Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Web Log - February, 2008


Victoria's Secret changes from "too sexy" to "ultra-feminine"

Yes, this story DOES have a generational angle.

One of the more demure pictures from the Victoria's Secret web site. It's a "Kate Fit bootcut pant," and it's "ultra-low rise for an ultra-sexy you."  A bargain at $69.50.
One of the more demure pictures from the Victoria's Secret web site. It's a "Kate Fit bootcut pant," and it's "ultra-low rise for an ultra-sexy you." A bargain at $69.50.

Sales have been plunging at Victoria's Secret stores, and CEO Sharen Turney said that a change is coming:

"We've so much gotten off our heritage ... too sexy, and we use the word sexy a lot and really have forgotten the ultra feminine. ... I feel so strongly about us getting back to our heritage and really thinking in terms of ultra feminine and not just the word sexy and becoming much more relevant to our customer. ... We will also reinvent the sleepwear business and focus on product quality. Our assortment will return to an ultra feminine lingerie brand to meet her needs and expectation."

From the point of view of Generational Dynamics, this is just one more indication of the sharp change in gender attitudes and roles that the country is experiencing as it enters a generational Crisis era.

The 1990s was a generational Unraveling era, and during such eras, "anything goes." Individual rights are paramount, and any political speech or sexuality or lifestyle is considered acceptable. While open sexuality is considered radical and progressive during an Awakening era (like America in 1960-70s), it's considered the norm in an Unraveling era, and generates a backlash during a Crisis era.

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Gender Issues
Feminist alert: Millionaires' mistresses and wives are biggest victims of financial crisis: Abusive, controlling husbands are forcing wives to do their own cooking and cleaning.... (5-Jul-2009)
A generational explanation of Iran's political crisis: What happens when an irresistible force meets an immovable object?... (23-Jun-2009)
Victoria's Secret changes from "too sexy" to "ultra-feminine": Yes, this story DOES have a generational angle.... (29-Feb-08)
ABC's Cokie Roberts conveys the frustration of feminists over Barack Obama: Obama himself is an empty vessel waiting to be filled.... (25-Feb-08)
Subprime mortgage executive kills wife and jumps off bridge to his death: There's a lot more to this story than the papers are telling.... (21-Jan-08)
Iran's President Ahmadinejad facing a growing "generation gap": Gas rationing and restrictions on women are infuriating the college-age generation.... (2-Jul-07)
Iranian police swoop down on women with loose headscarves: Sorry, I just can't stop laughing at this one.... (25-Apr-07)
Collapse of Duke rape case represents cultural change: False accusations against men are likely to occur less often now.... (22-Apr-07)
Activists accuse Fox's '24' of promoting torture.: In the end, it's just another way to bash our troops.... (18-Mar-07)
Boys, boys, boys! China is running out of girls.: A look inside a Chinese maternity ward... (1-Feb-07)
Feminism flourishes in Iran, as the international crisis on nuclear weapons intensifies: Iran's new president, Mahmoud Ahmadinejad, named a hardline Islamist cabinet on Sunday,... (15-Aug-05)
"It's going to be the 1950s all over again": Young women in droves are staying home to take care of the kids,... (11-Oct-04)
Gender gap replaced by a marriage gap or mother gap: The new phrase replacing "soccer moms" is "security moms," worried about their family's safety from terrorism.... (28-Sep-04)
CBS fined $550,000 because Janet Jackson bared her breast on MTV show: Women love "manly men"; the gender gap is narrowing. The sex revolution is over.... (24-Sep-04)
Vatican criticizes the "lethal effects" of feminism: This is one more indication, following the backlash against Janet Jackson's bared breast at the Super Bowl, that the sexual revolution is over.... (1-Aug-04)
China is getting more girls: With a huge surplus of boys, ultrasound exams are illegal in China,... (15-Jul-04)
The race and gender wars are abating: The amount of public polarization along issues of race, gender and crime has plummeted in recent years,... (30-Jun-04)
The New Sexual Revolution: The pendulum is swinging back. (27-Feb-04)
Schwarzenegger's victory could spell trouble for Bush: It also signals the end of the societal culture / gender wars. (8-Oct-03)

I've described all this many times on this web site. In "Iran's President Ahmadinejad facing a growing 'generation gap,'" I described how Iran, which is currently in a generational Awakening era, is experiencing the same kind of gender conflict that America experienced in the 1960s.

In America in recent years, there have been many, many signs of women returning to stereotypical female gender roles, which some feminists are viewing with horror, saying "'It's going to be the 1950s all over again.'"

I remember being really startled, just after 9/11, when newspaper articles said that women were being attracted to "manly men" again, and when firemen and policemen were being praised as heroes for their willingness to run back into burning buildings to save people. When I was growing up in the 1950s, if you had asked a boy what he wanted to be when he grew up, it's quite likely that he would have said "fireman" or "policeman" -- and a girl would have anwered "a mother." Those sentiments disappeared pretty much completely in the 1960s, but suddenly were returning after 9/11.

The same story is occurring all the time. Whether it's CBS being fined $550,000 because Janet Jackson had bared her breast on MTV's SuperBowl halftime show on CBS, or educated women choosing to stay home with the kids, or Cokie Roberts complaining that Hillary Clinton has been pushed out of the way by a "cute young man [who] comes in and says a bunch of sweet nothings," the story is the same: men and women are returning to their stereotypical gender roles.

This isn't the first time this has happened. America's previous generational Unraveling era was the 1920s "flapper" era, when female sexuality was as open and accepted as in the 1990s. It began to change as America entered a generational Crisis era in the 1930s, when open sexuality began to be criticized and questioned.

A sign of that transition is Cole Porter's title song from the 1934 show Anything Goes! Some excerpts from the song's lyrics are as follows:

"Times have changed,
And we've often rewound the clock
Since the Puritans got a shock,
When they landed on Plymouth Rock.

If today,
Any shock they should try to stem,
'Stead of landing on Plymouth Rock,
Plymouth Rock would land on them!

In olden days a glimpse of stocking
Was looked on as something shocking,
But now God knows,
Anything goes!

Good authors too who once knew better words
Now only use four-letter words
Writing prose,
Anything goes!

The world has gone mad today
And good's bad today,
And black's white today,
And day's night today,
When most guys today
That women prize today
Are just silly gigolos

So tho I'm not a great romancer
I know that I'm bound to answer when you propose
Anything goes!

When grandmama whose age is eighty
In night clubs is getting matey with gigolos,
Anything Goes!

When mothers pack and leave poor father
Because they decide they'd rather be tennis pros,
Anything Goes!

If driving fast cars you like,
If low bars you like,
If old hymns you like,
If bare limbs you like,
If Mae West you like,
Or me undressed you like,
Why nobody will oppose.

When every night the set that's smart is
Intruding in nudist parties in studios,
Anything goes!

If saying your prayers you like,
If green pears you like
If old chairs you like,
If back stairs you like,
If love affairs you like
With young bears you like,
Why nobody will oppose!

Just think of those shocks you've got
And those knocks you've got
And those blues you've got
From those news you've got
And those pains you've got
(If any brains you've got)
From those little radios.

So Missus R., with all her trimmin's,
Can broadcast a bed from Simmons
'Cause Franklin knows
Anything goes!"

The last verse is a reference to a "shocking" publicity campaign by Simmons Bedding Company featuring Eleanor Roosevelt, just before her husband, Franklin Roosevelt, became President.

And here's a video from a 2007 production of Anything Goes! with absolutely fantastically mind-blowing choreography:

The 1934 song "Anything Goes!" represents a transitional time in American attitudes towards sex. If, up to that point, good authors who "once knew better words now only use four-letter words" is true, then things had already changed dramatically by 1939 when Clark Gable's "I don't give a damn!" in the 1939 movie Gone with the Wind caused a scandal.

America is in a similar transitional time now, and Victoria's Secret's own transition is a microcosm. The "in your face" sexuality of the store is hurting sales because a new generation of young women is rebelling against the sexual attitudes of their older sisters and mothers. While young women of the 1960s complained about having to wear their mothers' girdles, young women of today don't want to see their mothers' negligées, at least not in public. Instead of "very sexy," Victoria's Secret is now talking about being "ultra-feminine."

My expectation is that the Victoria's Secret transition is far from complete. My expectation is that young women will see even the "ultra-feminine" message as being unacceptable, unless it's accompanied by a great deal more modesty. I'm not saying that women are going back to sleeping in ankle-length breeches, but I am saying that a retrenchment in open sexuality is in progress, and will continue for many years. (29-Feb-08) Permanent Link
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In Kenya, Kofi Annan's mediation talks collapse

Condoleezza Rice promises to take action, but exactly what is she threatening?

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Kenya's political coalition may collapse and lead to tribal warfare: Kenya is still reeling from the waves of gruesome ethnic violence... (18-Feb-2010)
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Ethiopians crush Islamists in Somalia, forcing retreat to Kenya: The problem is that Somalia may still not have a stable government.... (2-Jan-07)
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As I described when the violence first broke out, Kenya's last generational Crisis war was the Mau-Mau rebellion that ended in 1956.

Today, 52 years later, there are still a number of "elder" leaders around, aged 57 and above, who still remember the utter horror of the Mau-Mau rebellion, and will do anything possible to keep anything similar from happening again. Their children and grandchildren, however, don't feel so strongly.

Former UN Secretary-General Kofi Annan has been meeting with the "elders," and they're willing to look for a compromise, but they'll be killed by their younger supporters if the compromise goes too far.

Annan's effort never had a chance, as we've said. Kenya is UNLIKELY to spiral into a full-fledged ethnic civil war at this time, but in the next 5-6 years, when these aforementioned "elders" all disappear, a full-fledged ethnic war is a certainty.

So now Kofi Annan's mediation talks have collapsed.

Kofi Annan, you'll recall, considers the US to be the fount of most of the evil in the world. He condemned the US for intervening in Iraq, and condemns the US even more for NOT interfering in Darfur.

And now, Annan has one more failure to add to his resumé. He was mired in the mud of Saddam Hussein's money-for-oil scandal, and he whined for years about the Darfur civil war while it only got worse. Has he really ever accomplished anything except to pontificate?

Well, what's really shocking is the statement by US Secretary of State Condoleezza Rice. It goes through several paragraphs of diplomatic boilerplate, and then concludes:

"I want to emphasize that the future of our relationship with both sides and their legitimacy hinges on their cooperation to achieve this political solution. In that regard, we are exploring a wide range of possible actions. We will draw our own conclusions about who is responsible for lack of progress and take necessary steps. We will also exert leadership with the United Nations, the African Union, the European Union, and others to ensure that the political solution the Kenyan people deserve is achieved."

What "necessary steps" are we going to take? Omigod, we're not going to send in American troops, are we? I know that President Bush has been making some vague statements expressing sorrow that we didn't send troops into Darfur. He isn't looking to salve his guilty conscience in Kenya, is he?

From the point of view of Generational Dynamics, what's going to happen in Kenya is perfectly clear. There's a major fault line between ethnic groups -- The Kikuyus and their allies versus the Luos and their allies. The low-level violence we've been seeing will continue for weeks or months or years until something triggers the new genocidal crisis war that we've been referencing. Then there'll be massive slaughter between these ethnic groups. Probably one side will win, and the other side will come close to being exterminated. That's absolutely certain; only the exact dates are in doubt, although it's pretty certain within 5-10 years.

But all this is going to happen with or without Kofi Annan, with or without American troops. It's already "in the cards," as they say.

In that time frame, the "clash of civilizations" world war will be in full swing. We'll be dealing with our own wars of extermination. Let's hope that we don't get mired in a Kenya quagmire before then. (27-Feb-08) Permanent Link
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UN World Food Program to institute food rationing

Surging food prices are causing food riots around the world.

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Food panics and riots spread around the world: The unending sharp price wheat, corn and rice prices are destabilizing nations.... (9-Apr-08)
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Wheat price rises blocked by commodities market price increase limits: American wheat stockpiles are lowest since just after World War II.... (9-Feb-08)
Wheat prices surge above $10 per bushel, sparking little concern: World food stocks dwindling rapidly, according to the UN.... (23-Dec-07)
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The global warming fad is becoming the enemy of food production.: Food prices are continuing to increase sharply around the world.... (16-Jul-07)
Price of food is skyrocketing in India and China: In fact, crop prices are increasing around the world,... (11-Apr-07)
In Mexico, violent crime from drug cartels increases with tortilla prices: After Acapulco incident, Canada may advise citizens not to travel to Mexico.... (8-Feb-07)
UN World Food Program will cut Darfur humanitarian rations in half: This continuing genocide is a very sad situation, but it can't be stopped.... (29-Apr-06)
In a new bizarre move, North Korea demands an end to U.N. food aid: The famine-stricken country officially told the UN World Food Program... (26-Sep-05)
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China appears to be approaching a major civil war : Unrest is spreading, and economic disparities make China a textbook case for a massive civil war in the making (16-Jan-2005)
Green Revolution vs Malthus Effect: Despite the "Green Revolution," world population continues to grow faster than food production. This is one of the fundamental reasons why wars occur. (28-Jun-2004)

It will be no surprise to the regular readers of this web site that there's a real emergency going on in the world, and I'm not referring to the fad "emergencies" like climate change.

Food prices around the world continue to surge uncontrollably. Overall, prices of food are up 40% in the last year. This may not mean much to most Americans, since food is a relatively small part of the American budget. But in places where average earnings are less than a dollar a day, this throws more people into starvation.

UPDATE: After this article was posted, wheat prices have hit fresh highs. Wheat on the Chicago Board of Trade (CBOT) rose the maximum 90 cents allowed to $11.99 a bushel. (The 30 cent limit that I mentioned recently has been increased to 90 cents.) And Financial Times reports that prices of top-quality wheat jumped 25 per cent on Monday in Kazakhstan, a central Asian country that's one of the world's largest exporters of wheat. (This paragraph added on Feb 26.)

The United Nations World Food Program (WFP) is responsible for distributing food to world regions hit by war, natural disaster, or poverty.

However, food prices have been rising so rapidly, that the WFP's budget requirements have been rising by tens of millions of dollars PER WEEK.

According to the WFP's Josette Sheeran, we're "seeing a new face of hunger in which people are being priced out of the food market" with hunger now "affecting a wide range of countries", pointing to Indonesia, Yemen and Mexico in particular.

According to news reports, food riots have broken out in Morocco, Yemen, Mexico, Guinea, Mauritania, Senegal and Uzbekistan. Pakistan has reintroduced rationing for the first time in two decades. Russia has frozen the price of milk, bread, eggs and cooking oil for six months. Thailand is also planning a freeze on food staples. After protests around Indonesia, Jakarta has increased public food subsidies. India has banned the export of rice except the high-quality basmati variety.

There's little doubt that this can go on much longer. One of the features of the modern world is the success of modern medicine, and the reduction of the infant mortality rate, from 40-50% in the early 1800s to 1-2% today. This has created huge masses of young people around the world, often packed into huge "megacities," each containing tens of millions of people with no access to farmland. Families in poverty in those cities often survive by foraging in large garbage dumps for scraps of food left over by people who can afford to buy food. With the worldwide price of wheat doubling in the last year, and other food prices increasing as well, there are probably tens of millions more people in the world each month who have to forage through garbage dumps. Each month, more and more men are unable to feed themselves and their families, and their only choice for survival will be either mass rebellion or to join the army and go to war.

What never ceases to amaze me is how little attention this problem gets. We've just spent the weekend listening to the most bilious nonsense about whether it's plagiarism to quote someone who quoted the words, "We hold these truths to be self-evident." Can you think of a more moronic and fatuous debate?

But not a word about what is undoubtedly the greatest emergency in the world today -- the increasing starvation of millions of people, and the resulting instability.

From the point of view of Generational Dynamics, the world is headed for a "clash of civilizations" world war, with absolutely certainty, and it's just possible that it will be launched somewhere because a "tipping point" was passed in the growing price of food. (26-Feb-08) Permanent Link
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Investors euphoric as bond insurers' AAA ratings are re-affirmed

You could've knocked me over with a feather.

Unlock this door
Unlock this door

Boomers reading this web site may recall hearing the following on television many times during their youth: "You unlock this door with the key of imagination. Beyond it is another dimension. A dimension of sound. A dimension of sight. A dimension of mind. You're moving into a land of both shadow and substance of things and ideas. You've just crossed over into the Twilight Zone."

On Monday, S&P Ratings re-affirmed the AAA rating of "monoline" bond insurers MBIA Inc and Ambac Financial Group. Investors became so euphoric that they pushed the stock market up 189 points in the Dow Industrials.

I went to the S&P web site, and found the statement explaining their reasoning. It contains this text on MBIA:

"The ratings on MBIA Insurance Corp. ... were affirmed and removed from CreditWatch Negative; the outlook was changed to negative. In our view, MBIA's success in accessing $2.6 billion of additional claims-paying resources is a strong statement of management's ability to address the concerns relating to the capital adequacy of the company. It is also a strong statement by investors of their understanding of MBIA's franchise value and business practices. To further improve the company's claims-paying resources, management is pursuing alternatives to reshaping the insured portfolio through reinsurance transactions. We believe management is likely to succeed in implementing their reinsurance strategy.

However, the reversion back to a negative outlook is warranted in light of the absolute size of stress scenario losses relative to the adjusted capital cushion, as well as the uncertainty surrounding a possible reconfiguration of the company. In our view, several factors--the viability of the resulting corporate structure, investor acceptance, the effect on the company's franchise value, and the potential for disadvantaging any group of policyholders with regard to the availability of claims-paying resources--will require further assessment."

This is a pretty mealy-mouthed statement. They're saying (my paraphrase):

"MBIA obtained $2.6 billion of financing, which they can use to pay out claims on the tens of billions of dollars in CDOs that it insures, based on some assumptions that we've put together. If that isn't enough money, we think that MBIA can get some more money, so we're going to let them keep their AAA rating. But we're not sure that MBIA will really be able to get enough more money, so we're saying they have a 'negative outlook.' So we're covered, no matter what happens. Ha, ha."

We have to look at motivations here. S&P, along with other bond ratings agencies, took fat fees from bond issuers in return for giving AAA ratings on the CDOs, and did so long after it was clear that these CDOs were seriously flawed. They essentially lied for months. There's no reason to assume that they wouldn't lie now, if they felt that lying would be to their advantage.

MBIA, along with other bond insurers, took fat fees from bond issuers in return for insuring CDOs in order to give them AAA ratings, and did so long after it was clear that these CDOs were seriously flawed. They essentially lied for months. There's no reason to assume that they wouldn't lie now, if they felt that lying would be to their advantage.

(For those interested in the math behind the creation of CDOs from mortgage-backed securities, and how they get AAA ratings from "monoline" bond insurers, see "A primer on financial engineering and structured finance.")

We're now in the middle of a huge political battle, headed by New York Insurance Superintendent Eric Dinallo, to arrange a bailout of the bond insurers. This bailout involves money from the banks whose CDOs are in danger of losing their insurance and a signoff from the ratings agencies that they won't downgrade the insurers' AAA ratings.

If the bailout doesn't work, then it's widely believed that the stock markets will fall sharply, and whoever didn't cooperate in Dinallo's scheme would receive all the blame.

So the banks are willing to spend a few billion on financing MBIA and the others, because they're going to lose at least that much anyway, writing down CDOs in their portfolios. And the ratings agencies are willing to sign on, because otherwise they'll be blamed.

Everyone has major conflicts of interest, and no one has any credibility.

But let's look at this in another way.

Suppose that you own a house, and you have a homeowner's insurance policy that protects you against things like fires and robberies and other stuff that homeowner's policies are supposed to cover.

And suppose that your house is worth $200,000. (Let's assume these are normal times, and there's no deflating housing bubble, so the $200,000 is a real number.)

OK. One day you read in the newspaper that your insurance company is in some financial trouble, and they've lost their AAA rating.

So now your house is worth only $50,000.

Huh??? Is your house worth $200K or $50K? Why should your insurance company's problem mean that your home's value has fallen by 75%? That makes no sense at all.

But that's what we're talking about with these bond insurers. This is all part of the magic and alchemy that was dreamed up by the Generation-X genius "financial engineers" who set all this stuff up.

Let's use round numbers. There are, say, $60 billion of at-risk CDOs in the portfolios of various banks. They're all AAA rated, because a bond insurer has insured them against default.

Suddenly the bond insurer's rating goes down. The CDOs are now worth only $15 billion.

Huh??? Are these CDOs worth $60 billion or $15 billion? How can they fall in value by 75% just because the bond insurer loses its rating?

So now, someone gives the bond insurer $3 billion in credit. By magic, the CDOs go from $15 billion in value back to $60 billion in value.

You're entering the Twilight Zone
You're entering the Twilight Zone

DOO do DOO do
DOO do DOO do

Let's look at one more aspect of this, by going back to the $200,000 house that's worth only $50,000 when the insurance company gets into financial trouble. How could that ever be possible? (This and subsequent paragraphs were added on Feb 26.)

There's only one way it could be possible: The only reason your house was ever worth $200K is that you expect it to burn down, so that you can collect the insurance. Your house is worth four times as much if it burns down than if it stays up.

Translate that reasoning into the CDO case, and you see what's going on. You have $60 billion in CDOs, but they're worth only $15 billion when your bond insurance company gets into trouble. How could that ever be possible?

There's only one way it could be possible: The only reason that the CDOs were ever worth $60 billion is because you expect them to default, and the owners can collect the insurance.

Taking that reasoning a step further, if the industry is expecting $500 billion in additional CDO writedowns that can be avoided only if the bond insurers retain their AAA ratings, that can only mean one thing: That the $500 billion is going to come from payouts by the bond insurers. There's no other possibility.

When S&P reaffirmed MBIA's rating on Monday, they didn't follow that reasoning. Instead, they assumed that only a small fraction of the CDOs would default. That's why S&P's action is essentially fraudulent. But these financial institutions have been committing fraud with CDOs for a long time now, and so this is nothing new. The only really new thing is that the government, in the form of New York Insurance Superintendent Eric Dinallo, is fully involved in the fraud.

I've quoted the passage below before, but it's worth doing again. This is from John Kenneth Galbraith in his 1954 book, The Great Crash - 1929:

"A bubble can easily be punctured. But to incise it with a needle so that it subsides gradually is a task of no small delicacy. Among those who sensed what was happening in early 1929, there was some hope but no confidence that the boom could be made to subside. The real choice was between an immediate and deliberately engineered collapse and a more serious disaster later on. Someone would certainly be blamed for the ultimate collapse when it came. There was no question whatever as to who would be blamed should the boom be deliberately deflated. (For nearly a decade the Federal Reserve authorities had been denying their responsibility for the deflation of 1920-21.) The eventual disaster also had the inestimable advantage of allowing a few more days, weeks, months of life. One may doubt if at any time in early 1929 the problem was ever framed in terms of quite such stark alternatives. But however disguised or evaded, these were the choices which haunted every serious conference on what to do about the market." (p. 25)

Galbraith's paragraph describe's precisely what's going on now with Dinallo's working sessions, and in meeting rooms in banks around the world.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (26-Feb-08) Permanent Link
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Der Spiegel: Germany's public banks are near collapse

The "subprime virus" is spreading rapidly through Europe now.

These days, when pundits refer to a bank as "going to the confessional," they mean that the bank is making its latest announcement of how many billions of dollars it's losing because it has to write down worthless or near-worthless CDOs in its asset portfolio. Some banks and financial institutions have been to the confessional several times.

But in fact very few banks been to the confessional. Most have been sitting on their assets, waiting until either the problem goes away, or until someone sticks a gun to their backs.

German bank IKB - a bottomless barrel <font size=-2>(Source: Spiegel)</font>
German bank IKB - a bottomless barrel (Source: Spiegel)

That's what's happening to many of Germany's state-owned banks right now. The result is that these banks are turning to Angela Merkel's German federal government for bailouts.

The most dramatic situation is at Düsseldorf-based IKB Deutsche Industriebank AG. It began requiring bailouts with the international "credit crunch" financial crisis that began last August, and has has required one additional bailout after another, with a €1.5 billion ($2.2 billion) approved just last week. And there's no guarantee that further bailouts won't be required.

Another state-owned bank, WestLB, has received a €5 billion ($7.4 billion) rescue package. Sachsen LB has received €2.73 billion in loan guarantees from the states, as well as €14 billion from other state-owned banks. Nordbank needs €1 billion, while BayernLB just reported a €1.9 billion writedown, as a result of infection by the subprime virus.

Where did these German banks obtain all these CDO securities that were supposed to make them rich? Why, they obtained them from Swiss banking giant UBS AG, which itself has been to the confessional several times, has had to take a whopping $18.4 billion in writedowns.

Germany's Nordbank, for example, purchased some $15.6 billion worth of CDOs from UBS six years ago, as a low-risk high-yield investment. On Saturday, Nordbank announced that it was suing UBS, claiming that the investment had a much higher risk than UBS let on.

So let me get this straight. The guys at Nordbank (which, incidentally, is worth about €207 billion in assets), were so dumb that they let those sharp cookies at UBS snooker them into buying $15.6 billion of CDOs that are now turning out to be near-worthless. It's nice to know that, as we head for a time when great masses of people are going to be unemployed, bankrupt and homeless, that Nordbank's lawyers and UBS's lawyers are going to have plenty of money to spend on their yachts and mistresses.

Unfortunately, German bankers are still fooling themselves, if we're to believe the words of Rainer Skierka at Bank Sarasin. He referred to a recent announcement by Credit Suisse of massive further writedowns and said, "Credit Suisse was seen as transparent and more credible than other (banks). This has now all disappeared and it has lost substantial credibility over recent days."

But then he says that for other banks, there's only one problem left: "The only problem is the monoline insurers and what implications (weakness in that sector) might have for banks," he said.

This is a common fantasy that we've mentioned before. The "monoline" bond insurers are part of the alchemy that gave near-worthless CDOs their AAA ratings.

(For those interested in the math behind the creation of CDOs from mortgage-backed securities, and how they get AAA ratings from "monoline" bond insurers, see "A primer on financial engineering and structured finance.")

So the fantasy is that all these bailouts of all these banks can be avoided, if only the bond insurers are bailed out first. Then the bond insurers can work their magic again, and near-worthless CDOs in everyone's portfolios would suddenly get back their old bubble value, and the bubble can start growing again.

Incidentally, there's presumably been a high-profile working session going on all weekend, headed by New York Insurance Superintendent Eric Dinallo, who's trying to get everyone to agree to a bailout of the bond insurers. There are all sorts of screwy ideas on the table, but since the intention is to find a way to get the bubble to start growing again, they're all mathematically impossible.

As of this writing on Sunday evening, the Wall Street Journal is reporting that Ambac, the second-largest of the bond insurers, has obtained $3 billion in financing, allowing it to continue in business at least on the municipal bond side of its business, with the CDO side of its business still in doubt.

However, that's far from enough to reflate the credit bubble that's now leaking like mad.

So that leaves the German public banks left in their state of crisis. According to Der Spiegel:

"If an industry giant like WestLB were forced to its knees -- which almost happened two weeks ago -- at least two other state-owned banks and a dozen savings and loan associations would crumple along with it. The member banks of the German Savings Banks Finance Group (Sparkassen-Finanzgruppe) are closely interlinked, and they are required to vouch for each other -- as long as they are in a position to do so, that is. The failure of a major state-owned bank like WestLB would also inevitably affect corporate customers, even forcing some into bankruptcy.

It is a nightmare scenario that the government financial supervisory authority now believes is increasingly likely. Germany's public-sector banks speculated far more heavily than private banks in American subprime mortgage securities. Now these banks' beleaguered executives are calling on the government to bail them out from a disaster of their own making. ...

In other words, [the argument went,] WestLB failure would deeply jeopardize Köln-Bonner Sparkasse, as well as at least three other savings banks in North Rhine-Westphalia.

If that happened, the corporate customers of the affected banks could end up without access to their money for weeks, possibly even months. Despite the fact that the customers' deposits are in fact guaranteed, any bank insolvency is preceded by a moratorium on all bank transactions. This ... would only lead to further bankruptcies, especially since the remaining savings banks in North Rhine-Westphalia, as their association presidents conceded, would have trouble satisfying the regional economy's liquidity requirements, because they already have a total of €43 billion in WestLB loans on their books. Furthermore, many of these banks also invested in American subprime mortgage securities, which they too would have to write off. The Westphalia-Lippe savings bank association, for instance, invested €100 million in the securities that triggered the worldwide financial crisis.

The officials involved painted grim scenarios. What would happen if customers were to withdraw their deposits from the savings banks en masse? And what if the insolvency of WestLB led to difficulties at two other state-owned banks, HSH Nordbank and BayernLB? How would that affect Bavaria and Hamburg, where the banks are headquartered? Would the public-sector banking system even be capable of surviving the failure of three state-owned banks? Could this in fact lead to the collapse of the entire economy, which would affect growth rates, unemployment and, ultimately, the well-being of society for many years to come? In the end, the participants were so drained that they agreed to a compromise.

Six months ago, BaFin president Jochen Sanio was heavily criticized when he warned of the "worst financial crisis since 1931." But now many politicians are convinced that the situation is far more serious than they had assumed until now."

The date 1931 is as symbolic to German financiers as 1929 is to Americans, as described in "The bubble that broke the world."

On May 11, 1931, the Credit-Anstalt bank of Austria failed. This triggered mass panic and bank failures throughout Central Europe, and generated a worldwide banking crisis. On July 13, the German Danatbank failed. Foreign investors in Germany quickly withdrew their capital from Germany, heightening the crisis, leading to the complete collapse of the German economy. By the end of the year, there were over 6 million unemployed, and the resulting social tension gave rise to Communism and Naziism.

And so, there are many justified fears about what's going on in Germany today. The German public banks are heavily interlocked with one another, and are required to support each other when one is in trouble. I don't know the history of German banking, but I'd be willing to bet that this interlocking scheme was put into place in order to avoid another disaster like the one in 1931.

If a bank is in trouble, its peer banks are supposed to help out, rather than allow a bank to fail, with the resulting public panic. But how is that supposed to work when all (or most) of the public banks are failing? What if they all got infected by the "subprime virus," because they all invested heavily in AAA rated high-yield CDO securities? How can they bail each other out, when they ALL need bailing out?

That's the situation facing Germany today; that's why the federal government is being forced to provide bailout money to the banks; and that's why everybody in Germany's financial community is scared to death. (25-Feb-08) Permanent Link
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ABC's Cokie Roberts conveys the frustration of feminists over Barack Obama

Obama himself is an empty vessel waiting to be filled.

"Obama Girl" is selected as randomly chosen questioner on a <i>Saturday Night Live</i> skit mocking the press's adoration of Barack Obama.  Her "question" turns out to be her song, "I've got a crush on Obama." <font size=-2>(Source: NBC)</font>
"Obama Girl" is selected as randomly chosen questioner on a Saturday Night Live skit mocking the press's adoration of Barack Obama. Her "question" turns out to be her song, "I've got a crush on Obama." (Source: NBC)

I always say on this web site that Generational Dynamics is concerned with the attitudes and behaviors of large masses of people, entire generations of people. The attitudes and behaviors of politicians are irrelevant, except insofar as they reflect the attitudes of the great masses of people.

The rise of Barack Obama surely fits this category. There's been a huge surge in support for Obama among Democrats, and even among some Republicans. This support has translated into historically high campaign contributions from tens of millions of people. That a major change is going on is without question.

And it's pretty clearly a generational change. As I wrote a year ago in "Barack Obama to Boomers: Drop dead!" Obama has captured the enthusiasm of Generation-Xers by capturing and expressing their hatred for the Boomer generation. According to Obama:

"[Americans should turn to Generation-X] after the campus culture wars between freaks and straights, and after young people had given up on what überboomer Hillary Rodham Clinton called in a 1969 commencement address a search for 'a more immediate, ecstatic and penetrating mode of living.' ...

In the back and forth between Clinton and Gingrich, and in the elections of 2000 and 2004. I sometimes felt as if I were watching the psychodrama of the baby boom generation — a tale rooted in old grudges and revenge plots hatched on a handful of college campuses long ago — played out on the national stage."

On ABC's news interview show, This Week With George Stephanopoulos, on Sunday morning, Boomer feminist commentator Cokie Roberts expressed her frustration with Obama's success:

"What happened [to Hillary Clinton]? Wisconsin happened. She lost too much in Wisconsin, and she lost too many groups that had been with her. The only group she still has is white women, and I do think that there's some possibility that you will see a sort-of reaction among white women.

I had the opportunity to interview Billie Jean King this week, and she said, "You know, I feel that everything I've worked for all of my life is going out the window."

Cokie Roberts saying "cute young man" on <i>This Week With George Stephanopoulos</i>  <font size=-2>(Source: ABC)</font>
Cokie Roberts saying "cute young man" on This Week With George Stephanopoulos  (Source: ABC)

And there is that sense. I mean, here is this woman, she's worked hard, she's done it all the way you're supposed to do it, and then this cute young man comes in and says a bunch of sweet nothings, and pushes you out of the way. And a lot of women are looking at that and saying, "There goes my life."

Well, that's the way life is. Roberts' characterization of the battle between an older woman and a "cute young man" misses the mark, insofar as she believes that this is a man versus woman issue. It's not a gender issue. It's not a feminist issue. Gender and feminism are irrelevant. It's a generational issue.

For decades, Gen-Xers have been living in the shadows of the Boomer generation, and have developed enormous fury at and hatred for the Boomers. Now it's the Xers' turn, and they'll brush the Boomers aside. A collection of frustrated feminist politicians will have nothing to say about it.

There's a piece missing from the Obama campaign and Obama himself: A political philosophy, especially a foreign policy philosophy.

On this web site, I've frequently expressed contempt for Washington politicians on the left and right for not knowing basic facts about what's going on in the world.

This is certainly true of Obama. His remarks about unilateral withdrawal from Iraq are irresponsible, and his remarks about pre-emptive American attacks on Pakistan soil are extremely dangerous. These remarks show that he has no "antiwar" philosophy, and in fact no philosophy at all.

President George Bush has admitted many times that he had no real political philosophy until 9/11, after which he devoted his Administration to the war against terror.

Assuming that Obama becomes President, what political philosophy will he adopt? He doesn't know -- right now he's an empty vessel. And his enthusiastic, euphoric supporters don't know either -- except that they believe that he's going to "bring change," although they don't really know whether the change will be good or bad.

The "change" that feminists are seeing is particularly ironic. I've never really understood what even feminists believed that they wanted for women in the workplace, since in my decades in the computer industry I've never, except for once or twice, seen any woman who was willing to put in the long hours in the workplace that many men put in as a matter of course. As I wrote in "'It's going to be the 1950s all over again,'" young women themselves, even well-to-do well-educated young college women, are choosing more and more to stay at home with the kids, much to the horror of Boomer feminists.

So it's been clear now for some years that Gen-X women have little use for Boomer feminism, just as Gen-X financial engineers have little use for credit restraint that was practiced by Boomers' predecessors.

What will happen now if a Gen-Xer becomes President? In what ways will his contempt for Boomers be expressed? Will his naïveté lead us to war more quickly, or will his youthful earnestness calm international fears for a while? And when the "clash of civilizations" world war comes, as it must, will he panic and lead the nation initially to disaster -- as Franklin Roosevelt and Abraham Lincoln did initially in WW II and the Civil War, respectively -- or will his responses be more measured?

If and when Obama takes office, what we're most likely to see is a repeat of the public manic-depressive behavior that followed the Democratic Congressional election victory in 2006. That election was to "bring change" as well. A couple of weeks later, Donald Rumsfeld resigned, and the journalist David Gergen described in giddy terms, "This is the best moment we've had in over three years." The giddiness didn't last though, as could be seen when the new Congress came to town, and it was apparent that "change" wasn't going to happen. NBC newsman Chris Matthews spoke for the left when he launched an ignorant and vitriolic screaming rant against President Bush.

After the 2006 elections, the desire to effect change, no matter what change, no matter how irresponsible, was blocked by President Bush. If Obama takes office with the Democratic party in control of Congress, then public demands for "change" may cause a young President, anxious to prove his toughness, to panic and do something dangerous. That's what happened with President Kennedy and the Bay of Pigs disaster, for example.

The desire for change, led by Gen-Xers, that's now sweeping the nation will affect the character of our response to the massive world war that coming, but we have no way of knowing what form that response will take.

    My death waits like an old rouée
    So confident I'll go her way
    Harvesting the passing time

My death waits like a princess At the funeral of my youth Crying for the passing time

My death waits like a wicked witch At the torching of our wedding Laughing at the passing time

But whatever lies behind the door And what's waiting for me there, Angel or devil, I don't care, For in front of that door, there is you. -- From Jacques Brel, La Mort

Whoever is our next President, whether Barack Obama or someone else, we won't know what's behind the door until he (or she) opens it. (25-Feb-08) Permanent Link
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Anti-western violence grows in Serbia over Kosovo independence

Russia hints at using force on the side of Serbia.

A couple of days ago, I commented on the secession of Kosovo from Serbia as something that would certainly not bring peace to the region.

Now violence has been breaking out in Serbia, demonstrating against Kosovo's independence. The American embassy in Belgrade, the capital of Serbia, was attacked and burned by a mob on Thursday, in protest of the US recognition of Kosovo's independence.

There have been massive demonstrations in the city of Mitrovica, a city that's now in Kosovo, but has a very large Serbian population.

Analysts have expressed concern that the violence will spiral out of control spontaneously into a new Balkans war. This is, of course, completely impossible: This region just had a crisis war in the 1990s, and is now in a generational Recovery era (also called a High or Austerity era). So a major war of this type is completely impossible.

But it's well to review some of the thoughts that are going through people's minds.

It was June 28, 1914, that terrorists from Belgrade assassinated Austrian Archduke Francis Ferdinand, triggering the Great War and the massive slaughter of tens of millions of people. Germany got pulled into the war against its will, because of mutual defense treaty with Austria; it fought half-heartedly, and was forced to capitulate mainly because of political protests in Berlin. France got pulled in because it was allied with Russia and was attacked by Germany. America got pulled in because of an alliance with the UK. This was a non-crisis war for all of these countries.

This was a real crisis war for Russia and Turkey (the Ottoman Empire), the two main representatives of the Orthodox and Muslim civilizations at the time, and was the continuation of their long-held mutual genocidal hatred. The war led to the destruction of both countries, as Russia's Bolshevik Revolution ended six centuries of Tsarist rule, and the destruction of the Ottoman Empire ended six centuries of Muslim unity and a caliphate in Istanbul.

Now let's move back to today. The Balkan states have already had their next crisis war, in the 1990s, about 70 years after the end of World I. Russia and Turkey have not. They are both deep in a generational Crisis era. They are both increasingly xenophobic. Old religious practices are reasserting themselves, as the Kremlin is getting closer to the Russian Orthodox Church, and Islamists have replaced secular politicians in the Turkish government.

New violence in the Balkans is bound to fizzle out if it's allowed to. That's most definitely not the biggest danger now.

The biggest danger now is that Russia (which identifies with Orthodox Serbia) or Turkey (which identifies with Muslim Kosovo) may decide to intervene. A confrontation between Russia and Turkey in the Balkans could quickly spread into a confrontation surrounding the Black Sea.

The following map highlights the Black Sea region, and the three traditional battle regions -- the Balkans, the Crimea and the Caucasus -- where the Orthodox and the Muslims have had their crisis wars:

Black Sea region, highlighting the Balkans, the Crimea and the Caucasus
Black Sea region, highlighting the Balkans, the Crimea and the Caucasus

That's why the most ominous portion of the Serb / Kosovo story is the following:

"Also Friday, Russia -- which has not recognized Kosovo's sovereignty -- said it has not ruled out using force to resolve the dispute over the territory if NATO forces breach the terms of their U.N. mandate.

"If the EU works out a single position or if NATO steps beyond its mandate in Kosovo, these organizations will be in conflict with the U.N., and then I think we will also begin operating under the assumption that in order to be respected, one needs to use force," Moscow's ambassador to NATO Dmitry Rogozin said, in comments carried by Russia's Interfax news agency."

Exactly what kind of force was not specified, but that's the real danger in what's going on today in Serbia and the newly independent Kosovo. (23-Feb-08) Permanent Link
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China walks Olympics / Darfur tightrope after Steven Spielberg resigns

Steven Spielberg's resignation earlier this week as artistic adviser to the 2008 Olympics scheduled this summer in Beijing has clearly shocked Chinese officials. Spielberg's reason for resigning is that China is not doing enough to resolve the genocidal situation in Darfur. A particular issue is China's sales of weapons to the Sudan government, considered the aggressor in the war of genocide.

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I've previously said that the Olympics event has become as important to Beijing as a sweet 16 coming-out party for a teenage girl, and everything that happens seems to confirm that view. According to various news reports in recent months, China has:

There have been numerous international complaints directed at Beijing over its failure to help with Darfur. I admit to enjoy a fair amount of Schadenfreude over this, because China has always been a cheerleader for international protests against America, and now they're getting a taste of what they put out.

Liu Guijin, China's special envoy to Darfur <font face=Arial size=-2>(Source: BBC)</font>
Liu Guijin, China's special envoy to Darfur (Source: BBC)

Spielberg's resignation has been such a shock that they've actually let Liu Guijin, China's special envoy to Darfur, give a press conference in London, explaining how much China has done to resolve the Darfur issue.

Normally the Chinese don't allow their diplomatic representatives to speak publicly, for fear that they'll say something "wrong," as in 2006, when Sha Zukang, the Chinese ambassador to the U.N., started screaming anti-US threats about Taiwan to a BBC reporter.

So Liu Guijin's press conference, and his subsequent interview with the BBC is a very big deal. Here's what he said to the BBC (my transcription):

"We made it clear that we are against the sanctions or embargoes or pressures on the Darfur issue of Sudan, because we think that cannot solve the problems. We are rather advocating softer measures to solve the problem. That is negotiations and dialogue and positive engagement, and China has played an active role in trying to bring a fundamental and long-term solution to the Darfur issue. And China has been active in trying to bring the different sides together for talk, for negotiations, among themselves.

We have never threatened the government of Sudan with anything. We have never imposed anything. We have never forced them to do anything. We give them advice. We engage them. We try to persuade them."

This is an amusing illustration of China's diplomatic problems. He might have said, "We give them advice. We engage them. We try to persuade them. We supply them with weapons." But he left that last part out.

In fact the whole concept is hilarious. There are millions of people fighting each other to the death in Darfur. Is Liu really saying that sending a few people in for a friendly chat is going to change anything? As I've said many times, nothing can stop the genocide in Darfur, until it's run its course.

"We are not going to force anything on them. We are not going to exert pressures. We are not going to threaten them with sanctions or embargoes.

Just as equal partners, as friends, we give them advice for the better, for the good of the sovereign government. ...

The non-interference in the internal affairs of a sovereign country is the cornerstone abd basis of the Chinese diplomatic policy.

And the Chinese government's active engagement with regard to the Darfur issue does not mean that we have changed this policy, or that we are going to change this policy.

Because China, as a responsible member and one of the five permanent members of the Security Council, we have been asked, and we feel, that it is necessary for us to show more responsibility to play a more active role in finding settlements of international crises."

China's walking a tightrope here. China knows that if they criticize human rights in Darfur or anywhere else, then the international community will point out massive human rights violations in China (like being thrown in jail for years and tortured for uttering the words "falun gong").

Something's really building to a crescendo in Beijing. Almost every resource in China is focused on the summer Olympics. Once the Olympics games are over, China is going to have a letdown. We'll have to see how that letdown affects policy. (23-Feb-08) Permanent Link
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The BBC zings America for not sending troops to Darfur

Which do they want - intervention or non-intervention?

In reporting on President Bush's trip to Liberia, the last stop on his 5-nation tour of Africa, reporter Laura Trevelyan said this:

"For a President whose foreign policy has been DEFINED by military action in Afghanistan and Iraq, the tight focus of this trip has been on its humanitarian legacy. combating aids and malaria.

By going to Rwanda, George Bush was able to underscore what the US is doing in Darfur, a conflict that HE calls a genocide. America's been criticized for wringing its hands over the killings in the west of Sudan, while being unwilling to send in troops."

In these two sentences, one spoken right after the other, Trevelyan manages to zing the US twice, and in completely contradictory ways, without feeling any embarrassment about it.

I guess that this is what we have to expect, being Policemen of the World and all, but it would be nice if the BBC could tone down its hatred for America, especially its President. (23-Feb-08) Permanent Link
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Turkey invades PKK Kurd region of northern Iraq

Iraq is unfazed, and al-Sadr extends his cease-fire for six months.

Reportedly 10,000 Turkish troops crossed into Iraq on Thursday to destroy rebel Kurdish (PKK) bases in the extremely rugged mountainous region of northern Iraq.

The Turks say that it's a "limited operation," and that the troops will return to Turkey in the "shortest time possible."

According to security sources in Turkey:

"The ground operation started after Turkish warplanes and artillery bombed suspected PKK targets on Thursday, the military said on its Web site. The operation is expected to last 15 days, CNN Turk reported, citing security sources.

TV channels and news agencies reported 10,000 troops were taking part in the cross-border offensive and the Turkish troops entered 10 km inside the Iraqi border. But CNN Turk reported 3,000 troops from special forces take part in the operation, citing security sources. Reports say the operation focused on the Hakurk region of northern Iraq.

The operation is expected to last 15 days, CNN Turk reported, citing security sources. ...

[In related news], Turkish President Abdullah Gul called Iraqi President Jalal Talabani on the phone on Thursday and informed him about the cross-border ground operation launched by Turkish Armed Forces (TSK) against terrorist organization (in the north of Iraq). Presidency press center stated on Friday that Gul briefed Talabani about the target of ground operation which TSK initiated on Thursday."

As usual, when analyzing a situation like this, it's necessary to sort out the individual generational timelines of each of the countries involved.

Turkey is well into a generational Crisis era, and so this situation could be dangerous if Turkey's military involvement spirals out of control.

However, Iraq is in a generational Awakening era, as we've said a zillion times on this web site to explain why a civil war in Iraq was and is impossible. Thus, Iraq is UNLIKELY to mount a military response to Turkey's invasion, which means that the situation as a whole is unlikely to spiral out of control.

The most likely outcome from this incursion is that, at some point, Turkey will complete its operations in the northern Iraq mountains, and then withdraw, succumbing to mounting international pressure. This scenario could be thwarted if the effort to clear out the PKK terrorists ends up in a "Vietnam-like quagmire," but even then a spiraling war seems unlikely.

As if to emphasize the fact that Iraq is in a generational Awakening era, the Shi'ite cleric Moqtada al-Sadr has extended his Mahdi militia's ceasefire for another six months. His previous ceasefire was set to expire, but in a statement Friday addressed to his own Mahdi army militia fighters, he says the following:

"I am only ordering the good and eliminating evil. If you are the same then I am with you and among you ... I established this army of faith only so that it would be as the sinless (the Shiite imams) would want. And that is difficult. So anyone who sees in himself the endurance, the will, the strength, the ability, the authorization, the activeness ... then let him ask for what follows, implement it and believe in it.

Whoever applies this is truly in the (Mahdi) Army and is among those who will bring victory for the Imam (Mahdi) after his appearance, God willing. So I will give you another opportunity to gain wholeness, just as I have given it to myself before you. So I extend the freezing of the Mahdi Army until the 15th of Shaaban (mid-August.) You have my thanks and appreciation for your understanding and your patience, as well as your holy struggle and your continuing to rebel against infidels and your love of faith, the believers, Islam, Muslims, Iraqis and Iraq.

In conclusion, I say: God ... make the members of the Mahdi Army the best followers of the prophets ... make them satisfactory to you ... make them the best of believers."

I discussed the coming of the Mahdi two years ago in "Iran and Ahmadinejad are waiting for the Mahdi," something that's roughly equivalent to waiting for the second coming of Christ in the Christian religion.

Al-Sadr is thus tying belief in the Mahdi to his statement to his militia to extend the ceasefire in the war against the infidels (the Sunnis and the Americans).

This hints at the kind of "generation gap" that he's dealing with: His young warriors want to fight the infidels, but the warriors' parents, who survived the bloody and genocidal Iran/Iraq war of the 1980s, don't want any part of a new war. (23-Feb-08) Permanent Link
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Merrill Lynch: Home prices to fall by 25% through 2009.

According to a statement read on CNBC on Friday morning, Merrill Lynch is downgrading mortgage-finance firms Fannie Mae and Freddie Mac, because "The weakening macro trends add legitimacy to fears that these two companies are going to witness additional financial stress because they're highly leveraged."

What's interesting about this is that the the WSJ report simply says that Merrill Lynch "is taking a bearish view," without mentioning the 25% figure. I guess they didn't want to frighten people.

So I slogged through the Merrill Lynch site to find the actual report. It compares the current housing downturn to the 1991 housing downturn. Here's what it says (HPD = housing price declines, CME = Chicago Mercantile Exchange):

Housing market overhang will fuel added pressure

"The ML Economics team forecasts that home prices will decline roughly 25% through 2009 nationally, above the current market expectations of about 20%. To put this in perspective, the peak-to-trough HPD in the Case-Shiller Composite Index was -8.3% in the early 1990’s. A handful of large markets experienced double digit declines during this period, including Los Angeles (-27%), San Diego (-17%), Boston (-17%), New York (-15%) and San Francisco (-12%), which we think could be bested as prices revert to historical support levels on HH income. Thus, the de-leveraging process could lead to a more protracted downturn for housing beyond current expectations.

The housing market remains oversupplied, with 9.6 months supply of new homes, the highest level since January 1991 and 9.6 months of existing homes, only slightly below the record high of 10.7 months established in October 2007. We think the combination of sharp price declines and a contraction in supply will be necessary to correct the supply-demand imbalance. CME composite real estate futures contracts currently reflect assumptions of a peak-to-trough decline of about 19%, with the trough expected in late 2008, suggesting significant additional downside from current expectations.

Accelerating HPD and tighter guidelines will likely intensify the deterioration in credit trends, with delinquencies and foreclosures, already at high levels, rising significantly for the foreseeable future, in our view. Reduced borrower equity from continued weakness in the housing market and stricter credit standards will inhibit the ability of marginal borrowers to escape from their onerous mortgage debt."

This really is devastating news to those who have been praying for a quick recovery, and it means that the "subprime virus" is going to continue spreading and affecting everything. It's also totally consistent with the recent recent remarks of Meredith Whitney, and with other analysts who have been predicting a mere 20% housing price decline.

One financial type came onto CNBC a few minutes later, and said, almost hysterically, "That's not going to happen."

Why? he was asked.

"Because that would mean that the total value of housing in the US would go from $20 trillion to $15 trillion, and nobody's going to let that happen." Perhaps he thinks that the Hand of God will reach down and reflate the bubble.

From the point of view of Generational Dynamics, the housing price decline should be quite a bit larger than 25%, as we enter a new 1930s style Great Depression. (22-Feb-08) Permanent Link
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"Subprime virus" spreading rapidly to corporate bonds

Investors are increasingly aware that they have no idea what's going to hit them.

As you may recall, Fitch Ratings is one of the bond rating companies (along with Standard & Poor's and Moody's Investors Service) that are being blamed for being at the hard of the current credit crisis, because they took fat fees from mortgage-backed CDO issuers in return for giving the CDOs an AAA rating. Now, to save face, they're re-rating many of these mortgage-backed investments, and the results are increasingly gloomy.

On Thursday, Fitch released a statement on life insurance companies.

Now, perhaps you hadn't thought of this before, but when you buy life insurance, you send money each month to the insurance company, and the insurance company invests that money, so that it can pay out when you kick the bucket. And, like any other investor, life insurance companies have been looking for ways to get higher returns for their investments, and up till the middle of last year, that meant investing in mortgage-backed CDOs.

Well, now Fitch is taking a look at the investments of life insurance companies, and they've been found to be "problematic," although Fitch doesn't want to panic anyone, so they're calling the problems "manageable."

Here's what the statement says:

"[Fitch] continues to believe that the U.S. life insurance industry's investment exposure to problematic subprime and Alt-A residential mortgage collateral is manageable. However, Fitch notes that there has been significant deterioration in subprime mortgage performance in the second half of 2007, which has led to a material decline in market valuations, particularly in the fourth quarter of 2007, and increased downgrade activity. ...

Fitch estimates unrealized mark-to-market losses on subprime and Alt-A related investments held by U.S. life insurers to be in the $7 billion to $8 billion range, which equates to approximately 13% of exposure and 3% of aggregate industry statutory capital. Further, Fitch expects the industry to report realized losses of between $2 billion and $3 billion (GAAP) in the fourth quarter of 2007.

While Fitch expects further deterioration in the performance of subprime residential mortgages, particularly for 2006 and 2007 vintage years, our analysis suggests that the industry is well positioned to withstand current market volatility given its focus on high investment grade securities, relatively stable liability profile and positive cash flow. Despite the significant deterioration of subprime mortgage markets and increased credit risk in other fixed income markets, Fitch views the U.S. life insurance industry as well capitalized. ...

Several companies are being more closely monitored due to either significant CDO exposure or more significant investment in subprime RMBS with 2006 and 2007 vintages or exposures outside the insurance group."

There are several things to take away from Fitch's statement:

In fact, almost no corporation today is above suspicion.

This is the conclusion from a Wall Street Journal article to appear on Friday. It says that investors are increasingly concerned that many more corporations are going to default on their bond obligations.

How do we know that? Because the costs of "credit default swaps" (CDSs), the insurance you buy when you want to be sure that bond obligations WON'T default, is skyrocketing.

According to the article,

"The global financial squeeze is spreading to investments linked to the corporate-debt market, slamming the value of contracts that provide insurance against defaults and marking one of the first times that the debt of major companies has been affected by the turmoil.

Bonds issued by major corporations have been a rare bright spot in the battered credit markets -- few investors believe these companies will go bust even if there is a serious recession.

In recent days, investors in credit-default swaps, which act as insurance policies against defaults, have grown increasingly gloomy because of worries about the global economy and the possibility of problems in the market.

The losses are tracked by several indexes, which track the cost of buying insurance on bonds issued by 125 big companies. Two of the indexes are at records and have doubled since the start of the year, meaning investors who sold this insurance suffered losses. The worry is that the indexes' moves could prove to be self-fulfilling prophecies, causing heavy losses for investors and making it even harder for people and companies to borrow money. Adding to the anxiety: Analysts can only guess at the volume of investments tied to the indexes, who is holding them and what it would take to trigger a full-scale sell-off.

"You don't know when it is going to happen; you don't know how much it is going to be," said Michael Hampden-Turner, a credit strategist at Citigroup Inc. in London. That "makes everybody really nervous."

The article adds that the cost of insuring $10 million in bonds has risen to $152,000, up from $80,970 at the beginning of the year.

"Even in the absence of greater defaults, the moves in the indexes can cause a great deal of havoc, triggering a downward spiral in which the forced unraveling of complex investment products drives ever-larger losses for investors and rises in the cost of insurance, which in turn could ultimately drive up borrowing costs for companies all over the world.

"It is a kind of vicious circle," said Demetrio Salorio, deputy head of debt capital markets for Société Générale in London."

This kind of interlocking collapse is exactly the kind of thing that I've been talking about. It was the cause of the initial 1929 panic collapse, and it's expected to happen again.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate.

The heart of the ongoing discussion is the fate of the bond insurers (MBIA, Ambec, FGIC, ACA -- also called "monolines") that I've discussed at length.

Beauty and brains -- Meredith Whitney, director of equity research at Oppenheimer <font face=Arial size=-2>(Source: Telegraph)</font>
Beauty and brains -- Meredith Whitney, director of equity research at Oppenheimer (Source: Telegraph)

Meredith Whitney, an analyst at Oppenheimer, occupies a very special place in investors' hearts these days. She published a research note in October predicting that Citibank (actually, Citigroup) would not be able to pay a dividend to investors.

Now, you'll recall that the stock markets peaked on October 9, 2007, and have been generally falling ever since. Well, Whitney's being blamed for that, for costing the world $369 billion in lost stock market values. I can just imagine, based on my own experiences, how much abuse and anger have been directed at her.

Well, she appears to be like me in the sense that she keeps on making predictions that are certain to come true, but upset people. It's an obsession with me - maybe it is with her too.

Meredith Whitney <font face=Arial size=-2>(Source: CNBC)</font>
Meredith Whitney (Source: CNBC)

Anyway, she's now predicting that Citibank, along with Merrill Lynch and UBS, will be among the hardest hit banks in the world when the bond insurers lose their AAA ratings.

In an interview on Thursday afternoon on CNBC, she detailed the reasons as follows (my transcription):

"Believe it or not it's Citi [that will be the worst hit], because Citi has earnings problems. They've got balance sheet constraints, they have further CDO writedowns, they've got exposure to the monolines [bond insurers], and they have the single largest concentration of exposure to high LTV (loan to value) mortgages which -- now that house prices have declined --- over $50 billion exposure to 90+% LTV mortgages are likely under water. So they'll have the highest severity of losses with respect to those mortgages, and I estimate that Citi's anywhere between $6-12 billion under-reserved because of those exposures. There's no place to hide for Citi."

Bob Diamond, Barclays President <font face=Arial size=-2>(Source: CNBC)</font>
Bob Diamond, Barclays President (Source: CNBC)

There was an interesting exchange during this interview, in which Whitney essentially ridiculed a bank president who was saying that the worst might soon be over.

The interviewer, Maria Bartiromo, replayed a byte from an interview a couple of days earlier, who commented on whether the stock market might start going up again:

"If in the next couple of weeks we can get real clarity around whether the situation around monolines [bond insurers] is serious or not serious, or just some clarity around what will the financial impact be, and I think a little bit more clarity in terms of, has the Fed's bold and early action been enough to make us think about the economy in mid-year as we see growth back in the economy or recession. I think if those three things come online over the next couple of months, we could be looking more optimistically toward the second half of this year."

Whitney's response was to make the point that, essentially, nobody knows what's going on, and nobody knows how long the housing collapse will last -- something that many people (including me) believe will take years. And if nobody knows then, in particular, the ratings agencies don't know how much the bond insurers (monolines) will have to write down their own CDO assets. If they write down their own assets, then they won't have money to pay off insurance policies (just like the life insurance policies we discussed earlier):

"And for any of the rating agencies to understand how much capital the monolines actually need would be like the rating agencies understanding what the end of this housing market decline is actually going to look like. So anyone at the rating agency who can do that should be paid like John Paulson [hedge fund manager] last year, right?

There's no way they could do it, and for Bob Diamond to have such confidence, you know that's terrific for him, but he's a very small minority who speak with such confidence, because even when the most seasoned veteran lenders, guys like Jamie Dimon [James "Jamie" L. Dimon - CEO of JPMorgan Chase & Co.], guys like Al Kelly at American Express, guys like Ken Lewis [Kenneth D. Lewis , CEO and President of Bank of America], have been so shocked and so uprooted by the sudden and dramatic rise in loss rates -- even from the 3rd quarter to December -- even from November to December -- that their guidance is basically thrown out the window. And this is a micromanager like Jamie Dimon - so if he doesn't have control over things, it's amazing that anyone would. So hat's off to [Bob] Diamond -- I'm impressed that he has such boldness, because the people that I've talked to have never seen it this bad."

Note that these other financiers "have been so shocked and so uprooted by the sudden and dramatic rise in loss rates ... even from November to December -- that their guidance is basically thrown out the window."

This is a really critical point. People who have been listening to the various bank CEOs and Presidents who have been predicting that things would soon be all right are now, according to Whitney, in a state of shock.

Recall the table of the changes in fourth-quarter earnings estimates that people have been making, starting from the beginning of the fourth quarter:

  Date    4Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct  1:             +11.5%
  Dec  7:              -1.3%
  Dec 14:              -3.8%
  Dec 31:              -6.1%
  Jan  4:              -9.5%
  Jan 11:             -11.3%
  Jan 18:             -19.0%
  Jan 25:             -20.5%
  Feb  1:             -20.7%
  Feb  8:             -20.2%
  Feb 15:             -21.1%

This is an incredible table, because it indicates that these banks were expecting earnings to GROW by 11.5% at the beginning of the quarter, and yet they ended up FALLING by 21.1%. Whitney's point is that all previous guidance estimates have been thrown out the window, and that Bob Diamond it talking complete nonsense, something that should be no surprise at all to regular readers of this web site.

Shell-shocked Maria Bartiromo interviews Meredith Whitney <font face=Arial size=-2>(Source: CNBC)</font>
Shell-shocked Maria Bartiromo interviews Meredith Whitney (Source: CNBC)

As a side point to this interview, it's worth noting that Maria Bartiromo herself seemed to be somewhat shell-shocked. As I've pointed out several times, Bartiromo likes to be happy and perky and jolly and Pollyannaish, and doesn't like people who break her mood.

But she seemed really disturbed by this interview, and asked Whitney whether the market would sell off further. Whitney's response:

"I think that the best case scenario is 15% downside in the financials; the worst case scenario is 50% downside in the financials."

So Whitney is not pulling any punches, and I'll bet that a lot of people are really pissed off at her (again) today.

But it's not Whitney's fault that the "subprime virus" is quickly spreading into everything. As they like to say in those 1950s horror movies, "Eeeeeeeeeeeeeeek!! No one is safe!!!" And, indeed, no one is. The subprime flu is going to get you unless you protect yourself as quickly as possible. (22-Feb-08) Permanent Link
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Wealthy investors in auction rate securities can't get their money out

Closed end funds seem to be like a roach motel: You can check in, but you can't check out

I've been mentioning these arcane, obscure "auction rate securities" for a few days now -- in "Pundits are now referring to a spreading 'subprime virus'" and "'Credit crunch' domino effect is now affecting student loans."

The situation appears to be worsening significantly, according to a report by Steve Lieseman on CNBC on Wednesday morning.

As you read this, just get a sense of it, and don't worry about the technical details of what the different kinds of funds and securities are. Just remember that we're talking about the "safest" AAA rated securities -- supposedly as safe as cash -- securities that your pension fund, your college's endowment, your mom's money market fund or your employer might have invested in, because they're so "safe."

Here's my transcription of the report:

"CNBC has learned that investors with some $60 billion dollars worth of short-term cash-equivalent securities -- they're being told by Wall Street: "Take a hike"

Auction rate preferred securities <font face=Arial size=-2>(Source: CNBC)</font>
Auction rate preferred securities (Source: CNBC)

Major investment banks telling some of their richest investors that so-called "auction-rate preferred securities" -- they can't have their money back, and that the investors can't even sell the securities at a loss because there's no secondary market.

They're in the financial equivalent of limbo here.

One Investor's Plight <font face=Arial size=-2>(Source: CNBC)</font>
One Investor's Plight (Source: CNBC)

CNBC spoke with one investor in Miami Beach who has $2 million of these securities with closed end funds run by Blackrock, Gabelli, Calamos and Pimco. She says she can't withdraw her money to purchase a house she's contracted to buy, and she risks losing her $190,000 deposit if she walks away. She's told she can't have her money back.

Other investors can't withdraw to make hefty tax payments that are coming due.

These securities are sold at auctions in $25,000 units to wealthy investors and institutions. They expire every 7 to 28 days, at which point a new auction is held, but lately, the auctions are failing as part of the broader credit crunch. Not enough buyers are showing up, but more importantly, because the big investment banks -- they act as lead managers on these deals -- they're refusing to perform the role they've played for 25 years, and provide liquidity to the markets when they're out of balance.

How Preferreds Work <font face=Arial size=-2>(Source: CNBC)</font>
How Preferreds Work (Source: CNBC)

The funds from these auctions are used by closed-end funds. They lever up and they buy muni bonds. The auction rate preferreds are usually triple A rated -- a lot of good that's doing people now. They pay a tax-free interest rate of 3 and 4%. When the auction fails, they only reset a little bit higher.

I talked to Mario Gabelli [chairman of Gabelli Funds] by phone. He would not comment on the record but he asked me to give the broker of the investor we talked to his number. He called the broker, hoping that something could be worked out, without offering anything specific.

A Blackrock executive says, "These are unprecedented times in the industry." He held out little hope for investors.

The closed end funds are in a bind. Wall Street is getting a black eye from some of its best customers. But if they pay off the preferred holders, they risk hurting the holders of the common shares in the closed funds.

Here is a note: These are not regulated money market funds. They [who?] cannot buy these securities. ...

Before I came on air, about 15 minutes ago, Mario Gabelli calls me back again from the gym. He says that on our behest Gabelli has issued a statement. And the statement says that "the board of directors on this Gabelli equity trust has authorized the fund and advisors to explore alternatives, including the repurchase of these preferred in a secondary market. But since there are so many legal loopholes to navigate, it's going to take time."

Becky: The people in these funds are people who tend to be very conservative investors. These are people who are not looking for anything but to be in the safest securities, and the question is, were they marketed to these people as that.

Lieseman: I've spent 2½ days trying to understand these securities. They are the most messed up securities. There is no contingency plan for the failure of the auction. If the auction fails they simply hold your money, try to redo the auction again."

Here's part of the text of Gabelli's statement (PDF), as it currently appears on their web site:

"The holders of the ARPs [Adjustable Rate Preferreds] are not necessarily common shareholders of the Equity Trust, but they are utilizing these preferreds to accommodate their own financial needs and may be experiencing unexpected illiquidity.

The Board of Directors of the Equity Trust has authorized the Fund and its Adviser to examine and explore all alternatives including the possibility of repurchasing a portion of these preferreds if a secondary market develops.

Since there are many legal hoops and regulatory hurdles to navigate in order to provide liquidity, and since a secondary market for ARPs may be in the process of being developed, we are only able to move as quickly as legal counsel provides the necessary guideposts, the Board approves the appropriate measures, and the market opportunities develop."

Those who would like to understand more of the nitty-gritty details can find more information at these locations:

The point is that these were AAA rated securities, meaning that any investor or corporation or investment fund could feel completely safe in purchasing them. They were as good as cash. Of course US Treasuries are the safest of all, but the AAA rated securities are also as safe -- because they're AAA rated, right? -- and often pay a good, solid ½-1% more interest than Treasuries. That makes them worthwhile, doesn't it?

As usual, pundits and analysts, who believe that "history always begins this morning," have no idea what's going on. "What's wrong with these investors," they seem to be saying. "Why won't they attend these auctions and bid on the auction-rate securities? Why don't they know that they're still safe?"

A big part of the reason, as I've previously said, is that investors don't believe these pundits and analysts any more, because the pundits have always said that it was safe to ignore any bad news that comes along. As I wrote recently, the moral to the Aesop's Fable "The boy who cried wolf" is that "Nobody believes a liar, even when he's telling the truth."

However, there is a big picture here, as I've been saying for several years: There's been a mammoth worldwide liquidity and credit bubble, and now it's deflating, leaving less money in the world each day, as we head for a new 1930s style Great Depression. I didn't know several years ago that one part of the scenario would be that "auction rate securities" would be frozen -- hell, I never even heard of them until a couple of weeks ago. But I knew that the bubble would deflate, and that little chunks of the world economy would collapse, one after the other, until the whole thing collapses in a generational panic and stock market crash, the first since 1929.

When I first pointed this out to people in 2002, I was treated like an idiot, even though it's easy to prove, then and now, that the stock market is way overpriced. But nobody's calling me that now. Everything that I predicted is coming true, for the reasons that I predicted.

Another thing going on is the soap-opera drama of the "bailout" of the bond insurers (MBIA, Ambac, FGIC, ACA) that I recently discussed at length. It has been the Sisyphean task of New York Insurance Superintendent Eric Dinallo to arrange this bailout, but every time he proposes something new, it collapses and he has to start over again. (King Sisyphus of Greek mythology was sent to Hades and condemned forever to roll a huge boulder up a hill, only to have it roll down again on nearing the top.)

However, calling it a Sisyphean task may be giving Dinallo way too much credit. As far as I can tell, Dinallo is simply sitting at the bottom of the hill, not moving the boulder up the hill at all, but always telling everyone that it's near the top and will reach the top within a day or two. In other words, he's just stalling, holding off the inevitable failure of the bailout. It's easy to understand why he would stall -- an announcement that the bailout has failed inevitably means hundreds of billions of dollars in more writedowns by banks of near-worthless CDOs, and the stock market will fall still further, and guess who'll be blamed? Dinallo.

Speaking of the stock market, I used to talk about the euphoric mood of the investors, describing it as "Good news is good news because it's good news; and bad news is good news because it means that the Fed will lower interest rates, so it's still good news."

Then I described periods where investors adopted an anxious, panicky mood, where "even good news is bad news," because good news can't be trusted. This has generally been the mood since December, as the market fell almost continuously, reaching a recent bottom on January 22, as you can tell from my Dow Jones historical page.

Since then, the Dow Industrials index has remained in the low to middle 12000s, as if investors are shell-shocked and are just waiting for something to happen. And they are. The optimists are waiting for someone that they trust (i.e., not a proven liar) to say the "credit crunch" problems have been solved. The pessimists (like me and anyone else who knows what's going on) are waiting for the bond insurer bailout to fail.

If the optimists are right, then the Dow will jump up past 13,000, and the bubble will start growing again.

If the pessimists are right then, according to various pundits, the market will crash through the January 22 low (Dow 11971.19) and fall a lot lower.

There is one very big, very specific change that I've noticed in the opinions of pundits and analysts lately: Finally, almost everyone seems to realize that lower Fed interest rates are not going to solve the credit crisis, or keep the "subprime virus" from spreading.

That's not to say that they expect the Fed to stop lowering -- some pundits (I believe Lieseman is one) say that the Fed will continue lowering the Fed Funds Rate until it reaches 0%.

This may seem shocking, but it's what the Bank of Japan did for their funds rate in the 1990s. Even today, the BOJ funds rate is only ½%! So I agree that the Fed Funds rate will go a lot lower.

But it won't do any good, because the amount of liquidity that the Fed can inject into the financial system is tiny compared to the amount of liquidity being lost every day as the credit bubble deflates. So the sharp fall in the Fed Funds Rate will do no good whatsoever to stop the ravaging deflation (and certainly will not cause "hyperinflation," a nonsense concept that web site readers keep writing to me about to explain their purchases of gold at astronomically high bubble prices of nearly $1000/oz, plus commissions.)

But the point is that investors finally seem to realize this, where they didn't several months or even several weeks ago. They understand that oil prices at $100/barrel don't seem to push the markets down much, and 1-2% Fed Funds Rate decreases don't seem to push the markets up much.

Estimates of fourth quarter earnings have finally stabilized (after falling a little lower again). Here's the summary from Friday from CNBC Earnings Central:

"As of Friday, February 15th:

414 companies in the S&P 500 have reported earnings for Q4, 62.08% have beaten estimates, 11.84% were in-line, and 26.09% have missed. (Data provided by Reuters Estimates)

The blended earnings growth rate for the S&P 500 in fourth-quarter 2007, combining actual numbers for companies that have reported, and estimates for companies yet to report, fell to -21.1%.

At the start of the quarter, the growth rate for Q4 was 11.5%. (Data provided by Thomson Financial)"

At this point, 414 companies out of 500 have reported actual earnings, so we don't expect much change any more in the 4Q earnings estimates. Soon we'll be seeing estimates for 1Q earnings, and the fun can start again.

We can now update the table of the changes in fourth-quarter earnings estimates since the beginning of the fourth quarter, as follows:

  Date    4Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct  1:             +11.5%
  Dec  7:              -1.3%
  Dec 14:              -3.8%
  Dec 31:              -6.1%
  Jan  4:              -9.5%
  Jan 11:             -11.3%
  Jan 18:             -19.0%
  Jan 25:             -20.5%
  Feb  1:             -20.7%
  Feb  8:             -20.2%
  Feb 15:             -21.1%

Despite falling a little farther, the earnings estimates are finally relatively flat, and not likely to cause further concern.

Right now, the only thing that matters (apparently) to investors is the bond insurer bailout. There's a huge amount of tension over this issue and, barring a surprise, things will be on hold until that issue is settled -- or until investors conclude that Dinallo has no real plan and is just stalling.

People are always asking me to name a specific date when a financial crisis might occur. The market is overdue for a generational panic and crash, but I usually avoid the specific date by saying something like, "It might happen next week, next month or next year, but it's happening with absolute certainty, and probably sooner than later." That wording conveys a sense of urgency without specifying an exact date.

A web site reader recently asked me about a prediction being made on another web site that a major financial crisis will occur in October of this year.

Unfortunately, it's not possible to predict a financial crisis eight months in advance. This is provable from Chaos Theory. If the October prediction turns out to be right, it will be by pure luck. There's no methodological way to reliably arrive at such a prediction and, as I said, this is provable from Chaos Theory.

What I've tried to do in the Generational Dynamics forecasting methodology is to match historical patterns to present day situations, knowing that the long-term trend (a generational stock market panic and crash, and a 1930s style Great Depression) are 100% certain.

But it's like a weather forecaster predicting the date of the next hurricane. He knows that a hurricane is coming some day, but he doesn't know when. In fact, Chaos Theory was originally invented in the 1960s to provide a mathematical framework around the discovery that it's impossible to predict the weather more than a few days in advance. The same theory applies to a wide variety of other situations as well, including this one.

The only thing that weather forecasters can do is prepare models that identify certain patterns that, in the past, have preceded hurricanes. As soon as one of these patterns appears, then they can say that "the probability of a hurricane next week is around 50%." As the patterns get more and more definite, it's possible to adjust that percentage. Once the hurricane is bearing down on the Florida keys, you can be pretty accurate, but even then, there's a question of where the hurricane will make landfall.

And so, we have all this turmoil going on in the financial markets. What's the probability of a financial crisis next week? I consider it to be pretty high -- perhaps as high as 3%. That may not seem high, but in "normal" times it would be more like 0.0000001%. Furthermore, as various indicators (wheat prices, trade deficit, corporate earnings, home sales, etc.) continue to deteriorate, that 3% will remain steady or grow higher.

So what does that mean in practical terms?

Here's how you can get a feel for it. Get a pair of dice, and roll them. The probability of getting snake eyes (1+1) is just under 3%. So roll your dice over and over. Each roll corresponds to one week of waiting. See how many rolls it takes to get snake eyes. If you get snake eyes on the first roll, then your model predicts a financial crisis in one week. If you get snake eyes on the 50th roll, then your model predicts a financial crisis in 50 weeks, or almost a full year.

(If you don't have any dice around, then just use 5 ordinary coins. Toss all five in the air, and see if they come up all heads. Count how many times you have to toss the 5 coins before they come up all heads, and that's the number of weeks that your model predicts when a financial crisis will occur.)

Perhaps that will give you a better feeling for how this works.

While you're waiting, take a moment and shed a tear for those multi-million dollar investors who can't get their money out of closed-end funds using auction-rate securities. They thought that those investments were as safe as cash, but they didn't want to invest in US Treasuries because the funds paid ½% higher interest rates. Now they've gotten infected with the bird flu ... errr ... I mean the subprime virus, and they can no longer get their money out. Weep for their misfortune. (21-Feb-08) Permanent Link
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Review of recent international stories

Pakistan, Kosovo and Cuba in the news

It's time again for a summary of all the important international stories that I've been neglecting while I've been focusing on the deteriorating financial situation.

Musharraf's party defeated in Pakistan elections

Pakistan election - provisional results <font size=-2>(Source: BBC)</font>
Pakistan election - provisional results (Source: BBC)

Musharraf's party appears to have been routed in a low-turnout election on Monday.

Widely reported fears about election rigging and election day violence appear to be unfounded.

Provisional election results:

Official map of Pakistan, with the addition of the FATA (Federally Administered Tribal Areas), highlighting Swat Valley <font face=Arial size=-2>(Source:</font>
Official map of Pakistan, with the addition of the FATA (Federally Administered Tribal Areas), highlighting Swat Valley (Source:

The radical Islamist parties did very poorly.

Since no party has a parliamentary majority, the choice of Prime Minister will depend on formation of coalitions. Ethnically, the two opposition parties, PML and PPP, are very far apart, and it's unclear whether they can be completed united by their common hatred of Musharraf.

It's possible that the PML will form a government with Musharraf's PML-Q party. These developments have yet to unfold.

Musharraf claims that he won't step down as President, but if the opposition parties unite against him, he may be forced to.

Conflict risk level for next 6-12 months as of: 6-Nov-2007
W. Europe 1 Arab Israeli 3
Russia Caucasus 2 Kashmir 3
China 2 North Korea 2
Financial 3 Bird flu 3
Key: 1=green 1=Low risk 2=yellow 2=Med 3=red 3=High 4=black 4=Active

Six weeks ago, I raised the "conflict risk level" for Kashmir from 2 (medium risk of war within 6 months) to 3 (high risk of war within six months), to reflect the increasing chances of war between Pakistan and India. The period of greatest danger is approaching now. A change in government could derail the détente reached between Musharraf and India's Prime Minister Manmohan Singh, destabilizing the region.

Kosovo declares independence and roils international politics

Historically, there is no greater hatred between two civilizations than between Islam and Orthodox (Eastern) Christianity. There have been major wars between Western Christianity and Orthodox Christianity, but not as deeply penetrating as the wars between Orthodox Christianity and Islam. The three most common geographical regions for these wars have been the Caucusus, the Crimea, and the Balkans.

Yugoslavia was formed out of the Balkans after WW I, and it was controlled after WW II by bloody Communist dictator Marshall Josip Tito. Yugoslavia collapsed in 1990 with the collapse of the Soviet Union, and split up into individual states along ethnic lines -- largely Catholic Croatia, largely Orthodox Christian Serbia, and largely Muslim Bosnia and Albania. A bloody war broke up, leading to the 1995 Srebrenica massacre.

History has identified the Serbs as the group guilty of genocide in the Balkan wars of the 1990s. Because of that view, it has been felt by many that the Serbian province of Kosovo should be permitted to secede and become a separate country.

The Serbs are mostly Orthodox Christian, and the people of Kosovo are mostly Muslim Albanians, so this secession is politically correct.

Not everyone is happy about this, however.

China has several provinces -- Taiwan, and its western provinces of (Buddhist) Tibet and (Muslim) Xinjiang -- that would like to secede from China. China says that it's a mistake to let Kosovo secede from Serbia.

Georgia has two provinces -- Abkhazia and South Ossetia -- that would like to secede from Georgia and become part of Russia again. So Georgia is opposed to the secession of Kosovo.

You'd think that Russia would favor the secession, but quite the opposite. Like Serbia, Russia is an Orthodox country, and is closely aligned with Serbia. The Russians are saying that the Balkans will become unstable again if Kosovo secedes. I don't doubt that they're right -- they had to work with Tito all those decades, and they know how unstable Yugoslavia can be unless controlled by a murderous dictator.

Four major European Union nations -- Britain, France, Italy and Germany -- have endorsed the secession.

However, Spain, which has militant Basque separates, opposes the move. So do Romania, which has a significant Hungarian minority, and Cyprus, which is divided between Greek and Turkish populations.

This is really bizarre when you think about it. It's as if Kansas supported the secession, but California opposed it because it has a large Latino population. But the United States does speak with one voice when it comes to foreign policy.

But not so the European "Union," which has a different foreign policy for each nation.

Incidentally, President Bush has supported the independence of Kosovo from the beginning, because: "History will prove this to be a correct move, to bring peace to the Balkans. This strategy has been a long time coming ... The US supports this move because we believe it will bring peace. And now it is up to all of us to help the Kosovars to realise their peace."

And so, President Bush, does that now mean that we should have let the South secede after all?

That's a fantasy, of course. There'll never be peace in the Balkans, with or without Kosovo independence, because it's on the Orthdox-Muslim fault line.

Fidel Castro steps down as Cuba's President

Cuba's last crisis war was the Cuban Revolution, 1956-59, that brought Fidel Castro's Communish to power. The BBC, New York Times, and other élite mainstream media have always treated Castro as something of a hero, even though he's a butcher and anyone who opposes him is imprisoned. They treat life in Cuba as a Socialist Paradise, even though thousands of Cubans each year risk their lives to reach asylum in the United States.

In my opinion, the most interesting thing going on right now in Cuba is the sudden appearance of public student protests. We know this because some videos of student confrontations have been smuggled out of Cuba. Here's part of the CNN report on the confrontations:

"During a meeting between Ricardo Alarcon -- the president of the National Assembly -- and students at the University of Computer Science, the young people voiced some of the concerns many Cubans share in private, but don't often air publicly.

"It seems to us a revolution cannot advance without a plan," Eliecer Avila said, standing at a microphone. "I'm sure it exists, we just want to know what it is."

He asked about restrictions to Internet access and why workers are paid in Cuban pesos but have to buy many basic goods in another currency that is 25 times as expensive -- the "convertible peso" that foreign tourists are required to use.

"That means a worker has to work two or three days to buy a toothbrush," he said. ...

When asked why there are restrictions on Cubans traveling abroad, Alarcon said: "I wish all the Cubans could go out and get to know the world outside."

"I think it would be the end of the ideological battle in this country. When the people see how things really are, what's real, how other people live," he said.

Asked why Cubans aren't allowed to enter the island's tourist hotels freely, Alarcon told students about his times in New York, as Cuba's ambassador to the United Nations.

"How many times did they kick us out of a store?" he asked. "Because by the Latino accent and the color of our hair they realized we weren't Anglo-Saxons and shouldn't be in the store?"

Another video obtained by CNN shows a recent meeting held to explain a new tax on Cubans working for foreign companies.

The unpopular proposal drew open jeers and mocking laughter, something officials here aren't used to. While the questions and complaints on the video are nothing new, it is unusual to hear them voiced so openly."

With Cuba's crisis war ending in 1959, the Awakening era would have begun around 1975-1980. Normally such periods are characterized by a "generation gap," leading to strident student demonstrations objecting to austere rules laid down by the old heroes of the crisis war.

It would be an interesting social and historical student to determine exactly what form those protests took under Fidel's oppressive regime.

We know what's happened in Iran: Student leaders and a student newspaper editor who criticized Ahmadinejad's policies were jailed, even though Ahmadinejad has previously praised such students as symbols of Iran's freedom. These include students who led anti-Ahmadinejad demonstrations at Amir-Kabir University on December 7, 2006, where Ahmadinejad was speaking.

Comparatively speaking, Iran has more freedom than Cuba, and Iran has managed to suppress almost all dissent. Butcher Fidel has undoubtedly been even more effective.

Once the charismatic Fidel is off the stage, my expectation is that the protests will begin to grow, and Cuba will enter a politically chaotic period. We may see that soon. (20-Feb-08) Permanent Link
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Arson, vandalism and riots sweep across Denmark as Mohammed cartoon controversy is revived

Muslim governments around the world are condemning Danish officials, demanding that Mohammed be respected and that Muslims in Denmark be treated with respect as well. Iran's government has said that it may sever ties with Denmark.

Either by coincidence, or purposely, perhaps desiring to be ironic, the producers of the CBS news magazine 60 Minutes ran a segment on Sunday evening addressing the question of why the Danes are, according to a recent study, the happiest people in Europe:

"60 Minutes asked Danish newspaper columnist Sebastian Dorset what he thought about Denmark's number one status.

"If you didn't tell me about the survey I wouldn't believe that Denmark was the happiest place. Because everybody complains all the time," Dorset says.

"But I find it fascinating that you say people complain. But there is a real sense of contentment here," [Morley] Safer remarks.

"Yeah," Dorset agrees.

Dorset says that contentment may stem from the fact that Denmark is almost totally homogenous, has no large disparities of wealth, and has had very little national turmoil for more than a half century. "We have very little violence. We have very little murders. So people are, feel very safe," he says.

He says people feel secure. "[A] knife stabbing makes the front page every time. Yeah, I don't think that happens in America very often," Dorset says."

Even more enjoyable than the above broadcast is this video of the song "Wonderful wonderful Copenhagen" from Danny Kaye's 1953 movie, "Hans Christian Andersen":

The 50-year record of "little national turmoil" has been broken this week, as Denmark has seven nights of rioting and vandalism in Copenhagen and other Danish cities, with bands of youths setting fire to cars, buses and schools.

Putting together several newspaper accounts, here's what appears to have happened:


It's interesting that Denmark has had little social strife since World War II.

Denmark's role in World War II is still considered controversial. Nazi Germany conquered Denmark in 1940, but allowed Denmark to remain neutral in exchange for returning German Jews to Germany. Danish manufacturers profited from trade with Germany, and some Jews were sent to Germany, but a robust underground movement saved many other Jews, helping them to flee to Sweden.

Still, the ambivalence felt by Danes must have weighed heavily on many hearts in the decades after WW II, and undoubtedly contributed to the tolerance and integration of the small (2%) Muslim population within the mostly Christian population.

So it's not surprising that xenophobia is only increasing now, in a generational Crisis era, 63 years after the end of WW II. At this time, there are few people left who remember the horrors of the German occupation, and with population growth, there must be a competition for jobs and other resources.

The revival of the Mohammed cartoons is quite remarkable. The publication of these cartoons caused an extreme worldwide Muslim backlash two years ago. The boycotts of Danish goods did a great deal of harm to Danish businesses. You would think that newspaper editors would have the sense not to provoke such a backlash again.

But you know how it is with those arrogant, narcissistic Boomers. They want to prove a point of principle, and so the Mohammed cartoons just have to be printed again, no matter what the consequences.

It will be interesting to see whether the anti-Danish Muslim demonstrations will be as potent this time as they were last time, or whether they'll fizzle.

But the problems within Denmark itself go well beyond the cartoon controversy. The 60 Minutes broadcast gave as one reason for Danish happiness the fact that the Danish population is "almost totally homogeneous."

Well that's true. Its population is 95% Evangelical Lutheran, 3% other Christian (includes Protestant and Roman Catholic), and 2% Muslim, according to The CIA World Factbook.

Being 98% Christian does make Denmark "almost totally homogeneous," but the other 2% can't be ignored, and they are the ones demanding to be heard right now. (18-Feb-08) Permanent Link
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Pundits are now referring to a spreading "subprime virus"

Each week, the virus spreads to more banks and investors around the world.

I used an analogy several times last year. Here's how I described it in November:

"Think of the world economy as a huge, enormous bloated mansion made of wood, with all kinds of additions tacked on all over the place. Think of the CDOs as millions of termites that are eating away at the insides, so that another piece of the mansion falls off into the ravine almost every day.

The Fed and other central banks have been running around the mansion with hammers and glue and nails, patching things up as fast as they can, trying to keep ahead of termites. They've been pretty successful with their hammers and glue and nails in postponing the inevitable, even bloating the mansion up a little more, but they can't keep up with the termites.

[What's happening] is that the hammers and glue and nails aren't working, and it won't be long now before the entire mansion collapses into the ravine."

Cartoon depiction of the "subprime virus" destroying a bank by removing its supporting pillars. <font face=Arial size=-2>(Source:</font>
Cartoon depiction of the "subprime virus" destroying a bank by removing its supporting pillars. (Source:

The mainstream media, along with various analysts and financiers, are now using a similar kind of analogy: They're comparing the subprime crisis to a bird flu pandemic that's spreading around the world.

The comparisons can be quite imaginative. A recent WSJ opinion piece by Charlie McCreevy, EU commissioner for the internal market and services, begins as follows:

Curing the Subprime Virus

In the new Will Smith movie "I Am Legend," the central character finds himself seemingly alone in New York, struggling to find a cure to a virus that has infected the world. Judging by some of the reactions to the current financial market turmoil, there are those in the U.S. who think that they are in a similar situation, dealing with a crisis that has decimated Wall Street. The difference, though, is that they are not fighting this crisis alone.

As our intrinsically interconnected economies show, no one can remain immune to shocks in any part of the globe. The virus launched by the underpricing of risk has spread with extraordinary speed across the Atlantic. Very few people saw that a majority of the mortgage-backed securities engineered in the U.S. were in the hands of EU financial institutions. The critical point, though, is that rather than work alone in our separate laboratories, the subprime mess shows why we have to work together and find global solutions."

McCreevy's opinion is well supported by other European officials, who claim that Europe has become fully infected by the virus:

Damage to European economies may prove deeper than officials acknowledge

"The extent of Europe's infection from the U.S. subprime mortgage virus is becoming clearer....

But there are growing signs that the credit crisis and U.S. slowdown have hit Europe deeper than policy makers seem willing to acknowledge. Hopes that the euro zone can remain partly insulated from a U.S. housing bust and recession are receding. ...

Any suggestion that Europe was weathering a U.S.-focused downturn seemed wide of the mark.

While attention largely centered on a plunge in confidence among U.S. service firms in January, German, Spanish and Italian service sectors also recorded their first contraction in years.

Financial markets are waking up also to the idea that it may be dangerous to use the relatively robust ECB economic forecasts as anything other than an interest rate pointer.

"The market is becoming aware that the crisis in the United States will indeed have an adverse impact on growth in Europe," said Heino Ruland, strategist at FrankfurtFinanz in Germany.

European stock markets have had one of their worst January performances on record and entered bear market territory in the course of that month. The FTSEurofirst lost another 4 percent last week.

"We now see a deterioration in the euro area," said Luca Paolini, strategist at Credit Suisse. "If anything, the risks are higher in the euro area than in the U.S. - where expectations are already very low. And you still don't have a policy response from the ECB."

The ECB president, Jean-Claude Trichet, acknowledged the darkening economic horizon after the bank left interest rates unchanged again at 4 percent on Thursday, even as the Bank of England cut its benchmark rate again by a quarter of a percentage point.

"If I take all the data, they confirm risks lie to the downside," Trichet said at a news conference."

The "subprime virus" analogy has also spread to an opinion column in the Hong Kong's South China Morning Post, which has this:

"A virus that kills its host quickly is generally a failure. Once the host dies, the virus has trouble spreading.

A host that is moving around - interacting with and breathing on other hosts - is much more useful than one that is dead. A host that is not even aware that it is carrying a virus is even better.

The subprime loan market looked for a while to be a very effective virus. It spread rapidly from bank to bank, making each host a little sick, but not ill enough to prevent it from passing on the subprime assets to a bunch of other banks.

If fact, before any banks even realised they were carrying anything infectious, they had virtually all been contaminated.

And now it looks as if the subprime virus is about to demonstrate that it is actually too effective, since it has started killing off its hosts. One or two of them have succumbed, and more will soon follow.

Quarantines are now in place, and no one in their right mind will be engaging in any activity where they are likely to be exposed to the contagion. But it's a little too late.

And where do viruses come from? The ones that give us the flu and other illnesses have been around forever and simply evolve into one form or another. But this doesn't seem to be a great explanation for the subprime virus. The subprime virus was created by people. Imagine the evil computer hacker who creates a virus to be distributed over the internet or through e-mail.

Picture a bunch of guys in jeans and dirty T-shirts, sitting around late at night staring at their computer screens, coming up with ideas to effectively infiltrate the world's biggest financial institutions, with no concern for the impact they may have on everyone else. Now replace jeans and T-shirts with pinstripe suits and you have the answer: investment bankers.

No computer hacker has ever made anywhere near as much money as the investment bankers who invented the subprime virus, nor have they ever done anything like the harm that these guys did. Computer hackers are punished, and so will the investment bankers.

Some of them will receive only small bonuses this year, perhaps in the mere hundreds of thousands. Some of them may not be able to buy a new car. And some may even have to forgo the skiing holidays they had planned, at least until the end of the peak season."

This business about bonuses is a good point, because one can see story after story about how the people who perpetrated the fraud that caused the credit bubble are being very careful to make sure the funding stays in place for their bonuses.

I recently posted a murder-suicide story, where a subprime mortgage executive of a bankrupt company bashed his wife's head in, and them jumped off a bridge to his death.

I quoted the following astonishing paragraph from one of the news accounts:

"On Tuesday, the company filed a petition in bankruptcy court to pay $1 million in bonuses to Buczynski, two other senior officers, and Fieldstone's remaining workers so that the company could wind down its affairs and shutter the business."

These guys are up to their necks in wholesale corruption, but the one part of the whole mess that the perpetrators have inoculated against the subprime virus are their own bonuses, rewards and other perks.

Here's a little anecdote that someone posted online in December of last year:

"My son works at a hedge fund. They lost $100 million in August, $500 million in October. This month the loss will be about $1.3 billion. All these losses are being kept off the books. He is green under the ears so can't give me much other information, but he does know this -- there WILL be bonuses this year, and no layoffs are on the horizon. The world no longer makes sense."

And a recent article in the Telegraph starts with a headline that I'm sure is supposed to as ironic as are allowed in news headlines:

City bonuses weather the credit crisis

"City bonuses in London were not affected as strongly by the credit crisis as first predicted, according to London-based employment monitor Morgan McKinley.

From a survey of 220 financial services professionals in the capital, 80pc said they received a similar or higher bonus last month, than in January last year, while 70pc said their bonus either matched or exceeded their expectations. ...

He said: "Following on from a record bonus round in 2006/2007, speculation surrounding this year's bonuses was enormous, particularly given the significant volumes of write-downs by banks in the last quarter of the year. ...

The average salary in the sector rose 5pc in January, to £53,246 (over $100,000)."

Whew! I'm glad the financial execs aren't suffering at least!

The same can't be said of many cities and towns, as municipal bonds are being attacked by a particularly virulent strain of the subprime virus, according to the Financial Times:

"The subprime virus has mutated. It has now infected the municipal bond market. The same issues that roiled the asset-backed commercial paper market in the autumn are cropping up again. Liquidity risk turns out to be a bigger problem than credit-focused investors had reckoned with. And liquidity risk can be fatal. Look at what happened to structured investment vehicles, a market that shrivelled away.

Municipal issuers tap the capital markets in several ways and all of them now look under varying degrees of stress. Auction rate securities, a $330bn market according to JPMorgan Chase, have coupons that reset periodically at auctions. Now a few are failing, in part because of jitters around the insurers that support the credit ratings of municipal debt. There has to be a good chance that this type of funding vehicle, like SIVs, will lose its raison d’être.

What are the implications? First, issuers will have to dig deeper in their pockets. When auctions fail, some of them face resets on their coupons, inflicting varying degrees of pain on budgets. Then they have the continuing headache of restructuring their debt. Converting it into some form of structured debt could be tough since that is likely to require funding commitments from banks. Meanwhile, the rating agencies are likely to start worrying about the increased debt servicing load the issuers could face."

The above is a story about "auction-rate securities," an arcane investment vehicle that few people ever heard of. They have that name because the interest rates investors bid on the opportunity to invest in them, and the investor who demands the lowest interest rate wins the auction bid.

These are the same auction-rate securities that are used by student loan companies. I discussed these a few days ago in "'Credit crunch' domino effect is now affecting student loans."

The problem is: Nobody wants to bid on them any more, thanks to contagion from the "subprime virus." Now, municipal borrowers will have to pay much higher interest rates to fund their schools and hospitals, and those rates will be passed on to local taxpayers. Local taxpayers were, of course, the first to get the subprime virus, when they purchased or refinanced their homes using subprime mortgages; now they get to suffer a new round of the virus.

In the above article, I described through the mechanism of Step 1 through Step 4 how the "subprime virus" spread from a formerly obscure bond insurer (Ambac) to a very visible student loan organization in Michigan.

According to an article in the NY Times, the problem is getting more serious by the day (or perhaps I should say, "the flu victims are getting sicker every day"):

New Trouble in Auction-Rate Securities

"SOME well-heeled investors got a big jolt from Goldman Sachs this week: Goldman, the most celebrated bank on Wall Street, refused to let them withdraw money from investments that they had considered as safe as cash.

Types of auction-rate securities <font face=Arial size=-2>(Source: NY Times)</font>
Types of auction-rate securities (Source: NY Times)

The investments at issue are so-called auction-rate securities, instruments at the center of the latest squeeze in the credit markets.

Goldman, Lehman Brothers, Merrill Lynch and other banks have been telling investors the market for these securities is frozen — and so is their cash.

The banks typically pitch these securities to corporations and wealthy individuals as safe alternatives to cash, investors said. The bonds are, in fact, long-term securities. But the banks hold weekly or monthly auctions to set the interest rates and give holders the option of selling the securities.

Only this week almost 1,000 of these auctions failed. The banks also refused to support the auctions, leaving many investors wondering when they will get their money back.

“Investors have lost confidence in the liquidity of these instruments,” said G. David MacEwen, the chief investment officer for fixed income at American Century Investments, a mutual fund company. “These types of instruments depend on new investors showing up to own the securities.”

The $330 billion auction-rate market is dominated by municipalities and other tax-exempt institutions like the Port Authority of New York and New Jersey, which had issued some auction securities and had its interest rate soar to 20 percent on Wednesday. Closed-end mutual funds, student loan companies and corporations also issue such securities."

Notice that the situation described in the above article is very serious, because it means that the subprime virus is spreading from these banks to their clients -- corporations and wealthy individuals.

These examples show how the credit crisis is spreading, not just from bank to bank, but from banks to all investors. No corporation and no investor is safe these days, except those whose assets are in cash or US Treasuries.

India has been hard hit by the credit crisis, and downbeat article in an Indian investors' publication highlights the anxiety:

"No light at end of tunnel as yet

"The developed markets have seen a full-blown credit crunch since August. Even exceptional intervention by the US Federal Reserve has done little to ease the situation

It’s now a full year since the first cracks appeared in the US subprime mortgage market. ...

A lot has happened since then. The first reactions to what has now come to be known as the subprime crisis were pretty hopeful: it was seen as a problem in one corner of a huge global financial system.

But later revelations showed how the subprime virus has spread from one bank to another because of fancy derivatives. The developed markets have seen a full-blown credit crunch since August, and even exceptional intervention and interest rate cutting by the US Federal Reserve has done little to ease the situation. Some of the world’s best-known banks have seen profits tumble; the Chinese government has rescued many of them.

One year later, the US stands on the brink of recession and most other major economies face the prospect of lower growth this year. The problem has proved to be far more serious than what most believed a year ago.

The passage of a year has done little to improve matters. There is still little clarity about how deep the rot in the Western banking system is. The US Federal Reserve had initially estimated the potential subprime losses at $100 billion. That has proved to be way off the mark. The write-downs by banks till now have already topped the $150 billion mark. This week, the G-7 group of rich nations said credit-related losses could touch $400 billion.

If losses do indeed cross $400 billion, a lot of banking capital will be at risk. And this will affect the ability of banks to lend, leading to an even worse credit crunch. The worst prognosis is that the US could eventually slip into a Japanese-style deflationary spiral, with contracting asset prices and a wobbly banking system.

It is hard to say whether the darkest fears will prove to be true. But there is little doubt that the credit crisis has punctured several oversized egos in the financial system. While the calls for heavy government regulation of banks are a bit overdone, the events of the past few months have shown that banks are fragile institutions which need to be handled with care.

Else, their problems can pull down entire economies. It’s clearly too early to write off the entire Western banking system. But the past year has provided sobering lessons."

Sobering lessons indeed, but lessons that politicians, journalists, financiers, analysts, brokers and pundits have not yet fully learned.

And so, I guess perhaps I should change my "termites in a mansion" analogy that I began this article with.

"Think of the world economy as a huge, enormous, bloated hospital-city, with all kinds of research labs and workrooms and clean rooms and executive apartments. Think of the CDOs as trillions of "subprime virus cells" that have begun to infect people, so that another room in the hospital-city becomes infected each day.

The "financial virus engineers" have been working in the research labs to manipulate the virus cells to make money from them. They found ways to make make money and inoculate themselves, so they'd be safe, but their efforts freed the virus to spread faster throughout the hospital to other people, who become extremely sick, vomiting all over the place.

The Fed and other central banks have been running around the hospital with Tamiflu and disinfectant spray, trying to stop the spread of the virus. They've been pretty successful with their disinfectant spray and Tamiflu, postponing the inevitable, even allowing the "financial virus engineers" to collect their year-end bonuses, but they can't keep up with the virus.

Now influenza experts have been startled to discover that the "subprime virus" is mutating, and developing a resistance to Tamiflu, something that they had previously thought was impossible.

And so, what's happening is that the disinfectant spray isn't working on the subprime virus, and the Tamiflu isn't working either because the subprime virus has developed a resistance to it, and it won't be long now before everyone in the hospital becomes deadly sick from the subprime virus -- except for the "financial virus engineers" and their friends, who inoculated themselves, and now sit around in the executive apartments having parties with call girls."

Naaah. I like the analogy about the termites better. However, that stuff about the bird flu virus becoming resistant to Tamiflu appears to be true. (18-Feb-08) Permanent Link
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The Iraq war may be related to the bombing of Hiroshima and Nagasaki.

On the first anniversary of the successful "surge" strategy, we explore a generational theory that provides a completely different explanation of the 2003 ground invasion of Iraq, tying it to the use of nuclear weapons that ended World War II.

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Terrorist suicide bombings in Iraq may backfire against terrorists: During an awakening period, terrorist acts cause masses of people to shrink from more violence. (19-Aug-03)

The "surge" began on February 14, 2007. At that time, Baghdad and the region surrounding it was a virtual war zone, littered with bodies every day from suicide bombers, roadside bombs, and death squads.

Journalists, analysts, politicians, and pundits were all predicting the worst. Many Democrats, and pro-Democratic Party media, including the NY Times and NBC News, were openly declaring the situation a civil war, essentially aligning themselves in support of the terrorists and against America. NBC News was the most grossly disgusting, led by vitriolic headliners like Chris Matthews and Keith Olbermann, committing all its resources to advocating American failure and supporting the terrorists, even making a big theatrical announcement the previous November that it would then and forever call the Iraq war a "civil war."

Even those who supported the "surge" and were hoping it would be successful, felt an enormous anxiety that the whole thing could collapse into civil war at any moment.

Except it wasn't a civil war, as is now apparent to almost everyone except the real nutcases. Violence has not been eliminated, but it's down sharply to the level that might occur in an American city. And Iraq itself has become increasingly stable.

You can take almost every article and every analysis written in Washington about Iraq in the past five years, and stack them up into a big pile, and you wouldn't have anything but a big pile of garbage. There's barely a bit of common sense in any of them, whether coming from the left or the right. The "think tanks" were no better than tankheads.

So I'm not going to be shy about pointing out (again!) that I may be the only person in the world who got Iraq right. I've been writing articles about Iraq since 2003, containing analyses and predictions that were counterintuitive and not shared by other people, and these analyses and predictions all turned out to be right. You can see for yourself by clicking on any of the articles in the sidebar to the right. The Generational Dynamics forecasting methodology has never failed me. Every Generational Dynamics prediction that I've posted on this subject and others has either turned our right or is trending right; not a single one has been shown to be wrong.

I'm not a psychic, and I have no special powers. The way that I was able to predict in 2003 what would happen in Iraq and be right is because of one simple fact that nobody seems to grasp, no matter how many times I write about it: Iraq is in a generational Awakening era, just one generation past the end of the 1980s genocidal Iran/Iraq war, and so it's like America in the 1960s, just one generation past World War II.

The way I could be certain all these years that Iraq was not having a civil war is because it was acting like America in the 1960s, where there wasn't a civil war.

There are still "anti-war" politicians who are claiming that the surge has failed because Iraq hasn't achieved the same political stability as the United States. That's laughable when you consider that Congress is unable to get anything done, but even more so when you realize how unstable the United State was in the 1960s, with three failed presidencies:

The 1968 Broadway play Hair captures the contempt students felt by lowering their pants on stage and "mooning" their GI Generation hero parents. The lyrics of the song "Let the Sunshine in" express contempt for their mothers' clothing and perfume and their fathers' paper-pushing and lies:

We starve-look at one another
Short of breath
Walking proudly in our winter coats
Wearing smells from laboratories
Facing a dying nation
Of moving paper fantasy
Listening for the new told lies
With supreme visions of lonely tunes

Our space songs on a spider web sitar
Life is around you and in you
Answer for Timothy Leary, deary

Take a moment and watch that song as presented in the 1979 movie Hair, about Claude, who comes to New York to join the hippies, but gets drafted and sent to Vietnam instead. This is a really great video, well worth a few minutes of your time:

Now, expand your mind a little, and transplant those thoughts and sounds and smells from New York City in 1967 to Baghdad in 2007, making the necessary adjustments for language and scenery. Where Claude's parents were worried about a Communist invasion, Iraqi Shia were worried that the Sunnis would use chemical weapons on them again, as they'd done to the Kurds in 1998, and Iraqi Sunnis translated American support for the Shia into a defeat at the hands of Iran.

Just try to make that transformation in your mind -- try it as mental exercise. If you succeed, then you'll begin to understand how I knew all these years that there was no civil war in Iraq.

That mental exercise actually is easy compared to the mental exercise that you're going to have to try now, but this one is about why we invaded Iraq in 2003 in the first place.

This is only a hypothesis. But there is an increasing amount of evidence to support it, in the form of other similar things that have happened throughout history, but have never been linked together.

Brief history of Iraq war

First, let's look at some facts about Iraq that are mostly forgotten in today political maelstrom:

From the point of view of Generational Dynamics, it's not surprising that the American people would overwhelmingly favor a non-crisis war when they think it can be won easily, and then turn against the war when it becomes difficult. That's just human nature.

For Generational Dynamics, the interesting question is: Why did Americans suddenly so overwhelmingly support the Iraq war in 2003?

Generational Dynamics concerns itself with the attitudes and behaviors of large masses of people, entire generations of people. The actions and behaviors of politicians are of little interest, except insofar as they reflect the attitudes of the people.

There's little doubt in my mind that this was not driven by President Bush; it was driven by the American people, who were panicked over the possibility of Saddam Hussein using his WMDs to attack American interests, or even American soil.

What I'm saying is that the American people panicked over the possibility of WMDs. And in this article I'm exploring the reasons WHY they panicked.

The 58 Year Hypothesis

Related Articles

58 Year Hypothesis
South Korea's government in crisis over beef imports from U.S.: Hundreds of thousands of Koreans held candlelight demonstrations in Seoul... (12-Jun-2008)
The Iraq war may be related to the bombing of Hiroshima and Nagasaki.: On the first anniversary of the successful "surge" strategy,... (17-Feb-08)
Kenya settles into low-level violence on the way to Rwanda: So far, it's "ethnic cleansing," but not genocide,... (1-Feb-08)
Investors commemorate the False Panic of Monday, October 19, 1987: The Dow Industrials fell 22% in a single day, the largest one-day drop in history.... (19-Oct-07)
System Dynamics and the Failure of Macroeconomics Theory : Mainstream macroeconomic theory, invented by Maynard Keynes in the 1930s, has failed to predict or explain anything that's happened since the bubble started, including the bubble itself. We need a new "Dynamic Macroeconomics" theory. (25-Oct-2006)
Speculations about a stock market panic and crash : Will there be a stock market panic next week, next month, or next year, and will it lead to a crash? We speculate on some possibilities. (31-May-2006)
As stock markets melt down, the question is: Where's all the money going?: For the first time, analysts are debating whether the stock market is crashing.... (21-May-06)

The first time you hear this hypothesis it almost seems fantastical.

So instead of simply stating it, I'm going to try to present it in a way that (I hope) will be credible to most readers. This is the thought experiment, the mental challenge that I mentioned earlier.

First, suppose that you're a child, between 5 and 10 years old. You're living a happy life, playing with your trucks and dolls and your playmates, learning to read, write and compute percentages.

You have a happy, idyllic life, with nice parents, living in a nice house. Everyone is happy. You're happy, your little friends are happy. Your parents are happy. This is the way life is supposed to be -- because you've never seen it any other way. Remember, you're only 5 to 10 years old.

Then something horrible happens -- a national event that's so terrible and so unexpected that it changes your life completely. It causes deaths around you or starvation around you. Your parents talk about it all the time. Your teachers talk about it all the time. It's an event that's SO TRAUMATIC to you that you will remember it vividly for the rest of your life. You'll even have nightmares about it for decades. It affects everything and all your relationships for all time.

And not just you. This is an important point: it's not just you. EVERY person around your age goes through the same trauma. It's a national event, and so EVERY child was affected by it in the same way, and EVERYBODY in that age group suffers the same trauma throughout their lives.

What are examples of these horrible events? We'll consider four of them:

  1. The Spanish flu epidemic of 1918 that kills tens of millions of people, including some of your friends and perhaps people in your family.
  2. The stock market crash of 1929, leading to the Great Depression and the horrors of massive unemployment, massive bankruptcies, massive homelessness and massive starvation, perhaps affecting your own family.
  3. The genocidal war between Jews and Arabs in Palestine in 1948. For this example, we'll assume that you're a young Jewish child, 5 to 10 years old, and that you experienced the massive deaths and destruction all around you at that time.
  4. The use of nuclear weapons on Hiroshima and Nagasaki in 1945. Not exactly a traumatic event for you (unless you're Japanese), but in the context of the horrors of WW II, enough to cause you to fear nuclear weapons for the rest of your life.

So now let's go back. You're a young child, 5 to 10 years old, when something so horrible happens that it traumatizes you for life. You never forget it, and you never want it to happen again.

And so, you go through life, from one adventure to another, getting older and older. And so do all the other people who were kids at the same time that you were.

Now let's move ahead to the time 58 years after the traumatic event. When the original event occurred, you were 5 to 10 years old. Now, 58 years later, you're 63-68 years old.

Something strange happens. You have conversations with other people around the same age. That might include your wife, or your pals on the golf range or board room. But you really begin to wonder: Can it happen again?

There's the realization that all the people younger than you and your friends don't even care. They don't think about it at all. They're oblivious to the danger. They were born after it happened, or were too young to know what was going on. It's your group of 63-68 year olds that even realize that there's a danger; younger people don't.

Neil Howe and William A. Strauss, the founding fathers of generational theory, described the characteristics of an event that can alter generational attitudes and behaviors: They say that such an event must be "foreseeable but poorly foreseen."

Well, that's what you see. Something happens to make you fear that the event is going to happen again. The same anxiety grips all the other 63-68 year olds across the country.

Maybe the anxiety is well-founded, maybe it isn't, but the people in your age group panic, and the panic spreads to younger people who are influenced by your concerns.

That's the 58-year hypothesis: That 58 years after a traumatic national event such as we've described, the 63-68 year olds, fearing a recurrence, cause a panic to occur. If the danger isn't real, then we refer to it as a "false panic." Whether or not a panic is "false" may not be known for several years, until the danger can be fully analyzed.

Now let's return to each of the four examples above, and look at what happened in each case, 58 years later:

  1. The Spanish Flu epidemic occurred in 1918. In 1976, 58 years later, the "swine flu" panic occurred. The public became hysterical over the possibility of a new flu pandemic. Responding to public demands, the government prepared millions of doses of swine flu vaccine. The pandemic amounted to nothing, and the whole thing was a political fiasco.

    Today, in 2008, the younger generations have no fear at all of a bird flu pandemic, something that's a real possibility.

  2. The stock market crash occurred in 1929. In 1987, 58 years later, the "false panic of 1987" occurred. The market fell 25% in one day, but recovered quickly, because the market was underpriced at that time.

    Today, the younger generations have no fear of a new stock market panic and crash, which is a real possibility because the market is overpriced by a factor of almost 250%.

  3. The genocidal Jewish/Arab war occurred in 1948. In 2006, 58 years later, the kidnapping of two Israeli soldiers near the Lebanon border caused the Israelis to panic and and launch the war against Hizbollah within four hours, with no plan and no objectives.
  4. America used weapons of mass destruction on Hiroshima and Nagasaki in 1945, bringing WW II to an immediate end, and causing widespread fear that weapons of mass destruction would one day be used on Americans. In 2003, 58 years later, Americans panicked over weapons of mass destruction in Iraq, and launched a ground invasion.

    Today, the younger generations have no fear of weapons of mass destruction, and have turned against the war.

Most people, including myself, have assumed that the 2003 ground invasion of Iraq was triggered by 9/11. The 58-year hypothesis provides an alternate explanation, indicating that it would have occurred anyway, even if the 9/11 attacks hadn't occurred.

Methodology for identifying 58 year examples

The 58 year hypothesis really is pretty mind-blowing, because you can't grasp it unless you can go into the minds of a specific set of people -- the 63-68 year olds who experienced a national disaster in their youth. Anyone younger would have no emotional connection to the event, other than dry historical facts and a contagious sense of panic urged by their elders.

It's still a hypothesis, although the body of evidence supporting it in the form of additional examples is growing. I'll list more examples in some other article.

For college students who are interested in historical research, there's plenty to be done here -- determining additional examples.

However, I have to indicate a HUGE METHODOLOGICAL WARNING: Beware of cherry-picking.

Take the first example above -- the 1918 Spanish Flu epidemic causing the false swine flu panic in 1976. That's 58 years later, so it appears to support the hypothesis -- but more has to be proven.

Suppose that false flu panics happened in other years, say 1960, 1965, 1971, 1976, 1981 and 1985. They you can't just pick the 1976 date because it appears 58 years later, and claim that it supports the hypothesis, because it doesn't in that case. You can't ignore similar cases in other years. You can't "cherry pick" the years and events that make the hypothesis work.

In this case, there were no such other false flu panics. The only major flu fiasco of this kind that occurred in the last century, as far as I know, was the swine flu panic of 1976. Since there are no other similar dates around, it's fair to claim that you're not cherry-picking, and the 1976 date provides genuine support for the 58-year hypothesis.

Similarly, there was no other false panic like the false panic of 1987, and there was no other panicked war like Israel's attack on Hizbollah in 2006, and so that isn't cherry picking either. (In the latter case, you'd have to do more research to verify that other Israeli wars were much better planned than the 2006 war, something that few people would doubt anyway.)

With regard to the 2003 ground invasion of Iraq, were there similar events in other years? The Afghan invasion had nothing to do with WMDs. Neither did the original Iraq war in 1991.

The only previous war that appears to be similar was the 1962 Cuban missile crisis. That crisis was based on a panic that was remarkably similar to the panic that led to the 2003 Iraq invasion. The previous Bay of Pigs disaster had been based on faulty intelligence from the CIA, and the Cuban missiles probably could not even have reached American soil at that time.

However, the Cuban missile crisis occurred 41 years prior to the 2003 invasion of Iraq, and those events were far enough apart so that there's really no danger of cherry-picking.

The Generational Dynamics forecasting methodology has worked far better than I ever imagined when I started.

The 58-year hypothesis, if it can be verified, adds a very powerful tool to the forecasting toolbox. It's particularly interesting that it can be applied to explain the ground invasion of Iraq. (17-Feb-08) Permanent Link
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'Credit crunch' domino effect is now affecting student loans.

College-bound students may have problems in the fall.

Quick review of the major actors:

It's now turning out that the ratings agencies took fat fees from the banks to give AAA ratings to many, many CDOs and other bonds that are turning out to be near worthless. And it turns out that bond insurers took fat fees to insure many, many of these same bonds, and can't afford to pay off the insurance on them.

Now let's take a look at the domino effect that's going to keep your son or daughter from going to college in the fall:

Step 1: Fitch downgrades some Ambac assets

On January 18, 2008, Fitch Ratings issued a press release saying that it was lowering the rating on many Ambac's assets (not the securities that Ambac insures, but the assets that Ambac owns for itself):

"The decision to downgrade the IFS rating by two notches, coupled with the continuation of the Negative Rating Watch, reflects the significant uncertainty with respect to the company's franchise, business model and strategic direction; uncertain capital markets and the impact of Ambac's recent decisions on future financial flexibility; the company's future capital strategy; ultimate loss levels in its insured portfolio; and the challenges in the financial guaranty market overall."

This could happen to any company these days, and it usually means that the company tried to make a lot of money by investing in mortgage-backed securities that were turned into near-worthless CDOs.

(For those interested in the math behind the creation of CDOs from mortgage-backed securities, see "A primer on financial engineering and structured finance.")

Step 2: Fitch downgrades some bonds insured by Ambac

Once Ambac's assets were downgraded, it meant that Ambac could no longer guarantee that it will be able to pay off on all its insurance policies.

CDOs insured by Ambac have been purchased by all kinds of organizations around the world. Many of those CDOs would have had BBB or CCC ratings without Ambac's insurance. But with Ambac's insurance, they received AAA ratings, since they're doubly protected: The bond investor would receive payment from the bond or payment from the insurance policy.

But if Ambac's ability to pay insurance was degraded, then the bonds insured by Ambac were degraded as well. And that's what happened.

On January 18, 2008, Fitch Ratings issued a second press release saying that it would downgrade the ratings on many "reinsurance transactions" insured by Ambac:

"Fitch Ratings downgrades 420 classes of asset-backed securities (ABS) Additionally, the ratings remain on Rating Watch Negative by Fitch. This action follows Fitch's downgrade of the ratings on Ambac Financial Group, Inc. and its affiliated entities (Ambac)."

The press release then included a very long list of downgraded contracts from many different types of organizations. It's quite a list, and I wish I could include all of it.

But here's a taste of the organizations affected: Ballantyne Re, Babcock & Brown Air Funding, Capital One Auto Finance Trust, Hertz Vehicle Financing, AmeriCredit Automobile.

The largest group of organizations on the list had names like: Access to Loans for Learning Student Loan Corp., Alaska Student Loan Corp., CollegeInvest, Connecticut Higher Education Supplemental Loan Authority, Michigan Higher Education Student Loan Authority.

In fact, there are similar names of student loan organizations from Maine, Iowa, Massachusetts, Missouri, New Jersey, North Dakota, Texas, Pennsylvania, Rhode Island, Utah, Ohio and Vermont.

And so, what's apparent is that a lot of student loans were in trouble.

Step 3: Student loan bond auctions fail

These student loan corporations do the same sorts of things student loans that mortgage lenders did with mortgage loans.

The student loan lenders bundled then together, divided them into tranches, and sold them to investors through auctions. Since they're sold through competitive bidding at auctions, and since the interest rate depends on the amount the bidder pays, they're called "auction-rate securities." With the money obtained from investors at these auctions, the lenders could then offer more student loans.

Well, disaster struck the week before last.

What happens if you give an auction and no one shows up? That's what happened when the lenders tried to auction off their student loan securities. In most cases, there were no bids. Nobody was willing to buy them.

And why would anyone want to buy them? They may turn out to be worthless. Fitch Ratings had just downgraded many of these securities (see Step 2 above), and there's no way to know how much to bid for them, since there's no way to know whether or not they'll turn out to be near-worthless.

And so, many student loan lenders have no way to sell off their old student loan securities, and so they have no way to get money for new student loans. That's how the 'credit crunch' works.

Step 4: Michigan freezes student loan program

Notice in the list in "Step 2" above, the name "Michigan Higher Education Student Loan Authority" appeared as one of the organizations whose securities had been downgraded. Actually, it appeared many times on the Fitch press release, listing many of Michigan's securities.

On Monday, the following announcement appeared on the Michigan student loan web site:

"The Michigan Alternative Student Loan (MI-LOAN®) Program is offered by the State of Michigan, through the Michigan Higher Education Student Loan Authority (MHESLA), for the exclusive use of students who are attending Michigan degree-granting colleges and universities. This alternative loan program is intended to help students bridge the gap between college costs and traditional federal financial aid resources.

Due to the current and unprecedented capital markets disruption, there is not sufficient available capital to continue making MI-LOANs. After considerable analysis and significant efforts to secure sufficient MI-LOAN capital to make new MI-LOANS, the difficult decision to temporarily suspend MI-LOANs had to be made. Therefore, the MI-LOAN Program will be temporarily suspended at the close of business on Friday, February 15, 2008. When conditions warrant and funds become available, the MI-LOAN Program will be reinstated.

This temporary suspension will not affect any MI-LOANs for which school certifications have been received as of February 15, 2008, and those loans will continue to be disbursed in accordance with current MI-LOAN procedures. As the school certification process takes time, new MI-LOAN applications will not be accepted online after the close of business on Wednesday, February 13, 2008."

So far, only Michigan has made this kind of announcement. It remains to be seen whether other states will follow suit.

According to a WSJ article,

"The credit crunch that has so far caused more than $100 billion of losses for big Wall Street investment firms now extends to students in Michigan, and it could soon hit many other borrowers, ranging from California museums to the prestigious Deerfield Academy prep school in Massachusetts. ...

In the past few days, problems have mounted for many borrowers as an obscure -- but important -- corner of the credit market called auction-rate securities has gone into a deep freeze.

Borrowers ranging from student-loan authorities to municipalities to big bond funds depend on this market to raise money for making loans and funding projects. They do so by selling securities whose interest rates are reset every week as they change hands in auctions....

Moody's Investors Service estimates the size of this market at $325 billion to $360 billion.

In recent days, the money managers and other investors who typically buy auction-rate securities have been balking, out of fear the credit turmoil is spreading. The remaining bidders have commanded higher interest rates from borrowers including Deerfield, San Francisco's de Young Museum, New York's Carnegie Hall and many others. ...

Meantime, many investors who hold the securities would like to sell them but can't. Of roughly $20 billion in such securities auctioned yesterday, half -- or about $10 billion -- failed to generate enough demand from money managers to sell, according to one trading executive at a top dealer. That pushed up borrowing costs for the issuers to levels ranging from 4.6% to 18%, as their interest rates reset to "penalty" rates that kick in when an auction fails."

Take particular note of the last sentence above: "pushed up borrowing rates ... to levels ranging from 4.6% to 18%." These are HUGE interest rates for investors, at a time when Treasury bills pay around 3% or so.

This increase in securities interest rates (or "spreads") is not particularly visible to the public view, but it's something that's getting worse, and is another example of something that could reach a "tipping point" very soon.

In this article, we've used the mechanisms of Steps 1 through 4 to illustrate the domino effect, or chain reaction, that's beginning to occur more and more. A failure in one area triggers a failure in another area.

From the point of view of Generational Dynamics, we're going to see a lot more of these situations, as the massive credit bubble keeps leaking, and the "credit crunch" worsens. Generational Dynamics predicts that we'll see a generational stock market panic and crash, and a new 1930s style Great Depression.

If you're a parent hoping to send your kids to college in the fall with a student loan, then you may wish to take this situation into account, and apply for more loans than you had planned to. Better yet, line up a rich uncle who'd like to pay for the education of his nieces and nephews. (14-Feb-08) Permanent Link
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Treasury Secretary Hank Paulson: "The worst is just beginning - we all know that"

Who is this guy, and what have they done with Hank?

In an effort to cushion the blow of the surging foreclosure rate, Treasury Secretary Henry Paulson, along with a group of banks called the "Hope Coalition," announced an agreement to offer 30-day freezes on foreclosures.

Treasury Secretary Henry Paulson (right) and secretary of housing Alphonso Jackson <font face=Arial size=-2>(Source: Bloomberg)</font>
Treasury Secretary Henry Paulson (right) and secretary of housing Alphonso Jackson (Source: Bloomberg)

The announced program would start with a letter to homeowners more than 90 days delinquent. The letter lays out procedures to qualify for a "pause"in the foreclosure process. The homeowner has 10 days to respond so the lender is able to weigh payment options.

Subprime, Alt-A and prime borrowers are eligible, according to the plan. Subprime mortgages are made to borrowers with poor credit or high debt. Alt-A loans are for borrowers who want atypical terms, such as proof-of-income waivers or investment- property collateral, without sufficient compensating attributes, such as larger down payments. Securitized loans, those packaged and sold to investors, would also qualify.

It was just a month ago that Paulson was refusing to consider a bailout plan on foreclosures. However, the housing data is deteriorating so rapidly that he's been forced to change his opinion dramatically.

In response to a journalist's question, Paulson said that the worst was to come. You can watch it here:

Here's my transcript:

Question: "Sir, is the worst over? Will 2008 have fewer foreclosures and some rising prices compared with '07?"

Paulson: "Well, I would say this. In terms of subprime and the resets, the worst isn't over - the worst is just beginning. We all know that.

We all know there's close to 1.8 million 2 million adjustable rate mortgages where the rate is gonna be reset, and the ones that are going to be reset over the next couple of years are that vintage of mortgages where there are the most lax underwriting procedures.

So this is the biggest challenge, and this is why this is so important.

And I've also said that the housing correction, what's going on in the housing marekt, this is not over, it's going to take longer, and that is why we have said we have a diverse economy in the US. It's been growing in the face of the housing correction that's been going on for some time. Growth has slowed down significantly. And we said that we think the economy is going to continue to grow but the risks are to the downside.

That's why we're working so hard right now at IRS to speed up the process so we'll be getting these stimulus checks out and to individuals as early as the beginning of May."

At another point, Paulson said the following:

"That is modeled on a program that was put in place during the Depression. We have many institutions that are now in place that weren't there" to help in the 1930s, while the unemployment rate is now 4.9 percent, compared with 25 percent back then.

Regular readers of this web site are well aware, as perhaps Paulson is by now as well, that the country will soon be entering a new 1930s style Great Depression.

This foreclosure program will have no major effect, though it may help a few people. Or, it may simply give those who obtained their homes fraudulently a little while longer to enjoy their fraud.

It's amazing how far we've come. It's been obvious since 2004 that we're in a housing bubble, at least to readers of this web site.

Actually, even Fed chairman Alan Greenspan in 2004 said, in a statement exhibiting a bizarre form of circular reasoning, that there may be a housing bubble, but if there was it's OK, since it lets people use refinancing to pay off their credit card debt -- which was also increasing.

However, that statement was unique. Few people admitted that there was a housing bubble. Then when the housing bubble started leaking late in 2005, few people admitted it. As the bubble started leaking, almost everyone said that the bottom had been reached.

For years, journalists, pundits, analysts and politicians have been completely wrong. Only this web site has been right: All the predictions on this web site have come true or are coming true. You can see it before your eyes.

Now, with housing deteriorating so rapidly, even Treasury Secretary Paulson is saying so. This is an incredible change of attitude. It's the first REAL admission from the administration that things are going from bad to MUCH WORSE, and that it will continue.

For those people who have criticized Generational Dynamics or this web site or me, you now have to face the fact that almost EVERYONE ELSE has been wrong, and this web site has been right -- for years, time after time. There's no web site or pundit or analyst in the world with the predictive success of this web site.

The point I want to make is readers of this web site have a big advantage over most other people: You know what's coming. You can't stop what's coming, but you can prepare for it. Most people have no idea what's coming, and won't prepare. But you can.

Now is the time to put your affairs in order. If you're underwater in your mortgage, then decide whether you're going to "walk away" or take some other action. If you've embezzled money, then go talk to a lawyer right away.

Don't assume that the economy will save you, because it's only going to get a lot worse. This is something that you know for sure, that few other people do. Take advantage of this knowledge to save yourself and your family. (13-Feb-08) Permanent Link
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An invitation to contribute to this web site

If you "get" this web site, and would like to write an article for it, then please send me a message with your ideas or an outline.

This could be a one-time thing, or if things work out you could contribute something every day.

This web site now has over 5000 regular readers, and I'd like to expand the content if possible.

I've been kicking around what the "rules," if any, would be for other contributors to this web site. Basically I'm open to anything, but the following thoughts apply:

What are some of the topics that you might want to write about?

Here are some examples:

The above list is mostly America-centric, but similar contributions from the point of view of other countries would be particularly welcome.

Most articles on this web site contain predictions. Some predictions are absolutely certain trend predictions, and some are probabilistic predictions that depend on chaotic events.

Try to make your article relevant to the reader by telling how what you're describing will affect him, or how it will affect the world.

For convenience, here's a brief list of the major predictions that have appeared on this web site since 2003, and the year of first appearance:

Anyone interested is invited to write to me with suggestions, questions, or actual articles.

If you have a "hot topic," but don't think it's relevant to generational theory, ask me and perhaps I can suggest a way of angling it. (13-Feb-08) Permanent Link
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AIG announcement puts money market funds at risk

American International Group disclosed that inadequate internal controls, as determined by its outside auditing firm PricewaterhouseCoopers, had led to "material weakness" in financial reporting relating to the fair valuation of credit default swap (CDS) portfolio obligations of its subsidiary AIG Financial Products Corp.

CNBC has been reporting that writedowns are expected to total around $6.2 billion.

AIG had previously claimed that it had managed to escape the major problems that other financial institutions had encountered, forcing them to write down tens or hundreds of billions of dollars CDOs and securities. Monday's news throws this claim into doubt.

To understand the importance of this story, you have to understand the relationship between AIG and its subsidiary, AIG Financial Products Corp., and that's best explained on the AIG web site as follows:

"AIG Financial Products Corp. (AIG-FP) is a wholly-owned subsidiary of American International Group, Inc., world leaders in insurance and financial services. Founded in 1987, AIG-FP was one of the first companies focused principally on the derivatives markets in the United States. AIG-FP is active in a full spectrum of OTC derivative and structured products markets, including commodities, credit, energy, equities, foreign exchange, and rates. ...

As leading participants in the capital and derivatives markets, we provide clients with corporate finance, investment, and financial risk management solutions.

Unlike many financial institutions, we act as principal in nearly all of our transactions, including acting as a principal investor in the energy and infrastructure sectors. All of AIG-FP's payment obligations are guaranteed by our parent, American International Group, Inc.

Our clients include many of the world's top corporations, investment managers, pension funds, banks, investment banks, sovereigns, hedge funds, foundations and endowments, as well as select high-net-worth individuals."

And now, according to AIG's Monday announcement:

"American International Group Inc. said Monday that it has decided to clarify and expand its disclosures relating to the methodology and data inputs used to determine the fair values of the super senior credit default swap portfolio related to the multi-sector collateralized debt obligations of its AIG Financial Products and AIG Trading Group units."

Putting these statements together, you can see that the AAA rated "super senior CDS portfolio" has been feeding into the AAA rated "multi-sector CDOs," providing funding to "investment managers, pension funds, banks, investment banks, sovereigns, hedge funds, foundations and endowments, as well as select high-net-worth individuals."

(For those interested in the math behind the creation of CDOs from CDSs, see "A primer on financial engineering and structured finance.")

Peter Yastro, market strategist at MF Global <font face=Arial size=-2>(Source: CNBC)</font>
Peter Yastro, market strategist at MF Global (Source: CNBC)

According to Peter Yastrow, market strategist at MF Global, speaking on CNBC:

"What's scary about today -- and I think that people need to understand this -- a lot of people have money in cash, and on the sidelines in money markets, and we all assume that those investments are 100% safe, and I'm afraid that there's going to be more than hand-wringing if people find out that the money they have in cash is actually at risk."

From the point of view of Generational Dynamics, this kind of news, far from being surprising, MUST continue, as the humongous credit bubble deflates.

As I explained in "Will hyper-inflation make the dollar worthless (like the Weimar republic)?", and in "Questions and answers about the 'credit crunch,'" we're entering a harsh deflationary spiral, as the amount of money in the world contracts. The reason that it contracts is because the leveraged use of credit during the creation of the bubble created hundreds of trillions of dollars in credit derivatives in new securities. These securities, which are massively interlocked in many obscure ways, are newly created money, in the sense that they could be used as collateral or to make investments.

It's worth remembering that the world GDP is $45 trillion, and all the world's stock markets hold about $60 trillion in assets. This is small compared to the $700 trillion is credit derivatives.

Now that these securities transactions are unwinding, the amount of money in the world is decreasing. This AIG announcement is part of that, and will reduce the amount of money in the world by $6.4 billion -- not counting the effects on other funds.

As the markdown process continues, the writedowns will affect mutual funds, investment trusts, hedge funds, savings banks, pension funds, college endowments, money market funds, insurance companies, and any other institution with money -- possibly including institutions that hold YOUR money.

It's getting harder and harder to identify places where it's safe to keep money, as discussed last week in "Readers comment: Gold prices and where you should put your money." I've seen some reports, though I can't verify their credibility, that hundreds of regional bank failures are expected in the last half of this year, thanks to follow-on effects of the "subprime" crisis.

One issue with fund managers like Fidelity and Merrill is that their accounts are not insured. The funds may be worthless if Fidelity and Merrill themselves go under.

If your money is in a 401K held by one of these funds managers, one solution might be to transfer your money out of the funds and into specific assets -- Treasuries and bank CDs (certificates of deposit) -- that the fund managers are merely holding for you. You would own the actual assets, and you'd be protected.

One web site reader recently wrote to me as follows:

" Regarding holding treasury bonds and bills in Fidelity retirement accounts: I do this myself and it is a relatively straightforward process. Go to your Fidelity account online, choose "Trade Fixed Income", choose "Search Inventory", then choose "US Treasury, Auction." You'll see the list of treasury instruments being auctioned this week. (I do this on a Sunday for the upcoming week. The instruments shown depend on the day of the week.) Click the "Trade" link next to the maturity of instrument you are interested in, and enter the number of $1000 units you want to purchase.

Then when the auction occurs, Fidelity buys the instrument for you - with no fee charged - and you are then holding the actual Treasury instrument in your account rather than only a Fidelity treasury money market fund.

As I read somewhere recently, in the upcoming financial debacle if you can simply hold onto your money you will win. Yes, the Treasuries pay less than the inflation rate. But in these very dangerous and uncertain times, I am willing to pay that penalty in order to have my money in one of the relatively safe investment vehicles. I think that those who insist on chasing some yield at this time will simply lose principal."

That's very good advice. These are excellent philosophies if you want to survive what's coming.

This same reader indicated that he disagrees with me about buying gold:

"I am also a believer in a much higher gold price. Gold is not simply a commodity like other commodities, and in times of financial catastrophe people are going to be desperate for safe havens. The value of the dollar will be destroyed by a Congress with no sense of fiscal responsibility at all. And arguments that the dollar has been stable for two centuries hold no weight because the dollar was good as gold then, and hasn't been since 1971. We've had 36 years of a pure fiat currency regime and it's about due to collapse. Gold and other real assets will be the only viable way to protect your savings. That's why I'm currently 50/50 treasuries and gold and am prepared to go entirely to gold as circumstances demand. I don't know how high gold may go, but I do feel I know that Congress will show no restraint whatsoever when people start to demand relief. They will destroy the value of the dollar before they exercise financial restraint, because that is what the increasingly desperate electorate will demand of them."

Here I must strongly disagree with the writer. The dollar will NOT be destroyed, except in world war scenarios where the US itself is effectively destroyed. In any likely scenario, the dollar will remain the strongest and most valuable currency on the planet.

The writer refers to the "a Congress with no sense of fiscal responsiblity at all." Even if that were true, it would make no difference at all.

Congress today is talking about a $150 billion "stimulus package." That's peanuts. We've already had hundreds of billions of dollars taken out of the economy through CDO writedowns, so this "stimulus package" won't even compensate for the CDO writedowns. And that leaves the trillions of dollars in deleveraging knock-on effects completely untouched.

I have to repeat that we're being hit with a 10-mile high tsunami, and the only tools that the Fed and Congress have are one-foot high flood walls. The tsunami is going to wash over everything, and nothing else is relevant. The only thing that you can do is prepare by running to higher ground.

With regard to gold, here is my opinion on what's going to happen:

It's very hard for me to see any justification buying gold at the current bubble prices. When the bubble bursts, and gold falls below $500, then gold may again be a worthwhile investment.

However, if you DO buy gold, make sure that you take possession of the actual metal. Gold-backed funds may become as worthless as other funds. (11-Feb-08) Permanent Link
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Wheat price rises blocked by commodities market price increase limits

American wheat stockpiles are lowest since just after World War II.

I've been writing about skyrocketing world food prices since 2004, emphasizing their effects in creating new and worsening pockets of starvation, especially in large mega-cities around the world. I've described how it is that a man who can't feed himself and his family has little to lose by killing others for food or by joining the army to wage war.

Wheat prices 2003-Present <font face=Arial size=-2>(Source:</font>
Wheat prices 2003-Present (Source:

Each time there's a price increase in food, there's always a politician somewhere who calls it a temporary problem, saying that food prices will soon be falling again.

And yet, they haven't. The price of food had been generally falling for decades, thanks to the Green Revolution. But around 2000, all that changed, and prices started rising. By 2004, the price rises were clearly beginning to accelerate, and the rate of acceleration has been increasing since then.

Just a few years ago, wheat used to cost $3.50 per bushel on world markets. The last time I wrote about wheat prices, the cost had surged to over the milestone price of $10/bushel.

Prices pulled back by a few cents briefly, but that was only temporary.

Last week, the price of wheat rose so rapidly that trading had to be stopped because the exchange limit on price increases had been reached. That happened EVERY DAY this past week. The limit is 30¢ per bushel per day, so the price rose $1.50 this week alone to $10.93 per bushel on the Chicago Board of Trade (CBOT). The price of wheat has more than doubled in the last year.

Starting next week, the CBOT is doubling its daily price limits to 60¢ per bushel per day.

According to the Feb 28 USDA report. US stockpiles of wheat are falling, and are down 40% from a year ago.

Related Articles

Food Prices
Food rationing comes to the United States: After years of price rises, mainstream media is finally recognizing there's a problem.... (24-Apr-08)
Food panics and riots spread around the world: The unending sharp price wheat, corn and rice prices are destabilizing nations.... (9-Apr-08)
UN World Food Program to institute food rationing: Surging food prices are causing food riots around the world.... (26-Feb-08)
Wheat price rises blocked by commodities market price increase limits: American wheat stockpiles are lowest since just after World War II.... (9-Feb-08)
Wheat prices surge above $10 per bushel, sparking little concern: World food stocks dwindling rapidly, according to the UN.... (23-Dec-07)
UN expert calls biofuels a "crime against humanity": Separately, Oxfam says that biofuels won't work, and they "trample" poor people.... (7-Nov-07)
United Nations warns of social unrest as food prices continue meteoric climb: With world wheat prices now up 60% since January, countries are panicking... (08-Sep-07)
World wheat prices up 30% since May on panic buying: Wheat prices hit an all-time record high, as stocks are low, and poor weather... (25-Aug-07)
The global warming fad is becoming the enemy of food production.: Food prices are continuing to increase sharply around the world.... (16-Jul-07)
Price of food is skyrocketing in India and China: In fact, crop prices are increasing around the world,... (11-Apr-07)
In Mexico, violent crime from drug cartels increases with tortilla prices: After Acapulco incident, Canada may advise citizens not to travel to Mexico.... (8-Feb-07)
UN World Food Program will cut Darfur humanitarian rations in half: This continuing genocide is a very sad situation, but it can't be stopped.... (29-Apr-06)
In a new bizarre move, North Korea demands an end to U.N. food aid: The famine-stricken country officially told the UN World Food Program... (26-Sep-05)
Food prices continue to increase dramatically around the world: Hunger, poverty and starvation are spreading to increasing masses of people around the world,... (10-Aug-05)
China appears to be approaching a major civil war : Unrest is spreading, and economic disparities make China a textbook case for a massive civil war in the making (16-Jan-2005)
Green Revolution vs Malthus Effect: Despite the "Green Revolution," world population continues to grow faster than food production. This is one of the fundamental reasons why wars occur. (28-Jun-2004)

These are the lowest stockpiles of wheat since just after World War II, when America was exporting wheat around the world to prevent post-war starvation. (When I was in school in the 1950s, I recall my teachers saying with pride that "America is the bread basket of the world.")

According to analyses quoted by Bloomberg, there are several reasons why the price of wheat keeps rising unstoppably:

The survivors of World War II were very well aware of how dangerous it is to let people starve anywhere in the world. Starving people do not negotiate.

More and more, I find myself using the phrase "tipping point" in these articles. The continuing downward trend in stock share prices will soon be a tipping point that will trigger a chain reaction of hedge fund bankruptcies.

And this incredible never-ending, ever fast speedup in surging food prices cannot simply cannot go on much longer. It wouldn't surprise me to learn that there tens of millions more people each month foraging through garbage dumps, hoping to find something to feed their wives and children. In this case, the tipping point will occur when prices go so high that a war can't be prevented.

For the most part, today's Boomers and Gen-Xers don't have a clue about what's going on. They'll learn soon enough. (9-Feb-08) Permanent Link
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Bond insurer 'bailout' appears near crisis point

Federal and New York state regulators feud over who'll get credit for "saving the market," according to reporting by CNBC's Charlie Gasparino.

The problem of the "bond insurers" (also called "monolines") has been simmering for months, but because of its complexity I've only mentioned it a time or two, particularly in "The collapse of the bond insurers, ACA, Ambac and MBIA."

The bond insurance firms are part of the alchemy that financial engineers used to transform low-rated, highly risky CDOs and other structured securities into top-rate "risk-free" AAA rated securities. If you're an investment bank issuing questionable bonds, then you buy insurance from an insurer who promises to pay off the bonds if the issuer defaults. That way the bonds are "doubly-protected" -- either the bond will pay off or the insurance will pay off -- thus magically earning an AAA rating.

(For those interested in the math behind bond insurers and other structured finance games, see "A primer on financial engineering and structured finance.")

However, the bond insurers lose a lot of their magic power if their own ratings get lowered, and that's what's being threatened by the ratings agencies, Standard & Poor's, Moody's Investors Service and Fitch Ratings.

There's a great fear of a devastating chain reaction if the bond insurers lose their AAA ratings. If so, then all the bonds that they've insured also lose their AAA ratings. There are two main categories of bonds that would be affected:

In both of these cases, the resulting sales and downgrades will have a domino effect on other investment funds and hedge funds, forcing additional selloffs and downgrades.

During the last couple of months, there's been a huge drama being played out in the financial world. Here are the actors:

It wasn't so long ago that all of these actors were well respected organizations, but no more. They've all lied and prevaricated and defrauded the public so many times, that they have almost no respect remaining. As I wrote recently, the moral to the Aesop's Fable "The boy who cried wolf" is "Nobody believes a liar, even when he's telling the truth." Nobody knows when any of these organizations are telling the truth anymore, or are just covering their asses.

So now we come to next scene of this dramatic real-time farce.

On Friday afternoon, CNBC's Charlie Gasparino reported the following:

Well, who knows? Maybe the regulators have something in their bag of tricks that will lead to some agreement. But there's another, much more likely explanation.

It's much more likely that the State and Fed regulators are both convinced that the bailout will be a spectacular failure, and the supposed "fight over credit" is really a disguised "fight over blame." What each side is saying is: "Let's do this my way, or it will fail." That way, each side can blame the other for failure.

How bad will it be if the bond insurers lose their AAA ratings? There have been a wide range of opinions expressed.

According to a Wall Street Journal article,

"The financial crisis plaguing municipal-bond insurers has some people wondering what the world would look like without them. The answer: maybe not as bad as you would think. ... Municipal bonds don't default much. Municipal bonds with a double-B rating from credit-rating services have a cumulative average 10-year default rate of 1.74% since 1970. That is much lower than double-B-rated corporate bonds, which have a 29.93% 10-year cumulative default rate during the same period, according to research compiled by research firm Municipal Market Advisors."

This has led a number of analysts to conclude that municipal bonds don't really need insurance, and that they'll get along fine without insurance, if there's no bond insurer bailout.

But analysts aren't nearly so sanguine for the other part of the market, the structured finance securities like CDOs.

Josef Ackermann, chief executive of Deutsche Bank, said that bond insurer downgrades could have a big knock-on effect: "It could be a tsunami-like event comparable to sub-prime."

From the point of view of Generational Dynamics, we're overdue for a generational panic and crash, the first since 1929. What's really amazing is how investor attitudes have changed in the last year. A year ago, when the stock market bubble was still growing, the markets would go up almost every day, whether the news was bad or good. Tens of trillions of dollars of interlocking securities were built up on the assumption that the market would keep going up. Now the market has been on a general down trend, ever since December, with the market going down almost every day, whether the news is good or bad. This past week was the worst week for Wall Street since 2003. At some point a "tipping point" will be reached. It will trigger a domino effect that will cause multiple fund failures and forced selling. It's impossible to predict when that will occur, or whether bond insurers' ratings downgrades will have anything to do with it, but if the market continues its steady fall, then it should happen in the near future. (8-Feb-08) Permanent Link
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Both consumer and commercial credit is disappearing as deflationary spiral accelerates

Wall Street markets plummet 3% on Tuesday, as service sector contracts sharply.

A bad omen occurred around 8:45 am on Tuesday. The Institute for Supply Management (ISM) was supposed to release a report at 10 am. But suddenly they announced that they would release it at 8:55 am instead, because it had leaked. Even before the report was released, investors seemed to know that it would be bad news, and market futures began to fall.

ISM non-manufacturing business activity index

The report was worse than anyone expected. The "Non-manufacturing business activity index" was 41.9, much lower than the value 53, which is what economists had predicted.

Non-manufacturing busines activity refers to what is otherwise called the "service sector." It consists of everything from restaurants and banks to contractors, travel agencies and airlines.

(To add to the confusion, the ISM is introducing a brand new index with this report, the "Non-Manufacturing Index," or NMI. If you look at the the actual report, then you see NMI = 44.6% headlined. But economists are interested in only one component, the index they've been working with for a long time, the Non-Manufacturing Business Activity Index, which was at 41.9% in January.)

According to the actual report:

Business Activity

"ISM's Non-Manufacturing Business Activity Index in January registered 41.9 percent, indicating a significant contraction in business activity in January from the seasonally adjusted 54.4 percent registered in December. This is the first contraction in the non-manufacturing sector since March 2003, when the index registered 46.3 percent, and the lowest Business Activity Index since registering 40 percent in October 2001. Two industries reported increased business activity, and 14 industries reported decreased activity for the month of January. Two industries reported no change from December. Comments from respondents include: "Pervasive economic weakness"; "Less customer demand, stiffer competition"; and "Fewer job orders, fewer inquiries about our capabilities."

The industries reporting growth of business activity in January are: Utilities and Educational Services. The industries reporting decreased business activity in January are: Arts, Entertainment & Recreation; Agriculture, Forestry, Fishing & Hunting; Accommodation & Food Services; Health Care & Social Assistance; Transportation & Warehousing; Real Estate, Rental & Leasing; Management of Companies and Support Services; Construction; Wholesale Trade; Finance & Insurance; Information; Retail Trade; Public Administration; and Professional, Scientific & Technical Services."

The report includes the following quotes from survey respondents:

Economists found the report devastating. According to one economist quoted by Bloomberg, "This is a stunning fall. If accurate, it's dire news on the economy."

Generational Dynamics and service sector

From the point of view of Generational Dynamics, this development is significant.

I've been predicting a deflationary environment since 2003, and the initial explanation I gave was from my book, called the "crusty old bureaucracy" theory. I came up with this name because I had read some newspaper column describing some company as having a "crusty old bureaucracy."

According to this concept, there's a generational cycle in businesses, where bureaucracy sets in, and the products become gradually obsolete, and that this happens on a national basis. In the extreme, once enough businesses are producing obsolete products, inflation can't increase because no one will want the products at any price. The only way to fix the problem is through massive business bankruptcies and a new set of businesses.

In the case of American business, practically all of the old businesses went bankrupt during the 1930s Great Depression, and those that survived completely renewed themselves so much that they were new "lean and mean" businesses again.

During the intervening years, every organization -- business, government, education, etc. -- began to develop a bureaucracy of people and departments that were no longer "lean and mean." By the 2000s, most businesses were bogged down with a very heavy bureaucracy. These organizations could only produce products that nobody really wanted anymore.

When I was writing about this in 2003, it was well known that tens or perhaps hundreds of thousands of manufacturing jobs had fled or were fleeing to China. I expected that trend to continue, and the economy to spiral downward.

That didn't happen, and what I hadn't anticipated was the "second bubble," the huge credit bubble that was created by financial engineering and structured credit. This huge bubble created an enormous amount of liquidity, and the US economy was able to generate a lot of new service sector jobs.

In most cases, service sector jobs can start up more cheaply than manufacturing jobs. Manufacturing jobs usually require someone to build a factory; service jobs use products that were manufactured by someone else, so you can hire someone without building anything in advance. So service jobs just require money, and there was plenty of that around, thanks to the credit bubble.

So in 2003 I didn't foresee the enormous growth of the service sector, but I was right about the manufacturing sector. Today, about 90% of all American jobs are service jobs. The manufacturing sector has effectively been destroyed, thanks to the development of the crusty old bureaucracy in many businesses.

Now that the credit bubble is leaking very quickly, we're beginning to see the deflationary spiral that I was expecting in 2003. I would expect service jobs to start disappearing fairly quickly in the months ahead.

The collapse of the credit bubble

The huge credit bubble that began growing in 2003 is now deflating, and appears to be deflating more and more quickly.

The result is that it's getting harder to get credit every day. There are many ways to measure this -- for example, banks are toughening up their lending standards.

This became startling a few days ago, when Citibank actually cancelled the credit cards of many customers of Egg, a UK online bank. Citibank had acquired Egg plc a year ago in order to expand into new markets.

But last week, Citibank sent out an unexpected warning to 161,000 of the 2.1 million Egg credit card users saying that it will end their agreements in 35 days time, because they have a "higher than acceptable risk profile."

A lot of people are really pissed off about this for several reasons, not least of which is the fact that many of the canceled customers had perfectly high credit ratings. Many of them, apparently, either didn't use the card much or else paid off their monthly bills in full, which meant that Citibank could not make much profit on them. If you want to get a feel for the anger of many customers, read the reader comments to this Times Online article on the subject.

An article in WSJ says that banks are making it much tougher to get and keep credit cards, and suggests the following for "How to avoid getting squeezed":

Quite honestly, it's hard for me to see how much good this advice will do, given that Citibank canceled cards for people with perfectly good credit ratings.

Another sign that credit is disappearing is that the CDO market is almost frozen. These CDOs were the means by which banks expanded credit in the past. But with all the writedowns of CDOs, no one wants to buy them any more, so the market no longer exists, for all practical purposes.

On Tuesday morning, CNBC reporter David Faber gave a report on the credit markets as follows:

"Here it is February 5, and we're still talking about credit. It has been a lot of months, hasn't it? And it continues to be very similar in terms of news flow, and the conversation, and the concerns.

This morning, any number of different data points that you could cite as a reason why the markets are yet again focused on that area.

I will get to highly leveraged transactions in a moment, but it's like Sallie Mae getting downgraded by S&P to one notch above junk.

It's a report from Goldman Sachs - their institutional portal this morning saying "Credit is too tight to mention."

Specifically on the real estate side, the residential / commercial real estate markets painted by the report is unequivocally much bleaker -- both the demographics, the supply of real estate credit stand at their worst point since they started this series in the early 90s.

It is these kinds of small but significant data points that we get.

Europe credit blew out yet again today -- or at least is in the process of having a difficult time of things.

And then you get more specific kinds of reports about some of the deals out there.

For example, Harrahs, which had closed a couple of weeks ago -- the banks had hoped to sell as much as $14 billion in debt that financed the transaction -- they haven't been able to. That's not a surprise, of course, given the reluctance of the banks to really take significant hits on what are really likely to be money good deals -- but an unwillingness of people in the credit markets to pay anything near par for these names.

So you've got Harrahs sitting on the books of all these banks. That in turn of course has people concerned about the likes of ClearChannel communications, a company I've reported on many times. Why? Because of all the banks that are financing that huge "go-private." As I reported last week, the principals in the deal remain very positive on its prospects, but they are concerned that the banks are going to panic to such an extent that there is even the possibility that they might try any way they can to get out.

And if you're a bank, of course you're going to consider it. You don't want to fund any of these deals. Why would you? You know you're going to have to mark them down the minute they hit your books. You know that you're going to be unable to sell any of them.

The latest names also that is now going to be concerned about is BCE Inc. Some reports in the Canadian press late yesterday really just questioning how it is that the banks are going to be able to step up to finance a deal that they know they're going to have to keep on their books.

That of course the biggest leveraged buyout more or less of all time, I think topping TXU.

That's where we stand yet again, Erin. It's the same old story. Frankly it continues to worsen."

So this collapse of credit isn't just happening in one place, say real estate. It's happening to consumers, to small businesses, and to large businesses alike.

The collapse of corporate earnings

The fall in the growth rate of corporate earnings for the fourth quarter of last year has been enormous. The fall finally appears to be leveling off at -20% to -21%.

Here's the summary from Friday from CNBC Earnings Central:

"As of Friday, February 1st:

282 companies in the S&P 500 have reported earnings for Q4, 59% have beaten estimates, 14% were in-line, and 27% have missed.

The blended earnings growth rate for the S&P 500 in fourth-quarter 2007, combining actual numbers for companies that have reported, and estimates for companies yet to report, stands at -20.7%.

At the start of the quarter, the growth rate for Q4 was 11.5%. (Data provided by Thomson Financial)"

We can now update the table of the changes in fourth-quarter earnings estimates since the beginning of the fourth quarter, as follows:

  Date    4Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct  1:             +11.5%
  Dec  7:              -1.3%
  Dec 14:              -3.8%
  Dec 31:              -6.1%
  Jan  4:              -9.5%
  Jan 11:             -11.3%
  Jan 18:             -19.0%
  Jan 25:             -20.5%
  Feb  1:             -20.7%

In other words, at the beginning of 4Q, Thomson Financial was predicting that earnings would grow by 11.5%. That turned out to be a complete fantasy. As time went on, and actual results came in, the estimate fell sharply, now at a 20.7% loss.

The fantasy continues. According to a report on CNBC on Tuesday afternoon, Thomson Financial has provided its estimates for earnings growth in 2008. Here are the results:

  Period  Earnings growth estimate (Thomson Financial)
  ------- --------------------------------------------
  Q1 2008       2.6%
  Q2 2008       3.5%
  Q3 2008      20.0%
  Q4 2008      50.0%

This is so absurd that I don't even think many of the CNBC reporters believe it's possible, except for the Pollyannas.

The Pollyanna factor

Late Tuesday afternoon, Maria Bartiromo squawked, "What's going on? We've known all of this bad news for a long time!"

She was referring to the bad news, such as the ISM report and the earnings reports, that were evidently driving the market down. She was making the point that there had already been hints of reduced service sector activity and lower earnings. So why, she wondered, was the market falling now? Since it was old news, the bubble should be growing again.

The answer is that it's related to the old Aesop's fable about the boy who cried "wolf." The first time he cried "wolf" as a joke everyone ran to save him from the wolf. The same thing happened the second time he cried "wolf," But then one day a real wolf showed up. He cried "wolf," but nobody came to save him because they thought he was trying to fool them again. Aesop's moral is, "Nobody believes a liar, even when he's telling the truth."

Well, maybe that news was old news, but whenever bad news comes up on CNBC, the Pollyannas like Maria Bartiromo and Dennis Kneale simply say that it's irrelevant, a one-time thing that will disappear.

The first time Maria cries, "Ignore the bad news," people run to buy, because they believe her. The second time Maria cries, "Ignore the bad news," people run to buy, because they believe her. But the third time Maria says "Ignore the bad news," they think she's trying to fool them again, so they sell. You see, Maria, nobody believes a liar, even when she's telling the truth.

Even now, there are still airhead pundits saying that everything's OK. "It's beginning to feel like 1991 again," one of the them said.

Now, I don't care if it's an analyst, a journalist, a blogger, a pundit, a politician, a college professor, a Nobel prize winner, or anything else, but if someone says that the macro economy today is like 2001 or like 1991 or like 1982 or like l974 or like 1962, then I tell you, Dear Reader, that guy has his head up his a--.

What's going on today in the macro economy doesn't remotely resemble anything that's happened since 1929.

The market

The market rose last week, after the Fed's huge two-part interest rate cut, and after everyone became euphoric over the possible Microsoft leveraged buyout of Yahoo. It seemed like the punch bowl was back, and it was time to party on.

Instead, we're now resuming the downward trend that began in December.

Investors are hoping against hope that the Fed will save them -- by cutting interest rates again, so that liquidity will return and credit will return and leveraged buyouts will return, and so forth.

One thing that I didn't fully understand in 2003 that is fully apparent today is that the Fed has absolutely nothing to do with what's going on now.

The Fed can cut interest rates to zero, and it won't stop the deflationary spiral we're in. In fact, that's what Japan did in the 1990s -- interest rates were set literally to zero, and the deflationary spiral continued, and even today many prices are still falling.

In December, I posted an article called "Will hyper-inflation make the dollar worthless (like the Weimar republic)?" in which I explained why there will NOT be hyper-inflation, but rather deflation.

I've received many questions about that article, and I promised to write an update answering the questions, and it's still on my todo list, and I've even started it, but it isn't done yet, and I'm sorry, but it will get done.

In the meantime, let me address a point that several people asked. It was something like the following: "The Fed will print lots of money, and the dollar will become worthless."

First, the amount of currency in circulation is a very small part of the total money supply. It's so small that it's almost irrelevant. The Fed injects money into the financial system by creating credit by lowering interest rates.

What I didn't understand in 2003 is how little effect the Fed really has. The Fed can inject a few hundred billion dollars into the financial system, or maybe even a trillion or two.

But what really made me see the light was when I realized that there are some $700 trillion dollars of credit derivatives in the world today in various portfolios. Now, that's money too, in the sense that it can be used as collateral or to make investments.

The point is that the trillion or two that the Fed commands is almost nothing compared to the amount of money in the world. Alan Greenspan didn't cause the credit bubble; he had nothing to do with it. He couldn't have created it because the Fed can't control a $700 trillion total. Similarly, Ben Bernanke can't control it either.

The deflationary spiral we're in today is progressing and can't be stopped. Every day that $700 trillion comes down a little, as various securities get written down, or as companies or banks go bankrupt, or as credit cards get canceled. That's where the deflation is coming from, and it can't be stopped because it's too big to be stopped. As I always like to say, you can't stop a tsunami.

From the point of view of Generational Dynamics, we're headed to a new stock market panic and crash, triggering a new 1930s style Great Depression. It's impossible to predict the exact date, but unless the markets somehow reverse themselves quickly, the spiral will be reaching full speed before long. (6-Feb-08) Permanent Link
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Moody's and other rating agencies made big money overrating CDOs

No direct evidence of negligence or fraud yet, but a huge conflict of interest, according to CNBC's reporter Charlie Gasparino on Tuesday.

Gasparino went through publicly available information and found the following:

In the discussion that followed, commentator Vince Farrell of Scotsman Capital Management said:

"What these ratings agencies did is absolutely deplorable. They took the issuers' money and gave them a good rating back. I can understand how the complexity of this thing can throw you, but there were very smart people who were scratching their head at the time, saying, "How do you take triple B subprime stuff, and through financial alchemy, turn it into triple A stuff. It just doesn't make any sense. And now they're paying the price. I think this story is going to play out over a long period of time. I think there was negligence here."

And Gasparino responded:

"I have no direct evident of negligence. But there is clearly one issue here that not even the people at S&P, Moody's, the bond raters talk about, and that's the conflict of interest, where you have the issuers -- municipalities, corporations, companies -- and in this case when you package together these CDOs, it's like Bear Stearns and Merrill Lynch paying the rating agencies to rate the bond. Whenever you have that sort of disincentive -- why would Moody's want to piss off Bear Stearns, when Bear Stearns is essentially pitting Moody's against other bond rating agencies? That's one of the incentives to give higher ratings.

On top of that, these numbers show that structured finance was a HUGE moneymaker for these guys. These guys needed structure finance to make bucks."

To which Farrel replied, "These guys all marched off the cliff together. It's unbelievable."

This is just one more of many examples of retribution closing in on various of the scam artists in the "subprime" scandal. I've said repeatedly that all of these financial engineers might be able to claim that they didn't know what they were doing in 2002, or 2003, or 2004, or 2005, but by 2006 they must have known that the were defrauding investors and the public. By 2007, when Moody's was projecting this kind of fraud as a "growth" business, there is no plausible excuse whatsoever.

These rating agencies made huge amounts of money by issuing fraudulent ratings. The "marched off the cliff together," as Farrell says, and now retribution is getting closer. (5-Feb-08) Permanent Link
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Suicide bombing in Israel blamed on the Gaza border opening

Although Egypt finally closed the border on Sunday, it was apparently not soon enough to prevent the first Palestinian suicide bombing in a year in Israel.

On Monday, a Palestinian suicide bomber blew himself up at a shopping area in Dimona, in the south of Israel, near the Egyptian border.

There were actually two suicide bombers, but one was injured and knocked down by the first bomb. A lady went over to help him and discovered his suicide vest. She screamed to everyone to run, and as the man moved his hand apparently to detonate his explosives, the police shot and killed him.

The bombing took place in Dimona, near the site of Israel's top secret nuclear reactor. It's not known whether this was a factor in the terrorist choice of Dimona as site of the bombing.

Israel is blaming the successful suicide bombing on Egypt's failure to keep the border closed between Gaza and Egypt. However, the BBC said that someone from Al-Aqsa Martyrs Brigades claimed that the border crossing was not used.

Israelis were fearful and furious over the attack.

Palestinians in Gaza celebrated with dancing and free candy. The Palestinian terrorist group, Al-Aqsa Martyrs Brigades, claimed responsibility. Palestinian TV showed a video, recorded two weeks earlier, of the two suicide bombers praying and preparing for their attack. The two were identified as heroic martyrs.

Egypt's re-sealing of the Gaza border crossing is almost certain to cause additional conflict. Thousands of Palestinians have been using it each day to cross into Egypt for shopping or to visit relatives, and to cross back. Closing it again will cause unrest with the Muslim Brotherhood in Egypt as well as with the Palestinians in Gaza.

As in the past, the important thing to be watching for is whether these incidents so infuriate one of the parties (Israel, Palestinians, Muslim Brotherhood) that a serious war is threatened. Nothing like that appears to be the case so far, but tensions are growing.

From the point of view of Generational Dynamics, this region is headed for a new war between Arabs and Jews, re-fighting the genocidal 1949 crisis war that followed the partitioning of Palestine and the creation of the state of Israel. It's impossible to predict whether that war will begin next month, next year, or thereafter, but it's coming with mathematical certainty. (5-Feb-08) Permanent Link
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Blogger watch: Mish Shedlock goes gloomy, while John Mauldin gets muddled.

The word "Depression" is creeping into mainstream media.

Any regular reader of this web site is aware how critical I am of mainstream pundits, analysts and politicians. Journalists like Greg Ip at the Wall St. Journal have no idea what's going on. Economists like CNBC's Steve Lieseman or the NY Times' Paul Krugman talk pablum from mainstream economics, even though it hasn't predicted or explained anything that's happened in the last 10-15 years -- it doesn't explain why the bubble started in 1995 (as opposed to 1990 or 2000 or at all), it doesn't explain how we got to where we are now, and it provides no clue about what's coming next.

The bloggers -- Nouriel Roubini's blog, Michael ("Mish") Shedlock's blog, the Calculated Risk blog (with Tanta), the Sudden Debt blog, the MinyanVille blog, and others -- often pull the facts together, but fail to draw the right conclusions, for fear of getting people mad at them.

All of these people post analyses of things going on -- the latest jobs reports, the latest currency exchange rates, real estate foreclosure rates, interest rates, housing inventories, etc. They paint dark pictures of what's going on, but they never say what's coming next. Do they believe that we can get out of this mess? They never say that. Do they believe that there's going to be another 1930s style Great Depression? They NEVER say that.

Then you have the Fed chairmen -- Alan Greenspan and Ben Bernanke. They seem to have no idea what's going on either, but there's a suspicion that they're aware of what's coming, but don't want to say anything.

Today's situation is absolutely identical to what happened in 1929, as described by John Kenneth Galbraith in his 1954 book, The Great Crash - 1929, as follows:

"A bubble can easily be punctured. But to incise it with a needle so that it subsides gradually is a task of no small delicacy. Among those who sensed what was happening in early 1929, there was some hope but no confidence that the boom could be made to subside. The real choice was between an immediate and deliberately engineered collapse and a more serious disaster later on. Someone would certainly be blamed for the ultimate collapse when it came. There was no question whatever as to who would be blamed should the boom be deliberately deflated. (For nearly a decade the Federal Reserve authorities had been denying their responsibility for the deflation of 1920-21.) The eventual disaster also had the inestimable advantage of allowing a few more days, weeks, months of life. One may doubt if at any time in early 1929 the problem was ever framed in terms of quite such stark alternatives. But however disguised or evaded, these were the choices which haunted every serious conference on what to do about the market." (p. 25)

This could describe what's happening today as easily as it describes the time prior to October, 1929.

Michael "Mish" Shedlock

And so it's worth noting that one blogger, Michael ("Mish") Shedlock, has apparently decided to throw caution to wind and speak the word that dare not be spoken - "Depression."

Now admittedly he isn't as forthright as we are, choosing instead to make his claims by indirection, but his implications leave no doubt that he's predicting a depression.

He quotes a recent article about a 1929 "fiscal stimulus" package that President Herbert Hoover got passed to save the economy, and concludes, "Like the fiscal stimulus of 1929 the Fiscal 'Stimulus' Of 2008 Is Doomed To Fail."

Shedlock points to the following similarities between 1929 and 2008:

Shedlock adds a quote by Ludwig von Mises: "There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."

Shedlock refers to an article by Ben Bernanke, in written 2000, called "A crash course for central bankers." In that article, Bernanke explains how the Fed could have avoided the 1930s Great Depression by lowering interest rates faster.

Shedlock says, "Final analysis will show that Bernanke can change interest rates but not attitudes, and attitudes are far more important. Indeed, changes in attitudes will render all of Bernanke's academic theories about the Great Depression meaningless."

(Shedlock reaches the same conclusion that I did last year in my lengthy analysis, "Bernanke's historic experiment takes center stage." Note that Shedlock's "changes in attitudes" are the attitude changes in Boomers and Generation-Xers, as they go from stupidity and nihilism to anxiety and panic.)

Shedlock concludes,

"Greenspan had the wind of consumers' willingness and ability to go deeper in debt at his back. Bernanke has the wind of boomers fearing retirement in the midst of falling home prices and impaired bank balance sheets blowing stiffly in his face. There is no cure for what ails us other than time and price. And with the aforementioned attitude changes, the biggest, most reckless, global credit expansion experiment the world has ever seen is coming to an end. Central banks are powerless to do anything about it."

Shedlock might have mentioned that Gen-Xers are getting even more panicked than Boomers are.

John Mauldin

While Shedlock takes a professorial approach in his blog, John Mauldin runs an investment advisory service. In his newsletters, he likes to brag about enjoying $5-10 cups of coffee from Starbucks, and the fact that his target investor has $2 million or more in assets.

In last week's newsletter, Mauldin he responds to what he says are "lots of questions" about a possible recession and depression.

Now, Mauldin would not have very many $2 million clients if he were saying a depression was coming. On the other hand, he tries to give an analytic answer to his client's question. His conclusion is that the economy will "muddle through" for a couple of years, but since he's being pulled in both these directions, his whole column ends up being just muddled.

I'm actually not critizing Mauldin too much, because his newsletter is actually much more advanced than typical investment advice newsletters.

He responds to the following question:

"What are the differences between the current state of the economy from that of the 1930s that would allow us to have a 'muddle through' instead of a deflationary depression? There seem to be many technical and fundamental similarities. We westerners having been living above our means for a long time and something is going to have to give. If history repeats itself then the cure to our addiction requires us to go 'cold turkey' with a deflationary depression. Is there hope that perhaps we could have room-temp turkey instead?" - Dr. John E.

He begins with this:

"First, I have already lived through 5 recessions. And every one was different in nature and cause. It is likely most of my readers, all except the youngest, have lived through at least 2 recessions, although the last two were rather mild, for reasons we will go into later. And this next recession, if we have one (and I think we are already in one) will be different than the past recessions.

But the operative words are "lived through." The US economy will come through this recession and enter a new period of growth, just as we have in the past. As will, by the way, the European economy, which I also think will encounter a recession. Again, recessions are a normal part of the business cycle. Congress can't repeal them, and central banks can only fight them, but not prevent them entirely."

I don't think Mauldin intended it, but he's captured exactly the reason why Generational Dynamics works the way it does. He's old enough to have lived through 5 recessions, but not old enough to have lived through the Great Depression. So he has no idea what's going on.

What's fascinating though is his section, "It is All About Valuations," where he gets into price/earnings ratios.

I really want to go into Mauldin's arguments, because they're fascinating, and his reasoning, while slippery, appears to be unique to him.

But first, we have to take another look at my own P/E chart that I frequently post:

S&P 500 Price/Earnings Ratio (P/E1) 1871-2007
S&P 500 Price/Earnings Ratio (P/E1) 1871-2007

Now, nobody ever prints a long-term P/E chart like this one (except for that shocking NY Times article that I wrote about last August), because it's way too frightening for the tender intercourse of the mainstream media. Somebody could look at the above graph and actually figure out what's coming, and the mainstream media-ites wouldn't want that.

As this chart shows, the P/E ratio is poised to fall to 5, as it has several times in the last century, most recently in 1982. In order to do that, stock prices will have to fall by a factor of 3, pushing the Dow Industrials down to around 4000. Furthermore, since P/E ratios have been well above average for 12 years, they'll have to stay below average for an equivalent length of time -- that's the Principle of Mean Reversion.

Here's how Mauldin treats all the above points:

"Markets go from high valuations to low valuations back to high valuations, as nauseum. You can measure it in price to book or price to earnings or whatever metric you want. The affect is the same. There has never been a time where markets started out from high valuations that they did not eventually end up with lower valuations. These cycles lasted on average for 17 years, with the shortest being 13 years (so far).

And this is important. There has never been a time when valuations dropped to the mean and then went back up again without visiting a much lower valuation. Never. Not one time. Zip.

We are now back to the mean P/E ratio. Now maybe this time it is different. But those are dangerous words."

I'm not sure what 17-year cycles he's talking about; if you look that above graph, you'll see that the major cycles (labeled with bottoms at 5.31, 5.82 and 6.79 on the graph) occurred at roughly 31-year intervals. (The next bottom would thus be in 2012, meaning that it would have to start falling about now.)

Presumably Mauldin is referring to some sub-cycles, but it's confusing that he missed the major cycles.

However, Mauldin does hint at the Principle of Mean Reversion when he says, "There has never been a time when valuations dropped to the mean and then went back up again without visiting a much lower valuation."

That's the crucial point, and he should be applauded for emphasizing it.

"P/Es are now in the 15 range. But I contend they will go lower. How can we get to the low P/E ratios that have prevailed in all previous cycles?

Either one of two ways. The market can drift sideways for a long time while earnings continue to grow, or the market can drop enough to get us to lower valuations. ...

If the stock market were to drop 20%, then the P/E ratio gets to 12, assuming earnings don't fall. Of course, they will, but they are also likely to rebound as quickly as they did after the last recession."

With this, Mauldin begins to go wrong, but since he's trying hard, let's analyze his argument.

He says that there are two ways that P/E ratios can reach their previous lows: (1) A flat stock market, awaiting a return to earnings growth; or (2) A sharp fall in the stock market index. The way he describes it, neither possibility will be particularly bad.

Unfortunately, this argument is completely off the rails. Let's take a look at the problems:

Now here's an interesting thought:

"Why don't we just hit the mean P/E ratio and just bounce back on up? It is mostly psychology, and I spent a great deal of time in my book and in this letter trying to demonstrate the reasons behind these cycles. But in a nutshell, if you disappoint the market once, you get a small reaction. Disappoint investors again and the reaction is more pronounced, and don't even go there a third or fourth time.

Recessions produce earnings disappointments for a variety of reasons: reduced consumer spending, higher marginal cost of sales ratios, reduced business investment, etc. I think we are in for a few quarters of disappointment."

This is really silly. This is why mainstream economics has been a total failure for so many years at predicting or explaining anything. If you don't understand what's going on, then blame it on investor psychology. Utter nonsense. You might as well blame it on the man in the moon.

The question is: "Why don't we just hit the mean P/E ratio and just bounce back on up?" Well then it wouldn't be the "mean" would it? The word "mean" means the same as "average." The Principle of Mean Reversion says that, over the long haul, the average stays the same. Well, if you always bounced back up when you got to the average, then it would always be above average. This P/E ratio would fit in quite well in Lake Wobegon, where "all the women are strong, all the men are good looking, and all the children are above average."

The Principle of Mean Reversion says that if P/E ratios are above average for a while, then they have to be below average for an equivalent period of time, in order to maintain the long term average.

Mauldin says,

"As I said in my annual forecast, I expect to turn modestly bullish on the stock market when this recession has played its course, and seriously bullish when valuations get lower. I am looking forward to it. It is more fun to be bullish. You get invited to more parties."

I can sympathize with this. I don't get invited to too many parties either.

Carolyn Barber, a woman from the 1930s

People like Shedlock and Mauldin, born after World War II, really have no idea what's coming. Here's are some excerpts from an article in the Red Bluffs (CA) Daily News, written by Carolyn Barber, born in the 1930s, with a wholly different way of looking at things:

Carolyn Barber: The most spoken words of the present, 2/2/2008

Certain words become popular during ongoing generations.

One such word is paradigm. In the 1970s - '80s, every conversation centered on paradigm change. ...

A word being heard frequently these past few weeks is the R word. Sometimes we address words that are uncomfortable with recognition of only the first letter of the word.

I am wondering how many of us can readily identify the R word of current repetitive use. No, it isn't a double word like rebel rouser or rat fink.

The word most readily used and somewhat ominous to those who hear it today is recession.

The media use the word daily as do the politicians who are currently seeking possible remedies for the economy in the United States and in the world.

To a multitude of people, old and young, who have been visiting the local grocery stores and other basic needs establishments, the noticeable raise in prices has held their attention for more than a few weeks.

The word recession hit real people over a year ago in the form of challenging already lightly filled pocketbooks. These people already live on a tight budget and are daily faced with hard decisions on what to cut back on or to completely eliminate from their waning budgets. Some have resorted to making their groceries last a little longer, a need to enforced diet or filling their gas tanks for many less miles which means eliminating even short pleasure trips. ...

The dictionary speaks of it as being a short cycle. This recession, sometimes defined as just a little slide back, is hard to accept as small with the large numbers of repossessed homes on auction blocks everywhere.

Those that have lived through previous recessions see the prediction of a short business cycle as a frivolous presumption.

A remnant of the populace remember the economic crisis and the period of low business activity in the U.S. and other countries beginning with the stock market crash in October of 1929 and continuing to the 1930s. What occurred at that time in history was the Great Depression.

Some of us, born in the 1930s can remember stories of the depression (coming after the recession) told by their parents, their grandparents and aunts and uncles.

Thoughts of buying a home in those times was squashed by the fact that many families in the years of depression lost all that they previously owned.

My maternal grandparents had to leave their home and property in Nebraska and Grandpa Field's good job and migrate to the mountains of Colorado to find new employment.

Their young children had to seek jobs of any sort to help maintain the meager income of the total family. Possessions were left behind and were either sold or passed on to neighbors.

My sweet, grandmother, Elsie Fields, mourned over having to leave her precious pump organ, an item that drew the family together as she played and sang the favorite song of each child.

My parents started married life in a two room apartment situated over a pool hall; the residents of these small coal oil heated apartments shared a common bathroom. They also shared food and reused coffee grounds over and over until they could pool their monies to buy additional rations.

I was born in such an apartment, my uncle and aunt's was chosen for the birth, it being better furnished and more presentable to the attending doctor. People helped others through the remaining ravages of the Great Depression. What lesson can we learn from history? Perhaps it is not to take the word recession too lightly. Perhaps it means that we can plan ahead and ward off a full depression. Perhaps by all working together some of the sacrifices will not be those that bring us down to a depression of the mind and soul."

Ms. Barber makes a proposal when she asks: "What lesson can we learn from history? Perhaps it is not to take the word recession too lightly. Perhaps it means that we can plan ahead and ward off a full depression. Perhaps by all working together some of the sacrifices will not be those that bring us down to a depression of the mind and soul."

This is actually a question that I've asked myself many times in the last few years, only I asked it in a different way: Suppose that in 1996, instead of just talking about "irrational exuberance," Alan Greenspan announced that, "I've been studying generational theory, and I've concluded that the current irrational exuberance is the first part of a huge bubble that's going to lead to a new Great Depression. I ask everyone: Please control yourselves."

Or, suppose that around 2001-2002, President Bush learned about generational theory, and concluded that the country was headed for a new Great Recession. What could he have done to prevent the bubble from happening?

Generational Dynamics tells us the answer: Greenspan would have changed nothing, except possibly to get himself fired, and President Bush could have done nothing either.

The power of generational attitudes is too great. You can't stop them any more than you can stop a tsunami. Imagine either Alan Greenspan or George Bush telling Boomers or Gen-Xers that they shouldn't do things that might risk a bubble. You could hear the laughter all the way to the moon.

And so Ms. Barber's plea that we help each other so that a Depression can be avoided will have no effect. It's already in the cards. It's been in the cards for decades. It's 100% certain.

That's why I always tell people on this web site: You can't stop what's coming, but you can prepare for it. Treasure the time you have left, and use the time to prepare yourself, your family, your community and your nation. (4-Feb-08) Permanent Link
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Readers comment: Gold prices and where you should put your money.

What do you do if you're afraid that your 401K isn't safe?

In a recent article, "Fidelity Investments salesman admits that money market funds are not safe," I described the answers that a web site reader got when he called his Fidelity Investments salesman and asked, "If Fidelity goes bankrupt, then will my money be protected?"

The answer was "No" in every cases, except the case where you own Treasury bonds and Fidelity is holding them for you. But if you've invested in a money market fund, even one backed by Treasury bonds, then they're not safe.

I received several comments from web site readers. These are the most interesting.

Two months ago, I provided a number of additional suggestions in "Questions and answers about the 'credit crunch.'" Some of that information is repeated here.

Is gold overpriced?

I wrote that one choice is owning "Actual physical gold, if you're into taking risks, since gold is currently way overpriced."

"John - Gold is not overpriced as you will soon see (think inflation adjusted). All the best."

I'll be waiting.

"Hi, Is that your opinion that "Gold is currently way overpriced?". If you were a financial blog, I'd accept that.

Gold bars
Gold bars

If you want to know what's happening with gold please let me know and I'll send you so much information you will espouse only one investment to protect against doom and gloom. Gold will be going to 1000 pretty soon...and then 1600 this year. By next year it will be at 2500, EVEN then gold will be severely UNDER Priced, it would only then equal the 850$ reached in 1980 in real terms."

Wait ... don't tell me ... let me guess ... you sell gold. Right?

And you mean that if I rename this web log the "Generational Dynamics Financial Blog," then you'd change your mind? Weird.

"I have tried to find out without bothering you but cannot find material to justify your comment on gold being overpriced could you please help me out with this. I understand that in an deflation its price could collapse but we are in an inflationary climate. And in your opinion overpriced against what measure?

I understand gold has appreciated quickly as of late, and at these parabolic rises, a decline is inevitable and will possibly be ugly, do you mean it in the context of a coming economic collapse and great depression."

There's been a huge commodity bubble in the last five years. Gold has gone from something like $400/oz to almost $1000/oz. Copper went from $2000/ton to $8000/ton, though I think it may be down a bit now. Oil went from $30/barrel to $100/barrel, though it's down a little now. Wheat went from $2.50/bushel to $10/bushel, though it's down a little now.

It's possible that the commodity bubble will grow even larger, but sooner or later it will burst.

When this commodity bubble bursts, all of these commodity prices will collapse. There's no reason that I'm aware of that the same thing won't happen to gold. Gold is not magic, though many people believe it is. If it were magic, then I would have magic teeth.

If there's a war, then gold may or may not spike for a while, depending on how the war goes. That's a very high risk assumption and, in my opinion, does not make gold a good investment at this time.

But if you do decide to buy gold, make sure that you take possession of actual physical gold, since any gold-based securities are liable to end up being worthless.

"If you look at the current financial situation and how Ben Bernacke is handling the situation, I guess we go for global meltdown.

For me the best thing to do to protect yourself is to buy physical gold. Gold is something that is been used as money since the last 6000 years.

I guess gold will survive; dollar, euro, yen is only paper..."

Yes, gold has survived a long time, but some paper currencies (like the dollar and pound) have survived at least a few centuries of war.

Keep in mind that in the case of some national or regional emergency, you can't eat gold, and you may not be able to sell gold. So if you invest in gold, make sure that there will be other options available to you.

"For more risk, you could also consider many ETFs. You can bet on anything from Gold, grain, oil or other commodity prices rising, to indexes like the S&P500 or Nasdaq100 declining, there are even ETFs that double the inverse of these indexes (such as QID and SMN). You can bet on a decline in oil stocks via DUG (or bet on a rise via DIG). Obviously if your timing is bad, you could lose a lot of money.

If you are going to buy physical gold or silver, expect to pay extremely high commissions on both sides (buying and if you ever want to sell) which can give you an instant loss of as much as 20% right off the bat (10% to buy, and another 10 in the future when you sell). Buying the gold ETF (GLD) may make more sense for some people if you really want to buy gold but don't want to pay high upfront costs or be at risk of theft."

If gold were relatively cheap right now, then it might make sense to purchase gold, with the expectation that gold prices would increase. But with gold prices so high because of the commodities bubble, buying gold and paying a high commission as well makes no sense at all, as this reader indicates.

However, I can't recommend purchasing ETFs (exchange-traded funds), which seem to me to be the worst choice. You still pay the bubble price, but don't have the protection of having possession of actual gold.

For those who are curious about ETFs, here's the complete list of ETFs sold by Fidelity.

Finally, who are you going to believe, gold salesmen or Indian housewives?

From Financial Times: "Could Indian housewives be calling the top of the gold market? Many are selling unwanted jewellery into a surging recycling market and deferring all but essential purchases of the precious metal, commodity traders, economists and jewellers said yesterday.

India is the world's largest consumer of the precious metal and the apparent sell-signal from its value-savvy householders may prove unsettling for global investors hoping that gold will continue to be a safe haven in volatile markets.

"Demand for gold is virtually zero," said Suresh Hundia, president of the Bombay Bullion Association. "People are taking profits and selling their gold back to jewellers for 2.5-3 per cent less than international market prices."

What to do with your 401K?

"I recently inquired of you your thoughts about my 401k, which happens to be with Fidelity. I believe you suggested to find a holding that was insured by the FDIC. Well after checking my options, I found NONE of Fidelities funds that I can choose are insured. After reading the last article from a reader who questioned Fidelity, I feel like I am screwed. Would you suggest withdrawing my holdings altogether? I know the tax ramifications would be large, but that beats losing all my money. I am a novice when it comes to knowledge of the legalities of 401k's and 457 plans. Is it even an option to take all my money out???"

Whether you can take your money out is a technical question for which you'll need professional advice about your situation.

However, the answer given by the Fidelity salesman appears to provide some clues.

He said, "If you own actual government Treasuries that they're holding for you, then you're protected. But if you subscribe to a money market fund, even when it's backed by government Treasuries, then you're not protected at all."

What that says to me is that you should transfer your money out of the money market funds into actual Treasury bonds that you own.

A friend, who has an account with Merrill Lynch, told me that they offered him another option: Transfer your funds into an FDIC-insured CDs (Certificates of Deposit) in your name.

What these two solutions have in common is that the actual underlying assets (Treasuries or CDs) are owned by YOU, the investor, rather than by the securities firm. The firm is simply holding your assets for you. Some firms may offer this for other classes of assets as well, possibly even gold.

Incidentally, you don't have to go through a firm like Fidelity or Merrill to make these investments. You can get a CD from your local bank, and you can purchase Treasuries online at .

However, make sure that you have some money in the form of cash that you can access quickly, so that you can survive an emergency.

If any more web site readers have discovered other solutions to this problem, please let me know and I'll post them.

Stuffing cash into your mattress

I actually was joking when I suggested stuffing cash into your mattress, but so that no one will take it seriously, here are some suggestions from a web site reader:

"About mattress comments... this is generally my current approach, keeping physical cash (although I do use my bank as a vehicle for certain funds, like paying rent and bills through checks or debit cards, depositing the amount I need when I recieve bills). However, as the financial situation of certain individuals becomes desperate, a spike in non-violent theft crimes may be expected to increase out of desperation (i.e. burglary). The mattress idea is so cliche that any knowledgeable crook would look there first. I'd suggest finding more creative ways to hide cash - places that a criminal in a hurry wouldn't bother to look (hidden in old magazines, in the fridge, maybe inside couch cushions with zippers on them, in the pocket of an old pair of pants that is never worn anymore, and so forth.)"

These are all good ideas.

If you live in a house with a basement with stone or brick walls, you might consider the following, which I've heard of in the past: Loosen one of the stones, hide your money behind it, and replace it, making sure to camouflage the result.

FDIC - Federally insured bank accounts

"FDIC: I'm sorry but I wouldn't hang my hat on any type of Federal Insurance guarantees, especially when a depression, as you say, is around the corner."

As I wrote last year in "Is your bank deposit protected by the FDIC?", there are a lot of reasons for concern:

The Federal Deposit Insurance Corporation (FDIC) has only $50 billion of assets in its Deposit Insurance Fund, while the amounts insured come to $6.5 trillion in almost 9,000 institutions and 95,000 offices. So that $47 billion in the Deposit Insurance Fund won't go very far if banks start failing.

However, for most people, placing your money into an FDIC-insured bank account is still the safest choice. A stock market panic and crash or other financial crisis will probably not begin with a mass of bank failures, and so the FDIC assets will be fine for a while. Once a major financial crisis occurs, then it will be possible to evaluate the new situation, and possibly withdraw money at that time.

However, make sure that you understand all the rules. There are limits to the amount of money you have insured.

There are ways to get around those rules, as one web site reader suggests:

"You can sock away an unlimited amount of FDIC insured cash just by creating as many accounts as you need at multiple banks if you need to. Examples of how to max out your insured accounts at one bank can be found here:

Best CD rates:

Keep in mind that there are a lot of myths about FDIC payouts if the bank fails - the truth is that payouts are made quickly, within a few days in most cases, your money will not be tied up for months or years."

Certainly if you have more than $100,000 on deposit, be certain to check the rules very carefully to make sure that you're insured. (3-Feb-08) Permanent Link
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Catastrophic snow storm could potentially destabilize Chinese government

Xinhua: People are "dark, cold and hungry in dead cities," especially in hard-hit Hunan province in southeast China.

Even worse, tens of millions of migrant workers, who can visit their families only once a year, during the lunar new year celebrations, will instead spend their holidays stranded in train stations. According to CNN, there are over a million stranded would-be passengers in Beijing train station alone.

The snow storm, the worst since 1954, has created a national crisis. It's delayed food and coal transports, causing power outages and significant new food price increases in half of China's provinces.

According to China's official Xinhua news agency, Chinese meteorologists blame the snowstorm on La Niña. It has hit 19 provinces in southern and central China, has killed more than 60 people and forced nearly 1.8 million people to relocate over the past three weeks, inflicting economic losses of about 53.9 billion yuan (US $7.5).

News reports indicate that this snow storm is a monumental crisis of historic proportions, with enormous destruction, including the caving in of many homes and buildings. And the snow is expected to continue for another week.

Many of those stranded are migrant workers. There are well over 100 million migrant workers in China. Most of them come from rural areas, where the CCP (Chinese Communist Party) has confiscated small farms and turned them over to government-controlled agricultural conglomerates. Young people were forced to move to large cities to become temporary workers, sending money back to their families.

China and its provinces <font face=Arial size=-2>(Source: The Economist)</font>
China and its provinces (Source: The Economist)

Migrants and other disadvantaged groups are already infuriated at the huge income disparities versus the CCP élite. They would form a powerful core group of protesters leading a rebellion against the CCP, in a country with a repeated history of exactly that kind of rebellion. And ironically, the hardest hit province, Hunan, is precisely where previous national rebellions (the Taiping Rebellion and Mao Zedong's "long march") have originated.

That a snow storm would trigger such a rebellion is pure speculation, of course. The reason for the speculation is that we all saw what happened in terms of a huge political backlash against the American government following the Katrina disaster in 2005 -- and that disaster affected only a small region of the country. The size of that backlash caught me by surprise, and it's reasonable to believe it can happen elsewhere.

The snow storm apparently has caused a similar amount of devastation in China, but in a much larger region. Between the widespread destruction from the storm, combined with the widespread fury by migrants stuck in train stations rather than visiting their families, some sort of colossal anti-CCP backlash is all but certain. Whether it ends up being just a political backlash or something more violent remains to be seen. (2-Feb-08) Permanent Link
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Feds open criminal fraud investigation against investment bank UBS AG

The allegation: UBS "mismarked" CDOs to defraud investors

According to a Wall Street Journal article, Federal criminal prosecutors and the SEC are investigating whether Swiss bank UBS AG, Europe's largest bank, intentionally misled investors by overpricing mortgage-backed securities (CDOs):

"The SEC, deepening its own set of investigations into whether Wall Street firms improperly mispriced mortgage securities, recently upgraded probes of UBS and Merrill Lynch & Co. into formal investigations, people familiar with the matter say. ...

The investigations could raise the stakes for Wall Street in the multiple probes examining whether financial firms deliberately misvalued, or "mismarked," massive holdings of mortgage securities. ...

There is also a broader effort by the Justice Department to look into whether there was fraud in originating, packaging and selling mortgage-related products. The Federal Bureau of Investigation has said it has opened criminal inquires into 14 companies as part of an investigation of the subprime-mortgage crisis. The FBI wouldn't identify the companies under investigation. ...

In its investigations, the SEC also is delving into whether Wall Street firms placed higher values on securities they own than those they placed in customer holdings, the people say. The SEC previously has said it has opened roughly three dozen investigations tied to the downturn of the subprime market, which primarily is tied to borrowers with poor credit histories.

In the SEC's UBS investigation, the agency is examining, among other things, a situation last year in which a trader at a now-defunct hedge fund of UBS's Dillon Read unit was confronted and then ousted after he valued mortgage securities at prices below the value assigned to the same securities elsewhere at UBS. In late October, the SEC interviewed the Dillon Read trader following a front-page article in The Wall Street Journal detailing the incident, according to a person close to the situation. The SEC has issued subpoenas in the UBS probe since, according to a person familiar with the matter."

It's worth taking a moment to discuss the implications of this as a criminal investigation.

The article that I wrote last night, "Massachusetts sues Merrill Lynch for fraud," refers to a civil action. This means that nobody goes to jail, but it's much easier to prove, since the standard of proof is a "preponderance of evidence."

Now we're hearing more and more about criminal investigations. If the prosecutors win a criminal case, then the defendants can go to jail, but the standard of proof is much higher: The evidence has to prove the allegations "beyond a reasonable doubt."

Those of you who are nostalgic for the 90s will recall that O.J. Simpson was acquitted of murder in criminal court, where the standard of proof was very high, but was found responsible for murder in civil court, where the standard of proof was low.

We can expect UBS AG and other targets of criminal complaints to mount a strong defense against these criminal charges. We can imagine the argument in court to go something like the following:

UBS: "Hey look, we're the real victims here. After all, we've lost $14 billion ourselves, writing down CDOs in our own portfolio.

If we were intentionally deceiving investors, then we wouldn't have had these CDOs ourselves."

Prosecutor: "That doesn't prove anything except that you had motive to defraud investors, since you wanted to recoup some of your own losses by selling the worthless securities to someone else.

You people are the expert. Your financial engineers created these CDOs, and your salesmen sold them. You must have known what you were doing, but you did it anyway because you were making billions of dollars in fees and commissions.

It's been obvious since 2005 that we were in a housing bubble, and in 2006 that the bubble was deflating.

In fact, you kept selling these CDOs well into the middle of 2007, at a time when your experts must have known that the sales were fraudulent."

UBS: "Well, if it was so obvious, then how come Federal regulators didn't say so? If we're guilty of fraud, then so are the Federal regulators, the ratings agencies, the bond insurers, and lots of other banks who were doing to same thing we were."

Now, there you see the problem. The massive "subprime" fraud that's been going on has not been perpetrated by one bank or one small group of people. It was condoned and encouraged by government "oversight" agencies who didn't want to spoil the party. It was condoned and encouraged by these VERY SAME prosecutors who, through their inaction, permitted the obviously fraudulent activities to continue. It's still being continued by government officials who condone and encourage various bailouts and other mechanisms to permit banks to continue to "mismark" worthless CDOs by means of phony market sales.

The fraud was perpetrated by an entire generation -- the nihilistic, self-destructive Generation-X, under the noses of their equally guilty Boomer bosses, who exhibited "Lenscap Stupidity" by letting the fraud continue because they were all making so darn much money.

So that's going to be the problem for prosecutors: They're just as guilty as the people that they're prosecuting.

In Hannah Arendt's monumental study of the Nazi Germany in the book, The Origins of Totalitarianism (p. 335), she describes the enormous level of corruption at the time, and how it was reflected in Bertolt Brecht's play, The Three-Penny Opera [Dreigroschenoper], which presented gangsters as respectable businessmen and respectable businessmen as gangsters.

The theme song for the play was "Erst kommt das Fressen, dann kommt die Moral." I've been struggling for some time now to capture the meaning of this sentence, using my inadequate knowledge of German, supplanted by various online dictionaries and translators.

There's apparently an "official" translation of this phrase as "A hungry man has no conscience," but that translation is far too benign to match Brecht's cynicism. The people we're talking about were never hungry.

A word for word literal translation is the following: "First people gorge themselves, then comes the morality." That makes more sense, and we might simplify the translation further as: "First comes gluttony, then comes morality."

That is indeed what we're seeing today. The same generations of people who benefited from the massive fraud at all levels of the real estate bubble are now the same people who are calling for retribution. There are winners and losers in the mortgage fraud. The winners want to keep the bubble going, and are willing to commit fraud to do so. Once a winner becomes a loser by losing everything -- and only then -- he wants to punish the winners.

The massive fraud that has been taking place is matched today by the massive lenscap stupidity of people in denial. Investors are hoping against hope that the champagne party will return to the stock market, and the bubble will grow again. Cities and towns all over the country are holding useless Finance Committee meetings, completely oblivious to the fact that falling real estate prices and rising unemployment will soon cut their local budgets by 50% or more.

From the point of view of Generational Dynamics, there's no question at all of what's coming: A generational stock market panic and crash, leading to a new 1930s style Great Depression. It might happen next week, next month or next year -- predicting the exact date is impossible, since it depends on chaotic events -- but it's coming with absolute certainty, and it will be made much worse by the continuing gorging by massive numbers of people in denial. Afterwards, there'll be plenty of morality to deal with. (2-Feb-08) Permanent Link
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Massachusetts sues Merrill Lynch for fraud

After Springfield, Mass., lost 91% of its $13.9 investment in near-worthless CDOs.

According to the complaint filed by Sec'y of State William Galvin:

"This Complaint is focused on Merrill Lynch's sale, through agents Kipper and Choy, of certain esoteric financial instruments known as Collateral Debt Obligations ("CDOs") to the City of Springfield, Massachusetts, which were unsuitable for the City and which, within months ater the sale, became illiquid and lost almost all of their market value. ...

In November 2006, the City of Springfield hired Merrill Lynch ... to invest its surplus cash. The City ... hired Carl Kipper and Manuel Choy. ... The accounts ... were not discretionary accounts. It was understood that Merrill was supposed to invest only in safe money-market-like investments authorized by City personnel that would protect the City's principal.

However, in April and June of 2007, Kipper and Choy invested approximately $14,000,000 of the City's money into three CDOs, the "Centre Square CDO", the "South Cost Funding V CDO" and the "Tabs CDO". ...

The largest position was $12,600,000 in the Centre Square CDO, which had been underwritten by Merrill Lynch. Merrill Lynch received underwriting fees in connection with underwriting the CDO and remarketing fees in connection with selling pieces of it.

The City did not authorize these specific CDO purchases in advance. Kipper and Choy were, apparently, verbally instructed to pick instruments that yielded more than Merrill's money market account as long as the products were triple-A rated by the major credit rating agencies ....

At the time of the sale, Kipper and Choy did not discuss the risks of owning CDOs with the City, even though those risks were well known to Merrill Lynch. The basic fact that these instruments were CDOs was not even disclosed to the city until months after the sale. These instruments appeared on the City's account statements through June 2007 as "Centre Square Ltd." .... In July 2007, the exact same investments quietly began to appear on the account statements as "Centre Square CVO PVT" .... At the time of the sales, Kipper and Choy did not look at the disclosure documents for these CDOs. Nor did they make any attempt to understand what these CDOs were collateralized with. Nor did they evaluate the liquidity and other risks inherent in purchasing the CDOs or discuss the nature of the CDOs or the risks associated with owning them with City officials. ...

Within months after Merrill's sales of these CDOs to the City, the auction market for them began to dry up and their market value began to plummet. For example, the Centre Square CDO had been purchased in late April 2007. By august 2007, it was listed on the City's account statements as having an "estimated market value" of only 84 percent of its purchase price. By Spetember, it was down to 50 percent; by October it was down to 30 percent; and by December 2007, it was down to 5 percent. ... The City requested that these CDOs be sold, but City officials were informed that the auctions had failed and that there were no buyers. ...

The CDOs that Merrill sold to the City of Springfield were not the conservative, principal protected instruments that the City had sought when it opened its accounts with Merrill Lynch. ... The Centre Square CDO was a highly complex instrument that, according to its Offering Circular, should only be sold to sophisticated investors. ...

Merrill's underwriting fees earned in connection with the Centre Square CDO were in excess of $10,000,000."

Even before this suit was filed, Merrill had already agreed to reimburse Springfield for its losses.

Massachusetts is suing for additional fines, and to force Merrill to end its fraudulent practices. Merrill did, in fact, announce that it would terminate almost all of its CDO business.

It's hard to know what to make of some of this, but Merrill seems to be doing all it can to avoid being sued, and Galvin seems to be determined to push the suit forward.

It's easy to understand why Merrill doesn't want to be sued. If it can settle out of court, then other cases are unaffected. But if Merrill's conduct is found fraudulent by a court, then Merrill will be forced to settle up with the many other municipal governments around the country that have similarly been defrauded.

But it's also hard to understand why Galvin wants to go ahead with the suit -- for exactly the same reason that Merrill doesn't want to go through it.

Of course Merrill is guilty of fraud. I started talking about fraud a year ago, when I wrote, "As housing collapses, subprime mortgage loan officers may held accountable for fraud"

Last year in June, I started discussing the "mark to market scam" in "Bear Stearns bails out defaulting hedge funds, preventing broad market meltdown"

I mention this because the "mark to market scam" is still going on, and it goes to the heart of all the fraud that's going on.

All of these financial firms are doing business with CDOs at nominal value, when their real market value is typically 10 or 20 cents on the dollar. By law, these CDOs must be "marked to market" under a wide variety of conditions. Any investor purchasing these CDOs believing that their real value is the nominal value, or who uses them as collateral at their nominal value, is participating in fraud.

So government officials and financial firms at all levels are doing everything possible to perpetuate the fraud, for fear that forcing too many writedowns will crash the stock market.

So Galvin is taking a step that will force a writedown of many more billions of dollars in these near-worthless CDOs. I wouldn't be surprised if someone from the Fed or the Administration gives Galvin a call and asks him to cool it for a while.

I've been writing about this stuff for a long time now, and the stench is really getting to me. I'm no investigative reporter turning over rocks that no one else has looked at. This activity is going on in the full view of the public. There's fraud at all levels, most disgustingly at state and federal government levels in full view of the public.

And what's worse is that these activities are just causing more harm. The bubbles are already leaking like mad, and they cannot be stopped from bursting completely. Every action to delay the inevitable only makes the inevitable worse.

From the point of view of Generational Dynamics, we're seeing the Principle of Maximum Ruin in full force. Every effort will be made to waste every remaining bit of money to keep the bubble from collapsing, until finally no one has any money left. The Principle of Maximum Ruin says that the maximum number of people will be ruined to the maximum extent possible. That's what's going on now, and apparently will continue. (2-Feb-08) Permanent Link
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Kenya settles into low-level violence on the way to Rwanda

So far, it's "ethnic cleansing," but not genocide, according to Jendayi Frazer, the top American diplomat for Kenya.

It's an interesting distinction.

She was describing the situation where one tribe, the Kalenjins, were "cleansing" a region of a different tribe, the Kikuyus.


She said that it was NOT genocide because:

"The aim originally was not to kill, it was to cleanse, it was to push them [Kikuyus] out of the region. It was clear ethnic cleansing in the Rift Valley."

In other words, if the Kalenjins were killing the Kikuyus, that would be genocide. But apparently the modus operandi is to say: "You have 24 hours to get out of town if you want to avoid being killed," which means that the region is cleansed of the other tribe, even though they aren't killed.

(Incidentally, the State Dept. has backed off from the "ethnic cleansing" claim. Read the amusing contretemps between a reporter and the State Dept. spokesman.)

In fact, there are a number of news reports that confirm what's going on:

"They came at night by the hundreds, shooting villagers with arrows and attacking them with knives, hatchets, and farm tools. The killings were a warning to the rest of the village: Leave now, or die.

"These people were our neighbors, I knew them, but what I have seen is something that I cannot explain," says Julia Muthoni, an elderly widow who found refuge in the city of Nakuru. "The problem is that we Kikuyus are being targeted because we voted for the reelection of President Mwai Kibaki. Even before the election, they were threatening us saying that whether Kibaki wins or not, Kikuyus are going to be evicted."

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Although there are many ethnic groups (tribes) in Kenya, there are two major protagonists in the current violence: the market-dominant Kikuyu tribe, whose leader, Mwai Kibaki, won the Presidential election that triggered the violence; and the disadvantaged Luo tribe, whose political leader, Raila Odinga, was the opposition leader who lost the election to Kibaki. Many other tribes, including the Kalenjins, are aligning themselves with the Luos against the market-dominant Kikuyus.

The ethnic violence was started, according to many sources, by youthful activists in the Orange Democratic Movement (ODM), an anti-government Luo ally supporting Odinga for President.

Now, according to a recent human rights study, there are four kinds of violence going on in Kenya:

From the point of view of Generational Dynamics, all these kinds of violence, short of all-out genocidal civil war, is called "low-level violence," even though those living in Kenya would doubtless not call it "low-level." Still, the amount of violence has been tapering off, and even the gruesome "ethnic cleansing" events fall short of genocidal violence, since the lives of the enemy are spared.

This is consistent with what I was predicting weeks ago, just after the violence started.

Kenya's last crisis war was the "Mau-Mau Rebellion," an independence war largely fought by the Kikuyus against the British colonial government, climaxing in 1956. 51 years have passed since the climax of the last crisis war, making the current era a generational "Unraveling" era. At this point, 51 years after the climax of the last crisis war, Kenya is just entering the place on the generational timeline where a new crisis civil war becomes increasingly POSSIBLE, but is still UNLIKELY. As the timeline approaches and passes the 58-year point, a new crisis civil war becomes almost unavoidable.

So we see this low-level violence continuing, and will continue until some new shock or surprise triggers a "regeneracy," at which point a full-scale genocidal crisis civil war will begin.

Fortunately for all of us, the UN is rushing in to save the situation.

UN Secretary General Ban Ki-moon has warned of an impending catastrophe unless the two political leaders, Kibaki and Odinga, resolve the crisis.

On Thursday, France's Foreign Minister Bernard Kouchner appealed to the UN Security Council to stop the violence in Kenya, and prevent a slide into "deadly ethnic conflict."

The dreaded word on everybody's lips is "Rwanda." In 1994, close to one million people in the market-dominant Tutsi ethnic group in Rwanda were slaughtered, tortured, raped and dismembered by people in the disadvantaged Hutu ethnic group. That slaughter took only three months.

The UN was blamed by many for not "stopping the violence" in Rwanda. Early in 2004, the UN held a 10-year commemoration of the Rwanda genocide, and the Secretary General at that time, Kofi Annan, promised "Never again."

It was just a couple of months later, in June 2004, that Annan called for the UN to stop the genocide in Darfur. As I said at the time, the UN is completely irrelevant.

Now Kofi Annan, you'll recall, considers the US to be the fount of most of the evil in the world. He condemned the US for intervening in Iraq, and condemns the US even more for NOT interfering in Darfur.

Today, in 2008, the Darfur genocide is still going on. Somehow, the UN has remained irrelevant all these years.

So now we're talking about having the UN run in and stop another potentially genocidal situation. Kofi Annan is the mediator who's been working with both sides for the last couple of weeks.

"The world saw a ray of light this week that may help Kenya avoid a violent abyss," says one bit of punditry. "Mediator Kofi Annan got the two political rivals in this tragedy to sign onto negotiations."

Everyone's hoping that Annan will get the two leaders to come to some sort of agreement to stop the violence. Yes sir, all Kibaki and Odinga have to do is sit down and sign an agreement, and it'll be all over. Yes sir.

Actually, Annan will probably succeed in getting the two sides to sign some kind of interim "cooling off period" agreement. These days, this kind of peace agreement is almost a compulsory part of the foreplay leading up to full-scale genocidal civil war.

That's certainly what happened in Rwanda. In 1993, the UN sponsored a peace treaty between the Tutsis and the Hutus called the Arusha Accords. It created an interim government that was supposed to make everyone happy. Instead, it infuriated the Hutus. Then, on April 6, 1994, a plane crash killed the Rwandan president, a Hutu. Next morning, a Hutu leader announced over the radio, "Cut down the tall trees." It was some sort of prearranged signal, and, on cue, each Hutu did something like the following: Picked up a machete, went to the Tutsi home next door, or down the street, murdered and dismembered the man and children, raped the wife and then murdered and dismembered her. Close to a million Tutsis were tortured, raped and murdered in a three month period.

So now, let's return to the land of Kofi Annan, plying his trade, convincing the two political leaders to sign on to negotiations to stop the violence. I guess Annan didn't learn from what happened in 1993, when a UN sponsored agreement, the Arusha Accords, actually made things worse.

What are these people thinking? Can anyone possibly believe this fairy tale?

If Raila Odinga ever signed an agreement with Mwai Kibaki to stop the violence, the first thing that would happen is that their own supporters, the Luos and Kikuyus, respectively, would kill them for their betrayal.

On this web site, I always say, repeatedly, over and over, that what's important is the behaviors and attitudes of large masses of people, entire generations of people. The behaviors and attitudes of politicians, especially in the United Nations, are totally irrelevant, except insofar as they reflect the attitudes of their constituents.

The violence in Kenya is not coming from Odinga and Kibaki. They have no control over it whatsoever. They did not cause it, they could not cause it, and they cannot stop it. They can't make it get better or worse except accidentally.

The violence will spiral into full-scale crisis civil war when the appropriate trigger occurs. What will the trigger be? There's no way to predict. It will be some chaotic event (in the sense of Chaos Theory). Just as a butterfly flapping its wings in China might (or might not) trigger a chain reaction that will cause a hurricane in America, someone will say or do something, probably something completely minor and unexpected, that will trigger full scale civil war in Kenya. It can't be predicted, it can't be forced, and it can't be stopped.

I do want to draw a parallel, however, to the world financial situation -- something that I may expand upon further in the days to come.

When the "credit crunch" caused an international financial crisis in August, the world's central banks sprang into action to head off disaster. The Fed, the European Central Bank (ECB), and the Bank of England (BoE) all took various steps -- bailouts, auctions, interest rate adjustments -- to target the credit crunch with fresh liquidity to end the crisis.

However, the credit crunch was not the problem, but a symptom. The problem is that the real estate bubble, the stock market bubble, the credit bubble, and other bubbles are now all leaking like mad. There isn't enough money in the world to stop the leaking, but the central banks do not hesitate to try one thing after another to deal with one of the symptoms.

The same kind of thing is now happening in Kenya. Once the violence began, the UN sprang into action with human rights studies and with Security Council discussions and with Kofi Annan mediations.

In both the Kenya situation and the finance situation, the underlying fundamentals leading to the crisis not only are not being cured, but actually are getting worse as generational changes continue. Once the crisis actually begins, someone will be blamed -- perhaps Kofi Annan for not getting an agreement, perhaps Ben Bernanke for lowering interest rates too fast or two slow.

In fact, the underlying causes can only be determined by looking back in history, decades or even centuries, to learn how historic cataclysms created generational waves striking us now, just as an ocean earthquake can create a tsunami that can't be stopped.

So, Kenya is well on its way on the road to Rwanda. In a few years, that'll be clear. (1-Feb-08) Permanent Link
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