Archive for November, 2007

One kind of commentary I keep running across, even from people 26 sigmas smarter than me, goes like this: “Inflation fears are overblown. According to the Treasury Inflation-Protected bonds (TIPs) market, inflation is deteriorating rapidly because …”

Let’s go over the reasons why this kind of analysis is false and misleading:

1) It’s not very true according to its own (flawed) benchmarks. 5-year Treasuries issued at a coupon rate of 3.375% are now trading at 3.39%, basically the same yield as the coupon. 5-year TIPs, issued at a coupon rate of 2% (implying 1.375% CPI), are now trading at 1.12% yield. That’s nearly HALF the original coupon, and it implies that TIPs are almost twice as valuable (yield somewhat over half as much on the bond) as they were at issue. Additionally, the difference between TIPs yield and Treasury yield, as you can see for yourself, is not 1.375%. It’s 2.27%. That’s a huge increase in CPI inflation expectations relative to identical bond issues from earlier.

2) CPI is an extremely political benchmark, because all mandated growth in entitlement spending is indexed to it. So the government has an obvious incentive to understate it, and perhaps more importantly, there is an elite consensus on the issue. Therefore, it’s highly likely that CPI will be held down by all kinds of statistical magic, or less conspiratorially, the divergence between CPI and headline inflation should widen over time. Therefore, the Fed faces heavy political pressure (and everyone agrees that the Fed reacts to political pressure, at least slightly) to keep CPI down.

3) If you think inflation will rise, you probably don’t trust the Fed very much, since low inflation is part of the Fed’s job description. Therefore, you probably won’t trust the Fed’s measurement of CPI very much. Therefore, the last place you’re going to go to bet on rising inflation is the TIPs market. People who don’t trust the Fed have lots of better ways to bet on inflation than TIPs.

It’s analogous to walking up to a Wal-Mart checkout, slipping the card through the reader, and then saying to the clerk, “I think your products have been deteriorating in quality, and I think they suck!” You’re an idiot if you’re wrong and a bigger idiot if you’re right.

4) Even significant inflation fears now will only be a warble in the 5-year TIPs market, let alone longer-term TIPs, just because the length of the time horizon overshadows most current events. As long as people are willing to trade a Treasury/ Fed market, and thus trust it even to a lessened extent, there will always be the presumption that a spike in headline inflation will be met with subsequent money withdrawal to bring inflation back in line.

5) Even if you think CPI will exactly track “real” inflation, and that political considerations have nothing to do with CPI calculations whatsoever, you’re still not capturing the full effect of inflation. So you’re still missing out on some of the payoff of rising inflation. The methodology of CPI was altered dramatically in 1993 to effectively lower the stated rate of inflation by multiple percentage points per year, because the previous rate of inflation allegedly did not account for substitution effects, and so on and so forth; but under pre-1993 methodology, current inflation would be running over 7 percent, which incidentally is much closer to MZM minus real GDP.

For these reasons, I wish people would stop referring to the TIPs market as a valid indicator of inflation expectations. It isn’t.

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More Sivs freezing over

Florida isn’t the only state being left as a bagholder for the SIV mess. After a run started on a Florida SIV (causing FL to freeze withdrawals), Montana is also discovering that above-market yields are no free lunch.

SAN FRANCISCO (MarketWatch) — Florida’s investment troubles have triggered withdrawals from other states’ funds as the subprime mortgage crisis continues to spread.


Florida halted withdrawals from a $15 billion local-government fund on Thursday after concerns over losses related to subprime mortgages prompted investors to pull roughly $10 billion out of the fund in recent weeks. See full story.


Other states are experiencing similar problems on a smaller scale.


The Montana Board of Investments, which manages the state’s money, has seen $247 million withdrawn by local governments in the past three days from a $2.5 billion money-market-like fund called the Short Term Investment Pool.

It won’t be any consolation to them, but the Treasury/Libor spread shrank a lot today, so the interbank seizure has calmed down a lot since yesterday’s worst-in-21-years 3-month Ted spread of 2.26 (it’s at 2.05 now). However, I think it would be foolish to assume that yesterday’s peak fears will not go unrealized.


I’m also surprised by the dollar’s rally after Kohn and Bernanke gave the markets their early Christmas present yesterday and the day before. The fed funds gamblers have now priced a 25bp cut as 100% likely, and a 50bp cut at 34 percent.

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When Mideast analysts who know what they’re talking about (i.e. Stratfor) have previously gotten all giddy about prospects for peace in the Mideast, I have always had this kneejerk roll-eyes reaction. Not that their relatively pricey news isn’t worth it (far, far from it). But from my vastly less informed viewpoint, there are simply too many people invested in continuing the “stable disequilibrium” of the Iraq mess–both inside and outside the Middle East–for Mideast “peace” to be anything but an accidental, inevitably-aborted pregnancy.

For example, if Baghdad ever stopped cannibalizing itself, Kurdish independence would be jeopardized. The Kurds are probably not involved in any Iraqi sectarian problems right now, but they have 100,000 very well-equipped and well-trained soldiers. The Kurds could easily scuttle Iraqi unification if they wanted to.

The rest of our Gulf “friends” have enjoyed a half-decade windfall from oil’s “structural upward volatility” in oil prices, primed by Alan Greenspan and sparked by the Iraq war.

Ratcheting up Gulf tensions, and thus upping the perceived risk premium of oil, is easy for Iran. Sunni actors for their part tremble at the Iranians’ rise (a derivative of the Iraq mess) but they have no complaints about higher risk premia for oil, as long as it’s not their pipelines getting bombed.

Iraq has also been a godsend to the Saudi royal family, because Iraq has effectively imported all radicalized Saudi youths who would otherwise have followed in Juhaiman al-Utaibi’s footsteps. For the Saudis, although Iraq has powered international volatility by abetting the rise of Iran (bad), Iraq has soaked up the blood of every Saudi kid who would otherwise be throwing Molotov cocktails at the Saudi royal family (very good). (The best measure of supposed Saudi internal reform, btw, will be changes in the proportion of Saudis among the Iraqi body count.)

But the actor with by far the least to lose and the most to gain by sparking the Mideast powder keg is Russia. Russia is the world’s number 2 (I believe) oil exporter. It instinctively distrusts the United States on a visceral as well as a strategic level. Although it is no longer communist, Russian commodities interests (i.e. the people who run Russia) find Americans as their main competitors in global export markets, the Rusal-Alcoa rivalry being just one example.

So, the Russians have a lot of reasons to keep the Mideast on fire. Iran does too, for its own reasons. An alliance was born.

However, Soviet-Iranian relations have never been very stable. Stalin even occupied Iran in 1945, withdrawing only after the United States threatened one-way nuclear war over the issue. Iran’s current “friendship” with the Russians is very skeptical and opportunistic. Much as the Americans and Russians always, regardless of changing historical tides, find themselves fighting each other, so it is with Iran and Russia on a somewhat smaller scale.

Presumably, once the Americans are bled white enough to quit the Mideast, Russo-Iranian competition for Syria, Azerbaijan and the Central Asia ‘stans (“the Great Game”) will be the decisive factor in the Iranian-Russian relationship. It’s a lot like with Sauron and Saruman in the Lord of the Rings, with Saruman, the weaker warlord, happy to align himself with the “Great Satan,” but only to the extent that it helped Saruman.

This long-run ‘inevitability’ has manifested itself in Russia’s ‘assistance’ for Iran’s nuclear reactor at Bushehr. The Russians, who built the reactor themselves, are basically one fuel shipment away from revving up an autonomous Iranian nuclear program. Russian intelligence and armaments exporters are up to their eyeballs with the governments of Iran and Syria. However, when it comes to nuclear technology (to Iran), the Russians have been a much more capricious counterparty, constantly inventing new reasons to delay completion of the reactor. The Russians know they will lose a lot of leverage over Iran once the fuel is shipped, thus a mini-soap opera of Russian hemming, hawing, intransigence and general bad-faith behavior.

Unfortunately, the Russians are highly alarmed at the progress of American-Iranian negotiations. There is obviously a huge lobby in the United States to wind the war down in acceptable fashion. There is a large Iranian lobby, as well–even among the military, which is intricately involved in all parts of the economy. The American financial embargo of Iran has caused Iranian economic growth to be much lower, and inflation significantly higher, than it otherwise would be. The Iranian opportunity costs for ongoing hostilities are rising, if not as rapidly as for the United States.

Iran needs more concrete, long-term reasons for being a Russian proxy in the Mideast, than structurally upwardly-volatile oil prices and broken promises from the Russians over the Bushehr reactor.

It now appears that Sauron is willing to give his Saruman the ultimate ring of power in order to maintain the tempo of tension in the Mideast.


Russian President Vladimir Putin on Nov. 30 signed into law a bill that formally suspends Russian cooperation with the West on the Conventional Armed Forces in Europe (CFE) Treaty. On the same day, the International Atomic Energy Agency approved a shipment of Russian nuclear fuel for transport to the Russian-built Iranian reactor at Bushehr.

The CFE — a treaty that regulates how much conventional weaponry NATO and former Warsaw Pact states can have, and where — is the cornerstone of Eurasian security architecture. … But registering Russian displeasure with the treaty is one thing; leaving it is another.

Similarly, the Bushehr reactor — so long as it is not yet on line — is Russia’s primary lever for inserting itself into Middle Eastern events. But as soon as it goes on line, the West has no reason to engage the Russians on Iranian issues, and Iran shifts from needing tutors for its nuclear program to having the infrastructure in place to be self-taught. In the Russian mind, ending that influence could be worth the cost if it locks Iran and the United States into a protracted struggle.

The bottom line is that both leaving the CFE and making Bushehr operational are not rhetorical moves, but bridge burners that will force other powers to adjust their long-term security policies. …

Russia feels forced to take such actions because its world is quickly evolving in a direction it greatly fears. The European Union and NATO take up Russia’s entire western horizon and show few signs of being finished with their enlargements. The United States might have achieved some breakthrough in the past week on both the Israeli-Palestinian issue and relations with Iran. Simply put, things are coming to a head. …

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Good stuff.

Is the financial world about to collapse? You’d think so if you listened to the financiers

What on earth is happening in the financial markets? Last week Northern Rock was going bust, stock markets were collapsing and the world banking system seemed to be going down the tubes. Now everything has reversed. Markets are soaring. Northern Rock shareholders, instead of losing everything, as expected a week ago are threatening to sue the Government unless they double their money. The Abu Dhabi Investment Authority (ADIA), the world’s biggest investment institution, suddenly launched a dawn raid on Tuesday to snap up $7.5 billion worth of shares in Citicorp, the world’s biggest and most troubled bank. So is the financial world about to collapse or are all the crises over?

The answer, of course, is neither. Markets always go up and down and these short-term fluctuations tell us nothing about the world outside the City and Wall Street. This is particularly true today because the markets’ recent gyrations are caused mainly by short-term factors that will soon ebb away.

Investors are obviously still worried, as they have been since August, about the weakness of the US housing market and the exposure of banks to defaulting low-income mortgage borrowers, but these risks have not changed since mid-October, when stock markets all over the world were hitting record highs. What has changed is the emotional response of investors to these risks.

In a nutshell, investors feel betrayed. The banks told investors and regulators before the summer that they had learnt lessons from previous crises and had found new ways of making profits without exposing their capital to old-fashioned lending risks. Instead, these risks had been transferred, through clever financial engineering, to pension funds, insurance companies, Asian governments and other long-term investors with deep pockets. This has now been exposed as a myth. As a result, the share prices of banks are collapsing and their managers are being fired — though, being bankers, their reward for incompetence and deception is a multimillion golden handshake from the shareholders and taxpayers whom they abused.

This naturally makes people angry and, to make matters worse, the full extent of the deceptions has yet to be revealed, so that only the bravest investors, such as ADIA, can contemplate buying bank shares, however far they fall. Most of this uncertainty, however, will soon be resolved as the banks close their books for the year-end results, with directors and accountants aware that any significant mis-statements could land them in jail.

Will these results produce further shocks, triggering another stock market collapse? I have no idea and neither does anyone else, which is why the markets are so twitchy. What I do know is that market gyrations in response to these disclosures will matter much less than most financiers believe.

Financiers naturally think that they are the world’s most important people, so when their own jobs and bonuses are threatened they assume that the global economy must be under threat. Most of the time this is simply not true.

Meaningful economic indicators come out only rarely but stock markets trade every day, so in periods of uncertainty they start reacting to their own daily fluctuations as if these provided “new” information. When bank shares fall sharply, investors treat this as evidence that the financial system must be in trouble and analysts who were saying “buy” only a few weeks ago begin to scream “sell”. This, in turn, causes shares to fall farther and proves the sagacity, and maybe even inside knowledge, of those who sold. As bankers see their share prices falling, they threaten to cut lending to the real economy of jobs, investment and housing. The fear of a weakening economy then makes bank stocks fall again.

This self-reinforcing process was defined as “reflexivity” by George Soros, in his classic treatise, The Alchemy of Finance. A substantial academic literature has now confirmed that Mr Soros’s “theory of reflexivity” is a big driving force of boom-bust cycles in financial markets. But the question is whether these financial boom-bust cycles are as significant for the non-financial economy as he believes. The big mistake made by Mr Soros as an economic analyst, though not as an investor, was to exaggerate the power of his insight about reflexivity and therefore to conclude that capitalism is an inherently unstable system.

In reality, a modern mixed economy, especially one with a central bank actively managing demand, is protected by self-stabilising mechanisms that are much more powerful than the reflexive boom-bust behaviour of financial markets. In the present financial panic, for example, the dollar is falling sharply and this is boosting US exports. The acceleration of export growth is easily offsetting the slowdown in construction and consumer finance � at least so far. Another stabilising offset comes from long-term interest rates, which have now fallen back to the levels that triggered the global credit boom in 2004. As a result of such self-stabilising feedbacks, financial cycles tend to reverse of their own accord and almost never produce outright economic disasters. The 1930s Depression and Japan’s recent stagnation are often cited as counter-examples but these were caused mainly by central bank policy errors that were amplified by unstable financial markets, not the other way round.

Which brings me to the most important stabilising mechanism: the central banks. The true reason for this month’s grim mood in global stock markets has been disappointment with the US Federal Reserve Board. The Fed cut interest rates by a quarter point on October 31, believing (probably rightly) that this would be enough to avert a recession, but Wall Street wanted more. Since many investors think Wall Street is the economy, they believe the Fed has a duty to protect stock markets and banks against excessive losses, similar to the attitude displayed by the shareholders of Northern Rock. They therefore felt righteous anger when the Fed refused to promise another rate cut after October 31.

Wall Street in the months since the August panic has been like a spoilt child who has grazed her knee. As long as the Fed offered attention and sweeties, investors stopped screaming. But the moment the sweeties ran out, the screaming resumed. Like a weak parent, Ben Bernanke, the Fed Chairman, encouraged this naughty behaviour with indecisive policy flip-flops. In the next two weeks, however, the screaming will probably stop. On December 11, at the next Fed meeting, Mr Bernanke will doubtless back down and give Wall Street its extra rate cut. The tantrum will then be over and it will be cuddles all round in the City and Wall Street, at least until the next grazed knee.

He’s missing the FHLB bailout, though. $200 billion in liabilities for Uncle Sam that nobody has a clue about. Just go to the Federal Home Loan Banks’ website and look at their outstanding discount loans. $160bn to $330bn in 10 months.

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Ted spread update

3-month Libor: 5.12%

3-month Treasury: 2.86%

3-month Ted spread: 226bps

Ted spread precedents: Black Monday 1987 (~255bps), and before that, the 1979-83 bear market.

Suckers’ rally.

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Fed Up


We’ve been told not to imagine a world without the Federal Reserve. Maybe we should.
Post Date Wednesday, November 28, 2007

WASHINGTON–Recently, The Washington Post carried a front-page story about a federal raid on the headquarters of the National Organization for the Repeal of the Federal Reserve Act and Internal Revenue Code (Norfed). The Indiana-based company, which advocates “sound money,” has been selling coins and paper certificates backed by gold and silver for years, in effect trying to compete with the dollar.

The government ignored Norfed’s “Liberty Dollars” for a long time–until the group started selling thousands of coins with Ron Paul’s likeness to show support for the Republican presidential candidate. Paul also wants to abolish the Federal Reserve.

To the public at large, the activities of Norfed seem utopian, naive and even downright fraudulent. The idea that the world’s greatest economy could be run without a central bank and private parties could replace the government as issuers of currency is one that many people will find scary. With the dollar in something of a free fall and the United States in the midst of a housing and credit crisis that has sent some of the nation’s top CEOs packing, Americans will be looking for financial security, not monetary adventures.

And yet it is precisely in such a financially wobbly environment that the actions of Norfed should invite a critical look at the way money is managed. Some of the country’s greatest economists, including Nobel Prize winners, have been saying for years that the Federal Reserve has probably caused more problems than it has solved since its creation in 1913. Its role in the last century’s boom and bust cycles is a matter of record; it looks as though it played a similar role in the current housing market crisis too.

While the creation of the Federal Reserve was essentially a response to a series of bank runs, those crises were mild compared to the ones that were to follow. In 1913, the United States was under the gold standard. Although the government issued currency, the fact that currency was tied to gold meant the authorities could not manipulate the money supply easily. The Fed’s initial mission was to guarantee the convertibility of deposits into currency on demand. A few decades later, the United States abandoned the gold standard and the Federal Reserve became the country’s most powerful economic institution, exercising its monopoly in issuing currency based on the discretionary power of its board of governors.

All in all, financial instability has been far greater since the creation of the Federal Reserve. What did the Great Depression teach us? Essentially that even with the best of intentions, it is impossible for the authorities to manage the supply of money in accordance with the exact needs of the economy. A country’s economy is the sum of millions of people making decisions that no single individual is in a position to anticipate. As economist Murray Rothbard showed in his book America’s Great Depression, in the 1920s the Federal Reserve pumped up the money supply, expanding credit by more than 60 percent. Because the economy was very productive, this monetary expansion did not show up in the regular inflation figures. But, as is always the case with inflation, many resources went to the wrong kind of investments–until the crisis hit. The late Milton Friedman showed how the Fed made things worse by not providing the system with enough liquidity once the Depression was obvious.

The current housing market and debt market crises are in good part the children of the Federal Reserve. By cutting rates 13 times between 2001 and 2003, and then keeping them very low for years, monetary policy contributed to the housing bubble. That is not to say other factors–including financial instruments that made it difficult to see that the underlying foundation was not as solid as it seemed–did not play a part too. But, once again, the Fed has turned out to be a factor of financial instability.

In this context, Norfed’s attempt to prove to the Fed that the market is ready to trust private currency backed by gold is a welcome occasion to take a second look at some of the economic institutions we take for granted. Naive and utopian? You bet. But that is probably because of how far the world has moved from the time when money was too important to be left to the politicians.

Alvaro Vargas Llosa, author of Liberty for Latin America, is the director of the Center on Global Prosperity at the Independent Institute.

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Apparently, once again there are grounds for hope for a “more lasting accommodation” in the Mideast, judging by the latest kabuki signals between Pres. Ahmonajihad and Uncle Sam.

And, oh, right: Don Kohn said that we needed some more of that pragmatic flexibility on interest rates.

And there was much rejoicing.

My hobbyhorse du jour, the difference between the 3-month London interbank offer rate and 3-month Treasurys, stands at 212 basis points. The last time confidence was this low was… Black Monday, 1987.

Another way to look at it would be to examine the T-bill/Fed funds ratio 2.96/4.60 ~= .64. Except for August 20, 2007 (when the 3-month tbill divided by the effective fed funds rate was 3.06/5.03 ~= .62), this is the lowest the ratio has gone since the bona fide 26-sigma event of 9/11/2001, and its echo defaults–Enron and Worldcom. It is equal to the LTCM rate, and you’d have to go back to 1982 to find a comparable level of panic.

Somebody with much better information than me is calling BS on this rally.

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Bill Clinton: Reliving History

I don’t like to comment on partisan politics much. I used to. As I say in my ‘About’ page, once I figured out that Republicans and Democrats were more or less equally hypocritical, I hit the road, and have essentially been looking for a different kind of institution and a different channel for my life ambitions ever since. Currency trading works well enough, because there’s a lot of political game theory involved.

However, there is one tranche of the hypocrisy market–and judging by Americans’ willful ignorance about world affairs and eagerness to erase bad memories, it’s still a huge bull market, with no signs of a top–which happens to be (almost) completely cornered by the Democrats. It’s also the only kind of hypocrisy that still makes me genuinely angry, so apologies to any capital-D Democratic readers for not being even-handedly vitriolic.

That’s when a politician who, after inserting his requisitely absolving lawyerly exceptions and opt-out clauses before the vote, enthusiastically voted for the Iraq war five years ago, has since shifted with the political wind, and now fabricates a history of vociferous opposition to the war where none existed.

If you are Russ Feingold, Barack Obama, or anybody else who publicly opposed the war then, you can say whatever you want about Iraq as far as I’m concerned. But if you voted for the war, and then your base became really unhappy, you cannot back out. You are not entitled to get your ante back just because your team wasn’t dealt pocket aces. Nor are you entitled to get your ante back if you were dealt 7-2 offsuit. Whatever your initial read on the situation, you are in the hand until you win, or until you lose. The Democrats who have since invented excuses to vociferously oppose the war after previously voting for it, because it didn’t go perfectly according to plan (guess what: wars never go according to plan), because Bush sucks, because there weren’t enough negotiations — they are guilty of treason. As is Gordon Smith.
If you authorize a war, you are in it until it’s over. If you believe, before the rest of the authorizers, that the war was misguided and should be wound down, you cannot say so publicly until your group has reached an internal consensus to that effect, because to break and go public undermines the majority with whom you voted. The authorizers who have had second thoughts, precisely in line with shifting political winds, refuse to accept the burden of their own responsibility. If the war was “criminal,” as Gordon Smith suddenly realized about 20 months before the date of his Oregon Senate reelection, Smith is a criminal accomplice, not a victim. Ignorance is no excuse.

Authorizing a war is a long-term investment in a totally illiquid asset. Liquidating early carries an enormous cost for the others on your side of the transaction in the form of a longer war, more dead soldiers, more GDP chewed up in the bowels of the Pentagon, and perpetually irresponsible American political institutions.

It is commensurately profitable to Mahmoud Ahmadinejad, who has the luxury of jailing or killing anyone who tries to take his chips and back out from the Iranians’ side of the poker game.

Like America’s Too Big To Take Responsibility Fail banking institutions, the Clintons made what turned out to be a very bad (for them) leveraged, illiquid investment. They are rewriting their balance sheet, with the eager assistance of Drudge and the alphabet-soup media dinosaurs, and kicking the liability down the road for somebody else to pay. In this case, the US Army and the US taxpayer. The liability is already much bigger than it had to be, and it will balloon still higher.

There are no unpaid debts at the poker table of international power politics. Unfortunately, the Democratic base inhabits an alternate reality in which Bush and his lieutenants carry sole responsibility for every cost of the war, random Iraqi behavior carries responsibility for every success, John Edwards, who once shared liability for the Iraq war, is now a champion of the antiwar movement [*], Hillary Clinton was pretty much antiwar all along but just a little ambivalent about it, and Barack Obama is secretly a hawk who just said he was antiwar because he represented a super-liberal all-black district, and by the way, he’s naive and inexperienced and not ready for prime time.

Unfortunately, as rabidly aimless Democrats are just now figuring out, John Edwards is just not It. That leaves Clinton, alongside Obama, who while green is no proven hypocrite. (Just give him time.)


“Who are you gonna believe, me or your lying memory?” he explained.

The Clintons’/ Hillary’s war vote has never stopped haunting them. Apparently, Bill is getting uncomfortable with his wife’s Iowa numbers, and is alarmed by the potentially fatal “underdog Iowa slingshot.” It made Kerry in 2004, after all. Perfectly on cue with the 2004 race, Bill has officially taken over the Hillary campaign’s job of haphazardly rewriting the Clinton Legacy with regards to Iraq. As Ron Fournier says:

DES MOINES, Iowa – As only he can do, Bill Clinton packed campaign venues across eastern Iowa and awed Democratic voters with a compelling case for his wife’s candidacy. He was unscripted, in-depth and generous.

“Good Bill” and “Bad Bill” (his nickname among some aides) returned to the public arena Tuesday as Sen. Hillary Rodham Clinton brandished her double-edged sword of a husband to fend off rivals in the Jan. 3 caucus fight.

“Ladies and gentlemen,” Clinton told 400 Iowans at the start of his three-city swing, “I have had a great couple of days out working for Hillary.”

In the next 10 minutes, he used the word “I” a total of 94 times and mentioned “Hillary” just seven times in an address that was as much about his legacy as it was about his wife’s candidacy.

He told the crowd where he bought coffee that morning and where he ate breakfast.

He detailed his Thanksgiving Day guest list, and menu.

He defended his record as president, rewriting history along the way.

And he explained why his endorsement of a certain senator from New York should matter to people.

“I know what it takes to be president,” he said, “and because of the life I’ve led since I’ve left office.”

I, me and my. Oh, my.

Late in his 50-minute address, Clinton told the crowd that wealthy people like he and his wife should pay more taxes in times of war. “Even though I approved of Afghanistan and opposed Iraq from the beginning, I still resent that I was not asked or given the opportunity to support those soldiers,” he said. …

If the former president secretly opposed the war but did not want to speak against a sitting president (as some of his aides now claim), what moral authority does he have now? And did he share his objections with his wife? She started out as a hawkish Democrat but is now appealing to anti-war voters.

… He had four big reasons why Democrats should back her:

• She has the best policy plans;

• She works well with Republicans;

• She’s a problem solver;

• And she has the best range of experience.

For each of those reasons, he had a half dozen or so facts, anecdotes or arguments to support them — and each of those categories had several bullet points of their own.

Clinton navigated this mental outline with the same rhetorical crutches he used in Arkansas and Washington.

He would mention something in passing and promise to get back to it (“I’ll say more about that in a minute”), and he always did.

He would “show” people what he meant rather than just “tell” them (“I’ll give you just one example,” he said before giving two or three).

He gave any impatient crowd members hope that the speech would soon end (“And, finally, let me say … ,” he said at least twice before launching into another topic).

What he left the crowds with was the assurance that his wife understands their plight. For a man who convinced so many voters that he felt their pain, this may be his most powerful calling card Clinton can leave to Iowa crowds and his wife.

“You need somebody who is strong, competent and has good vision, and never forgets what it’s like to be you,” Clinton said.

And, no, he wasn’t talking about himself. Ding ding ding!

On the one hand, I’d say that a majority of the smartest people I’ve ever met have been Democrats. On the other hand, the Democratic base has always preferred to rewrite its collective memory–Edwards, Kerry, the Clintons, half the Democrats in the Senate, a slew in the House–over the pain of admitting their own mistakes (or at least punishing the mistakes of their party leadership) every single time. Saying “I’m sorry” is close enough to, “It never happened,” as far as Democrats are concerned.

My guess is that the Clintons will get away with the two-step pretty easily. If the Democratic base had vertebrae as well as common sense, their own media would be flogging the Clintons every day for the consequences. With few exceptions, that hasn’t happened. The alphabet soups and Drudge want some semblance of a race just because it’s good for business, but they can be counted upon to provide another “Pakistan gaffe” come clutch time. (I am still reeling at how effective that was.)

I did, after all, get this story straight off of Drudge, as I did the inconvenient truth of Clinton’s war support. But a Clinton flunky is in contact with Drudge all the time, and the only reason Drudge is doing this is because he’s alarmed by the falling interest in the race based on his click count. Drudge is in Hillary’s corner, at least as far as the Democratic nomination is concerned.

If you’re a conservative, it’s a pretty sweet deal, in a nearsighted way. Democratic activists saddle themselves with serially irresponsible leaders who can’t stomach being blamed for anything. (Not that the Republicans aren’t irresponsible, but the GOP can take blame for something without the entire leadership panicking and crashing to the exits.) As a result, Democratic voters always fulminate after the fact at their leaders’ risk aversion and resulting policy failures, only to walk off the same cliff four years later.

If the Democrats punished their leaders commensurate with their leaders’ respective mistakes, politics would be fun again. Until then Pinocchio will lead the Democrats by the nose, I will trade currencies, and pathetically spineless “leadership” will continue to plague the Democratic Party.

[*] Yes, he regrets it now. Too bad. He voted for it, and he only undermines the effort, and tries to make other parties pay for an alleged mistake which was partly his own, by backing out of his vote.

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So I understand the idea that the SWF put has once again displaced everything else at the front of the trader’s/speculator’s mind, and that it might justify some long-forgotten bullishness.

But meanwhile, the Treasury-London interbank offer rate, also approximated as the Treasury-LIBOR, Treasury-eurodollar, or ‘Ted’ spread, is now the widest it has been in at least 20, probably 27 years. It’s now at 2.08.

The market can get as deliriously bullish as it wants. But–why?? The exploding divergence in the interbank offer rate means that banks are extremely unwilling to lend to each other (as unwilling as any time in the past 27 years), because they don’t have confidence in each others’ balance sheets. I am pretty sure they have a better sense of that than I do.

So I will sit this rally out. There’s at least one dead whale that hasn’t floated to the surface yet.

Then again, Fed Vice-Chairman Don Kohn indicated today that he’s leaning towards more rate cuts. As I never tire of saying, the 1970’s have just begun.

The bond market is effectively forcing the Fed’s hand and pricing in a pretty massive slug of rate cuts over the next several quarters. Conventional wisdom is that the bond market is much smarter than the stock market. I don’t know.

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I’m talking, of course, about the Vatican.

When he was once asked how many people worked in the Vatican, Pope John XXIII (1958-63) is said to have replied: “About half, I think.”

Pope Benedict XVI, perhaps aware of this gibe, has decided to offer the first financial rewards and corporate-style incentives to Vatican employees who are thought to be “doing a good job”. The bonuses, which will apply to the 3,000 people who work in the Vatican, from the highest cardinal to the humblest cleaner, will be awarded on the basis of “dedication, correctness, professionalism and productivity”.

Job VII:2-3 Announcing the measure, Cardinal Tarcisio Bertone, the Vatican Secretary of State – the equivalent of prime minister – said that employees had been asking for such a bonus system for the past decade.

The Vatican will offer a three-tier “level of merit” bonus system, with the top bonus being 10 per cent of salary. “Meritocracy has breached the Vatican walls,” Il Messaggero, the Rome daily newspaper, said. The deal, to take effect in January, was negotiated with the Vatican’s association of employees, the ADLV, the closest organisation to a trade union in the Holy See. There are also about 1,000 clergy and nuns in Vatican City – one of the world’s smallest sovereign states. It is not clear how their “productivity” is to be measured, but this should prove rather easier with the administrators, secretaries, gardeners and mechanics, and the staff of the Vatican Museums, the Vatican Bank and Vatican Radio and Television.

At present the lowest-paid workers in Vatican City receive €1,100-€1,200 (£785-£860) a month, and the highest-paid employees up to €2,500 a month. The pay of cardinals and archbishops who head departments is said to be about €3,500 a month, but this is supplemented by many benefits, such as free housing and official cars. In addition all Vatican employees – many of whom are local Italians who live in Rome and commute – have access to the Vatican duty-free shop and tax-free petrol.

“If after a certain number of years an employee has worked well but has remained at the same employment level without promotion, he or she deserves to be rewarded with a rise based on merit,” Cardinal Bertone said. However, to pay for the bonuses, department heads would have to “keep a close eye on expenditure and ensure a wise use of resources”, the cardinal said. The Pope has asked Cardinal Bertone to overhaul the “machinery of government” in Vatican City.

The Vatican also gives one-off bonuses to its employees on special occasions such as papal birthdays and the election of a new pontiff. In April employees were given a bonus of €500 and a holiday to mark the 80th birthday of Pope Benedict.

When he was elected pontiff they received not only €500 to mark his elevation but also a further €1,000 as “gratitude for their service” to his predecessor, Pope John Paul II, during his 27-year reign.

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Seriously, how badly can you screw over your country before getting assassinated? Mao obviously takes the crown for gross utility destroyed, but his population gave him an unfair advantage over the competition. Bernanke, Rubin and Paulson are probably obliterating the most gross capital since Nixon-Burns, but they have so many generations’ accumulated toil to destroy that they might as well be running this sprint with a peg leg. Plus, the marginal utility of the capital they’re wrecking is so much lower, because America’s accumulated wealth, and the wealth of American foreign investors, is so high. So that means they are destroying fewer utils, in spite of their best efforts. Make it two peg legs.

I think Robert Mugabe has conclusively smashed the competition in the “utility per capita destroyed” sweepstakes.

Zimbabwe inflation ‘incalculable’

Zimbabwe’s chief statistician has said it is impossible to work out the country’s latest inflation rate because of the lack of goods in shops.

“There are too many data gaps,” the Central Statistical Office’s Moffat Nyoni told state media.

Many staple goods are often absent from shop shelves after the government ordered prices to be halved or frozen in a bid to stem galloping inflation.

September’s inflation rate was put at almost 8,000%, the world’s highest.

Other reports suggest the rate could be at near 15,000% and the International Monetary Fund had warned it could reach 100,000% by the end of the year.

Black market

Mr Nyoni said the Central Statistical Office has delayed the release of the inflation figure until an accurate way of calculating it can be found.

“We went to too many shops to observe and so compilations have not been completed,” he said.

Maize meal, bread, meat, cooking oil, sugar and other basic goods used to measure inflation largely disappeared from shops after Robert Mugabe’s government ordered prices to be slashed.

Manufacturers have said they cannot afford to sell goods at below the cost of producing them.

Most basics are intermittently available on the black market at well over the official prices.

Last month, the central bank offered loans, known as Bacossis, to businesses at 25% interest to restore supplies to shops, AP news agency reports.

“We hope the situation will improve, especially with the availing of Bacossi funds,” Mr Nyoni said.

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It’s the early 1990’s all over again: Citigroup has sold a fat chunk of its soul to them Ay-rabs again, who this time are calling themselves the Abu Dhabi Investment Authority.

I guess too many tongues started wagging when Citigroup went from -6.5% to -3% in one instant at today’s close, presumably completing ADIA’s purchase of $7.5 billion, or 4.9 percent, of Citigroup’s shares, after which Citigroup decided to fess up.

In the early 1990’s, Prince Alwaleed bin Talal made a gigantic bet on Citigroup when it was priced at $2.75 a share; of his $20 billion or so net worth, about $7.5 billion (it used to be much more) is a direct result of appreciation of his Citigroup shares.

At any rate, with this latest investment, Citigroup is twice bailed out and 10% directly owned by petrosheiks.

Update: That was the highest-impact piece of news I have seen in a long time. The Nikkei went from -300 to +150 immediately and the yen-based carry trade woke up from a coma. It’s as if the market had a collective Damascus moment and saw, in a flash of blinding light, that the Arabs and their giant piles of money will pay for all our sins, especially craptastic mismanagement at banking behemoths such as Citigroup.

This is the first dramatic realization of “the SWF put,” the idea that at the end of the day, SWFs (sovereign wealth funds) and their gigantic piles of cash will ride to the rescue of asset valuations.

On the flip side of the coin, I have always viewed the sovereign wealth funds, and worldwide USD foreign exchange reserves more generally, as expected future asset price inflation. It makes sense that foreign dollar-holders want to bail out of raw dollars as rapidly as possible. I have read elsewhere that Dubai has been a huge engine of gold purchases, as well.

Additional comment: Ouch. Citigroup had to offer an 11 percent coupon rate on the deal. There is a lot of other legalese here, but it seems that Abu Dhabi drove a pretty hard bargain, Muftigroup was extremely desperate, or both.


Citi gets $7.5bn capital fill-up from Abu Dhabi

By David Wighton in New York

Published: November 27 2007 03:39 | Last updated: November 27 2007 03:39

Citigroup announced Monday night that it had raised $7.5bn in new capital at a coupon of 11 per cent from the Abu Dhabi Investment Authority in an attempt to shore up its overstretched balance sheet.

The high cost of the new funds highlights Citi’s determination to meet its commitments to strengthen its balance sheet and carry on investing while maintaining its dividend.

It also underlines the challenge facing Citi as it searches for a new chief executive to replace Chuck Prince.

Mr Prince stepped down three weeks ago after Citi revealed it was facing up to $11bn of further writedowns on its holdings of mortgage-related investments.

Win Bischoff, acting chief executive, said the investment from ”one of the world’s leading and most sophisticated equity investors” would allow Citi to pursue attractive opportunities to grow its business.

Sheikh Ahmed Bin Zayed Al Nahayan, ADIA’s managing director, said Citi had a unique position in the financial markets throughout the world. ”We see in Citi a highly respected company with a premier brand and with tremendous opportunities for growth. This investment reflects our confidence in Citi’s potential to build shareholder value.”

The impact of credit market turmoil combined with a previous string of acquisitions, including Nikko Cordial in Japan, has left Citi’s balance sheet under strain.

Its Tier One capital ratio fell to 7.3 per cent at the end of the third quarter, below Citi’s target of 7.5 per cent, and has fallen further since. The company has committed itself to returning the ratio to its target by the end of June. The issue of mandatory convertible securities to ADIA would lift that ratio by about 0.5 percentage points.

The 11 per cent coupon, which is largely tax deductible, represents a slight premium to the yield on Citi’s shares.

Citi’s shares, which have almost halved this year, tumbled 6 per cent to $29.76 Monday, pushing the yield on them above 7 per cent.

Mr Bischoff said the investment would enable Citi to access capital in ”an efficient manner” and was consistent with its strategy of maintaining a balance sheet that benefits from highly diverse sources of funding in terms of both geography and type of security.

He added that ADIA is a significant participant in alternative investments and emerging markets financial services, two areas in which Citi has major positions and has been expanding.

ADIA’s investment will convert during 2010 and 2011 into ordinary shares at the equivalent of $31.83 to $37.24 per share. In addition to its small current holding, this would give ADIA a stake of less than 5 per cent.

Citi said the payment rate reflect market terms based on the conversion premium as well as Citi’s current dividend yield.

There have been a couple of dozen large issues of such securities in the past few years, including by companies such as Fortis and CIT. The yield premium and average conversion premium in the Citi deal are in line with the average for previous deals, according to a senior executive.

Gary Crittenden, Citi’s chief financial officer, has been pursuing a number of options to strengthen the bank’s balance sheet including disposals, shrinking its asset books and issuing hybrid securities. ADIA’s investment highlights the increasingly active role being played by sovereign wealth funds flush with cash thanks to the high oil price In July, ADIA bought a large stake in Apollo Asset Management, the US private equity group run by Leon Black. ADIA’s move recalls the investment made in Citi by Prince Alwaleed bin Talal, the Saudi billionaire, when it was struggling in 1991.

ADIA has agreed not to hold more than a 4.9% stake in Citi and will have no special rights of ownership or control and no role in the management or governance of Citi. It will have no right to any seats on Citi’s board.

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Fed moves to head off funding crisis

By Paul J Davies and Michael Mackenzie in London and Ralph Atkins in Frankfurt

Published: November 26 2007 16:28 | Last updated: November 26 2007 19:06

The US Federal Reserve aggressively ramped up its efforts to head off a new year’s funding crisis on Monday by giving an unlimited promise to inject to whatever cash was necessary to stop the overnight money markets freezing up.

It said it would inject enough cash to stop the overnight bank borrowing rate rising above its target rate of 4.5 per cent at year end. The first of a series of long-term operations to span the new year will start with a buying back of $8bn of Treasuries and other securities in a repo deal that matures on January 10.

This means that banks can lock in funds to carry over past December 31 and alleviate balance sheet constraints associated with the present credit squeeze.

The move comes as HSBC unveiled plans to take $45bn of mainly complex debt investments on to its balance sheet to end uncertainty surrounding its structured investment vehicles in the latest sign of the pressure banks are experiencing as a result of the credit squeeze.

The UK-listed bank said its decision to bail out its structured investment vehicles (SIV) would provide certainty for investors in the funds, for HSBC shareholders and for the bank itself and could help support the broader market by removing the threat of a firesale of the assets its vehicles held.

However, its decision to go it alone could be a blow for the US banks attempting to push through a US Treasury-backed plan to create the so-called super SIV by taking a large potential collaborator out of the game.

However, Citigroup, Bank of America and JPMorgan, the banks involved have said they will carry on alone if necessary.

The latest Fed moves, which coincide with new expected money market operations by the European Central Bank today, come amid increasing fears the financial system is moving into a new period of turmoil that could spill over into the real economy.

In statement, the New York Fed, which conducts the Fed’s liquidity operations, said it would “provide sufficient reserves to resist upward pressure on the federal funds rate above the Federal Open Market Committee’s target rate around year-end.”

The Fed often conducts term repo operations to address year-end funding needs but the $8bn operation announced yesterday is the largest for several years.

It also said it was relaxing the terms on which market participants could borrow Treasury securities from its own portfolio.

A New York Fed official said: “Given the high level of attention focused on the coming year end, we hope to reasssure market participants of our commitment to providing sufficient balances at that time by starting to provide these balances now.”

This week is the end of the fiscal year for several Wall Street investment banks and money market rates focused on the end of December have been rising. On Thursday, one-month Libor is expected to move sharply higher to around 4.80 per cent, after a move from 4.65 per cent since mid-November. In recent days, two-month Libor has risen to 5.06 per cent from 4.87 per cent.

In other news, the euro appreciated another .27% against the dollar today, and gold gained .22%. But inflation risks are contained. Ben Bernanke said so, and he knows more than you do about monetary policy.

Two-year Treasuries now yield 2.93%, which at today’s rate of inflation equals negative real interest. (That would be the Fed’s headline rate–3.5% … not to mention more credible, complete inflation indicators, i.e. MZM) . Who’s stupid enough to buy bonds at those rates? Good thing our equities markets are firing on all …

… nevermind.

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In case anybody thought the Fed was some kind of disinterested party in curing the banks’ SIV-positive balance sheets… do I have a shocker for you!:

Nov. 26 (Bloomberg) — Bank of America Corp., the nation’s second-largest bank, will lead efforts by Citigroup Inc. and JPMorgan Chase & Co. to convince smaller competitors they should help finance an $80 billion bailout of short-term debt markets.

… Loomis Sayles & Co. declined to invest after receiving one of 16 invitations for a personal meeting last week with current Fed Chairman Ben Bernanke, said Daniel Fuss, who oversees $22 billion as chief investment officer at the Boston-based firm.

“It’s so nice to get a personal invitation to go to Washington and have a one-hour visit with Ben Bernanke,” said Fuss, who decided participating wasn’t worth the risk to his firm. “Oh, boy, did I feel important for about 27 seconds, and then you smell a rat.”

What a flop. People aren’t going to give you money so that you can buy paper marked at 90% of par, which everybody knows to be garbage, dump the paper at 60% of par, and then stick the investors with the loss.

American debt markets are a lot more expendable than that.

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Another kind of academic shilling that really grinds my gears is when an academic/policy luminatus, who has lots of celebrity and political untouchability within academe, demands a stronger dose of the activism he originally implemented, which itself sowed the seeds of the current crisis. It is politically impossible for your typical risk-averse, but still quite ambitious young academic to point out the flaws of the argument, and the failures of the person who made it. So Larry Summers gets to pass off proven snake oil as a necessary policy remedy for the “problems” we’re facing.

Larry Summers, along with Robert Rubin and Alan Greenspan, originated the subprime economic policy with the Mexico bailout and the LTCM bailout.

Summers, you may recall, loudly banged the drums for monetization of banks’ debt (also known as “restoring the normal functioning of the financial system,” “restoring confidence in the markets,” and “improving the flow of information by restoring liquidity” among many others) back in August. I professionally predicted, as did many professionals with more intelligence and experience than myself, that rate cuts would do nothing to solve the problem, and would only socialize Wall Street’s losses, after Wall Street had privatized years of enormous gains.

I don’t have the credentials of Feldstein, Summers, or any of the other luminati who are fear-mongering their way to more Fed rate cuts–but I do have the cynicism to say that Wall Street knew this was coming, and knew it could count on narrowly brilliant, broadly useful idiots in academe and government to bail it out of its own collective fiasco.

Anyway, here‘s Summers:

Three months ago it was reasonable to expect that the subprime credit crisis would be a financially significant event but not one that would threaten the overall pattern of economic growth…

“Reasonable” to the willfully blind …

This is still a possible outcome but no longer the preponderant probability.

Even if necessary changes in policy are implemented, the odds now favour a US recession that slows growth significantly on a global basis. Without stronger policy responses than have been observed to date, moreover, there is the risk that the adverse impacts will be felt for the rest of this decade and beyond.

Several streams of data indicate how much more serious the situation is than was clear a few months ago. First, forward-looking indicators suggest that the housing sector may be in free-fall from what felt like the basement levels of a few months ago. Single family home construction may be down over the next year by as much as half from previous peak levels. There are forecasts implied by at least one property derivatives market indicating that nationwide house prices could fall from their previous peaks by as much as 25 per cent over the next several years.

Recessions happen. People have been forecasting and investing on the basis of this inevitability for years. There is no “policy response” to stop it, no free lunch, and nothing wrong with the self-corrective process. Recessions are, by definition, “adverse” in the short term. They also sow the seeds of healthier long-term growth.

Free markets are an evolutionary mechanism. A necessary part of market evolution entails destruction of wasteful capital. This is Japan in the 1990’s, all over again–an aging establishment that would rather strangle its economy than come to grips with downward volatility. The rest of the world has better places to put its money than an America that is “exceptional” only in its refusal to hold its institutions accountable for mistakes.

Second, it is now clear that only a small part of the financial distress that must be worked through has yet been faced. On even the most optimistic estimates, the rate of foreclosure will more than double over the next year as rates reset on subprime mortgages and home values fall. Estimates vary, but there is nearly universal agreement that – if all assets were marked to market valuations – total losses in the American financial sector would be several times the $50bn or so in write-downs that have already been announced by big financial institutions. These figures take no account of the likelihood that losses will spread to the credit card, auto and commercial property sectors. Nor do they recognise the large volume of financial instruments that depend for their high ratings on guarantees provided by credit insurers whose own health is now very much in doubt.

Stupid choices were made. Stupid choices have painful consequences, sooner or later.

Third, the capacity of the financial system to provide credit in support of new investment on the scale necessary to maintain economic expansion is in increasing doubt. The extent of the flight to quality and its expected persistence was powerfully demonstrated last week when the yield on the two-year Treasury bond dropped below 3 per cent for the first time in years.

Mistakes accumulated, and deadwood must be cleared. Since American monetary institutions obviously have difficulty coping with this reality, foreigners have begun dumping dollars on a massive scale. All actors are rational, on one time horizon or another. Dollar holders will not wait for their dollars to be monetized by an American government-financial priesthood that believes itself above responsibility, and above short-term pain.

What concrete steps are necessary? First, maintaining demand must be the over-arching macro-economic priority. That means the Fed has to get ahead of the curve and recognise – as the market already has – that levels of the Fed Funds rate that were neutral when the financial system was working normally are quite contractionary today. As important as long-run deficit reduction is, fiscal policy needs to be on stand-by to provide immediate temporary stimulus through spending or tax benefits for low- and middle-income families if the situation worsens.

Remember how Bernanke “moved ahead of the curve” with that audaciously unexpected 50-50 cut in mid-September? How that was a one-time fix for a “temporary” “liquidity shock”? And now we need more fiscal liquidity pumping, as well as rate cuts?

Second, policymakers need to articulate a clear strategy addressing the various pressures leading to contractions in credit. Very likely this will involve measures that are non-traditional, given how much of the problem lies outside bank balance sheets. The time for worrying about imprudent lending is past. The priority now has to be maintaining the flow of credit. The current main policy thrust – the so-called “super conduit”, in which banks co-operate to take on the assets of troubled investment vehicles – has never been publicly explained in any detail by the US Treasury. On the information available, the “super conduit” has worrying similarities with Japanese banking practices of the 1990s that aroused criticism from American authorities for their lack of transparency, suppression of genuine market pricing of bad credits, and inhibiting effect on new lending. Perhaps there is a strong case for it, but that case has yet to be made.

Third, there needs to be a comprehensive approach taken to maintaining demand in the housing market to the maximum extent possible. The government operating through the Federal Housing Administration, through Fannie Mae and Freddie Mac, or through some kind of direct lending, needs to assure that there is a continuing flow of reasonably priced loans to credit worthy home purchasers. At the same time there need to be templates established for the restructuring of mortgages to homeowners who cannot afford their resets, so every case does not have to be managed individually.

How many times can you repeat “maintaining demand” in one article? Paleo-Keynesianism is alive and well in the United States ruling establishment. Welcome back to the 1970’s.

Charles Gave can rail all he wants about how “the euro is absurdly overvalued” and how “the dollar is poised for a rebound.” Like many establishment forecasters and financiers, he judges the euro to be extremely weak on the basis of demographics, ossified labor-market institutions, and other “long-run” “structural” factors.

That argument is entirely correct, but its time horizon is much longer than the one most investors are currently using. The engine of the euro’s appreciation against the dollar is the abysmal “performance” of the dollar and dollar-denominated assets (bonds) in global asset terms. This was an extremely predictable consequence of the Fed’s conscious monetization of The Global Savings Glut and The Liquidity Shock. The dangers of near-term dollar devaluation by the Fed to foreign investors are so much greater than the present value of Europe’s medium-term economic weaknesses, to the point that European structural factors are probably not on the international time horizon at all.

The ECB knows that credibility is its only remotely “long run” asset, and it is protecting its credibility as much as possible by resisting calls from Sarkozy et al. to devalue the euro. I am increasingly doubtful that the ECB will be able to resist political pressure to join the made-in-China bout of competitive currency devaluation, but at least the ECB is trying.

The latest Summers article is sadly reminiscent of the rhetorical shadowboxing between the Fed and policy “authorities” following Bernanke’s 50-50 September cut, and subsequent reluctance to cut further. Gray eminences of the market responded, both publicly and privately, that that was a woefully insufficient “policy response,” and that for myriad reasons It Was Different This Time. So the Fed caved. The article is also eerily reminiscent of American policy hubris in the 1970’s–the presumption that recession and inflation were but distant memories; the presumption that foreign investors had no choice but to put up with American fiscal profligacy; and the unspoken terror among the bipartisan political establishment of the political consequences of a sharp recession.

Financial commentators are herding to a consensus that the dollar’s depreciation is overwrought. Certainly, the dollar has depreciated quite a bit in the last three months. But that by itself is no more a legitimate forecast than are the “chartist” predictions of trend reversals based upon fibonacci ratios and resistance points, whom higher-ranking financial clergy so eagerly mock.

Instead, I have always striven to predict prices by predicting future events and expected marginal information. There is one external scenario which could arrest the dollar’s collapse (a political fracturing of the “Club Med” from the eurozone). But that is still a distant possibility. The other two major “shock” scenarios–a yuan revaluation and a Gulf-wide currency revaluation–are profoundly bearish for the dollar.

But in the meantime, Washington has shown every indication, at the fiscal and monetary policy levels, of accelerating dollar depreciation. Barring a surge in intra-European political risk (which would scare investors out of the euro even faster than they piled in), I believe that the dollar, after a burp in the near future to 1.46/euro or so, will continue its downward skid.

Gold is looking pretty good right now.

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Academic malpractice

Academic policy advocacy, in the words of my nemesis Peter Griffin, really grinds my gears.. in many ways; to the point that I have conniption fits a healthy majority of the time that I read academic articles.

One way is when a well-known, or at least well-credentialed academic brandishes his credentials, mixed in with a lot of terminology that even financial cognoscenti are unsure of, and throws in some Minsky citations and citations of himself, to finally come up with an argument that is virtually unfalsifiable–just because of the time and information costs of rebutting it–but almost certainly wrong. Such is the case with Charles Calomiris’ VoxEU article, “Not Yet a Minsky Moment.” The article is itself a defense of a very long paper Calomiris wrote about two months ago, which basically argued that the August financial crisis was over (whoops).

Anyway, after a long series of paragraphs (which read like this: “e.g. i.e. ABCP CDO LSS MBS ABS AAA leveragingsuper-seniorAAA commercial paper”) [1], Calomiris gets to his set of amazingly falsifiable “Reasons to be cheerful”:

1. Housing prices may not be falling by as much as some economists say they are.

Too much weight is being attached to the Case-Shiller index as a measure of the value of the US housing stock. Stanley Longhofer and I, along with many others, have noted (Calomiris and Longhofer 2007) that the Case-Shiller index has important flaws.

If Case-Shiller were designed to measure the entire value of US housing, they’d measure it. Since they want it to be a leading indicator, not a complete index, it’s not supposed to be perfectly representative.

2. Although the inventory of homes for sale has risen, housing construction activity has fallen substantially.

Construction sector activity has fallen substantially! Fantastic news!

3. The shock to the availability of credit has been concentrated primarily in securitisations rather than in credit markets defined more broadly (for example, in asset-backed commercial paper but not generally in the commercial paper market).

ABCP is over half of the commercial paper market, as his own figure shows. That’s broad enough.

4. Aggregate financial market indicators improved substantially in September and subsequently.


5. As Figure 15 shows, nonfinancial firms are highly liquid and not overleveraged.

Yes, but many nonfinancial firms are hostage to leverage through their ultimate ownership (private equity and hedge funds), and massively-leveraged financial firms themselves are 30% of the S&P. If you take out the hyperleveraged components of US industry, you’re eventually going to be able to show that US industry ex-leverage is not overleveraged. Who cares.

6. As David Malpass (2007) has emphasised, households’ wealth is at an all-time high and continues to grow.

David Malpass has an awful lot of egg on his face right now. Nobody has a clue where household wealth is right now, particularly those who want to be intellectually honest about it and try to account for the subsample of people with substantially negative household wealth, who will be foreclosed out of the population of “household wealth” over the next 1-3 years.

7. Of central importance is the healthy condition of banks.

No further comment needed.

8. Banks hold much more diversified portfolios today than they used to. They are less exposed to real estate risk than in the 1980s, and much less exposed to local real estate risk, although US banks’ exposure to residential real estate has been rising since 2000.

“It’s different this time. Here’s one reason why: although, on second thought, it’s a difference that completely contradicts my point.”

Seems like a pretty dumb article to me. It will probably be forgotten soon, just because events will continue to shred his thesis more effectively than any bile spewing from my keyboard.

So basically, I don’t even know why I’m writing this, other than to fulminate at the world and put off a gigantic backlog of work. Cheers.

[1] According to the blogosphere’s resident securitized-det guru, JC Kommer (writing in Yves Smith’s comments section), Calomiris is wrong re: leveraged super-senior (“LSS”… as if this discussion doesn’t have enough alphabet soup) asset-backed commercial paper (ABCP).

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Saudi scheming in Pakistan

Pervez Musharraf, the most adroitly pro-American, pro-market, anti-anti-India, and (finally) anti-jihadist ruler of Pakistan in the country’s history, was facing the crisis of his life before Nawaz Sharif returned to Pakistan.

Sharif was the Prime Minister of Pakistan whom Musharraf overthrew in 1999, who has now returned on a private jet provided by the Saudi royal family.

It is odd that the Saudis have chosen this moment to kick sand in Musharraf’s face. $90+ oil has bought the Saudis unprecedented domestic tranquility, and has allowed the Saudi royal family to dramatically curb the influence of the Wahhabi clergy, liquidate al-Qaeda’s Saudi node, publicly align with the United States on a practical as well as a symbolic level, and implement a slew of liberal reforms — with popular support. The timing of their choice to knife Musharraf was hardly born of political necessity.

Saudi tentacles in Pakistan go back to the Afghan war against the Soviet Union. Along with the United States, the Saudi royal family funneled huge amounts of money through Pakistan’s Inter-Services Intelligence agency (ISI) to the Afghan mujahideen. Over the course of the 1980’s, the ISI became indistinguishable from its rabidly Islamist clientele. Although large parts of the agency are loyal to the Musharrafian army regime, too many ISI officers aren’t. Now that Musharraf is bleeding and the sharks are circling, the ISI has become the locus of resistance to Musharraf within the government bureaucracy.

Today, a huge attack on ISI headquarters incinerated at least 30 army officers and injured dozens more. It’s not clear exactly what organization was behind the attack, but a good guess would be anti-Musharraf ISI or other military governmental malcontents from NWFP (North West Frontier Province), Pakistan.

A different Times article suggests that Musharraf grudgingly acquiesced to Sharif’s return after Saudi, UK, and American pressure. Perhaps he isn’t facing as existential of a political crisis as everybody else thinks he is.

The next month will be decisive for Pakistan’s future and Musharraf’s survival. It is easy to oppose ‘a dictator,’ especially in this country, but the secular alternatives to Musharraf are not up to the job.

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American and European financial media seem to inhabit two different universes. Compared to the conservative European financial press, American financial media other than Bloomberg are hypnotized by cultish optimism. For example, yesterday, the NYT’s Floyd Norris wondered aloud if the US economy would just “shrug off” the housing bubble.

Evans-Pritchard’s article today is a bit on the panicky side even by my standards, but he still makes very good points, and remember that he also called the current financial crisis perfectly. Unlike America’s sophisticated permabear of the moment, Nouriel Roubini, Evans-Pritchard has not (as far as I know) been an unwavering doomsday prophet for the past five years. Today, Evans-Pritchard writes:

The die is now cast. As the euro brushes $1.50 against the dollar, it is already too late to stop the eurozone hurtling into a full-fledged economic and political crisis. We now have to start asking whether the EU itself will survive in its current form.

It takes eighteen months or so for the full effects of currency changes to feed through, so the damage will snowball late next year and beyond into 2009. Although “damage” is a relative term.

As Airbus chief Thomas Enders warned in a speech to the Hamburg workers last night, Europe’s champion plane-maker – the symbol of European unification, in the words or ex-French president Jacques Chirac — is now facing a “life-threatening” crisis.

Mr Enders said the company’s business model is “no longer viable”, and “massive losses” are on the horizon. So much for all those currency hedges that analysts like to cite. Have they ever tried to buy a currency hedge? They would discover how expensive these instruments are. Hedges cannot protect a company with $220bn in delivery contracts priced in dollars, when the euro/sterling cost-base is leaping into the stratosphere.

The sudden rocketing in sovereign bond spreads this week between core German Bunds and Club Med debt – Italian, French, Spanish, Portuguese, Greek, as well as Irish, Belgian and Slovenian – is a clear sign that markets are starting to price in a break-up risk for the single currency, however remote. Italian spreads have risen beyond the danger point of 40 basis points. This is less than the 100bp or so seen in Quebec (viz Ontario debt) when it looked as if the separatists might prevail. But it is dangerous nevertheless.

Moreover, these bond spreads are telling us that liquidity is drying up and that monetary policy is now too tight for the eurozone, as it is across much of the developed world. Two-year bond yields are collapsing in the US, Britain, and the Anglo-Saxon states, a signal that markets are now discounting possible recession. The whole central banking fraternity seems behind the curve, spooked by residual (lagging) inflation – and prisoners of a defective economic model (Neoclassical/New Keynesian synthesis). This is how the 1930 recession metastasized, although one doubts that Ben Bernanke will allow Part II to unfold this time. He has spent half his life studying the blunders of the Fed in 1930-1932.

One thing is sure, President Nicolas Sarkozy will not let Airbus go bankrupt, nor see decimation of the French industrial core, without an almighty fight against those countries deemed to be engaging in a beggar-thy-neighbour strategy of currency devaluation – benign neglect in Washington, less benign in Beijing.

He will have allies soon enough, once the housing bubbles collapse in Spain and across the Med. Mr Zapatero will not be in power for long in Madrid. Mr Prodi is on borrowed time in Rome. A new political order will soon take hold in much of Europe, bringing in a new wave of prickly national populists.

So, how will they fight? Will Mr Sarkozy and his allies resort to 1970s-style exchange controls to stem the rise of the euro?

They certainly have the power to do so. Four years ago a little-known cellule at the European Commission wrote a report – on prompting from Paris – exploring the legal basis for measures to stabilize the currency.

After combing through the EU treaties and court judgments, it concluded that Brussels may impose “quantitative restrictions” on capital inflows.

“Should extremely disturbing capital movements endanger the operation of economic and monetary union, Article 59 EC provides for the possibility to adopt restrictive measures for a period not exceeding six months,” it says.

It would be renewable each six months, so the policy would in fact become permanent.

Any decision would be taken by EU finance ministers under qualified majority voting. Britain would have no veto, even though the effects of such a move on the City of London would be catastrophic – and trigger the certain withdrawal of Britain from the EU (and good riddance, some might say in Paris).

This “disturbing” capital movement is occurring right now. Portfolio inflows into the eurozone reached a record EUR46.2bn in September. China, Asian wealth funds, Petrodollar sheikdoms, and now even Nigeria, have all joined a stampede into euros, utterly disregarding the underlying reality that Europe is in no better shape the United States itself. It is in worse shape, though this is disguised by the cycle. It is much worse in terms of economic dynamism and demographics.

Confidence has cratered in Germany, and the Netherlands, not to mention Belgium – which has not had a government for 165 days, and is now sliding towards disintegration. Since Belgium is a metaphor for the EU – an arranged marriage of squabbling tribes, speaking different languages, who do not love each other, and never did – this in itself amounts to a tremor for the EU system.

EU industrial orders fell 1.6pc in September. Spanish, French, South Italian, and Irish house prices are already all falling.

Spreads on the iTraxx financial index of 25 European bank and insurance bonds have jumped to a fresh record, worse than during the depths of the August crunch. The iTraxx Crossover of low-grade corporates is back to crisis levels above 400.

The European Covered Bond Council suspended trading in covered bonds this week because the spike in spreads had become disorderly, and three-month Euribor rates have gone through the roof again, and that is the rate that sets Spanish and Irish mortgages. Bond issuance in Europe is frozen.

France is in the grip of a national strike costing EUR2bn a day. The railways are paralyzed. The country’s 5.2m public workers are staging walk-outs.

Is this a currency bloc that should be now be deemed the ultimate safe-haven, the repository of trust in a dangerous economic world? This hodge-podge of disputatious clans, lacking a central Treasury, government, debt union, and guiding philosophy – let alone the sacred solidarity of a nation?

Returning to the Commission cellule, it said that: “Among the actions that can be undertaken when a member state experiences serious balance of payments difficulties, Articles 119 and 120 EC provide for the possibility to reintroduce ‘quantitative protective measures’ against third countries.”

The measures are of course exchange controls. This is the nuclear option, but Europe’s politicians could equally invoke Article 104 of the Maastricht Treaty giving politicians the power to set fixed exchange rates (by unanimous vote) or a dirty float for the euro (by majority).

The document is annexed to the Commission’s 2003 EU Economic Review. Nobody paid any attention at the time, just as the Commission had hoped – at least that is what one of the authors told me. This is the EU’s Monnet Method, one silent fait accompli after another.

French President Nicolas Sarkozy certainly seems inclined to go this route. He has again invoked his ideas for “Community Preference” – ie, a closed trade bloc – in a speech this month to the European Parliament. Contrary to claims, he is not letting go of his mercantilist plans.

The ECB may or may not intervene in the currency markets to cap the euro. But this is a red herring. Europe’s retort – if and when it comes – will be far more political, and far more dramatic. We are at one of History’s “inflexion points”.

One recalls the months leading up to the collapse of the Gold Standard in 1931. That was triggered first by Credit Anstalt in Austria and then by a British naval mutiny in Scotland.

Any bets on what will trigger the collapse of Bretton Woods II? I wager that it will be a decision by the Gulf states to break their dollar pegs, leading to a temporary surge of euro purchases. That will tip Mr Sarkozy over the edge.

Just idle speculation.

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The ECB freaks out

As we saw recently, the Europeans decided they didn’t like the way the bond markets were trading, so they shut down the covered bonds market until further notice.

Today, Jean-Claude Trichet announced that for the same time frame — “next week, and as long thereafter as necessary” — the ECB would be providing more of that “temporary” liquidity to the market.

From the FT:

Fresh emergency action to pump funds into the money markets was announced on Friday night by the European Central Bank amid renewed fears that liquidity in the credit markets is again starting to dry up.

On Friday night, the bank said it would inject an unspecified amount of extra liquidity next week, noting “re-emerging tensions” – and would do so until at least the end of the year.

Earlier, Jean-Claude Trichet, ECB president, had pledged continuing action to keep short-term money market interest rates in line with its main policy rate.

The new promise of intervention came as three-month US interbank rates rose for the eighth day in a row to 5.04 per cent, more than half a point higher than the US Fed Funds target rate of 4.5 per cent.

Three-month money usually trades just above the Fed Funds rate which is 4.5 per cent. Europe and UK money markets are showing similar strains.

Continuing problems in the markets were highlighted again on Friday as key interest-rate indicators hit fresh highs while the dollar plumbed new lows against the euro, falling to a record low of $1.4966.

The credit squeeze is also showing signs of dragging down eurozone economic growth, according to a closely watched survey published on Friday.

Service business growth in the 13-country eurozone slumped to the weakest level for more than two years, according to November’s purchasing managers’ indices, almost certainly because of financial sector weakness.

The eurozone’s services sector slowdown was “particularly relevant as it has been the engine of growth of the euro area on the past two years”, said Jacques Cailloux, economist at Royal Bank of Scotland, which releases the survey with NTC Economics.

The latest data will knock European policymakers’ confidence that the eurozone can remain relatively immune from the US subprime mortgage crisis, although few economists expect a serious slump.

Mr Trichet hinted that he expected financial turmoil to result in structural changes, saying banks’ losses “may trigger a reassessment by some of them of the suitability of the so-called originate-and-distribute business model”, which relies heavily on loan securitisation.

“Damn It Feels Good to Be a Banker” …

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Via Stratfor, Drudge, and everybody else:

Lebanon: State of Emergency
November 23, 2007 18 39 GMT

Lebanese President Emile Lahoud declared a state of emergency Nov. 23, ordering the army to take control.

As we saw earlier, the Hezbollah/Syria axis has laid meticulous plans for a hostile takeover of Lebanon. Emile Lahoud, the pro-Syrian president (facing a bare anti-Syrian parliamentary majority, whittled down by a string of blatant Syrian assassinations), has now initiated those plans.

According to sources in [Beirut, the capital of Lebanon], a security meeting recently took place between Syrian officials and Hezbollah to go over these contingency plans at the residence of Hussein Khalil, Hezbollah’s political consultant, in the eastern Baalbek region. The plan that was agreed on involves the occupation of 20 ministries and public institutions in the greater Beirut area by a combined military-civilian force provided by Hezbollah. It also calls for storming the Sarai, the headquarters of the prime minister, and reopening by force the coastal highway between Beirut and Sidon, as well as the Damascus highway — both of which lie within the Druze stronghold of Walid Jumblatt, who is allied with the anti-Syrian March 14 alliance. Controlling these key highways is central to Hezbollah’s plans to set up a rival government. The Damascus highway links Hezbollah strongholds in the central and northern Bekaa Valley with Beirut’s southern suburbs, while the coastal highway between Beirut and Sidon connects Hezbollah bases in the South with Beirut’s southern suburbs.

Occupying ministries by force undoubtedly will be a complicated affair if this plan actually goes into effect. By law, the Lebanese army would have to step in to defend these institutions. But here again we have another problem, in that Lebanon’s army already is deeply fractured and lacks the will to stand up to civilian protesters, much less to Hezbollah. Moreover, nearly half the army is comprised of Shia who will not necessarily go against their patrons in Hezbollah. Any foreign force that even attempts to intervene in such a scenario very rapidly will become bogged down in a domestic fight in which Hezbollah most likely will take the upper hand.

This plan by Hezbollah has long been in the making. Recently, Hezbollah replaced the party official in charge of the sit-in protest camps in downtown Beirut. While Hezbollah circulated rumors that the official was replaced because several of its members were caught smoking hashish in the downtown camp, the real reason was to prepare Hezbollah operatives for the coming confrontation by inserting a strong officer capable of mobilizing the group’s human resources in downtown Beirut. Recruiting and training efforts by Hezbollah also have picked up speed in recent months, with hundreds of men from the militias of Lebanese opposition groups undergoing training in the area of Wadi al-Nabi, between the villages of Brital and Hour Taala in the Bekaa Valley.

Expect Iraq to revisit hell in short order, as well. Hezbollah is the creme de la creme of Iran’s professional insurgency institutions, and Hezbollah can count on Iran “tying up” American forces in Iraq indeterminately–not to mention the price of oil.

American media have also bought the surge line hook, line and sinker. Iran was frightened by the combination of the surge and American carrier battle groups off the Iranian coast; but the Americans have levered tensions down. This is the crux of the problem in the Mideast: Iran can order its militias (Sadrists, Badrists, Hezbollah, MEK et al) to grind American forces down in an instant. American forces are bled by several hundred men. The Americans move carriers offshore, and just when everybody is nearly convinced that war happens, the Iranians make some “material” concessions (relative to the nothing previously offered), they talk for a while, and the carriers drift away. Then Iran starts ratcheting tensions up again. The rally of anti-anti-war media opinion retreats in embarrassment.

And in the meantime, the price of oil continues to rise, filling Iranian coffers. For Iran, ratcheting up tensions is instantaneous, and probably almost profitable. It takes the US much longer to make a move that actually threatens the Iranian ruling institutions, than it does for Iran to make a move that materially undermines the American war effort.

If the US is serious about playing a respectable geopolitical chess game, it needs to swing to kill. If it isn’t, it should leave.

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