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Web Log - March, 2008

Summary

Country of Iceland may be close to financial default

In an emergency move, Iceland's central bank raised interest rates to 15%.

Iceland's central bank raised interest rates by 1.25% this week to a record 15%, in an effort to support the country's crashing currency.

The statistics are grim. The króna ("krona" or "crown") currency has fallen in value over 30% since January 1 against the euro, over 3% on Friday alone. And inflation has jumped sharply in March to 8.7% from February's 6.8%.

How will raising the interest rate to 15% help the situation? That's because, in the words of Iceland's critics, for the past few years, Iceland has been acting like a hedge fund, instead of a country.

I actually wrote about this early in 2006, with an article entitled "Sudden collapse of Iceland krona portends bursting of 'carry trade' bubble."

At that time, there was some fear that the international "carry trade" was going to crash. After writing that article, I learned that those in the international carry trade are ALWAYS in fear that it's about to crash, so I dropped the subject.

However, this time the fear isn't over the international carry trade, but over possible failure of Iceland's banks.

It used to be that Iceland made most of its income from fishing. But in the last decade, Iceland got into the carry trade business. Iceland's central bank sent interest rates so high -- over 10% -- in order to encourage foreign investors to borrow money from Japan (where the interest rate is close to 0%), and then invest it in Iceland.

In any other country, setting interest rates so high would cause a deep recession, because businesses would not be able to borrow money at those high rates. But Iceland got away with it, because foreign investors would invest in Iceland to take advantage of the high rates.

In other words, it was just another way to abuse credit and make money in the credit bubble. On this web site we've discussed all kinds of abuses -- collateralized debt obligations (CDOs) and lately auction-rate securities (ARSs).

Now we have this additional scheme to make money in the credit bubble -- turning the country into a hedge fund and take advantage of the carry trade.

Now that the credit bubble is deflating, there's a credit crunch, where everyone is hoarding cash.

And so, Iceland's scheme is falling prey to the credit crunch for exactly the same reasons that CDOs and ARSs are failing -- because "cash" means "dollars" or "euros" or "yen," but does not mean Icelandic króna. Many investors now consider the króna to be as risky as subprime mortgage loans. Money is pouring out of Iceland, and the value of the currency is falling rapidly.


Credit default swap (CDS) spreads on Icelandic bank bonds <font face=Arial size=-2>(Source: FT.com)</font>
Credit default swap (CDS) spreads on Icelandic bank bonds (Source: FT.com)

And so the Iceland central bank has raised the interest rate to 15% in a desperate move to attract investors back.

Will it work? Lots of people don't think so. The interest spread on credit default swaps (contracts that "bet" that a company or, in this case, a country, will default) has been been surging so high that it means that investors are essentially betting that Iceland's banks WILL default.

Well, the Fed saved Bear Stearns from default and bankruptcy. Maybe the Fed (or the European Central Bank) will save Iceland from default and bankruptcy. We should soon know. (31-Mar-08) Permanent Link
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Investment bank UBS is now "writing down" clients' auction rate securities

From individual investors to tech firms, people are losing their money.

Last month, investors were told that they couldn't get their money out of funds that they'd invested in -- funds backed by auction-rate securities (ARSs) that they'd been told were as "good as cash," but which paid slightly higher interest rates than standard money market funds.

Now, UBS AG is telling investors that it's marking down the values of those investments. On Friday, according to an article in the Wall Street Journal, UBS began notifying investors that it will begin marking down the values of the securities in investors' accounts.

The markdowns will range from about 5% to more than 20% of the principal, depending on the securities.

Oh wait, there's good news: "The losses won't be realized immediately, as investors are currently unable to sell the securities for lack of a market," according to the article.

So, your investments have been marked down, but that's OK because you still can't get your money out anyway.

High-tech firms

In related news, high tech firms such as hand-held-device maker Palm Inc., internet-service provider EarthLink Inc. and internet job-search company Monster Worldwide Inc. are being forced to acknowledge substantial asset writedowns.

High-tech firms are particularly vulnerable, because they often keep a lot of cash on hand to make deals with. Auction-rate securities have been an attractive investment vehicle because they pay better interest rates than cash and because they're "as liquid as cash," a claim that's now turning out to be false. Starting next month, the list of companies disclosing large ARS holdings "is going to grow pretty quickly," according to an analyst, and many of these firms are going to be forced to write down significant portions of their assets.

If this prediction is true, then we'll see a huge ominous new twist in the credit crisis. For months we've been seeing large asset writedowns by numerous financial institutions. A spate of writedowns from high-tech firms would show that the "subprime virus" is now spreading rapidly outside of the financial community into the larger corporate arena, as well as to individual investors. From the point of view of Generational Dynamics, this change must come sooner or later anyway, but it will be a shock to the public when it happens.

Auction-rate securities (ARSs)

Interestingly, these assets being written down are not always CDOs or other mortgage-backed securities. More and more, the problems are with auction-rate securities (ARSs), which are "a whole nother thing."

Generally speaking, when you make a long-term investment, you can expect a higher yield (interest rate) than with a short-term investment, since a long-term investment carries a higher risk of default.

In the 1980s, investment brokers started using a trick. A municipality or a corporation would issue long-term bonds, and normally would have to pay high interest rates to investors in the bonds. But investment brokers converted the long-term bond into a series of short-term securities. Thus, a 10-year bond might be split up into 120 one-month securities. Since one-month securities normally pay much lower yields than 10-year bonds, the municipality or corporation would have much lower interest rates.

The only problem is that while a 10-year bond has to be sold only once, the one-month securities have to be sold over and over again, each month. So the investment brokers would hold monthly auctions, allowing investors to bid on the short-term securities. (In actual practice, these auctions might be held every 7 days, every 28 days, or every 35 days.) Since the yield (interest rate) on these short-term securities can change every time there's an auction, they're called "auction rate securities," or ARSs.

You know, I heard of this scheme some years ago, but I never paid much attention to it because it's so hare-brained that I thought it was a scam. It wouldn't be so bad if it were used sparingly, but like every other conceivable form of credit, it was abused during the credit bubble. It now turns out that hundreds of billions and perhaps trillions of dollars have been invested in ARSs. This hare-brained scheme has become the norm, much to my surprise.

I will say this for ARSs: They aren't based on massive fraud and corruption, the way that CDOs and mortgage-based securities are. The auction-rate securities are based on sheer, utter stupidity, the stupidity of people in the Boomer generation and Generation-X who think that if something makes money today, then it will make money forever. The stupidity is monumental, but it's just stupidity, not fraud. (However, it IS fraud if the broker tells the investor that they're "as good as cash.")

As long as the credit bubble was expanding, and there was plenty of money around, the investment banks were willing to guarantee the weekly or monthly auctions, in the sense that if there were no bidders for the ARSs, then banks would purchase them. But now with the deflating credit bubble and the credit crunch, investment banks are hoarding money and are unwilling to guarantee ARSs when the auctions fail. With most of these auctions failing nowadays, the ARSs can't be sold for cash, and so investors in ARS-backed funds can't get their money out.

This is affecting a LOT of people. If you'd like to get a feel for it, take a look at this February 27 BloggingStocks blog entry. It had over 800 comments, mostly from people telling their sad stories. Here's the first of the comments, from someone named Mike Rubin:

"I have a substantial amount of cash in Morgan Stanley and at my broker's suggestion put a lot of it in various Muni ARS. When things started looking dicey I called and was assured that none of my holdings were insured my AMBAC or MBIA or in student loan instruments so not to worry. Two days later things froze up. I was told that the senior partners were meeting to figure out what to advise or do. My broker tried to be helpful. I was offered a loan against my holdings if needed. Happily I did not need the cash and actually got higher rates as many of the instruments reset to penalty rates. I then was asked if I would be willing to buy some of the instruments from other of their clients who needed the cash. Things have evened out now but from this episode one should definitely take away a sense of how tenuous our security in general really is and just how much of it is based on simply confidence in the system."

Mike Rubin was lucky -- at least at that time (Feb. 28) -- because he hadn't really lost anything -- yet. But I'll bet that he's in a lot worse trouble today, unless he's been able to sell his ARSs in the meantime to some "greater fool."

The worsening deflationary spiral

This auction-rate security crisis is just the latest manifestation of the growing deflationary spiral. The credit bubble, which created hundreds of trillions of dollars in new "money" (mostly in the form of credit derivatives), is now deflating. Consumer and commercial credit is disappearing, as the deflationary spiral accelerates, and the credit crunch worsens.

Banks are hoarding cash, because they're hiding the fact that more asset writedowns are coming, and they'll need that cash when the writedowns actually occur. In a scenario laid out by Oppenheimer analyst Meredith Whitney, this could trigger a forced selling panic, as the market is flooded with near worthless CDOs and other mortgage-backed securities. And now we have to add ARSs to that mix of worthless securities.

The Fed can see this coming as well, and has been launching one new program after another to inject liquidity into the places in the system where it's needed most.

The Fed has provided some $260 billion in short-term loans to banks through a series of auctions beginning in December, and will hold two more auctions in April, offering another $100 billion. These measures, along with its hand in saving Bear Stearns from bankruptcy, have been getting increasingly desperate. Each new intervention requires more ammunition than the last one, and each has a diminishing salutary effect.

The climax of my "bloated mansion" analogy appears to be getting closer and closer each day. 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."

As each week goes by, you can just feel that Fed chairman Ben Bernanke is running around the mansion faster and faster, using up his supply of nails and glue, in the hope that that internal rot can be "contained," but it never can because the credit bubble engulfed the entire world when it was growing.

The credit bubble created hundreds of trillions of dollars in new money, mostly in the form of credit derivatives, in a huge Ponzi scheme or pyramid scheme. Now that the bubble is deflating, all that money is unwinding, and there's less money in the world each month than there was the month before.

The Fed has a few hundred billion dollars at its disposal. It does not have anything close to the hundreds of trillions of dollars that would be required to reflate the credit bubble, or avoid a huge financial crisis.

All in all, the Fed has been using its available assets very cleverly. It's managed to keep the mansion together with nails and glue at the the most critical structures, but it's a losing battle. I'm amazed that the Fed has been so successful thus far.

Corporate earnings estimates plummet again

As regular readers know, we've been keeping a running track of the analysts' estimates of corporate earnings. For the fourth quarter, analysts estimated 11.5% growth at the beginning of the quarter, but that became a -25.2% (i.e., a 25.2% fall) when actual earnings were announced.

Now we're seeing the same thing in the first quarter. Here's the latest summary from CNBC Earnings Central:

"As of Friday, March 28th:

23 companies in the S&P 500 have reported earnings for Q1, 73.91% have beaten estimates, 13.04% were in-line, and 13.04% have missed. (Data provided by Reuters Estimates)

The blended earnings growth rate for the S&P 500 in first-quarter 2008, combining actual numbers for companies that have reported, and estimates for companies yet to report, fell to -9.3% from -7.9%, mostly due to downwared revisions in the Financials sector.

On January 1st, the estimated growth rate for Q1 was 5.7%. (Data provided by Thomson Financial)"

So we can update our tracking table as follows:

  Date    1Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct 23:             +10.0%
  Jan  1:              +5.7%
  Feb  6:              +2.6%
  Feb 29:              -1.1%
  Mar  7:              -4.3%
  Mar 14:              -7.8%
  Mar 21:              -7.9%
  Mar 28:              -9.3%

And we can expect further reductions when the first quarter ends next week.

The public mood

I'm hearing all kinds of ridiculous things these days.

Long time readers may recall that in 2006, former Fed chairman Alan Greenspan blamed the housing bubble on the fall of the Berlin Wall.

Greenspan, who is trying to save his own legacy, has just written a commentary in Financial Times blaming the credit crisis on "animal spirits."

He says that existing macroeconomic models are simply failing -- which is exactly what I've been saying for years. But instead of trying to work "animal spirits" into the macroeconomics models, it would work better if they worked System Dynamics into the models, as I described in "System Dynamics and the Failure of Macroeconomics Theory."

If you're looking around for more silliness beyond "animal spirits," it's hard to beat the two "investment advisors" that I quoted in January as saying that people with brain disorders make better investors.

Here's some more silliness in the public mood:

On Friday morning, I was listening to a BBC financial report on how there are far fewer mergers and acquisitions this year than in previous years, and I was startled to hear the following statement:

"As the credit crunch takes hold, there's an inevitable slide in the number of mergers and acquisitions, the fuel of the financial markets."

This is an incredible statement. Mergers and acquisitions don't actually PRODUCE anything. They're simply financial transactions that generate enormous fees for investment brokers. Since most of these deals were leveraged, they were a big part of the "creation" of money during the credit bubble.

We've actually gotten to the point where financial reporters are putting forth the view that financial transactions are the "fuel of the financial markets."

Hey, folks, the fuel of the financial markets are businesses that produce things. JP Morgan doesn't produce things, but General Motors does.

This once again shows how different generational attitudes are. The generations of people who lived through the Great Depression would not have thought that financial paperwork was the fuel of the financial markets. People born after WW II have little understanding of the connection between production and income.

What's funny is that all of this will be "obvious" once the financial crisis begins. "Of COURSE companies like General Motors, not mergers and acquisitions, are the fuel of the financial markets. Of COURSE auction-rate securities violate the rules of the universe, and can't work forever. Of COURSE there was a huge stock market bubble based on credit. It's so OBVIOUS, why on earth didn't we see all this before???"

You'll be hearing that a lot.

You'll also be hearing this a lot: "Why oh why didn't I just save a few hundred dollars instead of spending everything. If I had, then I'd be OK now."

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. (29-Mar-08) Permanent Link
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Meredith Whitney lays out the template for financial crisis

The Oppenheimer analyst says to expect reduced earnings expectations next week.


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

Meredith Whitney is executive director of equity research at Oppenheimer and Co. She's also a Cassandra, predicting very troubled times ahead, but unlike most Cassandras, she's actually believed by some people.

I last quoted Whitney in an article last month, an article that's worth reading just for the pictures - she's a real babe.

But she's also just about the only analyst who ever appears on CNBC who tells exactly what's going on, which makes her very unusual. She made some calls last year about Citibank that got her a great deal of verbal abuse -- until they came true. So she's respected by a lot of people, albeit reluctantly.

Appearing again on CNBC on Thursday, she was interviewed by anchor Maria Bartiromo. In her interview, she essentially accused many banks of (a) fraud and (b) unmitigated stupidity -- although those words weren't used.

She also provides an explanation for why estimated earnings keep falling. I recently posted this table:

  Date    1Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct 23:             +10.0%
  Jan  1:              +5.7%
  Feb  6:              +2.6%
  Feb 29:              -1.1%
  Mar  7:              -4.3%
  Mar 14:              -7.8%
  Mar 21:              -7.9%

And earlier I posted a similar table for the fourth quarter. In both cases, the corporate earnings estimates kept falling, week after week. As we'll see below, Whitney expects a big drop in earnings estimates next week.

Bartiromo began by asking her about a report that she published on November 11, 2007, on the ratings agencies:

"From my perspective, that was the single most important report that we wrote last year. This was two weeks after I downgraded Citigroup, and the focus of this report was on the interconnected relationship between the rating agencies and the bank regulators.


Meredith Whitney often closes her eyes when she talks, as if she doesn't want to see other people's reactions to the bad news <font face=Arial size=-2>(Source: CNBC)</font>
Meredith Whitney often closes her eyes when she talks, as if she doesn't want to see other people's reactions to the bad news (Source: CNBC)

What I basically said was, after $100 billion in securities had been downgraded in the month of October, that would impact what the regulators would require the banks to maintain on their balance sheets, with respect to those downgraded securities.

So that the capital ratios would look far worse than anyone had imagined, worse expectations than anyone had. And as a result, there would be more of a broad-based round of capital raised, and that's in fact what's happened. ...

The point of my note today was that in the month of February, 3½ times, or $370 billion in securities were downgraded in the month of February. So first quarter earnings are going to put even more pressure on capital ratios, beyond all these charges that I expect."

So here's what's going on. Regular readers of this web site know that banks and financial institutions have been forced to write down billions of dollars in assets that they have in their portfolios. These are CDOs and other mortgage-backed securities that are nominally worth one value, but may be almost worthless on the open market.

So that's bad enough, but it causes another big problem for the banks: Regulators require banks to keep certain amounts of cash (or cash-equivalent securities) on hand to handle emergencies. These amounts of cash are called "capital ratios." What Whitney is saying is that once these writedowns occurred, they no longer had enough cash on hand, and had to go out and raise capital, thus affecting their earnings significantly.

She concludes by pointing out that the size of the writedowns was 3½ times as large in February as it was in October, so banks are in an even worse situation today.

Whitney goes on to explain what banks are doing wrong:

"Well, the fact that I've spoken about this a lot. If you are truly marking assets to market, then just sell them - you should be indifferent. But these banks have got themselves into trouble, are going to get themselves into trouble prospectively, because they refuse to sell these assets, because they think the market is bid too low.

Well the problem is that each month that they wait, the asset values go lower, and then when the ratings agencies downgrade these assets, they're required to carry even more capital against those assets.

And capital clearly in short supply in the financials right now. ...

There are a couple of things that go on. So you have people that refuse to sell assets.... So if banks don't want to sell these assets, the longer they wait to sell these assets, the values decline.

But then when, all of a sudden, banks decide TO sell all these assets, there'll be a supply jam on the market driving prices down even lower, so there'll be more write downs. And ultimately, I think these financials will sell assets at well below today's market prices. ...

So I am playing catch-up with the banks that are playing catch-up with the credit markets, and I think if everyone just took their poison -- or their medicine, so to speak -- it would be easier on all of us analysts."


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

This is actually very explosive stuff -- although neither of the women indicated that it was.

What Whitney is saying is that banks are trying to avoid having to write down their assets for as long as they can avoid it. But the longer they wait, the worse it is, because the mortgage-backed assets keep falling as time goes on.

But Whitney goes much farther -- she's predicting a full-scale panic when banks finally are forced to mark these assets down. Because the market will be loaded down with these securities from all sorts of financial institutions, they really will be almost worthless.

Just to provide context, as I've said before, the stock market panic of 1929 was caused when investors, who had purchased stocks on credit (margin), were forced to sell their good stocks to meet margin calls on their bad stocks. That forced selling caused share prices to fall even further, resulting in more margin calls to investors, resulting in more forced selling, until there was a full-scale panic.

Bartiromo has no clue about this, of course, but it's disturbing that Whitney doesn't seem to realize the full impact of what she's saying either.

She says that the banks should just "take their medicine," to which my response is, be careful what you wish for.

By the way, when she says that banks are stalling, she's essentially accusing them of defrauding the public, by pretending that their assets are worth more than they really are.

Bartiromo asks Whitney whether earnings estimates will come down next week:

"Not a doubt in my mind. Analysts typically like to wait until the end of the quarter -- [Monday, March 31] -- to put their estimate revisions out. I think it's pretty clear what's going on with this quarter, so why wait?

In February I cut [my earnings estimates] aggressively because I thought that the loss expectations for on-balance-sheet loans would be far higher than anyone expected. And at that time, I was 30% below the street. Going into yesterday, I was the HIGH on the street.

So these earnings estimates are being revised down dramatically on a consistent basis. So I don't think we're anywhere close."

This reflects the "earnings estimates" tables that I keep posting. She points out that earnings estimates have been falling steadily, and they'll fall even more next week.

Bartiromo asks whether the stock market will decline further:

"When the Bear Stearns news went down, I believe it was the 17th of March, I hoped that the stocks would go down to the levels where you could start getting interested in long term values. But the stocks didn't go down that much.

And what I had said at the time, what I had believed is -- this is an agony of incrementalism, where we have all these write downs are ultimately going to be, so we'll have a protracted environment where you have to continue to bolster up reserves."

Here's where Whitney is wrong. She thinks that all these writedowns will occur over a period of months, everyone will "take their medicine," and then things will be back to "normal." What she doesn't understand is that she's laid out a very explosive panicked selling scenario.

Finally, Bartiromo asks Whitney whether she'd buy financial stocks (like banks) right now:

"Even the financials that I like, I don't like. There are some great companies out there, but they're all going to get cheaper."

So the net of all this is that next week is going to be a very rocky week, after the first quarter ends, and actual earnings start pouring in.

Whether this results in panic selling at some point, as Whitney indicates it will, remains to be seen.

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. (28-Mar-08) Permanent Link
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Many investors believe that the subprime crisis worst is over

The reasoning is incredibly shallow.

On Tuesday morning, one of Wall Street's top financial analysts said that he's changed his "bearish" opinion, and now believes that the worst of the subprime crisis is over for the stock market.


Bob Doll, BlackRock Inc. global CIO of equities <font face=Arial size=-2>(Source: CNBC)</font>
Bob Doll, BlackRock Inc. global CIO of equities (Source: CNBC)

Bob Doll, global CIO of equities at investment management firm BlackRock Inc., appeared on CNBC and explained the reasoning. Other pundits said that they agreed with his reasoning, one saying that "there's an 80%-90% chance that stocks have bottomed out, and will start to go up."

Another pundit said, "This is the greatest buying opportunity for stocks we've seen in a long time."

This is like saying, "We've had a week of sunny weather, and so it will be sunny for the next few months." Or, it's like saying, "I've been winning at the roulette wheel for a while, and that means that I'll keep on winning."

I was amazed by how shallow the reasoning was. This is a guy who's known as "the trillion dollar man," and yet he was completely ignorant of the simplest fundamentals. It makes you wonder whether he's simply an out and out liar, saying whatever he has to, so that he won't lose his clients.

CNBC anchor Becky Quick asked him how he felt about stocks now:

"A lot better than I've felt in a while, Becky. No one rings the bell at the bottom, but I think I hear a bell ringing.

Here's the list. Last week, failure of Bear Stearns, opening up of the borrowing window of the Fed to non-bank institutions, Fed cut 75 basis points, easing of capital restrictions for Fannie and Freddie [quasi-governmental mortgage lenders], Bush administration willing to talk about housing relief, largest daily gain of stocks in 5 years, sharp correction in commodity prices, and it was only a four day week."

Doll is echoing something that I've heard frequently in the last few days: "The federal government is fully on board in doing everything possible to fix this problem. They're throwing everything but the kitchen sink at the problem, and will keep on doing so until it gets solved."

This is the principle reason for optimism, but it's based only on things that have happened in the last week! This is the reasoning of people who believe that "history always begins this morning."

Bob Doll continued as follows:

"I think with valuation levels where they are, with sentiment where it is, where policy being aggressive, creative and bold, I'm not sure were going to get a whole lot news coming our way to give us a chance to buy at these sorts of prices."

Now here's where Doll is probably lying. By "valuation levels," he's referring to the price/earnings ratio, and he's saying (by inference) that valuation levels are low, and that therefore investors will be motivated to buy stocks at these prices.

Either this "trillion dollar man" is lying, or else he doesn't know what he's talking about.

There's a price/earnings ratio chart at the bottom of this web site's home page, and it gets updated automatically every Friday. Here's the March 20 version of the chart:


S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 20-Mar-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 20-Mar-2008. (Source: MarketGauge ® by DataView, LLC)

As you can see from this chart, "valuation levels" have been fairly constant, around 18, since early in 2006. This can't be a coincidence, and it means that most investors are following the same formula, and keeping the price/earnings ratio constant. Surely Doll must know this, so when he implies that valuations are lower, he must be lying.

Why, you may ask (especially if you're new to this web site), are valuation levels constant, if stock prices have been falling so sharply during the last few months? If prices have been falling, then shouldn't price/earnings ratios also be falling?

The answer is that they would, except that corporate earnings have also been falling sharply.

Regular readers of this web site saw what happened with estimates of fourth quarter earnings. On October 1, at the beginning of the quarter, the official estimates were that 4Q earnings would GROW 11.5%. These estimates kept falling, week after week, as shown in the following table:

  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%
  Feb 22:             -21.0%
  Feb 29:             -25.2%

By the end of February, when almost all ACTUAL 4Q earnings had been reported, earnings had FALLEN 25.2%.

Now we're playing the same game with first quarter earnings.

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

"As of Friday, March 21st:

14 companies in the S&P 500 have reported earnings for Q1, 85.71% have beaten estimates, 7.14% were in-line, and 7.14% have missed. (Data provided by Reuters Estimates)

The blended earnings growth rate for the S&P 500 in first-quarter 2008, combining actual numbers for companies that have reported, and estimates for companies yet to report, stands at -7.9%.

On January 1st, the estimated growth rate for Q1 was 5.7%. (Data provided by Thomson Financial)"

So now we can update our table of first quarter earnings estimates:

  Date    1Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct 23:             +10.0%
  Jan  1:              +5.7%
  Feb  6:              +2.6%
  Feb 29:              -1.1%
  Mar  7:              -4.3%
  Mar 14:              -7.8%
  Mar 21:              -7.9%

March 21 in this table corresponds (roughly) to December 21 in the previous quarter, and so we're on pretty much the same path in the first quarter as we were in the fourth quarter.

Apparently investors are very well aware of this, because they've been keeping price/earnings ratios steady at 18. How could Doll possibly not know this?

Next, Doll addressed the question of asset writedowns. Regular readers know that Citibank, Merrill Lynch, and many other banks have lost tens of billions of dollars, after being forced to "write down" the value of CDOs and other mortgage-backed assets in their portfolios.

"That's why we're down the amount that we were. As you've heard me say before, markets hate uncertainty. And when we have no clue what the number is in terms of the writeoffs, that's when markets get the shivers. When we start to zero in on a number, even if it's a big number, that certainty is preferred to the uncertainty, and I think we're starting to get there. We're not there yet, but we're a lot farther along. ...

There's a light at the end of the tunnel, meaning that we're beginning to get our arms around the magnitude of the problem. Six months ago, three months ago, it was a big black hole. No one had any clue how big the writeoffs were going to be. Now we're beginning to get some handle, but ... a lot of it is still to be written off."

So there you have it. Based on the events of the last week, ignoring all the trends that have been established since August and earlier, all problems are solved, and now the bubble can start growing again. It is truly astonishing to me.

For six years, I've been saying, based on fundamentals, that the stock market is overpriced by a factor of almost 250%, and that we're entering a new 1930s style Great Depression. Those fundamentals have not changed in the last week, or in the last six years.

To repeat what I've said before, if you go back through history, there are many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash.

These are called "generational crashes" because they occur every 70-80 years, just as the generation of people who lived through the last one have all disappeared, and the younger generations have resumed the same dangerous credit securitization practices that led to the previous generational crash. After each of these generational crashes, the survivors impose new rules or laws to make sure that it never happens again. As soon as those survivors are dead, the new generations ignore the rules, thinking that they're just for "old people," and a new generational crash occurs.

We're now overdue for the next generational crash, and it might occur tomorrow, next week, next month, or next year.

In case you've forgotten, here's the historical graph of price/earnings ratios:


S&P 500 Price/Earnings Ratio (P/E1) 1871 to August 2007
S&P 500 Price/Earnings Ratio (P/E1) 1871 to August 2007

Once again, this is NOT rocket science. You can just look at this graph and see that we're close to the edge of a huge cliff that will bring P/E ratios down to the 5-7 range over a three year period, which will bring the stock market down to the Dow 4000 range or below.

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. (25-Mar-08) Permanent Link
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Sarkozy government becomes paralyzed after defeat in municipal elections

Socialists gain power across France, leaving economic reforms in doubt.

Last May, after French president Nicolas Sarkozy's euphoric victory over Socialist candidate Ségolène Royal, I posted a list of the campaign promises that he made:

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I joked that, after that, he would turn water into wine for the nationwide party. ` Now, ten months later, Sarkozy has accomplished almost nothing -- a minor change to overtime laws, and little else. Sarkozy's approval rating, which was at 65% last July, is now at 38%.

Last week, the leftists won a major victory against Sarkozy's center-right coalition by taking more than 30 cities and large towns, including a landslide victory in Paris. Under France's legislative system, this defeat severely limits Sarkozy's ability to implement reforms.

France's government is quickly sinking into the paralysis quagmire that's affecting all countries that fought in WW II as a crisis war:

The reason for this paralysis is that the generations that survived WW II are gone now. Those people did some great things -- they created the United Nations, World Bank, Green Revolution, World Health Organization, International Monetary Fund, and so forth. They created these organizations and managed them for decades with one purpose in mind: That their children and grandchildren would never have to go through anything so horrible as World War II. Now all those people are gone, and the people left behind have no idea what's going on or what to do. They're unable to lead or govern. All they know how to do is whine and complain, and wait until the next disaster, the next world war, forces them to do great things as well.

However, Sarkozy's image problems go beyond paralysis.

Many French people are now tut-tutting disapprovingly over Sarko's whirlwind romance and sudden marriage to singer and supermodel Carla Bruni.

For a long time, the two were inseparable, almost joined at the hip, as they traveled from country to country so that Sarkozy could fulfill his duties as President of France. It seemed sexy and romantic at first, but as it went on for months, the French people finally decided that it was just tacky, and they've given Sarkozy the name President Bling-bling.

Sarkozy is now taking steps to 'sober up' after the elections, in an effort to regain Presidential stature and the confidence of French citizens.

If you'd like to see "more" of Carla Bruni, you'll find plenty of opportunities to do so on the Internet.

For this article, we've selected a very pretty song that she sings in English. The title is, "Nobody Knows You when You're Down and Out," and the words reflect very real feelings of a great many people today:

"Once I lived the life of a millionaire,
Spending all my money, just didn't care,
Took all my friends out for a mighty good time,
Buying bootleg whisky, champagne and wine.
Then I began to fall so low;
Lost all my good friends, had no place to go.
If I get my hands on a dollar again,
I'm gonna hang on to it till that eagle grins.

Nobody knows you when you're down and out,
In your pocket, not one penny;
And all the friends, you don't have any.
If you get back on your feet again
That's when you find you long lost friend
It's mighty strange, without any doubt
Nobody knows you when you're down and out."

(24-Mar-08) Permanent Link
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Palestinian opinion shifts toward greater confrontation with Israel

A Khalil Shikaki poll shows increasing acceptance of violence against Israel in the Palestinian territories. The poll was conducted by Shikaki's Palestinian Center for Policy and Survey Research.

Shikaki told the NY Times that he was shocked because the survey showed greater support for violence than ever before, and that, for the first time, a majority favored an end to negotiations and the shooting of rockets at Israel. According to Shikaki,

"There is real reason to be concerned. The anger that this poll is registering is about equal to that at the very height of the second intifada. I am very worried about what is coming."

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Here's are the main findings from the poll:

"Findings indicate that a major shift, in Hamas’s favor, had occurred during the last three months with about 10% of the population shifting their attitudes and perceptions. The change included increased popularity of Hamas and its leadership, increased support for its positions and legitimacy, and greater satisfaction with its performance. These changes might have been the result of several political developments
  • starting with the breaching of the Rafah border with Egypt during the last week of January and first week of February,
  • followed by the Israeli military incursion into the Gaza Strip
  • leading to a large number of Palestinian causalities and
  • an increase in the number of rockets launched from the Gaza Strip against Israeli towns such as Sderot and Ashkelon,
  • the two suicide attacks in Dimona and Jerusalem leading to the death of nine Israelis, and
  • ending with the failure of the Annapolis process in positively affecting daily life of Palestinians in the West Bank, in stopping Israeli settlement activities, or in producing progress in final status negotiations.
These developments managed to present Hamas as successful in breaking the siege and as a victim of Israeli attacks. These also presented Palestinian President Abbas and his Fateh faction as impotent, unable to change the bitter reality in the West Bank or ending Israeli occupation through diplomacy."

As regular readers of this web site know, this is the kind of attitude change that I've been watching for, for several years.

In 2003, when I wrote "Mideast Roadmap - Will it bring peace?" I said that the Roadmap would fail, and that the death of Yasser Arafat, when it occurs, would be part of a major generational change that would lead to a new genocidal war between Jews and Arabs, re-fighting the war between Jews and Arabs that followed the partitioning of Palestine and the creation of the state of Israel in the late 1940s.

Arafat died in November, 2004, and Israeli Prime Minister Ariel Sharon went into a coma in January, 2006. These two men cooperated (consciously or unconsciously) in prevent a new genocidal war between Jews and Arabs, but now, with both of them gone, generational forces are taking over, and there is no way to prevent a new war.

Still, I've never yet seen the requisite fury and hatred from the Palestinians toward the Jews that would signal that such a war is getting close. (Nor have I seen it on the Jewish side, either.)

This is only one poll, of course. It indicates not a massive change in attitude, but an incremental change in attitude. But it's a significant change and, even more important, it represents a trend that may well be unstoppable. (24-Mar-08) Permanent Link
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Nationalist Party (KMT) candidate Ma Ying-jeou overwhelmingly wins Taiwan presidency

In a major change of political direction, Taiwan's voters elected Ma Ying-jeou by the largest margin of victory in the history of Taiwan's presidential races.

Ma's Nationalist Party (or Kuomintang party or KMT) candidacy defeated Frank Hsieh of the Democratic Progressive Party (DPP), the party of outgoing president Chen Shui-bian.

Voters shrugged off concerns about China's violent crackdown in Tibet, and the fear that China would crack down similarly on Taiwan, focusing instead on Taiwan's economic troubles, and the economic advantages of greater trade opportunities with the mainland.

Voters also rejected referendums that would have called on the government to try to gain Taiwan's admission to the United Nations separate from China. (The two countries' officials names are "Republic of China" or ROC, and "People's Republic of China" or PRC, respectively.)

The Central Election Commission also said two referendums calling on the government to work for the island's entry into the United Nations failed. China had warned that the referendums threatened stability in the region.

What's old is new again

Ma's victory, and his desire for closer relations with China, closes a circle that's almost a century old. After the (Awakening era) Chinese Revolution of 1911, the political chaos led, in the 1920s, to the Nationalist government led by Chiang Kai-shek. Challenging Chiang was the Communist faction, based on Russia's recent Bolshevik revolution, and led by Mao Zedong. Mao's "Long March" in 1934 launched the civil war between the two factions. The civil war ended in 1949, with Chiang's Nationalists fleeing to the offshore island of Formosa which, together with some other islands, form the province or nation (depending on your point of view) of Taiwan.

Communist China and Communist Russia (in the form of the Soviet Union) never got along very well, and never really had much in common, except for each having slaughtered tens of millions of people, and in the 1960s there was international concern that they two countries were close to nuclear war with each other. (Such a war, if it had occurred, would have been a non-crisis war for both nations, and most likely have ended quickly, with no use of nuclear weapons, following great political opposition to the war in both countries.)

Nonetheless, as the two major "Communist" countries of the world, China and the Soviet Union felt a kind of kinship that was completely shattered by the momentous events of 1989 and after:

Things came to a head when Taiwan's DPP won the Presidency in March, 2000. A shocked CCP clamped down on the Falun Gong in April, 2000, brutally repressing it. Falun Gong advocates claim that thousands of Chinese have been jail or executed, simply for practicing meditation exercises.

The CCP are the most paranoid people on earth today -- afraid of the Tibetans, the Falun Gong followers, and the people of Taiwan -- and even afraid of their own people, who have tens of thousands of anti-CPP demonstrations every year.

Ma Ying-jeou

Beijing has never ceased to express its continuing contempt for the DPP, and has openly stated that it favored the victory of KMT candidate Ma Ying-jeou.

That's why Ma's victory brings a circle to a close. The Nationalists and the Communists were allies in the 1920s. Then they split apart and fought a war, and became each other's hated enemy. But now they're back together again, promoting peace and harmony and cooperative economic development.

Ma Ying-jeou was born in Hong Kong in 1950 -- his parents were in the midst of fleeing to Taiwan, but had to pause in Hong Kong to give birth. Ma is Harvard educated, and speaks English well.

The irony aside, the question arises whether this means a détente in Taiwan / China relations. Ma is certainly not going to make it easy for Beijing. His "pro-China" campaign stressed closer business ties with China, but no peace treaty with China until Beijing dismantles its arsenal of missiles aimed at targets in Taiwan.

Election euphoria

One of the interesting things about Ma is that when you read the recent news profiles about him, some of them describe him as "charismatic," and others describe him as definitely "not charismatic." I guess it depends on chemistry and politics.

But his promises of change do seem to have gotten him elected on a wave of euphoria similar to the euphoria that's been surrounding Barack Obama in America. Such waves of euphoria always quickly dissolve within a few weeks or months, as the promised changes don't materialize, leaving an electorate that feels angry and betrayed, and looking for someone to blame.

One of the most bizarre signs of that euphoria was contained in a BBC pre-election report on Friday, describing a ferry service running across the Straits of Taiwan between the Chinese town of Xiamin, and the Taiwan island of Jinmen. Here's the final portion of the report (my transcription):

"In the booming [Taiwanese] capital Taipei, China might be on everyone's minds, but not so much as an enemy, but as vital to making money and trade. Past grievances are irrelevant against the needs to get on with life.

And those in the know say that China decided some years back that it would not be taking military action over Taiwan, no matter what.

Chong-pin Lin, Foundation on Cross-Strait Studies: "Beijing made the decision in summer of 2002 thinking that the economic development of China is more important then unification of the so-called 'motherland.'"

No one's actually announced that, but well there are regular direct ferries between Jinmen and Xiamin in what was once a flash point for global conflict.

Humphrey Hawksley, BBC News on the outlying Taiwanese island of Jinmen.

Now, I'm used to hearing bizarre things on the BBC, but this really tops the list. "People in the know"???? Who are they? Is Lin Chong-pin one of those people? It turns out that he's a supporter of the hated (by China) DPP party, so how would he ever get to be "in the know?"

This is exactly the kind of airhead expectation that's been occurring in places around the world, as the world enters a generation crisis era, 62 years after the end of World War II.

The Chinese have repeatedly threatened the United States with war over Taiwan, and have repeatedly threatened to invade Taiwan itself, and that's not going to change. China continues to accelerate its massive military buildup, preparing for war against Taiwan and the United States, and that's not going to change either.

Meanwhile, here are two "reality checks":

Here's President Bush's statement on the election results:

"I congratulate the people of Taiwan on the successful conclusion of their March 22 presidential election. Once again, Taiwan has demonstrated the strength and vitality of its democracy. I also congratulate Mr. Ma Ying-jeou on his victory.

Taiwan is a beacon of democracy to Asia and the world. I am confident that the election and the democratic process it represents will advance Taiwan as a prosperous, secure, and well-governed society.

It falls to Taiwan and Beijing to build the essential foundations for peace and stability by pursuing dialogue through all available means and refraining from unilateral steps that would alter the cross-Strait situation. I believe the election provides a fresh opportunity for both sides to reach out and engage one another in peacefully resolving their differences.

The maintenance of peace and stability in the Taiwan Strait and the welfare of the people on Taiwan remain of profound importance to the United States. We will continue to maintain close unofficial ties with the people on Taiwan through the American Institute in Taiwan in accordance with our long standing one China policy, our three Joint Communiqués with the People's Republic of China, and the Taiwan Relations Act."

What many people don't understand, except for the readers of this web site, is that a war over Taiwan could begin as early as tomorrow, if just one of these three parties miscalculates, panics and overreacts to something. Generational Dynamics predicts that there will be such a war next week, next month, next year, or thereafter, but it is coming with absolute certainty. (23-Mar-08) Permanent Link
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China's crackdown on Tibet is swaying the Taiwan presidential election

Ugly memories of the 1989 Tiananmen Square massacre are being revived.

In generational theory, China's 1989 Tiananmen Square massacre is an example of an "Awakening climax" -- an event so profound that it resolutely settles the "generation gap" political battles of the recent or ongoing Awakening era in favor of either the old generation of crisis war survivors, or the young generation of rebels.

In America's Awakening era, it was the resignation of Richard Nixon that signaled a victory of the Boomer generation over the WW II GI generation.

In China, the Tiananmen Square massacre firmly established Mao Zedong's generation as the political victors over the young generation, and today the Chinese Communist Party (CCP) is mostly led by Maoists in their 70s.

The people of Taiwan, watching the Tiananmen Square massacre from across the Taiwan Straits in 1989, were absolutely horrified.

Up to that time, the unchallenged assumption was that Taiwan would eventually reunite with China (the so-called "One China policy"). There was essentially only one political party, the Kuomintang Party (KMT).

But the Tiananmen Square massacre gave rise in Taiwan to a student movement called the "Wild Lily rebellion," formed to demand political reform in Taiwan, and to develop a unique Taiwanese identity different from that of China.

This rebellion evolved rather quickly into the new Democratic Progressive Party (DPP). DPP chairman Chen Shui-bian became Taiwan's president in 2000, and was reelected in 2004 in a wild election battle.

Beijing's CCP has never tired of expressing contempt and hatred for Chen Shui-bian and his DPP party, but they've lived with it by issuing one threat of war after another if the Taiwan government makes any moves at all towards an independent Taiwan.

One of the moves that most infuriated the Taiwanese was China's "Anti-Secession" law, which commits China to forcibly repatriating Taiwan to China.

In August 2006, Sha Zukang, the Chinese ambassador to the U.N., furiously and harshly threatened the U.S. over Taiwan. He was literally screaming in an interview with a BBC reporter:

"The moment that Taiwan declares independence, supported by whomever, China will have no choice but to [use] whatever means available to my government. Nobody should have any illusions on that. ...

It's not a matter of how big Taiwan is, but for China, one INCH of the territory is more valuable than the LIVES of our people."

[With regard to the U.S.'s constant criticism of China's rapid militarization:] It's better for the U.S. to shut up, keep quiet. That's much, much better. China's population is 6 times or 5 times the United States. Why blame China? No. forget it. It's high time to shut up. It's a nation's sovereign right to do what is good for them. But don't tell us what's good for China. Thank you very much."

And so it was with a measure of some relief to Beijing to see that Ma Ying-jeou, the KMT Presidential candidate, had a substantial double-digit lead over Frank Hsieh, the DPP candidate, according to polls in advance of the planned election on Saturday, March 22.

But now Ma's lead as fallen sharply, as Hsieh has been using the Tibet violence to bring back memories of Tiananmen Square.

According to the NY Times:

"Mainland Chinese officials loathe Taiwan’s current president, Chen Shui-bian, and his party, the Democratic Progressive Party, for pursuing greater political separation from the mainland.

Beijing authorities have been wary of the party’s candidate, Frank Hsieh, even though Mr. Hsieh has repeatedly voiced much more willingness than President Chen to allow more Taiwanese investment on the mainland and more cross-straits transportation links.

Mr. Hsieh and his party, with help from President Chen’s ministers, have moved swiftly to turn Tibet into a central issue in the campaign. They contend that Tibet’s fate is an example of Taiwan’s future if it does not stand up to Beijing.

“What has happened in Tibet in the past three decades, and what is going on now, is a warning to us,” said Shieh Jhy-wey, the minister of information and a Democratic Progressive Party hard-liner toward Beijing. “We don’t want to have the same fate as Tibet.”

Mr. Hsieh abruptly turned a campaign rally in Taipei on Wednesday night into a candlelight vigil for Tibetans who have been killed, injured or detained during the Chinese crackdown. Party activists unfurled a huge Tibetan flag and Tibetan students sang a Tibetan anthem."

Ma has been resorting to damage control. A recent statement by Prime Minister Wen Jiabao of China suggesting that Taiwan's future is with China, Ma condemned what he described as a, “ruthless, irrational, arrogant, foolish and self-righteous comment.”

The extremely paranoid Beijing CCP officials have their backs to the wall right now. They will not tolerate any sign of secession, from either Tibet or Taiwan, and there are signs that they're already overreacting in Tibet. This is only increasing secessionist desires in both places.

But as much as Beijing would like to clamp down even harder, they're restricted from doing so for fear of an international boycott of the summer Olympics. This would be an enormous humiliation.

From the point of view of Generational Dynamics, the US and China are headed for war over Taiwan. The only question is timing.

A victory by Ma on Saturday would do a lot to reduce tensions for a while. A victory by Hsieh would substantially increase tensions.

The worst case scenario for Beijing on Saturday would be a victory for Hsieh, accompanied by a "YES" vote on a referendum that calls on Taiwan to join the United Nations as a member separate from China. Even worse, the Tibet situation could become even more violent.

In this worst case scenario, Beijing may well take some kind of action once the Olympics games end.

From the point of view of Generational Dynamics, what's fascinating about this situation is how the 1989 Tiananmen Square massacre is reverberating forward through history, bouncing like a ball from Beijing to Taiwan to Tibet to Washington and back again. China has been trying to erase memories of the massacre ever since it occurred, and now it's up in their face at precisely the time they want it least -- the 2008 Beijing Summer Olympics. (21-Mar-08) Permanent Link
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Commodities prices fall as stock market experiences wild swings

Remember ages ago (i.e., last week) when things looked "normal"?

The stock market has exhibited extreme volatility and wild swings during the last few days, amid unprecedented events -- several hedge fund failures, a major investment bank failure and historic Fed interventions.

Commodities investors have begun to express caution as prices suddenly collapsed on Wednesday, breaking a very long period of bubble-like increases:

"Corn futures for May delivery fell the 20-cent maximum allowed by the Chicago Board of Trade, or 3.7 percent, to $5.2725 a bushel, the biggest percentage drop since Jan. 23. Most-active futures before today had gained 37 percent in the past year, reaching a record $5.795 on March 11 on rising demand for corn-based ethanol and livestock feed.

Soybean futures for May delivery fell 50 cents, or 3.6 percent, to $12.57 a bushel in Chicago. The exchange's limit for gains or losses in soybeans is 50 cents. The price has fallen 21 percent since reaching a record $15.8625 on March 3. Still, most-active futures have risen 66 percent in the past year after U.S. farmers planted the fewest acres in 12 years.

Gold futures in New York plunged $59, or 5.9 percent, to $945.30 an ounce, the most since June 2006, after the Federal Reserve cut U.S. borrowing costs less than investors expected yesterday. Gold reached a record $1,033.90 on March 17. Crude oil fell as much as 4.5 percent to $104.48 a barrel in New York. The most-active contract reached a record $111.80 on March 17."

There have been "waves of selling," according to the article, as hedge funds that have used leverage to purchase large commodities positions are now deleveraging, in advance of a possible bubble collapse.

Many investors are pulling out the market into the safety of Treasury bills, causing the yield on 3-month Treasuries to fall to 0.47% from 0.79% a day earlier, and 6-month Treasuries to fall to 1.1% from 1.24% a day earlier.

Pundits on CNBC were saying that they've never before seen anything like what's going on now -- especially the wild swings in all markets.

A web site reader wrote to me that she's lost a fair amount of money on her futures contracts in the last two days because of "Bernanke's clever fixes."

I admire people with such strong stomachs that they're even ABLE to deal with these kinds situations. This is not for the faint of heart.

I continue to strongly advise against getting into the short or futures markets.

Keep in mind that there may be a major financial crisis at any time, causing a domino effect of bankruptcies. In that case, investors could lose their escrow accounts or be unable to collect from counterparties.

Right now, about the only thing that makes sense is cash.

There is a little bit of good news in this: With commodity prices falling, the cost of wheat, corn and soybeans is falling, which may mean that a few million more people in the world may be able to afford to eat, at least for a while. (20-Mar-08) Permanent Link
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Treasury Bills are now hardly worth the trouble

After the Fed's Tuesday action, lowering the Fed Funds rate by ¾% to 2¼%, the yield on 3-month Treasury bills is now 0.79%, and on 6-month T-bills it's now 1.24%.

I've suggested short-term T-bills in the past as a perfectly safe investment vehicle for those who feel that they MUST be earning interest, and so would like to avoid just keeping cash.

But with T-bill interest rates so low, it may not be worth the trouble. It's even worse if you purchase T-bills through a broker who charges a fee. However, if you still wish to consider T-bills, you can get them online with no fee from http://treasurydirect.gov .

The other alternative you can consider is getting a bank CD (Certificate of Deposit). Many banks are now providing above-market yields, because they're anxious to get customers. As usual, though, make sure that the bank is FDIC insured, and that you carefully follow all the rules, especially if you're depositing more than $100,000. (19-Mar-08) Permanent Link
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E-mail unavailable on Tuesday

I was bombed with thousands of spam messages on Tuesday, and so my e-mail service was effectively shut down for a while. If you sent me a comment on Tuesday, I may or may not have gotten it, so you may wish to resend it.

This is a good time to remind you that you can write to me with comments and questions.

The web site traffic has been growing substantially, but fortunately for me, the rate of messages has been growing more slowly. And so, it may take a few days to get back to you, but so far I've been doing OK keeping up with the e-mail messages. Use either an e-mail message, or the "Comment" link at the top of this page.

If you want to have a more open debate, you can do so in the "Objections to Generational Dynamics" thread of the Fourth Turning forum.

Thanks to all my web site readers for coming back every day.

I know that a lot of people are in a great deal of pain these days, because things are happening that mainstream politicians, analysts and journalists have been oblivious to. This is the only web site in the world that's been telling you what's coming, and it's the only web site in the world that's been right every time. I'm glad that I've been able to help so many people prepare for the future.

Once again, if I can respond to any questions or comments, please feel free to direct them to me. (19-Mar-08) Permanent Link
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China's problems mount, as Tibet violence is linked to summer Olympics

Violence has spread well beyond the borders of Tibet itself.


Historic ethnic Tibet region within western China <font face=Arial size=-2>(Source: BBC)</font>
Historic ethnic Tibet region within western China (Source: BBC)

After a week of rioting, Chinese security forces have clamped down and restored calm to Lhasa, the capital of what China calls the Tibet Autonomous Region (TAR). Officials have demanded that all rioters turn themselves in to the police, and have warned that any further rioting will have severe consequences.

However, China's troubles are far from over. Rioting is increasing in historic ethnic provinces -- Qinghai, Sichuan and Yunnan. Rioting is increasing in Dharamsala, India, where the Dalai Lama and exiled Tibetans have been living since the 1959 Chinese clampdown. There's also rioting among Tibetans in Kathmandu, Nepal.

Although the violence in Tibet has not spiraled out of control, it's clear that the ethnic fault line between the Tibetans and Chinese is overwhelmingly hate-filled, especially on the Tibetan side. Tibetans in Lhasa have targeted Chinese businesses and committed abominations on Chinese people.

For decades, the Chinese authorities have done one thing after another to infuriate the Tibetans.

It doesn't take a rocket scientist to see that this is going to end badly. The only question is the time frame.

The Tibetans believe that this time is their best chance. With the Beijing Olympics only a few months away, Tibetans see this as the best time to reach their goal of a separate nation of Tibet.

The Chinese would never consider that, of course, since that would imply that Taiwan could also secede. So you can see that the Tibetan and Chinese positions can never be reconciled without a war.

The situation is of theoretical interest to Generational Dynamics because of the differing generational timelines. The Tibetans' last crisis war climaxed in 1959, while the Chinese' last crisis war climaxed in 1949. It's possible for an identity group to have a crisis war a few years "early," especially if they're attacked by another identity group already in a crisis era. This doesn't seem likely in the TAR itself, but something like it is quite possible in the areas Qinghai, Sichuan and Yunnan where the Tibetans and the Chinese Han intermingle and compete for resources. This is something to watch for and evaluate.

The greatest chance for violence is Chinese overreaction. The Chinese Communist Party (CCP) are probably the most paranoid group of people on earth these days, and they see the Tibetan rioting as a Great Tibetan Conspiracy to humiliate the Chinese in the Olympics. There's some truth to that claim, of course, but not to the massive extent that the CCP fears. If the CCP would only "cool it," then the riots would mostly fizzle, and prove only a minor embarrassment in the summer. Instead, the CCP is making the situation much worse than necessary.

Even worse for the Chinese is that countries around the world are linking the Tibet situation to the Olympics and calling for Chinese restraint. The Chinese are especially being warned not to repeat the 1989 Tiananmen Square massacre.

The paranoid CCP officials are facing potential humiliation on several fronts. The Tibet situation will undoubtedly continue; the Darfur human rights criticisms will continue, especially since Steven Spielberg resigned; and Taiwan is holding Presidential elections on March 22, including a referendum on Taiwan joining the United Nations separately from China. The temptation for the Chinese to overreact must be great.

And once the Olympics games have ended, then the CCP will have no further motivation to hold back. Beijing is probably already preparing action plans, possibly with military components, to be put into effect as soon as the games end. (18-Mar-08) Permanent Link
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What should you do with your retirement fund now?

According to Suze Orman, most people are too scared to do anything.

Appearing on CNBC late Monday afternoon, well-known financial advisor Suze Orman (who, incidentally, sounds exactly the same as her Saturday Night Live parody) answers the question of what "every day investors" are doing and should be doing:

"Here's what everybody is thinking - they don't know what to do, they don't know who to listen to, they don't know who to believe, and why should they?


Suze Orman <font face=Arial size=-2>(Source: CNBC)</font>
Suze Orman (Source: CNBC)

Nobody's been telling them the truth. They hear someone go on television last week and say, ohhh, Bear Stearns is fine, and then all of a sudden they've seen millions of dollars go down the tube.

But what's happening, Dylan, in my estimation, with really the people out there, the every day people, which are MY people that I'm talking to, they are so afraid, they are really taking their head and sticking it in the sand. They're not opening up their statements, they're not looking at what they have, they don't want to pay attention now because they don't know what to do, and things like today only make it worse for the common person on the street. ...

And where do they own [their] stock? Most people own stock in a 401K or a retirement plan. Normal, every day people don't even think really that they open up an account at a brokerage firm and besides their retirement account, they don't know that you buy stock outside a retirement account. Most people think that the only place and the only way that they invest is with their retirement accounts, so in their retirement accounts, are they looking at their 401K statements? No. Are they looking at the IRA statements, Roth IRA statements, SEP IRA ra statements? No. So they're just keeping plodding along or, worse, they've just stopped doing anything."

Orman then went on to recommend that "every day investors" should open their IRA statements and make sure they understand what's in their accounts. And then they should invest ONLY in good, solid stocks.

People who followed her advice at any time since October 2006 would be underwater today, since the Dow Industrials are now at their lowest since October, 2006.

Orman is an investment counselor. If she ever told people to sell all their stocks, then she would lose all her clients, and she would never be invited to speak on television. All of these people have a built-in conflict of interest -- their income depends on lying, if necessary, to say that stocks will continue to go up.

One reason that I've been right about everything for six years is that I have no such conflict of interest. I neither make nor lose money if the markets don't do as I predict, so I have nothing to lose by telling the truth. I have nothing at stake except my own credibility.

The collapse of Bear Stearns is very ominous, and portends bad times ahead. We're in a deflationary spiral that's accelerating, and can't be stopped by the Fed or any politicians. If you've put off selling your stocks, then you've already lost a lot of money, and unless you do so now, you're going to lose a lot more.

I've written several articles suggesting plans. One of the most recent, from last month, is "Readers comment: Gold prices and where you should put your money."

Now is the time to take action, before things get a lot worse. (18-Mar-08) Permanent Link
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Investors fear a "chain reaction" in stock market.

After Bear Stearns collapses in three days, who will be next?

A year ago, in January, 2007, Bear Stearns shares were selling for $171. At the beginning of 2008, they were selling for $85. A week ago it ws $30/share. On Sunday, Bear signed a deal to be acquired by JP Morgan Chase at $2.00 per share.

The Fed and the financial community were putting enormous pressure on both companies to avoid a Bear bankruptcy. The reason is not the obvious one (that investors would lose money). The reason is that many hundreds of small investment firms use Bear as a bank to clear their transactions, and those hundreds of banks would be unable to do business if Bear went bankrupt.

The analog to this is if, hypothetically, a large internet firm like Comcast went bankrupt. It's true that, in such a case, the investors would lose a lot of money, of course. But the worst effect to the public would be that all its customers would instantly lose their internet service.

So it's not that Bear was "too big to be allowed to fail," so much as a need to keep it providing services to its customers.

The problem is that Bear has a huge portfolio of CDOs with high notional values, but completely unknown "mark to market" values, since there IS no market for these CDOs.

Any company acquiring Bear would want to know the values of Bear's assets in order to decide what to bid. Are Bear's assets worth $171 per share? Or are Bear's assets worthless? The answer to that question could not be determined.

And as we wrote last night, there was a panicked desperation for Bear to be acquired before the Asian markets opened on Monday morning, which would be early Sunday evening in New York. The fear was that if Bear remained on the verge of bankruptcy, investors in the Asian markets might panic, and that would spread to Europe and North America on Monday.

What it came down to was that nobody wanted to bid on Bear under these conditions, according to reporting this morning on CNBC.

On Monday morning, the debate centered around two views:

The "bear" point of view was summarized by CNBC pundit Rick Santelli, speaking from the floor of the Chicago Board of Trade:

"I think that a chain reaction has begun and I think the Fed is going to do everything it can to escort all the players down the proper path to keep counterparties at least involved in the game.


CNBC's Rick Santelli, speaking from the floor of the Chicago Board of Trade (CBOT) <font face=Arial size=-2>(Source: CNBC)</font>
CNBC's Rick Santelli, speaking from the floor of the Chicago Board of Trade (CBOT) (Source: CNBC)

But I do think that the feeling on this floor is that the adjustment is afoot.

The thing that everybody has dreaded with the reversal of the credit crunch, the pricing of derivatives, the liquidation of collateral -- we are now in it, and we need to pay attention.

The Fed, naturally, according to traders, can't stop the process. They can only be there to insert liquidity. Overnight LIBOR is up big, as one would expect. Fed funds looking for a massive ease tomorrow, and that's chapter two.

Do you keep doing two things. The new things that they're forced to do that will help the liquidation, and do you keep liquifying, which is killing the dollar, and doing them no imminent good. That's the debate for the next 24 hours."

(Just a word of explanation: When Santelli says "Fed funds looking for a massive ease tomorrow," he's referring to the value of options on the Fed funds futures. Santelli is saying that investors are expecting the Fed to perform a "massive ease" in the Fed funds rate on Tuesday, when the Fed has a regularly scheduled meeting.)

For those readers who are trying to decide whether the "bull" view or the "bear" view will prevail, I would make the following point: The "bull" point of view has been wrong every time since August, and almost every time since the housing bubble started leaking two years ago. We've heard, "there's no housing bubble," then "housing prices have bottomed," then "housing prices have bottomed" again (and again), then the "subprime crisis is contained to suprime mortgages," then "the subprime crisis is contained to mortgages," then "the subprime crisis will be over after this quarter" (multiple quarters).

Every time, there's always a form of spin that says that the bad news is temporary, or that the bad news is really good news.

I'm always struck by how these investors always seem to believe that "history always begins this morning." They look at one data value or one part of the financial system, and have no concept of how the different parts of the world financial system are interlinked into one huge heavily interconnected system. They also have no idea how events propogate through that system, and how things that happened years or decades ago are still propogating through the system today.

As I've been saying hundreds of times since 2002, the stock market is overpriced by a factor of close to 250%, as I described in "How to compute the 'real value' of the stock market," indicating that we're entering a new 1930s style Great Depression. In 2002 I had no idea what scenario we would follow to reach that point, but the end result has always been certain with 100% probability.

Here's the first graph that I used in that article:


S&P 500 Price/Earnings Ratio (P/E1) 1871 to August 2007
S&P 500 Price/Earnings Ratio (P/E1) 1871 to August 2007

Have you ever seen anything like this graph in any financial publication? P/E ratios, or "valuations," are standard tools used by investors. But no one will publish it because it's about as close to a mathematical proof as you could hope for that we're headed for a major stock market crash. This graph shows that P/E ratios regularly fall to the 5-10 range, and that we're on the edge for another such collapse.

Now here's the thing: Over the years, I've gotten many personal remarks and e-mail messages about my "Great Depression" prediction, and I've been called all sorts of names.

But not one single person has ever challenged that graph (or its similar predecessors). No one says to me, "You haven't accurately graphed the P/E ratio index - you've drawn the graph wrong." No one says to me, "You've drawn the graph right, but here's why you're interpreting it incorrectly."

Instead, what I see all the time in financial publications, and hear all the time in CNBC is totally incorrect interpretations of the P/E ratio, calling stock valuations "cheap" at the current inflated value. Many of these people apparently don't even know how to compute a P/E value. (Hint: It's price per share divided by last year's earnings per share. Duh!) Why investment managers with six and seven figure salaries can't understand P/E ratios is beyond me.

I'm certainly not the only person who's understood this. In his March 2003 newsletter to his Berkshire Hathaway investors, Warren Buffett said that stocks were still significantly overpriced at that time -- and at that time, the Dow Industrials were at 8000!

And one day in 2005, I was watching Neil Cavuto's money show on FNC, where famous "bear" David W. Tice was appearing as a guest. He was asked where the market was going and he said, "Oh, it's going to fall below 4000." Cavuto shut him off instantly. Pundits like Cavuto don't even want to HEAR something like that.

To repeat what I've said before, if you go back through history, there are many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash.

These are called "generational crashes" because they occur every 70-80 years, just as the generation of people who lived through the last one have all disappeared, and the younger generations have resumed the same dangerous credit securitization practices that led to the previous generational crash. After each of these generational crashes, the survivors impose new rules or laws to make sure that it never happens again. As soon as those survivors are dead, the new generations ignore the rules, thinking that they're just for "old people," and a new generational crash occurs.

We're now overdue for the next generational crash, and it might occur tomorrow, next week, next month, or next year.

The collapse of Bear Stearns is VERY ominous, because it portends a chain reaction that will cause forced selling among many other firms.


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

Here's a final note from The Twilight Zone:

Some pundits on CNBC are hoping for a 500 point collapse in the Dow Industrials. Why? Because that would be a stock market capitulation signal, meaning that the market had bottomed, and would start going up again (meaning that the credit and housing bubbles would have to start reflating, which is impossible).

My response to this is as follows: Be careful what you wish for. (17-Mar-08) Permanent Link
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Fed approves desperation measures to deter worldwide bank failures

Near-bankrupt Bear Stearns has been sold off to JP Morgan at a small fraction of its former value as of just a week ago. JP Morgan Chase will acquire Bear Stearns at $2 per share. Last week, Bear Stearns shares were trading at $30.

At the same time on Sunday, the Fed cut the discount rate in an emergency move. A reduction in the discount rate makes it cheaper for banks to borrow money from the Fed.

All of this happened in a feverish meetings with officials from Bear Stearns, JP Morgan, the Treasury Dept., and the Fed. The goal was to get a deal signed by early evening, beforel the Asian stock markets opened, for fear that there would be a major correction.

The reasoning was that if a deal wasn't made right away, then Bear would go bankrupt, causing a domino effect that would unravel other markets and cause other bankruptcies.

I personally don't see how the final result makes much difference -- Bear would probably have been worth $2 per share in bankruptcy anyway. At this writing on Sunday evening ET, the Nikkei is already down 4%, and Dow Industrials futures are down over 200 points.

Perhaps the Fed or someone else can pull something new out of the hat on Monday morning, as has happened so many times since the credit crunch began last August. Each new "something" was bigger and more aggressive than the last "something," and each one has been less and less effective. Right now, the situation looks quite ominous. (17-Mar-08) Permanent Link
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China crushes protests by Buddhist monks in Tibet

The Dalai Lama, exiled in India since 1959, called for calm.

Thousands of protesters, led by Buddhist monks, filled the streets of Lhasa, the capital of Tibet, this week. Tibetans threw stones and set fires, particularly targeting Chinese businesses and properties. Tibet is a "secessionist" province of China, and Chinese troops responded, and dozens of Tibetans were killed.

Tibet's last crisis war was the Tibetan rebellion against the Chinese in the 1950s. This week's riots were timed to commemorate the climax of the rebellions, when the Chinese crushed the rebellion on March 10, 1959. At that time, hundreds of Tibetans, including the Dalai Lama, fled to India, where they've lived in exile ever since.

The current riots are occurring across a centuries-old fault line between two ethnic groups: the Tibetans themselves, and the Han, the principle Chinese ethnic group. The Tibetans and the Han have fought numerous crisis wars for centuries.


China and its provinces <font face=Arial size=-2>(Source: The Economist)</font>
China and its provinces (Source: The Economist)

However, it's been only 49 years since the 1959 climax of the last crisis war, and so Tibet is in a generational Unraveling era. That means that the demonstrations will fizzle before too much longer.

However, recall that a similar situation existed when there were similar demonstrations in Burma (Myanmar) last year in October, when Burmese civilians, led by Buddhist monks, demonstrated against the Chinese-supported government. Burma's last crisis war climaxed in 1958, and so Burma was also in a generational Unraveling era. And so, as expected, the Burma demonstrations fizzled. However, the Burmese demonstrations fizzled only after a violent reaction from the Burmese government.

Recall also that Burma's "88 generation" had massive student demonstrations on 8/8/88, demonstrations that were brutally suppressed by the Burmese government at the time.

Tibet had similar mass demonstrations a few months later, with a similar bloodbath, in early March, 1989, a month before the Tiananmen Square massacre.

Since the 1989 Tibet demonstrations, China has been forcibly relocating large segments of the Tibet population, in order to weaken Tibetan culture. At the same time, China has relocated millions of Han families into Tibet, in order to dilute the Tibetan population. The Han form a market-dominant majority in Tibet, contrasted to the disadvantaged Tibetans. This is the surest way for China to have created a hate-filled fault line between Tibetans and Han, and that's why the rioters have been targeting Han businesses and properties. (This paragraph was added on March 16.)

Returning now to the present, it's quite possible that the Chinese will overreact in Tibet in the current demonstrations. But whether they overreact or not, it's too early along the generational timeline for the demonstrations to spiral into full-scale war between Tibetans and Han, and so the demonstrations won't last long.

Beijing may well overreact, for three different reasons:

Last October's Burmese uprising has almost completely disappeared from the world's news pages today.

The situation in Tibet should end exactly the same way -- disappearing from the news pages within a few weeks. If it ends differently, it will be because it triggers something in China, rather than in Tibet itself. This remains to be seen. (16-Mar-08) Permanent Link
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A Hippie Fashion Guide

For those who think that today's kids are not different from 1960s kids,

I stumbled across this Hippy Fashion Guide, from the 1967 book, The Hippy¹s Handbook by Ruth Bronsteen, while I was surfing:


Hippy Fashion Guide
Hippy Fashion Guide

Hippies started appearing in the early 1960s as part of the Awakening Era. The above was published in 1967, the year of the Summer of Love. (15-Mar-08) Permanent Link
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A historic day in Ben Bernanke's Great Historic Experiment

In its biggest move yet, the Fed bails out a collapsing Bear Stearns.

What's most important about Friday's events is investors' reactions to it. But first, let's start with a few details.


Intraday Dow Industrials chart and final results for Friday, March 14, 2008
Intraday Dow Industrials chart and final results for Friday, March 14, 2008

After a 9:15 am vote by the Fed Board of Governors on Friday, the Fed invoked a Great Depression law that permits the Fed to loan money to a non-bank in return for sufficient collateral, and last used only in the 1960s. By 9:35 am, the Fed had announced that it was loaning an unspecified amount to Bear Stearns, but since Bear isn't a bank, JP Morgan Chase would be used as a conduit.

(Bear Stearns is an "investment bank," not a "bank." Ironically, Bear would be qualified to borrow directly from the Fed under the new program announced on Tuesday, but that doesn't take effect until March 27. Because this situation was considered an emergency, an arrangement was made to perform the loan through JP Morgan.)

Bank bailouts are becoming increasingly necessary. Britain has had to nationalized the Northern Rock bank to keep it from failing, and many of Germany's public banks are near collapse, and are begin bailed out.

As I've described in "Ben Bernanke's Great Historic Experiment" and "Bernanke's historic experiment takes center stage," Bernanke believes that the 1930s Great Depression could have been avoided if the Fed had simply injected more liquidity into the financial system. Actually, I can't be sure that's what he believes any more, but he certainly USED to believe that.

Unfortunately, there's no way to reflate the huge, leaking credit and housing bubbles, no matter what the Fed does, as regular readers of this web site already know.

The Bear Stearns announcement sent shock waves through the investor community. The markets had moved up at the 9:30 am open, but quickly tumbled after the announcement.

Let's start taking a look at investor reaction, as reported on CNBC.


Alan Schwartz, Bear Stearns CEO, on Wednesday, saying that Bear Stearns was fine. <font face=Arial size=-2>(Source: BBC)</font>
Alan Schwartz, Bear Stearns CEO, on Wednesday, saying that Bear Stearns was fine. (Source: BBC)

The context was that Bear Stearns' CEO, Alan Schwartz, had appeared on CNBC two days earlier, responding to rumors that Bear was having a liquidity crisis. At that time, he said:

"We finished the year, and we reported that we had $17 billion of cash sitting at the parent company as a liquidity cushion. As the year has gone on, since year end, that liquidity cushion has been virtually unchanged, ... The markets have certainly gotten worse, but our liquidity position has not changed at all, our balance sheet has not weakened at all,"

Investors were in a good mood on Friday morning. A day earlier, Standard & Poors had issued a statement expressing the opinion that the writedown of CDOs by financial institutions was half over, meaning that there was light at the end of the tunnel. And early Friday morning, there had been a favorable inflation report.

After the breaking news about Bear, these two favorable events were wiped out of investors' minds.

In particular, the statement by the Bear CEO once again made it clear that Wall Street executives could not be trusted -- saying one thing on Wednesday, and turning out to be dead wrong on Friday.

The CNBC anchors were very discouraged, because they had been hoping for an "up" day on the markets. Here's what Mark Haynes said:

"One thing that really strikes me is the similarity between a whole bunch of markets here. People never dreamed that the decline in the dollar would go on as long as it has. They never dreamed that the decline in real estate would go on as long as it has. They never dreamed that the decline in financials would go on as long as it has. That's also contributing to the crisis atmosphere. ... Another thing, people never imagined that oil would continued to climb for as long as it has."

This is what has been frustrating investors. The expectation is enormous that the credit crunch will be over in a year, and that the market will "find a bottom" almost any day now. So whenever there's any good news, investors think, "Aha! This is it! I'd better buy now, to make some money on the way up."

But that never lasts more than a day or so, because something goes wrong, and as Haynes was saying, it's always something different each time.

A few minutes later, the CNBC pundit Ron Insana came on and said the following:

"I find this interesting. You were saying that nobody dreamed that we would be in this position over a period of time. I think some people as early as last June had nightmares about this scenario. They may not have had dreams about it, but if you go back as far as last February, when we had these first hint of troubles in subprime, then by June it became fairly apparent that what we thought was just a passing phase in the credit markets was something more permanent, something more ominous.

We had the subprime problem, we went immediately into a real estate recession, CDOs, SIVs, Muni bonds, credit default swaps, the dollar, financial firms, the big runup in commodities -- all was emblematic of systemic risk in the United States. And people would not acknowledge that. They gave a variety of different reasons for all this stuff happening, but when you have the amount of leverage, the amount of credit, the number of derivatives in exotic financials, that have been created in the last five years, that are imploding in value now, that still remain something bigger than most people know, and usually, as several people have said, result in trouble in one or more financial institutions."

This is a very interesting list, because Insana was basically showing Haynes just how oblivious he and other investors were. That's what this whole web site is all about -- the things I write about on this web site are perfectly obvious, but nobody wants to believe them, so they believe their fantasies, and are shocked when their fantasies don't come true.

I'd go farther back than Insana, though. It's been perfectly obvious since 2002 that we were headed for a major stock market panic and crash, for the reasons given in "How to compute the 'real value' of the stock market."

Ron Insana is much better than most of the pundits. On a scale of one to ten, most of the pundits are a 1, but Insana is at least a 5. He doesn't get a 10, however, because he didn't realize the danger years earlier, and also because of what he said next, when Haynes asked him, "What's the total - I mean, I've seen REALLY scary numbers thrown around about how much unregulated, questionably rated debt, in the TRILLIONS." (This is funny. Haynes has absolutely no idea what's going on at all.)

Insana responded with "scary" numbers that I've referred to on this web site several times:

"Let me put it in the aggregate globally. There's about 500 to 750 trillion dollars of credit derivatives -- this is the notional value, the face value [Mark Haynes saying "Oh, my God" in the background] -- of credit derivatives worldwide.

That compares to $50 trillion in global GDP. Now, people who defend derivative structures as not being as risky, because that notional value doesn't represent the value at risk -- pick whatever percentage you want of that $750 trillion, let's say it's ½ of 1% that could go bad. It's still $3¾ trillion, and that's on the low side, against $50 trillion in GDP. You're talking about 8% of global GDP in terms of a debt structure that could go bad. That would have serious implications - it already has -- for the global economy. This is playing itself out - people are describing this as a "whack-a-mole" environment - as soon as you get past one problem -- it's Carlyle the other day - now you've got Bear Stearns - and you've got counterparty risk - you've got all these other considerations...."

This phrase, "whack-a-mole" environment is a good one. It captures the concept of one problem after another that Haynes was referring to earlier.

(Incidentally, I just saw Gillian Tett of the Financial Times talking on the BBC. I've quoted her stuff quite often. She really knows what's going on, and isn't afraid to say it. On a scale of 1 to 10, she may be close to a 10. Contrast her with Grep Ip of the Wall Street Journal, and you really have a really smart woman and a really dumb man.)

What all of this does is relate to the analogy I've been using of the world financial system being a huge, bloated mansion, parts of which keep falling off into the ravine. Soon, the entire mansion will collapse and crash into the ravine. There's no way to stop this.

That's why it's so disappointing to hear what Insana said next:

"The Fed, eventually, having already done some dramatic things, I think, is going to have to be the buyer of last resort, and provide a permanent solution to this liquidity problem by buying bad debts from primary lenders and banks, and monetize this debt in such a way that the credit markets start functioning again. It's an extreme view, but if you know Ben Bernanke's thinking on this, and even Alan Greenspan's for that matter, the Fed's job, at the end of the day, is to prevent a catastrophe, and I think at this juncture, that's the only way they can do it."

If the Fed tries this, they may be able to keep the mansion together for a few more days or weeks, but it will only make things worse when the final crash comes. It's discouraging that Insana doesn't understand that.

But this shows how poor the level of understanding is among experts who are supposed to know what's going on.

Let's have one more quote from CNBC on Friday, to show further the attitudes of investors. It's a conversation between reporters David Faber and Bob Pisani. The subject of the conversation was: How could Bear Stearns say on Wednesday that everything was OK, and then be near-collapse on Friday morning?

"Faber: On Wednesday afternoon, they started to get a sense [of what was happening], but it was Thursday afternoon, after speaking with people who knew exactly what went on, that they really realized they had a problem. It happens that quickly. We've talked about that. It's a typical run on the bank, where people say, "We're done." And whether it was rooted in truth or not, it doesn't matter, it becomes a self-fulfilling prophecy.

Pisani: The worry down here [in the NY Stock Exchange] is -- what's going to prevent this from spreading to somebody else -- let's name another broker down there, name another bank, that this could potentially spread to, and you can see the whole .... The question is, when the rumor becomes reality, where do you stop it? At what point can you come out and sufficiently calm people's nerves?"

This is exactly the point. This new Bear Stearns debacle is, once again, reinforcing the idea that everyone on Wall Street is a liar.

And even if Bear's CEO Alan Schwartz WASN'T lying on Wednesday, and it just "happened" -- which would indicate a fairly severe panic among Bear's creditors -- then it's just as bad, because statements by Wall Street execs can't be trusted anyway. So, either way, anything can happen at any time, and no one can feel confident about anything.

Last Friday, when I quoted an analyst as saying that the bond market had become "utterly unhinged," I described the Fed's new program of liquidity injections as "desperation."

Since last Friday, the hedge fund firm Carlyle Capital Corp. has completely collapsed, and now Bear Stearns is close to collapse. This is a manifestation of the "utterly unhinged" bond market, and it shows that the Fed's policies are doing nothing at all.

In fact, things are clearly much worse today than they were a week ago. The Carlyle collapse came in slow motion. We said that by the "cockroach theory" -- there's never just one cockroach -- there would be other hedge fund collapses, and the Bear Stearns collapse occurred within a 24 hour period, amid signs of panic.

From the point of view of Generational Dynamics, it's very interesting to understand how investors' attitudes are evolving. There's no longer any "bad news is good news" hopefulness. There's a dread, an anxiety, because nothing is going right. A lot of ordinary investors have been the farm on stocks continuing to go up, and they're getting very panicky as stocks keep falling.

There are certain more hedge fund collapse to come. The UK investment banks may be even more vulnerable than American banks, according to a Telegraph article:

"Bear Stearns crisis could hit UK banks

Funding costs for British banks are expected to soar in the wake of Bear Stearns' near-collapse, worsening the credit crunch and potentially pushing up the cost of lending.

Credit spreads for UK banks widened yesterday, providing clear evidence that they are now judged to be higher risk.

Fears are also growing that some banks may have large exposures to Bear Stearns that could prove very costly.

There are further concerns that, as Bear is forced to unwind its positions, banks will have to revalue their assets - leading to more write-downs.

British lenders such as Alliance & Leicester and Bradford & Bingley are already struggling with high funding costs and the knock-on effect from Bear could lead to further liquidity problems, analysts said. A&L has already put the cost of the credit crunch on its funding at £150m."

And so, the coming stock market panic and crash might well be triggered from Europe, rather than America.

From the point of view of Generational Dynamics, the last generational panic and crash occurred in 1929, and we're now overdue for the next one. It might occur tomorrow, next week, next month, or next year.

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. (15-Mar-08) Permanent Link
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Los Angeles Tent City keeps growing, despite attempts to limit it

A Tent City for 20 people that was formed last summer in Ontario, California, just east of Los Angeles, has now grown to hundreds of residents, including families with children.


Tent City in Ontario, California, has grown to hundreds of homeless people. <font face=Arial size=-2>(Source: BBC)</font>
Tent City in Ontario, California, has grown to hundreds of homeless people. (Source: BBC)

"It just dumb-founded me to see how many people were out here with nowhere to live, and they have nothing and they're trying to get on their feet," said Linda Parker. "I thought I was as low as I could go, but they're showing me I can go lower by taking what we have left."

The residents are getting help from volunteers. A nearby church is providing food, and other necessities are being provided by relief agencies.

Ontario city officials are now taking steps to limit and reduce the size of the tent city. Specifically, they're going to require that anyone living there must have a connection to the city, such as having lived there before.


Homeless Tent City resident points out the home where he and his family used to live, before he lost his home to foreclosure. <font face=Arial size=-2>(Source: BBC)</font>
Homeless Tent City resident points out the home where he and his family used to live, before he lost his home to foreclosure. (Source: BBC)

On Thursday, the Mayor told a crowd of homeless providers and volunteers that those who have ties to Ontario may stay at the camp, but all others must leave by March 24.

Wristbands will be issued to those permitted to stay, so that they can be identified.

After the exodus of out-of-towners, perimeter fencing will go up, a food service area and fire pits will be created, and rules will be enforced.

The city will issue a maximum of 170 permits to the remaining local homeless adults, and the area will be subject to new rules, including no pets, no one under 18, assigned spaces and no entry from 10 p.m. to 6 a.m.

In a related story, hundreds of people in Boca Raton, Florida, mostly mothers with children, stood in line for up to eight hours, hoping to get a housing voucher application. When there weren't enough vouchers, the police tried to disperse the crowd, but the crowd surged forward. People fell down and some were trampled. Two people were arrested and six to eight people hospitalized for exhaustion.

These two stories are rare enough now, but with foreclosures surging across the country, they won't be rare much longer.

Cities and towns need to start planning for this problem in advance. For more information, see "Cities and towns need to start helping themselves." (14-Mar-08) Permanent Link
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NY Governor Elliot Spitzer: A Generation-Xer gets his comeuppance

Rarely has someone's fall from grace been met with so much glee.


A grim-faced Silda Spitzer stands by her man, Elliott Spitzer, as a prop at Monday's press conference. Spitzer's three daughters were not present.
A grim-faced Silda Spitzer stands by her man, Elliott Spitzer, as a prop at Monday's press conference. Spitzer's three daughters were not present.

Like so many of the stories on this web site, this is so incredible it wouldn't even make believable fiction.

And it's not like NY Governor Elliott Spitzer simply gave in to momentary lust, or just needed to see a prostitute because his wife wouldn't do what he wanted in bed. Sins of the flesh are understandable, sometimes even forgiveable.

According to the complaint (excerpts here, full PDF file here), Spitzer illegally laundered money through overseas shell corporations to obtain the services of prostitutes who charged several thousand dollars per hour(!!!). He was "Client #9" of an international prostitution ring that obtained beautiful girls for wealthy men. He paid for these girls' travel expenses from New York to Washington, which itself is a federal crime (transporting a female across state lines for sex). This has been going on for six years.

Spitzer's hypocrisy and recklessness is astounding. He was using the services of an international prostitution ring at the same time that, as Attorney General, he was prosecuting prostitution rings and sending people like himself to jail.

He set himself up as a paragon of virtue and justice, and used his tremendous power as AG as a tool of extortion to jail people who were committing lesser crimes than he was.

Here's an example of one person he targeted, which a WSJ editorial says demonstrates the extortionary tactics regularly used by Spitzer:

And so you have this superstar Attorney General, declaring himself to be morally superior to everyone, using extortionary methods to attack and destroy people who, in the end, he never even charges, while he's committing the same kinds of crimes he was prosecuting others for.

And the sheer arrogance of it all: The complaint makes it clear that the girls knew that they were having sex with the Governor of New York -- it HAD to leak out sooner or later. But in Spitzer's mind, he was immune.

This is the contempt for the system that we've seen in Generation-X in other areas, especially the financial system.

(Update: I've received several questions about whether Spitzer, born in 1959, is a Boomer or a Gen-Xer. I consider people born in 1958 or 1959 or later to be Gen-Xers, although other people, including Strauss and Howe, put the cutoff at 1961. So I consider Spitzer to be an Xer, but in order to calm the waters, I'll concede that a Boomer might also have done what Spitzer did.) (This paragraph was added on March 12.)

As I discussed in "The nihilism and self-destructiveness of Generation X," and "Reader comments on the Nihilism of Generation-X," this is a generation whose contempt for the world financial system has destroyed it, bringing us to the edge of a worldwide financial crisis.

If you doubt the generational explanation, then you have to come up with another explanation for how some version of securities fraud occurred in almost every financial investment firm in North America and Europe. The pervasiveness of this fraud cannot be explained in any other way than the contempt of an entire generation for anything that came before them, and a reckless willingness to destroy it.

That's exactly the Elliott Spitzer attitude. To him, the entire criminal justice system was set up by people in older generations, people much stupider than he is. He would be able to manipulate the system so that he could prosecute and destroy anyone he chooses, while at the same time he could commit crimes at will, and remain immune to prosecution.

As Gen-Xers are learning, and will learn much more, these attitudes backfire. The reckless destruction of any system set up by people who came before them amounts to self-destruction.

The WSJ editorial referenced above said the following:

"Eliot Spitzer's self-destructive inability to recognize any limit on his compulsions was never more evident than his staff's enlistment of the New York State Police in a campaign to discredit the state's Senate Majority Leader, Joseph Bruno. On any level, it was nuts. Somehow, Team Spitzer thought they could get by with it."

This phrase, "self-destructive inability to recognize any limit on his compulsions" describes many Gen-Xers in positions of power.

Boomers are just as much as fault as Gen-Xers, but for a different reason: Boomers let Gen-Xers commit fraud or perform other compulsive acts because the Boomers stood to gain as much from the Xers' acts as the Xer perpetrators. But there's a difference: Boomers are destructive only through inaction, while Gen-Xers are actively nihilistic, destructive, and self-destructive.

Gen-Xers ought to take serious note of Elliott Spitzer's comeuppance, because the worst retribution is yet to come. (12-Mar-08) Permanent Link
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Fed makes massive move to shore up mortgage market

Markets around the world surged 3-4%, following Tuesday's announcement by the Fed that it would loan up to $200 billion to investment banks that use mortgage-backed securities as collateral.

(Update: A web site reader points out that it's important to say that the Fed is providing $200 billion in Treasury bills, not $200 billion in cash, in exchange for mortgage-backed securities as collateral. This means that there's no addition of liquidity to the financial system, since the Fed is swapping asset for asset.) (This paragraph was added on March 13.)


Intraday Dow Industrials chart and final results for Tuesday, March 11, 2008
Intraday Dow Industrials chart and final results for Tuesday, March 11, 2008

The purpose of this move is to effect a rifle-shot target on the "credit crunch," which is thought to be blamed on forced writedowns of mortgage-backed CDOs. According to this reasoning, if the Fed can find a magic bullet that ends the forced writedowns, then the credit crunch will end, and the leaking credit and stock market bubbles will start reflating.

The announcement was made at 8:30 am ET on Tuesday, and European markets immediately responded. The Dow Industrials gained 384 points at the 9:30 am opening, the second largest opening gain in Wall Street history. By the time the market had closed, all three indexes had gained almost 4%.

Here are the remarks of some of pundits and analysts:

Well, what do you think? Is the euphoria justified? Is March 11, 2008, destined to go down in history? Is this the day that the world financial crisis finally melts away?

Anyone who's read this web site for more than a few days already knows that this is impossible. The massive credit bubble is deflating, and can't reflate. The world financial system is entering a deflationary spiral in which trillions of dollars in money will disappear as credit markets continue to retrench.

I've been constantly surprised by wide variety of desperate attempts that have been made to reflate the credit bubble.

Whether it's Citibank's mind-boggling Master-Liquidity Enhancement Conduit (M-LEC), or the bond insurers' fraudulent AAA ratings, or the Fed's increasingly dramatic liquidity-injection stalling maneuvers, all they do is distort the financial system even more, and make sure that the unavoidable crisis will be even worse.

It's almost like a vaudeville show -- each act has to be good, and each act has to top the act before it. How many more acts does the Fed have, before we reach the Grand Finale?

From the point of view of Generational Dynamics, the last generational panic and crash occurred in 1929, and we're now overdue for the next one. It might occur tomorrow, next week, next month, or next year.

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. (12-Mar-08) Permanent Link
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Malaysia government in crisis after 'Sons of the Soil' turn against their leader

Malaysia's stock market fell 10% on Monday on panic selling, reacting to the stunning strength shown by opposition parties in Saturday's elections.

Following 1969's ethnic violence involving Malaysia's three main ethnic groups -- the indigenous Muslim Malays, the Chinese, and the mostly Hindu Tamil Indians -- Malaysians got behind a single party, the National Front Coalition Party (also called Barisan Nasional or BN) that has won a 2/3 majority of the seats in Parliament in every election since then -- until Saturday's election.

Abdullah Ahmad Badawi, who has been Prime Minister since 2003, still theoretically holds enough seats to remain in power, but there is growing pressure on him to step down. If he does, then the future of his development projects is also in doubt. This fear caused foreign investors to pull out of Malaysian markets, leading to the panic selling.

Abdullah's Barisan Nasional (BN) coalition won a landslide victory in 2004, winning 199 of 219 seats -- a 91% majority. That election was characterized by the same kind of euphoria we saw in America following the 2006 Democratic party congressional victory, and that we're seeing now over Barack Obama. This kind of euphoria is a kind of generational manic-depressive disorder, and when the manic hopes aren't realized, there's often an angry reaction from the public, as happened in January, 2007.

In Abdullah's case, the economic gains that he promised in 2004 simply have not been realized. Abdullah himself is Malay, the indigenous ethnic group making up 60% of the population. It was considered important for him to win at least 67% of the seats because (a) the BN has won at least that much in every election since the 1969 race riots, and (b) it was necessary to prove that Abdullah was being supported by all three major ethnic groups, not just the Malays alone.

Instead, Abdullah got about 51% on Saturday, indicating that even the Malays are abandoning him, blaming him for the economy's poor performance since 2004.

Let's look at a brief history of Malaysia, and start with a current map:


Malaysia
Malaysia

Different portions of Southeast Asia have been colonies of the Portuguese, the Dutch the Spanish and the British since the 1600s, but by the 1900s, Malaya (as it was then known) became a British protectorate. Malaya's last crisis war was WW II, when the Japanese attacked and defeated the British in Malaya and Singapore, occupying them until the end of the war.

Malaysia is in two parts: The Peninsular portion, extending down from Thailand, and the Borneo territories, on the northern part of the island of Borneo, with Indonesia occupying the southern portion. The capital city is Kuala Lumpur.

Singapore, the island city-state at the southern point of the Peninsula, was once part of Malaysia, but was expelled in 1965 because of agitation by its majority Chinese population.

As you look at the above map, note the "South China Sea" label. That entire region, and all the islands therein, are being claimed by Beijing as territory belonging to China, as we discussed in "China continues massive military expansion / announces 18% budget increases."

The history of the three major ethnic groups is as follows:

The Saturday elections are being described as a "political tsunami," recalling the real tsunami that struck Southeast Asia in 2005. The 1969 race riots fizzled fairly quickly, since Malaysia was in a generational Awakening era; if race riots begin today, then they may very well spiral out of control. So far, however, everyone is behaving, and there are no major signs of violence. A lot will depend on whether the euphoria of Saturday's election turns to anger and vengeance and, if so, where the desire for vengeance is directed. (11-Mar-08) Permanent Link
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First quarter corporate earnings growth estimates start falling

It's time to place your bets, ladies and gentlemen: where will it end up?

Recall that we've been following the official analyst estimates of fourth quarter corporate earnings. The last time that we looked at them, a few days ago, they were at -25.2% -- that is, 25.2% lower than last year. At the beginning of the quarter (on October 1), the experts had estimated that they would GROW by 11.5%, but we watched these estimates fall, week after week after week.

Well, now we're ready to start following the earnings growth estimates for the first quarter of 2008.


Quarterly S&P 500 earnings growth, 2000-present, with estimates for Q4 and for 2008 -- as of October 23, 2007.
Quarterly S&P 500 earnings growth, 2000-present, with estimates for Q4 and for 2008 -- as of October 23, 2007.

Let's begin with the adjoining graph, that I originally posted last year on October 23.

At that time, the asset writedowns were just starting. Analysts had predicted double-digit earnings growth for the 3rd quarter, but by October 23 it was clear that earnings growth was going to fall sharply.

Asset writedowns -- the kind that we've been hearing over and over again -- were just beginning, and they were bring earnings down. Bubbly financial analysts were saying that the third quarter would be a "kitchen sink" quarter. What they meant is that financial institutions would pack all their writedowns and any other losses into the third quarter report, so that they could go back to double-digit earnings growth in the fourth quarter.

As you can see from the above graph, that's what they were expecting. The graph shows that earnings growth for the 4th and 1st quarters were estimated at that time to be around 10%.

And so, we start from there: The 1st quarter earnings estimate as of October 23 was 10%.

And now, the CNBC earnings central page has change from 4Q earnings to 1Q earnings. Here's summary from Friday, March 7, from CNBC Earnings Central:

"As of Friday, March 7th: ...

The blended earnings growth rate for the S&P 500 in first-quarter 2008, combining actual numbers for companies that have reported, and estimates for companies yet to report, fell to -4.3% from -1.1%, due in part to downward estimate revisions from Citigroup and AIG.

On January 1st, the estimated growth rate for Q1 was 5.7%. (Data provided by Thomson Financial)"

This summary provides us with three different numbers, the estimates as of January 1, the estimates as of a week ago, and the estimates as of Friday. We can put this into a table:

  Date    1Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct 23:             +10.0%
  Jan  1:              +5.7%
  Feb  6:              +2.6%
  Feb 29:              -1.1%
  Mar  7:              -4.3%

So what do you think, Dear Reader? Do you think it will stabilize at around -4 or -5%? Or do you think it will fall to -25.5% like last quarter? Or maybe even lower? Ya places yer bets and ya takes yer chances.

Analysts are still fantasizing that earnings growth will return to double-digit values. However, earnings have been growing much faster than average for the last 12 years, and so by the Law of Mean Reversion, their growth will have to be equally below average for roughly the next 12 years.

Now here's something interesting.

There's a price/earnings ratio chart at the bottom of this web site's home page, and it gets updated automatically every Friday. Here's the March 7 version of the chart:


S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 7-Mar-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 7-Mar-2008. (Source: MarketGauge ® by DataView, LLC)

The top part of the above chart provides the P/E ratio, and the bottom part of the chart provides the S&P 500-stock Index.

Now, notice the following:

When you put these two facts together, what you see is that investors are following a formula: They're buying or selling based entirely on earnings, keeping the P/E ratio at 18. Putting it another way: The P/E ratio is remaining constant; therefore, P goes up when E goes up, and P goes down when E goes down.

And so, when you look at it that way, the S&P graph is actually the same as the graph for corporate earnings, when the scale is adjusted.

Well, I think this is a remarkable fact, and it's even obvious, but you never hear anyone talk about it.

Nor does anyone talk about the fact that earnings evidently are continuing to fall, and this means that the stock market is going to continue falling.

The Law of Mean Reversion applies to earnings, as we've said, and indicates that earnings are going to remain below average for many years.

But the same Law of Mean Reversion also applies to the P/E ratio index, and I explained in "How to compute the 'real value' of the stock market."

During the bubble days, we had a double-bubble: bubble earnings combined with bubble P/E ratios. Now we have a double-trouble bubble-bursting. Earnings are falling, but P/E ratios are also going to fall sharply, probably to the 0-5 range. This portends a 90% stock market collapse (same as 1929-33) to the Dow 1500 range.

It remains a puzzle when all of this is going to happen. I've given up trying to estimate a date, Now I just use a kind of "safe harbor" by saying that 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.

Having established this safe harbor, it still remains a subject of endless fascination to try to at least guess what the triggering event will be for this generational panic and crash, the first since 1929. It's folly to try to predict any chaotic event (in the sense of Chaos Theory), but it's irresistible. And don't we all occasionally do some things that are folly but irresistible?

What I've been particularly watching for, as I've said a number of times, the thing that triggered the 1929 crash: A domino effect, where market losses lead to margin calls, which lead to forced selling of stocks to get cash to meet the margin calls, which causes more market losses, in a vicious circle.

As I described in the article I posted yesterday, there appears to be something different happening this time: This vicious circle is already occurring in the bond market, a result of the "credit crunch" that began last August. With Wall Street markets now at 73 week lows, with markets in Asia and Europe also falling sharply, we may be very close to a stock market panic and crash. But the underlying driving force appears, at this time, to be a slow-motion panic, already in progress, in the "utterly unhinged" bond market.

The Wall Street Journal has posted an article headlined, "March may be quite cruel," which indicates that this bond market panic is going to get a lot worse in March:

"Some ailing companies are bracing for their own March madness.

It is the time of year when companies, as some deal makers say, "open the kimono," revealing to lenders year-end audits, budget projections or income-statement forecasts. These often give lenders an early glimpse of trouble ahead, a warning that a loan agreement could be violated or that a borrower will need more credit.

This year's meetings are likely to be a lot more tense than in recent years, bankers say. Credit and patience are in short supply, as banks try to husband capital and jettison underperforming loans.

"We are hearing from lenders who are wondering how much they should push a reluctant client to restructure. They are asking, 'Should I push to liquidate it now so I lose X, because if I wait six months I might lose 2X,'" said Vince Lambiase, managing director with Michigan-based restructuring firm BBK.

In the past week, jumbo-mortgage lender Thornburg Mortgage Inc. of New Mexico was pushed to the brink of a bankruptcy filing after lenders demanded $270 million in margin calls. Margin calls force borrowers to repay loans or put up more collateral to secure them.

Likewise, a growing number of lenders will this month push borrowers to choose among several painful options -- such as seeking a bidder to buy all or some of the company, undertaking a massive restructuring or finding an investor to inject more capital. If those choices don't work, that could mean new bankruptcy filings.

Sometimes called line-renewal season, March marks more than the start of college basketball's frantic championship tournament. It is the third-busiest month for corporate-bankruptcy filings over the past 16 years, according to research firm BankruptcyData.com. December and January rank higher. ...

The tightening of credit by once-patient lenders is why Standard & Poor's and Moody's Investors Service have projected corporate defaults to grow fivefold or more from the record lows of 2007.

Moody's on Tuesday estimated about $48 billion in speculative-grade corporate bank loans will mature between now and 2010, the majority of that next year and the year after. Moody's predicts corporate default rates to jump to 5.3% in 2008, up from less than 1% in 2007."

This analysis indicates that the "credit crunch" anxieties are going to get much worse during March -- as has already been the case so far in March anyway. Perhaps my 3% estimate should be increased to 4%, 5% or 6% for each of the remaining weeks of March. Referring back to my description in the the article where I described the 3% estimate, at 6%, that would equal the probability of tossing four coins in the air simultaneously, and having all four coins come up heads.

In any event, the important concept is that this bubble-leaking process is not reversible. This is a "wasting process," meaning that it's gradually destroying what's left of the world financial system. People who hope that some "bottom" will be reached, the bubble will start reflating, and the health of the world financial system will be instantly restored are dreaming.

I've used an analogy of a bloated mansion several times in the past. 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."

A web site reader has commented on this analogy with respect to a technical argument having to do with yield curve steepening (which occurs when long-term interest rates grow while short-term interest rates decrease):

"I see a psychological dynamic now that is similar to what you are seeing where analysts and investors are trying to find reasons that "this isn't really happening." An example of another theory out there is that the yield curve is steepening and there will be "balance sheet repair" going on from here on out.

It reminds me of your mansion analogy, except for the belief that the outcome will be a brand new mansion that cannot possibly collapse. What they don't understand is that, if we use the mansion analogy, this "balance sheet repair" is being accomplished by pilfering material from other rooms in the mansion to remodel one room and that the whole mansion will collapse into the ravine anyway."

Of course there WILL be a brand new mansion -- but not right away. When the bloated mansion collapsed in 1929, it took almost 25 years to rebuild that mansion and create a shiny, brand new world financial system. That financial system was made up of many new and important innovations -- new public averseness to abusing credit, new regulations like Glass-Steagall Act, new agencies like the Securities and Exchange Commission (SEC), even new worldwide organizations like the Bank of International Settlements, the World Bank and the International Monetary Fund.

But all the advantages of these major innovations have been wiped away by generational changes. Young generations, born after World War II, have no averseness to abusing credit; 1930s regulations have been either ignored or repealed; the SEC has totally failed in its primary function of preventing a new 1920s-like bubble; and world organizations like the World Bank and IMF are mired in scandal and bureaucracy.

We can look back 15 years and ask, "How is America different today than it was in 1993?" We can point to many differences, but those are minor compared to the major continuities that have continued during that period.

Today we're facing major discontinuities -- a devastating worldwide financial crisis, causing massive poverty, unemployment, starvation and homelessness, and a devastating new world war that will kill 2-3 billion of the 6.5 billion in the world's population today. Looking 15 years ahead from now, the world in 2023 will be a completely different place with almost no resemblance at all to the world of 2008. (9-Mar-08) Permanent Link
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Fed expands liquidity injections as bond market becomes "utterly unhinged"

With foreclosures surging and jobs disappearing, anxiety is increasing.


Intraday Dow Industrials chart and final results for Friday, March 7, 2008
Intraday Dow Industrials chart and final results for Friday, March 7, 2008

Stock markets around the world plummeted on Friday, with Wall Street falling to 52 week lows (actually, 73 weeks for the Dow Industrials), as the leaking credit and housing bubbles generated several new rounds of bad news:

In mid-December, the Fed and several international central banks announced a plan to end the "credit crunch." Central banks around the world announced a new "Term Auction Facility (TAF)" program that would allow banks to use whatever securities they have in their porfolios as collateral to bid for dollars at low interest rates.

On Friday, the TAF program substantially expanded. The intent is to permit banks to obtain enough cash so that they would be willing to lend money out again, bringing interest rates down.

The original TAF program worked pretty well for a while, reducing the impact of the credit crunch for the holiday season and year-end closing, but obviously it didn't work for much longer, since interest rates are back up again. This TAF expansion looks like a move of desperation, and it remains to be seen whether it helps the situation at all.

The fear is that banks will take advantage of the expanded TAF to obtain additional cash, but they'll hoard it, just as they've been hoarding the other cash they have available. Why? Because they have no idea how much their assets are worth, since asset-backed securities like CDOs have continued melting down. And because they have no confidence that if they lend to someone else, they'll be able to get their money back. And because they may have to repay loans of their own.

Remember that even money market funds are being frozen these days, often unbeknowst to the investors until they actually try to extract money, because the auctions used for auction rate securities are failing. So banks are holding on to every cent possible.

Margin calls and forced selling

There's a problem that's been going on for a few months now, and has been getting much worse recently, so it's worth describing.

In 1929, the crash occurred because of forced selling of stocks by investors who needed to meet margin calls. That is, brokers loaned money to investors to purchase stocks, using the purchased stocks as collateral for the loans. Once the market fell about 20% from its peak, brokers were making margin calls, meaning that investors had to come up with cash to pay off the loans, and the only way they could do that is to sell off their stocks. As each day's sales pushed the stock market lower, more stocks had to be sold to meet margin calls, leading to extremely heavy sell volume and a stock market crash.

This time, as of Friday, the market closed 17% down from its peak on October 9, but there haven't been any news stories of forced selling of stocks (although that may happen at any time).

Instead, we're seeing story after story of forced selling of bonds and securities.

Let's take a look at one particular example, the hedge fund firm Carlyle Capital Corp., which has missed several margin calls this week. Here are some excerpts from the story:

"Carlyle Fund Gets Default Notice After Margin Calls

March 6 (Bloomberg) -- Carlyle Group's publicly traded mortgage bond fund failed to pay margin calls, prompting creditors to seek immediate repayment, as the burning subprime mortgage market scorches investors in even the highest-rated debt. The stock fell 58 percent.

Carlyle Capital Corp. missed four of seven margin calls yesterday totaling more than $37 million, the Amsterdam-listed fund said today in a statement. The company expects to get at least one more notice of default related to the margin calls.

Started by David Rubenstein in 1987, Carlyle expanded its mortgage investments last year, selling $300 million of shares in Carlyle Capital. The fund used loans to buy about $22 billion of AAA rated mortgage debt issued by Fannie Mae and Freddie Mac, securities that Carlyle says have the ``implied guarantee'' of the U.S. government. Even those bonds have slumped, leading to the failure of hedge funds led by Peloton Partners LLP.

``The credit crisis is spilling over to the next asset class, agency bonds,'' said Philip Gisdakis, senior credit strategist at UniCredit SpA in Munich. ``There's never just one cockroach. If you see one highly leveraged hedge fund going bust, then there's another on the way.''"

Let's take a look at what's been going on in this case.

Now, this problem didn't just start last week. It started in August with the nightmare credit crunch that has been driving events. Let's take a look at a couple more paragraphs from the story:

"The Carlyle fund sold $900 million of assets in August and received a $100 million loan facility from parent Carlyle Group. Since then, Carlyle Capital has sold almost $1 billion of non- residential mortgage-backed securities to cut debt and also received a $150 million credit line from Carlyle Group. It didn't say how much of that credit line it had used.

Carlyle said in today's statement that margin prices requested for securities weren't ``representative of the underlying recoverable value'' of the notes. ``Unfortunately, this disconnect has created instability and variability in our repo financing arrangements,'' [Carlyle fund CEO John] Stomber said."

So the Carlyle fund has been pretty desperate since August, and has been trying to get hold of cash any way it can, in order to meet margin calls.


Index prices of high-quality ABX-HE-AAA- 07-2 credit derivatives and lower-quality ABX-HE-A 07-2 credit derivatives from Sept 4, 2007, to March 7, 2008 <font face=Arial size=-2>(Source: Markit.com)</font>
Index prices of high-quality ABX-HE-AAA- 07-2 credit derivatives and lower-quality ABX-HE-A 07-2 credit derivatives from Sept 4, 2007, to March 7, 2008 (Source: Markit.com)

You're seeing the meaning of "leverage." When you use $300 million to purchase $22 billion in securities, then you stand to make astronomical amounts of money if the value of the securities goes up. But -- and this is the big but -- if the value of the securities goes down, then you lose astronomical amounts of money.

But what about the last paragraph in the quote above -- where Stomber is whining that the margin call was unfair because the assumed values of the securities weren't "representative of [their] underlying recoverable value." How do you determine today's value those securities that Carlyle purchased for $22 billion?

Actually, I'm not sure exactly what index is being used to valuate those securities, but it's probably the ABX index, which measures the values of mortgage derivatives, or something like it. We used to write about the ABX index all the time, when it was the new and fashionable thing to do. But the ABX index is really old news now. But even though it's gone off the radar screen, it's still been out there -- falling and falling and falling, as you can see from the above graph.

And when this index falls, then the valuation of the mortgage derivatives in people's portfolios also falls an equivalent amount.

Notice that this is quite different from stocks. If you have stocks in your portfolio, then it's easy to get a current valuation for them -- just look at their current share prices on the stock exchange.

But these mortgage derivatives that Carlyle invested in have no stock market. Carlyle has to find a "mark to market" value for them, and the only way to get a market value for them is to use an index like ABX which, itself, is based on estimates provided by other financial institutions. So Stomber is complaining that the ABX index (or whatever index he's using) is being unfairly computed. Well, that's the only thing he CAN say, isn't it?

The securities that Carlyle had invested in are not stocks (obviously). They are credit derivatives known as "credit default swaps (CDSs)." These are insurance policies that someone might buy if they're afraid that some company might go bankrupt and default on its debt bonds. But what's really weird and bizarre is that the CDSs themselves become securities that can be bought and sold.

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

There are some $750 trillion in credit derivatives in portfolios around the world, of which some $50-100 trillion are CDSs.

These CDSs are now falling in value, and have been doing so ever since the the credit crunch began in August. Since many of these financial firms obtained these CDSs on margin, they've been facing margin calls. They have to come up with cash to meet the margin calls, and often they have to sell off the CDSs at fire sale prices to get the necessary cash. This pushes the ABX and other indexes down, causing more losses and more margin calls and more forced selling.

Collapsing credit default swaps (CDSs)

The above example involved mortgage-backed securities, and we all know that anything involving the housing market these days is suspect.

But the problem is not "contained" to the mortgage market. It's spread all over the place, including to commercial debt. This is what we've previously described as the "subprime virus," spreading from place to place, including corporate bonds.

In an article entitled "Credit Swaps Thwart Fed's Ease as Debt Costs Surge," the writer describes how even the strongest corporations are being hit by the subprime virus, thanks to the collapse of CDSs. General Electric Co. (GE), one of the strongest corporations in America, has to pay $17 million dollars more on its debt than a year ago.

The article gives all the details, which you can read there if you want. Here we'll just give a few highlights.

And so we have a few hedge funds in trouble, and we have some corporate debt in trouble, and we have many money market funds with frozen funds, without the investors even knowing it.

Then there's the "cockroach theory," as quoted by one financial analyst in the story above: "There's never just one cockroach. If you see one highly leveraged hedge fund going bust, then there's another on the way." That's how the domino effect works, and that's how the vicious deflationary spiral works.

The point I'm making is this: This cycle of "losses -> margin calls -> forced selling -> losses -> margin calls -> forced selling ..." occurred with stocks in the 1929 crash. So far we haven't seen it with stocks.

But we HAVE seen it with CDSs. And we're seeing it more and more, as the tens of trillions of dollars of these continue to unravel.

And so it's possible that the initial panic that we'll see won't be a stock market crash, but a bond market crash or, more specifically, a CDS "market" panic and crash. In fact, that panic may already be in progress, but without a public market like the NY Stock Exchange, it might happen in slow motion.

However, that's a distinction without a difference, because a stock market crash would immediately follow any significant panic in CDSs. Furthermore, with the Dow Industrials at 52 weeks lows (17% below their highs), a stock market panic might begin soon anyway.

Capitulation

The magic word that I always hear on CNBC is "capitulation." A typical conversation on CNBC might be where one pundit or journalist or analyst says to another, "That looks like capitulation!" "Wow, is it really capituation?" "Yes, it might be, but we can't be sure yet." "Wow. Well, if it is, then the stock market will start going up again."

I'm not entirely certain what "capitulation" is supposed to mean. It's something like this: The market is generally going down (a bear market), but it will reach bottom when everybody capitulates (gives up) and decides that it's never going to go up again. That's when it goes up again.

If you're like me, then you couldn't read the above paragraph without laughing, just as I couldn't write it without laughing, but that's the fantasy world that these people on CNBC live in.

At any rate, regular readers of this web site know that this "capitulation" concept is impossible, since it would mean reflating the housing and credit bubbles.

After the 1929 crash, the market didn't start rising again until 1933, so I suppose we can call that "capitulation." At any rate, it took four years then, and it's a long way off today.

Financial analysts, pundits and journalists are saying, with great authority, that no matter what happens now, things will be back to normal in a year or so. The rationale is that the only people who are really being hurt are those who have made leveraged buys and are facing forced selling to meet margin calls. According to this reasoning, if you can make non-leveraged buys of stocks and securities and just hold on to them, then you'll be ok in a year or so. Apparently there are still quite a few investors doing that.

John Kenneth Galbraith's 1954 book The Great Crash - 1929, contrasted the 1929 with previous panics:

"A common feature of all these earlier troubles [previous panics] was that having happened they were over. The worst was reasonably recognizable as such. The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune." (p. 108)

Galbraith shows what happened after the initial crash on October 24, 1929: "In the first week the slaughter had been of the innocents," in the second week it was "the well-to-do and the wealthy" who were slaughtered (p. 113), and then more and more people were sucked into ruin during the years that followed.

"The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost. The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. ... The bargains then suffered a ruinous fall. Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or fourth of the purchase price in the next twenty-four months. ... The ruthlessness of [the stock market was] remarkable." (p. 109)

Many times, I've used the phrase "Principle of Maximum Ruin" to refer to Galbraith's observation that the 1929 crash was "ingeniously designed" to ruin the maximum number of people to the maximum extent possible.

At the time that I made up that phrase, I really didn't completely understand how it would pan out. It's really incredible to see the Principle of Maximum Ruin in action. I can't stop shaking my head in astonishment. (8-Mar-08) Permanent Link
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China continues massive military expansion as it announces 18% military budget increases

This comes as a new Pentagon report documents China's military buildup.

China has been announcing double-digit military budget increases since the 1990s, and now has announced another one, with a surge of nearly 18% in increased funding for 2008.


China's announced military spending versus Pentagon's low and high actual estimates <font face=Arial size=-2>(Source: BBC)</font>
China's announced military spending versus Pentagon's low and high actual estimates (Source: BBC)

Even so, Chinese secrecy is so great that US government officials believe that their military budget is substantially higher than announced, as shown on the adjoining graph.

The increase was announced just a day after the Pentagon released its 2008 Annual Report on Military Power of China. The report documents China's development of new weaponry, including leading edge high-tech weaponry, and criticizes China for a "lack of transparency" in explaining its strategy in such aggressive military development.

In such circumstances, China always exhibits what might in America be called Boomer paranoia. In the all-too-scrutable Chinese way of thinking, it's OK to keep threatening war over Taiwan and to budget huge military increases, but you're a warmonger if you say that "China is threatening war over Taiwan and budgeting huge military increases.

Here are the comments of the Chinese Foreign Ministry on the Pentagon report:

"Stirring up the so-called "Chinese military threat", the Annual Report on China's Military Power(2008) issued by the US Department of Defence is a severe distortion of facts, an interference in China's internal affairs, and a violation of norms governing international relations. China is resolutely against this report, and has made solemn representations to the US. China has been unswervingly following the path of peaceful development and adopting a national defence policy which is defensive in nature. China remains to be a staunch force for peace and stability in Asia-Pacific and the world at large, instead of a threat to any countries. We urge the US to give up the Cold War mentality and have a correct understanding of China and China's development, reverse its erroneous act of issuing such reports, and take concrete actions to contribute to our mutual trust and constructive cooperation. We request the US to honor its commitment to abiding by the One China policy, the three China-US Joint Communiques, and opposing Taiwan independence. The US should stop selling Taiwan weapons, cut its military ties with the latter, refrain from sending erroneous messages to Taiwan separatist forces and work with China to safeguard peace and stability across the Taiwan Strait as well as the overall interest of bilateral relations.

As for the issue of hacking, China's position is very clear. China follows a path of peaceful development, and unswervingly adopts a national defence policy which is defensive in nature. China would never do anything to harm sovereignty or security of other countries. We are strongly dissatisfied with the groundless accusation from the US. As a matter of fact, cyber crime is a common challenge facing all countries in the world. China also falls victim to hacking. We would like to work with other countries to jointly respond to this issue. We demand the US side to present compelling evidence for its accusation so that we can carry out cooperation in this regard."

In response to a follow-up question on whether China pays civilians to hack American computers, he said, "I can assure you responsibly that the Chinese Government never does such kind of thing."

The above is really an incredibly paranoid statement, and though it was given in response to a question at a press conference, it's a prepared statement representing official China policy.

If you want to read an even more incredible statement, look at the truly hysterical statements by the Foreign Ministry a year ago.

To me, this is really incredibly ominous. It's an exhibition of paranoia that's so extreme, it could take any form whatsoever -- including total panic and launching a pre-emptive war to recapture Taiwan.

At times like this, I'm reminded of Friedrich Nietzsche, the German philosopher, who lived through the Franco-Prussian war and the extremely bloody Paris Commune civil war in 1871, and saw incredible craziness and said, "Insanity in individuals is something rare - but in groups, parties, nations and epochs, it is the rule." In the case of China, you have 1.5 billion people exhibiting paranoid insanity, and it doesn't bode well for the world.

Earlier this week, on Tuesday, President Jintao Hu made the statement that the "Taiwan independence" activities have become "the biggest menace to national sovereignty and territorial integrity, the biggest obstacle to the development of cross-Strait relations, and the biggest threat to peace and stability in the Taiwan Straits."

There will be a Presidential election on Taiwan on March 22 and, at the same time, there will be a referendum on whether Taiwan wants to join the United Nations as a separate entity from China. Beijing bitterly opposes any such more in the U.N. but, more than that, they even oppose allowing such a referendum in Taiwan. There's no telling how Beijing will react if the referendum vote is "Yes."

Still, this paranoia is actually a reduction from the norm. The Chinese have actually been toning down the rhetoric lately, as they prepare for their big sweet 16 coming out party, the summer Olympic games in Beijing. My expectation is that the rhetoric is going to get much more hostile once the Olympic games are over.

Here are some excerpts from the Pentagon report, and some comments:

We noted earlier in this article that China's extreme paranoia could lead it to panic and launch pre-emptive war for not reason at all.

The Pentagon report supports this view as follows:

"Potential for Miscalculation

As PLA modernization progresses, three misperceptions could lead to miscalculation or crisis. First, other countries could underestimate the extent to which PLA forces have improved. Second, China’s leaders could overestimate the proficiency of their forces by assuming new systems are fully operational, adeptly operated, adequately maintained, and well integrated with existing or other new capabilities. Third, China’s leaders may underestimate the effects of their decisions on the security perceptions and responses of other regional actors."

This shows how dangerous the situation is, and how war with China could begin at any time.

People are always telling me that we would never bother to go to war with China over Taiwan. One person even sent me a poll that showed that the American people really don't care about Taiwan.

This shouldn't be a surprise, since most Americans these days probably couldn't find China on a map, let alone Taiwan.

Nonetheless, we could be at war with China over Taiwan at any time. Young people in Taiwan increasingly want independence from China, and the old generations that remember life on the Chinese mainland are mostly dead and gone now. Taiwan could do something on any day that would be seen as a move toward independence by the paranoid officials in Beijing. They would then launch a pre-emptive war on Taiwan.

Would the U.S. go to war to defend Taiwan? There is no question about it. It would not be put to a vote of the American people. It would not be put to a vote in Congress. The confrontation would begin within hours, and the war would be on before most Americans even learned how to spell "Taiwan." (6-Mar-08) Permanent Link
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Regulators attempt to formulate new laws to prevent the subprime crisis.

This is truly closing the barn door after the horses have escaped.

The nominal reasons for implementing new regulations is to prevent anything like the "subprime mortgage crisis" from ever occurring again.

Examples of some of the new regulations being proposed are as follows:

What makes these so laughable is that many of these kinds of regulations were put in place in the 1930s by the survivors of the crash of 1929 and the Great Depression. Those people were determined that credit would never be abused again, the way it had been in the 1920s. So they created new agencies, like the SEC (Securities and Exchange Commission), to prevent anything like the 1920s stock market bubble from occurring again. And they created new laws, like the Glass-Steagall Act of 1933, that mandated two different kinds of banks: Investment banks that could issue securities, and commercial banks that could lend money. (Savings banks that offered homeowner mortgages were another category.)

Well, the stock market bubble of the late 1990s was just as bad as the 1920s bubble, and so the SEC has already completely failed in its primary responsibility. And the Glass-Steagall Act was repealed in 1999, allowing any bank to do any damn thing it pleases, giving rise to the incredible abuses that we've been seeing.

Well, you know how people think. These are "old people's laws." These laws are for people who drive Model T Fords, or who use phrases like "back in ought-five." They aren't for today's ultra-modern world where we know so much more and carry iPods.

The third set of proposed regulations described above are to require banks to make CDOs easy to understand.


Warren Buffett being interviewed by CNBC anchor Becky Quick <font face=Arial size=-2>(Source: CNBC)</font>
Warren Buffett being interviewed by CNBC anchor Becky Quick (Source: CNBC)

On Monday morning, Warren Buffett was interviewed on CNBC. Buffett was born in 1930, and so he remembers the horrors of the Great Depression from his childhood. Several years ago, he referred to credit derivatives as "weapons of mass financial destruction."

He was asked on Monday morning about derivatives. Here's what he said, according to CNBC's transcript:

QUICK: But we're going to start off with a question about derivatives, because Joe, you brought this up earlier. You were talking about those comments that Mr. Buffett's made in the past about these being weapons of financial mass destruction. And Warren, you said you had a couple other thoughts on derivatives.

BUFFETT: Well, you know, the ways you get into trouble in markets is doing things you don't understand, and then doing them with a lot of borrowed money. And derivatives combine those things. And--but the really important illustration that has never gotten picked up on much was that a couple of years ago Freddie and Fannie got into big trouble, billions and billions and billions of dollars of--that they had to restate. Now, Freddie and Fannie had auditors like everybody else, but they also had a government agency called OFHEO that had 200 people in it whose sole job was to oversee Freddie and Fannie. Two hundred people going to work every day, and those people did not pick up at all on all of these problems that Freddie and Fannie had. I mean, they were looking at complex financial instruments, you know, all kinds of swaptions and all that sort of thing. The auditors didn't pick up on it, but more important, 200 full-time--they didn't have to think about General Motors, they didn't have to think about AT&T. They had two companies to think about. And they issued a report later on telling about the failing of all--everybody else.

QUICK: Mm-hmm.

BUFFETT: But it shows you--when things get that complex, you're going to have a lot of problems. And CDO squared--I figured out, on a CDO squared you had to read 750,000 pages to understand the instruments that were underneath it.

QUICK: Oh, my gosh.

BUFFETT: Yeah. Well, you start with the RMB, that's the residential mortgage-backed securities, and that would have [50] tranches. And then you'd take--and that would be a 300-page document--you'd take a tranche from each one of that and create a CDO, 50 of those times three--300, you know, it becomes 15,000. Then you take a CDO squared with 50 more, and now you're up to 750,000 pages.

QUICK: You have to read through it.

BUFFETT: And the mind can't comprehend that. What people did comprehend was that the fees were terrific in selling them to the people.

For those who believe that Buffett is exaggerating, he certainly is not. Take a look at my article, "A primer on financial engineering and structured finance," and go through the math again, and understand that instead of a couple of tranches there can be up to 50 tranches.

Nothing illustrates the power of generational change than this attempt to use regulations to prevent another subprime crisis. These regulations are worthless because when the time comes for such regulations to work, the new generations of people will simply ignore them.

This is part of the cycle of generational crashes.

If you go back through history, there are many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash.

These are called "generational crashes" because they occur every 70-80 years, just as the generation of people who lived through the last one have all disappeared, and the younger generations have resumed the same dangerous credit securitization practices that led to the previous generational crash. After each of these generational crashes, the survivors impose new rules or laws to make sure that it never happens again. As soon as those survivors are dead, the new generations ignore the rules, thinking that they're just for "old people," and a new generational crash occurs.

We're now overdue for the next generational crash, and it might occur tomorrow, next week, next month, or next year.

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. (4-Mar-08) Permanent Link
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Your money market funds may be frozen without you knowing it

Many people don't know that they've invested in auction-rate securities.

According to a report on CNBC on Monday morning, many people have invested in auction-rate securities (ARSs) without even realizing it.

In my new analysis article, "Cities and towns need to start helping themselves," I describe how the abusive use of ARSs has been one of the factors in the continuing collapse of the municipal bond market. (Read this article if you're interested in how you can help your city or town avoid the worst.)

In "Wealthy investors in auction rate securities can't get their money out," I described how wealthy sophisticated investors in these ARSs are now unable to get their money out in order to pay their tax bills and other obligations.

But now it turns out that ordinary investors in money market funds may have their money frozen -- and they may not even know it, since nobody's telling them anything until they try to make a withdrawal.

This is according to James Stewart, SmartMoney's editor at large, being interviewed on CNBC on Monday morning. Stewart was shocked to discover last week that his own money, in a Merrill Lynch fund, is now frozen. Here's what he said (my transcription):

"These were sold as a money market equivalent. ... They were sold as ready cash -- something that was always liquid - you could get your money out very easily.


James Stewart, SmartMoney's editor at large <font face=Arial size=-2>(Source: CNBC)</font>
James Stewart, SmartMoney's editor at large (Source: CNBC)

In return you got a low interest rate, but it was better than pure cash.

And so I woke up the other day reading about these so-called failed auctions, and discovered that these [securities] had hit my portfolio -- and in fact they are completely illiquid -- I can't get the cash out, and neither can anybody else. ...

This is a $330 billion market -- and I think that there are a lot of people out there who have these things, sitting in their account, who probably don't even realize that they're frozen.

These things come in a variety of packages. ... Mine is a tax-free version - I think many of them are - the funds [selling the auction-rate securities] had bought tax-free municipal bonds [which are tax-free in the sense that the investor doesn't have to pay income tax on the interest earned].

Then, to determine the interest rate, they would [run an auction] every week. Essentially they would re-sell shares in the portfolio every week, so you got no real interest rate exposure. There was no interest rate risk, because the interest rate was being reset every week.

Now, for the issuers it was great because you paid a short-term tax-free rate and then you got a long-term bond out of it, so it was the best of both worlds for everyone involved.

But putting aside the technicalities, to me here, what's so appalling is that they were sold to people as a money market fund. This is not like reaching for super-high yield, or taking on known risk. They were sold by all the big firms as a money-market equivalent and now, when they auctions have gone bad ... suddenly they're failing because there's trouble in the municipal [bond] market. [These big firms] won't step up to the plate and honor this commitment. They will not make these funds available. The big firms are offering their clients margin loans to the amount [that they're owed.] In other words, ... it's like they're asking you to pay interest to get your own money.

[[And so, what's happening is that the big firms, like Merrill Lynch, won't give you your money, but they're willing to loan you an equivalent amount, and you'll have to pay interest on those loans. - JX]]

Now, I think this is outrageous. This goes to the integrity of Wall Street. How can you trust any of these firms again when they say, OK, buy this, for this reason, it's very liquid, when they have fundamentally betrayed you in a situation like this.

[[I have to laugh at this. These investment banks have been lying to us for months, perhaps years, selling CDOs and other faulty securities long after it was already obvious that the securities were faulty. And the ratings agencies gave them AAA debt ratings, and the bond insurers gave them AAA level bond insurance. All of these people have been lying for a long period of time, and nobody believes anything they say any more, and now Stewart is suddenly outraged because these liars have betrayed HIM. What did he expect? - JX]]

[On having written books about being betrayed.] I have. But I've written about rogues, I've written about criminals, some of them highly respected, very wealthy, unexpected, but nonetheless individual wrong-doers. These are the biggest blue-chip gold names on Wall Street who are refusing to honor these commitments to their clients, and I think it's really a very serious issue of trust.

Merrill Lynch happens to be where I have my account, and they sold me these securities -- but I don't really want to single out Merrill Lynch because everybody [has been doing it]."

There's another laugh here. What he doesn't understand, is that this is a generational issue. It isn't just the big investment firms that did this. It was the Generation-Xers in those firms, translating their hatred and contempt for Boomers into massive fraud. And their Boomer managers were just as bad, letting the Xers commit this fraud, because both Xers and Boomers made tons of money.

For those of you web site readers who can't believe a generational explanation like this, you tell me, how is it possible that this kind of fraud occurred in almost every financial institution -- banks, ratings agencies, insurers? What other possible explanation is there, except a generational explanation?

Incidentally, much to my own surprise, fourth quarter corporate earnings estimates have continued to fall sharply. I thought that they had leveled off around -21%, and that we'd be done with fourth quarter estimates. But I was shocked to read the following summary from Friday from CNBC Earnings Central:

"As of Friday, February 29th:

486 companies in the S&P 500 have reported earnings for Q4, 63.37% have beaten estimates, 11.11% were in-line, and 25.51% 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 -25.2%.

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%
  Feb  8:             -20.2%
  Feb 15:             -21.1%
  Feb 22:             -21.0%
  Feb 29:             -25.2%

And so, the 4Q earnings estimates have taken another substantial fall in just the last week, which was totally unexpected, even by me.

Now my astute web site readers may have the following question forming in their minds: "Hey, it's almost the end of the first quarter, and you're still talking about fourth quarter estimates. Where's the table for 1Q corporate earnings estimates?"

Well damn, you took the words right out of my mouth. And the answer is, I can't find any first quarter estimates. (If any web site reader knows where I can find them, please let me know.)

Here's what I think is going on. Recall the following table, that I posted about a month ago:

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

These figures are from Thomson Financial, the same group that provides the Q4 estimates above. When I posted this last table, I described it as "absurd" and a "fantasy."

Well, my guess is that in the last month, even the high-priced financial geniuses at Thomson Financial realized that this table is a fantasy. Obviously they've been made total fools of in the 4Q figures, where they didn't just make one wrong estimate, but where EVERY estimate since October has turned out to be ridiculous.

So my guess is that they've stopped issuing official 1Q estimates, until they see how bad 4Q ends up, which we may not know even yet.

As I've said before, if you think of the world economy as a big bloated mansion, then a piece of that mansion is falling off into the ravine every day. Before long the entire mansion will collapse into the ravine.

Well, the freezing up of the ARSs, and the consequent collapse of the muncipal bond market and the freezing of many so-called "liquid" money market funds is another few rooms and gables of the mansion sliding off into the ravine.

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. (3-Mar-08) Permanent Link
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Violence in Gaza escalates significantly as Israel contemplates an invasion

American warships are off the Lebanon coast to promote "regional stability."

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Israeli air strikes have killed 32 Palestinians in the last couple of days. There are presumably many Hamas militants among the 30, but there were also four Palestinian children.

At the same time, the massive rocket barrages from Gaza have grown much larger, hundreds every day, and are reaching further into Israel. One person has been killed, and several people have been wounded, including two Israeli children.

Some top Israeli officials are calling for "massive intervention" in Gaza. Matan Vilnai, the deputy defense minister called for a "catastrophic" response, and a top Knesset chairman says that Israel should reoccupy parts of Gaza and topple the Hamas government.

The rhetoric has been going over the top. Vilnai's word for "catastrophic" is the same Hebrew word that refers to the 1940s Holocaust, and Palestinian President Mahmoud Abbas said that the deaths of 32 Palestinians is already "more than a Holocaust."

Whatever the rhetoric, the IDF (Israeli Defense Forces) do appear to be massing on the border with Gaza for some kind of major intervention in Gaza, but whether it's a pinpoint invasion or a full-scale occupation is not yet known.

US warships and Lebanon

In a surprise related development, three US warships left Malta for Lebanon on Tuesday, and are remaining off the Lebanese coast in international waters.

The reasons given by the Pentagon include a "concern about the situation in Lebanon" and support for "regional stability." Lebanon's political crisis, that we last wrote about in November, has not abated, and the country has not yet found a way to select a new President. The US warships are seen by Hizbollah and some Lebanese political groups as being directed at them and Syria.

However, according to an article by Debka, which has contacts within Israeli intelligence but often gets things wrong, the US warships are there in anticipation of an Israeli ground action -- not only into Gaza (directed at Hamas), but also into southern Lebanon (directed at Hizbollah). Debka adds that there's another front as well: "The quarrel between Saudi King Abdullah and Syrian president Bashar Assad, which is nearing boiling point, threatens to be fought out in Lebanon, their main bone of contention. Both are sending quantities of arms and ammo to the Lebanese militias under their respective wings."

Memories of 2006

In 2006, 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.

The extreme state of anxiety that caused Israel to panic in 2006 still exists, because of the increasingly relentless barrage of rockets from Gaza into Israeli cities.

Thus today, calls by Israeli politicians for an overwhelming "catastrophic" response by the IDF are being tempered by fears of another panicked disaster.

News reports that I've read indicate that most analysts today believe that some kind of IDF response is coming soon, because the Israeli public will not tolerate the current situation much longer.

Generational Dynamics perspective


The Mideast
The Mideast

My first major Generational Dynamics prediction on this web site was in the May 1, 2003, article, "Mideast Roadmap - Will it bring peace?" In that article, I said that the Roadmap would fail, and that the deaths of Yasser Arafat and Ariel Sharon would be part of a generational change that would lead to all out war between Arabs and Jews, re-fighting the genocidal war that occurred in 1948 after the partitioning of Palestine and the creation of the state of Israel. Last month, in the article, "Violence continues in Gaza as Israel kills 18 to stop rocket attacks," I summarized all the events that have occurred since then.

I recently was engaged in a discussion with some online correspondents on how the coming Mideast war would "start."

There's some semantic confusion here about what we mean by "starting a war." That concept is very fluid, and can change retroactively. For example, it's possible that historians, looking back at this decade, may decide that the Mideast war began in Lebanon in 2006, or even that the World War began on 9/11/2001.

But from the point of view of Generational Dynamics, I mean something quite specific by the start of war -- it's a point of time defined in generational theory and known as the "regeneracy." The regeneracy is the point in time where an event, or series of events (like the Pearl Harbor attack and the Bataan death march in World War II or the Battle of Bull Run in the Civil War) unify a country or society behind its leader, and the survival of the country and its way of life become the highest priority, higher than the value of an individual life. This change opens the door to genocidal acts, since an individual human life has little value any more.

When a country goes through a crisis war (like WW II for the US), the survivors are very unified. But for children born after the war (like Baby Boomers after WW II), the austere rules imposed by the survivors become unbearable, and they rebel, creating a "generation gap" and an Awakening era (60s-70s in US). By the time another generation after that has been born and grown, all the austere rules have unraveled (1990s), and individual rights are all that matter, creating a social and civil climate of political bickering. The regeneracy is the point where the political bickering ends, and the people unite behind their leader. It's called the "regeneracy" because civic unity is regenerated for the first time since the end of the previous crisis war.

So from the point of view of Generational Dynamics, I'm trying to figure out where the regeneracy is coming from in the Mideast, and how it will lead to the renewed war between Jews and Arabs.

The regeneracy can't come from Lebanon, Syria, Iraq or Iran, because those countries are still in generational Awakening eras. (The last crisis war for each occurred in the 1980s: The Lebanon/Syria war, the Lebanese civil war, and the Iran/Iraq war.)

The regeneracy could come from the Palestinians, who are in a generational Crisis era, but here's where the semantic confusion occurs. It's true that the Gazans could launch a few thousand missiles, but that's what Hizbollah did in 2006, as part of a war that fizzled. A militant group within Gaza shooting off missiles into Israel is a terrible thing, but it's nothing like what the Gazans would do when a real crisis war begins.

That's why I keep saying that I'm waiting for signs that the Palestinians get so furious that they're ready to smash through the security wall and start killing Israelis in their homes. Until that fury grows to the point where an ordinary Gazan is ready, willing and able to do that, there is no regeneracy from the Gazan side.

Other countries in the region are in generational Crisis eras. Egypt, Jordan and Saudi Arabia are in Crisis eras, but their current governments are pro-Western, and so a massive attack from any of these countries at this time will not happen. However, if a palace coup occurred in any of these countries, then any one of these countries might follow with a massive attack on Israel of the kind that we're describing.

And so, absent a coup or some similar chaotic earthquake in the Arab world, the only place I can see a genocidal war being launched right now is from Israel. They've already panicked and done it once -- in 2006 in Lebanon. That war fizzled because Lebanon is in a generational Awakening era and is highly war-averse, in reaction to the Sabra and Shatila massacre; if Lebanon had been in a generational Crisis era, then the Israeli invasion would most likely have spiraled into a full-fledged crisis war, but not in a Lebanese Awakening era.

But the point is that Israel could panic and do something like that again, even though the Israeli government has learned severe lessons from the 2006 experience, and doesn't want to see a repeat.

However, some kind of massive attack by Israel could be triggered by some chaotic shock/surprise event that's currently unknown, or even by too long a continuation of the current barrage of rockets.

For Generational Dynamics, this would lead to an interesting situation: Israel would say that some other country or group started the war (depending on the triggering event), but from the Generational Dynamics point of view (and depending on the triggering event) it would be Israel that panicked and started the genocidal crisis war. Thus, it's possible that Generational Dynamics may hold a different view on the question of who started the war than historians and politicians do.

And so we're in a familiar situation with Generational Dynamics predictions: We know what the final destination is, but we don't know how we're going to get there -- although in this case, we've done some analysis to at least eliminate a few possibilities. However, the final destination is 100% certain: There WILL be a new massively genocidal crisis war between Jews and Arabs. There's no way to predict what will trigger it or when it will begin, but with the violence escalating on both sides in the Gaza / Israeli dispute, and with US warships waiting off the coast of Lebanon, it could begin soon. (1-Mar-08) Permanent Link
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