Federal Reserve losing control

[isachar]

All stops being pulled by Fed to keep banks afloat with a sea of insta-credit:

http://biz.yahoo.com/ap/080201/fed_credit_crisis.html

AP
Fed Plans $60B Auctions to Banks in Feb.
Friday February 1, 10:09 am ET
By Martin Crutsinger, AP Economics Writer
Fed Announces Auctions Totaling $60 Billion in February to Combat Credit Crisis


WASHINGTON (AP) -- The Federal Reserve said Friday it will provide $60 billion in fresh cash to commercial banks in two auctions in February and will keep holding auctions every other week for as long as needed to ease the credit crisis.
ADVERTISEMENT


The new auctions, to be held on Feb. 11 and Feb. 25, will mark the fifth and sixth times the Fed has used a new auction process announced in December to provide cash-strapped banks with extra reserves.

In a brief statement, the Fed said that it intended to keep holding the auctions every other week "for as long as necessary to address elevated pressures in short-term funding markets."

The Fed said that the minimum bid amount for the February auctions will be reduced to $5 million, down from $10 million in the previous auctions, to "facilitate participation by smaller institutions."

The Fed's hope is that the increased resources provided to the banking system will keep banks lending and prevent a severe credit squeeze from pushing the country into a recession.

On Wednesday, the Fed announced that it was cutting its federal funds rate, the interest that banks charge each other for overnight loans, by a half-point to 3 percent, marking the second big rate cut in just over a week.

Those two reductions in the federal funds rate represented the most aggressive rate cutting by the Fed in a quarter-century and underscored the Fed's resolve to battle the current economic slowdown.

In its statement Friday, the Fed said it would announce the size of the March auctions by Feb. 29.

The Fed started the auction process in December with two auctions of $20 billion each. It boosted that size to $30 billion each for the two January auctions, an indication of the success it was having with the new process.

The Fed went to the innovative auction procedure after it had only limited success in encouraging banks to use its "discount window," where the Fed makes direct loans to commercial banks.

Banks had been reluctant to use the discount window out of concern that they would be perceived as having trouble raising money through other avenues.

[dqueue]

On edit: Completely off-topic. Discussion regarding the Fed printing phresh cash triggered recall of the commentary below. In any case, I don't mean to derail the thread.

Cannonfire had a recent thread about the super notes. The thread received a late comment that resonated with me; it's the fifth (currently last) comment... direct comment linking seems to be broken. Anyhow... comment is posted below. It's interesting, and believable conjecture that the Fed, itself, prints the super notes...

Thank-you for the very interesting post and links.

The following is pure speculation, since I have no information beyond what you've supplied or linked to, but I think it at least takes into account what I see as the key points:

P1. The supernotes use genuine paper and inks, they're printed by very expensive machinery, and they have watermarks, coloured micro fibers, and embedded strips like the real notes do.

P2. The supernotes have been updated 19 times, tracking changes in design of the real bills.

P3. There exists an (at least) equally good $50 supernote which is not being circulated.

P4. Only $50 million of supernotes has been seized since 1989.

P5. Supernotes lack the microscopic ink splotches that presumably arise from conditions of mass production.

P6. Supernotes have "tells", minute changes from the design of the real notes which can be readily seen once one knows their specific location, but which are otherwise difficult to detect.

My conclusions (in full realization that many others are possible):

C1. The printers of supernotes are NOT doing so primarily to make money by passing supernotes off as real notes: the supernotes are massive overkill. P1-P3 indicate far more effort is going into producing the bills than is necessary to have them accepted as real, and that opportunities to spend less and profit more by skipping design updates or passing less-frequently tested $50 bills are not being taken. P4 and P5 provide alternative lines of evidence that large numbers of bills (in the currency-destabilizing range, say) are not being printed.

C2. The printers of supernotes want to be able to both easily detect and irrefutably expose batches of bills as supernotes, presumably at their convenience. Given the capabilities demonstrated by P1-P3, I can't see any other conclusion to be drawn from P6.

C3. The simplest (in some ways) explanation for P1-P3 is that the same people and facilities are responsible, knowingly or not, for printing supernotes as for printing real notes. Those in the know simply add tells to copies of whatever plates are currently in use, and arrange for those modified plates to be used for small runs (whose pretext could be that a shipment of genuine bills in a certain range of serial numbers was misprinted or accidentally destroyed, and must be reprinted); the tracking of design changes is then just a side-effect.

C4. The supernotes are not being produced simply to allow tracking of money, since serial numbers already allow that.

C5. If C3 is true, it's extremely unlikely to be a rogue inside operation, given how long it has persisted. Therefore it is officially sanctioned at some level high enough within the Bureau of Printing and Engraving or the Federal Reserve to forestall outside investigation.

I think C2 is key to understanding the purpose of supernotes. Suppose you are a government agency trying to take down (in whatever sense) a targeted individual or organization. Further suppose you are constrained to doing so via public charges that will stick in a court, whether judicial or of public opinion. Finally, suppose you cannot make charges about something the target has actually done; perhaps you are institutionally pure of heart and stymied by lack of real evidence, or perhaps you can't afford that the real reasons for the targeting be made public, perhaps because those reasons are illegitimate.
Then supernotes are a handy tool:

- arrange for the target to acquire, one way or another, an appropriate quantity of supernotes, perhaps by paying them (through a cut-out, of course) for goods or services. Because of P1-P3, it's unlikely the target will recognize them as counterfeit.

- it doesn't matter whether the target did anything wrong in exchange for the payment(s), only that it eventually ends up with a bundle of supernotes and starts to spend them.

- at your convenience, charge the target (formally or via the media) with passing counterfeit bills.

It's easy to demonstrate the truth of the charges (because of P6), and if the target has supernotes in sufficient quantity, any defence of ignorance becomes weak: P4 implies that the chances of any bundle of money having more than a couple of supernotes by chance is tiny.

Or perhaps you set up a Brewster-Jennings-style "honey trap", aimed at luring whomever might seek out counterfeiters for fast cash. How can other counterfeiters compete when you have such a high quality product. And you can easily prove they are counterfeits, since you know the tells.

As a given tell becomes known, perhaps due to public charges that you've made, you can print new supernotes with new tells. The lack of old tells on these bills can be used to "prove" they are genuine, until such a time as you find convenient.

You can probably imagine other sting operations, legitimate or not, that involve being able to reveal irrefutably, and at just the right time, that a pile of very genuine looking money sitting on a table, in a safe or in a briefcase is in fact "counterfeit".

And of course the agency responsible for supernotes need not be the only one putting them to use, and need not know that they aren't.

This falls apart if the Fed / BPE become widely suspected of printing the supernotes themselves, because then how will any charges of "counterfeit" still stick? So it makes sense to sporadically feed Interpol with reports of unknown expert counterfeiters and seizures of supernotes from villains of the day. - jmb

[Pazdispenser]

Anti, this is for you..... check out the bolded sentence........

FT.com
Insight: CDS market may create added risks
Tuesday February 5, 10:35 am ET
By Satayjit Das


In May 2006, Alan Greenspan, the former Federal Reserve chairman, noted: "The credit default swap is probably the most important instrument in finance. ... What CDS did is lay-off all the risk of highly leveraged institutions - and that's what banks are, highly leveraged - on stable American and international institutions."

The reality may prove different.

The CDS is economically similar to credit insurance. The buyer of protection (typically a bank) transfers the risk of default of a borrower (the reference entity) to a protection seller who for a fee indemnifies the protection buyer against credit losses. Current debate has focused on the size of the market. But the key problem is that a combination of documentation and counterparty risks means that the market may not function as participants and regulators hope if actual defaults occur.

CDS documentation, which is highly standardised, generally does not exactly match the terms of the underlying risk being hedged. CDS contracts are also technically complex in relation to the identity of the entity being hedged, the events that are covered and how the CDS contract is to be settled. This means that the hedge may not provide the protection sought.

In case of default, the protection buyer in CDS must deliver a defaulted bond or loan - the deliverable obligation - to the protection seller in return for receiving the face value of the delivered item (known as physical settlement). When Delphi defaulted, for example, the volume of CDS outstanding was $28bn against $5.2bn of bonds and loans. On actively traded names CDS volumes are substantially greater than outstanding debt making it difficult to settle contracts.

Shortage of deliverable items and practical restrictions on settling CDS contracts have forced the use of "protocols" - where any two counterparties, by mutual consent, substitute cash settlement (based on the market price of defaulted bonds) for physical delivery. In Delphi, the protocol resulted in a settlement price of 63.38 per cent (the market estimate of recovery by the lender). The protection buyer received 36.62 per cent (100 per cent - 63.38 per cent) or $3.662m per $10m CDS contract. Fitch Ratings assigned a recovery rating to Delphi's senior unsecured obligation equating to a 0-10 per cent recovery band - far below the price established through the protocol. The buyer of protection may have potentially received a payment on its hedge below its actual losses - effectively it would not have been fully hedged.

CDS contracts substitute the risk of the protection seller for the risk of the loan or bond being hedged. Some 60-70 per cent of ultimate CDS protection sellers are financial guarantors (monoline insurers) and hedge funds. Concerns about the credit standing of monolines are well documented. Recently, Merrill Lynch took a charge of $3.1bn against counterparty risk on hedges with financial guarantors.

In the case of hedge funds, the CDS is marked to market daily. Any gain or loss is covered by collateral (cash or high quality securities) to minimise performance risk. If there is a failure to meet a margin call then the position must be closed out and the collateral applied against the loss. As the case of ACA highlighted, banks may not be willing or able to close out positions where collateral isn't posted. Collateral models also use historical volatility and correlation that may underestimate the risk.

Then there are operational risks - mark to market of the CDS and control of collateral.

If the CDS contracts fail then "hedged" banks are exposed to losses on the underlying credit risk. The CDS market entails complex chains of risk - similar to the re-insurance chains that proved so problematic in the case of Lloyd's of London. A default may quickly cause the financial system to become gridlocked as uncertainty about counterparty risks restricts trading.

As the credit crisis deepens, the risk of actual defaults becomes real. The CDS market will be tested and may be found wanting.

CDS contracts may not actually improve the overall stability and security of the financial system but actually create additional risks.

The writer is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives

[antiaristo]

.


Thanks, paz. Nice catch.

That's possibly the third or fourth oblique reference to Lloyds that I've seen in the context of this crash.

This systemic financial meltdown: Per Roubini (slightly abridged).

Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past January?.... the flow of bad macro news in mid-January did not justify, by itself, such a radical inter-meeting emergency Fed action followed by another cut at the formal FOMC meeting.

To understand the Fed actions one has to realize that there is now a rising probability of a “catastrophic” financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe...

That is the reason the Fed had thrown all caution to the wind – after a year in which it was behind the curve and underplaying the economic and financial risks – and has taken a very aggressive approach to risk management....

To understand the risks that the financial system is facing today I present the “nightmare” or “catastrophic” scenario that the Fed and financial officials around the world are now worried about. Such a scenario – however extreme – has a rising and significant probability of occurring. Thus, it does not describe a very low probability event but rather an outcome that is quite possible.

Start first with the recession that is now enveloping the US economy. Let us assume – as likely - that this recession – that already started in December 2007 - will be worse than the mild ones – that lasted 8 months – that occurred in 1990-91 and 2001. The recession of 2008 will be more severe for several reasons: first, we have the biggest housing bust in US history with home prices likely to eventually fall 20 to 30%; second, because of a credit bubble that went beyond mortgages and because of reckless financial innovation and securitization the ongoing credit bust will lead to a severe credit crunch; third, US households – whose consumption is over 70% of GDP - have spent well beyond their means for years now piling up a massive amount of debt, both mortgage and otherwise; now that home prices are falling and a severe credit crunch is emerging the retrenchment of private consumption will be serious and protracted. So let us suppose that the recession of 2008 will last at least four quarters and, possibly, up to six quarters. What will be the consequences of it?

Here are the twelve steps or stages of a scenario of systemic financial meltdown associated with this severe economic recession…

First, this is the worst housing recession in US history and there is no sign it will bottom out any time soon. At this point it is clear that US home prices will fall between 20% and 30% from their bubbly peak; that would wipe out between $4 trillion and $6 trillion of household wealth..... a 30% fall in home values would imply that over 10 million households would have negative equity in their homes and would have a big incentive to use “jingle mail” (i.e. default, put the home keys in an envelope and send it to their mortgage bank)....

Second, losses for the financial system from the subprime disaster are now estimated to be as high as $250 to $300 billion. But the financial losses will not be only in subprime mortgages and the related RMBS and CDOs. They are now spreading to near prime and prime mortgages as the same reckless lending practices in subprime (no down-payment, no verification of income, jobs and assets (i.e. NINJA or LIAR loans), interest rate only, negative amortization, teaser rates, etc.) were occurring across the entire spectrum of mortgages; about 60% of all mortgage origination since 2005 through 2007 had these reckless and toxic features. So this is a generalized mortgage crisis and meltdown, not just a subprime one. And losses among all sorts of mortgages will sharply increase as home prices fall sharply and the economy spins into a serious recession. Goldman Sachs now estimates total mortgage credit losses of about $400 billion; but the eventual figures could be much larger if home prices fall more than 20%. Also, the RMBS and CDO markets for securitization of mortgages – already dead for subprime and frozen for other mortgages - remain in a severe credit crunch, thus reducing further the ability of banks to originate mortgages. The mortgage credit crunch will become even more severe.

Also add to the woes and losses of the financial institutions the meltdown of hundreds of billions of off balance SIVs and conduits; this meltdown and the roll-off of the ABCP market has forced banks to bring back on balance sheet these toxic off balance sheet vehicles.... And because of securitization the securitized toxic waste has been spread from banks to capital markets and their investors in the US and abroad, thus increasing – rather than reducing systemic risk – and making the credit crunch global.

Third, the recession will lead – as it is already doing – to a sharp increase in defaults on other forms of unsecured consumer debt: credit cards, auto loans, student loans..... As the Fed loan officers survey suggest the credit crunch is spreading throughout the mortgage market and from mortgages to consumer credit, and from large banks to smaller banks.

Fourth, while there is serious uncertainty about the losses that monolines will undertake on their insurance of RMBS, CDO and other toxic ABS products, it is now clear that such losses are much higher than the $10-15 billion rescue package that regulators are trying to patch up..... The monolines should be downgraded as no private rescue package – short of an unlikely public bailout – is realistic or feasible given the deep losses of the monolines on their insurance of toxic ABS products.

Next, the downgrade of the monolines will lead to another $150 of writedowns on ABS portfolios for financial institutions that have already massive losses. It will also lead to additional losses on their portfolio of muni bonds. The downgrade of the monolines will also lead to large losses – and potential runs – on the money market funds that invested in some of these toxic products. The money market funds that are backed by banks or that bought liquidity protection from banks against the risk of a fall in the NAV may avoid a run but such a rescue will exacerbate the capital and liquidity problems of their underwriters. The monolines’ downgrade will then also lead to another sharp drop in US equity markets that are already shaken by the risk of a severe recession and large losses in the financial system.

Fifth, the commercial real estate loan market will soon enter into a meltdown similar to the subprime one....

Sixth, it is possible that some large regional or even national bank that is very exposed to mortgages, residential and commercial, will go bankrupt. Thus some big banks may join the 200 plus subprime lenders that have gone bankrupt. This, like in the case of Northern Rock, will lead to depositors’ panic and concerns about deposit insurance. The Fed will have to reaffirm the implicit doctrine that some banks are too big to be allowed to fail. But these bank bankruptcies will lead to severe fiscal losses of bank bailout and effective nationalization of the affected institutions. Already Countrywide – an institution that was more likely insolvent than illiquid – has been bailed out with public money via a $55 billion loan from the FHLB system, a semi-public system of funding of mortgage lenders. Banks’ bankruptcies will add to an already severe credit crunch.

Seventh, the banks losses on their portfolio of leveraged loans are already large and growing. The ability of financial institutions to syndicate and securitize their leveraged loans – a good chunk of which were issued to finance very risky and reckless LBOs – is now at serious risk. And hundreds of billions of dollars of leveraged loans are now stuck on the balance sheet of financial institutions at values well below par (currently about 90 cents on the dollar but soon much lower)..... And add to this problem the fact that some actual large LBOs will end up into bankruptcy as some of these corporations taken private are effectively bankrupt in a recession and given the repricing of risk; convenant-lite and PIK toggles may only postpone – not avoid – such bankruptcies and make them uglier when they do eventually occur....

Eighth, once a severe recession is underway a massive wave of corporate defaults will take place. In a typical year US corporate default rates are about 3.8% (average for 1971-2007); in 2006 and 2007 this figure was a puny 0.6%. And in a typical US recession such default rates surge above 10%. Also during such distressed periods the RGD – or recovery given default – rates are much lower, thus adding to the total losses from a default. Default rates were very low in the last two years because of a slosh of liquidity, easy credit conditions and very low spreads (with junk bond yields being only 260bps above Treasuries until mid June 2007). But now the repricing of risk has been massive: junk bond spreads close to 700bps, iTraxx and CDX indices pricing massive corporate default rates and the junk bond yield issuance market is now semi-frozen. While on average the US and European corporations are in better shape – in terms of profitability and debt burden – than in 2001 there is a large fat tail of corporations with very low profitability and that have piled up a mass of junk bond debt that will soon come to refinancing at much higher spreads. Corporate default rates will surge during the 2008 recession and peak well above 10% based on recent studies. And once defaults are higher and credit spreads higher massive losses will occur among the credit default swaps (CDS) that provided protection against corporate defaults. Estimates of the losses on a notional value of $50 trillion CDS against a bond base of $5 trillion are varied (from $20 billion to $250 billion with a number closer to the latter figure more likely). Losses on CDS do not represent only a transfer of wealth from those who sold protection to those who bought it. If losses are large some of the counterparties who sold protection – possibly large institutions such as monolines, some hedge funds or a large broker dealer – may go bankrupt leading to even greater systemic risk as those who bought protection may face counterparties who cannot pay.

Ninth, the “shadow banking system” (as defined by the PIMCO folks) or more precisely the “shadow financial system” (as it is composed by non-bank financial institutions) will soon get into serious trouble. This shadow financial system is composed of financial institutions that – like banks – borrow short and in liquid forms and lend or invest long in more illiquid assets. This system includes: SIVs, conduits, money market funds, monolines, investment banks, hedge funds and other non-bank financial institutions. All these institutions are subject to market risk, credit risk (given their risky investments) and especially liquidity/rollover risk as their short term liquid liabilities can be rolled off easily while their assets are more long term and illiquid. Unlike banks these non-bank financial institutions don’t have direct or indirect access to the central bank’s lender of last resort support as they are not depository institutions. Thus, in the case of financial distress and/or illiquidity they may go bankrupt because of both insolvency and/or lack of liquidity and inability to roll over or refinance their short term liabilities. Deepening problems in the economy and in the financial markets and poor risk managements will lead some of these institutions to go belly up: a few large hedge funds, a few money market funds, the entire SIV system and, possibly, one or two large and systemically important broker dealers. Dealing with the distress of this shadow financial system will be very problematic as this system – stressed by credit and liquidity problems - cannot be directly rescued by the central banks in the way that banks can.

Tenth, stock markets in the US and abroad will start pricing a severe US recession – rather than a mild recession – and a sharp global economic slowdown. The fall in stock markets – after the late January 2008 rally fizzles out – will resume as investors will soon realize that the economic downturn is more severe, that the monolines will not be rescued, that financial losses will mount, and that earnings will sharply drop in a recession not just among financial firms but also non financial ones. A few long equity hedge funds will go belly up in 2008 after the massive losses of many hedge funds in August, November and, again, January 2008. Large margin calls will be triggered for long equity investors and another round of massive equity shorting will take place. Long covering and margin calls will lead to a cascading fall in equity markets in the US and a transmission to global equity markets. US and global equity markets will enter into a persistent bear market as in a typical US recession the S&P500 falls by about 28%.

Eleventh, the worsening credit crunch that is affecting most credit markets and credit derivative markets will lead to a dry-up of liquidity in a variety of financial markets, including otherwise very liquid derivatives markets. Another round of credit crunch in interbank markets will ensue triggered by counterparty risk, lack of trust, liquidity premia and credit risk. A variety of interbank rates – TED spreads, BOR-OIS spreads, BOT – Tbill spreads, interbank-policy rate spreads, swap spreads, VIX and other gauges of investors’ risk aversion – will massively widen again. Even the easing of the liquidity crunch after massive central banks’ actions in December and January will reverse as credit concerns keep interbank spread wide in spite of further injections of liquidity by central banks.

Twelfth, a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices will ensue leading to a cascading and mounting cycle of losses and further credit contraction. In illiquid market actual market prices are now even lower than the lower fundamental value that they now have given the credit problems in the economy. Market prices include a large illiquidity discount on top of the discount due to the credit and fundamental problems of the underlying assets that are backing the distressed financial assets. Capital losses will lead to margin calls and further reduction of risk taking by a variety of financial institutions that are now forced to mark to market their positions. Such a forced fire sale of assets in illiquid markets will lead to further losses that will further contract credit and trigger further margin calls and disintermediation of credit. The triggering event for the next round of this cascade is the downgrade of the monolines and the ensuing sharp drop in equity markets; both will trigger margin calls and further credit disintermediation.

Based on estimates by Goldman Sachs $200 billion of losses in the financial system lead to a contraction of credit of $2 trillion given that institutions hold about $10 of assets per dollar of capital. The recapitalization of banks sovereign wealth funds – about $80 billion so far – will be unable to stop this credit disintermediation – (the move from off balance sheet to on balance sheet and moves of assets and liabilities from the shadow banking system to the formal banking system) and the ensuing contraction in credit as the mounting losses will dominate by a large margin any bank recapitalization from SWFs. A contagious and cascading spiral of credit disintermediation, credit contraction, sharp fall in asset prices and sharp widening in credit spreads will then be transmitted to most parts of the financial system. This massive credit crunch will make the economic contraction more severe and lead to further financial losses. Total losses in the financial system will add up to more than $1 trillion and the economic recession will become deeper, more protracted and severe.

A near global economic recession will ensue as the financial and credit losses and the credit crunch spread around the world. Panic, fire sales, cascading fall in asset prices will exacerbate the financial and real economic distress as a number of large and systemically important financial institutions go bankrupt. A 1987 style stock market crash could occur leading to further panic and severe financial and economic distress. Monetary and fiscal easing will not be able to prevent a systemic financial meltdown as credit and insolvency problems trump illiquidity problems. The lack of trust in counterparties – driven by the opacity and lack of transparency in financial markets, and uncertainty about the size of the losses and who is holding the toxic waste securities – will add to the impotence of monetary policy and lead to massive hoarding of liquidity that will exacerbates the liquidity and credit crunch.

In this meltdown scenario US and global financial markets will experience their most severe crisis in the last quarter of a century.

Can the Fed and other financial officials avoid this nightmare scenario that keeps them awake at night? The answer to this question – to be detailed in a follow-up article – is twofold: first, it is not easy to manage and control such a contagious financial crisis that is more severe and dangerous than any faced by the US in a quarter of a century; second, the extent and severity of this financial crisis will depend on whether the policy response – monetary, fiscal, regulatory, financial and otherwise – is coherent, timely and credible. I will argue – in my next article - that one should be pessimistic about the ability of policy and financial authorities to manage and contain a crisis of this magnitude; thus, one should be prepared for the worst, i.e. a systemic financial crisis.

They've created a feedback spiral identical to the LMX spiral that consumed more than eighty percent of the "Names" at Lloyds of London.

And who are "They"?

The Iran-Contra mob.
Which includes Hillary Clinton.

[antiaristo]

.

More indications that the so called monolines are at the epicentre of what's coming.

And more evidence that the corruption spread from insurance to finance. Specifically from Lloyds of London to Wall Street.

New danger appears on the monoline horizon

By Paul J Davies
Published: February 6 2008 23:31 | Last updated: February 6 2008 23:31

As the bond insurers, or monolines, have seen their seemingly rock-solid AAA ratings begin to buckle, worries have grown about what downgrades for these companies might mean for banks.

Now, one particular type of trade done between banks and monolines is being seen as an extra hidden danger.

These so-called negative basis trades were done in large volumes in recent years. They allowed both banks and monolines to book apparently “free money” and saw monolines writing guarantees on each other. If they have to be unwound, it will be a costly business for all involved.

The real problem is that almost no one has any idea how significant the profits taken on these trades might be. These trades were profitable because a bond could pay out more in interest than it cost to buy the insurance available in the derivatives market to protect the holder against default. In the world of structured finance, a bank would buy a bond, get it guaranteed, or wrapped, by a monoline to support the bond’s AAA rating, but then also pay another monoline to write a default swap on the first monoline, to guard against it defaulting on its guarantee.

The difference between what the bank paid for the insurance and what it received in yield from the bond could be pocketed as “risk-free” profit – and in many cases banks took the entire value of that income over the life of the bond upfront.

One senior industry insider admits that billions of dollars worth of these trades were done, but insists they were mostly restricted to the arena of utility and infrastructure debt. These were attractive both because they were of long maturities and because they were often linked to inflation, which would increase the returns.

“On a £100m deal over 25 years a bank could conservatively book £5m up front – even more if it was index linked,” says the senior industry executive.

For the monolines, the trades were also seen as near risk-free profit when taking the position of writing protection on peers.

The same executive insists that monoline activity in CDOs was restricted to the hedging of senior tranches that banks had retained on their books after structuring deals and had nothing to do with negative basis trades.

However, others are less sure. Monoline analysts at some of the banks believe a large amount of negative basis trades in the US were done on super senior CDO tranches, but admit they have no idea what proportion of total CDO business for the monolines that was.

Bob McKee, an analyst at Independent Strategy, a London research house, believes that up to $150bn worth of CDO business done by the monolines could be negative basis trades.

Standard & Poor’s, in a note on the potential impact of monolines on banks this week, said it believed some of the CDOs hedged by bond insurers were part of a strategy of “negative basis trades”.

The problem is that if monolines are downgraded and their protection becomes ineffective, profits booked up-front need to be reversed. Restating earnings is a very tricky area for investment banks – not least because the traders involved will have long ago pocketed their bonuses.

http://tinyurl.com/22m548
(Financial Times)

"They allowed both banks and monolines to book apparently “free money” and saw monolines writing guarantees on each other."


See that? The banks and the insurers were signing contracts for the next twenty-five years. They both recognised a gain on signature.

How can that be right?
How can both parties recognise an economic profit on signature, when nothing more than paper-shuffling is involved?

They recognised all the "profits" on a 25 year deal in the first year.

How can that be right?

Looking at the numbers it looks as though at least $10 billion of such phantom profits have been booked in the past few years. They have been included in aggregate S&P 500 earnings data.

According to Sarbanes-Oxley, they will have to be written back, and earnings restated.


The insurers were writing guarantees on each other.

How can that be right?
Think about it. Insurer A buys a guarantee from Insurer B. It claims to be stronger. Insurer B buys a guarantee from Insurer A. It claims to be stronger.

How can both parties be stronger, when all they have done is to shuffle more paper?

This is the infamous LMX spiral, where Insurer A bought re-insurance from Insurer B, who bought re-insurance from Insurer C, who bought re-insurance from...Insurer A! Round and round it goes, generating fees and commissions, but no risk is dispersed.

It's also the model for the OTC derivatives market. This time I don't stress the sheer size: I stress the concentration. It's all Citibank, JP Morgan and Bank of America. About ninety percent.

What does that mean? It means that Citi has written contracts on JPM, which has written contracts on BoA, which has written contracts on Citi. Another spiral!

Two more for Lloyds.

[ninakat]

Thanks for keeping the info coming, anti. Here's Mike Whitney's latest.

The Bush Bust of '08
“It's All Downhill From Here, Folks”
By Mike Whitney

"I just saw a picture Bernanke stripped to the waist in the boiler-room shoveling greenbacks into the furnace.” Rob Dawg, Calculated Risk blog-site

On January 14, 2008 the FDIC web site began posting the rules for reimbursing depositors in the event of a bank failure. The Federal Deposit Insurance Corporation (FDIC) is required to “determine the total insured amount for each depositor....as of the day of the failure” and return their money as quickly as possible. The agency is “modernizing its current business processes and procedures for determining deposit insurance coverage in the event of a failure of one of the largest insured depository institutions.” ( http://www.fdic.gov/news/news/financial ... .html#body )

The implication is clear, the FDIC has begun the “death watch” on the many banks which are currently drowning in their own red ink. The problem for the FDIC is that it has never supervised a bank failure which exceeded 175,000 accounts. So the impending financial tsunami is likely to be a crash-course in crisis management. Today some of the larger banks have more than 50 million depositors, which will make the FDIC's job nearly impossible.

Good luck.

It's worth noting that, due to a rule change by Congress in 1991, the FDIC is now required to use “the least costly transaction when dealing with a troubled bank. The FDIC won't reimburse uninsured depositors if it means increasing the loss to the deposit insurance fund....As a result, uninsured depositors are protected only if a bank acquiring the failed bank will pay more for all of the deposits than it would for insured deposits only.” (MarketWatch)

Great. That's reassuring. And there's more, too. FDIC Chairman Shiela Bair warned that “as of Sept. 30, there were 65 institutions with assets of $18.5 billion on its list of "problem" institutions;” although she wouldn't give names.

So, what does it all mean?

It means there's going to be an unprecedented wave of bank closures in the US and that people who want to hold on to their life savings are going have to be extra vigilant as the situation continues to deteriorate. And it is deteriorating very quickly.

Right now, many of the country's largest investment banks are holding $500 billion in mortgage-backed securities and other structured investments that are steadily depreciating in value. As these assets wear-away the banks' capital, the likelihood of default becomes greater. This week, Fitch Ratings announced that it will (probably) cut ratings on the 5 main bond insurers (Ambac, MBIA, FGIC, CIFG,SCA) “regardless of their capital levels”. This seemingly innocuous statement has roiled markets and put Wall Street in a panic. If the bond insurers lose their AAA rating (on an estimated $2.4 trillion of bonds) then the banks could lose another $70 billion in downgraded assets. That would increase their losses from the credit crunch--which began in August 2007---to $200 billion with no end in sight. It would also impair their ability to issue loans to even credit worthy customers which will further dampen growth in the larger economy. Structured investments have been the banks' “cash cow” for nearly a decade, but, suddenly, the trend has shifted into reverse. Revenue streams have dried up and capital is being destroyed at an accelerating pace. The $2 trillion market for collateralized debt obligations (CDOs) is virtually frozen leaving horrendous debts that will have to be written-down leaving the banks' either deeply scarred or insolvent. It's a mess.

There were some interesting developments in a case involving Merrill Lynch last week which sheds a bit of light on the true “market value” of these complex debt-pools called CDOs. The Massachusetts Secretary of State has charged Merrill with “fraud and misrepresentation” for selling them a CDO that was "highly risky and esoteric" and "unsuitable for the City of Springfield.” (Most cities are required by law to only purchase Triple A rated bonds) The city of Springfield bought the CDO less than a year ago for $13.9 million. It is presently valued at $1.2 million---MORE THAN A 90% LOSS IN LESS THAN A YEAR.

Merrill has quietly settled out of court for the full amount and seems genuinely confused by the Massachusetts Secretary of State's apparent anger. A Merrill spokesman said blandly, “We are puzzled by this suit. We have been cooperating with the Secretary of State Galvin's office throughout this inquiry.”

Is it really that hard to understand why people don't like getting ripped of?

This anecdote shows that these exotic mortgage-backed securities are real stinkers. They're worthless. The market for structured debt-instruments has evaporated overnight leaving a massive hole in the banks' balance sheets. The likely outcome will be a rash of defaults followed by greater consolidation of the major players. (re: banking monopolies) The Fed's multi-billion bailout plan; the “Temporary Auction Facility” (TAF) is a quick-fix, but not a permanent solution. The real problem is insolvency, not liquidity.

The smaller banks are dire straights, too. They're bogged down with commercial and residential loans that are defaulting faster than any time since the Great Depression. The Comptroller of the Currency,John Dugan--who is presently investigating commercial real estate loans---discovered that commercial banks “wrote off $524 million in construction and development loans in the third quarter of 2007, almost nine times the amount of 2006”. The commercial real estate market is following residential real estate off a cliff and will undoubtedly be the next shoe to drop.

Dugan found out that, “More than 60% of Florida banks have commercial real estate loans worth more than 300% of their capital, a level that automatically attracts more attention from examiners.” (Wall Street Journal) He said that his office was prepared to intervene if banks with large real estate exposure maintained unreasonably low reserves for bad loans. Dugan is forecasting a steep “increase in bank failures.”

According to Reuters: “Dozens of U.S. banks will fail in the next two years as losses from soured loans mount and regulators crack down on lenders that take too much risk, especially in real estate and construction," predicts Gerard Cassidy, RBC Capital Markets analyst. Apart from the growing losses in commercial and residential real estate, the banks are carrying over $150 billion of “unsyndidated” debt connected to leveraged buyout deals (LBOs) which are presently stuck in the mud. Like CDOs, there's no market for these sketchy transactions which require billions in cheap, easily available credit. They've just become another anvil dragging the banks under.

On January 31, Bloomberg News reported: “Losses from securities linked to subprime mortgages may exceed $265 billion as regional U.S. banks, credit unions and overseas financial institutions write down the value of their holdings.” Standard and Poor's added that “it may cut or reduce ratings of $534 billion of subprime-mortgage securities and CDOs as default rates rise.” Another blow to the banks withering balance sheets. Is it any wonder why the "new loans" spigot has been turned off?

Surprisingly, there's an even bigger threat to the financial system than these staggering losses at the banks. A default by one of the big bond insurers could trigger a meltdown in the credit-default swaps market, which could lead to the implosion of trillions of dollars in derivatives bets. The inability of the under-capitalized monolines (bond insurers) to “make good” on their coverage is likely to set the first domino in motion by increasing the number of downgrades on bond issues and intensifying the credit-paralysis which already is spreading throughout the system.

MSN Money's financial analyst Jim Jubak summed it up like this:

"Actually, I'm worried not so much about the junk-bond market itself as the huge market for a derivative called a credit-default swap, or CDS, built on top of that junk-bond market. Credit-default swaps are a kind of insurance against default, arranged between two parties. One party, the seller, agrees to pay the face value of the policy in case of a default by a specific company. The buyer pays a premium, a fee, to the seller for that protection.

This has grown to be a huge market: The total value of all CDS contracts is something like $450 trillion..... Some studies have put the real credit risk at just 6% of the total, or about $27 trillion. That puts the CDS market at somewhere between two and six times the size of the U.S. economy.

All it will take in the CDS market is enough buyers and sellers deciding they can't rely on this insurance anymore for junk-bond prices to tumble and for companies to find it very expensive or impossible to raise money in this market." (Jim Jubak's Journal; "The Next Banking Crisis is on the Way", MSN Money)

Jubak really nails it here. In fact, this is what Wall Street is really worried about. $450 trillion in cyber-credit has been created through various off balance sheets operations which neither the Fed nor any other regulatory body can control. No one even knows how these abstruse, credit-inventions will perform in a falling market. But, so far, it doesn't look good.

The enormity of the derivatives market ($450 trillion) is the direct result of Greenspan's easy-credit monetary policies as well as the reconfiguring of the markets according to the “structured finance” model. The new model allows banks to run off-balance sheets operations that, in effect, create money out of thin air. Similarly, “synthetic” securitization, in the form of credit default swaps (CDS) has turned out to be another scam to avoid maintaining sufficient capital to cover a sudden rash of defaults. The bottom line is that the banks and non-bank institutions wanted to maximize their profits by keeping all their capital in play rather than maintaining the reserves they'd need in the event of a market downturn.

In a deregulated market, the Federal Reserve cannot control the creation of credit by non-bank institutions. As the massive derivatives bubble unwinds, it is likely to have real and disastrous effects on the underlying-productive economy. That's why Jubak and many other market analysts are so concerned. The persistent rise in home foreclosures, means that the derivatives which were levered on the original assets (sometimes exceeding 25-times their value) will vanish down a black hole. As trillions of dollars in virtual-capital are extinguished by a click of the mouse; the prospects of a downward deflationary spiral become more likely.

As economist Nouriel Roubini said:

“One has to realize that there is now a rising probability of a 'catastrophic' financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe. That is why the Fed has thrown caution to the wind and taken a very aggressive approach to risk management.” (Nouriel Roubini EconoMonitor)

"In the fourth quarter of 2007, new foreclosures averaged 2,939 a day, double the pace of a year earlier." (RealtyTrac Inc.) The banks are presently cutting back on home equity loans which provided an additional $600 billion to homeowners last year for personal consumption. Bush's $150 billion “stimulus package” will barely cover a quarter of the amount that is lost. As consumer spending slows and the banks become more constrained in their lending; businesses will face overproduction problems and will have to limit their expansion and lay off workers. This is the downside of “low interest” bubble-making; a painful descent into deflation.

Capital is now being destroyed at a faster pace than it is being created. That's why the Fed is looking for solutions beyond mere rate cuts. Bernanke wants direct government action that will provide immediate stimulus. But that takes political consensus and there's still debate about the gravity of the upcoming recession. The pace of the economic contraction is breathtaking. This week's release of the Institute for Supply Management's Non-Manufacturing Index (ISM) was a shocker. It showed steep declines in all areas of the nation's service sector---including banks, travel companies, contractors, retail stores etc—The Business Activity Index, the New Orders Index, the Employment Index, and the Supplier Delivery Index have all contracted at a “historic” pace. Everyone took a hit.

“The numbers are so terrible, it's beyond belief,” said Scott Anderson, senior economist at Wells Fargo & Co.

The $2 trillion that has been wiped out from falling home prices, the slowdown in lending activity at the banks, the loss $600 billion in home equity loans, and the faltering stock market have all contributed to a noticeable change in the public's attitudes towards spending. Traffic to the shopping malls has slowed to a crawl. Retail shops had their worst January on record. Homeowners are hoarding their earnings to cover basic expenses and to make up for their lack of personal savings. The spending-spigot has been turned off. America's consumer culture is in full-retreat. The slowdown is here. It is now. We are likely to see the sharpest decline in consumer spending in US history. Bush's $150 billion will be too little too late.

America's place in the world has been guaranteed not by what it produces but by what it consumes. The American consumer has been the locomotive that drives the global economy. Now that engine has been derailed by the reckless monetary policies of the Fed and by shortsighted financial innovation. When equity bubbles collapse; everybody pays. Demand for goods and services diminishes, unemployment soars, banks fold, and the economy stalls. That's when governments have to step in and provide programs and resources that keep people working and sustain business activity. Otherwise there will be anarchy. Middle class people are ill-suited for life under a freeway overpass. They need a helping hand from government. Big government. Good-bye, Reagan. Hello, F.D.R.

The Bush stimulus plan is a drop in the bucket. It'll take much, much more. And, we're not holding our breath for a New Deal from George Walker Bush.

link

[isachar]

.

More indications that the so called monolines are at the epicentre of what's coming.

And more evidence that the corruption spread from insurance to finance. Specifically from Lloyds of London to Wall Street.

New danger appears on the monoline horizon

By Paul J Davies
Published: February 6 2008 23:31 | Last updated: February 6 2008 23:31

One senior industry insider admits that billions of dollars worth of these trades were done, but insists they were mostly restricted to the arena of utility and infrastructure debt.

...............................

For the monolines, the trades were also seen as near risk-free profit when taking the position of writing protection on peers.

.........................................

http://tinyurl.com/22m548
(Financial Times)


anti: "The insurers were writing guarantees on each other.
How can that be right?"

"...and infrastructure debt" (see above for ref.)


Oooops, there goes the municipals market.

I wonder when we're going to hear how much exposure the public and private pension funds have to all this mess?

It could make Enron look like the collapse of a kids sidewalk lemonade stand.

And, waiting in the wings is the potential bust and unwinding of the commercial real estate market, loans, lenders and REITS. This is where various public and private pension funds have substantial exposure.

If anyone has any info on the pension fund exposure to this mess, please post.

[schadenfreude]

http://ftalphaville.ft.com/blog/2008/02/08/10810/cdo-update-talk-of-firesale-liquidations-begin/

[JackRiddler]

On Cannon's argument relating to the supernotes, I think we see again how smart people can use refined logic to outsmart themselves. I think it's too convoluted, he's invested somehow in the "Brewster Jennings" fantasy that USG is out to do a sting operation on some James Bond-type org like SPECTRE (or AQ Khan). This would never explain billions of these notes that are presumably in circulation (if "only" $50 million have been caught.)

He makes an excellent case that the supernotes are made at the mint. So the relative profit-loss is no consideration, it's no big expense to run these perfect notes with tells.

1) So they could be doing it for personal enrichment, and that's probably a side benefit.

2) The main reason is probably to fund operations off the books. (What operations? How the fuck do I know?)

3) The tells provide an insurance policy, assuring that the field operatives will stay under control, since they know they can be exposed.

4) Or else they're doing it to flood dollars into the system, without putting it on the books. But paper cash is a drop in the bucket compared to electron money, so I don't see what impact that's likely to have. But I could be dense.

5) Or, in a variation on Cannon's conclusion, the patsy in the sting wouldn't be an "organization," it would be a country.

"Uzbekistan! We've caught you passing enough supernotes that you must be the culprit! You're waging economic war! Die Die DIE!" For Uzbekistan you can fill in Iran, or North Korea if you prefer.

[slow_dazzle]

Not only a "recession" but one that is going to get a lot worse because the energy-based economies we operate just aren't able to revive to allow a recovery. No amount of techno fixes are going to sort it because money is a symbol for energy and that is the long and the short of it. And even if a techno fix somehow gets us back onto that silly treadmill of producing increasing amounts of stuff that still leaves the problem of food supply to resolve. All those who peddle the line that a change in our economic systems will take account of peaking of energy I would like you to answer one question: If the average input of calories to food output is around 10:1 please list a number of substitutes for food.

Anyway, I digress although I do feel pointing out that no amount of techno fixes can replace food is wholly pertinent. Can we eat technology?

I want to post a couple of articles that synch into the first post in this thread. The Fed has lost control and the evidence is mounting daily.

The first article is from Nouriel Roubini's site

Since in the previous article I described a 12 steps scenarios towards a financial meltdown and a deep recession the crucial policy question is whether the Fed and other policy officials can prevent such a scenario of a systemic financial crisis.

I will present in this article the eight reasons why I am skeptical that such a systemic risk scenario can be avoided…

The second article is about the situation on this side of the pond

TWO in every five employers plan redundancies over the next three months, according to an influential survey to be published tomorrow. It comes as two leading business groups warn of weak business confidence and a sharp slowdown in growth.

British Retail Consortium (BRC) figures will show, however, that consumers remain resilient in spite of economic worries. The BRC retail sales monitor, in conjunction with KPMG, is set to show total sales last month almost 5% up on a year earlier. Like-for-like sales – adjusted for new floorspace – have risen more than 2%.

Retailers had been very downbeat about prospects for January following a poor December, with like-for-like sales rising only 0.3%. This week’s figures will come as a relief, but the BRC is likely to warn that any strength is likely to be temporary.

Forget all the talk of abundance and articificial scarcity; we are up shit creek and there is little that we or the big financial institutions can do about it. This is all about energy supplies or the fact that the supply and demand lines have crossed. To reiterate my comment about product replacement I'd like the cornocupians to list their substitutes for food. Well? What are we going to eat as food gets scarce?

Not only is the Fed unable to stop the deepening economic crisis it sure as hell can't magic up food out of nowhere. So not only is the Fed unable to stop economic collapse (if you think that's doom mongering go read the financial pages instead of articles about faces on Mars) the food supply shortfall is going to bite us all on the ass.

Welcome to the peaking of energy supplies and the concomitant of economic collapse and food shortages. This was predicted several years ago.

[ninakat]

s_d, I agree with your perspective on all this, especially the direct connection between energy and the economy.

I don't mean to derail this thread, but here's an article on that connection that gives a pretty comprehensive analysis, although the author seems to imply that peak oil could be decades away (I believe it is imminent, give or take a year or two).

The (un?)sustainability of growth
http://www.zcommunications.org/znet/viewArticle/16462

[slow_dazzle]

I'd love nothing more than a peak being pushed back by several decades. At least we would have time to try to put something in place to deal with the hardship of PO/PG (latter = Peak Gas). I'll read the article because all information is welcome.

I still think we are up shit creek because energy supplies are peaking and that interfaces directly with economics as we practice the subject. I have purposely avoided labelling economics a science because it is nothing more than a branch of moral philosophy. Physics is a science. Structural theory is a science. Materials science is a scientific subject. I can say this because I know about all three subjects. Economics is a moveable feast, the composition of which depends upon whoever is putting forward whatever "theory" of economics.

Watch the markets over the next year or so. Watch the Dow Jones etc numbers. If I'm wrong I'll post here to say how stupid I was to think the "invisible hand" would not come riding to the rescue.

Even though Adam Smith would call corporations the antithesis of free market doctrine as he envisaged in "The Wealth of Nations".

[antiaristo]

.

Funny business at SocGen:

Kerviel’s lawyer accuses SocGen of complicity

By Peggy Hollinger and Ben Hall in Paris
Published: February 10 2008 22:05

The lawyer for Jérôme Kerviel – the man who allegedly masterminded the biggest rogue trading fraud in financial history – on Sunday accused his employer, Société Générale, of complicity in the scandal that has cost the bank €4.9bn ($7.1bn).

“The question we ask is can we really speak of fraud when it seems that everyone knew what Jérôme was doing?” said Guillaume Selnet. He insisted there was “no Jérôme Kerviel organisation. He is not at the head of some network,” implying that Mr Kerviel had worked alone but suggesting complicity on the bank’s part because it was aware of his trades.

Mr Kerviel is accused of forging documents to cover the fact that he had built up unauthorised futures positions of about €50bn on three European indices.

The lawyer declined to say how the bank might have known about these transactions or how Mr Kerviel had forged these hedges, saying these issues went to heart of the investigation.

Jean Veil, SocGen’s lawyer, rejected accusations of complicity. He said, “nothing shows that [Kerviel’s] immediate superiors had any knowledge of his actions and the forged documents”.

Meanwhile Mr Selnet said the revelation of an alleged accomplice at the SocGen broking subsidiary Fimat, now known as Newedge, hours before Mr Kerviel was due in court had been timed to ensure the trader’s bail would be withdrawn.

Moussa Bakir, 32, the Fimat broker questioned by police after instant message exchanges between the two men were revealed last week, was released without charge on Saturday. “Bakir is a non-event and it is confirmed by the fact that he has been let go,” said Mr Selnet.

http://www.ft.com/cms/s/0/a8450852-d80b ... fd2ac.html


"immediate superiors" ???????

Why the need for the qualifyer?


And it looks like AIG is in some SERIOUS trouble:

... as a result of current difficult market conditions, AIG is not able to reliably quantify the differential between spreads implied from cash CDO prices and credit spreads implied from the pricing of credit default swaps on the CDOs, and therefore AIG will not include any adjustment to reflect the spread differential (negative basis adjustment) in determining the fair value of AIGFP’s super senior credit default swap portfolio at December 31, 2007. ...

AIG has been advised by its independent auditors, PricewaterhouseCoopers LLC, that they have concluded that at December 31, 2007, AIG had a material weakness in its internal control over financial reporting and oversight relating to the fair value valuation of the AIGFP super senior credit default swap portfolio. AIG’s assessment of its internal controls relating to the fair value valuation of the AIGFP super senior credit default swap portfolio is ongoing, but AIG believes that it currently has in place the necessary compensating controls and procedures to appropriately determine the fair value of AIGFP’s super senior credit default swap portfolio for purposes of AIG’s year-end financial statements.

http://www.sec.gov/Archives/edgar/data/ ... 87e8vk.htm


Translation: The numbers are so bad that we don't accept them and we're not making the adjustment.

The auditors may have to resign.

AIG is down about FORTY percent since the start of this year.

[isachar]

Not only a "recession" but one that is going to get a lot worse because the energy-based economies we operate just aren't able to revive to allow a recovery. No amount of techno fixes are going to sort it because money is a symbol for energy and that is the long and the short of it. And even if a techno fix somehow gets us back onto that silly treadmill of producing increasing amounts of stuff that still leaves the problem of food supply to resolve. All those who peddle the line that a change in our economic systems will take account of peaking of energy I would like you to answer one question: If the average input of calories to food output is around 10:1 please list a number of substitutes for food.

Anyway, I digress although I do feel pointing out that no amount of techno fixes can replace food is wholly pertinent. Can we eat technology?

I want to post a couple of articles that synch into the first post in this thread. The Fed has lost control and the evidence is mounting daily.

The first article is from Nouriel Roubini's site

Since in the previous article I described a 12 steps scenarios towards a financial meltdown and a deep recession the crucial policy question is whether the Fed and other policy officials can prevent such a scenario of a systemic financial crisis.

I will present in this article the eight reasons why I am skeptical that such a systemic risk scenario can be avoided…

The second article is about the situation on this side of the pond

TWO in every five employers plan redundancies over the next three months, according to an influential survey to be published tomorrow. It comes as two leading business groups warn of weak business confidence and a sharp slowdown in growth.

British Retail Consortium (BRC) figures will show, however, that consumers remain resilient in spite of economic worries. The BRC retail sales monitor, in conjunction with KPMG, is set to show total sales last month almost 5% up on a year earlier. Like-for-like sales – adjusted for new floorspace – have risen more than 2%.

Retailers had been very downbeat about prospects for January following a poor December, with like-for-like sales rising only 0.3%. This week’s figures will come as a relief, but the BRC is likely to warn that any strength is likely to be temporary.

Forget all the talk of abundance and articificial scarcity; we are up shit creek and there is little that we or the big financial institutions can do about it. This is all about energy supplies or the fact that the supply and demand lines have crossed. To reiterate my comment about product replacement I'd like the cornocupians to list their substitutes for food. Well? What are we going to eat as food gets scarce?

Not only is the Fed unable to stop the deepening economic crisis it sure as hell can't magic up food out of nowhere. So not only is the Fed unable to stop economic collapse (if you think that's doom mongering go read the financial pages instead of articles about faces on Mars) the food supply shortfall is going to bite us all on the ass.

Welcome to the peaking of energy supplies and the concomitant of economic collapse and food shortages. This was predicted several years ago.

sd, this and your subsequent post seems to be an extension of the amory lovins/PO thread, but I'll respond here, nevertheless. For others just coming to this conversation I would refer you to the amory lovins thread for background on this discussion to this point.

Your 10:1 ratio seems to be an estimate for the U.S., though the range of estimates is +/- 30 to 50% of this figure, which apparently includes not just production but transportation, milling, and packaging (I'm unclear if it includes retail advertising and promotions). So, there is quite a bit of uncertainity in the number you cite.

However, whatever the actual number is, it is supposed to be representative of the 'typical' US diet which is reliant on agri-business, features empty calories, long-distance trucking, and mostly non-organic, non-local production, as well as all the attendant waste associated with packaging, distribution, etc.

Now, what would the figure be were, say, 50% of the the over-packaging be done away with? For instance 70% of the energy embedded in a soft drink packaged in an aluminum can is for the packaging. Or, how much energy input would be done away with if, say, a nice and equal size serving of chicken a'la orange were substituted for half of steak/beef meals consumed? How much energy and other savings would result from the beneficial health effects of such?

Once again, we're just looking at the low-hanging fruit here. What if, say, 20% of all calories were to be obtained from local farms, instead of being trucked from, say, California or Mexico, or being shipped from New Zealand or Chile?

I think most would agree the energy savings would be substantial, and we haven't even begun to address obtaining nitrogen and phosphorous from recycled yard and/or animal wastes, or reclaimed/diverted from wastewater treatment plants or 'humanure' toilets.

Everything is related, you see.

Unlike the two-dimensional PO view of the world that only two things (e.g., petroleum and food, petroleum and heat, petroleum and x, petroleum and y, ad nauseum) are relevant and are exclusively related, and that these relationships exist in exquisite isolation from all others.

For starters, you might want to look at some of Wendell Barry's thoughts on re-establishing the fertility cycle. This might give an idea of the potential for linking urban settlements with food producers to complete this cycle, rather than the disconnect that currently exists.

Of course there's a host of other potential substitutions and changes that also affect the food/energy relationship that I could go into, but I don't want to add yet more sources of complexity/confusion...

Maybe we should take this back to the lovins thread where it seems to more properly belong.

None of this is to say that all or even most transitions are necessarily smooth and seamless, mind you, or aren't inhibited by powerful entrenched interests....

[ninakat]

Burning Down the House
by Jim Kunstler, Feb. 11, '08

Behind all the blather and bullshit about the Federal Reserve's rescue gambits and the machinations of the ratings agencies, and the wiles of foreign sovereign wealth, and the incomprehensible mysteries of markets, and the various weather forecasts of a gathering "recession" is the simple fact that the USA is a way poorer nation than we imagined ourselves to be six months ago. The American economy has been running on the fumes of "creatively engineered" finance (i.e. new-and-improved swindling) for years, and now these swindles are unraveling. In their aftermath, they leave empty wallets, drained bank accounts, plundered retirements funds, boiled away capital reserves, worthless stocks, bankrupt companies, vandalized housing tracts, ruined families, and Wall Street executives who are still pulling down multimillion-dollar pay packages despite running their companies into the ground.

We're burning down the house and kidding ourselves that there is a remedy for it. All the rate cuts and loans to big banks and bank-like corporate organisms, and "monoline" bond insurers, and mortgage mills amount to little more than a final desperate shell game to conceal the radioactive pea of aggregate loss. The losses are everywhere, and when you add up seven billion here and eleven billion there they probably amount to something like a trillion dollars in sheer capital evaporation -- not counting the abstract "positions" that the capital was leveraged onto by the playerz and boyz who mistook algorithms for productive activity.

The shell game may run a few more weeks but personally I believe the timbers are burning. The losses are no longer "contained" or concealable. A consensus has now formed that we're in for a "recession." The idea is that, yes, this seems to be the low arc of the business cycle. Fewer Hamptons villas will be redecorated in the interim. We'll gird our loins and get through the bad weather and when the sun shines again, we'll be ready with new algorithms for new sport-with-capital.

Uh-uh. Think again. This is not so much financial bad weather as financial climate change. Something is happenin' Mr Jones, and you don't know what it is, do ya? There has been too much misbehavior and it can no longer be mitigated. We're not heading into a recession but a major depression, worse than the fabled trauma of the 1930s. That one occurred against the background of a society that had plenty of everything except money. Back then, we had plenty of mineral resources, lots of trained-and-regimented manpower, millions of productive family farms, factories that were practically new, and more than 90 percent left of the greatest petroleum reserve anywhere in the world. It took a world war to get all that stuff humming cooperatively again, and once it did, we devoted its productive capacity to building an empire of happy motoring leisure. (Tragic choice there.)

This new depression, which I call The Long Emergency, will play out against the background of a society that has pissed away its oil endowment, bulldozed its factories, arbitraged its productive labor, destroyed both family farms and the commercial infrastructure of main street, and trained its population to become overfed diabetic TV zombie "consumers" of other peoples' productivity, paid for by "money" they haven't earned.

There is a theory (see Nouriel Roubini's blog) that a reform process will now ensue in the financial realm, new regulation and oversight of the same old familiar activities. This too, I'm afraid, will prove to be wishful thinking. The financial system will not be reformed until it lies in smoking wreckage, and when that "re-form" happens the armature of the re-organizing society will barely resemble the one that the previous burnt-down-house was designed to dwell in. Among other things, it will not support capital enterprise at anything like the scale that we became accustomed to lately. Globalism will be over. The great nations of the world will be scrambling desperately for the world's remaining oil supplies. It will not be a friendly contest, and anyone who thinks that current trade relations and capital flows will continue despite that is liable to be disappointed. (Are you reading this Tom Friedman?)

Long before the mathematical projections of oil depletion play out, the oil markets themselves -- and all the complex operations that they comprise, such as drilling and exploration, and the movement of tankers around the planet -- will destabilize and seize up. We will no longer be any oil exporter's "favored customer." Many of the exporters will enjoy watching us suffer. Contrary to the political platitude-du-jour, the USA will never become "energy independent" in the way we currently imagine. Rather we'll become energy independent by being deprived of imported oil, and we'll be thrown back on our own dwindling supplies -- which means that we're not going to run our system of daily life the way it has been set up to run. When Americans can no longer run their cars on a whim, they will simply go apeshit and you can kiss normal politics goodbye.

The financial system that emerges from this cataclysm, and the economy it serves (which is supposed to be the master of its capital deployment "arm," not its servant) will likely be modest to a degree that will shock and embarrass everyone currently connected with what we have lately called finance. If it even trades in paper, that paper will have to stand for something based in reality, either a productive activity or a genuine asset. It may take decades for this society to even regain the confidence necessary to operate such an elementary system -- or it may not come back at all, at least as far as the horizon lies before us. That's how bad the mischief and the damage has been.

It's not hard to understand why the Bernankes, Paulsons, Lawrence Kudlows and other public representatives of capital keep pretending that everything is under control. On the other side of their pretenses lies disorder and hardship. One wonders, of course, what they really see in their private minds' eyes. Do they actually believe that the statistics issued by their serveling agencies amount to a plausible picture of reality? Are they so lost in their fantasies of "management" that they think they're controlling events?

My guess is that their credibility is spent. In the weeks ahead, nobody will know who or what to believe. We may even run out of questions to ask as we just all collectively stand there in a thrall of wonder and nausea, watching the nation's financial house burn down.

(lots of comments at the link)