Phil Anthropy

High Likelihood of a Market Crash

If we keep our attention on the fundamentals, all will be well. What are the fundamentals? That any policies we formulate will ensure that the super rich become even richer. Therefore, keep an eye on policies regarding the banks and the oil companies. They will get richer in any political climate. I have yet to see a good analysis of past 10 years of leveraged profits by the banks. The current losses do not strike me as being large enough to offset the cumulative profits of the past. I could be wrong on this, and if anyone has the actual facts, please post them.

The Fed's Lose-Lose Decision

Instead of lose-lose, the Fed's decision is win-win -- for them. Banks stocks have soared in the past few weeks as various government bailouts come through, and will go higher if the $145 billion "stimulus" package comes to pass. Banks require slow growth or recession, because in a high growth environment, long-term interest rates will go up and therefore bank profits from existing fixed-rate mortgages will go down. When the smoke and mirrors and circus music stop, the banks won't be the ones looking for a musical chair to sit on. They'll be firmly seated in solid profits. The Fed is a profit-making, private bank. The GAO will never audit it, nor will anyone else, and the rules of the free market do not apply to the Fed in any real way. In many respects the United States is more a financial oligarchy than a political democracy. And as in any "fixed" game, the house always wins.

After the Subprime Crisis, Which Is the Next Domino to Fall?

It is rowing against the current of history to posit that governments would allow the global banking system to fail. Consequently, liquidity will be forthcoming. Bank debt will be swept under the rug in many ways, including transfer or debt off books through legal means to keep the numbers looking rosy. Just as the Resolution Trust Corporation didn't provide any real bargains to the public during the Savings & Loan debacle, but instead subsidized massive mismanagement and regulatory foolishness, in a similar manner the banks of today will be bailed out and made whole at taxpayer expense. Staying in cash is wise for the moment, as the big players predate in a whipsaw market, but when the election year rally starts in earnest, jumping on the bandwagon could be very lucrative.

The Inevitable Derivative Meltdown

The somewhat dramatic nature of the post merits a dramatic comment. I hope readers will excuse my divergence from the kind of learned financial prose and dry wit that makes this site so useful and entertaining. I am ready for possible rebukes from those who feel that I am wasting their time.
There are good reasons why people such as Mr. Ruggiero may feel uneasy in the midst of what seems like financial chaos. I might point out that doom-'n-gloom books have been around for many decades in many forms, often written by reputable authors. I recall "Blood in the Streets" and a host of others that predicted hyperinflation and economic collapse years ago. However, the doomsday scenario has not come to pass, and it's worthwhile to ask oneself why, when the probabilities are often in favor of it.
First, let's make an assumption that explains the way much of the world works: an operational imperative for the "how," without worrying about the "why." Here it is: Everything happens so that the rich can get much richer. Once you accept this, all else follows, and it all makes sense.
Within the convoluted web of mortage-backed securities and derivatives, one thing has become abundantly clear. There may be losers in this game, but the losers are not the banks. Let's work it through.
The Fed is a for-profit, private bank which to my knowledge has never been publicly audited. It doesn't like to lose money, and it doesn't want its colleague banks to lose money, either. The fact that the Fed sometimes operates in the interests of the U.S. economy is tangential to its drive for profit, regardless of the cost to the average American (through inflation or other economic artifacts which the Fed can affect).
When talking about the huge potential and actual losses from real estate derivatives, keep in mind that these derivatives have been generating double digit percentage gains for nearly a decade on several trillion dollars of leveraged money. The loss of a few billion dollars is barely a blip on the screen in comparison.
The real tragedy is that the big losses are probably not being taken by the banks, but rather by the "end users" of the derivatives, such as pension funds, college endowments and others whose greed for a little extra return led them to put their eggs in a rotten basket. I may be wrong on this, however, and apologize if I have seemed unsympathetic to banks which have fallen on hard times as a result of their awful investments.
But I'm getting off track. Let's assume that the interlocking financial derivative transactions are indeed a house of cards. Then they are a house of cards where each card is quarter-inch plate steel. They may look flimsy, but they are solid.
The U.S. has spent almost a trillion dollars on the war in Iraq. Regardless of whether one is for or against this war, this level of spending shows that we are quite capable of coming up with a trillion dollars out of nowhere to do something with, and the economy hasn't tanked as a consequence. Indeed, since the Iraq war began, our economic strength has been robust. It would seem that there is plenty of money available to provide liquidity for the banks. We just have to print it, and the Fed can do that in various ways.
Since banks have methods for masking losses -- so I've heard -- such as putting worthless assets into "on sale" status and carrying them on the books at full face value; or "selling" worthless assets at full face value, but with off-books "puts" attached that require buyback later at the same price; we really don't know what kind of awful financial shape large banks are in, especially those that aren't publicly traded. On the other hand, we don't know how much wealth banks have been earning and arranging to shield off books over the past decade, which could be substantial. What we do know is that the banks are irked because they are not making as much money as the used to, and bailouts make for happy banks, a happy Fed, and happy rich people. So that is what will happen.
Let's think about the "butterfly" effect, also related to positive feedback nonlinearities called reflexivity by George Soros, who may have taken that nomenclature from the 20th century scientific philosopher Alfred Korzybski. This effect says that there are nonlinearities which are unpredictably self-reinforcing, so that small causes can lead to huge effects. This is undoubtedly true in "undamped" systems which don't have offsetting negative feedback to calm the waters. However, the banking system, unlike an ocean where an underground earthquake can cause a disastrous tsunami, has plenty of ability to apply negative feedback wherever it wants. Therefore, the thought that a small transaction could lead inevitably to an avalanche is not quite accurate. It is accurate to say that reverse leverage is painful, but as long as the presses keep printing money to keep the leverage in place, the house of steel cards continues to withstand the hurricanes. It worked for the LTCM bailout years ago, and it can work again, particularly since financial institutions are much wealthier now than they were a few decades ago.
Ask yourself, where has all the money gone over the past half century? Not the money that goes around in circles in our economy, but the money that gets taken out as the "house cut" by the Fed, organized crime, and the super rich. Consider GNP totalled over the past 50 years, and you'll see that it's quite a bit. Much of the production consists of services, which do not retain value, and of depreciating assets such as automobiles. But some of it consists of sales of income-producing assets, such as valuable real estate, large corporations, transportation systems, utilities, etc. I believe that over the course of the last half century, "ownership" of a substantial portion of the U.S. has been amassed by relatively few entitites. For instance, we know from public reports that hundreds of billions of dollars per year are taken out of the economy through various forms of organized crime. That money goes to buy things, and not all of the things are fast boats and small planes. The money also might buy banks, agri-business and influence in corporate America (and perhaps on Capitol Hill, but let's not go there).
It's not impossible that there has evolved in this country, as in others, a significant group of super rich people. They are not like Bill Gates, who for reasons of his own decided against founding a dynasty with his wealth by legally funneling it offshore into trusts or holding companies or other entities sufficiently at arms length to legally avoid taxes on subsequent profits (which Howard Hughes did, I have heard, with his Hughes Medical Foundation, after getting Congress to pass the law that let him do it). Instead, Bill Gates gives his money to charity. However, not all super rich people have this perspective. Some are perfectly content to place their assets in legal hibernation until some descendent shows the promise of leadership and takes the helm of the flagship. There are many fictionalized stories of how this works in the Orient, and indeed that culture has a far longer view than we do concerning the wielding of financial power. But again, this has been a long digression, so we return to the point.
The point is that the super rich, the banks and the federal governments of the developed world are not, in this modern era, going to sit idly by and watch the winnings of their cronies evaporate. The person in the White House may not have obligations to floundering local governments, whose budgets are being slashed as real estate prices fall, but s/he has definite obligations to the military industrial complex, the large oil companies and the many other players who put him/her in office. Those folks don't like to lose money, and they might even get nasty about it if they start to. We have never heard the full story of why Ross Perot pulled out of the presidential race some years back. Rumor had it that there were threats made. I wouldn't doubt it, because he wasn't necessarily a "team player." Corporate America likes "team players;" and for the super rich, having a president with that perspective is indispensable.
So, we see that the combined weight of the wealthy and powerful is set against a global meltdown. I believe this weight is quite sufficient to prevent any looming financial disaster, however probable it might seem.
The only scenario to be cautious of, in my view, is the one in which the super rich have already placed their bets on the short side. That is, they would make more money on their puts and short sales than they would lose in asset value decline during a global depression. One must also factor in the money they would gain from buying back in at the bottom, so it's not a straightforward calculation. My conclusion is that a global depression isn't worth it to those who, through their inaction, could refrain from preventing it.
Therefore, the positive action will be forthcoming, whether in the form of loans from Dubai or Central Bank liquidity or government bailouts or jawboning to stop ARM resets. The global system will continue to lurch forward, as it has since World War II, with the rich getting much, much richer, and with the quality of life eroding for the middle class. In the U.S. of today, with our vast technological and medical breakthroughs, it is lamentable that it takes two parents working full time to make ends meet in a modest way. It's going to get a lot worse for the middle class, regardless of which way the economy goes, because we are gradually selling out our country and our future, but the voters don't have the time or wherewithall to change this, or even to understand it.
Therefore, I cannot agree with doomsday scenarios, even though they may have a sound scientific basis, because the game is rigged. The probabilities are not as they seem, and the most likely scenario is not the one that will occur. Just as the prices of stocks often fluctuate wildly for no good reason, due to "market" forces at work behind the scenes, similarly our economy will prevail -- and it certainly will prevail in an election year.

Should the Federal Reserve Remain Independent?

Perhaps a better question to ask is not whether the Fed should be independent, but whether the U.S. government remains independent or is instead a servant of the international banking system, of which the Fed is a for-profit part.

Why Treasuries Are the Way to Go in This Market

Not sure I understand why I should buy treasuries when a) one can get some of the new preferred stocks issued by major companies in lieu of bonds, which can yield over 7% at qualified dividend tax rates; b) the Fed will find it increasingly difficult to lower rates further, meaning that treasury yield is probably all one can expect, not additional appreciation of the bond.

Headed For a Normal 20-30% Correction

It is interesting to watch the ebb and flow of billions of dollars as just the froth on the rolling waves of international finance. In my view, a credit crunch is just the nomenclature banks use in order to raise interest rates on mortgages without stating their true agenda: greed. Dow up or down 300 points? It makes no difference, because that action is just the market movers casting wide nets to take out the riff raff trying to make a quick buck on the short-term trends. Who are the actual losers in the hedge funds? Probably anonymous foreign interests, private investors looking for the gravy train, and a few unfortunate college endowment managers who overreached their market knowledge. There are no losers among the very rich; that is the important lesson to take away from this.

When banks actually start to lose money, the Fed or other central banks inject liquidity rapidly, because after all, the Fed is a private business, not part of the government. If a slowing economy is desirable to thwart inflation, it is not that inflation is dangerous, but rather that the rich want to drive down the price of real estate so that they can buy it up cheap from the little guys in order to begin the next thrust of development and ownership.

The concept of laissez-faire capitalism is a smokescreen for market manipulaton on the grandest scale in history. I grant that sometimes the big players are at cross purposes and do not act in unison, which leads to counterexamples, but this anomalous model has a certain simplicity that other explanations lack.

So let's make some predictions, based on the theory of manipulation, and see if they come to pass.

. More hedge funds will fold, but their clients will be relatively small investors. The hedge fund managers and financial institutions will come through unscatheed, as will the cynical rating companies that led the public to believe their leveraged investments were safe.

. Residential real estate prices will drop another 20%, at which point they will stabilize as mammoth holdings are accumulated by REITS controlled by foreign interests. Interest rates will then mysteriously fall, inventories will vanish, and construction will resume -- with illegal immigrant tradesmen ironically forming the customer base for the very residential real estate they are building.

. The dollar will remain relatively steady against foreign currencies, not because it should, but because it's kept there. As someone recently said on Kudlow (to Kudlow's consternation), we have financed our war with foreign money. Now that the Chinese have us on a short leash through their complete control of long-term interest rates (their recycled dollars buying our treasuries), we must dance to their tune economically. The Chinese currency is linked to the dollar, so they don't care much how strong or weak the dollar is. They will continue to increase exports to us, and since we have become totally dependent on their cheap goods, already priced into our consumption budgets, we would put our economy into free fall if we tried to curb imports, which would reduce consumption.

. The stock market will end at Cramer's predicted 14,000 plus, not because of any rational valuation, but because that is the level where the amount of market cap increase will float enough new money in the economy to make up for the drains elsewhere, as foreign interest buy up this country (and other countries, too; we're not unique).

. There will be no big stock market correction. Normally, it would take asset deflation to bring down interest rates and thereby increase the spread on interest rates between savings accounts and loans, which helps the banks. But in the current Looking Glass economy, the rates are controlled by the Chinese (and perhaps by Fed open market operations), so no deflation is necessary. What we can predict with relative certainty is that there will be no significant inflation, because that might actually benefit borrowers, as they pay back their debt with inflated dollars. In today's world, we love individual debtors, because they pay the vigorish, but they can't be allowed to actually benefit from their loans in constant dollar terms.

. Stocks with global exposure will rally, because they are independent of our economy, and the rest of the world is doing far better than we are. I favor big tech, agricultural genetics, overseas pharmas (not limited by our regulations), jewelers (the rich get richer, and need jewels), food producers (we are breeding more people), luxury hotels -- you get the drift.

. Gold will rally precipitously, but not until the vultures are poised to pick our infrastructure carcass clean. This picking will not happen in the well moated financial world, but rather in the world of natural resources and large scale undeveloped real estate holdings. The Chinese will inexplicably begin to sell treasuries at a discount on the international secondary market, gradually divesting themselves of their core dollar holdings and accumulating Euros and commodities futures. The dollar will suddenly weaken as the Chinese dump dollars and treasuries directly and relentlessly on the primary market. Interest rates will spike, and the Fed will come to the rescue with inflated dollars to buy the waterfall of unwanted treasuries. As the dollar weakens, the Chinese will buy dollars with their gold and Euros, and immediately use those dollars to buy up our industrial and agricultural base. The resulting demand-driven price inflation will spearhead a rally in real estate and a rise in interest rates, which will strengthen the dollar somewhat, but not enough to offset gold's rising store of value. When the music stops, everyone has a chair except the American taxpayer.

Anyway, it's easy to make predictions. The hard part is to make accurate predictions. We'll see what happens.

Is the Dow's Two-Day Loss a Correction, or a Calamity?

Each year we have healthy corrections to the market. I say "healthy," because what they really may be is a way for the market movers to make money on their shorts, having not made enough on their longs. But in any case, we have them.

With the Chinese and Saudi currencies linked to the dollar, these countries are our partners, not our creditors. If our economy suffers, so do theirs, and the timing is poor for that.

Saudi Arabia has a very high birthrate, which outstrips its economic growth. It cannot afford the social upheaval that would result from an economic slowdown. Unemployment rates for native Saudis (as opposed to cheap, imported labor from surrounding countries) are probably higher than the Saudi government would like, despite new laws requiring companies to hire native Saudis.

China is looking towards the Olympics as a prestige-building event to springboard them onto the world stage as a major player. Some may recall the enormous effort China put forth during the IOC voting when Sydney won. There were crowds of countless thousands of Chinese on television, waving flags and singing, in an attempt to win the vote. The Chinese lost face then, and do not intend to lose face again by doing a bad job on the Olympics, and to do a good job requires vast sums of money to improve their infrastructure. This money comes from exports, in large part to the U.S.

Saudi Arabia, China and other major players, including Japan, Taiwan, and the Fed, are not interested in a stock market debacle in the U.S. All the vested interests want the market to remain strong.

I believe the Japanese yen is strengthening due to a decision by the Bank of Japan to slow down the carry trade in yen. Japan doesn't mind people making free money off the carry trade, because a weak yen (caused by yen being borrowed at low interest rates and then sold in vast quantities to buy other currencies, which are invested at higher interest rates) is good for their exports. But they see the complex real estate derivatives in the U.S. as being so highly leveraged that there could actually be some grief, and are therefore putting on the brakes. This won't "unwind" the carry trade, but will merely constrain it. It's a warning to the big players that they have gone too far, and have to make free money a little less rapidly, and with a little less risk.

What I see is a well orchestrated effort to keep the global economy on an even keel. I think that effort will work, because there are so many vested interests pulling in the same direction. I am not worried by subprime mortgage difficulties, because these represent a small percentage of all mortgages. Even with the closing of a few hedge funds, I think the damage is limited. Those who buy the junk debt at pennies on the dollar will probably end up with a profit as the real estate market recovers in a few years.

Overall, job creation is contininuing. People may be forced to own one car rather than two, or to rent out part of their homes to tenants, unpalatable as that may be, and suddently there would be enough income to pay the bills with. There are many defaulters who are speculators and "flippers," but I don't think it is a large proportion, and after the ARM adjustments crush them, the real estate market will likely stabilize.

So my bet is for a near-term recovery in the market, with a return to uptrend. I expect the Fed to keep rates the same (because if they raise rates, the bankers make less money, and if they lower rates the dollar will weaken, and our creditors -- holders of our treasuries -- will become grumpy. Therefore, the status quo is the goal. But that said, I have stop loss trade triggers in place with very little downside slack, so that if next week is the abyss, I'll be out of the market early on.

Ben Bernanke's Fed Offers Investors False Reassurance

The Treasury Sec on CNBC was talking about Chinese investment in our treasuries. I was confused, because on the one hand he said that foreign direct investment was ok, including purchase of treasuries, but on the other hand he said in reply to questions on Chinese diversification of reserve currencies that the amount of Chinese investment in treasuries was not that great. Assuming I understood him correctly and am quoting him correctly, I don't know which to believe. It seems to me that several speakers over the past months have said that the Chinese purchase of treasuries wasn't a large enough proportion of treasuries to hurt us if they stopped buying. If that is true, then who is doing the buying of treasuries? My own theory, for what it's worth, is that the Fed itself has been doing the buying, using printed money. I don't know if that could actually happen, but it would explain how interest rates can remain so low when our deficit is increasing, and how the printing of money can be noninflationary (it never gets into the economy -- just recycles into treasuries and other federal debt). I would love to be wrong on this, so please correct me if you have information that shows it to be all foolish conjecture on my part. From what I see, we are locked in a financial deadly embrace. If the dollar plummets, it will destabilize financial systems. So everybody is walking on eggshells trying to avoid that while still protecting themselves if it actually happens. I would presume that the diversification of reserve currencies isn't a big deal now, because governments are probably hedged against a falling dollar through currency options. But those options don't last forever, so eventually the Euro will ascend as the world's dominant currency, in my view. The big risk is that more countries will start pricing oil in Euros, not dollars, so nobody will want our dollars. We do have a lot of overseas sales of manufactured goods, but it is only a matter of time until the Chinese and Indians undercut us in those markets. I give it another 20 years or so, and unless trends change, we'll be waiters and dishwashers to the world's tourists. I hope I am wrong.