Archive for January, 2008

is that SG took the opportunity of Jerome Kerviel’s fraud to throw out the kitchen sink, i.e., Kerviel’s losses composed a significant fraction of SG ‘s $7.2bn loss, probably a majority, but certainly not the entirety thereof.

In not-so-related news, the feds, who have bailed out the financiers with $300 billion in FHLB discount debt, indebted American consumers with $150 billion of printed money, the banks yet again with a $60 billion TAF, plus larger quantities of repurchase agreements in circulation, and an interest rate differential 200 basis points larger between the Federal Reserve and the world’s central banks, are now fashioning yet another bailout.

More Risk for Fannie, Freddie?

New Stimulus Package
Promises to Change
Standards on Loans
January 25, 2008

One of the features of the economic stimulus package fashioned yesterday by Congress and the Bush administration would provide guarantees to more — and much larger — mortgages in an effort to boost the housing market. But it also would expose the nation’s two government-sponsored mortgage companies to greater credit risk.

With defaults rising, investors lately have shunned nearly all mortgages not guaranteed by Fannie Mae and Freddie Mac. They assume that the two companies, which are private but were created by Congress, would get a bailout in a crisis.

Fannie Mae and Freddie Mac buy from lenders only mortgages that conform to their standards. Currently, that means the largest mortgage they will buy on single-family homes in the continental U.S. is $417,000. Their standards on down payments and verification of income are stricter than were those of many lenders during the housing boom.

Democrats and Republicans provided conflicting versions of how much more leeway the companies will get. The package agreed upon by Congress would temporarily allow Fannie and Freddie to buy or guarantee mortgages as high as $729,750 in cities with high housing prices, according to House Speaker Nancy Pelosi. House Republican Leader John Boehner put the ceiling at $625,000, according to a news release.

The higher allowance would expire Dec. 31, though it would be permanent for loans guaranteed by the Federal Housing Administration, the New Deal-era agency that typically helps low- and middle-income home buyers qualify for low-interest mortgages. Currently, FHA can’t guarantee mortgages higher than $367,000.

The amount of short-run stimulus injected into the economy is the largest stimulus since LBJ, if not Herbert Hoover. I imagine its consequences will be proportionately crippling to the long run health of the US economy.

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Well, we knew the NY Insurance Super’s effort to bail out the monolines — entailing a capital injection of “$5-15 billion” — was a headline- grubbing joke. But now we have some harder numbers, in case you weren’t sure:

America’s biggest mortgage bond insurers collectively need a $200 billion (£101 billion) capital injection if they are to maintain their key AAA credit ratings, a figure that dwarfs a plan by New York regulators to put together a capital infusion of up to $15 billion, a leading ratings expert said yesterday.

The failure to maintain their AAA ratings will lead to a further round of multibillion-dollar writedowns among the Wall Street banks and other large owners of the bonds, Sean Egan of Egan Jones Ratings Company, said. It would also push some of them into receivership, Mr Egan added.

Egan Jones makes its money by selling its research to money managers, rather than through fees from the companies it rates. It has the same “nationally recognised statistical rating organisation (NRSRO)” accreditation from the US Securities and Exchange Commission as Fitch, Moody’s and S&P, the mainstream credit agencies.

Mr Egan’s warning comes after the New York Insurance Department, which regulates the state’s insurance industry, held a hastily convened two-hour meeting this week to try to persuade key Wall Street firms to bail out the bond underwriters. The meeting is thought to have been attended by about 25 people, including representatives of Citigroup, JPMorgan, Goldman Sachs and Lehman Brothers, which would be likely to suffer if the bond insurers went under.

Because it raises the possibility that an insurer may not meet its commitment, loss of its AAA credit rating cuts the value of the bonds it insures.

A ratings downgrade also makes it harder for an insurer to write new business, as the market loses confidence in it. Furthermore, many bond investors require that their debt holdings be underwritten by a AAA-rated insurer.

One insurer, Ambac, has already lost its AAA-rating, while Mr Egan has a B-plus rating on MBIA, the biggest bond insurer, which is 13 notches below the AAA-rating it has from S&P, Moody’s and Fitch. …

It does not matter how much Bernanke throws America’s savings under the bus to service America’s most incompetent institutions. The simple fact of the matter is that the monolines are screwed. Over. Done. They have guaranteed something between $1.2 trillion and $2 trillion in debt (the numbers are all over the place), and a lot of it isn’t AAA, because the insurers aren’t AAA. Just because the Fed, the banks, the Fed and Treasury say they are still AAA, doesn’t make them AAA.

Now, I happen to think that the $200 billion estimate is far too high. I would estimate, in ridiculously uninformed fashion, that $75-100bn is a more accurate range. $200 billion smells a little sensationalistic to me. But $75 billion or $200 billion, it’s still way more money than anybody can afford, except the Fed, of course.

The Fed’s January decision will be an extremely interesting one. If they vote for 25 basis points or zero, that will be mildly encouraging, in the sense that a crack addict’s having stayed clean for 36 hours is encouraging. Because, although financial media are far too sycophantic to say it out loud (god forbid that they lose their precious “access”), the fact of the matter is that the Federal Reserve cut 75 basis points because of one fraudster at Societe Generale.

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By mid-morning this past Monday, when the Asian markets had been massacred and the European massacre was in full swing, the smartest people I know believed that “somebody in Europe needed money, so they sold stocks.”

Looks like they were right, once again.

Jan. 24 (Bloomberg) — Societe Generale SA said unauthorized bets on stock index futures by an unidentified employee caused a 4.9 billion-euro ($7.2 billion) trading loss, the largest in banking history.

France’s second-largest bank by market value plans to raise 5.5 billion euros from investors after the trading loss and subprime-related writedowns depleted capital, the Paris-based company said today. The Bank of France, the country’s banking regulator, said it’s investigating the situation.

The trading shortfall exceeds the $6.6 billion Amaranth Advisors LLC lost in 2006, and is more than four times the $1.4 billion of losses by Nick Leeson that brought down Barings Plc in 1995. An offer by Chairman Daniel Bouton to resign after the trades were discovered this past weekend was refused by Societe Generale’s board, the bank said.

“At first this seemed like a joke,” said Nicolas Rutsaert, an analyst covering European banks at Dexia SA in Brussels. Societe Generale “was a leader in derivatives and was considered one of the best risk managers in the world.”

Societe Generale fell 5.09 euros, or 6.4 percent, to 73.99 euros by 2:44 p.m. in Paris trading, bringing declines this year to 25 percent and valuing the bank at 34.5 billion euros.

Fake Trades

The trading loss from European stock index futures wipes out almost two years of pretax profit at Societe Generale’s investment-banking unit, run by Jean-Pierre Mustier. The company is suing the trader, who had a salary and bonus of less than 100,000 euros a year and worked at the bank since 2000.

Four to five people will be fired as a result of the loss, Mustier told reporters at a press conference in Paris. Luc Francois, the head of equity markets, is among those who will lose his job, said spokesman Hugues Le Bret.

“The transactions that were built on the fraud were simple, positions linked to rising stock markets, but they were hidden through extremely sophisticated and varied techniques,” Bouton, 67, said in a letter posted on the bank’s Web site.

His approach was to balance each real trade with a fictitious one, and his “intimate and perverse” knowledge of the bank’s controls allowed him to avoid detection, co-Chief Executive Officer Philippe Citerne told reporters. He rolled over his real trades before they reached maturity.

`In the Money’

By the end of December, he was “massively in the money,” said Philippe Collas, the head of asset management at the bank. Since the beginning of the year his trades became unprofitable.

The trades first came to management’s attention on the evening of Jan. 18, when a compliance officer found a trade that exceeded the bank’s limits, Mustier said. When Societe Generale called the counterparty, they were told the trade didn’t exist.

The employee, who moved to the trading floor from the back office in 2006, helped with the investigations throughout the weekend, said Mustier. He said he doesn’t know where the trader is now.

“He is in his thirties, very quiet and a loner,” said Yves Messarovitch, an external spokesman for Societe Generale. “He had made his dream of becoming a trader come true.”

The trader didn’t enrich himself from the fraudulent trades, which began in early 2007, and his motivations are unclear, Bouton said at the press conference.

He “breached five levels of controls,” Christian Noyer, the governor of the Bank of France, said at a press conference today. He described the trader as “a computer genius” and said he had been told he was “on the run.”

Societe Generale joins a list of at least five financial firms since the start of the 1990s to suffer losses from unauthorized trades, including Kidder Peabody, Barings, and Allied Irish Banks Plc.

Capital Increase

French President Nicolas Sarkozy wouldn’t comment on the investigation beyond calling it “fraud,” said spokesman David Martinon. Foreign Minister Bernard Kouchner said in an interview at the World Economic Forum in Davos, Switzerland, that he is “concerned” about the case.

The bank said it will post a profit of between 600 million euros and 800 million euros for 2007 and pay a dividend equal to 45 percent of its earnings. “Most of the sectors, in France and abroad, continue to produce good, and sometimes excellent results,” Bouton said.

The company said it plans to raise capital by selling shares in a rights offer underwritten by JPMorgan Chase & Co. and Morgan Stanley. Following the transaction, the bank’s Tier 1 ratio, a measure of solvency, will rise to about 8 percent from 6.7 percent at the end of 2007.

Takeover Target

Bouton, asked whether the affair made Societe Generale a more likely takeover or merger target, said “we are not looking for this. Our goal is to have the bank working as well as possible after this incredible accident.”

Bouton said he wasn’t seeking capital from sovereign funds, which have invested in banks including Citigroup Inc., Merrill Lynch and Co. and UBS AG in the past two months.

“It’s a disaster,” said Guy De Blonay, who helps manage about $41 billion at New Star Asset Management Group Plc in London. Still “an acquirer could be tempted. You have got a superb franchise here at an attractive price.” De Blonay said he had bought shares in the bank today.

Societe Generale, founded in 1864, has 120,000 employees in 77 countries and 22 million retail-banking clients, according to information on its Web site.

Rogue Traders

“Banks, despite the implementation of sophisticated risk management solutions, are still under the threat that an employee with a good understanding of the risk management processes can get round them to hide his losses,” said Axel Pierron, a senior analyst at Celent, an international financial research firm.

Societe Generale has ranked first or second during the past five years in client surveys of equity derivative firms, according to Risk Magazine. In 2007, it received the award for “Equity Derivatives House of the Year” from The Banker, a London-based monthly magazine.

Societe Generale’s report of fraud comes four months after French competitor Credit Agricole SA said an unauthorized proprietary trade at its investment-banking unit in New York cost it 250 million euros.

In 1994, Kidder Peabody, then owned by General Electric Co., took a $210 million charge against first-quarter earnings to reflect what it said were false profits recorded by bond trader Joseph Jett. The allegations and unrelated bond losses led GE to sell most of Kidder to Paine Webber in 1995. UBS AG bought Paine Webber in 2000.

`Mr. Copper’

Sumitomo Corp. disclosed a $2.6 billion loss in 1996 on copper trades. The Japanese firm blamed unauthorized trades by its chief copper trader, Yasuo Hamanaka, who was known as “Mr. Copper” in the markets because of his aggressive trading. Hamanaka was sentenced to eight years in prison in 1998.

Allied Irish Banks Plc discovered in 2002 that John Rusnak, a trader at its Allfirst Financial Inc., had amassed and hidden $691 million of losses over more than five years before the company noticed any discrepancies. Rusnak was sentenced to 7 1/2 years in prison. Allied Irish sold the Baltimore-based unit to M&T Bank Corp.

Societe Generale said that it has already closed all the positions set up by the trader, who had used his experience working in the back office to hide his trades through fictitious transactions.

Societe Generale said it’s taking 1.1 billion euros of writedowns linked to the U.S. residential real estate market, 550 million euros related to U.S. bond insurers, and 400 million euros on other unspecified risks.

In the third quarter, the bank reported 375 million euros of writedowns and trading losses linked to turmoil in financial markets. The world’s biggest financial companies have announced more than $120 billion in writedowns and credit losses as the U.S. housing slump rattles debt markets.

So, the latest financial panic was caused by mass liquidations among French/ European banks which knew SocGen had to dump a gigantic portfolio in order to come up with $7.2 billion immediately.

This was what precipitated Bernanke’s 75-basis point rate cut.

Absolutely hilarious.

Note the silence of the mandarins who, as of yesterday afternoon, were defending the Fed’s overclocked money-printing as “necessary” in light of the “worst financial crisis in 60 years.” Unfortunately, their panic has precipitated a yet greater bubble.

Now that the panic of early this week has been exposed as something of a mirage, the Fed has absolutely no reason to ease by 50 basis points next week. The financial markets will scream in contrived agony, and Ambac and MBIA will return to the fore.

Talks with the NY Superintendent of Insurance are not going to do anything to help the banks. It would be one thing if the NY Fed were leading the discussions — the NY Fed has significant financial power. The NY Superintendent of Insurance is a politician grubbing for headlines.

The game configuration of the monolines will fall through for the same reason that the “private-sector” MLEC failed. The banks are all exposed to the monolines, but some are much less exposed than others, and the ones with less exposure are not interested in taking a bullet for the highly-exposed banks. The stronger hands will walk away. Only a federal bailout can save the monoline sector in the near term, and only a Buffett takeover of the bond insurance business can save the monoline sector in the longer term.

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Banks, New York Regulator Meet on Bond Insurer Rescue (Update2)
By Erik Holm

Jan. 23 (Bloomberg) — New York State’s insurance regulators met today with U.S. banks to discuss raising new capital for bond insurers, said a department spokesman.

Talks in New York with the unnamed banks are part of Insurance Superintendent Eric Dinallo’s effort to stabilize the bond guarantors and bolster the market’s financial condition, said agency spokesman Andrew Mais in an interview.

New capital may help preserve the top credit ratings for the bond guarantors such as MBIA Inc., the industry’s largest, and halt any erosion of investor confidence in the $2 trillion of assets they guarantee. Ambac Financial Group Inc., MBIA’s biggest rival, lost its AAA grade from Fitch Ratings this month on concern about rising defaults tied to subprime mortgages.

“Clearly the market likes it,” said Gregory Peters, credit strategist at Morgan Stanley in New York. “But it’s not an easy situation to fix. The intent is good but we need the details; the details matter.”

The new capital may be as much as $15 billion, the Financial Times reported. MBIA rose $4.08, or 33 percent, to $16.61 in 4:07 p.m. New York Stock Exchange composite trading, while Ambac added $5.73, or 72 percent, to $13.70.

News of the meeting helped spur a rally in U.S. stocks, which slid Jan. 18 after Fitch lowered the rating of Ambac. The Standard & Poor’s 500 Index rose 2.1 percent to 1,338.60 at 4:40 p.m. in New York, halting a five-day slide.

Mortgage Values

Moody’s Investors Service and Standard & Poor’s are reviewing Ambac and MBIA, both based in New York state, for possible downgrades. Insured municipal bonds usually carry the debt rating of the insurer rather than the underlying debt.

Downgrades may force sales by investors who are required to hold only the highest-rated bonds and cut profit for banks that have already posted more than $130 billion of writedowns and credit losses tied to the falling value of mortgage securities.

Ambac and MBIA have suffered losses because of guarantees they sold for structured investments such as collateralized debt obligations backed by mortgages. The industry collectively guaranteed $127 billion of CDOs linked to mortgages that were given to borrowers with poor credit.

The securities have plunged in value as defaults by borrowers soared to a record in the third quarter of last year, according to the Mortgage Bankers Association.

A message for Ambac spokesman Peter Poillon wasn’t immediately returned. An e-mail message sent to Michael Sitrick, spokesman for MBIA, was not immediately returned.

The authorities are getting together to agree that disbelief should be willfully suspended. So what if Ambac and MBIA are on the brink of insolvency; if we all agree that they are still AAA, who cares, right?

At some point, somebody big is going to get out of this game.

Once again, “free markets” exist only in the realm of fantasy and the eyes of fools.

Unfortunately, there are still far too many fools in today’s market. They will be bled out sometime, perhaps not too long. Once again, dollar holders are subsidizing failure and hyperspeculation.

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I was surprised that the UN was drafting another sanctions resolution for Iran, after the CIA-led bureaucratic coup demolished previous momentum for sanctions.

I’m not as surprised now:

France advocates “minimal” sanctions against Iran due to its refusal to stop uranium enrichment, based on the December 2007 U.S. National Intelligence Estimate stating with “high confidence” that Tehran is not developing nuclear weapons, French Foreign Minister Bernard Kouchner said Jan. 23. Kouchner made his comments ahead of a planned meeting with Iranian Foreign Minister Manouchehr Mottaki at the World Economic Forum in Davos, Switzerland.

Basically, France is giving Israel a little PR. But the understanding among European banks and other financial bodies will be that it’s fine to keep doing business with Iran, as long as they aren’t too obvious about it.  And the costs to Iran will be vanishingly small.

Israel needs to act unilaterally, or get used to a regionally hegemonic Iran.

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On the heels of Mervyn King’s not-quite-credible vow [*] to continue fighting inflation (which he predicted would surge), Jean-Claude Trichet has effectively signalled that he will bring Europe into recession if that’s what it takes to attract global savings to Europe. He is not interested in following in the Fed’s inflationistic footsteps.

Jan. 23 (Bloomberg) — European Central Bank President Jean- Claude Trichet said he’s committed to fighting inflation, attempting to quash speculation he’ll follow the U.S. Federal Reserve in cutting interest rates after stocks plunged.

Particularly in demanding times of significant market correction and turbulences, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility,” Trichet told the European Parliament in Brussels today. [Any way we can print a few billion USD and rent him as Fed Chairman for a few years?–ed]

Bond investors dismissed his comments and raised bets on an ECB interest-rate cut. European two-year government notes rose the most since September 2001 and yields on June rate futures dropped as much as 21 basis points. The U.S. central bank cut its benchmark by three quarters of a percentage point to 3.5 percent yesterday after global stocks tumbled on concern a recession in the world’s largest economy will curb global growth.

“Europe is not going to get special dispensation from a global slowdown,” Stephen Roach, chairman of Morgan Stanley in Asia, said on a panel at the World Economic Forum in Davos, Switzerland. “Europe is not this dynamic, rapidly growing economy.”

Euro-region service industries grew this month at the slowest pace in more than four years after credit tightened and the euro neared a record, an industry report showed today.

Room for Maneuver?

Trichet on Jan. 10 threatened to raise the bank’s key rate from 4 percent if unions push through wage increases that take the jump in inflation into account. Euro-region inflation was 3.1 percent in December, the fastest in six years and well above the ECB’s 2 percent limit.

He suggested today that slowing growth may give the Frankfurt-based ECB more room for maneuver. While the bank is sticking to its base scenario that the economy of the 15 euro nations will expand about 2 percent this year, there are “downside” risks to the outlook, Trichet said.

“We’ll see how the real economy develops in the future because it can have an effect on inflation,” he said.

That remark “suggests any cut in rates by the ECB will only come on the back of poor economic data,” said James Nixon, an economist at Societe Generale in London. The Fed’s “concerns of a credit crunch appear to be absent in Frankfurt, even though European bank stocks have been hit just as hard as in the U.S.”

European stocks extended declines. The Dow Jones Stoxx 600 Index shed 1.6 percent as of 3:20 p.m. in London, erasing yesterday’s gain that was triggered by the Fed’s cuts. The index has plunged 15 percent already this year.

Summers Concerned

“The outlook for Europe is being revised downwards quite rapidly,” former U.S. Treasury Secretary Lawrence Summers in a Bloomberg Television interview in Davos. “One has to be concerned about financial strains and what they bring in Europe.”

European bonds rallied on speculation the ECB will be forced to follow the Fed and cut interest rates. The yield on the two- year note fell as much as 24 basis points, the biggest decline since the day after the terrorist attacks of Sept. 11, 2001, and was at 3.22 percent at 2:49 p.m. in London.

“Trichet’s warning about inflation risks today does not mean that he won’t cut interest rates in three months,” said Marco Kramer, co-head of European economics at UniCredit MIB in Munich. “It’s only rhetoric to fight inflation expectations.”

BNP Paribas SA today said it now expects the ECB to lower its key rate to 3.75 percent in June rather than September. Barclays Capital said the central bank will reduce rates twice this year instead of keeping them unchanged.

`Difficult Year’

“We’re already in a recession in the U.S.,” Klaus Kleinfeld, chief operating officer at Alcoa Inc., the world’s third-largest aluminum producer, said in Davos. “2008 will be a difficult year. I don’t think that the world can decouple itself from what’s happening in the U.S.”

Still, ECB council member Axel Weber said last night that any impact in Europe from a U.S. slowdown “could emerge with a time lag” and may “be less strong than in former times.”

ECB Vice-President Lucas Papademos and Executive Board member Juergen Stark also said yesterday that economic fundamentals in Europe remain sound.

European manufacturing unexpectedly maintained its pace of expansion in January. A gauge of manufacturing held at 52.6, beating economists’ forecasts for a decline to 52.1, a report from Royal Bank of Scotland Plc showed today.

“Our mandate consists of ensuring price stability for European citizens in the medium term,” Trichet said. The ECB has to be “credible in guaranteeing price stability.” Policy makers next meet to decide on interest rates on Feb. 7 in Frankfurt.

Before the Fed’s rate cut, the Bank of England was cautious about reducing its interest rates further. Policy makers on Jan. 10 voted 8-1 to keep the benchmark rate unchanged at 5.5 percent, minutes of the meeting published today showed.

We will see. According to conventional wisdom, ECB doves outnumbered hawks even before accounting for some German hawks’ shifting to dovish positions on the ECB central committee. Southern Europe is already in recession, and under the euro regime, it does not have the option of monetizing its debts.

If European central bankers shift towards more hawkishness, they will make a second play at dramatically raising the euro’s currency market share, at the price of a sharper European recession. Their comments must be watched closely.

[*] See: “Northern Rock”

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3-Month   2.26 / 2.31 0.13 / -.535  
6-Month   2.38 / 2.45 0.19 / -.396  
2-Year 3.250   102-03+ / 2.13 0-13 / -.214  
5-Year 3.625   104-07¼ / 2.70 0-20¾ / -.139  
10-Year 4.250   105-27 / 3.54 0-24+ / -.091  
30-Year 5.000   112-10¾ / 4.26 0-13½ / -.023  

When bond yields plunge, as 3- and 6-month Treasuries just did, that means their value is going up. Which means bonds had an awesome day, in spite of the most inflationary monetary policy in history.

I am still resolutely bearish on bonds. I do not understand why anybody would want to hold bonds right now. I do not understand why anybody would want to hold dollars; I do not understand why the Saudis, Dubai, or China has any interest whatsoever in footing the bill for US inflationism.

I can’t imagine a reason, beyond pure panic, why investors would want to pile into Treasuries yielding 2.3 percent. The dollar lost 1.1 percent today. How’s that for yield?

If there is one unifying theme of this blog, it is United States dollar policy and exogenous events which could alter the dollar’s value.

In every global recession, the dollar’s value usually goes up. But if I were Saudi Arabia or Dubai, with a dollar peg and double-digit domestic inflation before the latest rate cut, I would have absolutely every reason to leave the dollar union; and absolutely every reason to de-dollarize my $trillions in savings. These people are getting butchered by Bernanke’s policy. They. Do. Not. Want. Bonds.

Meanwhile, American savers, such as Berkshire Hathaway and Citadel Investment Group, have no place to put their dollars when the Fed is printing new ones through artificially cheaper credit at a reckless rate. Why should Ambac sell its soul to Warren Buffett when the government is so panic-driven and so willing to post a bailout?

As usual, LSE prof and Bank of England monetary policy advisor Willem Buiter best captures the Fed’s utter, invertebrate incompetence. He would make an infinitely better Fed chairman than the current poodle of the American banking industry.

The Bernanke put: buttock-clenching monetary policy making at the Fed

It is bad news when the markets panic. It is worse news when one of the world’s key monetary policy making institutions panics. Today the Fed cut the target for the Federal Funds Rate by 75 basis points, from 4.25 percent to 3.50 percent. The announcement was made outside normal hours and between normal scheduled FOMC meetings.

This extraordinary action was excessive and smells of fear. It is the clearest example of monetary policy panic football I have witnessed in more than thirty years as a professional economist. Because the action is so disproportionate, it is likely to further unsettle markets. Even the symptoms of malaise that appear to have triggered the Fed’s irresponsible rate cut, the collapse of stock markets in Asia and Europe and the clear message from the futures markets that the US stock markets would follow (a 500 point decline of the Dow was indicated), are unlikely to be improved by this measure and may well be adversely affected.

In the absence of any other dramatic news that the sky is falling, I can only infer from the Fed’s action that one or both of the following two propositions must be true.

  • The Fed cares intrinsically about the stock market; specifically, it will use the instruments at its disposal to limit to the best of its ability any sudden decline in the stock market.
  • The Fed believes that the global and (anticipate) domestic decline in stock prices either will have such a strong negative impact on the real economy or provides new information about future economic weakness from other sources, that its triple mandate (maximum employment, stable prices and moderate long-term interest rates) is best served by an out-of-sequence, out-of-hours rate cut of 75 basis points.

The first proposition would mean that the Fed violates its mandate. The second is bad economics.

This panic reaction is destabilising in the short run. In the medium term it subordinates the price stability target to the real economic activity target. It also lays the foundations for the next credit bubble, after the recession of 2008 has become a distant memory.

It would have been far preferable, particulary because the stock market decline is a global phenomenon, to have a coordinated modest rate cut of, say, 25 basis points, by all leading central banks at some later date, when this would not look like a collective knee-jerk response to a fall in global equity prices.

With this irresponsible act, the Fed has just become part of the problem. Interesting times indeed.

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As a gold bull, I have always bet on [government reflationary intervention]. If the S&P lock limits down tomorrow, the panic will be pretty extreme, and gold will blast through 1,000 before the quarter’s end.

Well, I timed that one well, didn’t I.

Release Date: January 22, 2008

For immediate release

The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent.

The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.

The Committee expects inflation to moderate in coming quarters,


but it will be necessary to continue to monitor inflation developments carefully.

As one longtime bond trader said:

At the risk of being crude, today’s move amid a melt confirms that Bernanke is officially the market’s b!tch.

Notably, the Fed’s announcement barely budged US equity futures. The S&P is still primed to open down 4.3 percent. The Fed has squandered its ammunition.

The Fed is going to have to overtly print credit in order to save the monolines; that’s the bottom line.

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This is pretty staggering.

^AORD All Ordinaries 5,222.00 12:11AM ET Down 408.90 (7.26%)  
^SSEC Shanghai Composite 4,596.67 1:15AM ET Down 317.77 (6.47%)  
^HSI Hang Seng 21,709.63 1:30AM ET Down 2,109.23 (8.86%)  
^BSESN BSE 30 15,344.40 1:30AM ET Down 2,260.95 (12.84%)  
^JKSE Jakarta Composite 2,236.55 1:45AM ET Down 249.33 (10.03%)  
^KLSE KLSE Composite 1,439.49 Jan 18 Down 21.22 (1.45%)  
^N225 Nikkei 225 12,573.05 1:00AM ET Down 752.89 (5.65%)  
^NZ50 NZSE 50 3,607.13 Jan 21 Down 39.77 (1.09%)  
^STI Straits Times 2,764.57 Jan 21 Down 152.58 (5.23%)  
^KS11 Seoul Composite 1,609.02 1:02AM ET Down 74.54 (4.43%)  
^TWII Taiwan Weighted 7,581.96 12:46AM ET Down 528.24 (6.51%)  

I have never recommended buying Asian stocks to anyone. That’s about all I can say. This is an epic rout, with India’s BSE down 12 percent and Hong Kong almost 9, but this forest fire has a very February/March 2007 feel to it. Are things really this bad? Compared to bonds, are stocks this unattractive? The markets had already priced in an extremely dovish rate cut schedule, and stocks had already punished forward P/E’s in anticipation of a moderate recession.

Now, there is the money-pumping issue. But the dollar has strengthened recently, not weakened. Fed pumping or not, the last several days have not been marked by capital flight from the dollar. The euro, yes; the dollar, no.

I have to sleep on this for a while. But the next four days will be crucial. If the US Congress and Federal Reserve succumb to the wider panic, the current plunge will be as fleeting as the plunge in February and March: there will be a quick bounce, followed by a longer run reflation, followed finally by another monster crash and another inflation-or-panic fork in the road.

If the market is allowed to finally bleed itself out, Ambac and/or MBIA will blow up, there will be a lot more blood, and the markets will have achieved some painful, but permanent, evolution.

As a gold bull, I have always bet on the former. If the S&P lock limits down tomorrow, the panic will be pretty extreme, and gold will blast through 1,000 before the quarter’s end.

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Governing institutions once again face the painful battery of choices that they faced on August 16, 2007: let volatility ride, and let the market decide, or pump more cash for trash? They are certainly poring over the choices as we speak. Governing institutions being what they are, they will almost certainly make the most short-term-oriented decision possible.

If my worldview has been correct, Bernanke (and the ECB) will opt for “cash for trash,” yet again. And we will have another quasi-reflation, punctuated by pseudo-crises, until one of the pseudo-crises outraces the rate of reflation, and a pseudo-crisis becomes an uber-crisis, along the lines of August 16, or now. The true, August 16-reminiscent panic — brokers and HNW types calling up their managers and quietly asking, “How bad will it be?” on a weekend/ holiday night — is back.

Of course, if everyone calmed the hell down, Buffett would let the monolines bleed a little more, and then he would blast into the monoline industry with Berkshire’s unassailable credit rating and cash hoard, and everyone would calm down. But the financial industry’s time horizon is a lot shorter than that, and my guess is that they will get an obscene money dump — in the form of 100 basis points’ lower rates, and a TAF equivalent for the monoline industry — far too easily. Again.

A few important principles bear repeating:

The Federal Reserve does not have the power to stop a recession;

A “crisis in confidence” always has a stronger basis in reality than the elites who decry it;

A “crisis in confidence” is solved by painful institutional reforms, not the printing of more money; and

The Federal Reserve does not have the power to stop a recession.

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Or is the Bush Administration retaliating for the NIE? Who knows. The article makes worthy reading regardless. The author, Jeff Stein, was the same guy who unearthed the gem that House Intelligence Subcommittee Chairman Silvestre Reyes didn’t know what the difference between a Sunni and a Shiite was. So he’s legit as far as I’m concerned. (H/T Danger Room)

Top U.N. Nuclear Watchdog a Russian Spy, Defector Says in New Book

The top U.N. official responsible for monitoring the clandestine nuclear programs of Iran and Pakistan is a Russian spy, according to a new book on Moscow’s espionage operations in the United States and Canada.

The official is identified only by his Russian code name, ARTHUR, but other sources identified him as Tariq Rauf, 54, a Pakistani-born Canadian who is chief of verification and security-policy coordination at the International Atomic Energy Agency (IAEA).

The job “puts him in direct contact with both inspectors and countries around the globe,” a Canadian online magazine reported last year. “Rauf is responsible for ensuring IAEA scientists get into countries such as Iran and negotiating the access they need to completely verify the use of nuclear material.”

The allegations appear in “Comrade J: The Untold Secrets of Russia’s Master Spy in America After the End of the Cold War” by former Washington Post reporter Pete Earley, author of two previous books on Russian spying in the United States.

The book amounts to a blistering memoir by Sergei Tretyakov, a former top Russian intelligence operative stationed in New York and Canada during the 1990s, first with the communist-era KGB and then its successor, the SVR.

Earley writes, but Tretyakov does not confirm in the book, that he worked as a double agent for the FBI for three years before he defected to the United States in 2000.

Rauf called Tretyakov’s allegation “nonsense.”

He had “never” worked “for any intel types whatsoever. I am a impartial loyal international civil servant,” he said by e-mail from the IAEA’s headquarters in Vienna on Friday.

But in the first of two telephone conversations earlier in the day, Rauf was far less dismissive, declining an opportunity to flatly deny the allegations. He refused to say whether he knew or had ever met Tretyakov, who worked under diplomatic cover.

“Comrade J” describes several other alleged Russian spies in Canada only by code name, but in such rich detail that it’s not hard to figure out who they are.

Tretyakov’s description of ARTHUR all but names Rauf as his spy.

“When Sergei had recruited ARTHUR [in 1990],” Earley writes, “he worked at the Canadian Centre for Arms Control,” a think tank for experts on nuclear weapons.

Later, ARTHUR was “a project director at the Center for Nonproliferation Studies, part of the Monterey Institute of International Studies, a California think tank,” he relates.

A few years later, when Tretyakov became deputy chief of Russian intelligence in New York, he renewed his relationship with ARTHUR, who had become “a U.N. senior verification expert,” who specialized in the clandestine weapons programs of “rogue states” such as Iran, Libya and his native Pakistan.

“I know that he is still employed at the agency and I have no reason to believe he has stopped working for Russian intelligence,” the one-time master spy says in the book.

“He hated America.”

Rauf’s résumé is identical to Tretyakov’s description of ARTHUR’S career. They are one and the same, according to multiple sources.

A former Russian diplomat and arms control specialist who knew Tretyakov well in New York, reviewed the description of ARTHUR and said it appeared to describe Rauf.

“The fingered Canadian guy, well, you know only too well who could theoretically fit this reference,” he said on condition of anonymity.

Another former Monterey arms expert, when asked whether Rauf might be the spy code-named ARTHUR, said, “Yes, the name you provided is correct.”

When contacted for this story, Rauf said a Canadian newspaper reporter had presented him with the same allegations days earlier.

He said he had not decided whether to contest the allegations in court.

Author Earley said he had examined Tretyakov’s records — photographs, e-mail, even a restaurant napkin on which ARTHUR scribbled notes about Ukrainian missiles — to back up every allegation.

“If they want to sue us, fine,” said Earley of all the Canadians that Tretyakov describes as spies. “We’ll just run Sergei up there with our stuff and see what happens.”

Talking Talbott

Tretyakov has other sensational allegations in his book, which officially goes on sale Jan. 24 but is available now online. Tretyakov says Russian intelligence considered Strobe Talbott, the Clinton administration’s top Moscow hand, such a valuable source of inside information, and so vulnerable to its manipulation, that it classified him as a SPECIAL UNOFFICIAL CONTACT.

“I want to underline that he was not a Russian spy,” Tretyakov says of Talbott, who was a Rhodes Scholar with future president Bill Clinton at Oxford and a highly respected Time magazine correspondent before turning to diplomacy. “In fact, I suspect he was the opposite — an ardent American patriot.”

But a Russian official under the control of the SVR, then-Russian Deputy Foreign Minister Georgi Mamedov, Tretyakov alleges, was able to get inside information from Talbott by massaging his considerable ego.

“He became a valuable intelligence source,” Tretyakov says.

Talbott, who now heads the Brookings Institution, called the book’s “interpretation of events erroneous and/or misleading in several fundamental aspects.”

“[T]here was never a presumption” during his meetings with Mamedov “that what we said to each other in our one-to-one sessions would remain private,” Talbott said.

Tretyakov “offers no amplification or corroboration” on his allegations that Mamedov, whom he socialized with, was able to manipulate his views on Russia.

“There can be none,” Talbott said. He further pointed to several U.S. diplomatic accomplishments after the collapse of communism in Russia, which included “getting Russian troops to leave the Baltic states, getting the Russians to accept NATO enlargement . . . to support us in Bosnia and . . . to help in ending the Kosovo war on NATO’s terms.”

Mamedov, now ambassador to Canada, also dismissed the allegations, calling them “rubbish, an attempt to smear a fine American patriot . . . who was always tough as nails in nuclear arms negotiations with us.”

Unanswered Questions

Earley describes in the book how the CIA and FBI introduced him to Tretyakov in a hotel room at the Ritz Tyson’s Corner, near the Washington Beltway, with the idea that they do a book together.

Other than that, Earley says, the CIA and FBI had no role in the book, other than vouching for the Russian’s credibility.

“The fact that this defector was given a financial package significantly higher than what any other previous Russian spy has ever received is a strong indication of how valuable he has been to us and how much the U.S. appreciates what he did,” an unnamed FBI official told Earley.

The book’s sensational allegations, however, conveniently allow U.S. intelligence to showcase old news — that the Russians have been spying and pulling “dirty tricks” on the United States and its allies as much, if not more, than they were during the Cold War — on a new platform.

Likewise, some see the hand of the Bush administration in Tretyakov’s allegation that the IAEA’s top nuclear verification official is a Russian spy.

It could be used to taint IAEA chief Mohamed ElBaradei, who drew the wrath and scorn of the White House by contradicting its claims that Saddam Hussein’s Iraq had weapons of mass destruction. The Nobel Peace Prize laureate has also opposed administration threats to attack Iran.

But if Tretyakov is right about Moscow’s spies, how come nobody he’s fingered has been charged, much less arrested? (He gave the names of his alleged spies to Canadian security officials years ago.)

Because he’s making it up, suggests James M. Olson, a former CIA chief of counterintelligence who now lectures on intelligence issues at Texas A&M University.

“Tretyakov, obviously egged on by his publisher, needed something sensational to sell his book,” says Olson, who worked against the Russians for three decades.

“The Strobe Talbott allegation is patent nonsense. If there were anything to it, the U.S. government would have acted on it long ago,” said Olson, author of “Fair Play: The Moral Dilemmas of Spying,” a 2007 book.

“Sadly, there’s not much honor among spies,” he said. “The CIA can’t control what defectors do and say once they’re settled and on their own.”

But a former FBI official offers an alternate explanation: You can’t arrest somebody for espionage on the mere word of a defector (unlike the administration’s policy on suspected terrorists). You’ve got to catch them doing it, which can take years.

“You’ve got to have the evidence to go along with it to make a case stand up in court,” says Harry B. “Skip” Brandon, a former deputy assistant director for counterintelligence at the FBI.

In addition, Brandon says, Canadian security officials might have “thought Tretyakov was a disinformation agent,” sent by Moscow to plant misleading information about its secret operations in Canada.

“Maybe the Canadians viewed it that way,“ said Brandon, who now runs a global intelligence and security firm in Washington, in partnership with former CIA agent Gene M. Smith.

The Canadian Security and Intelligence Service isn’t talking, Spokesperson Manon Bérubé said she was familiar with the book but, “We are not commenting on questions about our operations.”

Nobody Can Be Trusted

“Comrade J” has plenty more sensational spy stories, all of which will be chewed over and debated by national security analysts.

President Vladimir Putin, a former KGB spy himself, personally approved of Russian agents stealing millions of dollars worth of U.N. oil-for-food funds during the pre-war Iraq sanctions, Tretyakov says.

The notion that “Nuclear Winter” would follow a nuclear exchange was “a myth” promoted by Russian agents to derail the deployment of U.S. missiles in Europe, he says.

But it’s not all bad news.

Russian intelligence, Tretyakov says, got some of its best ideas from American books and movies — mostly thrillers, of course.

Three Days of the Condor,” the 1975 CIA thriller starring Robert Redford, spurred Moscow Center to launch a major new program, he says.

“It stuns the hell out of me,” says James Grady, author of the novel the movie was based on, “Six Days of the Condor”, which portrays a CIA unit tasked to find ideas for spy operations in books.

“Here we have reality aping fiction, which apes reality, which apes fiction,” Grady said Friday night. “It really closes the loop.”

One of Condor’s major themes: Nobody can be trusted.

Certainly not a defector, Grady says.

“If you burn people you convinced to trust you with their lives,” Grady says, “ultimately you burn any reason to trust you.”

The Talbott stuff definitely rings true, among those of us who have honed total cynicism regarding the State Department’s competence and self-regard.

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Today the euro is having its worst day in memory.


EUR-USD 1.4440 -0.0182 -1.24
EUR-JPY 152.9650 -3.2350 -2.07
EUR-GBP 0.7423 -0.0054 -0.72

The yen is having the biggest day of all. The pound, as usual, is faring worst.

It’s getting to be about that time for the Arabs and Chinese to make some more big acquisitions, and for Buffett to take over the monoline market. The prices are getting quite good.

The markets are completely freaking out over the collapse of the monoline sector. Dow futures are pricing in a 515 point drop tomorrow. S&P futures are pricing in -4.5%. Small caps will probably fall harder still.

It won’t be long now…


The limit down for the S&P tomorrow is -5 percent, a drop of 70 points. Only 10 points to go, according to the futures markets …

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This is State’s “diplomatic surge,” I guess. The Iranians hate Petraeus, because Petraeus doesn’t want to give them Iraq on a silver platter. So, we should pack him off to the bureaucratic backwater that is NATO? WTF?

Pentagon weighs top Iraq general as Nato chief

By Michael R. Gordon and Eric Schmitt

The Pentagon is considering General David H. Petraeus for the top NATO command later this year, a move that would give the general, the top American commander in Iraq, a high-level post during the next administration but that has raised concerns about the practice of rotating war commanders.

A senior Pentagon official said that it was weighing “a next assignment for Petraeus” and that the NATO post was a possibility. “He deserves one and that has also always been a highly prestigious position,” the official said. “So he is a candidate for that job, but there have been no final decisions and nothing on the timing.”

The question of General Petraeus’s future comes as the Pentagon is looking at changing several top-level assignments this year. President Bush has been an enthusiastic supporter of General Petraeus, whom he has credited with overseeing a troop increase and counterinsurgency plan credited with reducing the sectarian violence in Iraq, and some officials say the president would want to keep General Petraeus in Iraq as long as possible.

In one approach under discussion, General Petraeus would be nominated and confirmed for the NATO post before the end of September, when Congress is expected to break for the presidential election. He might stay in Iraq for some time after that before moving to the alliance’s headquarters in Brussels, but would take his post before a new president takes office.

If General Petraeus is shifted from the post as top Iraq commander, two leading candidates to replace him are Lt. Gen. Stanley A. McChrystal, who is running the classified Special Operations activities in Iraq, and Lt. Gen. Peter W. Chiarelli, a former second-ranking commander in Iraq and Defense Secretary Robert M. Gates’s senior military assistant.

By this fall, General Petraeus would have served 19 months in command in Iraq and would have accumulated more than 47 months of service in Iraq in three tours there since 2003. In the NATO job, General Petraeus would play a major role in shaping the cold-war-era alliance’s identity, in coping with an increasingly assertive Russia and in overseeing the allied-led mission in Afghanistan.

General Petraeus, 55, has been criticized by Democratic lawmakers opposed to Mr. Bush’s decision to send additional combat forces to Iraq. A NATO post would give him additional command experience in an important but less politically contentious region, potentially positioning him as a strong candidate in a few years to serve as chairman of the Joint Chiefs of Staff, several military officials said. They and some others who discussed the potential appointment declined to be identified because they were speaking about an internal personnel matter.

Some experts, however, say General Petraeus’s departure would jeopardize American efforts in Iraq, especially since the No. 2 officer in Iraq, Lt. Gen. Raymond T. Odierno, is scheduled to complete his tour and leave Iraq in mid-February.

General Petraeus “should stay at least through this year,” said Anthony Cordesman, a military specialist at the Center for Strategic and International Studies. “We really need military continuity in command during this period in which we can find out whether we can transition from tactical victory to some form of political accommodation.

“We have in Petraeus and Crocker the first effective civil-military partners we have had in this war,” Mr. Cordesman added, referring to Ryan C. Crocker, the United States ambassador in Baghdad. Gen. George W. Casey Jr., General Petraeus’s predecessor, served nearly three years in the top Iraq job before becoming Army chief of staff.

There has been speculation that General Petraeus’s next post might be as head of the Central Command, which has responsibility for the Middle East region. That would enable him to continue to influence events in Iraq while overseeing the military operation in Afghanistan and developing a strategy to deal with Iran. The Central Command post is currently held by Adm. William J. Fallon. Admiral Fallon, through a spokesman, denied that he intended to retire from the military in the next several months.

General Petraeus, through a spokesman, declined to comment on a possible NATO assignment. Geoff Morrell, the senior Defense Department spokesman, said no decision had been made.

“Trying to guess General Petraeus’s next assignment is the most popular parlor game in the Pentagon these days,” Mr. Morrell said. “Where and when the general goes next is up to Secretary Gates and President Bush, and they have not yet decided those matters. However, they very much appreciate his outstanding leadership in Iraq and believe he has much more to contribute to our nation’s defense whenever his current assignment comes to an end.”

General Petraeus’s last post in Europe was as a senior officer for the NATO force in Bosnia, where he served a tour in 2001 and 2002. “He did a great job for me as a one-star in Bosnia,” said Gen. Joseph W. Ralston, who served as NATO commander at the time and has since retired. “He would have the credibility to keep Afghanistan focused for NATO.”

This is ridiculous. There is no reason to kick out the first successful general on the basis of bureaucratic procedure. Something else is up.

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^AORD All Ordinaries 5,630.90 12:11AM ET Down 168.50 (2.91%)  
^SSEC Shanghai Composite 5,020.70 12:24AM ET Down 159.81 (3.08%)  
^HSI Hang Seng 24,487.27 12:42AM ET Down 714.60 (2.84%)  
^BSESN BSE 30 18,587.43 12:42AM ET Down 426.27 (2.24%)  
^JKSE Jakarta Composite 2,573.68 12:57AM ET Down 37.46 (1.43%)  
^KLSE KLSE Composite 1,439.49 Jan 18 Down 21.22 (1.45%)  
^N225 Nikkei 225 13,362.89 12:37AM ET Down 498.40 (3.60%)  
^NZ50 NZSE 50 3,646.91 Jan 20 Down 17.45 (0.48%)  
^STI Straits Times 3,055.38 4:56PM ET Down 48.87 (1.57%)  
^KS11 Seoul Composite 1,676.30 12:57AM ET Down 58.42 (3.37%)  
^TWII Taiwan Weighted 8,110.20 12:46AM ET Down 74.45 (0.91%)  

Paint it red …

Shanghai %ch from 52-week peak: -17%

Hong Kong: -25%

Bombay: -13%

Japan: -30%, probably closer to -15% after adjusting for yen appreciation

Singapore: -23%

Seoul: -18%

Taiwan: ~-19%

In all cases, remember, the local currency has appreciated significantly against the dollar, for sure. So after adjusting for the local currency the declines are not as dramatic as they appear…

Meanwhile, on this side of the pond, the S&P is down about 15 percent from its 52-week high, last June or so. Of course the dollar is also down something like 8 percent.


^IXIC = Nasdaq.

^GSPC = S&P.

But both indices are not currency-adjusted. To get “real return” on US stocks, you have to layer the 12 percent decline in the dollar over the past 52 weeks on top of the the -6 percent 52 week return from the S&P/ Nasdaq.

Update: Europe has been massacred, too: Germany crashed over 5 percent, France is down more than 6 percent, and the euro tanked over 1 percent. Ouch.

I am liking my call towards the end of the week. Until at least one of Ambac or MBIA files for bankruptcy, stay out of equities.

According to equity futures, if US equities traded today, they would have lost 3 percent of their value.

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The new IPO of Reliance Industries, a huge Indian power conglomerate, was 73 times oversubscribed (investors tried to buy 73 times the shares available).

One of the not-so-hidden secrets of the IPO business is to artificially constrict the offering of a famous domestic brand. Every single Chinese IPO does it — PetroChina, for instance, floated 2 percent of the company to retail investors, who promptly lined up to buy hundreds of times the amount of shares available. As a result, PetroChina’s minuscule public offering ballooned on its first day.

Facebook did the same thing. Zuckerberg, instead of selling, say, 45% of his company to the public for a realistic offering price ($3 billion, maybe), sold 5 percent of his company for $750 million, a vastly superior offering per share.

In my experience, these “hot” constricted domestic offerings mark a market’s final bullish round, before the deluge.

Bombay is already off its peak, but this offering does indicate that very substantial Indian retail savings are potentially in play.

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Looks like

Clinton has won Nevada.


You would think that Obama would have begun closing by now, because presumably he’d disproportionately benefit from locally higher turnout. But 50 percent of precincts are in and the margin is stuck at 50-44.

Depending on how well the Culinary Workers and SEIU have oiled their own machines, Obama could well still make a comeback; but the window is narrowing.

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As the usual suspects chorus with irresponsibly politicized Republicans and intellectually invincible academics on the urgent consensus in favor of monetary stimulus — the Fed Funds market probabilities for the Fed’s January 30 decision stand as follows:

Probability of 50bp cut in the Fed funds rate: 42 percent

Probability of 75bp cut in the Fed funds rate: 40 percent

Probability of 100bp cut in the funds rate: 17 percent

(Probability of 25bp cut in the funds rate: 1 percent)

On Friday afternoon, there was a truly nightmarish rumor ricocheting around: that Ambac was securing some kind of government bailout of the bond insurance industry. After Ambac’s 52 percent Thursday plunge, it was up 20 percent throughout most of Friday, but at the end, it nosedived, presumably smothering the bailout rumor.

If the government will step in and bail the financial sector out–ok, I take that back because it already has thrown hundreds of billions at the mortgage brokers and the banks off-balance-sheet, at the expense of the US dollar–then the monoline sector is the obvious weak link in the dam. Buffett has already started his own monoline, Berkshire Assurance, but he will not make any big moves until at least one of the monolines actually files for bankruptcy and unleashes the final round of (credit-deflationary) chaos onto the financial system. That will mean tens of billions more writedowns for institutions all over the country (especially if Buffett waits until MBIA blows up, as well as Ambac).

At that point the game theory for the financial elites gets very interesting. Once Ambac dies, will MBIA be able to secure heavy hedge-fund or SWF financing at the height of the panic? Will it die and subsequently trigger a massive government intervention? Or will Bernanke et al. just let MBIA die and let capitalism solve its own problem? Buffett wants to dive in at the height of panic, but if the federal government gets too panicky and pre-empts him, he loses. The current crowd has been choking the credit markets with new paper for the past six months, and has exhibited pure panic.

At the same time Buffett knows that there are very few people alive with his combination of knowledge of the monoline sector, his real AAA credit rating, and his pile of ready cash. So a lot of potentially flush speculators would be extremely leery of jumping into the business before Buffett does. The previous iteration of bulls who rode into Citigroup and the monolines in November are bankrupt or horribly burned.

If we did not have so much panic-driven bureaucratic power to deal with — the Treasury, the Fed, Congress, and the White House, in that order — the markets would be operating much more efficiently. There would be no chance of a government bailout, so the monolines would have thrown in the towel in November. Banks’ credit portfolios wouldn’t have the Fed’s paper crutch to lean on, so they would have fire-sold their credit portfolios to the Buffetts and Citadels who had waited out the most frenzied chapter of the bull market for the opportunity.

Instead of focusing on actual economic activity, we must parse every grammatical construct of our born-again-inflationist high priests to see how and if they will continue to thwart market efficiency, by printing more forms of paper to “erase” old debts and subsidize bad habits.

Undergirding all this policy machinery is a pernicious “establishment consensus” that deflation is some kind of terror that must be stopped at all costs.

Sure, “deflation is bad,” in a vacuum. But what are the alternatives to deflation? Deflation means a massive slowdown in consumer spending. Which, in a vacuum, “is bad.” But we’re not in a vacuum. American borrowing has reached absolutely unprecedented levels. Deflation is the market’s cure for a low aggregate savings rate. It forces debts to be fire-sold in the near term, and in the longer term, it brings down formerly inflated asset prices into the reach of more people. Deflation is a price phenomenon as well as a debt and wage phenomenon, remember…

More inflationist decisions by institutional elites now mean more deflation later.

It is one thing for the government to intervene in financial markets to offset an exogenous shock, such as 9/11. There is no rationale for the government’s intervening against an endogenous financial shock.

Deflation is a short-term consumption killer, but a long-term shot in the arm for the savings rate. It’s not “evil.” Saying “Inflation is bad” is like saying, “Vomiting is bad.” Vomiting is unpleasant, but if you have had too much to drink, vomiting is very good for you.

Unfortunately, commanding-height institutions have a way of never admitting they’re wrong. If history is any guide, the “credit crunches” will continue, with sporadic Fed helicopter-scrambling to temporarily “calm credit fears,” until the dreaded wage-price spiral kicks in to overcompensate for five years’ soaring energy, food, healthcare, and education prices which the Fed has willfully ignored.

Why is anyone surprised that Americans don’t save, when government’s pain-averse, inflationistic ideology is what it is?

Right now, we have credit deflation occurring alongside consumer price and commodity inflation. The Fed is entirely focused on the former, but popular inflation expectations are moored to the latter. The Fed has “greater” priorities than price stability or dollar credibility.

Market manipulations can work if they’re very short-lived. I have seen just a few with my own eyes. But long-run attempts at market manipulation always fail.

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The financial information spectrum, from the utterly uninformed (Yahoo! financial ‘news’) to the well informed (i-banking institutional research and premium financial consultancies) are all lasering in on the nature of the Bush-Bernanke “stimulus package.” Bush, as usual, threw out the biggest number ($140 billion) because, well, when it comes to the federal budget Bush really likes big numbers. Or something.

Bush outlines $140bn stimulus package

By Krishna Guha and Jeremy Grant in Washington

Published: January 18 2008 18:24 | Last updated: January 18 2008 19:01

President George W. Bush on Friday outlined a $140bn fiscal stimulus plan involving temporary tax relief for both consumers and companies in a bid to keep the US economy out of recession.

The administration said his plan would create or safeguard half a million jobs at risk from the economic downturn.

Mr Bush’s comments cap a week of growing bipartisan calls for the government to step in to boost demand amid fears that the brutal housing slump is starting to take its toll on jobs and consumer spending.

It comes at the end for a dismal week for Wall Street, which saw huge writedowns announced by Citigroup, Merrill Lynch and JPMorgan Chase. The S&P 500 index was down 5.3 per cent on the week in midday trading, heading for its worst week for more than five years.

Mr Bush said: “I believe there is enough broad consensus that we can come up with a package that can be approved with bipartisan support” and implemented quickly.

He said that a fiscal stimulus would “provide a shot in the arm to keep a fundamentally strong economy healthy”.

The president said that the package must be “big enough to make a difference in an economy as large and dynamic as ours – which means it should be about one per cent of gross domestic product”.

He said it should be “built on broad-based tax relief” and “not the kind of spending projects that would have little immediate impact on our economy”. Mr Bush insisted that it should include “tax incentives for American businesses” as well as “direct and rapid income tax relief for the American people”.

Members of Congress said the Bush administration had been floating the idea of tax rebates worth $800 for individuals and $1,600 for families. However, the president did not offer any detail on Friday.

Hank Paulson, Treasury secretary, said “the president intentionally put out guidelines, broad principles, because we are looking to be collaborative, working with Congress.”

Mr Paulson – who spent much of the past fortnight consulting members of Congress – said there were “broad areas of agreement” on a fiscal package.

Whatever the final number is, it will probably be a smorgasbord of pork-barrel garbage, combined with temporary “rebates” which will effectively offload a minuscule slice of American consumer debt onto Uncle Sam’s balance sheet. (One-off rebates such as the 2001 Bush tax-cut rebates tend to have negligible impact on consumer spending; more often the rebates are used to pay off older debts.)

It almost certainly will not include any kind of capital-gains tax cut, or rendering permanent of the 2003 dividend/capital gains cut. You would think that Ben Bernanke, our nation’s highest-ranking born-again asset price inflationist, would be driving the bandwagon of tax-code tweaks to keep asset prices inflated. Unfortunately, Bernanke is a (poor) politician; he knows the Democrats don’t want to hear more tax cut endorsements, so he won’t give them one. He has already stated “no preference” between a paleo-Keynesian spending orgy or a neo-Keynesian tax-cut orgy.

It all adds up to the same thing: inflation.

The nominal federal deficit will probably clock in under $200 billion for FY2008. Of course, that doesn’t include the $380 billion in outstanding discount notes from the FHLB — a large percentage of which have almost certainly curdled — or the printing-press-backed debt issuance from the Federal Reserve’s TAF, which I believe stands at $60 billion.

After today’s crapped-out rally, I think it would be safest to wait until the monoline dead sharks (MBIA, Ambac, FGIC et al) float up to the surface before wading back into equities. Should be in the next two weeks, according to RBS (h/t FT Alphaville):

From a rating perspective, in the absence of a bail-out, we see the agencies as more likely to downgrade than not, and once the first downgrade has gone through (likely Fitch with respect to SCA next week), it will become much easier for the other agencies to follow suit with other monolines. We now expect the future for the monolines to play out as follows. Fitch will likely downgrade SCA next week, and FGIC and Ambac the following week – assuming it sticks to its own six week deadline. Moody’s will follow in due course with downgrades to Ambac, MBIA, FGIC and SCA, and S&P will downgrade FGIC. The damage the downgrades of other agencies will do to these monolines is likely to prompt the others to downgrade as well. In theory, these downgrades will be to the double-A category, based on the comments of the agencies so far.

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Ambac is done

Raising $1 billion in capital gets tougher after your stock falls 52 percent in one day.

Jan. 18 (Bloomberg) — Ambac Financial Group Inc. scrapped a plan to raise equity capital after the bond insurer’s shares plunged 70 percent in the past two days, putting its AAA credit rating in jeopardy.

Without new money, New York-based Ambac risks losing the top ranking it depends on to sell bond insurance. Ambac, the second- largest financial guarantor, may have to stop writing insurance or sell itself, said Robert Haines, an analyst at CreditSights Inc., a bond research firm in New York.

“This is a stunning development,” Haines said. Ambac will probably be downgraded by Moody’s Investors Service and Fitch Ratings, Haines said.

Ambac blamed “market conditions” and scrutiny by ratings companies for its decision to drop efforts to sell $1 billion of shares or convertible notes. Moody’s said this week it may cut Ambac’s ratings after the company forecast writedowns of $3.5 billion on subprime-mortgage securities. Fitch demanded the company raise $1 billion by the end of the month.

Ambac, which traded at more than $96 eight months ago, rose 55 cents to $6.79 at 10:15 a.m. in New York Stock Exchange trading. The company’s market value has tumbled 93 percent to $683 million in the past 12 months.

Shareholder Evercore Asset Management LLC yesterday called on Ambac to shelve the plan and relinquish its AAA rating. Ambac should allow the policies it has written to run off, Evercore Chief Investment Officer Andrew Moloff said yesterday in a letter to Ambac’s board.

MBIA’s Capital

MBIA Inc., the largest bond insurer, was also placed under review by Moody’s this week. The company today said it was surprised by the ratings company’s decision.

MBIA raised $1 billion last week in the sale of surplus notes and last month entered a deal to sell $1 billion of equity to private-equity firm Warburg Pincus LLC. Both companies slashed their dividends and took out reinsurance on some securities to help shore up capital.

The surplus notes plunged as low as 70 cents on the dollar today, indicating a yield of about 25 percent, traders said. MBIA dropped $1.63, or 18 percent, to $7.59 on the New York Stock Exchange, extending its 56 percent decline this week.

Bond insurers place their AAA stamp on $2.4 trillion of debt sold by thousands of municipalities across the country, as well as subprime-mortgage securities. Losing those rankings may cost borrowers and investors as much as $200 billion, according to data compiled by Bloomberg.

Bankruptcy Chance

Ratings companies, which affirmed their assessments a month ago, are scrutinizing bond insurers to ensure they have enough capital to protect against losses. Standard & Poor’s yesterday said industry losses on subprime securities will be 20 percent more than it initially forecast. S&P said that isn’t enough to start downgrading the companies.

Prices for credit-default swaps that pay investors if Armonk, New York-based MBIA or Ambac can’t meet their debt obligations imply a 73 percent chance the companies will default in the next five years, according to a JPMorgan Chase & Co. valuation model.

Contracts tied to MBIA’s bonds have risen 10 percentage points the past two days to 26 percent upfront and 5 percent a year, according to CMA Datavision in New York. That means it would cost $2.6 million initially and $500,000 a year to protect $10 million in MBIA bonds from default for five years.

Credit-default swaps on Ambac, the second-biggest insurer, rose 11.5 percentage points to 26.5 percent upfront and 5 percent a year yesterday, prices from CMA Datavision show. They were unchanged today.

Warren Buffett will step in once Ambac files for bankruptcy — but not before.

The half-trillion dollars of munis insured by Ambac will get chopped, and there will be even more chaos across all markets. If MBIA follows Ambac over the cliff as should be the case, that’s going to be a total of $1.2 trillion of municipal bonds chopped from AAA to CCC (for the most part).

Update: Ding!

14:28 ABK AMBAC Fincl: Fitch cuts AMBAC Financial Group long-term rating to ‘A’ from ‘AA’ – Reuters

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