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Web Log - July, 2008

Summary

Oppenheimer's Meredith Whitney predicts imminent meltdown of over 25 financial institutions

The new Merrill Lynch asset writedowns are triggering a race to the bottom.


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

In March, Meredith Whitney, Oppenheimer's executive director of equity research, appearing on CNBC, said that banks have been 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.

Whitney went much farther -- she predicted 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.

Last Friday, National Australia Bank marked its CDOs down to 10% of their original nominal value. In writing about this markdown, I noted that the extraordinary size of the writedown might be the trigger that launches this panic.

On Monday, Merrill Lynch announced a large writedown of its CDOs to 22% of a portion of their CDO portfolio, originally valued at $30.1 billion, to $6.7 billion. They had already been written down to $11.1 billion during the second quarter, so Monday's action represents an additional $4.4 billion writedown.

On Wednesday, Whitney appeared again on CNBC, and indicated that she feels that her March prediction is in progress. In answer to the question, "Who's next?", she answered:

"It's all the guys who got into bed with these housing related assets, so it's Citi, UBS -- Merrill has taken its writedown, but Citi and UBS have the greatest exposures -- Bank of America has some exposures to a lesser degree.

I think that Wachovia, not with the same exposures, will be in the market soon. ...

Look, these institutions are not alone, because everyone was involved in mortgages.

You know it's interesting ... how much of Wall Street banking revenues really gravitated towards the mortgage market. I mean these were lopsided business models. And because they're so levered in the mortgage market, they have so much downside to the mortgage market. And so I think we're going to see '25 plus' institutions come back for capital inside of the next two months."

These '25 plus' institutions, beginning with Citi and UBS, will be coming to the capital markets within the next two months because they'll be forced to write down their assets that are similar to those held by Merrill.


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

When asked whether Lehman Brothers Holdings Inc. would even survive, she answered as follows, grinning:

"Ummm .... I-i-i-i ... I-i-i-i .... ummm .... I think ... ummm ... I don't know. I don't know."

Ummmmm, I think we get the message. Lehman Brothers is now the smallest Wall Street investment bank, ever since Bear Stearns collapsed in March, and investors have been fearing a collapse ever since.

When asked whether we've seen the worst of the credit crisis, she answered as follows:

"I keep saying that we're less than 50% of the way done, and it seems we've been at less than 50% for a really long time. But what you know is that, capital today -- all the capital that has been raised, hundreds of billions of dollars of capital, has just plugged holes.

And the valuations and the assumptions that companies are using and carrying assets, are still unrealistic.

The central root of all this issue is housing prices. House prices continue to decline, and these assets are valued at really aspirational values, so you're going to continue to be writedowns, capital will continue to be raised, recapitalizations by so many of the financial institutions, and the whole notion of equity is really designed to fund growth. This equity is just plugging holes. It's not funding any growth. And as a result, there's less and less lending available. And that means that there's more and more strain on businesses, and more and more strain on the consumer."

Once again, Whitney is not directly answering the question, but she's sending the message that there's much worse to come.

Merrill Lynch's motives

The appearance of a panicked sale was described earlier in the day by CNBC reporter Charlie Gasparino, who said the following about the Merrill Lynch deal:

"I want to say this. There was no funding crisis at Merrill Lynch, from what I understand. The stock went down 10% on Monday, because there was all this talk about a possible funding crisis - that wasn't true.

But what was going on, and what has been going on recently, not just Monday, is growing trepidation among institutional clients about this continued drip of bad news. You put both of those things together, and from what I understand, sometime late last week, they just decided, let's pull the trigger.

They had this hedge fund, this Lone Star fund, willing to do the deal. They thought, OK, this is not the best deal -- this is heavily financed, there's a lot of bells and whistles to this, but we have the firm that's ready to do it, we could be the first out of the box.

I think one of the things that Merrill was worried about - was that if they weren't first out of the box, if they have to compete for selling this stuff with maybe a Lehman Brothers or a Citi, which holds similar assets, they wouldn't get as good a deal.

So they decided -- and from what I understand they worked the entire weekend -- to pull the trigger, and they got it done."


CNBC's Charlie Gasparino <font face=Arial size=-2>(Source: CNBC)</font>
CNBC's Charlie Gasparino (Source: CNBC)

There are a couple of interesting things about this statement.

The first is that it indicates that panicked selling was in play. Panicked selling occurs when people sell as quickly as possible, because they fear that prices are going to go even lower. That's what happens in a stock market crash, and Gasparino is describing it here in Merrill's case.

The second issue is one that nobody ever seems to mention these days (except of course for me on this web site).

Question: What's missing from the reasons reported by Gasparino for wanting to get the writedown out of the way?

Answer: What's missing is the reason that they should have written down these assets right away because it's the honest thing to do.

For those who aren't aware of it, banks are required to "mark to market" their assets, so that there assets are always valuated at the best possible price. There's no market for the CDOs, but there have been enough writedowns in the last few months so that it should be possible to determine that substantial writedowns must occur. Not doing so is fraud, because investors in the bank are fooled into thinking that the bank is worth more than it actually is worth. But let's face it. Fraud is OK these days because everybody is doing it, and because government officials are actively encouraging banks to do it.

John Thain's credibility


Merrill Lynch writedowns <font face=Arial size=-2>(Source: econompicdata.blogspot.com)</font>
Merrill Lynch writedowns (Source: econompicdata.blogspot.com)

What did John Thain know, and when did he know it?

That's the question being asked by a lot of bloggers this week, referring to John Thain, the CEO of Merrill Lynch.

There have been a lot of writedowns, as the adjoining diagram shows. Each time a writedown occurs, there's a big announcement, and a promise that there won't be any more.

Here's how the EconomPicData blog describes the situation:


Merrill Lynch CEO John Thain meets Minnie Mouse <font face=Arial size=-2>(Source: ftalphaville.ft.com)</font>
Merrill Lynch CEO John Thain meets Minnie Mouse (Source: ftalphaville.ft.com)

On the other hand, there's a Reuters article that says that Thain's credibility survives:

"Merrill Lynch & Co Inc's ... perennially optimistic chief executive has made something of a habit of promising not to issue common shares, only to raise capital weeks later.

So far, though, investors seem to be cutting him a fair amount of slack. In fact on Tuesday after John Thain's latest about-face, Merrill's shares rose 7.9 percent.

But patience for the former Goldman Sachs and NYSE executive's flip flops may wear thin, critics said.

"This may be the last time, or you could see more writedowns. You just don't know," said Jim Huguet, co-chief executive at fund manager Great Companies.

Merrill Lynch said on Monday it was raising $8.5 billion capital after agreeing to sell toxic debt assets at a loss.

The share sale comes less than two weeks after Thain said on a conference call with investors, "Right now, we believe we are in a very comfortable spot in terms of our capital."

Thain has been making positive statements about the bank's capital for months. In an April interview with Japan's Nihon Keizai Shimbun, Thain said, "The goal is to maintain our current ratings. No more capital raising; I'm sure we have enough capital."

I really have to laugh at this. How many flip-flops does a CEO have to make before his credibility "wears thin" enough to be un-credible?

If Thain or any of these CEOs at least made a gesture to their fiduciary, ethical and legal duties, by saying something like, "We wrote down these assets for many reasons, one of which is that we owe our investors and the public the truth" -- if one of them ever said something like that, I'd be so shocked, I might actually believe him.

But these guys are exhibiting no ethics whatsoever. If they ever tell the truth, it's because they have no choice or because they're trapped or because they accidentally stumble into it.

For a lengthier discussion of (lack of) ethics, read, "'Operation Malicious Mortgage' indicts 406 people including Bear Stearns execs." (31-Jul-2008) Permanent Link
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India is on high alert as synchronized bombs strike two cities

Relations between India and Pakistan are coming under increased strain after terrorist bomb attacks in cities in India on Friday and Saturday.


India: Explosions strike Bangalore on Friday, Ahmadabad on Saturday <font face=Arial size=-2>(Source: Pakistan Daily Times)</font>
India: Explosions strike Bangalore on Friday, Ahmadabad on Saturday (Source: Pakistan Daily Times)

46 people were killed in the two attacks. The southern city of Bangalore, a major Indian information technology (IT) hub was struck on Friday.

On Saturday the city of Ahmedabad, near the Pakistan border, was struck by an extremely sophisticated series of 17 synchronized bombs. The first group of bombs exploded in a crowded marketplace, and the second group exploded half an hour later at the crowded emergency rooms of two nearby hospitals.

A little known group calling itself "Indian Mujahideen" has claimed credit for the Ahmedabad bombings.

Although Indian Mujahideen is not a known terrorist group, it's thought to be linked to one or all of the following:

Many Indian analysts suspect the hand of Pakistani groups in these and other terrorist bombings in India, and possibly even Pakistan's government itself. According to one analyst, "The way in which the attack in Ahmedabad took place – the multiplicity of the bombs and the way in which they were coordinated – suggests a level of expertise not yet associated with any Indian group. It is reasonable to say this group has benefited from external involvement."

In fact, there's a kind of "attitudinal imbalance" on the Kashmir/Jammu issue between Pakistan and India; namely, India is satisfied with the status quo, and Pakistan isn't.

Kashmir and Jammu


Indian subcontinent, showing the disputed regions of Kashmir and Jammu.
Indian subcontinent, showing the disputed regions of Kashmir and Jammu.

Kashmir+Jammu (K+J) is an overwhelmingly Muslim area, but has been disputed by both Pakistan and India since Partition occurred in 1947. At that time, the Indian subcontinent was partitioned into two nations, India and Pakistan, but Partition led immediately to a massively bloody genocidal crisis war between Muslims and Hindus. K+J itself was partitioned by a boundary known as the "Line of Control," but the status was never settled.

In the years after Partition, it was the objective of both countries to gain control of all of K+J. The Pakistanis claimed that it should be Pakistani because the population was mostly Muslim, while the Indians claimed it should be Indian for historical reasons.

The 1971 war between India and Pakistan changed things somewhat.

(Aside: Prior to 1971, Bangladesh was part of Pakistan, and was known as East Pakistan. As a British colony, it was known as Bengal. The 1947 Partition also partitioned Bengal into (and here it's a bit confusing) West Bengal, which became the easternmost part of India, and East Bengal, which became East Pakistan.

The 1971 Pakistan-India was a non-crisis war in the east, between Pakistan and India, but Bengal was always on a different generational timeline, and the 1971 war was a generational crisis war for that region. One consequence was that East Pakistan broke away from Pakistan and became Bangladesh.)

Part of the agreement that ended the 1971 war was that the Line of Control would become a permanent international boundary, according to D. Suba Chandran in The Future of Kashmir. In the aftermath, that was satisfactory to India, but not to Pakistan, which insisted that the J+M people should determine control of the entire regions.

Things came to a head in May 1998 with the Kargil conflict, which was launched by Pakistan to gain some territory. (Kargil is a district within Kashmir.) An additional objective was to "internationalize" the conflict, gaining international sympathy for Pakistan's desire for a vote by the K+J people. The result was a humiliating defeat for Pakistan.

The Kargil conflict was launched just after Pakistan and India had signed, in February 1998, the Lahore Declaration, a peace agreement that provided a framework for resolving the K+J disputes. The agreement turned out to be meaningless, and so one byproduct of the Kargil conflict was that Indians are immediately suspicious of Pakistani involvement in any terrorist act. This suspicion usually focuses on Pakistan's Inter-Services Intelligence (ISI) agency.

The suspicion applies to Afghanistan as well. Earlier this month, a suicide bomber drove a car into crowds of people outside the Indian embassy in Kabul. Afghan president Hamid Karzai said that "outsiders" wanted to "damage good relations between Afghanistan and India." There is no doubt that he was referring to Pakistan's ISI. Pakistan has denied the charges, but Karzai canceled a series of planned meetings with Pakistan whose purpose had been to reduce tension.

Sunni vs Shia

Almost all contemporary analyses of the relationship between Pakistan and India refer to it mainly as a conflict between Muslims versus Hindus.

Actually, the truth is quite different, as I've discovered doing this research. In fact, it's much more accurate to say that it's Sunni Muslims versus Hindus and Shia Muslims.

Pakistan claims the entire K+J region, and points out that the partitioning of Kashmir supposed to be temporary, and that the UN Security Council mandated an election in 1951 to permit Kashmiri self-determination. That election has never been held.

What is becoming increasingly significant, as illustrated by the latest wave of bombings in India, is that the various Muslim groups dissatisfied with the status quo in Kashmir are increasingly linking up and working with one another.

For years, the conflict in Kashmir has been a proxy for the larger conflict between Pakistan and India (i.e., between Muslims and Hindus). However, it's increasingly the case that militant Taliban terrorists now see the war in Afghanistan as an even more effective proxy for the Pak-Indian conflict, with the additional advantage of involving the United States and NATO. This became most apparent on July 7 when a car bomb exploded in front of the Indian embassy in Kabul, killing dozens.

When we talk about the Pak-Indian conflict as being between Muslims and Hindus, that's not the whole story. The Taliban, al-Qaeda, and the various terrorist organizations (SIMI, Lashkar, JuNI) are all Sunni terrorist organizations.

There's a "politically correct" tendency at this point in a generational Crisis era to assume that ethnic and religious differences really don't matter the way they used to. Thus, Palestinians and Israelis could live side by side in two states in the Mideast; the English and the French really can live together in a European Union; and Sunni and Shia Muslims are just two sides of the same Muslim coin.

Sometimes this belief leads to total craziness, as when Iranian leader Mahmoud Ahmadinejad, whose Shia Muslim beliefs are deep and mystical, arranges to give money to terrorist Sunni organizations like Hamas. His fantasy is that one day Iran will have hegemony over all Muslims, Sunni and Shia, throughout the Mideast - a concept as bizarre as Napoleon's belief that he could have ruled all of Europe, or Hitler's belief that he could have ruled the world.

If you're trying to figure out what's going on in the world, you're much more likely to be right if you assume that Sunni/Shia hatred runs very deep, and that Sunni/Hindu hatred also runs very deep. And when leaders of Sunni terrorist groups like al-Qaeda and the Taliban refer to "infidels," they aren't just talking about Christians and Jews -- they're also talking about Shiites, whom they consider to be "not Muslim."

(As an aside, Iraq has been an exception, as I've described many times. Sunni/Shia differences in Iraq run deep, but in their last two crisis wars, the Great Iraqi Revolution of 1920 and the Iran/Iraq war of the 1980s, Iraqi nationalism united the Iraqis, trumping the Sunni/Shia differences.)

Sunni/Shia differences do run very deep in Pakistan and Afghanistan, despite attempts by politically correct political leaders to pretend that they don't exist. A bizarre example of this is the assassination of Benazir Bhutto. When I was trying to analyze the consequences of the assassination right after it happened, I read dozens of news articles, and I don't recall that a single one mentioned that Bhutto came from a well-known Shia Muslim family, which she did.

The Sunni terrorist group Tehrik-e-Taliban Pakistan (TTP or Taliban Movement of Pakistan), has taken credit for the assassination of Bhutto. There may be many reasons why TTP wanted to assassinate Bhutto -- her links with the West are always given as a major reason -- but Sunni hatred for Shias is certainly at the top of the list.

Shia militancy began to increase following Iran's Islamic Revolution in 1979, and this led to the creation of Sipah-e-Sahaba Pakistan (SSP), an anti-Shia Sunni terrorist group. That gave rise to Sipah-e-Muhammad Pakistan (SMP), a Shia terrorist group.

The Taliban versus the Northern Alliance

People with memories may recall than when the Afghanistan war began after 9/11, it was a battle between the Taliban and the Northern Alliance. For a lot of people (including me), it wasn't clear what either of these groups were, except that the Taliban was harboring Osama bin Laden and al-Qaeda terrorists.

It's now possible to clarify the nature of these groups, starting with the following map, which I've modified from a map at columbia.edu:


Afghan-Pak-India ethnic map
Afghan-Pak-India ethnic map

Let's touch on a few features of the above map:


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

Recall that the Soviets invaded Afghanistan in the 1980s. That war was largely fought by the Soviets versus the Pashtuns, with the US supporting the Pashtuns against the Soviets. At that time, Turmenistan, Uzbekistan and Tajikistan did not exist, but were part of the Soviet Union.


Pakistan's  Federally Administered Tribal Areas (FATA) form a safe haven for Taliban and al-Qaeda terrorists. <font face=Arial size=-2>(Source: cfr.org)</font>
Pakistan's Federally Administered Tribal Areas (FATA) form a safe haven for Taliban and al-Qaeda terrorists. (Source: cfr.org)

After the collapse of the Soviet Union in 1991, the ethnic groups in Afghanistan realigned. In the massive, bloody Afghan civil war that followed from 1992 to 1996, many Uzbek and Tajik fighters continued with the Northern Alliance, but many Sunnis joined up with the Pashtuns and the Taliban. The Taliban ruled Afghanistan until 9/11, when the Afghan war began and the Taliban were defeated.

Today, the Pakistan FATA region has to be considered the terrorism center of the world, thanks to the safe haven provided to Taliban and al-Qaeda terrorists.

The FATA region provides for terrorist training camps for terrorists who act within both Afghanistan and Pakistan. The "al-Qaeda" name has become a brand name for young al-Qaeda terrorists around the world from southeast Asia through the Mideast to northern Africa.

India vs Pakistan in Afghanistan

When we talk about the conflict between Pakistan and India, we usually refer to it as Muslim versus Hindu (and Sikh). Actually, it's Sunni Muslim versus Hindu (and Sikh).

Hindus have a long historical relationship with Shia Muslims and, in fact, some histories show that a large Hindu family fought with the Persian Shias versus the Sunnis in the seminal battle of Karbala that created the Sunni/Shia split in 680 AD.

India sided with the Soviets in the 1980s Afghan war, with the result that India lost all influence in Afghanistan when the Taliban took over in 1996. However, after 9/11 and the defeat of the Taliban, India has worked hard to regain influence in Afghanistan, providing more than $500 million in assistance to Afghanistan.

For India, Afghanistan is an important strategic relationship, since it provides a link to the Shia Muslim community and Iran. In particular, India and Iran are proposing to build an the Iran–Pakistan–India (IPI) gas pipeline, although the US considers this proposal to be a security risk to US interests.

For Pakistan, India's increasing involvement in Afghanistan is somewhat threatening. Pakistan increasingly feels surrounded by its former (and future) enemy, India. Relations between the Afghan and Pakistan governments are becoming increasingly hostile. India and Afghanistan are blaming numerous terrorist attacks in their countries on Pakistan's Inter-Services Intelligence (ISI) agency.

For its part, Pakistan is accusing India's Research and Analysis Wing (RAW) and Israel’s Mossad of working together to plan terrorist attacks within Pakistan. (To make clear what we're talking about, ISI, RAW and Mossad are all intelligence agencies, like the CIA in America, or Britain's MI5.)

Summary: The gathering storm

In a previous article, I promised to do a complete analysis of the Afghan war. With this article, we're about 2/3 of the way there.

What we see is a "gathering storm" of increasing tension and conflict in the entire region.

Basically, the Sunni terrorists (Taliban and al-Qaeda) are succeeding. They see the 1979 Iranian Shia Islamic Revolution as a model for achieving a Sunni Sharia state in Pakistan by precipitating a massive war (revolution).

Ironically, the success of the American forces in driving al-Qaeda in Iraq out of Iraq has made Afghanistan and Pakistan far more dangerous than they were. Thanks to the Anbar Awakening in Iraq, al-Qaeda had no safe haven, and was eventually driven out by Iraq's own Sunnis.

This has caused a strategy change for al-Qaeda. The safe havens in Pakistan's FATA give al-Qaeda the perfect home from which to pursue their objectives.

One result is that foreign fighters -- Sunni terrorists from Arab countries and North Africa -- have been traveling to FATA and Afghanistan to fight the jihad. This is making al-Qaeda a much more powerful fighting force, and they're becoming far more successful than they ever were in Iraq.

The most plausible scenario for a major war in this region is one that begins with a Sunni vs Shia ethnic fighting within Pakistan itself. With Pakistan and India in a generational Crisis era, such fighting would quickly spread into a civil war and then an international war -- and then a nuclear war, as both Pakistan and India are nuclear powers.

Paradoxically, such a war would NOT spread in a meaningful way to Afghanistan itself, because Afghanistan's last crisis war was recent -- the 1992-96 civil war. Afghanistan is in a generational Recovery era, and it's impossible for any Crisis war to start during a Recovery era. If any war begins, it will fizzle before long.

However, Afghanistan's immunity to a crisis war wouldn't make much difference. The United States and Russia would be quickly drawn into such a regional fight, on the side of India, and China and Bangladesh would be drawn in on the side of Pakistan. (30-Jul-2008) Permanent Link
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National Australia Bank marks its CDOs down 90%

Saying that soaring US mortgage defaults require preparing for a "worst case scenario," the Melbourne-based National Australia Bank (NAB) Ltd., set aside A$830 million (US$795 million) for credit market losses. This followed a decision to write down its CDO portfolio, nominally valued at A$1.2 billion (US$1.15 billion), by 90%, to 10% of its nominal value.

(For those interested in the math behind the creation of CDOs from CDSs, see "A primer on financial engineering and structured finance." For a discussion of credit default swap (CDS) counterparty risk, see "Brilliant Nobel Prize winners in Economics blame credit bubble on 'the news.'")

An analysis by Credit Suisse indicates that other Australian banks may now be required to make similar writedowns of their US mortgage-based assets.

This NAB action has the potential to be extremely significant.

This appears to be the next step in the scenario predicted by Oppenheimer analyst Meredith Whitney.

Speaking on CNBC, Whitney said 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.

Whitney went much farther -- she predicted 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.

The NAB writedown of 90% establishes a market value for the CDOs in its portfolio. Other Australian banks may be forced to make similar writedowns, through either public or regulatory pressure. That same public or regulatory pressure may move to other countries, including America, and force American banks to start making more aggressive writedowns of their near-worthless mortgage-based assets. This could create a domino effect which, over a period of weeks, might trigger the panic that Whitney predicted.

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-Jul-2008) Permanent Link
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Obama continues to damage his candidacy with his Iraq policy.

Obama is hurting himself by bobbing and weaving on the success of the "surge."

Some people have been accusing me of an "ideology" biased in support of John McCain for President. So let me make clear that I do not support either McCain or Barack Obama. My only "ideology" is the one that has appeared on the home page of this web site for six years: I am "pro-American."

I've taken no position on health care policy, immigration policy, economic policy, trade policy, the New Yorker, or other "hot" political issues. Most of what politicians of either party say on these issues is fatuous political nonsense, and rarely even makes sense, so I leave it to others to reach monumental conclusions.

My concern on this web site is the survival of the United States in the coming financial crisis and "Clash of Civilizations" world war. To that end, I expect American politicians to support America's interests.

So in the 2004 presidential campaign, I thought it was outrageous that John Kerry refused to repudiate his 1971 testimony to Congress, in which he essentially accused the American armed forces in Vietnam of being the equivalent of Nazi storm troopers, committing atrocities and war crimes on a day to day basis, with the full awareness of officers at all levels of command.

I was (and am) absolutely infuriated by those views, and I stated at the time that unless he repudiates those views, then he's not qualified to be President. How can the President lead America's war against terror if he believes that the American soldiers are worse than the terrorists?

Kerry has repeatedly whined that he was "swift-boated," referring to political ads criticizing his actions while serving in Vietnam. He claimed that the accusations were false, but what he never understood, and still doesn't understand, is that the accusations were credible because he refused to repudiate his 1971 testimony. In fact, in 2006, Kerry finally reaffirmed his belief that American soldiers in Vietnam were just a bunch of torturers, rapists and murderers. Let us all be grateful that this man never became President, and I'm still ashamed that a man with those beliefs represents my state of Massachusetts in the Senate.

The point I'm making here is that Kerry shot himself in the foot by refusing to repudiate his 1971 testimony, and now Obama is doing the same by refusing to repudiate his earlier comments about the "surge" in Iraq.

There are evidently many, many other people who feel the same way. On Meet the Press on Sunday morning, where the entire show was devoted to an interview with Obama, he bobbed and weaved about his attitudes about the "surge" under questioning by Tom Brokaw.

Here's a brief excerpt from the transcript:

"MR. BROKAW: Do you believe that President Maliki would be in a position to more or less endorse your timetable of getting troops out within 16 months if it had not been for the surge?

SEN. OBAMA: You know, we don't know, because in my earlier statements--I mean, I know that there's that little snippet that you ran, but there were also statements made during the course of this debate in which I said there's no doubt that additional U.S. troops could temporarily quell the violence. But unless we saw an underlying change in the politics of the country, unless Sunni, Shia, Kurd made different decisions, then we were going to have a civil war and we could not stop a civil war simply with more troops. Now, I, I..."

It went on in this vein for several more questions.

During this portion of the interview, there were several screens displayed that showed how lacking in credibility Obama is:


Meet the Press screen shots
Meet the Press screen shots

What all of this shows is that Obama, who is doing so well on other issues, is hurting himself badly on the issues surrounding his Iraq policy.

In fact, Democrats have almost no credibility on Iraq. It's worth remembering that John Kerry's position on the Iraq war in 2004 was almost identical to George Bush's. The Democrats supported the war in 2002 and 2003, when it was popular to do so, they started equivocating in 2004 when they weren't sure what would be popular, they opposed the war in 2006 and 2007 when it was popular to do so. And now, after taking the politically expedient position at every time in the last six years, now that the "surge" has succeeded, Obama is claiming that he was right all along.

Let's excerpt another part of Obama's interview:

"SEN. OBAMA: Well, the--well, the--look, there's no doubt, and I've said this repeatedly, that our troops make a difference. If--you know, they do extraordinary work. The troops that I met, they were proud of their work, they had made enormous sacrifices, they had fought, they had helped to construct schools and, and rebuilt the countryside. But, for example, in Anbar Province, where we went to visit, the Sunni awakening took place before the surge started, and tribal leaders made a decision that, instead of fighting the Americans, we're going to work with the Americans against al-Qaeda. That was a political decision that was made that has made a huge difference in this entire process."

We should note in passing that Obama is not making the same mistake that Kerry made in saying that American soldiers are no better than a bunch of torturers, rapists and murderers. He makes a point of expressing his pride in America's soldiers every chance he gets.

However, the second part of his answer is an insult to everyone's intelligence, since he's implying that the Anbar Awakening was part of his calculation when he opposed the "surge." I don't think anyone doubts that he was making a politically expedient decision at the time.

In fact, at some level I find this response to be personally insulting. In my 2003 article, "Terrorist suicide bombings in Iraq may backfire against terrorists," I wrote that Iraq was in a generational Awakening era, and that "During an awakening period, terrorist acts cause masses of people to shrink from more violence." I said that, "The massive bombings of the United Headquarters headquarters, oil pipelines, and the Jordanian embassy may backfire against the terrorists by causing the population, currently going through an awakening period, to turn against the terrorists."

If you go back and read that article, you'll find that I was absolutely right about what was going to happen in Iraq. I repeated those predictions many times after 2003, even at times when they seemed a fantasy. My Iraq predictions have been completely right, over and over, and I don't know of anyone else in the world who has gotten Iraq right. And that was only one of numerous predictions that I got completely right, following the Generational Dynamics forecasting methodologies.

(See "List of major Generational Dynamics predictions" for more information about these predictions.)

When I wrote "Iraqi Sunnis are turning against al-Qaeda in Iraq,", and again with "The 'Anbar Awakening' may be good news in Iraq," I was describing exactly this phenomenon. The Anbar Awakening, which even used the generational word "Awakening," was the fulfillment of exactly what I predicted in 2003.

But the Democrats had no idea of this when they were voting on the "surge." Here are some of the things that I wrote about at the time:

I wrote many articles on this subject at the time, giving many more examples of this type of stuff. And I said many times that it's an absolute disgrace that these congressmen, as well as many other politicians and journalists and analysts -- and web sites like http://moveon.org and http://dailykos.com -- have committed their careers and credibility to America's defeat and humiliation in Iraq. These people were openly aiding and abetting the enemy, in a manner that was close to being treasonous.

So now, here comes Senator Obama, saying that he was right all along because of the Anbar Awakening. He must think that I and a lot of other people were born yesterday to believe that crap.

As I've said many times, the coming financial and war crises will be coming irrespective of who is President. Nobody can predict which of McCain or Obama would be better able to ensure America's survival during these crises. McCain would be steadier and Obama would be likely to overreact, but even that observation doesn't indicate who would be the better President. From the point of view of Generational Dynamics, the choice of President has no PREDICTABLE effect on the outcome of the financial crisis or the Clash of Civilizations world war, and so I personally do not have any preference.

Based on the polls and what I've seen so far in the campaign, Senator Obama has a very good chance of winning the Presidential election. But if he loses, it will probably be because of his handling of the Iraq issue.

In the screen shots of Sunday's Meet the Press above, there's a quote from a USA Today editorial asking these questions: "Why ... can't Obama bring himself to acknowledge the surge worked better than he and other skeptics ... thought it would? What does that stubbornness say about the kind of president he'd be?"

That's exactly the question I'm asking. (27-Jul-2008) Permanent Link
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Barack Obama in Berlin calls for greater European militarism

Obama enthralls huge German audience with a history-making speech.

Europeans have little credibility these days, as was really apparent in the bizarre aftermath to the Irish vote against the Treaty of Lisbon. Europeans like to sit in their easy chairs, enjoy their 35-hour work week, complain about the "Anglo-Saxon model," make pompous statements about "global warming" but do nothing about it, and make pompous statements about the wars in Iraq and Afghanistan, but never live up to their own commitments.

The best way to get Europeans excited is to say something anti-American. Europeans hated George Bush from the day he took office, as they mocked his Western accent and cowboy hat. Not surprisingly, they hate anything that Bush stands for, even if they love the same quality in Barack Obama.

It's worthwhile remembering all this, if you want to understand the European reaction to Barack Obama's speech in Berlin on Thursday.


Barack Obama in Berlin <font face=Arial size=-2>(Source: CNN)</font>
Barack Obama in Berlin (Source: CNN)

Why do the Europeans love Obama? The German newspaper Bild.de tries to explain (English version here):

"Germany has caught 'Obamania'!

Obama's speech in front of Berlin's Sieges Saule ('victory column') memorial in the Tiergarten park has been was greatly anticipated by Germans who see a hopeful future in the charismatic candidate, not only for the US but for the whole world. But why are so many Germans excited about the American Senator from Illinois? BILD breaks down the reasons for Germany's 'Obamania':

He's young! ...

He's multicultural and modest! ...

He doesn't just talk, he preaches! ...

He stands for freedom!

Within 16 months, Obama wants to withdraw the US troops in Iraq, a total of 4,125 soldiers. He wants to meet with the mullahs in Tehran and close Guantánamo Bay. In short, he hopes to make the world a better place. American publicist Roger Cohen said: "Europeans see Obama as the good American."

He's not Bush! ...

Bush in Germany is considered by many as a warlord, Obama stands for diplomacy."

This is what the Germans want to believe about Obama.

So here's a portion of Obama's speech:

"Will we stand for the human rights of the dissident in Burma, the blogger in Iran, or the voter in Zimbabwe? Will we give meaning to the words "never again" in Darfur?

Will we acknowledge that there is no more powerful example than the one each of our nations projects to the world? Will we reject torture and stand for the rule of law? Will we welcome immigrants from different lands, and shun discrimination against those who don't look like us or worship like we do, and keep the promise of equality and opportunity for all of our people?

People of Berlin - people of the world - this is our moment. This is our time."

Guess what got the wildest applause? It was the anti-American sentence, "Will we reject torture and stand for the rule of law?" No surprise there.

Here's another portion of the speech:

"This is the moment when we must defeat terror and dry up the well of extremism that supports it. This threat is real and we cannot shrink from our responsibility to combat it. If we could create NATO to face down the Soviet Union, we can join in a new and global partnership to dismantle the networks that have struck in Madrid and Amman; in London and Bali; in Washington and New York. If we could win a battle of ideas against the communists, we can stand with the vast majority of Muslims who reject the extremism that leads to hate instead of hope.

This is the moment when we must renew our resolve to rout the terrorists who threaten our security in Afghanistan, and the traffickers who sell drugs on your streets. No one welcomes war. I recognize the enormous difficulties in Afghanistan. But my country and yours have a stake in seeing that NATO's first mission beyond Europe's borders is a success. For the people of Afghanistan, and for our shared security, the work must be done. America cannot do this alone. The Afghan people need our troops and your troops; our support and your support to defeat the Taliban and al Qaeda, to develop their economy, and to help them rebuild their nation. We have too much at stake to turn back now.

This is the moment when we must renew the goal of a world without nuclear weapons. The two superpowers that faced each other across the wall of this city came too close too often to destroying all we have built and all that we love. With that wall gone, we need not stand idly by and watch the further spread of the deadly atom. It is time to secure all loose nuclear materials; to stop the spread of nuclear weapons; and to reduce the arsenals from another era. This is the moment to begin the work of seeking the peace of a world without nuclear weapons."

This is NOT the message that the Germans wanted to hear, so there was little or no applause.

The fight in Afghanistan is supposed to be a NATO fight. That means that the Europeans should be participating. The Europeans do have small contingents of troops in Afghanistan, but they're forbidden from fighting. They teach schools and build roads and plant gardens, but they don't fight the terrorists. That work is left to the Americans, the British and the Canadians.

So Obama is chiding the Europeans for not wanting to fight the war on terrorism in Afghanistan. He points out, indirectly, that al-Qaeda in Afghanistan was responsible for the subway bombings in London and Madrid, for the massive terrorist bombings in Indonesia and Lebanon, and for the terrorist acts of 9/11. He's telling the Europeans that they aren't doing their part, and until that happens, the terrorist acts on their own cities are going to continue.

But the Europeans don't want to hear that. They don't want to hear anything that implies a commitment on their part. They don't want anything except to join in the whining about America and about George Bush, the warlord.

The Europeans certainly don't hear that Obama is turning into quite a warlord himself. He's been talking about a much larger commitment to the war in Afghanistan, as I wrote last week in "Barack Obama endorses growing American troop force in Afghanistan."

And when he says that it's necessary "to stop the spread of nuclear weapons," he's talking about Iran. In an earlier speech in Israel, Obama made it clear that President Obama would not tolerate nuclear weapons in Iran. But that's not what the Europeans want to hear.

I'm now going to make a comparison now to Hitler, but I'm MOST EMPHATICALLY NOT comparing Obama to Hitler. The comparison I'm making is the reaction of the German people to Hitler, as compared to the reaction of the German people to Obama.

Here's a quote from a speech that Hitler gave in 1939:

"In the course of my life I have very often been a prophet, and have usually been ridiculed for it. During the time of my struggle for power it was in the first instance only the Jewish race that received my prophecies with laughter when I said that I would one day take over the leadership of the State, and with it that of the whole nation, and that I would then among other things settle the Jewish problem. Their laughter was uproarious, but I think that for some time now they have been laughing on the other side of their face. Today I will once more be a prophet: if the international Jewish financiers in and outside Europe should succeed in plunging the nations once more into a world war, then the result will not be the Bolshevizing of the earth, and thus the victory of Jewry, but the annihilation of the Jewish race in Europe!"

One can imagine the cheers that Hitler received when he gave this speech. Did those cheering people even know what they were cheering at?

It's been one of the greatest enigmas of the last 65 years, how the people of Germany could have voted for Hitler and cheered all his speeches, knowing what he stood for. How was that possible?

We get a glimpse of it here, as we see Germans cheering wildly for a Barack Obama that doesn't really exist, except in their minds. They must have thought that Hitler was going to save the world, and now they think that Obama is going to save the world.

But I'm unfair picking on the Germans. The Americans seem almost as crazed about the great Obama in the sky as the Germans are. The journalists can barely contain their enthusiasm. After Obama's Berlin speech, CNN's lovely smitten anchor Kyra Philips could barely contain her joy and enthusiasm, as she used the phrase "powerful speech" about five times. I wonder if she even knew what the speech was about? Or is she just happy that he isn't George Bush? (25-Jul-2008) Permanent Link
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Accused Bosnian war criminal Radovan Karadzic captured

Hiding in plain sight, he grew a beard and posed as a new age guru with a mistress.


Top left: "Dr. Dragan Dabic". Top right: Radovan Karadzic, mid-1990s. Bottom: Karadzic with his girlfriend Mila. <font face=Arial size=-2>(Source: FT/Daily Mail)</font>
Top left: "Dr. Dragan Dabic". Top right: Radovan Karadzic, mid-1990s. Bottom: Karadzic with his girlfriend Mila. (Source: FT/Daily Mail)

Radovan Karadzic, the military commander responsible thousands of deaths and numerous atrocities in the 1990s war in Bosnia, was captured on Monday near Belgrade, in Serbia.

Karadzic, an Orthodox Christian Serb, is considered a war hero by most Serbs for his military accomplishments in the war against Bosnian Muslims in 1992-95. But for most of the Western world, he's considered a war criminal, and has been indicted by a UN war crimes tribunal on charges of genocide and crimes against humanity.

After the war ended, Karadzic went into hiding, where he was given protection by those in the Serb population who knew who he was. During the 13-year manhunt for Karadzic, he was thought to hiding out in a farm somewhere where in Serbia where few would recognize him.

As it turns out, the bloodthirsty murderer had changed professions and become a new age health guru, taking the assumed name Dr. Dragan Dabic, and disguising himself with a long, grey beard and glasses. He lived for years in a Belgrade suburb with his mistress Mila, and frequently hung out with her in Madhouse bar, sitting unrecognized underneath a large wall picture of himself from his war days.

Bosnian War

The Bosnian War was a 1990s re-fighting of World War I, along the same Orthodox/Muslim religious fault line.

Historically, there is no greater hatred between two civilizations than between Islam and Orthodox (Eastern) Christianity. There have been major wars between Western Christianity and Orthodox Christianity, and between Sunni and Shia Muslims, but not as deeply penetrating as the wars between Orthodox Christianity and Islam.

From the point of view of Generational Dynamics, East Europe and West Europe are on different generational timelines.

World War II was a generational Crisis war for Western Europe, with England, France and Germany being the main protagonists.

For Eastern Europe, World War I was the Crisis war, and the Balkans (the former Yugoslavia), Russia, Turkey (the Ottoman Empire) and the Mideast were the main protagonists. England, France and Germany were involved in WW I, but not as a crisis war.

(For information about generational Crisis wars, and the differences between World Wars I and II, see "Basics of Generational Dynamics.")

For the most part, the East European crisis wars have been between two great civilizations: The Orthodox Christian civilization and the Muslim civilization. These wars have been fought not only in the Balkans, but also farther east in the Crimea and in the Caucasus.

World War I was triggered when a Serb high school student assassinated Austrian Archduke Franz Ferdinand on June 28, 1914 in Sarajevo. The spreading war led to the Bolshevik Revolution in Russia, and the destruction of the Ottoman Empire.

From the point of view of Generational Dynamics, the next Balkans war began pretty much right on time -- in 1992, just 78 years after the assassination of Archduke Ferdinand.


Slobodan Milosevic
Slobodan Milosevic

The Siege of Sarajevo was directed by Serbian president Slobodan Milosevic, and was executed by his two generals, Ratko Mladic and Radovan Karadzic.

The Orthodox Christian Serbs completely blockaded the city of Sarajevo, allowing no one to get out, or any supplies to get in. They then shelled the Muslim civilians in the city, and Serb soldiers went from one neighborhood to another committing horrendous atrocities.

In her book, World on Fire, here's how author Amy Chua describes the Bosnian war: "In the Serbian concentration camps of the early 1990s, the women prisoners were raped over and over, many times a day, often with broken bottles, often together with their daughters. The men, if they were lucky, were beaten to death as their Serbian guards sang national anthems; if they were not so fortunate, they were castrated or, at gunpoint, forced to castrate their fellow prisoners, sometimes with their own teeth. In all, thousands were tortured and executed."

The Bosnian War climaxed when tens of thousands of Bosnian Muslims had taken refuge in the Bosnian town of Srebrenica, supposedly a "United Nations Safe Area." The Serbs massacred thousands of Muslim men in what has become known as the Srebrenica massacre. (See "Srebrenica massacre: Survivors commemorate."


Radovan Karadzic, center, with his wife Ljiljana and Ratko Mladic <font face=Arial size=-2>(Source: Times Online)</font>
Radovan Karadzic, center, with his wife Ljiljana and Ratko Mladic (Source: Times Online)

Since the end of the war in 1995, Milosevic, Mladic and Karadzic have all been charged with ethnic cleansing, genocide, crimes against humanity, and war crimes.

Former Serb President Slobodan Milosovec was the first to be brought to trial. The trial was never completed, as he was found dead in his cell in March, 2006.

The capture of Radovan Karadzic brings another manhunt to a close, but the search is still on for the remaining general, Ratko Mladic.

The crisis war imperative

There are all kinds of ironies going on in this situation.

The Bosnian War genocide occurred in the same general time frame as the Rwanda genocide of 1994. United Nations officials have repeatedly held commemorations and ceremonies, declaring "Never again will we allow this to happen." But they always do.

In fact, the Bosnian War was only the most recent of a regular series of East European / Mideast crisis wars between the Orthodox and Muslim civilizations. Karadzic himself has said that he was avenging 1389, referring to the Battle of Kosovo that ended in 1389. Since then, new wars along the same fault lines have recurred with relentless regularity: the Fall of Constantinople (1453), Ottoman conquest of Syria and Egypt (1520), War with Habsburgs (1606), War with Holy League (1699), War with Russia (1774), Crimean War (1856), World War I (1922).

The following map from The Independent shows the various ethnic and religious fault lines in the Balkans:


Balkans fault lines <font face=Arial size=-2>(Source: Independent)</font>
Balkans fault lines (Source: Independent)

Most people think that wars are somehow rational, driven by greedy or obsessed politicians, inflicted on unwilling masses. If that were true, then Karadzic wouldn't be considered a war hero by masses of Serbs. Non-crisis wars are rational, but crisis wars are visceral, and are as much part of the human DNA as sex is. The human race could not have survived without sex, nor could it have survived without massive, genocidal, bloody crisis wars.

After each war, there's a vow of "Never again" among the generations of survivors. And as soon as those survivors are gone, replaced by younger generations born after the war, a new, horrible war begins again.

Here's what Telegraph reporter Martin Bell wrote yesterday, remembering the Bosnian war:

"And so began the most destructive war in Europe since 1945. It was a war that would cost 97,000 lives; drive more than two million people from their homes; and bring shame on the United Nations and the Western democracies. ...

My ... thought was: this is bad, and it is bound to get worse - a modern European city under siege by weapons mainly of First World War vintage, hundreds of thousands of people at risk and the world outside hardly cares. We should have needed no history lessons concerning the repercussions of a first shot fired in anger in Sarajevo.

Something else I found, as the front lines were established over that summer, was that a war like this could be a thing of spectacular beauty. It kept all hours. The Jewish cemetery, between Muslim and Serb-held parts of the city, was fought over day and night.

Parachute flares illuminated the ruins and added allure to devastation. Tracer fire rose and fell in a perfect parabola like a rain of molten hyphens. We caught it all on camera, and still no one cared.

Civilians, it seemed to me, were not just caught in the crossfire but were being deliberately targeted. There was a shortage of bread, so the snipers targeted the bread queues. There was a shortage of water, so they targeted the standpipes. ...

With the possible exception of Rwanda, it was the UN's darkest hour in modern times."

It's interesting that Bell's commentary at least mentions a connection between the Bosnian War and WW I, although he evidently considers it to be nothing more than a coincidence.

But why would it be the "UN's darkest hour in modern times?" The "killing fields of Cambodia" in the 1970s was a crisis war with some 8 million civilians killed. Why isn't that the UN's darkest hour? And of course, there's the current Darfur crisis civil war. Isn't that the UN's darkest hour in modern times?

In fact, the UN is completely irrelevant to these crisis wars. The UN could no more stop a crisis war than it could stop a tsunami.

Refighting World Wars I and II

Many of the great battles of World War I were refought in the 1980s and 1990s -- as the Iran/Iraq war, the Syria-Lebanon war, the Lebanese civil war, the Bosnian War, the Afghan war. But many other great WW I battles -- the Russian civil war, the Armenian massacre, the Mexican revolution -- have not yet been refought, and are still awaiting the right trigger.

In the meanwhile, it's getting to the time where some of the great WW II battles are due to be refought, especially Japan's invasion of Manchuria and China, and China's own Communist Revolution (civil war). Other battles of WW II might wait a few years to be refought, but with the right trigger they could begin again today.

When a war is "refought," it isn't a duplicate war. Quite the opposite, the new war appears sufficiently different that it catches the world by surprise. But when you look beneath the surface, the same old fault lines and hatreds are back. As Mark Twain said, "History doesn't repeat itself, but it does rhyme."

As we approach the "Clash of Civilizations" world war, history is about to rhyme again. Just as the Bosnian War wasn't a duplicate of WW I, the new world war won't be a duplicate of WW II. The UN and its politicians are completely irrelevant to this. The coming world war is a ten-mile-high tsunami that was launched decades and even centuries ago, and no politicians even have a clue that it's coming, let alone know how to stop it. (24-Jul-2008) Permanent Link
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Bad news: Continually falling earnings keep price/earnings ratios stratospheric

Good news: Disastrously low financial services earnings are still "better than we feared"

As regular readers know, every week or two I post the table of S&P 500 average corporate earnings estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters.

Here's the latest table for second quarter earnings:

  Date    2Q Earnings estimate as of that date
  ------- ------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%
  Jul  3:             -12.4%
  Jul  8:             -13.0%
  Jul 11:             -14.7%
  Jul 18:             -17.1%

Once again, earnings have taken a very big hit; during the last week, earnings growth estimates went from -14.7% to -17.1%.

As usual, a fall in earnings estimates means an increase of price/earnings ratios estimates. Here's the latest version of the graphic that appears on the bottom of the home page of this web site. Here's last Friday's version:


S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 18-July-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 18-July-2008. (Source: MarketGauge ® by DataView, LLC)

Price/earnings ratios are maintaining a stratospheric level of 21 or 22, far above the already extremely high level of 18 that investors have been targeting for the preceding four years. Assuming that investors continue to follow the same formulas that they've been following, market indexes will have to fall another 15% to bring P/E ratios down to 18.


Market summary, July 22,23, 2008
Market summary, July 22,23, 2008

However, that didn't happen on Tuesday or Wednesday. We said last week that the short-term direction of the market would probably depend on the actual earnings for financial services firms.

Well, those earnings have been pouring in, and they're absolutely devastating -- often -40% or -50% compared to second quarter of last year.

But guess what? Investors had been expecting -60% or -70%, and so the actual earnings are better than expectations!! So investors have concluded that the worst is over, and that it's time for the stock market bubble to start growing again!

Listening to the babble on CNBC, all I can do is repeat my usual total astonishment at the stupidity and obliviousness of the analysts, journalists, investors and politicians.

I'm not the only one who's noticing it this time. The Financial Times blog notes: "Five of the largest US financial institutions, led by Wachovia and Washington Mutual, reported combined quarterly losses of more than $11bn but their shares jumped an average of 14% on rising hopes that bank stocks have fallen about as low as they can go."

In fact, here's an article from Wednesday's New York Times that would be absolutely hilarious if it weren't describing a disaster:

"Can the bad news for banks get any worse?

After the last week brought another round of woeful quarterly results from the industry, capped by news on Tuesday of multibillion-dollar losses at the Wachovia Corporation and Washington Mutual, that question is nagging banking executives and their investors.

Kenneth D. Lewis, the chief executive of Bank of America, insisted this week that the industry was turning the corner, after his company reported a mere 41 percent drop in profit. Many investors seem to see signs of hope in red ink that once would have shocked them.

But it has now been a year since the credit crisis erupted, and, so far, the optimists have been proven wrong time and again. Skeptics say it could take years for banks to recover from the worst financial crisis since the Depression. And even when things do improve, the pessimists maintain, banks’ profits will be a fraction of what they were before.

There are many reasons for caution. Home prices continue to decline, and defaults are accelerating on a wide range of loans. As lenders struggle, loans are becoming even more scarce for hard-pressed consumers and companies. That, in turn, could slow any recovery in the broader economy.

For now, at least, some investors seem to have become so inured to the bad news that results that would have once been viewed as disastrous are now seen as good, or even great. The sober phrase often used on Wall Street to describe solid corporate results — “better than expected” — has been replaced by “not as bad as feared.”"

Even now, after all this time has passed, there's no hint here of any understanding of the world global situation from a system point of view, or how something that occurred decades ago could be affecting us today. There's no grasp of the fact that the stock market is overpriced by a factor of over 200%, as I described in "How to compute the 'real value' of the stock market."

With these people at the New York Times or CNBC or Wall Street Journal, history always begins this morning, and 99% of the time they don't have the vaguest clue what's going on. At least the Times finally acknowledges that they've been wrong over and over again.

The Telegraph's Ambrose Evans-Pritchard, who says that the European economic situation is worse than America's, now says, "The global economy is at the point of maximum danger. It feels like the summer of 1931. The world's two biggest financial institutions [Fannie and Freddie] have had a heart attack. The global currency system is breaking down. The policy doctrines that got us into this mess are bankrupt. No world leader seems able to discern the problem, let alone forge a solution."

And we might as well throw in the fact that the super-high prices for energy and food have thrown the economies of Vietnam, Bangladesh and Pakistan and other Asian countries into a near-crisis situation.

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. (23-Jul-2008) Permanent Link
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Bad news: America is failing. Good news: America is too big to fail.

Treasury Secretary Henry M. Paulson Jr. is arduously pushing his bailout plan for Fannie Mae and Freddie Mac, the government sponsored entities (GSEs) that guarantee about half of the mortgages on American homes, worth some $6 trillion.

Paulson is essentially asking Congress for a "blank check" to do whatever is necessary to keep the two companies afloat. "Congress understands how important these institutions are," said Paulson.

The message is clear: Fannie and Freddie are too big to fail.

If they failed, it would be disastrous to the American mortgage marketplace, and would trigger a severe chain reaction of bank failures.


Foreign holdings of non-Treasury American securities <font face=Arial size=-2>(Source: nytimes.com)</font>
Foreign holdings of non-Treasury American securities (Source: nytimes.com)

But there's another reason why they're too big to fail: Almost $1.5 trillion worth of Fannie and Freddie bonds are held by foreign investors. If Fannie and Freddie failed, then foreign investors would lose all faith in the credit quality of the entire US government.

As I've said for several years, it's been clear for a long time that the US government would never be able to redeem all the long-term Treasury bonds that it's issued -- something like $9 trillion dollars worth. However, last weekend's near failure of Fannie and Freddie has made that fact obvious even to normally oblivious investors.

The bailout of Fannie and Freddie would essentially mean that the $6 trillion of their debt would be added on to the US government's debt, which would now owe $15 trillion.

This is causing investors to start asking for the first time: Is America too big to fail.

An article on that subject goes into a great deal of detail to explain why it is:

"The logic for that assurance goes like this: The American consumer has for decades served as the engine of world commerce, using borrowed cash to snap up the accouterments of modern living - clothes and computers and cars now manufactured, in whole or in part, in factories from Asia to Latin America. Eliminate the American wherewithal to shop, and the pain would ripple out to multiple shores.

Globalization, in other words, allowed China and Japan to amass the fortunes they have been lending to the United States."

The article blames globalization for the situation, and implies that it's a rather new phenomenon to be in this situation.

In fact, that's not true. As we've said many, many times, from the point of view of Generational Dynamics, 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.

So there's nothing new about the current situation. What's going to happen next? We can look to the past to get an idea.

If you haven't read the fascinating story of "The bubble that broke the world," then now is a good time to do so. It's the story of what happened in 1930 and 1931, when the world's central bankers got together to save the world from financial collapse.

However, when you read that story, and compare to the situation today, remember that America was a creditor nation in 1931, but a debtor nation today. The debtor nation in 1931 was Germany, and the creditor nation today is China. Thus, we should expect China today to act like America in 1931, and America today to act like Germany in 1931.

Central bankers in Britain, the US and France got together with a plan to prevent the financial collapse of Germany by injecting huge amounts of liquidity into the European banks. It worked for a while, but not for long.

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

The statement "America is too big to fail" is the first step in repeating that process. Countries like China and Japan will realize that America is never going to repay its debt anyway, and so they'll cancel the debt, just as we canceled Germany's debt in 1931. But it won't work for long. How that failure will affect America and world remains to be seen. (23-Jul-2008) Permanent Link
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Barack Obama endorses growing American troop force in Afghanistan

The loony left ironically forces Obama to change from "anti-war" to "pro-war."

I was shocked earlier this week when CNN International gave 45 minutes of its one-hour prime newscast to Senator Barack Obama's speech to the NAACP. Senator John McCain's speech to the NAACP, arguably a more important news story, got about 30 seconds coverage. I guess I really shouldn't be surprised, after CNN practically turned the network over to the Democrats in the 2006 Congressional campaign. And now Obama is getting wall-to-wall "roadblock" coverage on all news networks on his overseas trip.

Obama has overwhelmingly one-sided news coverage. He appears to have the ability to get almost unlimited campaign funding. Almost everyone under 45 adores him, and Generation-Xers particularly love his contempt for and rejection of Boomer and Silent generation core values.

So it seems increasingly more probable that Obama will be our President next year, and increasingly more worthwhile for this web site to analyze not only how his attitudes reflect, and are affected by, public attitudes, but also how these attitudes will affect American foreign policy under an Obama presidency.

Obama becomes pro-war in Afghanistan

Leading Democratic party figures including Obama, disgraced themselves early in 2006 by committing themselves to America's failure and humiliation in Iraq. Obama himself specifically said that the "surge" would fail. Now that the surge has apparently been spectacularly successful, these Democrats have to face up to their positions.

As I wrote several weeks ago, Obama was attempting to "refine" his position in Iraq, but the loony left may harm him by forcing him to stick to his "immediate withdrawal" policy, which is not sustainable.

This has in fact happened, and Obama has apparently abandoned any attempt to "refine" his position on Iraq.

The thrust of the loony left in the Democratic Party might be characterized as "anti-Bush," "anti-American," and sometimes even "pro-terrorist." But the attitude was never really "anti-war," in any meaningful sense, and that's becoming increasingly apparent as Obama's policy towards Afghanistan becomes increasingly "pro-war."

This is the really ironic thing. As Obama is boxed into his "immediate withdrawal" position by the loony left, he's becoming increasingly strident and war-like in his policies toward Afghanistan.

Obama's interview on Face the Nation

Obama summarized his opinions in an interview with CBS foreign affairs correspondent Lara Logan in Kabul, broadcast on Sunday morning on Face the Nation:

Obama: "For at least a year now, I have called for two additional brigades, perhaps three. I think it's very important that we unify command more effectively to coordinate our military activities. But military alone is not going to be enough.

"The Afghan government needs to do more. But we have to understand that the situation is precarious and urgent here in Afghanistan. And I believe this has to be our central focus, the central front, on our battle against terrorism."

...

"The United States has to take a regional approach to the problem. Just as we can't be myopic and focus only on Iraq, we also can't think that we can solve the security problems here in Afghanistan without engaging the Pakistan government."

Logan: "And how do you compel Pakistan to act?"

Obama: "Well, you know, I think that the U.S. government provides an awful lot of aid to Pakistan, provides a lot of military support to Pakistan. And to send a clear message to Pakistan that this is important, to them as well as to us, I think that message has not been sent."

Logan: "Under what circumstances would you authorize unilateral U.S. action against targets inside tribal areas?"

Obama: "What I've said is that if we had actionable intelligence against high-value al-Qaeda targets, and the Pakistani government was unwilling to go after those targets, that we should. My hope is that it doesn't come to that - that in fact, the Pakistan government would recognize that if we had Osama bin Laden in our sights that we should fire or we should capture him."

Logan: "Isn't that the case now? I mean, do you really think that if U.S. forces had Osama bin Laden in their sights and the Pakistanis said 'No,' that they wouldn't fire or wouldn't go after him?"

Obama: "I think actually this is current doctrine. There was some dispute when I said this last August. Both the administration and some of my opponents suggested, 'Well, you know, you shouldn't go around saying that.' But I don't think there's any doubt that that should be our policy."

Logan: "But [not going after him] is the current policy."

Obama: "I believe it is the current policy."

Logan: "So there's no change, then?"

Obama: "I don't think there's going to be a change there. I think that in order for us to be successful, it's not going to be enough just to engage in the occasional shot fired. We've got training camps that are growing and multiplying."

Logan: "Would you take out all those training camps?"

Obama: "Well, I think that what we would like to see the Pakistani government take out those training camps."

Logan: "And if they won't?"

Obama: "Well, I think that we've got to work with them so they will."

Logan: "Would you consider unilateral U.S. action?"

Obama: "I will push Pakistan very hard to make sure that we go after those training camps. I think it's absolutely vital to the security interests for both the United States and Pakistan."

Logan: "You do have a situation seven years on into this war where Osama bin Laden and all his lieutenants and all the leaders of the Taliban, they're still there. They're inside Pakistan."

...

Logan: "What would be a 'mission accomplished' for you in Afghanistan?

Obama: "Well, a 'mission accomplished' would be that we had stabilized Afghanistan, that the Afghan people are experiencing rising standards of living, that we have made sure that we are disabling al-Qaeda and the Taliban so that they can longer attack Afghanistan, they can no longer engage in attacks against targets of Pakistan, and they can't target the United States or its allies."

Logan: "Losing is not an option?"

Obama: "Losing is not an option when it comes to al-Qaeda. And it never has been. And that's why the fact that we engaged in a war of choice when were not yet finished with that task was such a mistake."

Logan: "Do you believe the war on terror can't be won if Osama bin Laden is still alive and if he's still out there?"

Obama: "I think there would be enormous symbolic value in us capturing or killing bin Laden, because I think he's still a rallying point for Islamic extremists. But I don't think that by itself is sufficient. I think that we are going to have to be vigilante in dismantling these terrorist networks."

...

Logan: "Do you have any doubts?"

Obama: "Never."

When Obama says "Losing is not an option," he's talking a lot as President Bush did before (and after) the 2003 Iraq ground invasion. But why is he a little vague about those 2-3 brigades?

It seems that there's more to this story.

Did Face the Nation doctor the interview?

Like most mainstream news reporters these days, Face the Nation moderator Bob Schieffer has been totally in the tank for Obama for some time now. That's the only reason I can think of why the most newsworthy part of the interview was cut out from the presentation on his show.

The way that I know this is that those other parts are in a portion of the interview that was broadcast earlier on CBS News Sunday Morning. And the portions that were cut out are the portions where Obama made the most strident remarks about Afghanistan.

The following is my transcript:

Obama: "Right now, our most important strategic focus has to be to shut down al-Qaeda and the Taliban, and prevent them from being able to project their chaos and destruction to the far-flung corners of the globe, and that is going to have to be our top priority."


Unsmiling, sexy, sultry CBS correspondent Lara Logan interviews rock star Senator Barack Obama in Kabul. <font face=Arial size=-2>(Source: CBS)</font>
Unsmiling, sexy, sultry CBS correspondent Lara Logan interviews rock star Senator Barack Obama in Kabul. (Source: CBS)

Logan: "How deep is your commitment to that goal? How long would you be prepared to keep US troops in Afghanistam?"

Obama: "We have to win in Afghanistan."

Logan: "So losing is not an option."

Obama: "Losing is not an option when it comes to al-Qaeda, and it never has been."

Logan: "So what are the tangible changes that US troops on the ground will experience under your presidency?"

Obama: "Well, if you've got two or three additional brigades in Afghanistan, that's gonna obviously relieve the pressure on the troops who are currently here, who have to cover a huge amount of territory."

Logan: "So, two or three additional brigades won't make that much difference."

Obama: "Actually, it can make a significant difference here."

Logan: "And if those additional troops are not enough, then what?"

Obama: "We're gonna keep on going until we make it work."

Logan: "Would you send more of them?"

Obama: "I think right now let's see if we can get those two or three in."

I'm sure that if CBS were asked why this was left out of the Schieffer version, they'd give some spin answer. But the tone of this portion of the interview is far more warlike and strident than the other parts, even though CBS News Sunday Morning is really an entertainment show, while Face the Nation is supposed to be a hard-news show.

At any rate, this portion of the interview makes it clear that Obama is just as strident about Afghanistan as Bush was (and is) about Iraq. Obama is just as "pro-war" as President Bush is, as vice-president Dick Cheney is, Donald Rumsfeld is, as the neo-cons are, etc., etc., except that he's "pro-war" about a different war, and a far more dangerous war, and a war far more likely to escalate.

Logan and Obama

There's a side story here, as well. The interviewer is Lara Logan. Which of the following describe her?

The answer is "All of the above."

And now, Dear Reader, I'm sure you must be thinking, "Why in heaven's name is this stuff in the story? Is this just another one of your excuses to include a picture of a good-looking woman in the story?"

That may be one reason, but there's another reason, and it relates to the entire point of this story.

Lara Logan is young, super good looking, caught having an affair with a married colleague, pregnant, but still wants to be taken seriously as a foreign affairs correspondent. She has to work twice as hard to prove herself.

Bob Schieffer can doctor an interview tape and even be completely in the tank for Obama, and get away with it, because everyone "knows" that he's a hard-news, hard as nails, "unbiased" reporter.

But Logan can't get away with anything like that. She has to prove that she can handle the tough assignments and stand up to everyone. That's why she always had that weird, grim expression on her face during the interview. If she once smiled at Obama, she would be perceived as finding him sexy, and in the tank for him.

That's also why she asked Obama some very tough questions, and really cornered him on Afghanistan. It wouldn't surprise me to learn that Obama was surprised by the toughness of the questions, and perhaps got word to Schieffer to leave the tough parts out of the Face the Nation version of the interview.

Barack Obama has similar problems. He's young, he's a rock star, and having an affair with the loony left. He's not pregnant, but he's impregnated with their nihilistic, destructive view of the world, and can't break free, and still wants to be taken seriously as a Presidential candidate. He has to work hard to prove himself in foreign affairs.

John McCain doesn't have to prove himself. Everyone knows that he's a war hero, and that he's taken numerous trips abroad. If he took a position that was "soft" on Iraq or Afghanistan, he could get away with it, and no one would accuse him of being "soft."

But Obama can't get away with anything like that. He has to prove that he can handle the tough situations and stand up to everyone. That's why, after taking a weak position in Iraq, he has to compensate by taking a "strong" position in Afghanistan.

So swimsuit model Logan and rock star Obama have a lot in common and are very similar. Both want to advance in their careers. Both have used their good looks to advance this far. But now they want to get further ahead, and their good looks are perversely calling their abilities into question.

Actually, Logan has already gotten her promotion, as reported in an effusive Washington Post story that provides many details. In April, she was promoted to CBS's chief foreign affairs correspondent, and she now works in an office in Washington.

Obama is now looking for his own promotion -- to President. His trip this weekend is intended to prepare him for that.

Logan and Obama have something additional in common: Although they need to work hard to prove that there's more to them than their youthful good looks, in both cases most of their adoring fans really couldn't care less how much they know.

The war in Iraq


Admiral Mike Mullen, Chairman, Joint Chiefs of Staff <font face=Arial size=-2>(Source: Fox)</font>
Admiral Mike Mullen, Chairman, Joint Chiefs of Staff (Source: Fox)

Admiral Michael Mullen, chairman of the Joint Chiefs of Staff, was interviewed at length on Fox News Sunday. He responded to the "timetable" question for Iraq:

"WALLACE: But I'm asking you in the absence — forget about Obama. Forget about the politics. If I were to say to you, "Let's set a time line of getting all of our combat troops out within two years," what do you think would be the consequences of setting that kind of a time line?

MULLEN: I think the consequences could be very dangerous in that regard. I'm convinced at this point in time that coming — making reductions based on conditions on the ground are very important.

We've been able to do that. We've reduced five brigades in the last several months. And again, if conditions continue to improve, I would look to be able to make recommendations to President Bush in the fall to continue those reductions.

WALLACE: Why dangerous to set a timetable now for what's going to happen over the next two years?

MULLEN: When I have discussions with commanders on the ground, basically — and I did a couple weeks ago — they are very, very adamant about continuing progress, about making decisions based on what's actually happening in the battle space, and I just think that's prudent.

That's served us very well in — certainly, since the surge, which has been very successful, and I think will continue to serve us well based on the overall conditions that I see in Iraq right now.

WALLACE: And why? What would happen if you don't do it as condition-based? What if you sit there and say, "Right now, timetable, two years, all combat troops out?" What's the downside?

MULLEN: Well, it's hard to say exactly what would happen. I'd worry about any kind of rapid movement out and creating instability where we have stability.

We're engaged very much right now with the Iraqi people. The Iraqi leadership is starting to generate the kind of political progress that we need to make. The economy is starting to move in the right direction. So all those things are moving in the right direction.

And from the standpoint of moving forward, I think it's a pretty good path right now."

Obama is going to continue to have a great deal of trouble dealing with this question, thanks to his inability to stand up to the loony left.

The war in Afghanistan

I'm currently working on a full analysis of the war in Afghanistan, so I'll just briefly mention a couple of things here.

Obama's "two or three brigades" is modeled after the "surge" that worked so well in Iraq. However, Afghanistan is quite different, and a similar "surge" will not work in Afghanistan.

Afghanistan has much more complex ethnic and religious rivalries. Their last crisis war, the extremely bloody and violent 1992-96 civil war, involved multiple ethnic groups aligned largely as a war between Sunnis and Shia in Afghanistan.

That was never true in Iraq. Historically, in crisis wars, Iraqis have considered themselves to be Iraqis first, and Sunnis and Shia second.

Iraq was infiltrated by Sunni al-Qaeda fighters, but they had no safe haven, and were eventually expelled by the Iraqi Sunnis themselves.

Afghanistan has been infiltrated by Sunni al-Qaeda fighters, but they have safe haven in the Pakistan tribal regions (FATA). Furthermore, they're supported by the Sunni Pashtun/Taliban groups in the general public in Afghanistan, who see them as their allies in opposing not only the NATO forces, but also the Shia Hazara and related ethnic groups in the north.

In many ways, the Afghan war is, like the conflict in Kashmir, part of a larger proxy war between India and Pakistan. That proxy war is only going to escalate. As the US itself escalates in Afghanistan, it will eventually be pulled into the larger war, on the side of India.

There's one more very interesting thing that Obama said in the above interview. He referred to his previous statements that if he knew as President where Osama bin Laden was hiding in Pakistan, and Pakistan refused to do anything about it, he would send American forces into Pakistan to kill him.

In Sunday's interview, he said: "I think actually this is current doctrine. There was some dispute when I said this last August. Both the administration and some of my opponents suggested, 'Well, you know, you shouldn't go around saying that.' But I don't think there's any doubt that that should be our policy."

Obama may be onto something here: There may well have been a de facto change of policy since last August.

In August, Pakistan was still being led by a strong President Pervez Musharraf. Any talk about US forces in Pakistan could be dealt with directly and firmly.

But no more. Musharraf's power has been substantially eclipsed by parliamentary elections. He's no longer head of the army, and the army is now almost completely autonomous. The Pakistan government is paralyzed and rudderless, unable to cope with substantial problems. The strength of terror groups is growing. There were violent protests at the Karachi Stock Exchange last week, as the stock market appears to be crashing. The economy appears to be crashing too, thanks to surging food and energy prices. There are electricity shortages and even a water shortage.

And so, if Obama were President today, and ordered some kind of invasion of Pakistan to go after bin Laden or other terrorists, who in Pakistan would stand up to him? So things in Pakistan today really are quite different than they were last August.

Overreaction

From the point of view of Generational Dynamics, it makes little difference who is elected President. Either way, there will be a major financial crisis, and a "Clash of Civilizations" world war.

The difference is that President McCain would be a lot more steady.

President Obama would be young and forced to prove himself, and so he would overreact. We already see that in his warlike stance in Afghanistan.

However, that doesn't necessarily mean that he would provoke a war more quickly. The trend towards world war is based on huge generational changes in countries around the world, not on the actions of one country or one President.

The most that can happen is that a politician might say or do something that triggers a war response. It's even possible that historians looking back will say that the politician "caused" the war. But in fact, it was coming anyway.

No politician can predictably speed up or slow down the financial and war crises that are headed our way. All we can do is wait for them, and use the time to prepare for them as well as we can. (21-Jul-2008) Permanent Link
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More questions from readers on finance and investing

Anxious readers wonder what's going on, what to do next.

Last month's "Questions from readers on finance and investing" was only the beginning. I'll try to answer these questions as well as I can, but remember that we're headed for a crisis the nature of which is not fully known. All of these answers could be affected by chaotic (in the sense of Chaos Theory) events that can't be predicted, but these answers are the best I can give, based on historical trends that I've identified.

Where should I put my money?

"It is rather amazing to me that the current environment has very little to choose from in terms of a "safe haven." Where do you put your "money?" Gold could tank, the dollar could tank, the Euro could tank, banks could fail, the FDIC insurance may not be large/good enough....Personally, I am debt free and have a good chunk in cash and a bunch of freeze dried food but still feel "unsafe" and "unsure," even though I have a good grasp (maybe too good for my own good?) on what is going on in this messed up financial landscape. Any thoughts on this would be appreciated."

It looks like you're doing pretty well, but the question you raise is a very difficult one. How do you prepare for a crisis, when you don't know exactly what form the crisis will take?

My answer in the past has been: Cash, FDIC-insured bank accounts, short-term Treasury bills. However, recent events call for additional caution.

FDIC-insured bank accounts

Previously, I've suggested putting money into an FDIC-insured bank account, because I made the following assumption: That once a financial crisis occurred, there would still be some time before there were numerous major bank failures. After all, after the 1929 crash, the bank failures didn't really begin in earnest until 1931.

However, last week we had the collapse of IndyMac Bank, against the backdrop of the GSEs (Fannie Mae, Freddie Mac) bailout. Furthermore, there has been widespread publicity that the FDIC expects numerous additional bank failures, and some analysts are predicting that they may number in the hundreds.

This has created an atmosphere of extreme anxiety among depositors in general, despite the soothing words of government officials. We now have to assume that a major bank panic could occur at any time. Unfortunately, there's no way to predict the exact nature of that panic: How soon the FDIC will run out of insurance money, and how much additional funding the government will provide once that happens.

If you keep your money in a bank, then you should at least diversify -- spread it among two or three banks. If you have a safe in your home, they you could also keep some in your home.

If you have more than $100,000 total in all your accounts in any one bank, make sure that you take the time to check the FDIC insurance rules at the following site: http://www.fdic.gov/deposit/deposits/financial/examples.html

If you have anything different from a vanilla savings or checking account, then there may be other issues.

Update: If you have more than $100,000 in the bank, consider the Certificate of Deposit Account Registry Service (CDARS). This is a service offered by 2,000 banks and financial institutions, and provides FDIC insurance protection for up to $50 million. Here's how it works, according to the web site:

"Financial institutions can offer CDARS because they are members of a special network.

When you place a large deposit with a network member, that institution uses CDARS to place your funds into certificates of deposit issued by banks in the network. This occurs in increments of less than $100,000 to ensure that both principal and interest are eligible for full FDIC insurance.

Other network members do the same thing with their customers' deposits. With the help of a sophisticated matching system, network members exchange funds. This exchange occurs on a dollar-for-dollar basis, so that the equivalent of your original deposit comes back to your institution and effectively stays local (meaning the full amount can support lending initiatives that build a stronger local community). Alternatively, with your consent, network members can receive fee income instead of matching deposits. In either case, the full amount of your original deposit becomes eligible for complete FDIC protection and you receive just one regular statement detailing all your holdings."

Like anything else, you should carefully research this option for yourself before taking advantage of it. (Update added 21-July)

Treasury bills

For years, I've always recommended staying away from long-term (5, 10, 30 year) Treasury bonds. The reason is that there are trillions of dollars worth of these bonds being held by foreign governments, and with the balance of payments growing exponentially, it's been pretty clear for a long time that those bonds will never be redeemed.

The bailout plan for the GSEs (Fannie Mae and Freddie Mac) has now made these risks much more visible to the international investor community. The price of credit default swaps (CDSs) on US Treasuries has risen from 2 to 12 basis points. Translated into English, this means that investors are beginning to "bet" that the US government is going to default. As a practical matter, the US government could lose its AAA rating.

The immediate cause is that the planned bailout of the GSEs is going to add trillions of dollars of new obligations to the US government. As I said, it's been obvious for years that the US government would default, but these new obligations make it clear to a lot more people.

Of course the GSE bailout proposal is only a proposal - it still has to be approved by Congress. But it will be a big problem either way. Fannie and Freddie are "too big to fail," and so some kind of bailout is required, but the proposed bailout is a problem.

In my opinion, based on trends that I see, short-term (6-12 months) Treasury bills should still be safe investments for the near future. But the GSE problems do add a level of risk that didn't exist before. As I wrote in March, the interest being paid on Treasury bills is so low right now, that they probably are no longer worth the trouble for many people.

If you have enough money, however, then you may wish to include some T-bills as part of your diversification plan, in addition to spreading money around different banks.

Deflation and CPI

"Thank you for your extremely informative website. I'm just an average Joe trying to save my honest dollars. One thing I'm not quite certain of is exactly what you mean by deflation - or more precisely, what this deflation means to me."

Based on long-term trends, I'm expecting the CPI (Consumer Price Index) to fall, rather than increase. That means that things you buy will become cheaper, rather than more expensive. In 2004, I wrote that I expect prices to fall by 30% by the 2010 time frame, and that still seems to be a reasonable estimate, because of the financial crisis and deflationar spiral that seems to be more and more imminent.

"Thank you John, your common-sense analyses and straightforward explanations are truly one-of-a-kind. This makes me feel a little bit more secure about my dollars, but I still have my doubts about the security of US government debt (T-bills) and insurance (FDIC). What I was thinking is that the Japanese crash was like a generational reflection of the US in 1929 as creditor nation, while the incipient crash of the US market is a generational reflection of the Weimar republic as a debtor nation. In reference to your 2004 article about deflation, I'd say that you were absolutely right with the exception of gasoline. As an average joe buying regular stuff from Wal-Mart and the like, I'd say that prices for regular family stuff have decreased significantly from 2002 to 2006, especially in durable goods. Today it seems like prices are moving quickly back up, however, but it could just be my perception. I guess that's not the story that the CPI or the foreign exchange rate tells, but that's why the macroeconomic data consistently confuses me as a consumer. All that I can say is that I'm greatly more aware of the world for having stumbled onto your site and thus I will continue to learn as much as I can from it. Thank you again for such an excellent resource."

As you suggest, the CPI and the foreign exchange rate are different things. The CPI measures the rate of inflation internally within the country, while the foreign exchange rate measures inflation on international markets. The long-term trend that I described applies only to the CPI.

I do not know of any long-term trend that indicates whether the dollar's inflation rate internationally will be positive or negative (the latter being deflation). In fact, it could go either way, depending on chaotic events that can't be predicted.

The international value of the dollar depends not only on the dollar but also on competing currencies. The euro may be worse off than the dollar, for example, and in that case the dollar will become more valuable relative to the euro.

Incidentally, you mention the Japanese crash of 1990. It took 16 years for Japan to recover from that, and that provides an idea of how long it will take America to recover.

For further historical insight into what life will be like in the next couple of years, read the article on "The bubble that broke the world," which describes how things changed in 1930 and 1931.

Gold

"I know that you have been in the deflation camp and feel that gold is a bad investment for that reason. Do you thus disagree with the Bank of International Settlement's opinion that "disorderly decline in the value of the dollar cannot be ruled out"? Exchange rates and inflation/deflation are two different animals. However, in the event of a disorderly decline in the value of the dollar, it would be rather surprising to see gold go down in price."

Gold is now overpriced by a factor of 2 or so, because it's in a bubble, and when the bubble bursts, the value of gold will collapse.

However, that could change because of chaotic events that can't be predicted. As you suggest, in the case of an international emergency, such as a war or loss of faith in the dollar, then the price of gold may spike up again. If you think that might be the case, you might invest in gold, provided that you have the stomach to sell quickly, once that hoped-for spike occurs. (Many people would not do that, but would wait too long, until the price fell again.)

If you have enough money that you'd like to diversify even further than we've suggested in the preceding paragraphs, and you're willing to risk losing half your investment, then you may wish to purchase some gold. But for most people, investing in gold doesn't make sense.

Perhaps your situation is special. The issue for the next few years is survival. Will owning gold (instead of cash) help you survive? That's the decision you have to make.

Oil prices

"I read on one of your postings in June of this year that you believe speculators are not causing a big impact on oil price because they wouldn't be able to house the oil...In 2000 the CFTC (Commodities Futures Trading Commission) deregulated futures trading and as I understand it, this is what led to the Enron scandal and now to some extent, the high price of oil. It isn't required for futures contracts to be delivered, which is what allows the speculation.

As you may already know, McCain's economic adviser Phil Gramm (whose wife served on Enron's board ending sometime in the early 90's) had a hand in passing this legislation in 2000 and another bill called the Gramm-leachey-biley act I believe, which essentially repealed the Glass-Steagall Act.

Thanks for your diligent work on this site."

It is indeed possible to speculate on oil futures contracts, up to the point where it's necessary to take delivery of the oil. At that point, the price becomes real, and if there's been an artificially high futures price, then the delivery price would be significantly lower than the futures price, and apparently that hasn't been happening.

I think a lot of the confusion today has to do with confusing prices of futures contracts with prices of oil deliveries. One of them can be targeted by speculators, but the other one is real, and both of them seem to be in the $130s per barrel range.

Hari Seldon

"John, I really enjoy the website and your insights. Do you ever feel like that character from Isaac Asimov's "Foundation" [science fiction] novels, Hari Seldon? He was mapping out the future of universe, through what he called "psychohistory."

Sort of, but Isaac Asimov's psychohistory (Hari Seldon) was proven to be pretty much impossible in the 1960s and 1970s by the development of Chaos Theory. On my web site, I try to carefully distinguish between Generational Dynamics predictions (trend predictions) and probabilistic predictions (depend on chaotic events).

I discussed the whole subject in "Chapter 4 - Chaos Theory and Generational Forecasting" of my long languishing book, "Generational Dynamics for Historians." It's a bit out of date now, but it covers the subject.

How long will the crash last?

"Could we reach bottom in a matter of several months instead of years?"

The 1929 crash continued for three years. Could "modern technology" make it occur more rapidly today?

This would require many institutions to collapse very rapidly. It takes a long time period to build up an institution, and that time period can't be sped up in most cases. Similarly, it takes a long time to collapse an institution, and that time can't be sped up either, although it will typically be a much shorter time period than was spent building it up.

It's possible that major worldwide catastrophe -- such as a bird flu pandemic that kills hundreds of millions of people -- would speed things up a lot. That might bring about a bottom more quickly than three years, but this depends on chaotic events that can't be predicted.

Hiring a financial consultant

"Thank you for all the research you put out on Generational Dynamics. I just discovered it today, and I am looking forward to digging into your articles further. I came across your site after doing some research for money managers, and then started reading your stock market predictions. With a bleak outlook for the next several years, I was wondering if you have any specific advice you could share. I am 25, and my father recently passed away, and my mother and sister and looking to me to help manage his assets, but I have very little experience. Is there anyone or any firm you would recommend I get in touch with?"

I'd suggest that you hire me as a consultant, but everything I can say is already on my web site. Hopefully, the answers to the last five or six questions will provide you with some guidance.

If you decide to hire someone, then you have to understand that they have a conflict of interest. They make money only when you buy or sell. They don't care whether you make money or lose money, since they're just interested in their commission.

The winners in today's market are the ones that don't lose assets. That's the best suggestion I can give you.

Don't spend a penny

"Picture yourself a 30 year old father of 3 kids under 5. There is a lot of love in my household and not so much cynicism. What would be the best advice you could give for our immediate future? Thanks for your reply."

Picture a world where you're a 30 year old father with 3 kids under 5, you've lost your job with no hope of getting another job, so you and your family have to live for the foreseeable future on what you have today. How would you change your life?

You would save every penny, knowing that if you can save a dollar today, then that dollar may save your life a year from now. You would cut out every expense not necessary for survival - magazine subscriptions, piano lessons for the kids, clothes, movies, pizzas, wide-screen tvs, lights left on when nobody's around, driving when you can take the bus, etc., etc.

The best advice I can give you is to speak to your family now, tell them what's coming and why you have to save every penny, and then follow through.

One more thing: Many people should start thinking about moving in together. Two families sharing a home will save a lot of money. If your rich cousins have a couple of extra bedrooms in their mansion, ask them if you could live there. You'll both save a lot of money.

Conclusions

I wish I could give better answers to these financial questions, just as I wish I could give a straight answer when people ask me where the safest place is to live. Unfortunately, there are no certainties.

Actually, it's getting tougher and tougher for me to give answers to these questions, because of the way things are changing.

For example, a year ago I could unhesitatingly advise people to put their money into an FDIC-insured bank certificate of deposit. Today, because of the events last week, there is some risk attached to that advice.

All you can do is do your research and reach an educated conclusion on the best way to increase your probability of survival.

Remember that as a reader of this web site, you have a huge advantage over everybody else, because you know a lot about what's coming. If you've been reading this web site since 2003, then you knew long before other people did that there was a housing bubble, a credit bubble, and a stock market bubble. And you knew long before anyone else what was going to happen in Iraq, Darfur and other places in the world. (See "List of major Generational Dynamics predictions" for more information about these and other predictions.)

And since you know a lot more than other people, you're able to make much better decisions. Not only that, you're able to help other people, family and friends whom you would like to see survive as well as you do.

I thank the ever-increasing number of readers of this web site. I spend most of my spare time on this web site, but it's you that make it all worth it.

The amount of e-mail has been increasing, but I'm still managing to answer pretty much all of it, although sometimes it takes me longer than it used to. As usual, you're invited to send me a comment or question via the "COMMENT" link at the top of each page.

I'll end with the same message I've given many times: No politician can stop what's coming, any more than they can stop a tsunami. You can't stop what's coming, but you can prepare for it. Treasure the time you have left, and use it to prepare yourself, your family, your community and your nation.

Hopefully, this posting will help you prepare. (18-Jul-2008) Permanent Link
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SEC blames stock market problems on "false rumors" and "naked short selling"

Meanwhile, disappointed pundits bemoan Wednesday's market rally.

On Tuesday, July 15, the Securities and Exchange Commission (SEC) issued Emergency order 34-58166 (PDF) that begins as follows:

"False rumors can lead to a loss of confidence in our markets. Such loss of confidence can lead to panic selling, which may be further exacerbated by “naked” short selling. As a result, the prices of securities may artificially and unnecessarily decline well below the price level that would have resulted from the normal price discovery process. If significant financial institutions are involved, this chain of events can threaten disruption of our markets.

The events preceding the sale of The Bear Stearns Companies Inc. are illustrative of the market impact of rumors. During the week of March 10, 2008, rumors spread about liquidity problems at Bear Stearns, which eroded investor confidence in the firm. As Bear Stearns’ stock price fell, its counterparties became concerned, and a crisis of confidence occurred late in the week. In particular, counterparties to Bear Stearns were unwilling to make secured funding available to Bear Stearns on customary terms. In light of the potentially systemic consequences of a failure of Bear Stearns, the Federal Reserve took emergency action. ...

We intend these and similar actions to provide powerful disincentives to those who might otherwise engage in illegal market manipulation through the dissemination of false rumors and thereby over time to diminish the effect of these activities on our markets. In recent days, however, false rumors have continued to threaten significant market disruption. For example, press reports have described rumors regarding the unwillingness of key counterparties to deal with certain financial institutions. There also have been rumors that financial institutions are facing liquidity problems.

As a result of these recent developments, the Commission has concluded that there now exists a substantial threat of sudden and excessive fluctuations of securities prices generally and disruption in the functioning of the securities markets that could threaten fair and orderly markets."

What a pathetic agency the SEC has become, publishing garbage like this. The SEC was created in the 1930s. Its purpose was to prevent any new stock market bubble like the 1920s stock market bubble, with the intention of preventing anything like the 1929 stock market crash from ever happening again.

The SEC totally failed to prevent the huge 1990s dot-com stock market, and subsequently failed to prevent the even huger 2000s stock market bubble based on the housing bubble and the credit bubble. Having failed in its principal mission, the SEC is a total failure as an agency, and is now reduced to issuing regulations that border on gibberish.

Let's just make a few points:

There seems to be no limit to the insanity in today's financial marketplace.

Anger

I recently received the following message from a web site reader:

"The article about dumbing down IT was very interesting. it did seem, however, that the ranting almost got a little bitterness in it. I can understand that. I'm a 30 year old IT director, and I get more cynical everyday. What is the generational suggestion to guard my caring heart against that? Prayer is the only answer I suppose. Thanks for a great read."

Every now and then I get a complaint that I'm too "angry," and I can only agree. You wouldn't believe how angry and cynical I am. I've been writing for this web site for six years, and the stench of corruption and fraud -- from politicians, journalists, analysts, financial management, government regulators, and others -- has been overwhelming. After writing this web site for six years, I don't know how I could be anything BUT angry and bitter.

And now we have this garbage from the SEC saying that Bear Stearns collapse -- which occurred after months of provable lying and fraud by Bear Stearns, other financial companies, politicians, government regulators, analysts and journalists -- was caused by "false rumors." Let me apologize to those readers who are offended if they feel that this particular weblog posting is an "angry rant." If it makes you feel any better, I can assure you that the language that I'm using is extremely subdued, compared to the language that I'd like to use.

In response to the person who wrote the message, I wish I had an answer for your caring heart. All I can really do is repeat what I've been saying for years, as this day has approached closer and closer: No politician can stop what's coming, any more than they can stop a tsunami. You can't stop what's coming, but you can prepare for it. Treasure the time you have left, and use it to prepare yourself, your family, your community and your nation.

I'll be posting an article tomorrow giving specific advice and suggestions.

And now, back to our story.

Short selling

If you think that a stock price is going to go up, then you can buy shares today and sell them later, thus making money if you were right. That's called "going long" or "buying long."

If you think that a stock price is going to go down, then you can sell shares today (even if you don't have any shares to sell) and buy them back later, thus making money if you were right. That's called "going short" or "short selling."

In the typical case, the short seller doesn't have any shares to sell, and so he has to borrow some shares, paying a borrowing fee of about 0.2% of value of the shares. (By the way, borrowing fees have been increasing recently to as much as several percent, because of increased demand for borrowed shares for short-selling.)

So, in a typical case, there are four people in a short sale: The Trader who wants to short-sell, the Broker, the Lender who lends the shares, and the Buyer who buys the lent shares.

The Trader tells the Broker that he wants to short-sell for, say, three months. The Broker borrows some shares from the Lender, paying a borrowing fee on behalf of the Trader. The Buyer buys the lent shares, and the Broker puts the sale proceeds into an account on your behalf. At the end of the three months (or at any time before), the Trader can "cover his shorts" by purchasing shares to replace the ones he borrowed. If he was right, then the shares he purchases will be cheaper than the ones he sold, and he'll make money.

Short-selling is considered a perfectly acceptable practice, and has been for centuries.

Naked short selling

When a Trader and Broker execute a short-sale, they must obtain shares to be sold. The Broker may already own such shares, and can use those in the short sale, or the shares may be borrowed from a Lender. The rule is that the shares must be obtained and settled within three days.

If the shares are not provided within three days, it's called "failure to deliver." If the Trader never had any intention of providing shares, it's called "naked short selling."

Naked short sales are sometimes perfectly legal. For details, see SEC Regulation SHO, which gives examples of short sales and naked short sales that are legal.

However, naked short sales are illegal when their intent is to manipulate the market by driving the prices of shares down. The way this is supposed to work is that a large hedge fund registers a huge short sale for a particular stock, with no intention of borrowing the shares. The huge short sale looks like a sale to other investors, who panic and sell their own shares, thus driving the price down.

The SEC's new emergency regulation prohibits even those naked short sales that were formerly legal. However, this change only applies for the rest of the month, and only to short trades involving a specified list of financial institutions.

Apparently the intent is to see how this short term regulation works, and that will determine whether the regulation will be extended.

Pundits have been going nuts over this regulation. CNBC's Jim Cramer did a 5-minute on-air rant, waving around a piece of paper which he claimed was the SEC regulation that said that naked short sales have been illegal all along. However, that claim is wrong, as can be seen by reading Regulation SHO, referenced above.

Is the market plunge caused by naked short sales?

The SEC has failed to provide even a single credible example where naked short sales have driven share prices down.

The SEC, which has totally failed in its primary mission, is now looking for other people to blame. This is quite standard procedure, especially for government officials.

In fact, after the market crashed in 1929, a lot of people blamed the crash on short sellers. Here's a description from John Kenneth Galbraith's 1954 book The Great Crash - 1929:

"The decline had run its course. However, the end coincided with one last effort at reassurance. No one can say for sure that it did no good. One part was the announcement by the New York Stock Exchange of an investigation of short selling. Inevitably in the preceding weeks there had been rumors of bear raids on the market and of fortunes being made by the shorts. The benign people known as "they," who once had put the market up, were now a malign influence putting it down and making money out of the common disaster. In the early days of the crash it was widely believed that Jesse L. Livermore, a Bostonian with a large and unquestionably exaggerated reputation for bear operations, was heading a syndicate that was driving the market down. So persistent did these rumors become that Livermore, whom few had thought sensitive to public opinion, issued a formal denial that he was involved in any deflationary plot. "What little business I have done in the stock market," he said, "has always been as an individual and will continue to be done on such basis." As early as October 24 [Black Thursday in 1929], the Wall Street Journal, then somewhat less reserved in its view of the world than now, complained that "there has been a lot of short selling, a lot of forced selling, and a lot of selling to make the market look bad." Such suspicions the Exchange authorities now sought to dispel. Nothing came of the study." (p. 136)

In the end, the new investigation into short sellers is just as meaningless as the one in 1929. It allows government regulators to project the appearance of doing something, but in reality they're doing nothing.

Should you try short-selling?

Several people have criticized me for writing that short selling is dangerous because brokers' escrow accounts would be in jeopardy during a market crash that drover brokers into bankruptcy.

The situation that I envisioned was the following: The Trader (you) initiate a short sale. The Broker borrows stock, and sells it to the Buyer for, say, $100,000. The Broker keeps the $100,000. Now suppose the market crashes and falls 40%. You purchase back the shares for $60,000, and you've made $40,000. But suppose that the Broker goes bankrupt. Then you might lose the $100,000, and you'll end up still having to pay $60,000 to cover your short position.

A web site reader wrote to me as follows:

"That's not how it works. You keep confusing brokerage funds with customer funds. The $100,000 belongs to the customer, it goes into the customer's account, it is invested into whatever the customer wants to invest it in, most likely a money market fund. The money market fund most likely consists of US Treasuries which have no default risk (because once again, the government cannot technically go bankrupt, they are the ones that spend (create) money into existence, money that is backed by nothing)."

And so I put the question to an online correspondent into these things. He replied that the $100,000 would go into a segregated account that would be safe if the Broker went bankrupt during a market crash.

He provided some very technical additional information about what might happen if the market meltdown occurred while the short transaction was still being processed:

"As far as your question, yes, in the event of a market meltdown, any funds already present in a segregated futures account prior to the meltdown are safe. As I understand it, the funds are non interest bearing US dollars which are not dependent on the integrity of any underlying financial instrument. What would likely happen after any large and sudden financial meltdown is that the short would have a credit due on their position that would not be paid in normal fashion due to the fact that the long accounts would not have sufficient funds to sweep in the amount due....

Any trades consummated during the meltdown would work in the same manner. The customer's margin would be wired directly into the segregated account, but any profit on short positions taken during the meltdown would be subject to sweeping the available money out of the long accounts and there would likely be a shortfall in the case of a severe multi sigma (we could say) type of meltdown. As far as the brokerages, I seriously doubt what your correspondent is saying is correct, but ... I know of no brokerage that uses a treasury (t-bill) only money market account as their default account for customer funds. Any of the default money markets I have looked at are chock full of ABCP [asset-backed commercial paper] and other junk."

So I think the moral to this story is that if you have a very, very strong stomach, and you're willing to take some risks, then you might make a lot of money short-selling across a stock market crash, but you really have to know what you're doing. What's absolutely crucial is that you have to keep track of your money ($100,000 in the above example) and know where it is every minute. That money is the greatest potential source of disaster in short-selling into a market crash.

Incidentally, don't forget that short-selling can be disastrously expensive even during a "normal" transaction while in a bear market. The market today (Wednesday) rallied 2˝%, and if you had shorted the market, you would have lost a great deal of money.

The capitulation fantasy grows in importance


Market summary, 15,16-July-2008
Market summary, 15,16-July-2008

Pundits were happy on Tuesday, when the Dow Industrials fell 92 points, because they were sure that the market couldn't go much lower, and that capitulation was near.

One pundit wrote, "Capitulation is nigh!":

"Panic is in the air. ...

"[S]ome capitulation activity has been accelerated and the likelihood of an intermediate bottom forming today, tomorrow or Thursday is now over 95 per cent."

As we've previously said, the capitulation concept is a fantasy. It supposedly will occur after everyone sells off, giving up any hope that the market will go up again. At that point, goes the fantasy, the market will go up again.

The logical paradox is that everyone is expecting capitulation to occur after a couple of sharp market plunges, which will mean that everyone's given up hope. But since everyone knows that that means capitulation, everyone will expect the market to go up again, so capitulation hasn't occurred after all. So capitulation can never occur.


CNBC's Sue Herrera points to the word "Turmoil" in the Washington Post headline <font face=Arial size=-2>(Source: CNBC)</font>
CNBC's Sue Herrera points to the word "Turmoil" in the Washington Post headline (Source: CNBC)

But what I found interesting on Wednesday is the pathetic desperation in people's voices, asking each other, "Is this capitulation?" Here's one of many examples, from CNBC anchor Sue Herrera:

"We obviously read all the newspapers every morning, and this one caught our eye in a big way. I'm gonna hold it up, because there's a key word here. This is the Washington Post -- almost the entire front page is dedicated to the economy, and I'll point you to the word, right here, which is "Turmoil." an economy thrown into turmoil. Is that indeed the case? ...

If you look at the Washington Post and some of the magazines and some of the headlines, we could be looking at a point of capitulation. ...

This could really be a sign that we're near the bottom."

The capitulation fantasy is obviously growing, and is going to a major feature in the attitudes of investors.

Corporate earnings

I wrote the other day that the latest earnings update had mysteriously not appeared on the CNBC Earnings Central web site. Well, it did appear finally on Tuesday afternoon, and here is the resulting table:

  Date    2Q Earnings estimate as of that date
  ------- ------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%
  Jul  3:             -12.4%
  Jul  8:             -13.0%
  Jul 11:             -14.7%

As usual, corporate earnings estimates have fallen significantly for another week. Once again, this will push price/earnings ratios up higher, and that will cause formula-driven investors to sell off, driving the stock market down further. Well, at least there's some good news: That will make the "capitulation pundits" happy.

The second quarter earnings for financial services firms are starting to come in. Wells Fargo came in higher than expected on Wednesday, and that's one of the factors contributing to the Wall Street rally. JP Morgan Chase & Co. will be reporting on Thursday morning, and Merrill Lynch will be reporting late Thursday afternoon.

These financial service firm earnings will probably determine the short-range direction of the market. If they're better than expected, the market will go up, at least for a while; if they're as bad as expected, or worse, the market should continue going down.

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. (16-Jul-2008) Permanent Link
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The Top Ten signs that you have a bad bank.

Some advice from late night talk show host David Letterman.

From the Late Show with David Letterman: Now that IndyMac Bank has been closed, here are the Top Ten signs that you have a bad bank:


David Letterman
David Letterman

10. Teller asks, "How may I swindle you?"

9. Instead of Andrew Jackson, their $20 bills have a picture of Tito Jackson.

8. They promise they'll have your money if you come back after tonight's Keno drawing.

7. Interest paid not in money, but in Saltines.

6. ATM looks suspiciously like a Ms. Pac-Man machine.

5. Loan officer will approve your mortgage only if you let him rub you.

4. Bank robbers leave with a sack of IOU's -- that how bad things are, ladies and gentlemen.

3. Most banks are backed by the FDIC; your bank is backed by KFC.

2. They made $2 million loan to the Hillary Clinton campaign.

1. Manager giggles whenever he says, "Early withdrawal."

(15-Jul-2008) Permanent Link
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South Korea recalls its Ambassador to Japan over island dispute

The Korean government warned it would "sternly deal" with any Japanese claim to the disputed Dokdo islands.


The Dokdo/Takeshima islands, located in the East Sea/Sea of Japan <font face=Arial size=-2>(Source: BBC)</font>
The Dokdo/Takeshima islands, located in the East Sea/Sea of Japan (Source: BBC)

Korea's foreign ministry said, "The Korean government makes it clear once again that Dokdo is Korean territory, which is obvious when referring to history, geography and international law. Again, we’ll sternly deal with any attempt to undermine our sovereignty over the islets."

Japan's Prime Minister Yasuo Fukuda asked South Korea to show more understanding, and to act more calmly. "While we're coming from different positions, we need to overcome these differences and try to understand each other more deeply," Fukuda said.

Japan colonized Korea from 1905 until the end of World War II in 1945. In the subsequent international agreements settling the war, the status of these islands was left to be settled at a future date.

Tsk, tsk. If they'd understood generational theory, they would have realized that probably the only way the status would be determined is through another crisis war, 60-70 years later.

In 2005, this issue caused street protests in Seoul. Anti-Japanese feelings are deep in Korea, thanks to the 50-year occupation, and also because Japanese soldiers used Korean women as "comfort women" during World War II. Since then, both sides have made an effort to calm the demonstrations and rhetoric.

The issue flared up again because of a recent decision by the Japanese to mention the dispute in a teacher's guide to middle-school textbooks. The Korean Ambassador to Japan lodged a strong protest with the Japanese Foreign Ministry, and was then "temporarily" recalled home.

If you look at Japan's Foreign Ministry web site, you'll find a wealth of materials -- maps, histories, analyses, video presentations -- to prove Japan's claim to the islands.

If you look at South Korea's Ministry of Foreign Affairs and Trade web site, you'll find a similar collection of materials to prove South Korea's claim to the islands.

Take a look at this flash presentation on the Korean web site. It shows various photos of the islands. It's two rocks sticking out of the sea. If you look very, very closely, you'll see a tiny building that someone's built on top of the right-hand rock. The Koreans put that building there to establish their sovereignty.

The disputes contain a lot of nationalistic pride on both sides, but really no one cares much about a couple of rocks. As usual, it's not about anything but money. Whoever owns the islands also owns rich fishing grounds surrounding them, as well as potential gas reserves.

Surging food and oil prices are making populations in both countries anxious and panicky, and neither side wants to lose these riches. However, this dispute will not be settled except by means of a new crisis war. (15-Jul-2008) Permanent Link
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Investor and public anxiety levels are sky-high following weekend twin bailouts

300 more banks are thought likely to be facing failure, said according to RBC Capital Markets analyst Gerard Cassidy, who had in February estimated no more than 150.

Washington Mutual Inc. appears to be at the top of the list, along with a number of smaller banks. "You have to look at companies with the greatest exposure to the highest-risk assets, which include construction loans and exotic mortgages," Cassidy said. "The final nail in the coffin for any depository institution would be a funding crisis where it is unable to gather deposits at reasonable cost, or wholesale funding markets are cut off."

There were two bailouts over the weekend, following the economic turmoil that occurred on Friday. IndyMac Bancorp Inc. was nationalized by the FDIC, after panicky depositors withdrew $1.3 billion in deposits.

In a separate action, unrelated the IndyMac action except that they happened to occur on the same weekend, GSEs (government sponsored entities) Fannie Mae and Freddie Mac, which guarantee $6 trillion in mortgages, was promised unlimited funding by the Fed and the Dept. of Treasury, to prevent it from defaulting.


Market summary, 14-July-2008
Market summary, 14-July-2008

Wall Street markets opened much higher on Monday morning, with the Dow Industrials immediately gaining 170 points. By noon, however, investors had lost confidence, and the market had turned negative, and by 1 pm the market was well over 200 points below it's morning high. It end the day net down 45 points, 22% below the October high.

Crisis of confidence

As I've said many times, the ups and downs of the stock market are not important except insofar as they reflect the attitudes and behaviors of the large masses of investors.

It used to be that I would write about the euphoria and insanity of investors, as they pushed up the stock market indexes to ever newer highs, making the stock market bubble larger and larger.

For the last few months, it's been the opposite. Now it's the repeated lows that reflect changes in behaviors and attitudes -- for both investors and ordinary people. The totally irrational euphoria has been replaced by enormous anxiety. The "bad news is good news" syndrome is gone altogether.

For ordinary people, CNN had hours of programming on Monday on the economy. They referred to the stock market problems as a "crisis of confidence," and they sought to reassure bank depositors that their savings would be OK, even if their bank failed and the FDIC took over. Still, the news video showing hundreds of people standing in line to withdraw their deposits from IndyMac Bank in California really set the tone.

CNBC gave me the impression of chaos. There were lots of incredibly glum faces, but no one was saying much of anything except the usual sound bytes about strong fundamentals.

One thing that really set the tone for me is the increase in blame and finger-pointing, as evidenced by the fallout from Senator Charles Schumer's June 26 remarks that IndyMac's lax lending standards left it on the brink of failure. For the last three days there's been a spitball fight, with regulators blaming Schumer for sinking IndyMac, and Schumer blaming the regulators for not having done their jobs.

On Monday afternoon, analyst Chris Thornberg at Beacon Economics appeared on CNBC. He had said that the next batch of banks to fail will be banks with exposures to builders' loans, since commercial real estate is now failing in just the way residential real estate has been failing. But Thornberg refused to name names, for fear that he'd be blamed for anything that happened: "A lot of people are blaming Chuck Schumer for this. The only thing that Chuck did was point out what should have been obvious to investors in the first place, and that was that IndyMac was in big, big trouble."

Politicians and analysts have not been known for their honesty and openness for a long time now, but the Schumer drama is apparently casting an enormous pall that will keep anybody from saying anything negative. Do not, under any circumstances, believe any soothing words that you hear or read from anyone in the mainstream media.

Another indicator of anxiety is the MarketPsych investor fear index, which is computed by a computerized analysis of news stories in business publications. The index is computed essentially by counting the number of words in these stories that reflect anxiety, versus the number that reflect calm.

Here's Monday's version of the index:


MarketPsych Fear Index -- 14-July-2007 to 14-July-2008 <font face=Arial size=-2>(Source: Marketpsych)</font>
MarketPsych Fear Index -- 14-July-2007 to 14-July-2008 (Source: Marketpsych)

As you can see from the above graph, the index spiked high last August, when the global credit crisis began, and again in March, when the Bear Stearns crisis occurred. As you can see on the far right of the graph, in the last week, it's been spiking up again, higher than ever, indicating extremely high investor anxiety. This matches the chaos I saw on CNBC on Monday.

If I were to judge when the CNBC anchors appeared most anxious and panicky of all, it was when they were discussing the announcements of second quarter earnings for financial services firms. There was a brief discussion of the fear that Citibank, Merrill Lynch, and others will be announcing disastrous new asset writedowns. Other pundits said, essentially, "Well, maybe the earnings announcements will be better than expected."

On a related note, there's something strange to report. As regular readers know, each week I depend on the CNBC Earnings Central web site to tell me the latest estimate of S&P 500 corporate earnings growth, and I post a table showing how those earnings estimates keep falling, week after week. The CNBC web page is usually updated every Friday afternoon, but this week it hasn't been updated at all, so far. Now, it's a good thing that I'm not a paranoid person, or I would suspect that earnings estimates have fallen so far that CNBC doesn't want to risk shocking people by posting them. but since I'm not a paranoid person, I'm sure it's just an oversight, caused by someone being on vacation or something. (Update: The new stats appeared on Tuesday afternoon, 15-July.)

Actual second quarter earnings for financial services firms are going to start pouring in within a couple more days. These will probably determine the short-range direction of the market. If they're better than expected, the market will go up, at least for a while; if they're as bad as expected, or worse, the market should continue going down.

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. (14-Jul-2008) Permanent Link
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Economic turmoil increases as California's IndyMac Bank collapses

Fannie Mae and Freddie Mac are "insolvent"


Economic turmoil
Economic turmoil

Government officials, including President George Bush, Treasury Secretary Henry Paulson and Senator Christopher Dodd, were expressing confidence in the soundness of the American economy on Friday, as the bad news poured in. The problem is that, since the August 2007 beginning of the global credit crisis, there have been so many lies about the soundness of the economy coming from government officials and media sources like CNBC and the Wall Street Journal, that fewer people are finding such reassurance credible.

The Federal Deposit Insurance Corp. seized IndyMac Bancorp Inc. on Friday, after panicky customers withdrew $1.3 billion in deposits in the past 11 days. This may be the largest bank failure in US history, and the FDIC will pay an estimated $4-8 billion to insured depositors. About another $1 billion in deposits are uninsured, and depositors may still be able to recover half of those. The bank will reopen on Monday morning under a new name, the IndyMac Federal Bank.

IndyMac has been a troubled bank for a while, but the current panic is being blamed on Senator Charles Schumer, who said on June 26 that IndyMac's lax lending standards left it on the brink of failure. Senator Schumer was telling the truth, but he won't be saying anything like that again any time soon. This little drama shows why politicians, journalists and analysts simply cannot be trusted: If they tell the truth, then they're blamed for the results. So they lie about the soundness of the economy, so they won't be blamed for anything. (I've actually had a couple of people write to me suggesting that this web site might be causing people to panic and that I might be to blame for economic problems, a concept to which I can only react with ironic laughter.)

There was a lot more bad news on Friday as well. Stock prices for Lehman Brothers investment bank fell 16% on Friday, despite reassurances from the Standard & Poor's ratings agency that Lehman Brothers is financially sound. Lehman was once the largest U.S. underwriter of mortgage bonds, and has lost nearly 78% of its market value this year after reporting its first quarterly loss in its history.

We can really see the "chickens coming home to roost" here. S&P ratings has no credibility at all these days, after years of taking fat fees in return for AAA ratings for CDOs and other mortgage-backed securities that turned out to be worthless. Lehman Bros is now the smallest Wall Street investment bank, ever since Bear Stearns collapsed in March, and investors aren't taking any chances for fear that it might collapse as well.

Insolvency of Fannie Mae and Freddie Mac

The biggest news on Friday was the 20%+ plunge in stock share prices for Fannie Mae and Freddie Mac. Fannie and Freddie shares have both dropped more than 80 percent in the last year, because of the housing crisis. The two are called GSEs (Government Sponsored Enterprises), and they're responsible for guaranteeing most home mortgages. They've guaranteed $6 trillion in home mortgages, but the high foreclosure rate in the last year has put both agencies into technical insolvency, according to former St. Louis Federal Reserve president William Poole.

Should Fannie and Freddie be bailed out by the Federal government? It depends on whom you believe -- and keep in mind that there are no barriers to lying these days, among politicians, analysts and journalists:

Bank failures and the FDIC

You can take a look at the FDIC's failed bank list, and notice that bank failures are relatively rare:

These figures aren't so high, when compared to the almost 9,000 financial institutions whose deposits the FDIC insures.

However, that's about to change. In February, the Wall Street Journal reported that the FDIC was staffing up to handle the dozens of additional bank failures expected later this year and next.

This was confirmed on Friday, when FDIC Chairman Sheila Bair said that IndyMac could be the biggest bank failure in US history, and that there would be many more bank failures. (Other news sources say that the FDIC has 90 banks on its confidential watch list.) However, Bair adds, "There will be increased failures, but it will be within range of what we can handle. People should not worry." She added, "Nobody's ever lost a penny of insured deposits."

The last statement is true, but somewhat disingenuous. The FDIC was formed in 1933, after the last stock market crash, it's never been severely tested since then.

Besides, what would Bair be saying if she were worried that the FDIC was going to fail? The answer is that she would be saying exactly what she did say.

The collapse of Depression-era institutions

I recently wrote: "Basically, if a major banking crisis occurred, then the FDIC would run out of money." I referred to an article I wrote last year, "Is your bank deposit protected by the FDIC?"

I received the following criticism from a web site reader:

"Why do you keep posting stuff like this? FDIC is backed by the credit of the US government. For FDIC to run out of money would be for the US Government to run out of money. You know darn well that the US government can NEVER run out of money, because they are the ones that make it! Our money is not backed by anything. In case you haven't noticed we currently have a 9+ TRILLION dollar debt. Why haven't we "run out" yet? And at what point do you believe we will "run out"?

First off, I don't believe anything that government officials say these days. In particular, the soothing words of FDIC Chairman Sheila Bair would have been uttered no matter what the true situation was.

Second, the arithmetic doesn't add up. The FDIC has under $50 billion in its insurance fund, and it's losing $4-8 billion for just IndyMac. There are 90 more banks on the watch list, and that could eat through the entire fund very quickly.

Third, even that doesn't account for the chain reaction effect. Those 90 banks on the watch list are those that are ALREADY in trouble. If dozens of those banks are expected to fail, then many other assets (bank bonds, credit default swaps) will also lose value, leading to many more bank failures.

In fact, what we're seeing is the failure of one Depression-era institution after another.

Let's start with the dot-com bubble of the late 1990s. The Securities and Exchange Commission (SEC) was formed in the 1930s specifically for the purpose of preventing any such bubble from occurring. They had learned that the 1929 crash was the result of the 1920s bubble, so they wanted to make absolutely certain that no such bubble ever occurred again. The occurrence of the dot-com bubble, and subsequently the housing and credit bubbles, are testaments to the complete failure of the SEC.

The Federal National Mortgage Association, nicknamed Fannie Mae, was created in 1938 in reaction to the massive homelessness of the Great Depression, after so many people lost their homes through foreclosure. Its purpose was to make sure that every American family could live the American dream with his own home. In 1968, Fannie Mae was made into a private, shareholder-owned agency, since it was felt that it could make money on its own. However, it still had special privileges as a GSE (government sponsored entity) that made it a virtual monopoly. As a result, Congress created a competitor in 1970 -- the Federal Home Mortgage Corporation, nicknamed Freddie Mac.

Now Fannie Mae and Freddie Mac are insolvent.

In 2004, Fed Chairman Alan Greenspan gave a speech warning the Baby Boomer generation not to count on Social Security and Medicare. He advocated that policy changes be made immediately to protect the Social Security and Medicare programs, since the Boomer generation would begin retiring very soon. Well, Congress did nothing, of course, and the Boomers are now retiring, pushing those programs in the direction of insolvency.

People who say that there's no serious problem are only looking at one problem at a time.

If the FDIC were the ONLY problem, then we'd be OK.

If Fannie and Freddie were the ONLY problems, then we'd be OK.

If Social Security and Medicare were the ONLY problems, then we'd be OK.


UK housing price index from mortgage lender Halifax <font face=Arial size=-2>(Source: Telegraph)</font>
UK housing price index from mortgage lender Halifax (Source: Telegraph)

For that matter, if the US economy were the only one in trouble, then perhaps things wouldn't be so bad.

But in the UK, the slide in housing prices is the worst since the Great Depression.

In Spain, government officials have been shocked by the intensity of the downturn now engulfing the country. Car sales fell 31% in June, industrial production has fallen 5.5% over the past year and the collapsing property sector is shedding almost 100,000 jobs a month.

In France, industrial output fell 2.6% in May, and in Germany it was down 2.4%.

China's stock markets are crashing big time, and there are plenty of good reasons to believe that China will have some sort of financial crisis once the Olympics games end. In addition, the economies of many emerging markets are collapsing, including Iceland, Vietnam, Russia and China. Soaring food and oil prices are making thing worse everywhere.

Each one of these problems, when looked at in isolation, might be solvable. But when you put everything together, you see a massive slide into financial chaos in progress. The entire financial structure built by the generations that survived the Great Depression and World War II has been sabotaged by ignorant and destructive Boomers and Generation-Xers.

The climax of my "bloated mansion" analogy appears to be getting closer and closer each day. Here's how I described it in November of last year:

"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."

And so, the final answer to my web site reader's question is that the printing presses can't possibly print fast enough to keep up with all this.

Government institutions around the world made many promises after World War II. They promised a world where everyone could eat, everyone could survive, and everyone could have a decent life. All of those promises are now coming into question. It will not be possible for any but a small portion of those promises to be kept.

Which promises will be kept and which will be discarded? What kind of triage process will be used?

It's impossible to predict with certainty, but some clues are provided by Neil Howe and the late William A. Strauss, founding fathers of generational theory, on whose theory Generational Dynamics was originally based. On page 258 of their book, The Fourth Turning, they describe historically what happens when a major disaster (like the 1929 crash or the bombing of Pearl Harbor) propels a society from a generational Unraveling era into a generational Crisis era:

"Private life also transforms beyond prior recognition. Now less important than the team, individuals are expected to comply with the new Fourth Turning standards of virtue. Family order strengthens, and personal violence and behavior now face implacable public stigma, even punishment. Winner-take-all arrangements give way to enforceable new mechanisms of social sharing. Questions about who does what are settled on grounds of survival, not fairness. This leads to a renewed social division of labor by age and sex. In the realm of public activity, elders are expected to step aside for the young, women for men. When danger looms, children are expected to be protected before parents, mothers before fathers. All social arrangements are evaluated anew; pre-Crisis promises and expectations count for little. Where the Unraveling had been an era of fast-paced personal lives against a background of public gridlock, in the Crisis the pace of daily life will seem to slow down just as political and social change accelerates."

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-Jul-2008) Permanent Link
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CNNMoney.com's 'Depression Comparisons Misguided' shows that a depression is imminent

Guest article by Paul Lamont, President of Lamont Trading Advisors, Inc.

After reading CNNMoney.com Editor Paul La Monica’s piece on the comparisons to the Great Depression we felt compelled to respond. Unfortunately for Mr. La Monica, the article regurgitates common beliefs about the Depression which conflict with historical fact and basic economics. We hope to set things straight. We begin with Mr. La Monica’s words:

“The unemployment rate skyrocketed during the Depression, peaking at nearly 25% in 1933. The current unemployment rate is just 5%. And that's only up from 4.5% a year ago. Contrast that with the far more explosive spike at the beginning of the Great Depression - from about 3% in 1929 to nearly 8.7% in 1930, according to the U.S. Bureau of the Census.”

These numbers are accurate. However Mr. La Monica’s use of a lagging indicator for his strongest point is telling. The economy won’t experience the highest unemployment numbers until it hits bottom. At that point, his commentary would be too late to be of any use.

“Another hallmark of the Depression was deflation, which is obviously not happening today. Wages are rising - albeit by less than many would like.”

Once again we agree. Deflation was the hallmark of the Depression. But deflation is evident by the fall in the general price level, not just wages. Today a larger, more widely held asset class is falling in value than coincided with the beginning of the Great Depression. Does that mean it could be worse? The rise in wages is not good news either. According to Murray Rothbard, real wages were increasing into 1931, “thereby greatly aggravating the unemployment problem as time went on.” Perhaps this could cause the ‘explosive spike’ in unemployment that Mr. La Monica first cites. He continues with a description of how different it is today:

“The main fear is inflation in the cost of food and oil. And there's reason to believe that inflation pressures may eventually ease since there is a bit of a speculative bubble going on in commodities. Plus, if the Federal Reserve can stabilize the dollar, that could cool off the recent run-up in gas and food costs.”

Inflation fears were the main concern during 1930-1933 as well. It was given by investors as the ‘excuse’ for the U.S. corporate bond sell-off. Simultaneously, the CPI was falling. A speculative commodity bust (see chart below) and a rising U.S. dollar would also fit with the onset of the Great Depression. Mr. La Monica’s analysis of today’s environment could have been given in 1930.


Commodity Index, 1910-40
Commodity Index, 1910-40

Mr. La Monica continues:

“Finally, there's the issue of the stock market. I've taken a lot of flack for mentioning the bounceback in stocks since many readers seem to think that what happens on Wall Street does not affect Main Street.”

This is where similarities are even more exact.


Dow Industrials, 1928-33
Dow Industrials, 1928-33

As you can see from the chart above, after the initial Crash of 1929, the DJIA bottomed out in November. Its ‘bounceback’ lasted until April of 1930, (a typical .618 retracement, check your S&P500 chart of the recent rally, yes same .618 rebound) at which time it was generally accepted that the ‘worst was over.’ Even Hoover remarked in a speech on December 5th that the worst was behind them (according to Murray Rothbard, America’s Great Depression). What occurred next is related to us by Frederick Lewis Allen in Only Yesterday

“During the first three months of 1930 a Little Bull Market gave a very plausible imitation of the Big Bull Market. Trading became as heavy as in the golden summer of 1929, and the prices of the leading stocks actually regained more than half the ground they had lost during the debacle. For a time it seemed as if perhaps the hopeful prophets at Washington were right and prosperity was coming once more and it would be well to get in on the ground floor and make up those dismal losses of 1929. But in April this brief illusion began to sicken and die. Business reaction had set in again. By the end of the sixty-day period set for recovery by the President and his Secretary of Commerce, commodity prices were going down, production indices were going down, the stock market was taking a series of painful tumbles, and hope deferred was making the American heartsick.”

This ‘third leg of the bear market’ (1930 to 1933) was characterized by the failure of the banking system to provide credit and money for the proper functioning of the economy. With bank failures currently looming, we ignore history at our own peril.

Mr. La Monica continues:

“Keep in mind that the Depression was kicked into gear, if not necessarily caused, by the stock market crash of October 1929… The Depression was a product of a one-time shock that took years to recover from.”

Today’s credit markets have not recovered from this ‘one-time shock’ either. The main crash has already occurred in the value of real estate loans held by financial institutions. Writedowns have already totaled $380B. However rating agencies and financial guarantors have allowed bankers to prevent realization of most of the losses and subsequent forced increases in reserves. As Warren Buffet recently stated, “You've got a lot of leeway in running a bank to not tell the truth for quite a while.” According to Homer Hoyt in One Hundred Years of Land Values in Chicago; “Real-estate loans, not failed stockbrokers’ accounts, were the largest single element in the failure of 4,800 banks in the years from 1930 to 1933.” Mr. La Monica goes onto say:

“The massive plunge in the value of an asset, in this case stocks, sent the economy spiraling into its most severe downturn in history.”

Replace ‘stocks’ with ‘real estate’. Mr. La Monica then cites Chris Probyn, chief economist of Global State Street Advisors, for the reason ‘why today is different.’

“’But the Fed has cut interest rates. Congress has responded aggressively with a fiscal stimulus package,’ Probyn added.’ One of the problems in the Great Depression was that there was no fiscal policy employed preemptively to stop it.’”

This is easily dismissed, because it is factually incorrect. According to Murray Rothbard, before October 1929, the rediscount rate was at 6%. It was lowered to 4% in November 1929, 2% by December 1930, and finally 1.5% in mid-1931. At the same time, President Hoover “increased expenditures by $130 million of which $50 million was new construction.” State and local governments increased expenditures by $700M. The Hoover Dam began construction in 1931. Despite (relatively) greater fiscal stimulus as well as drastic rate cuts, the fractional reserve banking system collapsed in 4 years. Why? Bankers were unable or unwilling to lend, either because of continued losses on real estate loans or because of a run on deposits. The unavailability of credit and money caused the deflationary spiral of the Great Depression.

Nothing New Under The Sun

Currently, the Federal Reserve is providing banks access to half of its balance sheet as the lender of last resort. This is to keep the banking system lending. However further mortgage downgrades, financial guarantor failures or the complete use of the Federal Reserve balance sheet could force banks into crises similar to that of 1930-33.

We don’t like the similarities either. But we also can’t ignore them. Mr. La Monica’s article represents the current widespread belief that is so commonly wrong at major market turning points.

Paul J. Lamont is President of Lamont Trading Advisors, Inc., a registered investment advisor in the State of Alabama. (10-Jul-2008) Permanent Link
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Pundits and analysts are baffled by the market's performance

They have some interesting fantasies, as well.


Market summary, 9-July-2008
Market summary, 9-July-2008

The Dow Industrials fell another 2.08% on Wednesday. The index is now at 78% of its October high.

These dreary plunges aren't going to continue long, according to some analysts.

In fact, the analysts at Deutsche Bank AG, Lehman Brothers Holdings Inc. and UBS AG say that things will really take off in the second half of 2008. They say that the market indexes will gain the most in 26 years! Pop the champagne! The party is on again!


Ashwani Kaul, Thomson Reuters director of research <font face=Arial size=-2>(Source: CNBC)</font>
Ashwani Kaul, Thomson Reuters director of research (Source: CNBC)

How can these analysts possible believe that kind of fantasy? Well, it turns out that it depends on another fantasy that they believe in.

On Tuesday morning, Ashwani Kaul, director of research at Thomson Reuters, was on CNBC talking about corporate earnings. He said that they're now estimating that S&P 500 earnings for the second quarter have fallen 13% from the second quarter of last year.

As regular readers know, I frequently post the estimated corporate earnings for the most recent quarter, and show how the estimates keep falling, week after week. Well, Mr. Kaul was kind enough to provide one more data point.

With that, here's the latest table for second quarter earnings:

  Date    2Q Earnings estimate as of that date
  ------- ------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%
  Jul  3:             -12.4%
  Jul  8:             -13.0%

As usual, the earnings estimates have fallen again in the 5 days since the last estimates was posted on CNBC Earnings Central. Lower earnings estimates mean high price/earnings ratios (valuations), motivating investors to sell off their stock holdings. That's why the market has been falling.

Well, Mr. Kaul was kind enough to go and give us his estimates for the third and fourth quarters:

Quarter              Earnings growth estimate
--------------       ------------------------
Third quarter        +13%
Fourth quarter       +59%

Wow! No wonder the pundits believe that the stock market is going to take off like a rocket.

How do they justify this fantasy? Well, third quarter earnings last year were pretty bad, and fourth quarter earnings were VERY bad. And so, this year's quarterly earnings will grow 13% and 59% respectively, because the growth results will be computed based on last year's lowered earnings.

Now this is really interesting reasoning. I always talk about the Law of Mean Reversion, meaning that earnings have been well above average for many years, and so they'll have to be equally below average for approximately the same number of years, so that the historic average will be the same.

But these pundits have invented an entirely new law: The Law of Bubble Reversion. According to their reasoning, the recent fall in earnings growth was just a blip, and earnings will recover just as if that blip hadn't happened. So earnings will be back in full bubble mode.

The Law of Bubble Reversion. I like it! And the "Bubble Reversion" concept goes so well with the hopes and dreams that the days of the champagne parties will return again.

And why do they think that Bubble Reversion will occur, and push earnings growth up to 59%? Well, that depends on yet a third fantasy.

Kaul said it during his CNBC interview -- that the 13% and 59% figures are computed under the assumption that the asset writedowns are over.

Well, we've heard that before, haven't we. Do you remember, Dear Reader, what I wrote on October 25 of last year, just after Merrill Lynch had shocked Wall Street with a massive $8.4 billion writedown?

Here's an excerpt from that article:

"At any rate, bubbly investors now have one less hook on which to hang their hats.

In the "bad news is good news" frame of mind, investors have been treating previous writedowns as a good thing. The phrase we've been hearing was that the third quarter was a "kitchen sink" quarter, meaning that financial institutions would get all their writedowns out of the way in the third quarter, so that they could go back to inflating the bubble in the fourth quarter.

This concept is no longer viable. It's now clear that, at best, financial institutions have no idea how big their exposure is and, at worst, they do know, but are fraudulently hiding it from the public.

Either way, bubbly investors are now beginning to realize that the "kitchen sink" concept doesn't work, and that there will be a lot more writedowns in the quarters to come.

And with foreclosures surging and real estate prices falling, it's increasingly clear that much worse is yet to come."

Remember that great phrase, "kitchen sink quarter?" Last year's third quarter would be a kitchen sink quarter, when all the writedowns would be taken, and the bubble could grow again.

Well, Dear Reader, we heard the same thing at the end of the fourth quarter, at the end of the first quarter, and now again at the end of the second quarter.

It's impossible on its face. Residential housing prices are still falling, and foreclosures are still increasing, and are expected to continue increasing into 2010. The asset writedowns are directly linked to the increasing foreclosure rate, and so obviously the writedowns are going to continue and increase.

I just have to take a breath here, before we go on to the next step. You know, I've been writing for this web site for six years now, and I've discussed so many unbelievably stupid things said and done by analysts and reporters and politicians and government officials, and yet each new example astonishes me just as much as the previous ones.

But of course it's much worse than stupidity. As I've outlined in detail many times, these same analysts, reporters, politicians and government officials have committed fraud or have been complicit in fraud. Even today, certain government officials are encouraging and helping banks to hide the true values of their assets, thus defrauding investors who continue to buy stock shares in the banks. The stench of corruption and fraud continues to be sickening, as it's occurred throughout the finance industry, the real estate industry, the IT industry, and probably every other industry as well. An online correspondent has told me that she's seen massive fraud and loss of ethics among lawyers and judges as well.

Anyway, back to our story.

We were saying that it's ridiculous on its face to assume that the asset writedowns are over, but the ridiculousness has been confirmed by a confidential study from hedge-fund firm Bridgewater Associates Inc. The study was leaked to a German language newspaper, and their article was translated by the Infectious Greed blog by Paul Kedrosky:

"Explosive Study: The banking crisis will be much worse

Westport (USA) - The expected losses from the financial crisis will reach $1600 billion [$1.6 trillion]. To-date financial institutions have so far announced only $400 billion. The pessimistic forecast comes from a confidential study by Bridgewater Associates, the second largest hedge fund in the world.

"We are facing an avalanche of bad assets," says the study. The biggest losses were the U.S. credit banks before. "We have big doubts that the financial institutions will be able to have enough new capital in order to cover the losses," the authors write.

Bridgewater Associates in financial circles enjoy a first-class reputation, several central banks are among its customers. "Bridgewater are on the pessimistic side," says George Magnus, Senior Economic Adviser at UBS in London, "but they are absolutely right."

Well, let's see. The credit crisis began last August, just after the Bear Stearns writedowns began. That's 11 months. According to this report, only 1/4 ($400 billion) of the total writedowns ($1.6 trillion) have yet occurred. That would seem to indicate that the writedowns will go on for another 33 months, if the writedowns continue at the same rate.

Actually, that's not what's going to happen. At some point there's going to be total panic. That's the scenario that Oppenheimer analyst Meredith Whitney predicted, as she laid out the template for the coming financial crisis.

Anyway, anyone who's betting that those 13% and 59% growth figures are going to come to pass are going to lose a lot of money.

The capitulation fantasy - a logical paradox

There's one more fantasy to mention. It's something that I wrote about a few months ago.

According to what the pundits keep saying, capitulation occurs when investors lose all hope, and when they do, the market will go up again. They talk about capitulation on CNBC every day. "Do you think this is capitulation?" the anchor will ask the guest. The guest usually answers, "No, I don't think it's capitulation yet."


Carter Worth, Oppenheimer chief market technician <font face=Arial size=-2>(Source: CNBC)</font>
Carter Worth, Oppenheimer chief market technician (Source: CNBC)

After the Wall Street markets closed on Wednesday, Oppenheimer's chief market technician, Carter Worth, described why capitulation hasn't yet occurred. He noted that the market had just gone down 236 points, but went UP 152 points for a big rally on Tuesday:

"The problem is not today. The problem is yesterday. That's exactly what we don't need. We can't have those kinds of rallies. It needs to go down 300 for the market, next day down 300, next day up 20, then down 300. Then we'll get this done. But the hope is alive. As long as the hope's alive, the bear market's very much intact."

In other words, when the market goes down another 1200 points or so, to approximately the Dow 10,000 level, then everyone will lose hope, and the market will go up again.

This is insanity at so many levels, it's hard to know where to begin.

First of all, why would anyone lose hope? All the brokers, analysts and investors watch CNBC, where they talk about capitulation all the time. If the market suddenly went down to 10,000, all the girls on CNBC would be squealing, "It's capitulation!!! It's capitulation!!! That means the market is going up again!!!" Instead of losing hope, everyone's going to believe that the worst is over, and the champagne party will begin again.

Thus, we have a logical paradox. If capitulation occurs, then everyone on CNBC will tell the world that it's occurred, and everyone will assume that the market will start going up again, so capitulation hasn't occurred. So capitulation can't possibly occur.

For some reason, this logical paradox doesn't occur to all these anchors and guests and CNBC. I guess it's just another one of those things that's so complex and abstract that only readers of this web site are capable of understanding it.

If you look at my Dow Jones historical page, you can see how all this worked out after the 1929 crash. The market kept falling until summer, 1932, when it reached 10% of it's peak value in 1929.

But it didn't go straight down. The market rallied frequently during those three years, sometimes a great deal or for a very long time. Whenever one of those rallies occurred, President Hoover would say, "The worst is over!" But somehow it never was. They didn't use the word "capitulation," but it was the same thing.

As gruesome as it is for me to follow what's happening today, and write about it almost every day, it's also incredibly fascinating to see how the things that are happening today explain the mysteries of what really happened in 1929.

I've quoted the following paragraph from John Kenneth Galbraith's 1954 book The Great Crash - 1929, where he contrasted the 1929 with previous panics, but I never really had a feel for what was really going on. Now I do:

"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)

This is the capitulation concept in a nutshell. The same logical paradox occurring today also occurred in 1929-1933. Maybe they didn't use the word "capitulation," but they were expecting the same thing: A few sharp market plunges, everyone would lose hope, and the market would go up again. But everyone knew that the market was supposed to go up again, so they never really lost hope. So the market kept falling. I would guess that by summer 1933, when the market had fallen 90% from its peak, people really DID lost hope.

We've discussed so many hopes, dreams and fantasies in this article, that it's good to remember how we know that a crash is coming.

As I've been saying hundreds of times since 2002, the stock market is overpriced by a factor of more than 200%, 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

The historic average of the P/E1 (price divided by one-year trailing earnings) is about 14. From 1995 to the present, it's averaged around 25, creating a huge bubble. By the Law of Mean Reversion, the price/earnings ratio will fall well below 10 for a dozen years or so. You can see that it's poised to fall quickly in the near future, leading to a stock market crash.

Forget the CNBC fantasies. Forget the imaginary Law of Bubble Reversion. Here's the reality.

Over the next couple of weeks, actual second quarter earnings for financial services firms will be announced. These will probably determine the short-range direction of the market.

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. (10-Jul-2008) Permanent Link
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Obama "refines" his Iraq position, reflecting major change

Expect a lot more "refinements" to come

Barack Obama insisted this week that he hasn't changed his position on the Iraq war, only refined it.

Actually, it was a fairly dramatic change. He's previously demanded that President Bush "bring the troops home NOW," then said that as President he'd have them out in 2009, then within 16 months. And now he's refining his 16 month claim.


Ted Koppel on <i>This Week With George Stephanopoulos</i> <font size=-2>(Source: ABC)</font>
Ted Koppel on This Week With George Stephanopoulos (Source: ABC)

According to veteran news reporter Ted Koppel, appearing on Sunday on This Week With George Stephanopoulos, Obama will have to make many more refinements:

George Stephanopoulos: "It does look as if Barack Obama is in a double bind. If he does have a huge shift in emphasis, people will say he's unprincipled, he's coming off his positions. If he doesn't, he gets accusing of being out of touch, not listening to what's going on, not watching what's going on on the ground in Iraq."

Ted Koppel: "You know George, you said we were going to get to the energy thing later. Let me suggest we get to the energy thing right away.

I think Senator Obama's advisors have conveyed to him what I'm sure he has known all along. And that is that US troops are in a part of the world that produces -- not the majority -- but a huge amount of oil and natural gas. We will have US troops in that region for years to come, whether we want to or not. And I think Senator Obama has come to that realization, has come to realize that you cannot pull all the troops out of Iraq unless you put them somewhere else.

You talked a little bit about Iran, and about the dangers in Iran. This is not a time to be saying, "Yes, we're going to pull all the US troops out of there, come what may."

Stephanopoulos: "He's always said there's going to be some residual force in Iraq."

Koppel: "But I think people believed he was talking about maybe 20, 30, 40,000. I think you're going to have 80-100,000 troops in there 3-5 years from now. ...

And with the price of oil going up to $4.50 a gallon, imagine what would happen to the price of oil if we precipitously pulled troops out of the Persian Gulf. It's not going to happen."

That's one of many reasons why removing the troops from the Persian Gulf region could be disastrous. As I've said for many years, my expectation is that the troops will remain in Iraq until we HAVE to pull them out because of the Clash of Civilizations world war.

It's worth stopping a moment here, and comparing the political process today to the political process that was going on in 2002, prior to the Iraq ground invasion.

I've had about five people in the last month criticize me for something that I've been saying for years, most recently in my detailed Iraq war analysis in February: That if Al Gore had been President after 9/11, he certainly would have pursued the same Iraq policy, and we'd be in the same place as we are today.

I'll just briefly summarize the reasons again:

People who call themselves "antiwar" today have very short memories. Overwhelmingly, they and the general public and the politicians favored the Iraq war when they thought it was popular, they equivocated (as John Kerry did in 2004) when they weren't sure, they were opposed when it went poorly and became unpopular, and now, with the war going well after the "surge," there's an embarrassed silence.

If Obama has difficulty dealing with the Iraq issue today, the left-wing Democrats have no one to blame but themselves. They disgraced themselves early in 2007 by committing their careers to America's failure and humiliation. Democratic party sites like MoveOn.org were populated by hard-left Gen-X nihilists almost determined to destroy the Democratic party by trying to force Congress into disastrous "antiwar" positions, such as ending all funding for the Iraq war. Many of these positions were close to treason. This continued even when the news showed signs of improvement, as when the "Anbar Awakening" began taking effect.

Now the Democrats in general, and Obama in particular, have to live those positions. They made huge bets that the "surge" would completely fail, and that America would be humiliated in Iraq, and now they have to answer for their bad judgment.

That's why Obama is now forced to "refine" his position. He was so totally committed to American failure in Iraq that he's going to have difficulty extricating himself.

Ironically, Obama's supposed allies on the left are going to make it even more difficult for him. Obama is trying to "move to the center" in order to win the votes of independent voters in the general election, but his hard-left allies are trying to prevent him from doing that.

Almost as shocking to them as his shifting position on Iraq is his new support of the "FISA" bill, allowing warrantless telephone wiretapping of foreign terrorists.

Thus, left-wing blogger Arianna Huffington said that Obama's move to the center was "Realstupidpolitik," and that "Moving to the middle is for losers."

Similarly, MSNBC's nutjob Keith Olbermann, who has been as committed as anyone to wanting America to be humiliated in Iraq, referred to the "FISA" bill that Obama is now supporting as "fascism."

So now let's compare George Bush in 2002 with Barack Obama today.

In 2002, Bush moved toward the ground invasion of Iraq because he was inclined to, and because the public overwhelmingly supported it. A President Gore would have done exactly the same thing.

Today, Obama has to move towards the center. In the case of Iraq, that means leaving the troops there as long as necessary to get the job done.

Obama's disadvantage, compared to Bush in 2002, is that Obama has a small cadre of hard-left activists determined to punish him for any move toward the center. So Obama MUST move toward the center, but the activists of his own party will make him pay for it.

Obama's success as a candidate this year is not dependent on having the totally inflexible hard-left view of the Iraq war. He's successful because Generation-Xers love his contempt for Boomer and Silent generation values. And most young people (unless they have a friend or family member there) couldn't find Iraq on a map, let alone care what happens there.

If Obama had the same political freedom to follow the public mood that Bush had in 2002, then Obama would "refine" his position suitably and probably win without a problem. He may still win, but his candidacy is being threatened by a small group of hard-left nihilistic Generation-Xer activists. Those activists may cause him to lose the election.

But win or lose, what happens in Iraq next year will not depend on what Barack Obama or John McCain or any politician wants. It will depend on the what the masses of people want, here and in the Mideast, and the consequences will almost certainly not be what anyone expects. (8-Jul-2008) Permanent Link
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France/EU President Sarkozy is turning the screws on Ireland

It's beginning to look like a bad situation comedy.

French president Nicolas Sarkozy will not be deterred in getting the "European project" completed.


Eiffel Tower with blue and gold stars, symbolizing the EU colors
Eiffel Tower with blue and gold stars, symbolizing the EU colors

Last week, when he became EU President for six months, he signified his determination by flaunting a dazzling "new" Eiffel Tower with blue and gold stars, symbolizing the EU colors.

He's not going to let a little thing like the Irish people's rejection of the Lisbon Treaty stop him.

So Sarkozy is starting to "isolate" Ireland, to "pressure" Ireland, or, as the London Times puts it, to turn the screws on Ireland.

Sarkozy will try to force Ireland to have a new referendum on the Lisbon Treaty. This has a precedent: When Ireland rejected the Nice Treaty in 2001, they held a new referendum in 2002 and it was ratified.

But as we've said many times, it's the generations of World War II survivors that generally favor European integration, because they believe it will prevent another European war, and it's the post-war generations that generally oppose European integration, because they believe that it will harm them economically. Today there are far fewer WW II survivors than there were in 2002, so the chances of a new referendum leading to a ratification are slim indeed.

But that won't slow Sarkozy's determination. "If the perspective of a second vote in Ireland has been raised it is because it has happened before," he says, referring to the Treaty of Nice. "We need some kind of vote to get out of the situation – in parliament or in a referendum, I don’t know. But when democratic society says ‘no’, you need a democratic solution."

All this is going to come to a head next weekend at an EU summit meeting and on July 21 when Sarkozy visits Dublin. It's expected that Sarkozy will be applying a great deal of pressure to Brian Cowen, the Taoiseach (the Irish word for Prime Minister). And you can just imagine how much the Irish people are going to love that.

Today, 18 of the 27 European Union member states have ratified the Lisbon treaty. Germany, Italy, Spain, Sweden, Belgium and the Netherlands are expected to ratify it in their respective Parliaments without a problem. Poland and the Czech Republic have indicated that they may not ratify it.

This means that Ireland isn't Sarkozy's only headache.

There's a real feeling of comedy about this, with Sarkozy running around, demanding that everyone sign on, or else. Does Sarkozy believe that that kind of threat will convince the Irish people to ratify the treaty? He'll be lucky to get as many votes as last time.

Recent polls in many countries, including Britain and France, show that support for the treaty is decreasing, and that's not surprising. One web site reader from Paris wrote to me as follows:

"I was born in 1963, from the son of an Armenian immigrant and a German mother. I am French and I had voted "no" at the referendum [in 2005] about the European constitution. But I had voted "no" because I really believe that it was not democratic: the Commission being able to take decision without control, and the list of sectors where this would have been possible not clearly defined + an economic system described in the constitution hence which could have been changed only by revolution.

However if there was a new referendum with a simple question about how to take decisions in the EU, I would vote "yes". I would favor decisions to be taken by a 2/3 majority of the state members, without ponderation by population size. But weeks after the Irish referendum, our politicians only try to organize a new referendum over there. Up to now I have only seen my idea in an academic article.

Our politicians are not worth their wages/advantages."

This writer captures much of reason for opposition among the EU people. The Lisbon Treaty is not an elegant document. Instead, it's a patchwork quilt of rules and regulations, and it's practically impossible to read.

Right now, many EU decisions require unanimous consent by all members. Perhaps replacing this with a simple 2/3 requirement, as the writer suggests, would be better than the current system, but since that would give more political power to the small countries, the large countries would undoubtedly find it unacceptable.

The "European project" is pretty much dead for now. After the Clash of Civilizations world war it will be revived, and it will be successful then. But today there's no chance.

It's not hard to see that this going to end badly. Sarkozy appears to be getting crankier and crankier, and his opponents will become more and more intransigent. The only real question is: How much bitterness and acrimony will surface in next week's EU summit and in EU summits to come. (6-Jul-2008) Permanent Link
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The Dow Industrials in euros

If Americans have it bad, pity the Europeans.

The following graph from the Alea blog shows the Dow Industrials from the point of view of somebody investing euros in Wall Street stocks:


DJIA in euros, 2001-Present
DJIA in euros, 2001-Present

A European investor in Wall Street prior to 9/11 would have lost almost 50% of his investment today, thanks to the falling value of the dollar against the euro.

Such an investor would have lost almost 30% just since last summer.

Things may get worse for foreign investors.

In its annual report, published last week, the Bank of International Settlements says that a disorderly decline in the value of the dollar cannot be ruled out:

"Beyond these global risks to the inflation outlook, the prospects for both growth and inflation in individual regions will also be affected by exchange rate movements. One source of concern is what might happen in the markets themselves. Against the background of a still wide US current account deficit and rising external debt levels, the decline in the effective value of the US dollar has to date been remarkably orderly. However, this need not be a guide to the future. Foreign investors in US dollar assets have seen big losses measured in dollars, and still bigger ones measured in their own currency. While unlikely, indeed highly improbable for public sector investors, a sudden rush for the exits cannot be ruled out completely."

Such a disorderly plunge would have serious consequences.

Even for traders who invest in dollars, the stock market has plunged to 79% of its peak value in October. As we've written several times, this is related to the fall in corporate earnings since that time.

As regular readers know, every week or two I post the table of S&P 500 average corporate earnings estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters.

Here's the latest table for second quarter earnings:

  Date    2Q Earnings estimate as of that date
  ------- ------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%
  Jul  3:             -12.4%

As you can see, the downward trend continues for another week. Each time earnings estimates fall, the price/earnings ratios (also called "valuations") go up. They've been pushed to stratospheric levels since mid-March, but they've started falling again in the last two weeks, accelerating the fall in the stock markets. (If earnings estimates are falling AND investors' target P/E ratios are falling, then the two factors multiply together to cause an accelerated fall in the market.)

Over the next 2-3 weeks, actual second quarter earnings for financial services firms will be announced. These will probably determine the short-range direction of the market.

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. (5-Jul-2008) Permanent Link
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Nicolas Sarkozy becomes EU president as Lisbon Treaty appears near collapse

A new French/British acrimonious shouting match begins over the same old issues.

When Nicolas Sarkozy became President of France, he promised numerous advancements -- make France important in Europe, improve the economy, solve immigration problems, and solve the Mideast problem with a "Mediterranean Union." Almost none of his program has been implemented, because of opposition from labor unions and leftist organizations.

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Now Nicolas Sarkozy has become President of the European Union, as France takes its turn in the rotating presidency. His term runs from July 1 to the end of the year.

And when he became EU president, he promised numerous advancements -- make the EU important in the world, improve the economy, solve immigration problems, and solve the Mideast problem with a "Mediterranean Union."

Making the EU important in the world was to be accomplished by getting each of the 27 member countries to ratify the Lisbon Treaty. This would be done by having each country's legislature ratify, thus avoiding all that nastiness and unpleasantness that occurred after referendums in France and the Netherlands rejected the European Constitution in 2005. Let the politicians decide, not the people.

Sarkozy's plan came unglued last month. Ireland's constitution required a referendum anyway, and the Irish voted 'No'.

Hoping to save the Lisbon Treaty, the energetic Sarkozy has been pushing for other countries to continue the ratification process, so that by the end of the year every country but Ireland would have ratified it.

But the Irish rejection has brought out the "Euroskepticism" in other countries.

The Czech Republic's president Vaclav Klaus pronounced the treaty dead. Next, President Lech Kaczynski of Poland said, "For the time being the question of the treaty is pointless." Even German President Horst Köhler is refusing to sign the treaty, although Chancellor Angela Merkel favors it.

This is turning out to be a case study of the Generational Dynamics principle that policies are set by large masses of people, entire generations of people, and not by politicians.

It's not at all surprising that the "Europe project" is becoming less and less popular.

As I wrote in my own analysis of the 2005 French referendum vote, which I updated last month, the vote was divided along generational lines, with WW II survivors more often voting "yes," and post-WW II generations voting "no." Since the WW II survivors are dying out, there is less and less support for an EU Constitution, or for its replacement, the Lisbon Treaty.

What's particularly interesting is that politicians and journalists are suddenly noticing that ignoring the people's wishes simply isn't working, no matter what the politicians want. For example, one German newspaper say: "Those who want a future for the European Union have to stop trying to change the citizens. Instead they should change the policy."

Another states it more clearly:

"The methods of achieving European integration have been successful for 50 years but they have become worn out. Many voters mistrust these methods, and quite a few simply reject further integration. That may well be short-sighted but the referenda in France, the Netherlands and now Ireland have shown it to be a political fact. Whether Lisbon fails or is saved in the end, one thing is certain: A public debate about the meaning and the goals of the EU is long overdue."

This says that previous methods "have become worn out" and that voters "mistrust" them. This isn't precisely right, since it implies that people have been changing their minds. That's not true. It's always been true that the WW II survivors favored European integration, and those born after WW II did not.

Even Sarkozy's France is turning more and more against the European project, as only one in three people still believes in it, down significantly from 61 percent just five years ago.

Sarkozy says, "Europe worries people and, worse than that, I find, little by little our fellow citizens are asking themselves if after all the national level isn't better equipped to protect them than the European level. We must therefore completely change our way of building Europe."

This really is quite remarkable when you think about it -- just about every politician in Europe is in favor of Europe integration, but they can't get it done. The people, buffeted by "fear," "anxiety," and "miseducation," refuse to vote for it.

That's why I keep saying that major events are brought about by the masses of people, not by politicians. World War II would have occurred with or without Adolf Hitler. The Vietnam War would have occurred with or without President Kennedy. The Iraq war would have occurred with or without President Bush.

(Thursday's news is that Democratic presidential candidate Barack Obama is changing his position on such issues as ending the Iraq war and tapping into foreign phone calls of suspected terrorists. This is no surprise. Whatever happens next year will have nothing to do with whether Obama or McCain is elected.)

And now another ages-old issue is reasserting itself: The fault line between the English and the French, which has led to multiple crisis wars at least since 1066.

This conflict flared in 2005 after the French referendum rejected the EU Constitution. There followed an acrimonious European Union summit meeting in June 2005, where British Prime Minister Tony Blair, Luxembourg Prime Minister Jean-Claude Juncker and French President Jacques Chirac exchanged vitriolic accusations over how the EU budget, especially the agricultural subsidies for France, were to be divided among the EU members. Under no circumstances would France compromise on its agricultural subsidies.

Now the same conflict has arisen in a different way.

EU's trade commissioner is Peter Mandelson, and he's been representing the EU in international trade talks at the World Trade Organization (WTO), with intention of reducing tariffs and opening markets worldwide. The EU's official position is that farm import tariffs should be reduced, and that position is part of the negotiations that Mandelson is pursuing.

Unfortunately, there are two problems. Sarkozy views that position as threatening France's agricultural subsidy. And Peter Mandelson is British, and used to be in Tony Blair's cabinet, and Sarkozy dislikes him.

During the past two weeks, Sarkozy has been launching verbal attacks at Mandelson. He accused Mandelson of taking an incompetent position at the WTO talks, and even blamed Mandelson for the Irish "No" vote on the Lisbon Treaty referendum.

As the French like to say, "Plus ça change, plus c'est la męme chose" -- the more things change, the more they are the same.

The visceral dislike that the French and the English have for one another is centuries old, and is not about to end. Sarkozy's attack on Mandelson, particularly blaming him for the Irish "No," is particularly nasty.

In fact, the French have not forgotten that there was an attempt at a European "union" two centuries ago -- when Napoleon conquered all of Europe. They've never forgiven the English for defeating Napoleon at Waterloo, and ending that attempt at a unified Europe. Similarly, Sarkozy won't hesitate to blame the British for the current failure to form a unified Europe.

I'm going to take a wild guess here that Sarkozy is not going to achieve his objectives as EU President for the next six months, just has he hasn't really accomplished any of his objectives as French President. In fact, the next six months can be expected to return to the extreme acrimony of 2005. And by the way, neither the EU Constitution nor the Lisbon Treaty will be ratified. (4-Jul-2008) Permanent Link
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Stock markets continue downward trend as earnings fall further

Price/earnings ratios have only begun to fall from stratosphere.

"Investors keep selling into rallies" is the complaint from CNBC commentator Bob Pisani. What this means, he explains, is that if the stock market shows any signs of rallying, traders immediately sell in order to make back some money they've lost. The Dow Industrials have fallen 21% since their peak last October.

What pundits are praying for is "a series of good news stories, one after the other." This would presumably make investors more risk-averse again, and would allow the stock market bubble to expand once more.

Pundits are blaming the current stock market plunge on the high price of oil, now reaching $142-143 per barrel on international markets. They point out that the price of oil has been highly correlated (inversely) to the S&P index for the last few weeks.

But I don't believe that. The price of oil has been going up for a long time now, and it's only very recently that investors even cared. Investors don't care about anything long-range. They react to today's news only. And lately, the news has been about oil prices. Next week or next month, something else will be the news, and oil prices will be forgotten.

However, there is one thing that investors do pay attention to: Price/earnings ratios. And the way I know that is by looking at the latest version of the graph that appears on the bottom of the home page of this web site. Here's last Friday's version:


S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 27-June-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 27-June-2008. (Source: MarketGauge ® by DataView, LLC)

The long range view from the above graph is this: The historical average is 14, but it's been well above average since 1995, indicating that we're in a 13 year old stock market bubble. By the Law of Mean Reversion, we can expect a 13-year long correction.

But there's also a short-range view. Note that the P/E ratio has been around 18 for over two years until recently. This can't be a chance happening. Whatever formula traders have been using, whether it's the "Fed Model" or something closely related, traders must have been purposely keeping the P/E ratio at 18.

There are two possible ways that this could have happened:

Reading the above graphs indicates that probably there's a mix of these two strategies.

It was mid-December when it first became clear that 4'th quarter earnings growth was going to be sharply negative, and it was shortly after that that the S&P 500 index started falling sharply as well. That seems to indicate that Strategy 1 traders were actively selling, just enough to keep the P/E ratio still near to 18.

However, it was three months later, in March, that it first became clear that 1'st quarter earnings growth was ALSO going to be sharply negative. This time Strategy 2 came into play. This was the time when the Fed made the historic move of saving Bear Stearns from bankruptcy, convincing many investors that the worst was over, and the earnings would start rising again. Traders ignored the falling earnings, and assumed that they would continue rising as they had in the past, and P/E ratios began rising to stratospheric levels.

Now let's move ahead three months again, to June. (In case you haven't noticed, we're always talking about the last month in the quarter.) It was in June that it became apparent that 2'nd quarter earnings growth would again be negative, dashing traders' hopes that the worst was over. Since then, P/E ratios have been falling.

How far will they fall in the short run? This brings us back to the "series of good news stories, one after the other," that I mentioned above.

Second quarter earnings for banks and other financial services industry companies will be announced in the next two weeks. If those earnings beat expectations, then there may again be a short-term rally. If earnings are at or below expectations, then the P/E ratio should be expected to fall further, which means that stock prices will fall further.

As regular readers know, every week or two I post the table of S&P 500 average corporate earnings estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters.

Here's the latest table for second quarter earnings:

  Date    2Q Earnings estimate as of that date
  ------- ------------------------------------
  Jan  1:              +4.7%
  Feb  6:              +3.5%
  Apr  1:              -2.0%
  Jun  6:              -7.3%
  Jun 13:              -8.1%
  Jun 20:              -9.0%
  Jun 27:             -11.3%

As you can see, earnings estimates have continued to fall, week after week. It will sure be a big surprise, especially to me, if all of a sudden financial services companies start showing earnings growth.

With Wednesday's 1.46% fall in the Dow Industrials, the market has now fallen to 79% of its peak in October. As can be seen on my Dow Jones historical page, this was the level at which the chain reaction leading to the 1929 crash began. We can't be certain what level is necessary to trigger a new generational crash today, but it seems likely to be somewhere around the low to mid-70s%.

A generational crash is an elemental force of nature, like a tsunami. You'll have millions or even tens of millions of Boomers and Generation-Xers in countries around the world, never having seen anything like this before, and in a state of total mass panic, trying to sell all at once. Computer systems will crash or will be clogged for hours (as has already happened to some systems, incidentally, on February 28), or perhaps even for a day or two. People who had hoped to get out just as the collapse is occurring will be totally screwed, and will lose everything. Brokers and other institutions will go bankrupt. People who went short hoping to make a fortune will find that their brokers' escrow accounts are gone, and they'll be totally screwed, and will lose everything.

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-Jul-2008) Permanent Link
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Wall Street Journal describes Iran's generational Awakening era

Young Iranians turn away from the Quran and go for self-help and New Age.

In a page one article on Monday, the Wall Street Journal uses a gee-whiz tone to describe changes in Iranian society:

"TEHRAN, Iran -- When Hassan Bakhtiar couldn't find a job last year, his mother told him to pray and read the Quran.

Instead, the 25-year-old aerospace engineer dropped in on a packed appearance by Alireza Azmandian, Iran's most famous motivational speaker and self-help guru. Now, he meditates by staring at a flickering candle and chants Mr. Azmandian's inspirational catch phrases.

"Religion doesn't offer me answers any more," Mr. Bakhtiar says, after listening to Mr. Azmandian at a public auditorium in a shabby neighborhood of South Tehran. But, he says, "this seminar changed my life."

The self-help craze -- long part of life in the Western world -- is taking the Islamic Republic by storm. Iran is one of the world's youngest nations, with 70% of its 65 million under the age of 30. There's widespread disenchantment among young people with Iran's strict theocratic regime, which requires headscarves for women and bans alcohol. And jobs are scarce.

In other Middle East countries with similar demographics, like Egypt and Turkey, young people are increasingly turning back to their Muslim identity for solace. But Iran's mostly well-educated youth are more likely to seek other remedies -- such as self-help seminars, New Age theories, meditation and yoga.

"The regime presumed it could mold the society into whatever shape and form it wanted, but we are seeing the opposite take place," says sociologist Hamid Reza Jalalipour. The younger generation is "turning away from conventional religion and tradition."

There are a few interesting things about this.

First, you could change "Quran" to "Bible" and change the people's names to European names, and this could almost describe America in the 1960s.

That's not surprising. Iran is in a generational Awakening era today, just one generation past the genocidal Iran/Iraq crisis war of the 1980s. America was in an Awakening era in the 1960s, just one generation past the genocidal World War II.

(For information about generational Awakening eras, see "Basics of Generational Dynamics.")

The second interesting thing is the contrast to "other Middle East countries with similar demographics, like Egypt and Turkey, [where] young people are increasingly turning back to their Muslim identity for solace."

Egypt and Turkey are in generational Crisis eras, and so they are likely to be attracted to religion to differentiate themselves from their potential enemies. Iran is in an Awakening era, where the population is more likely to seek accommodation with their former enemies, which usually means rejecting sharp religious differences.

Even more interesting is a certain fact about "Alireza Azmandian, Iran's most famous motivational speaker and self-help guru":

"A father of three, with a Ph.D. in industrial engineering from the University of Southern California, Mr. Azmandian, 55, says he was drawn to the motivational-speaker circuit when he was a graduate student in the U.S., after reading a few self-help books and seeing how his own life improved. He returned to Iran in 1995 to teach at Tehran University and bought a small private office to promote positive thinking and self-help."

In other words, if you do the math, Azmandian was in America around 1970, the height of America's Awakening era. So Azmandian has done something that so many people would like to do, but can't: He's recaptured the exciting days of his youth.

He learned about the excitement of Awakening eras when he was in America, and then, 35 years later, he's a leading "self-help guru" in Iran's Awakening era. What fun!

It's a shame that the Wall Street Journal reporters know absolutely nothing about generational theory, or they would have been able to put their article into better context. Once you understand how an Awakening era works, then you can actually understand Iran's international strategy, as I explained recently in my comparative strategy of Iran and China, and earlier in "Iran's President Ahmadinejad is facing a growing 'generation gap.'"

What's the next stop for Iran's youth? I'll hope for an Iranian Summer of Love. The mullahs ought to love that! (1-Jul-2008) Permanent Link
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Blogger Watch: Michael "Mish" Shedlock comes over to the dark side

Referring to 1929, Shedlock now says, "History is about to repeat."

Over the last couple of years, I've been very critical of the economic bloggers for refusing to face up to the consequences of their own analyses. They would post blog entries telling of disastrous economic data, but then talk only about nothing more serious than a recession.

It was just a couple of months ago that I posted an article, "Blogger watch: Hellasious at SuddenDebt gets it right," in which I was mocking Michael ("Mish") Shedlock's blog for predicting nothing stronger than "the U.S. slipping in and out of recession for a prolonged period of time, perhaps 3-4 years or more."


Michael "Mish" Shedlock
Michael "Mish" Shedlock

But now, Shedlock apparently has had an epiphany. Not only is he predicting a return to 1929, he's actually giving it a generational twist. People who have said to me that I'm on "the dark side of the road" should know that it's beginning to get crowded over here.

In his Monday posting, Deflationary Hurricanes to Hit U.S. and U.K., he says the following:

"It will be hard for the US and UK to avoid a depression.

What started as a tropical storm called "Subprime" has intensified in magnitude to engulf Alt-A, HELOCs, credit cards, commercial real estate, municipal bonds, corporate bonds, and the stock market, just as baby boomers are headed for retirement.

If you prefer, you can think of this as Many Hurricanes, Many Eyes. ...

Most do not even understand the nature of the storm that is about to hit. ...

Property values are crashing, unemployment is rising, wages are falling, global wage arbitrage is king, and most importantly Peak Credit Has Arrived.

It is impossible to get inflation out of that mix. Berananke could cut interest rates to zero tomorrow and it would not cause inflation, at least as properly defined: a net expansion of money and credit. Banks are strapped for cash. They cannot lend. Businesses do not want to borrow. There is overcapacity everywhere. The Shopping Center Economic Model Is History.

I struggle to see how anyone can get inflation out of that mix. Last Thursday when the stock markets were in a freefall, I asked Is The Inflation Scare Over Yet? Well, I guess it's not. ...

Ben Bernanke at the Fed, Mervyn King at the Bank of England, and Jean-Claude Trichet at the ECB are not in control of what is about to happen. When it comes to commodity prices, peak oil and China's willingness to allow its economy to overheat are going to be the driving forces. Trichet can hike all he wants and it will not matter much to the price of oil. However, it may crush individual economies in the EU. ...

Implications of Peak Credit

When it comes to the collapse in credit, the above Central Banks are powerless to do a thing about it. This is to be expected now that we are on the backside of Peak Credit.

The saturation point has been reached. It took decades but we have finally arrived. None of the financial engineering jobs that fueled this credit boom will ever be needed again. SIVs, Conduits, Toggle Bonds, Covenant Lite loans are all dead for years, more likely decades to come. Add to that liar loans, Pay Option Arms, insane leverage, and numerous other ridiculous lending arrangements. And if those things are not coming back, we do not need Wall Street shills to securitize that garbage and pitch it to unsuspecting suckers.

In addition to financial engineering jobs, there was a boom in commercial real estate, home depots, remodeling companies, landscaping, furniture, appliances, plumbing, heating, air conditioning, restaurants, and even things like grass seed.

There is no source of jobs to replace what has been lost and what will be lost. Discretionary spending is dead. Boomers about to retire are about to get religion. Sadly, it's too late. Savings they thought they had in their house, have now vanished into thin air. It was all a mirage in the first place, but mountains of credit has been extended on the basis of that mirage. Trillions of dollars of imagined wealth has gone up in smoke. Trillions of dollars more are about to.

Deflation Has Set In

It is amusing that in the face of this carnage, many are still screaming inflation, stagflation, or even hyperinflation simply because food and energy prices are rising. Deflation is here and now in the US. Deflation is knocking on the door of the UK and Eurozone. And there is nothing that can be done about it.

Can The Fed Print Its Way Out?

Some will insist that I am wrong, that the Fed can print. Well the Fed can print, but the Fed cannot spend. In addition, the Fed cannot give money away, nor would the Fed even if it could. Finally, the Fed cannot force banks to lend or businesses or consumers to borrow.

Bank credit is contracting with the Fed Funds rate at 2%. Bank credit would not be going much of anywhere even at 0% in my estimation. The reason is simple: banks are insolvent!

The Fed is like the powerless man behind the curtain in the Wizard of Oz. Once peak credit sets in, all the Fed can do is bluff. The notion of a helicopter drop is pure nonsense. ...

Attitudes Lead The Way

It took nearly 80 years for people to get as reckless as they did in 1929. 80 years! Few are still alive that went through the great depression. That is the nature of the game. People have to forget what a depression is like to bring about the conditions that cause them. And they did. And they made the same mistakes over again, except larger.

The madness of crowds, however, can only go so far. A significant reversal is now underway. The secular peak in consumption has been reached. A reversal in attitudes towards consumption started with houses, but it’s spreading to cars, boats, and even Starbucks coffee. It will take a long time for attitudes to get back to equilibrium. And attitudes, like pendulums, will not stop at equilibrium once they get there.

The odds of a significant bout of inflation now are about the same as they were in 1929. Next to none. History is about to repeat."

What's particularly interesting about this is the generational twist that he puts on it. (Do you suppose he's read this web site?) He says that "People have to forget what a depression is like to bring about the conditions that cause them." That's the heart of generational theory.

Actually, the Great Depression is being mentioned more and more these days. Incredibly, it was actually discussed for 10-15 seconds the other day on CNBC, where all such talk is normally forbidden. And a Washington Post article on Friday said that we have a "housing slump more severe than any since the Great Depression."

From the point of view of Generational Dynamics, 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.

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. (1-Jul-2008) Permanent Link
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