FedUpUSA

Archive for the ‘Credit Crisis’ Category

An Introspective Look At The Future Of America

By Craig Harris
earthblog.news@gmail.com

As we close out 2009 and look forward into 2010 and beyond, this has been a year of near financial catastrophe and monumental change, none of which benefited America or ordinary Americans. Late in 2008 and throughout 2009, events have happened in the US which would have been labeled unfathomable just a few short years ago, and yet already these monumental changes are expected to be filed into the memory hole and Americans are expected to believe nothing has changed.

As we exit the year, we are told the US is a laissez-faire free market economy and yet the US government is now the largest owner of housing in the US as well as the owner of last resort for some of the largest and completely insolvent US corporations. The Federal Reserve, a privately and anonymously owned and controlled corporation chartered with issuing the nations currency, were given the green light by themselves to transfer to themselves and their shareholders the people’s wealth in the form of their future labor. The FED balance sheet has ballooned to become a junk bond warehouse as they overtly and covertly buy their own debt, immune from any sort of oversight, regulation or auditing and operating above the law. Along with that, increasingly coercive brute force measures are now routinely necessary to manage and manipulate so called “free market” asset prices which are cheerled by so called “financial news media” whose board members and management are all the same people who transferred the people’s wealth to themselves. The corporate media party line idea of a “free market US economy” now seems like a distant memory and it all feels like systemic fraud, corruption, malfeasance and organized crime at the very highest levels.

During 2009 we have seen the continued collapse of American industry amid wave after wave of layoffs. The corrupt corporate media cartel likes to trot out a group of FED sponsored shills who call themselves “professors” to call this a “jobless recovery” although it’s difficult to imagine a recovery where American industry has collapsed and is now owned by the government. US cities both large and small have been decimated by the loss of the US manufacturing base. Detroit now resembles a third world country with a 50% unemployment rate. Ransacked, foreclosed houses go for a dollar apparently because no one who has a choice is willing to own property or live there. The US has an officially stated unemployment rate of ten percent and a real unemployment rate of over 20 percent. Wall Street may have recovered due to a direct injection of capital from the future labor of the people, but there has been no action taken whatsoever to improve the situation of the average citizen as the disconnect between the ruling Oligarchs and Wall Street, the real economy and the lives of ordinary Americans continues to widen. The people’s bailout money, which represents the future labor of Americans, went directly into the pockets of the people who created the crisis in the first place because they are in the enviable position of being “too big to fail”. Interestingly, or sadly, the same people and institutions responsible for and who profited from the catastrophe are still in charge and have handed even more power and control to themselves. Although there has been talk in Washington of “too big to fail” being undesirable, the result of the post collapse policies have resulted in ever fewer, ever larger players with more power and control and instead of being “too big to fail” now wield so much money and power that they demonstrate wholesale ownership of the entire US political body.

Due to the post collapse monetary and fiscal policies, the people have now been saddled up with an unpayable level of debt. The cause of the near total collapse of the financial system was too much debt and the “solution” has has been even more debt piled on to the original debt. During the year, the Dallas FED estimated the financial obligations of the US government at 99 trillion dollars. The head of the TARP program estimated the bailout cost at 24 trillion dollars. Totaled together the US has in the neighborhood of 120 trillion dollars of current and future obligations on an annual revenue of around 2 trillion dollars which is falling due to high unemployment, higher state and local taxes and fees and lower wages. Cutting that down to size, imagine earning 200,000 a year and having a debt of 12 million dollars. In short, the US dollar has become a token of an unpayable debt and thus the anchor of the entire global financial system is a ponzi fraud. It becomes impossible to compute the value of anything as measured in a fraudulent currency that represents an unpayable debt.

The banking system is not lending money because it’s still insolvent. The people, having lost over 5 trillion dollars in the real estate bust are also collectively insolvent. Many US states and cities are bankrupt or near bankrupt. One in nine Americans subsist on food stamps. Even as a college education has become unaffordable to most Americans, college graduates now find themselves jobless. One in seven households now have their adult children living back at home due to the inability to find a job. The homeless population is growing and tent cities sprouted up across America during 2009. The estimated homeless population in LA alone is 40,000 people a night. People in the US if they have a job are working longer and harder to make the same income. Wages have remained stagnant and the real cost of living continues to spiral ever higher for ordinary Americans. The new man in charge, elected on a platform of “change”, has delivered his change in the form of change=no change, or how do you like your change now?

By any metric you choose, whether it’s the median home costing half the median income even at artificially low interest rates, to the ballooning cost of insurance, healthcare, education or anything else people spend their money on, the US is experiencing a rapid decline in the standard of living for ordinary Americans and an emerging ultra rich ultra powerful shadow oligarch rule amid a generalized and widespread financial and social decay. The US population is becoming a nation of voiceless serfs with fewer and fewer remaining civil and property rights and a rapidly decaying standard of living, the antitheses of everything America is said to represent and strive for.

The hypocrisy and fraud of the oligarch rule corporate media story line is now nearly impossible for an educated, informed adult to digest. As Jim Grant pointed out recently, according to Section 19 of the Coinage Act of 1792, the penalty prescribed for any official who fraudulently debased the people’s money is death, yet in 2009 debasing the people’s money resulted in a “man of the year” award from the self serving corporate media who will be next in line for a bailout from the people for their good service to the new oligarch rule. This organized crime, this theft, occurring right out in the open, may explain why employees of the largest US financial institution are now not allowed to gather in groups larger than 12 outside and their executives are carrying firearms. In an affront to the intelligence and sensibility of any citizen of this planet, the new US president expanded a war he was elected to end and started a new frontier in Pakistan, for that he was awarded a Nobel Peace Prize. The people who were awarded hundreds of billions of dollars of the people’s money because they lost all their money are skimming millions and billions off the top for themselves and their associates in what they call “bonuses”. 2009 has been a year of egregious assault on the American public by the people in charge.

The “people’s representatives” as they like to be called, no longer represent the people at all but instead solely represent and pledge allegiance to the special interests and corporate lobbyists who have bought and paid for their votes, along with the media oligarchs who control who sits in the seats. Regardless of whether they call themselves Democrats or Republicans, they are a group of self important, self serving, morally bankrupt, corrupt, clueless buffoons and criminals running unchecked by a complicit corporate media.

Every American should be ashamed, embarrassed and sad that their country has been bought and sold to an organized criminal enterprise which includes the entire political body and the media. The only thing the “people’s representatives” have in common is contempt for the people they are ostensibly representing. It is revolting for any American to watch these cretins heaping praise Ben Bernanke at the congressional theater of the absurd. His institution has already debased the dollar by 95% and failed miserably in every mandate they had since they took over in 1913. If any American has managed to retain or save any money, he can now put it on deposit in their banking system and earn a negative real return (a loss of his purchasing power) while at the same time the banks will take his deposit and loan it to his brother at 30% interest. So Mr Bernanke the money printer has control over the largest legal loan sharking operation ever concocted and it is funded by the America people, against the America people.

During 2009, the leadership has taken actions which benefit the corporations and special interests who own them, while showing nothing but wanton disregard for the millions of citizens whose lives their sponsors have destroyed. What we are headed towards in the US if we are not there already, is a Straussian society of ultra rich, ultra powerful oligarchs and a serfish powerless population with no middle class to speak of. The US president De Jour is, and from here on out will be a yes man, subservient to the ultra powerful too big to fail oligarchs who control the money and power and are responsible for putting him in the drivers seat. This is not compatible whatsoever with prosperity, democracy or anything else the US still holds itself out as. Here at the end of 2009, the United States has morphed into a bankrupt fascist oligarchy which owns the military machine as a policy enforcement tool, the entire political body and the media. It isn’t going to fix itself because the fraud, corruption and malfeasance is systemic. It meets every definition of organized crime and it’s all happening right out in the open.

In my way of thinking, this is not at all unlike the breakdown of the Soviet Union where for a period of time a sort of mafia of oligarchs weilded the wealth and power, carved up the remaining wealth of the country among themselves and had their way with the country amid a climate of manufactured fear, chaos and decay. The key point being that the people in control are out to make money and increase their power at the expense of the citizens. Mr Orwell said “the purpose of power is power” and that statement needs to be well understood. These megalomaniac, sociopathic aspirations of ever more power and control by an elitist group of criminals come at the expense of America and future Americans. It doesn’t matter whatsoever to the oligarchs because they have property waiting in Croatia. When the remaining wealth has been extracted from America, they will all pull out and the citizens will be left with a rusted out bankrupt hull. I believe the circumstances for this eventuality have already been created, just not yet realized due to the enormous size of the economy and the momentum it has. In other words, I believe it’s collapsing as fast as it can although living through it seems like slow motion. When viewed from the future in a historical context however, I think it will have seemed fairly rapid.

The financial markets have deteriorated into a Las Vegas casino atmosphere where the the only consistent winners are the house and the too big to fail entities trading on foreknowledge and inside information shared freely between the treasury and the few remaining large trading houses. The entire system is bankrupt, fraudulent, corrupt and irretrievably broken. The anchor of the global financial system, the US dollar, has become the worlds largest ponzi scheme and the remaining 95% of the worlds population would like a new, viable standard. At this point however, despite any action the FED may or may not take, the US debt is far too large to ever be repaid. It is questionable if the interest payments will even be serviceable if interest rates were to rise, and the only reason interest rates are low is because the FED is using brute force. At this time the only way out without a complete collapse is to inflate away the debt, thus turning a deflationary collapse into a long period of inflationary decay and declining standard of living.

I have been of the opinion that what we saw in October 2008 was a collapse of the global fiat financial system which was more or less expected due to the collapse of the real estate bubble. I have reminded my subscribers that when I was forecasting a drop in real estate prices of as much as 50% during the heyday of the mania, that sounded unfathomable. What I believe is in store for our future sounds nearly as unfathomable now as that idea did back then. I believe the reason it sounds unfathomable is due to the constant barrage of lies, misinformation and propaganda from the tight knit corporate media oligarchy which has essentially merged with the new power structure of the US in a corrupt, overt form of fascism that would make Mussolini blush or Goebbels the propagandist nod in approval.

Over a period of decades and with one FED induced serial bubble after another, the financial system finally reached an unsustainable level of debt and leverage in 2008. When the FED started raising interest rates, when the real estate bubble burst, it involved so much debt and leverage that the whole system failed, pricing models and risk models failed, and the banking system quickly became insolvent.

I believe we have already had a systemic collapse, and the only thing the FED can do now is alter the look and feel of the collapse and to manage the allocation of the remaining wealth. In the end, whether by deflationary collapse or inflationary decay, the result of the collapse will feel the same to the US general population regardless of the interim path taken.

If the FED had done nothing, the whole system would have quickly degenerated into a deflationary collapse and failure of the financial system due to insolvency. The course the FED chose however is the one myself and many others predicted beforehand…the FED chose to solve the problem of too much debt by creating even more debt by taking the unprecedented action of buying it’s own debt under euphemisms like “quantitative easing” and “debt monetization” and also covert buying to artificially force negative real return rates of interest. Through this course of action, the FED so far has been able to turn what would have been a rapid deflationary collapse into a decaying inflationary depression which is euphemistically called “a recession that is now over” by the six people who control 96% of the global media and attempt to pass off propaganda as “news” to a woefully mis informed, dumbed down and apathetic general public.

Going forward, If the FED doesn’t buy enough of their own debt, then interest rates on the long end would rise and the risk becomes a deflationary collapse into insolvency for the FED and it’s banking system. If interest rates remain effectively at zero on the short end and artificially suppressed by quantitative easing on the long end, then the real estate market can recover and the banks can regain solvency. If interest rates rise as the free markets would argue for however, then the real estate market sinks even further, the US dollar rises, and greater insolvency of the banks follows. The higher interest rates go, the thinner the knife edge gets and the FED would quickly find itself staring into another October 2008 collapse kind of situation. On the other hand, if by buying enough of their own debt they can keep short and long term interest rates down, then the free money percolates through the banking system, puts pressure on the dollar, lifts commodity and real estate prices and pulls out of the collapse via inflating away the debt so long as they can avoid run away hyperinflation in the process. This is the path we have traveled throughout 2009.

The key point is that the FED has had the option of doing two things…creating even more debt in order to save itself and the banking system, or do nothing and watch themselves collapse into a mass of failure, loss of power and control, insolvency and domino style bankruptcy and default. They have chosen the expected course, which is to increase the debt and print money, which is the way they save themselves and their banking system. In short, given a choice between saving the people and saving themselves after a collapse, they have taken the expected course which is to attempt to save themselves. What else would you expect? If they had wanted to save the people they would have taken the peoples bailout money and handed it to them in the form of a check. Instead they handed it to the banks.

Although they have been somewhat successful in reducing the insolvency of the banking system, they have effectively created a giant wealth transfer mechanism whereby all the money that disappeared in the collapse was re created out of thin air and given to the banks and wall street. I think of it as a sort of shell game. The money disappeared from Mom and Pop’s 401k and re appeared on the balance sheets of the banks via freshly created new money (debt). As a result, we have something still called “free market capitalism” which is not free market capitalism at all. We have emerged from this crisis with a sort of financial oligarchy where a few entities who control all the wealth and power also control politics and media. Understanding this will help to understand issues like “healthcare reform” which will involve you paying more and getting less, with the primary beneficiaries being the oligarchies who control health care and insurance.

The one major point I have to make at this time is throughout 2009, there was no action taken that put the average citizen in a better position, but instead during the course of the year there was a gigantic wealth transfer from the citizens to the banking system, effectively orchestrated by the so called “people’s representatives” who are in fact, all owned by the banking system and Wall Street with half a dozen or so oligarchies and lobbyists in a public display of fraud, malfeasance and corruption that sets a new historical precedent.

I have been and remain of the opinion that the ultimate “solution” to this crisis will be for the entities who now control the wealth and power to accumulate even more wealth and power via a global central bank and global currency which now for the first time in public has been discussed on and off throughout 2009 and described as the New World Order by such luminaries as Henry Kissinger. So looking out beyond 2010, I see a new global reserve currency emerging and a global central bank which will effectively also be a global governing authority where the heads of state effectively report to the group of central bankers and their anonymous shareholders who effectively control the money, power and politicians on a global scale. When the global currency is introduced, only then do I expect a sort of collapse of the US dollar versus this global currency. In this way, the world can carry on while the former global reserve currency called the US dollar will be free to depreciate to a level where solvency is regained and the now unpayable US debt is inflated away to the point where it can be repaid in depreciated dollars. US citizens will experience a continued decay as the US becomes to resemble more and more, a third world country. Detroit is already there. The corporate media won’t show it to you but if you do a youtube search on Detroit what you see will shock you.

My view of the world tends to be the long view. Throughout 2009 I have been positioned and trading in in various hard assets including but not limited to gold silver, back month crude oil, Soybeans, raw land and Americana. I own and trade some Chinese shares but no US equities or bonds. I have lost confidence in the US leadership. I have lost confidence in the fairness of the “system” where some elite entities are free to keep the profits and nationalize their losses. I have opted to opt out by embarking on a long term effort to transfer more and more capital “off wall street” and their organized crime ring they call the banking system, and instead investing in things without fraudulent or impaired balance sheets. At some point in the future, I want to be short US 10 and 30 year bonds because it is nonsensical to me that anyone would be willing to loan a bankrupt country money for 30 years at an interest rate of 4% or so. The only reason this situation exists today is due to the FED monetizing debt and attempting to manipulate the long end using brute force.

So as we head off into 2010, I see a lot of uncertainty in the short term. If interest rates rise and the US dollar gets stronger, by mid year I would expect a repeat of October 2008. What I expect to happen over the longer term however is that the FED will ultimately print enough money to attempt to slowly inflate the debt away to a manageable amount amid a generalized and severe decay in terms of the standard of living for Average Americans. At some point along the line, I expect the world reserve currency role to be moved into a global currency and for the US dollar to be allowed to float against it without the benefits associated with the world currency role, and for the US standard of living to continue to decline and eventually decay into a societal collapse followed by something different. I expect China to emerge as the dominant economic power in the world and to purchase a large amount of US assets. Somewhere along the line I also expect the Nobel Peace Prize recipient to bomb Iran because he will be ordered to do so by the people who control the money.

Personally, based on what I see coming over the long term I have elected to forego city life and have embarked on a long term project in the picturesque Appalachian foothills in an effort to increase my degree of self sufficiency and insulate myself from the continued decay and declining standard of living sweeping the country. My long view for the US is high inflation which will not show up in the government’s fraudulent statistics, along with a declining standard of living, increasing decay and ultimately leading to chaos, societal and government collapse in the US within a decade or two, maybe sooner.

I would like to end by quoting Marc Faber with one of the most compelling quotes of 2009. I find this quote compelling because the price of anything as measured by a fraudulent standard is meaningless. To me, it is a gift to be able to still exchange US dollars for anything with real value.

“I would buy every three months some gold and not worry so much about the price because the weight stays the same”

I have written hundreds of articles documenting that unregulated, speculative derivatives (especially credit default swaps) are a primary cause of the economic crisis.

And I have pointed out that (1) the giant banks will make a killing on carbon trading, (2) while the leading scientist
crusading against global warming says it won’t work, and (3) there is a
very high probability of massive fraud and insider trading in the
carbon trading markets.

Now, Bloomberg notes that the carbon trading scheme will be centered around derivatives:

The
banks are preparing to do with carbon what they’ve done before: design
and market derivatives contracts that will help client companies hedge
their price risk over the long term. They’re also ready to sell
carbon-related financial products to outside investors.

 

[Blythe]
Masters says banks must be allowed to lead the way if a mandatory
carbon-trading system is going to help save the planet at the lowest
possible cost. And derivatives related to carbon must be part of the
mix, she says. Derivatives are securities whose value is derived from
the value of an underlying commodity — in this case, CO2 and other
greenhouse gases…

 

 

Who is Blythe Masters?

She is the JP Morgan employee who invented credit
default swaps, and is now heading JPM’s carbon trading efforts. As
Bloomberg notes (this and all remaining quotes are from the
above-linked Bloomberg article):

Masters, 40, oversees the New York bank’s environmental businesses as the firm’s global head of commodities…

 

As
a young London banker in the early 1990s, Masters was part of
JPMorgan’s team developing ideas for transferring risk to third
parties. She went on to manage credit risk for JPMorgan’s investment
bank.

Among the credit derivatives that grew from the bank’s early efforts was the credit-default swap.

Some in congress are fighting against carbon derivatives:

“People
are going to be cutting up carbon futures, and we’ll be in trouble,”
says Maria Cantwell, a Democratic senator from Washington state. “You
can’t stay ahead of the next tool they’re going to create.”

 

Cantwell,
51, proposed in November that U.S. state governments be given the right
to ban unregulated financial products. “The derivatives market has done
so much damage to our economy and is nothing more than a
very-high-stakes casino — except that casinos have to abide by
regulations,” she wrote in a press release…

However, Congress may cave in to industry pressure to let carbon derivatives trade over-the-counter:

The
House cap-and-trade bill bans OTC derivatives, requiring that all
carbon trading be done on exchanges…The bankers say such a ban would
be a mistake…The banks and companies may get their way on carbon
derivatives in separate legislation now being worked out in Congress…

Financial experts are also opposed to cap and trade:

Even
George Soros, the billionaire hedge fund operator, says money managers
would find ways to manipulate cap-and-trade markets. “The system can be
gamed,” Soros, 79, remarked at a London School of Economics seminar in
July. “That’s why financial types like me like it — because there are
financial opportunities”…

 

Hedge fund manager Michael Masters,
founder of Masters Capital Management LLC, based in St. Croix, U.S.
Virgin Islands [and unrelated to Blythe Masters] says speculators will
end up controlling U.S. carbon prices, and their participation could
trigger the same type of boom-and-bust cycles that have buffeted other
commodities…

 

The hedge fund manager says that banks will
attempt to inflate the carbon market by recruiting investors from hedge
funds and pension funds.

 

“Wall Street is going to
sell it as an investment product to people that have nothing to do with
carbon,” he says. “Then suddenly investment managers are dominating the
asset class, and nothing is related to actual supply and demand. We
have seen this movie before.”

Indeed, as I have previously pointed out, many environmentalists are opposed to cap and trade as well. For example:

Michelle Chan, a senior policy analyst in San Francisco for Friends of the Earth, isn’t convinced.

 

“Should
we really create a new $2 trillion market when we haven’t yet finished
the job of revamping and testing new financial regulation?” she asks.
Chan says that, given their recent history, the banks’ ability to turn
climate change into a new commodities market should be curbed…

 

“What
we have just been woken up to in the credit crisis — to a jarring and
shocking degree — is what happens in the real world,” she says…

 

Friends
of the Earth’s Chan is working hard to prevent the banks from adding
carbon to their repertoire. She titled a March FOE report “Subprime
Carbon?” In testimony on Capitol Hill, she warned, “Wall Street won’t
just be brokering in plain carbon derivatives — they’ll get creative.”

Yes,
they’ll get creative, and we have seen this movie before …an
inadequately-regulated carbon derivatives boom will destabilize the
economy and lead to another crash.

by Marla Singer and Geoffrey Batt

Buried in the depths of page 26 of the Office of the Special Inspector General for the Troubled Asset Relief Program’s (SIGTARP’s) November 17, 2009 report “Factors Affecting Efforts to Limit Payments to AIG Counterparties” hidden in footnotes 33 and 34 is something of a mystery.  It might be the beginning of an interconnected financial chain involving Dubai, the Federal Reserve, AIG, Basel I, Eastern Europe and even Switzerland and which, even if it doesn’t worry you, probably should.  Or it might be nothing at all.

Consider first “footnote 33,” that reads as follows:

The first Basel Accord, known as Basel I, was issued in 1988; it focused on the capital adequacy of financial institutions. The capital adequacy risk—the risk that a financial institution will be hurt by an unexpected loss—categorizes the assets of financial institution into five risk categories (0 percent, 10 percent, 20 percent, 50 percent, and 100 percent). Banks that operate internationally are required to have a risk weight of 8 percent or less….

The original paragraph that references the footnote reads thus:

As of September 30, 2009, AIG had $172 billion in exposure to swaps in its foreign regulatory capital portfolio.  The portfolio contains swaps purchased by financial institutions, principally in Europe, to provide regulatory capital relief under Basel I. [note 33]  AIGFP’s COO informed SIGTARP in July 2009 that they expect that most of these swaps will be terminated by the end of the first quarter 2010 as most financial institutions complete their transition to Basel II.  Currently, financial institutions are required to hold a certain level of capital against their assets, and one way for a financial institution to reduce the amount of capital is to purchase swap protection on its assets.  However, new requirements decrease the level of capital required for such assets and, in most cases, there will be limited capital benefit to holding on to the existing swaps. Nonetheless, AIG warned in a June 29, 2009, SEC filing that if credit markets deteriorate, the company may recognize unrealized losses in AIGFP’s regulatory capital credit default swap portfolio. [note 34]  AIG could continue to be at risk if the swaps in its regulatory capital portfolio are not terminated by the end of first quarter 2010 as expected. (Emphasis added).

Taken together we read the thrust of this section to mean that a number of European banks, seeking to limit their regulatory capital requirements under Basel I (read: seeking to increase their leverage) bought swap protection on their assets from AIG.  These obligations still sit with AIG and, in the event credit markets sink materially, AIG is likely to take losses on these instruments.  Not just that but:

According to an AIG SEC filing, an ongoing concern for AIGFP is whether it will have to post more collateral if credit markets continue to deteriorate.  The amount of future collateral postings is partly a function of AIG’s credit ratings, which may be affected by any further decline in AIG’s financial condition. (Emphasis added).

Simply put, AIG might also have to post more collateral.  Moreover, though AIG initially expected most of these swaps to “be terminated by the end of the first quarter 2010 as most financial institutions complete their transition to Basel II,” we see from footnote 34 that:

Subsequent to the June filing, European regulators adjusted the implementation timing of Basel II, potentially affecting the holders of AIGFP’s regulatory capital swaps to hold beyond previously anticipated termination dates.

In other words, AIG is still on the hook- and hadn’t planned to be.

This raises a number of questions:

1. If the European banks that bought swap protection from AIG are still relying on this protection to meet their capital requirements, and AIG might be unable to make good on the agreements, are these banks actually out of Basel I compliance as we type this?
2. Are the banks still able to use swap protection to reduce their collateral requirements because of the implicit or explicit backing of AIG by the Federal Reserve?
3. If this situation existed in September-November 2008, as it certainly appears to have, how exactly can the Federal Reserve claim in good faith that it lacked the leverage to negotiate with these banks from a position of strength?  (One assumes that many of the same names collecting payment from AIG were also AIG swap protection buyers of the sort mentioned in the SIGTARP report).  Failure to back up an insolvent AIG would have resulted in near-immediate Basel I non-compliance as the protection offered by these swaps, and on which these banks depended for their reduced capital requirements, evaporated- a near death sentence.
4. Or had these banks somehow, and in the middle of the credit crisis, managed to boost their capital to levels that made the swaps unimportant?
5. If so, why keep them on the books now, instead of unwinding them?
6. Since it doesn’t seem likely that a teetering AIG could make good on these agreements without substantial assistance is the Fed is currently the ultimate backstop for AIG?
7. Does this mean that the Fed is effectively underwriting these swap agreements?
8. Will the Fed post collateral if deteriorating credit conditions at AIG (today’s -$11 billion news suddenly seems especially daunting if the potential insurance shortfall has an effect on credit ratings) or general credit market issues require it?  Or are we missing something significant?  By September 30, 2008 AIG had already posted $974 million in collateral for its “Foreign Regulatory Capital” portfolio.
9. What if European banks are hit with more losses from, oh, we don’t know, say… Dubai?  Deleveraging, risk reduction and credit tightening would have an effect on LIBOR, the Eurobond market and, of course, Eastern Europe.  Might not that sort of contagion easily spread to, say, Switzerland, which enjoyed the other side of the carry trade for years by lending Swiss Franc like mad to any Eastern European mortgage borrower who could sign documents?
10. Could it be that the Fed, once again, might have to bail out the world?

Or maybe we are just missing something obvious.

By Economic Forecasts & Opinions

Stock markets around the world cracked on Friday with the Dow Jones industrial average down more than 150 points (Fig. 1), and commodities plunging as Dubai debt woes unnerved investors, and sent tremors of uncertainty throughout all markets.

The crisis flared after Dubai, a part of the United Arab Emirates (UAE) federation, asked to delay interest payment for six months on $60 billion of debt issued by the state-run conglomerate Dubai World and its main property unit Nakheel.

Concerns that a government-backed investment company risked default ripped through world markets. Investors read it as a sign of yet another sovereign implosion after Iceland and Ireland, and recoiled from risk and piled into dollars.

Las Vegas on Steroids

Dubai World has served as Dubai’s main driver of growth, operating ports, transportation groups, spearheading real-estate & infrastructure projects both at home and abroad. Its real-estate subsidiary Nakheel built Dubai’s iconic palm-tree-shaped island, packed with luxury villas and hotels, many still under construction. Real estate and construction accounts for about 23% of Dubai’s GDP.

With little oil, Dubai financed much of this rapid real estate development with debt. After incurring its estimated $80-$90 billion of debt in a four-year construction boom to transform its economy into a regional financial and tourism hub, Dubai suffered the world’s steepest property slump in the first global recession since World War II.

Deutsche Bank estimates that Dubai’s property prices, both commercial and residential, have halved since August last year, and could fall a further 15-20% this year.

U.S. Banks Less Exposed

Most analysts believe U.S. banks are probably less exposed than European rivals to a potential debt default by Dubai World, but a lack of transparency and the interconnection of the modern financial system make it difficult to know which institutions are ultimately exposed.

Dubai World’s largest creditors are reportedly domestic banks in Dubai and Abu Dhabi. MarketWatch noted data from the Bank for International Settlements which put cross-border banking exposure for the UAE as a whole at $123 billion at the end of June. Of that total, European banks hold 72%, with the United States and Japan only holding 9% and 7% of the exposure, respectively. The United Kingdom is by far the biggest creditor with a share of 41%.

Reminder of Other Risks

On a global scale, Dubai World’s debt problem seems relatively minor, but it illustrates the impact from one tiny country in an increasingly interconnected world. The Dubai news also cast doubt over the strength of the U.S. economic recovery, and the prospects for a bottoming of property prices.

Commercial Real Estate

As pointed out in my previous article that the commercial real estate sector posed a much greater threat than the over-hyped “mother of all carry trades.”  The Dubai debt crisis further reinforces this viewpoint.

The potential for contagion from Dubai’s debt woes could further unhinge an already fragile U.S. commercial real estate sector, whose values have already fallen 42.9% from their 2007 peak, close to the lowest since 2002, according to Moody’s. (Fig. 2) The latest Moody’s projection is for prices to bottom at 45-55% below their peak, but could drop as much as 65% from their peak in a “stress case”.

As commercial property values fall, debt defaults rise. The $3.4 trillion outstanding in debt backed by commercial real estate poses a real threat to the recovery. Trepp LLC reported that last month, delinquencies on U.S. commercial real estate loans that were packaged into commercial mortgage-backed securities reached 4.8%, more than six times the year earlier level. Hotel loans, at 8.7% distressed, have begun falling into delinquency faster than any other kind of commercial real estate debt.

Write-downs and losses at banks around the world have risen to more than $1.7 trillion since 2007 as the credit crisis undermined the value of assets owned by financial institutions, according to data compiled by Bloomberg. Any further deleveraging and the resulting credit tightening from commercial real estate would impede the financial sector and probably derail the U.S. economy sending it into another recession. 

Housing Market Mortgage Crisis

So far, the appearance of recovery in the housing sector is being driven primarily by reduced prices combined with federal programs to lower mortgage rates with the goal of bringing more buyers into the market.

Based on a study released by Zillow.com, the foreclosure crisis has moved beyond subprime mortgages and into the prime mortgage market. (Fig. 3) While subprime borrowers are still a factor in the current foreclosure epidemic, it’s becoming increasingly apparent that the weak labor market is the driving force behind the mortgage crisis we face today.

According to the Mortgage Bankers Association, one in seven U.S. home loans was past due or in foreclosure as of Sept. 30, putting that quarterly delinquency measure at its highest level since the report’s inception, 1972, and up from one in ten at the beginning of the year.

The continued surge in delinquencies suggests that a recovery in the housing market could be hindered by the weak job market as well as by further fallout from the easy money and loose lending practices of the past. The foreclosures and delinquencies are expected to keep rising well into 2010, not leveling off until the unemployment rate starts to moderate.

In a study by First American CoreLogic found that one in four of all U.S. mortgage-borrowers owe more than the value of their properties in the 3rd quarter. And many experts didn’t expect U.S. home prices to hit bottom until early 2011, perhaps falling another 5-10%, as more foreclosures get pushed onto the market.

Negative equity is another outstanding risk hanging over the mortgage market.

Dubai Is No Lehman

The circumstances behind Dubai’s moves are murky, making it hard to gauge the exact risk to the pertaining bonds and Dubai’s own general creditworthiness. UBS cautioned that Dubai’s overall debt “might be higher than the generally assumed $80 billion to $90 billion, due to potential off-balance sheet liabilities. These could include unlimited and unquantifiable amount of credit default swaps (CDS) and other derivatives against the underlying assets, and once unraveled, could potentially erupt into a subprime-like crisis.

The current expectation; however, is that there’s a good chance that Dubai’s problems will probably prove a local issue. Most likely, Dubai, or its neighboring emirate, Abu Dhabi, won’t risk tarnishing their images and reputation further, and will come up with a reasonable resolution.

Even if Dubai goes into sovereign default, the amount is probably not enough on its own to threaten the financial system since any actual losses would be a fraction of the total. So, the problems in Dubai are unlikely to be as serious as last year’s Lehman Brothers collapse, nor is it a reflection on the ability of emerging markets to lead a global economic recovery.

Rational Expectations?

But Dubai could well spur a broader crisis of investor confidence in overly leveraged economies as market confidence world-wide is still fragile from the severity of the financial crisis.  The debts of many emerging markets have risen even further as the countries governments have fought the ravages of the global recession by issuing more stimulus debt to fill the gap voided by private investment.

The spread of credit-default swaps on developing-nation’s bonds jumped 14 basis points after the Dubai news broke, the most in a month, to 3.24 percentage points, according to JPMorgan Chase & Co.’s EMBI+ Index. There is also a clear sign of potential contagion effects of global risk aversion on basically all risky assets, with the dollar and yen being the prime beneficiaries.

Rational expectations or not, for now, the Dubai crisis is simply a reminder that the severe global recession has relegated much debt to near junk status, and there still remains a high degree of uncertainty as to the percentage recoverable on all outstanding debt which is going to be coming due over the next 5 years.

Despite some seminal signs of green shoots in the news headlines during this 9 month liquidity driven rally in many asset classes around the globe, we should be reminded that all that glitters is not gold, and that the global economic recovery is still on shaky ground.

#  “I know the odds are against me, but if there’s a win I’m gonna find it!”  ~Goku  #

Economic Forecasts & Opinions

Karl Denninger Speaks at the American Liberty Alliance Tour in Tallahassee, Florida – October 2, 2009

If you don’t yet fully understand what is being perpetrated upon us in this country, you will wonder no longer, after watching these videos.

Note: The videos are misnumbered, but presented here in their correct order.

Part 1:

Part 2: