of whom have U.S. units that participate in the fed funds market, faced an unexpected jump in loan demand, perhaps from issuers of commercial paper who could not roll the paper over and thus turned to back up lines of credit at banks. It may be that some banks holding excess reserves were reluctant to lend them out, anticipating a need for them for their own purposes or uncertain as to the safety of the counterparties to whom they might otherwise lend.

For more detail on Fed open market operations, read “Understanding Open Market Operations,” on the Web site of the Federal Reserve Bank of New York.

Financial Train Wreck

The fed has pumped liquidity into financial markets in an attempt to loosen the tight fists of scared stiff bankers who have become (overnight it seems) reluctant to loan cash to each other. I’m sure they are worried about being paid back. I know I would be.

The Fed didn’t print fresh dollar bills and drop them from helicopters ala Bernacke, but did a piece of financial alchemy instead, offering ‘repos’ (what those consist of I’m not quite sure but I think they function something like an I.O.U.). Now they can say no cash is involved but if the deals backed by repos go south, real money is going to evaporate. These repos represent a certain cash value that will be demanded to settle any of the bad loans they back that dry up. If the Fed offered them instead of cash, the Fed will eventually have to come up with cash the best way they know how, print more…

This brings me to the next part of my rant. If the Fed prints its’ way through this mess it’s a bailout for the banks who made freakin’ wild-ass bets involving CDOs, derivatives and the like, and the inevitable printing party that will follow will devalue each and every dollar we have stuffed under our mattresses. That adds up to a tax on the lower classes plain and simple. Bank execs and hedge fund managers get to keep their billion dollar bonuses while the Fed debases our savings, engaging in unauthorized rear entry of the population in the process, and I’m sure they won’t be offering us dinner and a drink first.

The sad part is, it probably won’t work anyway. Derivatives gearing involves tens or even hundreds of $ trillions.
We’re freakin’ doomed.

Sometimes I feel like we are all in a great train wreck; the front cars have derailed but the passengers in the rear don’t know it yet. All the gyrations to calm the markets are only buying time, time for what, I don’t know, but I’m sure it will become clearer as the back of the train joins the front in the crushing misery that is to come.

That’s my rant. If anyone of my readers can fill me in on repos or straighten me out on my logic, please post. Criticism is welcome.
Vern

Look Out Below II

More from: charles hugh smith


The stock market's 4-year cyclical low has been put off for an entire year by the explosion of liquidity/credit. Now the chickens are coming home to roost. One of the most reliable cycles in U.S. markets is the 4-year cycle: about every 4 years, the stock market hits a low. It has been remarkably consistent: 1982, 1987 (OK, 5 years), 1990, 1994, 1998, 2002--so the low was "scheduled" for 2006.



In 1986, Mr. Market missed its appointment; but that simply set up the October 1987 "appointment" which resulted in a 22% drop in a single day. Now the U.S. stock market has blown right past this 2006 "appointment"--but the appointment wasn't cancelled, it was simply re-scheduled for the future. That future is now:

Historically, a 20% decline is quite a normal occurrence. With this is mind, it is risible how market cheerleaders/pundits are screaming and shouting and shaking in terror now that the Dow Jones Industrial Average has declined a mere 6% from it's all-time high.

Recall that stock market meltdowns aren't the result of some fundamental dislocation in business or the economy--they result from credit contractions/panics/dislocations. Which is exactly what we have right now.

It looks like Mr. Smith called this one right on the money. Thanks Charles. If you haven't visited his site I recommend you give it a click, good stuff. charles hugh smith

I didn’t know about the four year cycle but I do know that the markets are over valued. In fact most every asset class is now over valued and waiting for an adjustment, which, if you have been following the news, seems to be upon us.

Even the PPT (Plunge Protection Team) seems impotent in the face of this re-pricing as investors are questioning values and running for cover. Australia, Canada, Japan, the Federal Reserve and the E.C.B. have all been pumping money, ($130 Billion in the case of the E.C.B.) into financial markets for two days now to no effect.

Normally I would feel a little optimistic, trusting in the inherent greed of my fellow investors to predict a re-entry to the markets to scoop up bargains, but I’m not feeling so optimistic this time. If the PPT can’t turn this stampede, we are in for a long drop.
Vern

Beyond The Credit Implosion

From: Charles Hugh Smith
Sublime Subprime: Beyond The Credit Implosion
To investment bankers packaging all those mortgage-backed securities and derivatives (CDOs), subprime/exotic loans were indeed sublime. Despite daily exhortations by financial leaders such as Treasury Secretary Paulson that the credit meltdown was "contained," we find that the credit reactor core has in fact burned through its containment shield and is in full "China Syndrome"--i.e., burning straight through the Earth to the Central Bank of China, who holds $1.3 trillion in plunging dollars and billions in MBS and other rickety U.S. credit instruments.

Like drops of water falling, each mortgage default in the U.S. is a seemingly small amount of money. Yet as the defaults grow into the hundreds of thousands, they come together to form a mighty river of fear cutting straight through the soft sand of the global credit markets.

The credit "dislocation"/panic doesn't stop with subprime. Take a look at this chart of total U.S. mortgages, and see how few are "safe" 30-year fixed-rate loans:

Add in all the other at-risk loans--FHA/VA, alt-A, no-down, adjustable-rate and HELOC--and you get a domino effect which is unstoppable:

The defaulting of tens of thousands of mortgages promises to topple dominoes far beyond the mortgage credit markets. Consider just this small sampling:

* Local government tax revenues immediately drop. Empty houses, bankrupt/closed lenders-- who's responsible for paying those sky-high property taxes which have fed the spectacular growth of local government spending? Answer: no one. Good luck on finding someone to pay those overdue property taxes, and good luck on finding a buyer willing to pony up thousands in taxes to clear the title. The Housing Bust: Local Government Fallout.

Let's say the eventual "owner" of the property claims the house is worth $300,000, and tries to sell it for $280,000, telling potential buyers that they've dropped the price to reflect the $20,000 in property tax liens which have to be paid by the new buyer. Who will be dumb enough to think this is a good deal? Very few, I suspect, for everyone knows the house may well actually be worth $250,000--who even knows? Meanwhile, every 6 months the tax liens grows larger.

* Mosquitoes breeding in stagnant swimming pools. A seemingly trivial concern? It will suddenly seem very serious when someone you know comes down with West Nile virus. Vacant pools leave neighbors swimming in mosquitoes (USA Today)

* Lawsuits over shoddy construction will clog the courts and may eventually drive teetering homebuilders into bankruptcy. Readers of this humble blog have known about this issue for a year: Construction Defects: The Flood to Come? (June 1, 2006)

and Construction Defects, The Flood to Come, Part II (June 3, 2006).

BusinessWeek finally woke up and ran a story this week: You Call This A Home? The next boom for builders may be complaints from angry homeowners.

* Nervous foreign owners of dollars, U.S. mortgage and corporate bonds may decide to cut their losses and unload some of their holdings. These owners are unlikely to be persuaded by Paulson and Company's sweat-flop pleas to buy more or even hold on: China stopped buying US mortgages in May. Even modest selling could beget further selling, creating a selling frenzy beyond the control of our financial markets' handlers. Thus do raindrops become rivulets which becomes streams which join into a massive unstoppable flood.

Cramer loses it, states "We have Armageddon"

Wow, I have no words for this.
You have to see the clip.

Honey, I Shrunk the Company

Bloomberg.com ---
The winner of this week's ``Honey, I Shrunk the Company'' award has to be American Home Mortgage Investment Corp. Worth more than $1.8 billion just six months ago, the company's value dropped to as low as $56 million this week.

The lender specializes in Alternative A mortgages, a catch- all classification for loans made to borrowers that don't meet the standard to be classified as ``prime'' while not scoring low enough to drop into the subprime category.

In April, American Home Mortgage said demand from financial companies that buy and repackage its so-called Alt-A mortgages was ``stabilizing.'' This week, banks cut its credit lines.

Perhaps part of its downfall was the May decision to let customers make their mortgage payments using American Express Co. credit cards. Think about that for a second. Using your Amex card. To make your mortgage payments. Can you spell usury?

A cardholder with a $3,000 monthly obligation could earn enough points in a year to get a free DVD player or portable video player. Never mind that gizmos like that come free with cornflakes these days. Or that the hapless borrower would be paying double interest for the privilege.

Global Liquidity Defined

You’ve heard the term ‘global liquidity’ bandied about in the financial news a lot lately. Some of us have an idea what it means but not really. Here is a primer on just what those financial pundits are talking about when they use those two words together in a sentence.

It’s an excellent piece that’s easy to follow and bottom lines what we are now facing in the rapidly deteriorating global economy and housing crisis.
Vern

by Michael NystromAugust 3, 2007

Editor's Note: The following is in answer to a reader's
question "What do they mean when they talk about global liquidity drying up?"

In remembrance of my high school biology teacher, who always reminded us that the only stupid question is an
unasked question, I offer the following explanation. ---

Financial analysts and news reporters often refer to the concept of "liquidity," as though it were a magic wand. One touch and all ills are cured. Until recently, it was often heard that "the world is awash in liquidity," which was considered a good thing. More recently, the en vogue observation is that "global liquidity is drying up," which is spoken in ominous
tones. ---

The rest of the article at: bull not bull.com

Can we trust the numbers or the reporting?

The U.S. stock market is in choppy waters and no wonder, one hedge fund after another is melting. Trouble in the derivatives market is spreading at an unknown pace but I’m sure institutional investors are seeing the damage spread through their bottom lines.

On one hand a number of companies are reporting double digit percentage rises in earnings while US jobs come in weak and housing is looking worse, but consumer sentiment is soaring. I’m not sure what to make of it all but I smell a little B.S. in the air.

Everybody who’s paying attention knows the shit is about to hit the fan and I don’t just mean a little bit, I mean enough to get on everybody. Bad news drives the market down hard. Is it any wonder? Everybody who knows better has their finger on the sell button. But the market powers back up with schizophrenic swings that leave me emotionally drained by the end of each session.

What gives? I’ll take a guess, fear and greed. We are all waiting for that next hedge fund to announce they are going off a cliff and taking the rest of the market down with it, as most of us know a major re-pricing of all assets is due.
But we all, including me, keep jumping back in for that one last bit of profit.

Here’s hoping the collapse doesn’t come over night.
Vern

Subprime could create global crisis, economist says

WASHINGTON (Market Watch) -- The problems in the U.S. subprime mortgage market could spiral out of control into a global financial crisis, economist
Mark Zandi said Thursday.

With a "high level of angst" in the financial markets about who will take the losses from more than $1 trillion in risky mortgages, we could be just one hedge-fund collapse away from a global liquidity crisis, said Zandi, chief economist for Moody's Economy.com.

A global meltdown is not likely, but the risks are growing,
Zandi emphasized in a conference call with reporters following the release of a new study on subprime debt that concludes that the housing crisis could be deeper and last longer than investors now believe. Read the latest data on home sales.

And it could spread. "Mounting mortgage delinquencies and defaults now pose the most serious threat to the global financial system and economy," Zandi said in his report.

"If there is a fault line in the global financial system, it runs
through the U.S. housing and mortgage markets," he said.

Zandi's comments came as U.S. financial markets reeled from a growing credit crunch, centered not in the subprime arena, but in the leveraged corporate debt market.

After Bear Stearns was forced to write off the value of two large hedge funds that had invested heavily in securities backed by subprime debt, it could take just one more "Bear-like event" for the financial system to freeze up,

"If there's another major hedge fund that does stumble, that could elicit a crisis of confidence and a global shock," Zandi said. The potential "is quite high," he said. He gave it a one-in-five chance.

Zandi said global financial conditions have been supported by
strong growth and substantial liquidity, supercharged by "unprecedented risk tolerance." But that's changing. Global liquidity is drying up, with central banks tightening. And risk is being re-priced.

"The credit window is now closed," wrote strategist Barry
Ritholtz in his blog.

The world is flat…economically speaking.
As more countries have been brought into cooperation with the world economy it has progressively flattened until we find ourselves interconnected and interdependent. That is why, in a nut shell, we will all suffer from a major economic event like the one that is now brewing in the U.S. housing market. Sure some of us will zig or zag at the right moment and manage to land in the gravy but the majority won’t. The result will surely be changes to everyone’s lifestyles regardless of current or future financial status.

I predict another result will be anger amongst the masses. Remember the guy in Oregon who destroyed his house before surrendering it to the bank? ( Man uses pigs to trash own house )

That kind of anger.



Only this time it may be blindly aimed at anything or anyone who represents the source of their pain. Imagine that kind of anger displayed by millions of economically ruined people world wide…
Not a pretty picture.
Vern