George Washington's Blog
Courage and Hope
For new readers who aren't familiar with my first website, here are some messages of hope and courage in these difficult times:
We Should Not Hold Off on Criticizing Obama Until He's Sworn In
In response to criticism of Obama's appointment of people who are not only at the center of the status quo, but who helped to create our current problems, many people argue that it is unfair to criticize Obama because he hasn't even been sworn in yet.
Are they right?
Well, as Naomi Klein says:
The key issue here I think coming back—the issue is Obama is coming to thesedecisions because he is under enormous pressure from above, Wall Street.
How do you transition from a pro Obama campaign movement to an independent social movement that puts will counter-pressure on him from below? Those are the conditions under which Roosevelt sold the new deal as a compromise to elite. We do not have those dynamics right now. We have a situation where we have super-fans for Obama, constantly apologizing for every decision that he makes versus a gloves-off elite who are putting real pressure on him behind the scenes. And we are seeing the result.
In other words, the elites are successfully pressuring Obama to appoint insiders like Summers, Geithner, Clinton, and Gates - who will ensure that nothing really changes - because the American people are idly sitting by taking a wait-and-see approach.
Indeed, they are guaranteeing that - instead of change - all the American people will get in return for their trillions in taxpayer debt is chump change.
Experts Warn of Food Shortages
The headline of an article on Bloomberg warns "Food Prices Will Rise, Causing Export Bans, Riots".
Leading economist Nouriel Roubini warns of possible food riots.
The Financial Times points out that farmers rely on credit, and credit is drying up.
One of the top experts on derivatives, economist Nassim Nicholas Taleb, warns
that supermarkets may not be able to borrow against their inventory, and will thus be forced to shut down.
I hope they're wrong. But when experts like Roubini and Taleb warn of a potential problem, I have to listen.
After Paulson Announces New $800 Billion Bailout, Credit Default Swaps Against U.S. Rise to All-Time High
You might assume that government bailouts would assure investors about the health of the U.S. economy. After all, the government is pulling out all of the stops to make sure that the economy recovers, right?
Actually, no. As Markit's Miles Johnson writes:
The news pushed the cost of protecting against US default over five years to an all-time high, rising 5 basis points to 49bp. The spread on ten year contracts too reached record highs, up from a close of 48bp to 53bp.
Why?
Maybe because investors are starting to understand that the U.S. is running out of the ability to raise more cash and may go bankrupt.
The U.S. isn't alone. As the above-described article by Johnson states:But the US isn’t the only country about which investors are increasingly concerned. Alistair Darling’s latest plan to resuscitate the UK economy has got the markets in a fluster too - UK CDS hits new highs every day.
How Could It Be Worse Than the Great Depression When We Have So Many "Modern Tools" to Address the Crisis?
Glass-Steagall and other Depression-era legislation was repealed based upon the claim that the modern financial system was totally stable.
The basis of this argument?
Yup, derivatives.
The financial boys thought they were so smart that they had modeled all potential risks for every investment or transaction using derivatives. And they convinced government regulators with their big talk.
Former Fed chairman Paul Volker explained that the entire modern financial system is based upon derivatives, and the financial system today is entirely different from the traditional American or global financial system because derivatives - a relatively new concept - now underly the entire fabric of the financial system.
How Are the New Tools Working for You?
Bernanke and Paulson and Congress constantly talk about all of the "tools" we have that weren't available to stop the Great Depression.
How are those new tools working for you, boys?
Not very well, as the worsening financial crisis shows.
Why aren't they working?
Economist, highly-regarded investment advisor, and one of the world's foremost authorities on derivatives Nassim Nicholas Taleb explains (together with the creator of fractal theory and chaos theory, Dr. Mandelbrot) that the financial crisis will be worse than the Great Depression because of derivatives. Specifically, in a PBS interview, Taleb explains that the architecture of the current financial system prevents frequent periods of instability, but that when instability does occur, it is on a catastrophic scale.
Taleb is saying that - in thinking they were so smart by trying to control risk through the all-pervasive use of derivatives - the financial gambers have created a perfect storm which will result in a crash worse than the Great Depression.
All of the fancy "tools" in the world cannot solve the crisis unless derivatives are tamed, because - as Volker says - the entire financial system is built like a house of cards on top of derivatives. Or, as many writers describe it, the world economy is getting sucked into a black hole of derivatives debt.
As a writer for one of the leading British newspapers said a couple of months ago, trying to calm the financial storm without dealing with the huge derivatives liability was building a canvass tent as one's strategy to weather a hurricane.
That is why former Goldman Sachs chairman John Whitehead, economists like PhD economist Krassimir Petrov, and even Bush are saying the current economic crisis is worse than the Great Depression.
They are right, unless derivatives are tamed.
More Proof That Uncle Sam Is In Trouble
PhD economist Marc Faber thinks the U.S. will go bankrupt. He's not alone.
Credit default swaps betting that America will default on its obligations keeps going up and up and up:
(click for full image; and see this).
The failure of Citigroup has put the viability of the entire banking system in question.
And as a MarketWatch commentator points out:
Washington needs credit counseling. The federal government has an $11.32 trillion credit limit, and it's carrying a balance of $10.66 trillion, according to a Treasury Department spokesman.
Government officials stress there's no borrowing planned as a result of Citigroup Bailout No. 2. But they also acknowledge the government doesn't have any cash to cover Citi's losses.***Throw in some tax cuts and declining demand for our debt overseas, and we have the ingredients for a toxic mix that could end up making our debt more expensive, even if we avoid default.
"There's no God-given gift of a 'AAA' rating," Standard & Poor's John Chambers told Reuters in September. "The U.S. has to earn it like everyone else."See also this.
Uncle Sam is in trouble.
Citigroup - Fresh From Being Bailed Out of Derivatives Black Hole - Now Selling Yet Another Type of Derivative
Citigroup has received $45 billion in direct bailout money, plus a guarantee of $306 billion. Citigroup was brought to its knees by - among other things - credit default swaps bet against it, and huge derivatives holdings.
Goldman Sachs and JPMorgan also each got $25 billion in taxpayer bailout money. The bailout money helped save them from the black hole of derivatives debt.
So what are these grateful companies doing now? Are they confessing about the error of their ways, and warning others to stay away from derivatives?
Uh, no.
They are using a type of derivative called "Default-Recovery Swaps" to bet against other companies. As Bloomberg writes:
Goldman... Citigroup ... and JPMorgan ..., which helped turn bets on company defaults into a $47 trillion market, are among banks offering wagers on the amount investors may recover from bonds after borrowers go bankrupt.
Credit-recovery swaps are trading on the debt of about 70 companies, including automaker General Motors Corp. and bond- insurer MBIA Inc. That’s up from 40 during the summer, according to Mikhail Foux, a strategist at Citigroup in New York. ***
Also known as recovery locks, the agreements are bought as insurance by sellers of credit-default swaps, such as banks, hedge funds and insurers.
“The market definitely has potential to grow,” Foux said. “As we see more defaults -- and there’s no doubt we’re going to see more defaults -- you’re going to see more recovery swaps trading.”***
Specifics about recovery-lock contracts aren’t generally available because they are made privately and don’t trade on an exchange.
So let me get this straight.
Instead of getting out of toxic derivatives, these recipients of taxpayer handouts are selling yet another type of derivative which allows people to bet against the failure of companies like GM - that the taxpayers are probably going to end up paying to bailout.
Citibank Is The Third Largest Holder of Derivatives. Do You Know Who Number 1 and 2 Are?
Citibank was the biggest, and was considered one of the most stable, banks a little while ago. But its derivatives exposure killed it.
However, Citibank was only the third largest holder of derivatives as of June.
Who were number 1 and 2?
JP Morgan holds around three times more derivatives than Citigroup. And Bank of America is number 2.
As Martin Weiss, PhD writes:
Bank of America was a somewhat bigger player, holding $39.7 trillion in derivative bets, with 93.4% traded outside of any exchange.
But JPMorgan Chase was, by far, the biggest of them all, towering over the U.S. derivatives market with more than double BofA’s book of bets — $91.3 trillion worth. This meant that JPMorgan Chase controlled half of all derivatives in the U.S. banking system — a virtual monopoly that tied the firm’s finances with the fate of the U.S. economy far beyond anything ever witnessed in modern history. Meanwhile, $87.3 trillion, or 95.7% of Morgan’s derivatives, were outside the purview of any exchange.
One bank! Making bets of unknown nature and risk! Involving a dollar amount equivalent to six years of the total production of the entire U.S. economy! In contrast, Lehman Brothers, whose failure caused such a large earthquake in the global financial system, was actually small by comparison — with “only” $7.1 trillion in derivatives.***
At Bank of America, the [Office of the Comptroller of the Currency] calculated that, at mid-year, the bank was exposed to the tune of 194.3% of its capital. In other words, for every $1 of capital in the kitty, BofA was risking $1.94 cents strictly on the promises made by its betting partners. If about half of its betting partners defaulted, the bank’s capital would be wiped out and it would be bankrupt. And remember: This was in addition to the risk that the market might go the wrong way, and on top of the risk it was taking with its other investments and loans***
And if you think that’s risky, consider JPMorgan Chase. Not only was it the largest player, but, among the big three U.S. derivatives players, it also had the largest default exposure: For every dollar of capital, the bank was risking $4.30 on the credit of its betting partners.
Paulson Changing TARP Program for the FIFTH TIME
Paulson is changing the purpose and scope of the TARP bailout program for the fifth time.
The New York Times discusses versions 1 through 3:
Now, he’s shifted gears again, and is directing Treasury to use the money to force bank acquisitions. [Version 3]"
Then, Paulson said he'd leave half of the $700 billion TARP bailout funds unused, for Obama to control. That's number 4.
Now, Paulson is changing his mind again, saying he wants to use the remaining $350 in bailout funds in connection with consumer asset-backed securities.
Paulson - who is acting like a dictator, and not taking input from anyone - is riling the economy with his constant changes as much as anything else.
No wonder Steve Forbes has called him the worst Treasury Secretary in modern times.
The Citigroup Deal is Lousy for America
The verdict on the Citigroup bailout is pretty much unanimous: its a terrible deal for America.
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"A bailout was necessary — but this bailout is an outrage: a lousy deal for the taxpayers, no accountability for management, and just to make things perfect, quite possibly inadequate, so that Citi will be back for more. Amazing how much damage the lame ducks can do in the time remaining."
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- Economist Paul Kedrosky:
- Financial advisor and analyst Yves Smith:
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Paulson and Bernanke: Ineffective, Dishonest, And Criminal
Everyone knows that Paulson and Bernanke's actions have been ineffective.
And they have been dishonest. For example, a New York Times article says that Paulson knowingly lied to Congress, and many people believe that Paulson has treated the U.S. like a banana republic. Indeed, as economist and former labor secretary Robert Reich said today:
“I think that the great bailout that he engineered was really sold to Congress on false pretenses,” Reich said on Late Edition.But they might also be illegal.
As Paulson himself said last week:
Federal law, and in particular the Anti-Deficiency Act, prohibits Treasury from spending money, lending money, and guaranteeing or buying assets without Congressional approval. The Federal Reserve can and does lend on a secured basis, but only if it expects not to realize losses. The Fed couldn't legally lend against the Lehman assets if it expected that loan to result in a loss of any size; this was much different than the case with Bear Stearns.According to the Government Accountability Office, the Anti-Deficiency Act prohibits any government officials from:
- Making or authorizing an expenditure from, or creating or authorizing an obligation under, any appropriation or fund in excess of the amount available in the appropriation or fund unless authorized by law. 31 U.S.C. § 1341(a)(1)(A).
- Involving the government in any obligation to pay money before funds have been appropriated for that purpose, unless otherwise allowed by law. 31 U.S.C. § 1341(a)(1)(B).***
- Making obligations or expenditures in excess of an apportionment or reapportionment, or in excess of the amount permitted by agency regulations. 31 U.S.C. § 1517(a).
More importantly, when Paulson switched from the original TARP plan of buying toxic assets to giving billions to banks, he arguably "involved[ed] the government in [an] obligation before funds [were approved by Congress] for that purpose.
As well-regarded economic Michael Hudson writes:
Congress did not approve the Treasury’s $250 billion of “preferred” stock investments in Wall Street banks.Moreover, Bloomberg's lawsuit demanding that the Federal Reserve reveal what types of assets it is accepting as collateral for its trillions of dollars of loans becomes more interesting in light of Paulson's comment that "The Federal Reserve can and does lend on a secured basis, but only if it expects not to realize losses."
As Hudson points out:
The Fed has refused to let Congress know any details – any details at all – about its cash-for-trash swaps with these institutions. This is what concerns Congress, and what has prompted reporters at Bloomberg to bring a lawsuit in order to discover and publicize the details. It is not hard to see why this curiosity exists. Hudson then implies that it is certain that the Fed will suffer tremendous losses on these assets.
Ineffective. Dishonest. And probably criminal.
But that's just par for the course for the Bush administration and their bipartisan allies in Congress.
Instead of Giving Citigroup $20 Billion and Guaranteeing $306 Billion in Toxic Assets, The Government Should Have Cancelled Credit Default Swaps
As of June, Citibank was perhaps the world's third largest holder of derivatives, with over thirty trillion dollars (nominal value) in derivatives.
On Friday, Business Week wrote about the risk of counterparties to Citigroup's credit default swaps defaulting on their payments to Citibank:
For each dollar of risk-based capital, Citibank was exposed to $2.58 in such credit risk on June 30 ....Citibank's parent corporation - Citigroup - is many times larger than Citibank. Given that Citigroup is a highly diversified financial services company, it is certain that derivatives were held by many subsidiaries besides Citibank, so Citigroup's total derivatives holdings had to have been a lot higher.
Today, the U.S. government is giving Citigroup another $20 billion dollars (in addition to the $25 billion already given), and guaranteeing $306 Billion in toxic assets.
Given that alot of Citigroup's toxic assets - which American taxpayers are going to have to pay for - are derivatives (and the failure of a major financial institution like Citigroup could have caused direct derivatives losses of $400 billion and indirect losses of $1.5 trillion), and given that part of the reason that Citigroup fell so fast is because piranhas bet against it using credit default swaps (driving the price of business way up), wouldn't it have been cheaper for the government to just rescind CDS owned or bet against Citigroup than to bailout Citigroup? Wouldn't canceling AIG's CDS have been cheaper than bailing out that giant?
And because all of the trillions spent and all of the dramatic measures taken by the government have completely failed to stabilize the economy, isn't it obvious by now that the only way to avoid a depression is to rescind the toxic CDS - the market for which is bigger than the world economy? Putting CDS on exchanges - the current proposal of the G-20, Bush, Bernanke, Cox and the gang - is too little, too late. We'll crash and burn before the exchange is even launched.
Nothing Paulson, Bernanke, Obama, Geithner or anyone else does will work unless these weapons of mass destruction are taken apart and buried in the ground piece-by-piece.
Again, the legal theory for rescinding CDS is that they were sold using fraudulent claims that they were fairly safe and risk-free. It is basic law 101 that fraud is basis for rescission of a contract, and CDS are a type of contract.And I am not for rewarding the purveyors of these weapons of mass destruction., but it would have been much cheaper for taxpayers if the government had bought out the CDS effecting the most vulnerable companies by "condemning them" in the same way the government uses eminent domain to condemn land, and to pay the sellers and/or holders of the CDS some small sum to compensate them. Again, I think they should be rescinded with no money spent. But if our leaders don't have the spine to do that, then condemn them and pay out some nominal sum. But deal with them - don't fritter away billions more on schemes which won't work because they don't address the core issues.
German False Flag in Kosovo
Reuters has the story on what is apparently the latest false flag operation:
Germany declined to comment on on Saturday on reports that three Germans arrested on suspicion of throwing explosives at an EU office in Kosovo were intelligence officers.
The explosive charge was thrown on Nov. 14 at the International Civilian Office (ICO), the office of EU Special Representative Pieter Feith, who oversees Kosovo's governance, but caused only minor damage. The men were detained on Thursday.
A spokesman for the German foreign ministry in Berlin confirmed that three Germans had been arrested, but declined to make any further comment as an investigation was under way.
A police source in Kosovo told Reuters: "They are members of the BND", but gave no further details.
The German weekly Der Spiegel also said the men worked for the German intelligence agency BND, and that they had told investigators they had been examining the scene of the explosion, but had not been involved in it.
Well-Known Financial Analyst Says PPT Manipulates the S&P 500
Frequent Bloomberg and CNBC commentator Scott Nations, President of Fortress Trading - a Chicago-based firm that trades options and futures - said in a CNBC interview that the PPT (Plunge Protection Team) manipulates the S&P 500.
This isn't big news, but it is impressive that Nations discussed the PPT on a mainstream news program.
The Bond Market is Expecting a Corporate Default Rate CONSIDERABLY HIGHER than the Great Depression
Junk bond guru Martin Fridson told Bloomberg on Wednesday:
We've Already GOT Deflation - The Only Question is Whether It Is the Good Kind or the Bad Kind
In an article entitled "Deflation: Disaster or Just A Nice Discount?", the Wall Street Journal says we've already got deflation:
When economists think deflation, they see looming disaster in the form of Japan’s deep recession of the 1990s or even the Great Depression.
But when U.S. households see deflation, they might just notice a little extra money in their pockets.
Right now, deflation appears to be that latter, better, variety: Every day is a sale.
Because people use the word "deflation" in different ways.
Everyone agrees that deflation is negative inflation. One economist writes:
Economists define deflation as a decline in the average price of the products and services in a market. Well, we certainly have a decline in the average price of goods and services right now. The U.S. has actually experienced many brief periods of deflation, so this is not uncommon.
Many people define deflation as a "persistent decrease in the general price level of goods and services." But no one agrees on how long deflation must be to be "persistent".
In fact, while they won't admit it, I believe that whether or not economists think we've got deflation comes down to whether they think we've got the "good" or the "bad" kind of deflation. Not on whether or not average prices or falling or the number of months they've been falling.
For example, the above-quoted Wall Street Journal notes:
What the Federal Reserve has to avoid is the kind of chain reaction that ensues when consumers and businesses expect prices to keep falling, leading to a downward spiral of lower spending and job cuts.***
We've already got deflation. The only question is whether it is the good kind - where consumers get a price break - or the bad kind, where the economy crawls to a standstill because no one is buying and employers slash wages and jobs.
The Austrian school of economics defines deflation as a shrinking money supply, and considers falling prices as simply a symptom of the smaller money supply. Personally, I agree with that definition. See this for more information.
Today's Economic Pulse: All-Time Swaps, Soaring Bond Risks and Failing Giants
Today's economic pulse is more accurately measured by the following developments:
- Credit default swaps are at all-time crisis levels, even higher than after the failure of Lehman
- Bond risks are soaring as the market returns to crisis mode.
- Citigroup - the world's largest financial services company - is saying "we're not insolvent" but looking for a buyer (sound familiar?)
As Bloomberg writes:
Citigroup, Inc., which fell 26 percent in New York trading today, is considering selling off pieces of the bank or the whole company, the Wall Street Journal reported online, citing people familiar with the matter.***
The government will do whatever it takes to stabilize Citigroup, including pouring more money into the company, because of the threat its failure would pose to the global economy, said Peter Wallison, a fellow at the Washington-based American Enterprise Institute.
As CNBC notes, Citigroup is also open to a merger:
Citigroup has already received $25 billion in bailout money, plus countless billions more in "loans" from the Federal Reserve. But it may very well go back to Paulson for more bailout money.
Even the Oracle Got Blindsided by the Severity of the Economic Crisis
The world's richest man, Warren Buffet, is nicknamed "The Oracle of Omaha" for his investment foresight.
Buffet's reputation is so great that when his investment company, Berkshire Hathaway, invested billions of dollars in companies like Goldman and GE, the stock market rallied on that news alone. Buffet's investing success is such that people figured if The Oracle was buying, the market must have hit bottom.
Buffet is also one of Obama's primary economic advisors, and his advice and assistance is sought by hundreds of CEOs.
But in a sign of the times, the Oracle's Berkshire Hathaway is in real trouble. BH is down 50% from its all-time high.
More importantly, as Bloomberg points out:
The cost of protecting against default by Warren Buffet's AAA rated Berkshire Hathaway Inc. has almost tripled in two months, a sign of just how skittish investors have become amid the global financial crisis.
The cost to protect against Berkshire being unable to meet its debt payments, based on credit-default swaps, is more than four times that of rival insurer Travelers Cos. At those levels, the swaps are typical of companies rated Baa3 by Moody's Investors Service, one level above junk. The price may have risen on concern that the billionaire's firm could lose a $37 billion bet on world stock market values more than a decade from now. ***
For the swaps to pay off, Berkshire would have to exhaust its $33.4 billion cash hoard, and Buffett's decades-long record as the world's most successful investor would have to come to a cataclysmic end.
And as financial analyst and former high-level derivatives trader, Roger Ehrenberg, writes:
Berkshire Hathaway is genuinely threatened by a potential run on its credit, due to contractual provisions in its derivatives agreements that could compel it to post more collateral at exactly the worst time . . . .
If we are even talking about Berkshire Hathaway being at risk, then ANY company is at risk of a run on its credit . . . .
Economic conditions are so bad that they even blindsided the Oracle.Central Bankers, Prime Ministers and Bond Holders Fear Deflation
The big boys - such as central bankers, prime ministers and big bond holders - are afraid of the threat of deflation.
An article today in the Guardian says:
With recession now a reality in major economies from Japan to Germany, policymakers are starting to fret about the chance of a phenomenon many see as even more deadly: deflation. ***
Prime minister Gordon Brown told the House of Commons yesterday: "Next year, the problem is deflation and the problem of inflation close to zero."Fortune Magazine writes:
Forget about inflation. The opposite threat - deflation - is what has policymakers sweating now.***
Bankers are worried that the destruction of trillions of dollars of wealth in the collapse of the housing and stock markets will stem demand for goods of all sorts, creating the kind of falling price environment not seen here since the 1930s. Among central bankers, there is "a real sense of concern about falling inflation," says Lena Komileva, an economist at interdealer broker Tullett Prebon in London. ***
Treasury bond investors are also betting on protracted deflation (and see this).
Update: Bloomberg writes:
"The Federal Reserve put deflation back on the table as a significant policy concern,'' said Vincent Reinhart, former director of the Fed's Division of Monetary Affairs, who is now a visiting scholar at the American Enterprise Institute in Washington. Note: I think we've already got deflation, and that it will eventually give way to hyperinflation.
Deflation: Here, Now
I've been warning of deflation for some time. Specifically, I predicted 1-1/2 to 2 years of deflation, followed by hyperinflation.
Well, deflation is here.
Specifically, consumer prices in the U.S. have declined the most since records began in 1947 (producer prices are also plummeting).
As Bloomberg writes:
"We are moving into an environment where prices are falling across the board,'' David Resler, chief economist at Nomura Securities International Inc. in New York, said in an interview with Bloomberg Television. "That is going to continue. Deflation is spreading across the economy.''
***Consumer prices were forecast to fall 0.8 percent, according to the median forecast of 77 economists in a Bloomberg News survey. Estimates ranged from a decline of 1.2 percent to a gain of 0.4 percent. Costs excluding food and energy were forecast to rise 0.1 percent, the survey showed.Many leading economists have recently changed their predictions to forecast deflation in 2009. And central bankers, prime ministers, and big treasury bond investors are all very worried about deflation. But I agree with the analysts who say that deflation is here, now (see this and this).
The Austrian school of economics points out that inflation and deflation are really about the size of the money supply, and not prices. The reason we have deflation is that it is difficult to pump money into an airplane with a hole in its side.
Remember, "cash is king" during a deflation, but gold may do well during the later stages of deflation.