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Archive for the ‘doomsterism’ Category

It has been abundantly obvious from day one that Ben Bernanke has no understanding of “liquidity” — whatsoever.

Only 2 months (?) after Bernanke helicoptered $122 billion to AIG, AIG has come cap in hand to Uncle Sam with a down face and a confession: “The money’s all gone.” AIG supposedly wants $200 billion in new money.

AIG in talks with Fed over new bail-out

By Francesco Guerrera in New York

Published: November 8 2008 02:00 | Last updated: November 8 2008 02:00

AIG is asking the US government for a new bail-out less than two months after the Federal Reserve came to the rescue of the stricken insurer with an $85bn loan, according to people close to the situation.

AIG’s executives were last night locked in negotiations with the authorities over a plan that could involve a debt-for-equity swap and the government’s purchase of troubled mortgage-backed securities from the insurer.

People close to the talks said the discussions were on-going and might still collapse, but added that AIG was pressing for a decision before it reports third-quarter results on Monday.

AIG’s board is due to meet on Sunday to approve the results and discuss any new government plan, they added.

The moves come amid growing fears AIG might soon use up the $85bn cash infusion it received from the Fed in September, as well as an additional $37.5bn loan aimed at stemming a cash drain from the insurer’s securities lending unit.

AIG has drawn down more than $81bn of the combined $122.5bn facility. The company’s efforts to begin repaying it before the 2010 deadline have been hampered by its difficulties in selling assets amid the global financial turmoil.

AIG executives have complained to government officials that the interest rate on the initial loan – 8.5 per cent over the London Interbank Borrowing Rate – is crippling the company.

They compared the loan’s terms with the 5 per cent interest rate paid by the banks that recently sold preferred shares to the government.

One of AIG’s proposals to the Fed is to swap the loan, which gave the authorities an 80 per cent stake in the company, for preferred shares or a mixture of debt and equity.

Such a structure would reduce the interest rate to be paid by AIG and possibly the overall amount it has to repay. An extension in the term of the loan from the current two years to five years is also possible, according to people close to the situation.

The renegotiation of the loan could be accompanied by the government’s purchase of billions of dollars in mortgage-backed securities whose steep fall in value has been draining AIG cash reserves.

AIG is also proposing the government buy the bonds underlying its troubled portfolio of credit default swaps in exchange for the roughly $30bn in collateral the company holds against the assets.

Losses on the mortgage-backed assets, which were acquired by AIG with the proceeds of its securities lending programme, and the CDSs caused the company’s collapse.

Since the government rescue, they have continued to haunt AIG, which is required to put up extra capital every time the value of these assets falls. AIG and the Fed declined to comment.

Red staters get a lot of sh*t from their coastal cousins for being stupid. I will say one thing in red staters’ defense, though: it truly takes a blue coast, blue-blood stupidity to concoct such dangerous national policy as Bernanke’s.

It’s the kind of stupidity that only an Ivy League education can buy.

What is Bernanke going to do when he issues $2 trillion in Treasuries next year, and nobody buys?

All the people who thought they got a great deal when Pepsi priced its last bond at 7.5% are going to feel pretty damn stupid 12 months from now. Either that, or AAA corporates will have lower yields than Treasuries.

At the primary dealer desks, there is no net Asian sovereign demand for US sovereigns anymore.

Right now, Uncle Sam is printing the money and planning to float Treasuries “soon.” I am not exaggerating. It is the dirty secret that every FX macro desk at every major institution knows: the Treasury is printing now and issuing later.

In the ivory towers at Treasury and the Fed, “printed” money will be converted to Treasuries soon, because the Fed and Treasury (okay, just the Fed) think that there is an “irrational” “liquidity crisis”, which will abate any day now.

It won’t abate. It will get worse: all bond yields are based on Treasury yields. Treasury yields are definitely going up in the next year. All other yields (corporates … munis … ) will go up too.

That will be the real “credit crisis.” We are just mostly through the second act.

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Complacency triumphant:

The pollsters for John McCain’s campaign sent out a memo challenging the findings of a poll conducted by the Los Angeles Times and Bloomberg. Hundreds of polls are released during a typical campaign without such a public objection. One finding in particular caught their attention. According to the L.A. Times, 22 percent of those surveyed identified themselves as Republicans, 39 percent as Democrats, and 27 percent as independents. The party identification in this poll, argued McCain’s pollsters, “is greatly out of line with what most other surveys are reporting.”

They’re right. And that fact probably helps explain why the L.A. Times/Bloomberg poll has Barack Obama beating John McCain by 15 points (in a field including Nader and Barr)–a much larger margin than most other respected polls. (The Gallup daily tracking poll, the McCain campaign eagerly points out, has McCain down just 3 points.)

McCain’s pollsters point to the findings of other surveys on party identification. That they would do this suggests just how damaged the Republican party brand is heading into the 2008 general election. Although the L.A. Times/Bloomberg poll shows a larger gap between Democrats and Republicans than all others–+17 for Democrats–the news for Republicans is uniformly bad.

Among the numbers the McCain campaign highlighted: AP/Ipsos’s +14 for Democrats; CBS News/New York Times‘s +14 for Democrats; and Democracy Corps’s +12 for Democrats. The average advantage for Democrats in the ten surveys the McCain campaign cited was 9.3 points. So Republicans are clearly at a significant disadvantage.

The conventional wisdom, adopted and internalized by many on the McCain campaign, is that McCain must move to the center to appeal to independents. So that’s largely what he’s done. Immediately after McCain became the de facto nominee, he toured the country touting his biography. Shortly after that he spent a week on a trip informally dubbed the “Places Republicans Don’t Go” tour. Not long afterwards, he traveled to Washington and Oregon talking about global warming. He has launched radio ads explicitly targeting Hispanics and last month held secret meetings with Hispanic and gay leaders. Twice in recent weeks, McCain has participated in virtual town halls targeting disaffected Democrats and moderates.

[…]

“Where are they going to go?” asks one McCain adviser, expressing a sentiment I’ve heard from several others.

One possibility: nowhere. Unmotivated by a candidate who would rather talk about global warming than gay marriage, conservatives might simply stay home. This lack of enthusiasm for McCain among conservatives was evident in the Washington Post/ABC News poll taken in mid-June. Ninety-one percent of those who identified themselves as Obama supporters say they are “enthusiastic” about their candidate; 54 percent say they are “very enthusiastic.” Seventy-three percent of self-identified McCain supporters say they are “enthusiastic” about his candidacy; but only 17 percent say they are “very enthusiastic.” More ominous, while almost half of the liberals surveyed are enthusiastic about Obama, only 13 percent of conservatives are enthusiastic about McCain.

Republican pollster David Winston believes that McCain can close this enthusiasm gap by campaigning on issues where there are sharp differences between the candidates. “We are still a center-right country,” says Winston. “And voters will still prefer a center-right candidate to a liberal one.” …

All surveys are showing declining Republican affiliation over their time series. Whether it’s Dems +8 or Dems +15, Republican party ID has collapsed over the past 12 months.

At this point in the horse race, the guy arguing against the data trends is the guy who’s losing.

Oil prices aren’t going anywhere until Asian economies stop subsidizing oil consumption, which incidentally would cripple the Asian export advantage by forcing businesses to pay the full cost of energy. Therefore, inflation-driven discontent against the incumbent administration won’t subside in the near term.

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Limits Put on Some Oil Contracts On ICE Amid Outcry Over Prices
By IAN TALLEY
June 17, 2008

WASHINGTON — The U.S. commodity futures regulator Tuesday said ICE
Futures Europe has agreed to make permanent position and
accountability limits for some of its U.S.-traded crude contracts,
subjecting itself to the same regulatory oversight as its New York
based counterpart.

Following intense scrutiny and censure by Congress over skyrocketing
oil prices, the U.S. Commodity Futures Trading Commission also said it
would require daily large trader reports, and similar position and
accountability limits from other foreign exchanges.

Many in Congress have criticized the agency for not doing enough to
rein in what they believe is rampant speculation contributing to
record energy prices and have pointed the finger in particular at
trading on IntercontinentalExchange’s ICE Futures Europe.

ICE and other foreign exchanges have been exempt from the many of the
rules that govern the New York Mercantile Exchange, which critics
charge has attracted a host of financial investors intent on pushing
prices higher. The new agreement, made in consultation with the U.K.’s
Financial Services Authority, will subject ICE to the same oversight
as Nymex.

“This combination of enhanced information data and additional market
controls will help the CFTC in its surveillance of its regulated
domestic exchanges,” while preserving the integrity of its
cross-border cooperation with other regulators, acting CFTC Chairman
Walter Lukken said in prepared testimony.

“We have not found a smoking gun… [but] we’re definitely taking
constructive steps to make sure the markets are working correctly, to
make sure there is not excessive speculation driving the markets,” Mr.
Lukken said.

Specifically, the agreement will require trader reports on positions
in the benchmark U.S. crude contract — the West Texas Intermediate
contract — traded on the ICE Futures exchange. The contract is linked
to the WTI contract on the regulated New York Mercantile Exchange.

ICE has 120 days to implement the new reporting requirements.

On the Nymex, where the majority of oil futures are traded, most
traders face accountability levels and position limits on their
positions in crude oil and other commodities. Accountability levels
are guidelines for trading in all futures contracts, while position
limits are hard-and-fast caps on the number of front-month contracts a
trader may hold in the last three days before the contract expires.

Traditionally, the U.K.’s FSA has had informal accountability levels
of 10,000 contracts in West Texas Intermediate crude, but no position
limits, an ICE spokeswoman said. The new CFTC rules will make ICE oil
trading consistent with practices on Nymex: a 3,000 contract position
limit in the last three days of trading, and a 20,000-contract
accountability level.

Lukken said the same oversight requirements would apply to the Dubai
Mercantile Exchange if it were to also offer the WTI contract.

The Nymex and DME have been mulling offering such a contract and will
decide in the next few months, said Nymex chief executive James
Newsome.

ICE Warns Oversight Won’t Lower Prices

The CFTC will incorporate the ICE data into its commitment of traders
report, a weekly report categorizing positions held by speculators and
companies that use futures contract to hedge against operations in the
physical energy market.

ICE said it would comply with the new regulations but warned tighter
oversight won’t lower oil prices.

“With a mere 15% market share of global WTI, on a futures equivalent
basis, we feel it is highly unlikely that the ICE Futures Europe’s WTI
market is the primary driver of WTI prices,” Charles Vice, ICE
president, told a special Senate committee exploring exploring
oversight and resources for the CFTC.

“Therefore, any expectation that WTI crude oil prices will fall as a
result of increased restrictions on this relatively small portion of
that market are likely to go unmet,” he said.

Jennifer Gordon, an analyst at Deutsche Bank in New York said the
greater regulatory oversight was driving volatility and leading to
less liquidity in the oil markets. “So whatever the CFTC is doing, it
is certainly scaring away the marginal player,” she said. Ms. Gordon
noted that the CFTC move was “adding to the bearish tone on crude,” in
Tuesday trading.

Oil prices climbed within shouting distance of $140 a barrel on Monday
before slipping towards $134.03 on Tuesday, down 58 cents. Prices are
still up about 40% so far this year.

The CFTC action follows rebuke by Congress, which has ratcheted up its
efforts to regulate oil-markets trading. Several of the most powerful
U.S. senators and representatives have introduced proposals that would
give more money and power to the agency.

In the past several weeks, the CFTC has announced a raft of
investigations and new initiatives targeting speculation, the role of
financial participants in current prices and the potential for market
manipulation. Mr. Lukken said the agency couldn’t rule out that market
manipulation was going on in the commodity markets.

The agency disclosed in late May that it is conducting a broad
investigation into practices surrounding the purchase, transportation,
storage and trading of crude oil and related derivative contracts.

Mr. Lukken said the agency was studying the impact of swaps deals and
index trading in the commodity markets and would report back to
Congress by Sept. 15.

The agency said the massive increase in commodity trading, the growing
complexity of the market and an aging CFTC workforce meant that it was
just about able to maintain a business status quo.

“This agency’s lack of funding over the course of many years has had a
negative impact on our staffing situation, rendering it unsustainable
for the long run,” Mr. Lukken said.

“Given our staffing numbers, the agency is working beyond its steady
state capacity and is unable to sustain the current situation for much
longer without being forced to make…choices about which critical
projects should be completed and which ones will be delayed,” the
acting chairman said in his testimony.

The agency is now requesting a 20% rise in its funding for the next
fiscal year to $157 million, from $130 million previously requested.

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on today’s seismic Treasury selloff:

“The point is that the world was long Treasury, and we can see how they’ve been suckered.”

In other news, more insanity from the federales, who think they can permanently reduce commodities prices by shoving out leveraged players.

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Didn’t get this memo. No sir.

Fetch your tin helmets once again. The European Central Bank is opting for a monetary purge. So too is the US Federal Reserve, now ruled from Dallas.

Über-hawks and Cromwellians have gained the upper hand at the great fortress banks. Whether or not they admit it, both are embarked on policies that must lead to retrenchment across the Atlantic world.

The City mood turned wicked as the full import of this policy switch sank in last week. On Wall Street, the Dow’s 396-point dive on high volume late Friday had an ugly feel.

“There is now the distinct possibility of a simultaneous sell-off in global bonds, equities and commodities,” said Jonathan Wilmot from Credit Suisse.

I dunno. I saw Lehman almost die again, and we all knew that the Fed was ready to fire a paper fusillade in the hole.

Trichet’s hawkishness is not in doubt. Bernanke’s is. Spain and Ireland do not a dovish majority make.

Bernanke’s hawkishness is in doubt.

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Thomas Palley, Open Society Institute pontificator emeritus cum DC-cocktail laude, mocks himself best when he’s most honest. As do most political people.

Defending the Bernanke Fed

Filed under: U.S. Policy, Uncategorized — Administrator @ 6:37 am

Federal Reserve Chairman Ben Bernanke has recently been on the receiving end of significant criticism for recent monetary policy. One critique can be labeled the American conservative critique, and is associated with the Wall Street Journal. The other can be termed the European critique, and is associated with prominent European Economist and Financial Times contributor, Willem Buiter.

Brought up on the intellectual ideas of Milton Friedman, American conservatives view inflation as the greatest economic threat and believe control of inflation should be the Fed’s primary job. In their eyes the Bernanke Fed has dangerously ignored emerging inflation dangers, and that policy failure risks a return to the disruptive stagflation of the 1970s.

Both argue the Fed has engaged in excessive monetary easing, cutting interest rates too much and ignoring the perils of inflation. Their criticisms raise core questions about the conduct of policy that warrant a response.

At least he didn’t call us “liquidationists.” Generous.

Rather than cutting interest rates as steeply as the Fed has, American conservatives maintain the proper way to address the financial crisis triggered by the deflating house price bubble is to re-capitalize the financial system.

Correct.

This explains the efforts of Treasury Secretary Paulson to reach out to foreign investors in places like Abu Dhabi. The logic is that foreign investors are sitting on mountains of liquidity, and they can therefore re-capitalize the system without recourse to lower interest rates that supposedly risk a return of ‘70’s style inflation.

“Supposedly.

The European critique of the Fed is slightly different, and is that the Fed has gone about responding to the financial crisis in the wrong way. The European view is that the crisis constitutes a massive liquidity crisis, and as such the Fed should have responded by making liquidity available without lowering rates. That is the course European Central Bank has taken, holding the line on its policy interest rate but making massive quantities of liquidity available to Euro zone banks.

In other words, the Buiter critique advocates one set of interest rates for banks, and a very different one for individuals, without regard to respective credit risk. Presumably, there would be no arbitrage between these two bifurcated markets. Presumably, liquidity provisions to other banks–“inflation by other means”–would both 1) save the banks, and 2) not institutionalize higher prices on the tabs of the people who didn’t take the stupid risks.

Never made much sense to me either. [I used to like Buiter because he was the only person who trashed Bernanke way back in the day. Unfortunately his “lender of last resort” bailout loophole was an unforgivable leap of illogic, and while formally very different from the Bank of Japan’s disastrous early-1990’s bailout, was functionally indistinguishable.]

According to the European critique the Fed should have done the same. Thus, the Fed’s new Term Securities Lending Facility that makes liquidity available to investment banks was the right move. However, there was no need for the accompanying sharp interest rate reductions given the inflation outlook. By lowering rates, the European view asserts the Fed has raised the risks of a return of significantly higher persistent inflation. Additionally, lowering rates in the current setting has damaged the Fed’s anti-inflation credibility and aggravated moral hazard in investing practices.

The problem with the American conservative critique is that inflation today is not what it used to be.

It’s different this time.

1970s inflation was rooted in a price – wage spiral in which price increases were matched by nominal wage increases. However, that spiral mechanism no longer exists because workers lack the power to protect themselves. The combination of globalization, the erosion of job security, and the evisceration of unions means that workers are unable to force matching wage increases.

DC establishment liberal: “Inflation is okay now, because workers have to eat all costs themselves.” As if workers will just sit back and take this? As if they can’t read these internet posts, which presume weakness, ignorance and stupidity on the part of American workers?

The problem with the European critique is it over-looks the scale of the demand shock the U.S. economy has received. Moreover, that demand shock is on-going. Falling house prices and the souring of hundreds of billions of dollars of mortgages has caused the financial crisis. However, in addition, falling house prices have wiped out hundreds of billions of household wealth. That in turn is weakening demand as consumer spending slows in response to lower household wealth.

Different. This. Time.

Countering this negative demand shock is the principal rationale for the Fed’s decision to lower interest rates. Whereas Europe has been impacted by the financial crisis, it has not experienced an equivalent demand shock. That explains the difference in policy responses between the Fed and the European Central Bank, and it explains why the European critique is off mark.

The bottom line is that current criticism of the Bernanke Fed is unjustified. Whereas the Fed was slow to respond to the crisis as it began unfolding in the summer of 2007, it has now caught up and the stance of policy seems right. Liquidity has been made available to the financial system. Low interest rates are countering the demand shock. And the Fed has signaled its awareness of inflationary dangers by speaking to the problem of exchange rates and indicating it may hold off from further rate cuts. The only failing is that is that the Fed has not been imaginative or daring enough in its engagement with financial regulatory reform.

Copyright Thomas I. Palley

The bottom line is, DC policy emerati are profoundly ignorant, sycophantic, and irresponsible people.

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As noted here time and again, Iran has nothing to lose by waiting out the end of George Bush’s term.

Iranian Foreign Minister Manouchehr Mottaki said May 29 that Iran thinks U.S. voters want to change the foreign policies of President George W. Bush, and he said that the present U.S. presidential campaigns make that clear, The Associated Press reported. Mottaki, who would not endorse a candidate, said that foreign policy would play an important part in the election of the next U.S. president.

Iran could not have had a better March-May. A rumored Israeli Gaza offensive, against Iran’s proxy Hamas, failed to materialize. Hezbollah, staked by Iran, was forced to go all-in in Lebanon, won, and has returned to a defensive crouch.

Mottaki’s announcement is a signal to Ahmadinejad’s domestic foes that Iraq is worth waiting for for a little while longer. He happens to be right.

US econo-political analysis is divided into two camps. The “mainstream” camp sees US growth figures as credible, and takes at face value the idea that the US, by sheer economic vitality, has avoided a recession. This school views US inflation as temporary. It views 10/90 “right track/wrong track” numbers as merely a dubious poll, a product of stampeding pessimism, spawned by the media’s sensationalizing of US malaise. This group has faith in government and banking institutions, and little faith in consumers’ ability to assess or predict their own behavior. Curiously, this group is also disproportionately Republican and “free-market.” It does not see much potential for an economic- or inflation-driven political upheaval in November 2008.

The “cynics,” e.g., Bill Gross, Mish Shedlock, and John Williams, trust consumers’ perceptions over the government’s. Cynics argue that consumers are telling the truth when they say how pessimistic they are, and trace the dissonance between official and consumer perceptions to vagaries of BLS unemployment and inflation accounting–a story flogged to death here, and much more persuasively on other sites.

The cynics see much higher potential for political upheaval in November 2008.

Apparently, so does Iran.

Bush Administration policy vis-a-vis Iran/Iraq usually means dialing up tensions over Iranian nukes and weapons supplies into Iraq, bringing up aircraft carriers, launching large operations against Iran’s Mehdi Army Iraqi proxy, slapping sanctions on Iranian banks, using its own militias to incinerate strategic people inside Iran, etc.

After Hezbollah routed the US alliance in Lebanon (followed by an abrupt end to the US/Iraqi crackdown on Sadr in Baghdad) one would assume that the Bush Administration policy of “we’d like to talk, but we’re happy to pull the trigger too” attitude has lost credibility. Iran is quietly leveraging its gains by edging the US out of Iraq:

May 29, 2008 1419 GMT
Senior Iraqi official Sa’ad Javad Qandil told Alalam television May 29 that a draft of an agreement to extend U.S. troops in Iraq beyond 2008 was problematic, especially any condition that would allow the U.S. to establish a military base there.

Predictably, Qandil is a member of the Islamic Supreme Council of Iraq, Teheran’s “mainstream” Iraq proxy (the Mehdi Army is, most of the time, its militant proxy). Hezbollah’s unanswered victory in Lebanon has ramifications across the entire region, not so much in the eyes of Americans as in the eyes of Arabs who were reminded, once again, that the personal bonds between Ahmadinejad and militia leaders can result in very quick and decisive action when Teheran’s interest are threatened.

Anyway, Iran hasn’t been deterred by US tough talk in the past, and there’s less reason than ever to think that louder tough talk will change Iran’s behavior at all. Lebanon has changed the game.

I would repeat my “sh*t or get off the pot” mantra about the US and Iran, but the US has backed down one too many times. I’m beginning to believe we should throw the Saudis the keys as soon as possible, to hedge against a probably adverse US election outcome while it’s still possible.

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“With Bold Steps, Fed Chief Quiets Some Criticism”:

[…]

“It has been a really head-spinning range of unprecedented and bold actions,” said Charles W. Calomiris, professor of finance and economics at Columbia Business School, referring to the Fed’s lending activities. “That is exactly as it should be. But I’m not saying that it’s without some cost and without some risk.”

[As yours truly noted back in November, Charles Calomiris wrote a verbose and obtuse article for VoxEU which proclaimed that there was no credit crisis — a restatement of his August claim that there was no credit crisis. I guess that makes him almost as good a forecaster as Bernanke is. ]

Timothy F. Geithner, president of the Federal Reserve Bank of New York, and a close Bernanke ally, defines the Fed chief’s “doctrine” as the overpowering use of monetary policies and lending to avert an economic collapse. “Ben has, in very consequential ways, altered the framework for how central banks operate in crises,” he said. “Some will criticize it and some will praise it, and it will certainly be examined for decades.”

Mr. Bernanke’s actions have transformed his image as a self-effacing former economics professor.

“I am tempted to think of him as somewhat Buddha-like,” said Richard W. Fisher, president of the Dallas Federal Reserve Bank. “He’s developed a serenity based on a growing understanding of the hardball ways the system actually works. You can see that it’s no longer an academic or theoretical exercise for him.”

Did he just say “Buddha-like”?

Within the Bush administration, Mr. Bernanke’s willingness to work with Democrats in Congress on measures to prevent mortgage foreclosures has stirred unease. “The fact that he, an appointee of George Bush, has come very close to advocating — though he hasn’t quite advocated it — a piece of legislation that George Bush threatened to veto is an illustration of his willingness to put his head on the chopping block,” said Alan S. Blinder, a professor of economics at Princeton and friend of the Fed chief.

One reason Mr. Bernanke is sticking his neck out is that he believes the broader economy’s recovery depends on the housing sector, which remains in a serious slump. Plenty of new evidence surfaced on Tuesday that this year’s spring home-buying season will be dismal, with one report showing that prices fell 14.1 percent in March from a year earlier and another that new-home sales are down 42 percent over the last year.

Among Democrats, Mr. Bernanke, a Republican, had previously been criticized by such party luminaries as the two former Clinton administration Treasury secretaries, Robert E. Rubin and Lawrence E. Summers, who worried that he was downplaying the dangers of a recession. But that view has changed.

“I think in the last few months they’ve handled themselves very sure-footedly,” Mr. Rubin said of the Fed. Many Democrats in Congress agree.

“They say that crisis makes the man,” said Senator Charles E. Schumer, Democrat of New York and the chairman of the Joint Economic Committee. “He’s made believers out of people who were just not sure about him before.”

To lessen the chances of a financial collapse, Mr. Bernanke engineered the takeover of one investment bank, Bear Stearns, and tossed credit lifelines to others with exotic new lending facilities — the Fed now has seven such lending windows, some of them for investment banks as well as commercial banks.

He also allowed the Fed to accept assets of debatable value — mortgage-backed securities, car loans and credit card debt — as collateral for some Fed loans. For the first time ever, he installed Fed regulators inside investment banks to inspect their books.

Much to the dismay of conservative economists, Mr. Bernanke has also presided over an extraordinarily aggressive series of interest rate cuts, lowering the fed funds rate seven times, to 2 percent from 5.75 percent, since last September, though it has signaled a pause in further rate-cutting barring a further crisis. …

Bernanke and Paulson are the worst thing that’s happened to capitalism since Arthur Burns and Richard Nixon. Carter would have been awful, but conditions were so bad by 1979 that he had to authorize significant deregulation and capital gains tax cuts (from 35% to 28%, from memory) kicking and screaming.

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… underwritten by PIMCO’s Bill Gross.

Just in time for the huge TIPS burp a couple of nights ago, when massive buying pushed the 5-year TIPS yield down to -.77.

I’ve been a huge fan of the SS hypothesis for a long time, so it’s good to see the world’s biggest fixed income guru practically copy-paste from the Shadow Stats website for his latest letter.

Without further ado:

What this country needs is either a good 5¢ cigar or the reincarnation of an Illinois “rail-splitter” willing to tell the American people “what up” – “what really up.” We have for so long now been willing to be entertained rather than informed, that we more or less accept majority opinion, perpetually shaped by ratings obsessed media, at face value. After 12 months of an endless primary campaign barrage, for instance, most of us believe that a candidate’s preacher – Democrat or Republican – should be a significant factor in how we vote. We care more about who’s going to be eliminated from this week’s American Idol than the deteriorating quality of our healthcare system. Alternative energy discussion takes a bleacher’s seat to the latest foibles of Lindsay Lohan or Britney Spears and then we wonder why gas is four bucks a gallon. We care as much as we always have – we just care about the wrong things: entertainment, as opposed to informed choices; trivia vs. hardcore ideological debate.

It’s Sunday afternoon at the Coliseum folks, and all good fun, but the hordes are crossing the Alps and headed for modern day Rome – better educated, harder working, and willing to sacrifice today for a better tomorrow. Can it be any wonder that an estimated 1% of America’s wealth migrates into foreign hands every year? We, as a people, are overweight, poorly educated, overindulged, and imbued with such a sense of self importance on a geopolitical scale, that our allies are dropping like flies. “Yes we can?” Well, if so, then the “we” is the critical element, not the leader that will be chosen in November. Let’s get off the couch and shape up – physically, intellectually, and institutionally – and begin to make some informed choices about our future. Lincoln didn’t say it, but might have agreed, that the worst part about being fooled is fooling yourself, and as a nation, we’ve been doing a pretty good job of that for a long time now.

I’ll tell you another area where we’ve been foolin’ ourselves and that’s the belief that inflation is under control. I laid out the case three years ago in an Investment Outlook titled, “Haute Con Job.” I wasn’t an inflationary Paul Revere or anything, but I joined others in arguing that our CPI numbers were not reflecting reality at the checkout counter. In the ensuing four years, the debate has been joined by the press and astute authors such as Kevin Phillips whose recent Bad Money is as good a summer read detailing the state of the economy and how we got here as an “informed” American could make.

Let me reacquaint you with the debate about the authenticity of U.S. inflation calculations by presenting two ten-year graphs – one showing the ups and downs of year-over-year price changes for 24 representative foreign countries, and the other, the same time period for the U.S. An observer’s immediate take is that there are glaring differences, first in terms of trend and second in the actual mean or average of the 2 calculations. These representative countries, chosen and graphed by Ed Hyman and ISI, have averaged nearly 7% inflation for the past decade, while the U.S. has measured 2.6%. The most recent 12 months produces that same 7% number for the world but a closer 4% in the U.S.

This, dear reader, looks a mite suspicious. Sure, inflation was legitimately much higher in selected hot spots such as Brazil and Vietnam in the late 90s and the U.S. productivity “miracle” may have helped reduce ours a touch compared to some of the rest, but the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors which should have had an opposite effect, everything else being equal. I ask you: does it make sense that we have a 3% – 4% lower rate of inflation than the rest of the world? Can economists really explain this with their contorted Phillips curve, output gap, multifactor productivity theorizing in an increasingly globalized “one price fits all” commodity driven global economy? I suspect not. Somebody’s been foolin’, perhaps foolin’ themselves – I don’t know. This isn’t a conspiracy blog and there are too many statisticians and analysts at the Bureau of Labor Statistics (BLS) and Treasury with rapid turnover to even think of it. I’m just concerned that some of the people are being fooled all of the time and that as an investor, an accurate measure of inflation makes a huge difference.

The U.S. seems to differ from the rest of the world in how it computes its inflation rate in three primary ways: 1) hedonic quality adjustments, 2) calculations of housing costs via owners’ equivalent rent, and 3) geometric weighting/product substitution. The changes in all three areas have favored lower U.S. inflation and have taken place over the past 25 years, the first occurring in 1983 with the BLS decision to modify the cost of housing. It was claimed that a measure based on what an owner might get for renting his house would more accurately reflect the real world – a dubious assumption belied by the experience of the past 10 years during which the average cost of homes has appreciated at 3x the annual pace of the substituted owners’ equivalent rent (OER), and which would have raised the total CPI by approximately 1% annually if the switch had not been made.

In the 1990s the U.S. CPI was subjected to three additional changes that have not been adopted to the same degree (or at all) by other countries, each of which resulted in downward adjustments to our annual inflation rate. Product substitution and geometric weighting both presumed that more expensive goods and services would be used less and substituted with their less costly alternatives: more hamburger/less filet mignon when beef prices were rising, for example. In turn, hedonic quality adjustments accelerated in the late 1990s paving the way for huge price declines in the cost of computers and other durables. As your new model MAC or PC was going up in price by a hundred bucks or so, it was actually going down according to CPI calculations because it was twice as powerful. Hmmmmm? Bet your wallet didn’t really feel as good as the BLS did.

In 2004, I claimed that these revised methodologies were understating CPI by perhaps 1% annually and therefore overstating real GDP growth by close to the same amount. Others have actually tracked the CPI that “would have been” based on the good old fashioned way of calculation. The results are not pretty, but are undisclosed here because I cannot verify them. Still, the differences in my 10-year history of global CPI charts are startling, aren’t they? This in spite of a decade of financed-based, securitized, reflationary policies in the U.S. led by the public and private sector and a declining dollar. Hmmmmm?

In addition, Fed policy has for years focused on “core” as opposed to “headline” inflation, a concept actually initiated during the Nixon Administration to offset the sudden impact of OPEC and $12 a barrel oil prices! For a few decades the logic of inflation’s mean reversion drew a fairly tight fit between the two measures, but now in a chart shared frequently with PIMCO’s Investment Committee by Mohamed El-Erian, the divergence is beginning to raise questions as to whether “headline” will ever drop below “core” for a sufficiently long period of time to rebalance the two. Global commodity depletion and a tightening of excess labor as argued in El-Erian’s recent Secular Outlook summary suggest otherwise.

The correct measure of inflation matters in a number of areas, not the least of which are social security payments and wage bargaining adjustments. There is no doubt that an artificially low number favors government and corporations as opposed to ordinary citizens. But the number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. If core inflation were really 3% instead of 2%, then nominal bond yields might logically be 1% higher than they are today, because bond investors would require more compensation. And although the Gordon model for the valuation of stocks and real estate would stress “real” as opposed to nominal inflation additive yields, today’s acceptance of an artificially low CPI in the calculation of nominal bond yields in effect means that real yields – including TIPS – are 1% lower than believed. If real yields move higher to compensate, with a constant equity risk premium, then U.S. P/E ratios would move lower. A readjustment of investor mentality in the valuation of all three of these investment categories – bonds, stocks, and real estate – would mean a downward adjustment of price of maybe 5% in bonds and perhaps 10% or more in U.S. stocks and commercial real estate.

A skeptic would wonder whether the U.S. asset-based economy can afford an appropriate repricing or the BLS was ever willing to entertain serious argument on the validity of CPI changes that differed from the rest of the world during the heyday of market-based capitalism beginning in the early 1980s. It perhaps was better to be “entertained” with the notion of artificially low inflation than to be seriously “informed.” But just as many in the global economy are refusing to mimic the American-style fixation with superficialities in favor of hard work and legitimate disclosure, investors might suddenly awake to the notion that U.S. inflation should be and in fact is closer to worldwide levels than previously thought. Foreign holders of trillions of dollars of U.S. assets are increasingly becoming price makers not price takers and in this case the price may not be right. Hmmmmm?

What are the investment ramifications? With global headline inflation now at 7% there is a need for new global investment solutions, a role that PIMCO is more than willing (and able) to provide. In this role we would suggest: 1) Treasury bonds are obviously not to be favored because of their negative (unreal) real yields. 2) U.S. TIPS, while affording headline CPI protection, risk the delusion of an artificially low inflation number as well. 3) On the other hand, commodity-based assets as well as foreign equities whose P/Es are better grounded with local CPI and nominal bond yield comparisons should be excellent candidates. 4) These assets should in turn be denominated in currencies that demonstrate authentic real growth and inflation rates, that while high, at least are credible. 5) Developing, BRIC-like economies are obvious choices for investment dollars.

Investment success depends on an ability to anticipate the herd, ride with it for a substantial period of time, and then begin to reorient portfolios for a changing world. Today’s world, including its inflation rate, is changing. Being fooled some of the time is no sin, but being fooled all of the time is intolerable. Join me in lobbying for change in U.S. leadership, the attitude of its citizenry, and (to the point of this Outlook) the market’s assumption of low relative U.S. inflation in comparison to our global competitors.

William H. Gross
Managing Director

The SS hypothesis extends to unemployment statistics, as well. In most European economies, anyone unemployed between 19 and 55 years of age is apparently counted as unemployed. The massive graduate education and “nonprofit” apparatus in the United States (Peace Corps, Teach for America, etc) means that many Americans who are effectively unemployed — and who often use such institutions to say that they “have something to do” — are not counted as such.

When you add up all the American distortions, the US economy expressed in European metrics comes to approximately 7 percent inflation, 8 percent unemployment, and very low growth.

Which begs the question of what European governments do to cook their own books, which is something I can’t know. Gold-buggery seems to be an overwhelmingly American phenomenon, and virtually all research into effective gold price support has come from Americans, which means that the CPI-skeptic worldview is very familiar with the nuances of American book-cooking, but not at all familiar with European equivalents.

However, European bonds are not nearly the economic anchor that American fixed income and equities prices are.

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The credit crisis has separated true libertarians from phony libertarians, and separated true liberals from phony liberals.

The phony liberals have inadvertently mocked themselves throughout the entire credit crisis, manning the barricades to defend the greatest act of socialism for the rich in US history. Ditto for supposed “libertarians,” eg Robert Rubin, Bruce Kovner, and the vast majority of institutional Wall Street which found itself drowning in its own quagmire, and changed their tune faster than you can say “WTF.”

Anyway, here’s the link.

The editorial in question is by Robert J. Shiller, who is a professor of economics and finance and famous analyst of speculative bubbles. A specialist in behavioral economics, in the application of psychology to understanding financial markets. A co-founder of Case Shiller Weiss, that house price index we talk about a lot. His editorial, “The Scars of Losing a Home,” speaks not of lofty academic economic concepts but of human sympathy, of things that are “really important.” With references from famous academic psychologists. I haven’t taken this kind of a tiger by the tail since I went after Austan Goolsbee last year.

Yes, it was only a year ago that the distinguished Dr. Goolsbee wrote this on the same editorial page:

And do not forget that the vast majority of even subprime borrowers have been making their payments. Indeed, fewer than 15 percent of borrowers in this most risky group have even been delinquent on a payment, much less defaulted.

When contemplating ways to prevent excessive mortgages for the 13 percent of subprime borrowers whose loans go sour, regulators must be careful that they do not wreck the ability of the other 87 percent to obtain mortgages.

For be it ever so humble, there really is no place like home, even if it does come with a balloon payment mortgage.

I actually think Goolsbee’s piece was the high-water-mark of the “subprime helps the poor” talking point. You certainly don’t hear much about that these days. Less than two months after Dr. Goolsbee’s earnest op-ed, we got an interview in the very same NYT with one Bill Dallas, CEO of the famously defunct Ownit Mortgage, effusively testifying to his own burning desire to help out the unfortunate in a way that finally put paid to the respectability of that line (“‘I am passionate about the normal person owning a home,’ said Mr. Dallas, who is also chairman of the Fox Sports Grill restaurant chain and manages the business interests of the Olsen twins. ‘I think owning a home solves all their problems.'”) Plus by now we’ve got some numbers on the 2007 mortgage vintage, the one that Dr. Goolsbee was afraid wasn’t going to ever materialize if we tightened up lending standards too much. A year ago we were looking at a 13% subprime ARM delinquency rate. Per Moody’s (no link) the Q4 07 subprime ARM delinquencies were running 20.02%. And that is not, you know, “just” another 7%. By now, those delinquent borrowers in Goolsbee’s 13% have probably mostly been foreclosed upon and are off the books. The 20% or so who are now delinquent were either part of the 87% that Goolsbee thought were “successful homeowners” last year, or else they’re those lucky duckies who bought homes after the publication date of Goolsbee’s plea that we not tighten standards too much.

Of course Shiller wasn’t exactly spending his time a year ago defending the subprime mortgage industry on the grounds that it put poor and minority people into ever-so-humble homes with balloons attached. I seem to recall him mostly arguing that homebuyers were engaged in a speculative mania. In a June 2007 interview:

Well, human thinking is built around stories, and the story that has sustained the housing boom is that homes are like stocks. Buy one anywhere and it’ll go up. It’s the easiest way to get rich.

At the time, that kind of statement struck some of us, at least, as not possibly the entire story either, but in any event a useful corrective to the saccharine silliness of the “Ownership Society” and Bill Dallas solving everyone’s problems by letting them put Roots in a Community (for only five points in YSP).

So I hope I can be just a tad startled by the New Shiller:

Homeownership is thus an extension of self; if one owns a part of a country, one tends to feel at one with that country. Policy makers around the world have long known that, and hence have supported the growth of homeownership.

MAYBE that’s why President Bush’s “Ownership Society” theme had such resonance in his 2004 re-election campaign. People instinctively understand that homeownership conveys good feelings about belonging in our society, and that such feelings matter enormously, not only to our economic success but also to the pleasure we can take in it.

So it’s no longer irrational exuberance or plain old speculating; it’s now an instinctive affirmation of some eternal verity of the human psyche? The ultimate patriotism: the definition of self so tied up in ownership of a slice of the motherland that to rent becomes not only psychologically dangerous–these people without selves can’t be up to anything good–but politically dangerous as well? Is it possible that Shiller can mean what he is writing here?

If you just scanned the first few paragraphs of Shiller’s op-ed you might come away with the impression of a sincere but somewhat hackneyed plea for us all to have a bit of sympathy for the foreclosed among us, foreclosure not in anyone’s experience being a walk in the park. Fair enough. It being Sunday in America, I suspect millions of us are being treated to exhortations to take a kinder view of the unfortunate than we often do; we need those exhortations; we are often lacking in sympathy. Hands up all who disagree.

But you keep reading and you find Shiller trying to explain the “trauma” of foreclosure. And that’s where this really gets weird:

Now, let’s take the other perspective — and examine some arguments against the stern view. They have to do with the psychological effects of strict enforcement of a mortgage contract, and economists and people in business may need to be reminded of them. After all, too much attention to abstract economic statistics just might make us overlook what is really important.

First, we have to consider that we cannot squarely place the blame for the current mortgage mess on the homeowner. It seems to be shared among mortgage brokers, mortgage originators, appraisers, regulatory agencies, securities ratings agencies, the chairman of the Federal Reserve and the president of the United States (who did not issue any warnings, but instead has consistently extolled the virtues of homeownership).

Because homeowners facing foreclosure must bear the brunt of the pain, they naturally feel indignation when all of these other parties continue to lead comfortable, even affluent lives. Trying to enforce mortgage contracts may thus have a perverse effect: instead of teaching homeowners that they should respect the contracts they sign, it may incline them to take a cynical view of the whole mess.

We need to modify mortgage contracts to keep homeowners from becoming cynical? That’s somehow more respectable an idea than the one saying we should throw them out on the street to “teach them a lesson”? If Shiller is serious that all those other parties are “to blame,” then why isn’t the obvious solution to throw them out on the street? There seems to be an assumption here that nothing can be done to punish those who are “really” to blame, so we’re left managing the psyches of those who can be punished. And that’s not cynical?

This the point at which Shiller dredges up the most stunningly unfortunate quote from William effing James (1890) to define the “fundamental” psychology of homeownership:

Homeownership is fundamental part of a sense of belonging to a country. The psychologist William James wrote in 1890 that “a man’s Self is the sum total of all that he CAN call his, not only his body and his psychic powers, but his clothes and his house, his wife and children, his ancestors and friends, his reputation and works, his lands and horses, and yacht and bank account.”

Now, that’s breath-taking. Horses. Yachts. His wife and his children. Ancestors. The whole late-Victorian wealthy male WASP defining the “Self” (with a capital!) as the wealthy male WASP surveying his extensive possessions, an oddly-assorted list that ranks the family and friends somewhere after the clothes and the house. (Yes, James did that on purpose.) The kind of sentiment that was a caricature of the late-Victorian male even in 1890. And Shiller drags this out in aid of generating sympathy for homeowners? Really? You couldn’t find some psychological insight about the emotional relationship of people to their homes that doesn’t speak the language of the male ego surveying his domain, sizing himself up against all the other males to see where he ranks?

(James on the psychological effect of losing one’s property: ” . . . although it is true that a part of our depression at the loss of possessions is due to our feeling that we must now go without certain goods that we expected the possessions to bring in their train, yet in every case there remains, over and above this, a sense of the shrinkage of our personality, a partial conversion of ourselves to nothingness, which is a psychological phenomenon by itself. We are all at once assimilated to the tramps and poor devils whom we so despise, and at the same time removed farther than ever away from the happy sons of earth who lord it over land and sea and men in the full-blown lustihood that wealth and power can give, and before whom, stiffen ourselves as we will by appealing to anti-snobbish first principles, we cannot escape an emotion, open or sneaking, of respect and dread.”)

I’m actually, you know, in favor of some sympathy for homeowners, but one thing that does get in the way of that for a lot of us is, well, the rather disgusting shallowness that a lot of them displayed on the way up. There is this whole part of our culture that has sprung into being since 1890 that takes a rather severe view of conspicuous consumption, unbridled materialism, and totally self-defeating use of debt to buy McMansions, if not yachts. We were treated to a fair amount of that kind of thing in the last few years. In fact, we had Dr. Shiller explaining to us last year that a lot of folks just wanted to get rich, quick, in real estate.

It is undeniably true, I assert, that not everyone was a speculatin’ spend-thrift maxing out the HELOCs to buy more toys, and that part of our problem today with public opinion is that we extend our (quite proper) disgust for these latter-day Yuppies to the entire class “homeowner.” But it is surely an odd way to engage our sympathies for the non-speculator class to speak of it in Jamesian terms as the man whose self is defined by his Stuff, and whose psychological pain is felt most acutely when he recognizes that he is now just like the riff-raff.

It’s worse than odd–it’s downright reactionary–to then go on to that evocation of homeownership as good citizenship and good citizenship as “feel[ing] at one with [the] country.” This puts a rather sinister light on Shiller’s earlier insistence that we need to make sure people don’t get too “cynical.”

I see that Yves at naked capitalism was just as disgusted by Shiller as I am:

Now admittedly, this is not a validated instrument, but a widely used stress scoring test puts loss of spouse as 100 and divorce at 73. Foreclosure is 30, below sex difficulties (39), pregnancy (40), or personal injury (53). Change in residence is 20.

Note that if we as a society were worried about psychological damage, being fired (47) is far worse than foreclosure (30), and if it leads to a change in financial status (38) and/or change to a different line of work (36) those are separate, additive stress factors. Yet policy-makers have no qualms about advocating more open trade even though it produces industry restructurings that produce unemployment that does more psychological damage than foreclosures. As a society, we’ll pursue efficiency that first cost blue collar jobs, and now that we’ve gotten inured to that, white collar ones as well (although Alan Blinder draws the line there).

But efficiency arguments don’t apply to housing since we are sentimental about it. And it’s that sentimentality that bears examination, since it engendered policies that helped produce this mess.

I would only add that we are about five years too far into a war that has not made a majority of us “feel at one with that country.” I think of another really important policy change we could be pursuing right now to shore up everyone’s psychological estrangement from their patriotic self-satisfaction. But “efficiency arguments” don’t apply to wars, either.

My fellow bleeding heart liberals like Goolsbee found themselves defending the subprime industry in the name of increasing minority homeownership. Now we’re treated to the spectacle of Shiller arguing for homeowner bailout legislation in the same terms that Bush used to defend the “Ownership Society.” Housing policy, I gather, makes strange bedfellows. It certainly makes strange editorials.

Shiller’s unwitting self-parody embodies the principle at the heart of the TAF and every other tentacle of the Wall Street bailout. Far more than “economist statistics which can cause us to lose sight of what’s really important,” what’s REALLY important is protection of those Selves which include “lands and horses, and yacht and bank account.”

You can *not* make this stuff up.

Pardon my French, but our economy is being run by f*cking idiots.

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IFR:

[13:57 US GOVTS: Fallout From Credit Crisis Seen in TIC Data]

Boston, May 15. Though foreigners continued to buy treasuries (a record $55 bln) and agency ($18 bln) paper hand over fist in the latest March TIC data the net flow for the month was actually a negative $48 bln. While far from an expert in these numbers it appears that the shortfall was made in the private flow category and specifically bank liabilities which fell $115 bln.

The thinking is that the latter number ($115 bln) represents a falloff in US bank lending to their European counterparts over the heighten counterpart concern engendered by the subprime/credit crisis. If so, this may be yet another reason why the Fed is contemplating expanded both the size and term maturity of the TAF program.

Either way, the data is causing quite a stir on the Street and is seeing a knee-jerk buying and curve steepening reaction in the treasury market as traders try to sort out what it all means.

Interesting.

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[edited and tempered a bit–EC]

I’ve wanted to talk about something that’s been simmering for a long time in my mind, namely the obvious institutional dysfunction of the West in the face of Muslim, particularly Shia, tribal fortitude.

There are two kinds of societies: unstructured, tribal societies, and structured, institutional societies. The Bush Administration’s Iraq odyssey has allowed vibrant contrast between tribal and institutional societies.

Charisma is the currency of a tribal society; money is the currency of institutional society.

In a tribe, any person’s leadership ability is contingent upon how well he husbands the lives and resources of his tribe in the face of external threats, up to and including throwing himself on the rails to save his family/ unit/ clan/ tribe. A leader’s credibility is based upon 1) his ability to forecast and surmount future threats, and 2) his perceived willingness to die for the tribe’s sake to surmount such a threat — the fact that, as he gambles with his tribe’s lives, he sees his own life no differently from lesser members of the tribe. So, tribal societies generally produce very astute gamblers as leaders.

Institutional societies produce exactly opposite leaders. People rise through institutions by public competence and private ‘politicking’ (what a tribal society would call ‘treachery’). Winning the leadership lottery of an institution is defined by strategically timed risk avoidance, whereas tribal leaders are defined by strategic risk-taking.

Institutions can attain heights of complexity and ‘sophistication,’ be it in the form of weaponry, markets, technology, art, or social ritual, which tribes can only, rarely, hope to rent. For that conceit, institutions pay a steep price. They are extremely slow to adapt to anything. Institutions can scale up intellect, but unlike tribes they cannot scale up trust. Institutions are hamstrung by internal political jockeying to a much greater extent than are tribes.

Because testosterone and charisma are pretty closely correlated, “demographic change” is never a tribal problem. Children are necessary to perpetuate and augment the tribe, and are totally encouraged. People who have difficulty producing children are accepted, but not treated as well. People obviously incapable of producing children, i.e. homosexuals, are ostracized, unless they show exceptional fighting ability/ stand up for themselves. Institutions, which put a premium on an individual’s “paying dues” of time at the expense of everything else, disproportionately produce leaders with few or no children. Institution-driven government policy overwhelmingly discounts from future investment (of which children are a big part) to the present.

Tribal leaders see much more meaning in death — or, in the case of black US tribes, very long-term imprisonment — than do institutional leaders. They know that even if their lives’ works ‘end’ in death, their sacrifice will reflect well upon their “peoples” ie their children.

Because tribal leaders are judged by their ability to defeat external challenges and encroachments on a continuous basis, and are not protected by legal or institutional formalisms, they react immediately and overwhelmingly to, for example, attempts to steal the property of the tribe.

So, institutional societies produce too many “leaders” eager to take credit for vanquishing small risks over small time horizons, and very large risks over extremely long time horizons (i.e., blame/credit cannot be fully allocated until after the leader in question is dead).

You can see where I’m going with this. The Muslim world is defined by its tribes, and the West is defined by its institutions. It would be over-dramatic to call Iraq a clash of civilizations, but it still is, sort of. Who has been winning? Iran certainly hasn’t been losing. The US seems to be holding firm, except that public support for the war has completely collapsed, and the state of the US government’s balance sheet is much worse than any agency seems to realize.

The US government really reminds me a lot of Citigroup: every agency further amortizing the future, on the assumption that, if its bets don’t pay off, every other agency will take cuts for that agency’s mistakes. In musical chairs, somebody has to lose.

I have been raised by, and have benefited from, a structural society. I would like to believe in it. However, Western institutions’ schizophrenic, ill-informed dysfunction has offered a pathetic contrast to the Iranian model. Every all-in challenge by Hezbollah has been met with pathetic procrastination by Israel, the United States, and proxy tribes seduced by Western institutional promises. Olmert’s Israel, which talks about negotiations as it’s hit by Palestinian Katyushas every day, is a particularly dramatic exposition of this, although the rest of the West suffers the same myopic affliction to lesser degrees.

Tribal elements of the West, i.e., Israeli settlers, lower echelons of the US Army Mormons, US “white trash,” and others who for all their faults are proud enough to put their flesh on the line for their homelands, nonetheless can’t help but feel that the institutions which purport to represent them only waste any lives they offer, on the altar of the Kadima/State Department cult of peace.

The “uncultured” “barbarian” tribes have been bleeding the West dry for the last five years. Western firepower is overwhelming, and could have imposed prohibitive costs on Iranian militia-style maneuvering years ago. Why hasn’t it? As if any negotiation can erase the fact that the Western empire has no clothes, and will not defend itself despite getting its teeth spattered onto Beirut’s pavement. [*]

I think Western governments’ increasingly aggressive discounting of the future is a direct byproduct of the institutionalization of Western society. Today, for example, big agribusiness is stealing $300 billion in plain sight. How is this sustainable — let alone acceptable? Is there a point at which it becomes moral to kill these people? S&P has already stated that a Fannie/Freddie bailout alone would cost $400 billion to $1.1 trillion, and would jeopardize the US’s AAA bond rating. There just isn’t the money for these expenses anymore.

Governments discount youth’s earnings in many ways. Government mandated barriers to entry are overwhelmingly protectionism for existing workers at the expense of future workers, and force youth/future workers to seek poorer alternatives. America’s gigantic intergenerational liabilities are another such tax on youth. I posit that growth of government has directly depressed Western birthrates. US native birthrates are collapsing in line with continental Europe’s, as is its growth of government. [**] There is a yawning gap between deep pessimism of Western youth, especially in the United States, and relative optimism of the 55+ crowd. The two groups are facing very different arrays of future liabilities and future payments, that’s for sure.

Maybe that’s the difference. You hear about all the rent seekers all the time, but you don’t hear as much about the ones that are rising. I don’t know. There is an awful lot of rent-seeking going on, but nobody outside the financial industry seems to have a clue about it, or what it will mean for future generations. This has really, really Never Happened Before, except in Japan, and the results were very bad–especially for birth rates.

Maybe you could say that institutions are a necessary evil for especially big societies. In any case, they are no match for the Mideast’s tribal collectives, epitomized by the extremely high-trust tribal institution Hezbollah. The West’s leaders are no match for Ahmadinejad and Nasrallah at all. Sure, there are those who might be if they had the backing of even a cohesive minority of their society, such as Petraeus, but they don’t, because there is no critical mass willing to risk as Ahmadinejad and Nasrallah are. So we continue fighting this stupid, never-ending war, losing money, face, and men all at the same time.

There’s something about the West that makes it unwilling to win wars, and I don’t know what it is.

Or, maybe I should just rename my blog “a neoconservative, mugged by doomsterism.”

[*] again, the notion of action being important now is premised upon a Republican loss in the 2008 presidential election, something approaching a foregone conclusion, which hasn’t seeped into the conventional wisdom yet.

[**] One should take into account the relatively enormous US local governments, nonprofit sector, and government contractors when arriving at a size of US government. The latter two in particular have exploded over the past eight years.

The sum total will likely surpass 40 percent of GDP this year, and will explode in an Obama Administration as opaque liabilities from the financial bailout make themselves more apparent later.

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MS-01

The MS-01 runoff was today.

Mississippi’s first congressional district voted 63-37 for Bush in 2004. There are 110 Republican House seats more competitive than MS-01.

Today, despite a desperate ~$2m in spending from the NRCC and Freedom’s Watch (a big neocon 527), a Democrat won the district, 54-46.

Once again the GOP tried to hang Jeremiah Wright around the neck of a Democrat. Once again, common sense would have indicated that nobody gives a sh*t about Jeremiah Wright. Once again, common sense made a fool out of the conventional wisdom.

There are 150 Republican House seats in play in the fall of 2008. About GOP 10 Senate seats are in jeopardy too.

Republicans can psych themselves up with dreams of Obama’s unelectability all they want. The powerbrokers know better. The empirical results don’t lie.

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Regular finance-focused readers have probably noticed that I’ve neglected economic commentary recently. That’s because 1) there hasn’t been much net marginal information recently to clarify what I see right now (monstrous reflation in the West, looming monstrous deflation in the East, looming war in the Mid-East, commodities as The Big Thing through late July). 2) the geopolitics of Lebanon is probably the single most influential thing going on (for commodities markets, anyway) with such a corresponding lack of true public analysis.

Anyway, as I have scrolled through my lonnnnnng list of finance blogs and gotten more and more bored, one wasteful meme in particular has infected more and more online financial discourse. (Which is still way ahead of the NYT and WSJ, who are probably wondering how best to appeal to the estrogenated millenials, i.e. the yuppie female/ gay demographic,  with more front-page fashion coverage.) Let’s call it the Complex Systems Meme.

The Complex System Meme is what all the Smart Guys In The Room, the quants, talk about these days. CSM exhibits a predictable life-cycle.

  1. Quant adds long, verbose, high-syllable-per-word, hypertechnical, and thus unfalsifiable comment to a mainstream financial blog.
  2. Blogger, realizing he’s in the presence of a Smartest Guy In The Room, gracefully and tacitly hands over the reins of discussion to Quant.
  3. Many, many jargon-intensive paragraphs ensue. Frequently sighted examples of jargon intensity include “information latency,” “Knightian uncertainty,” “systems architecture,” “the financial transmission mechanism,” “the securitization process is driven by nonlinear systemic processes,” “counterproductive proliferation of systemic dependencies,” “constructive ambiguity” (Greenspan’s fave), and “reflexivity.” The liquidity of discussion within the broader discursive framework of the weblog, if you will, exhibits a six-sigma nonlinear growth trajectory.
  4. At this point, 100.00% of common sense has been scared the hell out of the room. Only certified high priests of quantology, and their most zealous qualitative admirers, remain.
  5. After paragraph count has vaulted into the upper two digit range, absolutely nothing has been said that couldn’t have been stated much more simply.
  6. However, Quant’s intellectual stature has been established beyond all dispute. If anything, the transaction cost of challenging him (requiring at least as many ubersyllabic paragraphs as were just hemorrhaged) has become prohibitive.

Verbose commentary wastes everybody’s time.

I don’t blame quants for crappy writing, just as I don’t blame myself for crappy quantification. The problem is that carpet-bombing a discussion with unnecessary technical verbiage excites a majestic awe in influential qualitatives least able to challenge — but best able to disseminate — quants’ “solutions” to the “problem,” which are at least as benighted as everybody else’s, yet treated with greater credibility.

Everything in life is nonlinear.

Just because liquidity is an economy of scale, doesn’t make it a national imperative of the federal government. In the long run, economic surplus of even the largest economies of scale is captured by the operators of that system. For example, mass transit seems like a great idea on paper, and it is — in the medium run. However, the workers and conductors of any mass transit system quickly realize that society is capturing much more surplus from their activity than they are. So their rational best choice is to unionize, and go on strike, holding the broader economy hostage until they capture (in the form of higher salaries, pensions, etc) the entire social surplus of that activity. Such is the case with the French railway workers’ union.

Liquidity isn’t nearly that nonlinear — I’m just using a more dramatic example to make the point.

Every commodity, whether it’s oil, debt, or whatever, has a parabolic marginal cost/marginal benefit curve. “Scale economies'” MB/MC curves currently seem to offer higher rates of return with greater investment, until some point farther off in the future, than those of corresponding industries. Over time,  scale economies become identical to those of non-economies of scale, except that the production side has fewer participants. Fewer producers relative to consumers means that consumers’ bargaining power asymptotes to zero. Consumers get mad, and government steps in and regulates producers. Leveraging of producers’ superior bargaining power ends. In the long long long run, both producers and consumers enjoy more surplus. In theory.

The market for lending, ostensibly a sacrosanct economy of scale, obviously went into negative territory on that curve. Now it’s snapping back. Government interventions to maintain the current level of debt are only going to cause a snapback much more “nonlinear” than whatever nonlinear correction we would otherwise have undergone.

Getting wrapped up in “the nonlinear nature of liquidity” only obfuscates the discussion for everyone. Every process is nonlinear relative to itself at the distribution of previous moments in time. But processes tend to be much more linear relative to all other processes. Since we’re talking about subsidizing one somewhat nonlinear process (debt-funded liquidity) at the expense of all other nonlinear processes, why bring nonlinearity into the discussion at all.

If smart people spent their time weighing on other Smart People to solve simple problems, instead of taking themselves so seriously and flaunting their technical knowledge, maybe we would actually get somewhere in terms of stopping BS Bernanke & Co. from butchering the financial credibility of the United States, and actually get some return on all this talking/typing time investment.

When that starts happening, and private parties are barred from free-riding off of AAA government bond ratings courtesy of taxpayer sweat, I will crawl out of my dollar-bearish, euro- and “safe” fixed income-uberbearish hibernation. And maybe the future of finance will become an interesting topic to blog about again. It’s just that with Fannie Mae et al. going $400bn-$1.1trn in debt, in addition to the Fed ~$400bn of Treasuries exchanged for worthless MBS, AND $500 billion in FY09 debt, the medium term US bond rating is already staring at either much higher taxes or an epochal downgrade. Capital is already leaving in anticipation of necessarily higher taxes, which will mean still higher taxes on whatever capital is left. Prescriptions of “solutions” to the current “credit crisis,” as if we can outsmart mean reversions of debt if we just think hard enough, are as stale as they are futile.

And in case you were wondering what the point of all that bloviation was … it was just a rant. It’s frustrating, waiting and wishing for a better alternative to capital flight.

[*] unless the abbreviation damages rhythm too much

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That’s what happens when you have someone like Fred Thompson run a fraudulent, stalking-horse campaign solely to fracture the southern white/ evangelical vote.

People don’t just “take” a limitation of choices, as Thompson inflicted upon the party. They stay unhappy.

Voters may be dumb. Just not as dumb as GOP strategists think. Black turnout across the South will be through the roof, and white evangelical turnout will be depressed. November will bring nasty surprises for the GOP, not least of which will be a crippling “blue shift” in North Carolina and Virginia.

That said, considering idiotic posts like this, I don’t blame the GOP strategoi for appraising the Republican grasstops as the useful idiots they are:

This morning, Senator John McCain speaks at Wake Forest University. The speech begins at 10:00 a.m. Present with him will be Senator Fred Thompson. That’s important.

We’ve seen already that Thompson has been more visible in recent weeks. Why? Well, he’s decided to come out and support his friend. He is for conservatives what Joe Lieberman is for moderate squishes — a reassurance that John McCain will hear us. And given Thompson’s track record of getting McCain to listen to him, which is very good, we should take comfort in his presence by McCain today and on the campaign trail.

No, I don’t think this signals “Thompson as Veep.” In fact, I’m positive it does not. What I do think this signals is that Thompson is the guy McCain will listen to on conservative issues — Thompson will be the judge sherpa, making sure there are no Harriet Miers moments and plenty of John Roberts moments. …

I can practically hear the DCers laughing from here …

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More trash for the Fed to haul out?

Merrill Says Level 3 Assets Jump 70% in First Quarter (Update2)

By Joyce Moullakis

May 6 (Bloomberg) — Merrill Lynch & Co. said so-called Level 3 assets climbed 70 percent in the first quarter, as the largest U.S. brokerage reclassified commercial mortgages and other assets as hard to value.

Merrill’s Level 3 assets, the firm’s most difficult to value, rose to $82.4 billion as of March 28 from $48.6 billion at the end of December, according to a regulatory filing today. The New York-based company’s ratio of Level 3 to total assets rose to 8 percent from 5 percent.

While many subprime-related assets that lost almost 100 percent of their value since July were categorized in Level 3, other holdings such as private-equity stakes, real estate and rarely traded corporate debt are also included because market prices for them aren’t available. More assets have become difficult to value in the last three months as investors shunned a wider array of credit, freezing the trading of securities.

“Valuation-related issues confronted by ourselves and market participants since the second half of 2007 include uncertainty resulting from a drastic decline in market activity for certain credit products,” Merrill said in the filing.

Merrill fell $1.75, or 3.4 percent, to $49.65 as of 10:15 a.m. in New York Stock Exchange composite trading.

The company transferred $5.6 billion of European commercial mortgages and $12.2 billion of credit derivative assets to Level 3 from Level 2, the filing showed.

Merrill’s Level 3 assets include mortgage-related holdings which sit within trading assets of $9.3 billion, according to the filing. Derivative assets accounted for $20.6 billion, loans measured at fair value for $12.5 billion, credit derivatives for $18 billion and private equity and principal investments for $4.3 billion, it said.

Goldman, Morgan Stanley

Other New York-based securities firms have also had a rise in Level 3 assets. Goldman Sachs Group Inc.‘s holdings of the assets surged 39 percent to $96.4 billion in the fiscal quarter ending in February. Morgan Stanley reported a 6.1 percent increase to $78.2 billion.

Citigroup Inc., the biggest U.S. bank, yesterday said Level 3 assets rose by 20 percent in the first quarter to $160.3 billion.

Merrill also said it’s received requests from government departments for information on auction rate securities and the recent failure of auctions, the filing said. The firm is “cooperating” with the requests.

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I can barely find anything about the Muslim Brotherhood’s May 4 strike in Egypt so I assume that Mubarak’s measures to jack up wages 30 percent fizzled the strike.

And what do you know, the *next day* Mubarak proposes a 35 percent increase in fuel prices.

The Egyptian parliament’s ruling party proposed May 5 large increases on Monday in fuel and cigarette prices and in vehicle licence fees as a means of paying for the costs of President Hosni Mubarak’s recent proposal for public-sector pay raises, Reuters reported. In the proposal, the price of 90 octane fuel would rise 35 percent.

This story isn’t over … Egypt is going to spawn a lot of problems for us in the next few years.

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As someone who has spent an enormous amount of time analyzing what does, and what doesn’t, influence opinion polls, I have always maintained that the Obama “gaffes” — from the Pakistani nukes, to his general “lack of presidential stature” as proclaimed by overpaid Beltway bloviators, to Tony Rezko, Bill Ayers [1], and Jeremiah Wright today — will have zero impact upon the 2008 election. I am a big fan of empiricism, and we got a great empirical case study of the salience of Wright, Obama and Pelosi over the weekend in a Republican stronghold district.

LA-06, a Republican district formerly held by Richard Baker which went 55-43 for Bush in 2000, and 59-40 in 2004, had a special election on Saturday. On Charlie Cook’s Partisan Vote Index scale, this district has a +7R PVI. (Generally “swing districts” have PVIs between +5R and +5D.) The GOP has held this district for at least thirty years. Guess what happened?

LA-06: The Sweet Smell of Success

Sun May 04, 2008 at 03:07:49 PM PDT

Congratulations to Congressman-elect Don Cazayoux, new Representative of Louisiana’s 6th District, and to all who had a hand in his election. The Sixth District, which voted for Bush 55-43 in 2000 and 59-40 in 2004, will be represented by a Democrat for the first time since the Dixiecrat era.

This was a terrific win for the party, for a number of reasons. First, it is always exciting and inspiring to win an election in such strongly Republican territory. Only 15 Democratic Representatives out of 235 hail from more GOP-friendly districts than Louisiana’s 6th, and taking another seat on such red turf is yet another indicator that Democrats are in the catbird seat heading into November. This is the second special-election victory in a former Republican stronghold within the span of three months, and it was nearly accompanied by another victory in the crimson First District of Mississippi (and may yet be, come the May 13 runoff).

We had no real business winning this district, but we managed to do so anyway, by running a candidate who was a good fit for the district, by wisely allocating national party resources to help that candidate compete, and by simply being lucky enough to face a genuine nutcase on the Republican side.

Needless to say, this is a major feather in the cap of the DCCC, and a terrific blow to our Republican counterparts. NRCC chairman Tom Cole must be losing his breakfast, especially on the heels of the loss in IL-14, and facing another possible loss in an even redder district (MS-01). On our side, the DCCC did a fine job; they fended off the combined forces of the NRCC, Freedom’s Watch, and the Club for Growth, and came out on top.

The Club for Growth has been backing losing candidates for some time-they’re far more interested, it seems, in having doctrinaire nutters on the Republican ticket than in actually winning a majority-but this is a particularly bad black eye for Freedom’s Watch, a group which has already taken a lot of hits. Having targeted LA-06 as their first big experiment-apparently, backing Woody Jenkins was the first thing their leadership could agree on as a priority for this cycle-Freedom’s Watch looks positively impotent. They were supposed to be the scary new kid on the block, the shadowy Republican hit squad doing all the GOP’s dirty work this election cycle. But if they can’t swing a special election in an R+6.5 district, they’re going to have the devil’s own time swinging the presidential election.

As reported, the GOP’s strategy in this election was to tie Cazayoux to national Democrats like Barack Obama and Nancy Pelosi. I should think that the results speak for themselves, and that they indicate that this strategy has failed. …

At the very least, their efforts to demonize Cazayoux by linking him to Obama proved a double-edged sword. Although Woody Jenkins did outperform expectations in several areas of the district, and it’s possible that that was due to the NRCC’s attempts to link Cazayoux to Obama, it was certainly negated by increased black turnout in East Baton Rouge, which appears to have ultimately provided Cazayoux with his margin of victory. In other words, the GOP lost at least as much by alienating black voters as they may or may not have gained with these attacks.

Idiot Republicans.

“The Audacity of Hope” would make a great title for their 2008 national campaign blueprint.

250 Democrats in the House, ~57 Democratic senators, and a confident liberal in the White House. Say hello to 25-30% capital gains, 40% top marginal income tax (45 if Obama lifts the SS cap), and a very large selloff between October 2008 and January 2009.

[1] Speaking of Ayers, remember the Weathermen pardoned by Bill Clinton in 2001? Of course you don’t. Selective outrage is the opiate of the masses’ collective memory . . .

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Forget about NYC ever recapturing London’s financial crown. What sane hedge fund manager would de-privatize all his information, and submit to “surveillance” by the very Praetorians who have exacerbated every shock of the last 20 years?

Treasury eyes stronger powers for Fed

By Gillian Tett in London and Krishna Guha in Washington

Published: April 29 2008 23:23 | Last updated: April 29 2008 23:23

Meanwhile, data showed accelerating US house price declines and further declines in consumer confidence.

The Federal Reserve could use proposed new regulatory powers to try to stop credit and asset market excesses from reaching the point where they threaten economic stability, the US Treasury said on Tuesday.

David Nason, assistant secretary for financial institutions, said the Fed could even use its proposed “macro-prudential” authority to order banks, hedge funds and other entities to curtail strategies that put financial stability at risk.

By “leaning against the wind” in this way, the US central bank could “attempt to prevent broad economic dislocations caused by potential excesses”, he said.

His comments come amid debate inside the Fed as to whether it should try to do more to contain asset price bubbles, following the housing and dotcom busts. Some see enhanced regulatory powers as a better tool for this than interest rates.

The proposed new powers – outlined in a Treasury blueprint published last month – require legislation and may never be authorised. But policymakers see the plan as offering a template for future regulation.

The blueprint envisages giving the Fed roving authority to collect, analyse and publish market data from a wide range of institutions, from banks to hedge funds.

“The market stability regulator must have access to detailed information about all types of financial institutions,” said Mr Nason.

Hedge funds are uneasy about this proposal. However, many European central bankers are eager to acquire the kind of macro-prudential powers the Treasury would like to give to the Fed.

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What would happen when non-government T-bill chumps figure out that they’re getting between negative 5 percent and negative 9 percent real interest on a 2-year Treasury note?

… In March, consumer prices rose 0.34 percent, for an annualized rate of more than 4 percent, according to the U.S. Department of Labor. That’s only slightly lower than the 2007 annual rate of 4.1 percent – which was the highest inflation rate this decade.

On the other hand, so-called core inflation – which excludes energy and food prices because they are considered volatile – rose only 0.15 percent, or 2.4 percent over the past year, which is close to the Federal Reserve’s 2 percent comfort zone.

For the Federal Reserve, the core inflation rate amounts to a green light to continue its policy of lowering interest rates in order to keep the economy from falling into a deep recession. A higher inflation rate could conceivably make the central bank freeze or raise interest rates.

But many economists say the core rate does not show how inflation is affecting the typical consumer. Because salary raises for most people are not keeping pace with the rising cost of living, people are using a greater percentage of their wages to buy a smaller amount of goods.

“Food prices and the price of gas are really eroding the purchasing power not just of the working class, but people in the middle class, who are already beginning to have a hard time making ends meet,” said business-trend consultant Joel Kotkin.

John Williams, who spent more than two decades as an economic consultant to Fortune 500 companies, said the government figures understate the true rate of inflation. …

I am getting a little tired of hearing about food inflation, by the way. I bet that a hedge fund got about 100 people to buy massive amounts of food at bulk wholesalers around the country, loaded them on a container for China, and sold the rice for a gigantic profit. The food inflation meme is getting deafening.

Having said that, there’s no doubt that the Fed’s inflation statistics are dripping with phoniness. “Core inflation” is a joke and everyone knows it.

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