Remarks at the Reserve Bank of Australia's 50th Anniversary Symposium, Sydney, Australia

The U.S. Financial System: Where We Have Been, Where We Are and Where We Need to Go

by William C. Dudley

Today, my remarks will focus on the U.S. and global financial systems:

• What went wrong to produce the worst financial crisis in the past 70 years?
• Where are we now?
• What should be our top priorities to ensure that this never happens again?

As always, my views are my own and do not necessarily reflect those of the Federal Open Market Committee or the Federal Reserve System.

With respect to what went wrong, it is important to recognize that the financial crisis occurred for a host of reasons and, thus, there is no single silver bullet to avoid such crises in the future. At the heart of the crisis was a tremendous buildup in leverage, which our regulatory framework failed to prevent. Large amounts of opaque, illiquid, long-term assets were financed by short-term liabilities, and much of this financing occurred in the shadow banking system. When the housing bubble burst, financial asset prices fell and exposed the deep linkages and overall fragility of our system. Interbank funding markets seized up, the shadow banking system crumpled and several major financial firms—banks and nonbanks alike—collapsed or approached the brink of collapse. Extraordinary interventions of governments and central banks around the world were necessary to prevent a complete collapse of the financial system and the broader economy.

As a general matter, regulators did not appreciate beforehand how vulnerable the system was to shocks. In particular, there was a failure to appreciate the important interconnections among the banking system, capital markets, and payment and settlement system. For example, the disruption of the securitization markets caused by the poor performance of highly rated debt securities led to significant problems for major financial institutions. These banks had to take assets back on their books, backstop lines of credit were triggered, and banks could no longer securitize loans, thus increasing the pressure on their balance sheets. This reduced credit availability, which increased the downward pressure on economic activity, which caused asset values to decline further, and in turn, increased the degree of stress in the financial system.

Moreover, regulators did not adequately understand how the dynamics of the system tended to exacerbate shocks, rather than dampen their impact. For example, with respect to capital, firms under stress had incentives to continue to pay dividends to show that they were strong. These dividend payments actually depleted capital, making the firms weaker and vulnerable to credit rating downgrades. When credit ratings were indeed cut, that increased collateral calls, which intensified the pressure on scarce liquidity resources.

Regulatory gaps were another important factor in causing the crisis. American International Group, Inc. (AIG) is a case in point. AIG Financial Products, a subsidiary of the AIG parent company, provided guarantees against default on complex collateralized debt obligations, leveraging the AAA rating of the AIG parent company in the process. This activity was conducted with inadequate regulatory oversight, poor risk management and insufficient capital.

Finally, many of the incentives built into the system ultimately undermined its stability. The problems with incentives were evident in a number of areas, including faulty compensation schemes and risk management that was too narrowly focused on one business area without regard for the broader entity. These incentives created important externalities in which participants did not bear the full costs of their actions.

Turning to where we are now, the U.S. financial system is in much better shape today than it was a year ago. The capital markets are generally open for business—with the important exception of some securitization markets—and the major securities dealers that survived the crisis have seen a sharp recovery in profitability. The largest U.S. bank holding companies, which went through the Supervisory Capital Assessment Program exercise, have more and better quality capital, having raised more than $100 billion of common equity over the past year in the capital markets and generated nearly as much common equity via preferred stock conversions and from gains on asset sales.

However, many smaller and medium-sized banks remain under significant pressure. This reflects several factors. First, such institutions hold assets that are carried mainly on the books on an accrual basis. Compared with mark-to-market assets, such assets adjust much more slowly to changes in market conditions and the economic environment. Second, many of these banks have a much more concentrated exposure to commercial real estate, a sector that remains under considerable pressure. Not only have capitalization rates risen sharply—meaning the investors will pay much less for a dollar of rental income than before—but the rental income streams on these properties also have declined as the performance of the U.S. economy has declined. Together, these two factors have pushed U.S. commercial real estate prices down by about 40 percent to 50 percent from the peak reached in 2006. Loan losses in commercial real estate and consumer and mortgage loans seem likely to continue to pressure smaller banks for some time to come. This in turn means that credit availability to households and small businesses will still be curtailed.

The improvement in the overall health of the financial system and in market function has allowed the Federal Reserve to phase out many of the special liquidity facilities that were enacted in response to the crisis. These facilities were generally successful in achieving their objectives—helping to restore confidence and rebuild market liquidity in a way that safeguarded the taxpayers' interests. When a full accounting of the special liquidity facilities is complete, it seems likely that the facilities will have generated substantial incremental earnings that the Federal Reserve will remit to the Treasury. Although these incremental earnings were not the objective of these facilities, they are a pleasant outcome relative to the alternative.

As the crisis has abated, our attention has shifted to what we need to do to prevent another crisis in the future. We need to take the necessary steps to build a strong and resilient financial system. In my opinion, three broad sets of actions are needed:

• Effective macroprudential supervision. By this, I mean conducting supervision not just vertically institution by institution, but also horizontally across institutions and markets. We need to better understand how the system operates as a whole and how problems in one area can affect financial stability elsewhere. This means both how the overall system affects individual firms and how the activities of a single firm or market affects the entire financial system.
• Make financial institutions and market infrastructures more robust to withstand shocks and become less prone to failure.
• Change the system so that no financial firm is "too big to fail."

Macroprudential supervision is essential for two reasons. First, it addresses the problem of gaps in the regulatory regime and the regulatory arbitrage that such gaps can encourage. Second, macroprudential supervision is needed because the financial system is interconnected. Siloed regulatory oversight is not sufficient. Supervisory practices must be revamped so that supervision is also horizontal—looking broadly across banks, nonbanks, markets and geographies. This also means that regulatory standards need to be harmonized across different regions. Without harmonization, there will inevitably be a "race to the bottom" and regulatory arbitrage will be encouraged, rather than inhibited.

Many steps are needed to make financial institutions and infrastructure more robust. For example, we need to strengthen bank capital requirements, improve liquidity buffers and make financial market infrastructures more resilient to shocks when individual firms get into trouble.

In terms of capital requirements, many changes are needed, including global capital standards that put more emphasis on common equity, establish an overall leverage limit and better capture all of the sources of risk in the capital assessment process. Improved risk capture, for example, includes the trading accounts of banks. Some institutions had clearly not set aside adequate levels of capital given the risks that were embedded in their trading positions.

It would also be very desirable to develop a mechanism to bolster the amount of common equity available to absorb losses in adverse economic environments. This might be done most efficiently by allowing the issuance of debt instruments that would automatically convert to common equity in stress environments, under certain pre-specified conditions. Such "contingent capital" instruments might have proven very helpful had they been in place before and during this crisis. Investors would have anticipated that common equity would be replenished automatically if a firm came under stress, and this knowledge might have tempered anxieties about counterparty risk. At a minimum, contingent capital instruments might have enabled common equity buffers at the weaker firms to be replenished earlier and automatically, thereby reducing uncertainty and the risk of failure.

On the liquidity front, there are a host of initiatives underway. The Basel Committee on Banking Supervision is working on establishing international standards for liquidity requirements. There are two parts to this. The first is a requirement for a short-term liquidity buffer of sufficient size so that an institution that was shut out of the market for several weeks would still have sufficient liquidity to continue its operations unimpaired. The second is a liquidity standard that limits the degree of permissible maturity transformation—that is, the amount of short-term borrowing allowed to be used in the funding of long-term illiquid assets. Under these standards, a firm's holdings of illiquid long-term assets would need to be funded mainly by equity or long-term debt.

With respect to financial market infrastructures, the Federal Reserve is working with a broad range of private-sector participants, including dealers, clearing banks and tri-party repo investors to dramatically reduce the structural instability of the tri-party repo system. Similarly, over-the-counter (OTC) derivatives clearance activity is being pushed toward central counterparties and exchanges. In addition, the Federal Reserve and others are evaluating how greater transparency with respect to OTC derivatives prices would improve financial stability. The Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions are doing a review of standards for payment, clearing and settlement systems. This work will inform the efforts of the Financial Stability Board to strengthen such standards.

There is also work underway on the problem of how to ensure that financial institutions have compensation structures that curb rather than encourage excessive risk-taking.

Finally, it is critical that we ensure that no firm is too big to fail. This is about both fairness and having proper incentives in the financial system. Having some firms that are too big to fail creates moral hazard. These firms are able to obtain funding on more attractive terms because debt holders expect that the government will intervene rather than allow failure. In addition, too big to fail creates perverse incentives. In a too-big-to-fail regime, firms have an incentive to get large, not because it facilitates greater efficiency, but instead because the implicit government backstop enables the too-big-to-fail firm to achieve lower funding costs.

To solve the too-big-to fail problem, we need to do two things. First, we need to develop a truly robust resolution mechanism that allows for the orderly wind-down of a failing institution and that limits the contagion to the broader financial system. This will require not only domestic legislation, but also intensive work internationally to address a range of legal issues involved in winding down a major global firm.

Second, we need to reduce the likelihood that systemically important institutions will come close to failure in the first place. This can be done by mandating higher capital requirements, improving the risk capture of those requirements and by requiring greater liquidity buffers for such firms.

Although the raging crisis appears to be over, our work is not close to being complete. Making sure this work keeps moving forward and is coordinated internationally is hugely important. Differences in views across countries and regions should not divert the international community from the more important prize—taking the actions collectively that will ensure a robust and resilient financial system.

Last March, my study of the effect of peak oil on U.S. imports had brought Mexico to the fore (“The Impending Oil Export Crisis”). As our #3 source of imports, the crashing of its supergiant Cantarell field had put the future of our oil supply into serious jeopardy.

The possibility that Mexico’s oil and gas exports to the U.S. could go to zero within seven years looked very real.

Under December's Copenhagen Accord, rich countries are pledging some 10 billion dollars over the next three years to help poor countries tackle climate change.

A big but so far unspecified chunk of the cash will go on programmes to prevent loss of tropical forests, which is a major source of greenhouse gases

When it comes to renewable energy innovation and equipment manufacturing, China is challenging the West, and the outcome will decide where millions of jobs go in the future.

As The New York Times reported recently, "China vaulted past competitors in Denmark, Germany, Spain, and the United States last year to become the world's largest maker of wind turbines, and is poised to expand even further this year. China has also leapfrogged the West in the last two years to emerge as the world's largest manufacturer of solar panels. ... These efforts to dominate renewable energy technologies raise the prospect that the West may someday trade its dependence on oil from the Mideast for a reliance on solar panels, wind turbines, and other gear manufactured in China."

The Obama administration is forming a new agency to study and report on the changing climate.

Also known as global warming, climate change has drawn widespread concern in recent years as temperatures around the world rise, threatening to harm crops, spread disease, increase sea levels, change storm and drought patterns and cause polar melting.

Back in October, I participated in the 2nd International Biophysical Economics Conference at SUNY-ESF in Syracuse, New York. Charlie Hall had written to me, inviting me to come and give a talk. Specifically, he wanted me to go back to my post from January 2008 called Peak Oil and the Financial Markets: A Forecast for 2008 and explain why my forecasts had turned out pretty close to correct, while many others widely missed the mark. The title he suggested for the talk was Delusions of Finance.

0208101 -

Dear Extended Family,

New York State spending is out of control. California tried to go off the dollar but the California IOU is a total failure.

There are 38 states right behind California and New York, all of which are too big to fail.

The debts of the weaker European Union states are under attack by the huge short players. In time every currency will come under attack by the same ever-growing source of wealth.

Today’s action in gold, especially before the Crimex attack and dollar linking in the inverse, has delivered me my answer.

The following is ABSOLUTELY correct, so therefore sell all currencies into strength and buy gold on all weakness. There is no other strategy that will survive.

This is all you need to know:

1. Bretton Woods was folded.
2. The floating exchange rate system is about to be folded.
3. By default or design we are going to a one-world currency and a one-world central bank of central banks.
4. For Portugal, Ireland, Italy, Greece or Spain to break off from the euro would be an expansion of the floating exchange rate system under present conditions.
5. There are presently 3 major currencies. That is the US dollar, the euro and gold.
6. The SDR was an attempt to form a single reserve currency that never took flight.
7. The SDR is an accounting unit made up of an index of currencies much like the USDX.

Respectfully,
Jim

 

Thought For The Day:

The recent two central banks meeting are so secret that it has all the appearance of how the Nazis were tricked into thinking General Patton would lead the invasion of Europe.

They were cordoned off by military or police to a distance of three miles in all directions with air force cover protection.

I accept the action of gold in Asia and Europe pre-Crimex attack with a modestly lower Euro as confirmation of the conclusions contained in the email sent to you over the weekend.

Social security is headed for the rocks.

The longer the heavy business conditions last the more retirements will occur within the social security network.

You have to ask yourself if there is anything government wise of a financial nature that is not a wreck. Then ask yourself can these wreckers make anything right except the OTC derivative winners.

You have to ask yourself if the social security system is being analyzed as net cash or gross cash and receivables from the Federal government.

Should it be the latter then the problem is more serious.

Rash of retirements pushes Social Security to brink
By Richard Wolf, USA TODAY

WASHINGTON — Social Security’s annual surplus nearly evaporated in 2009 for the first time in 25 years as the recession led hundreds of thousands of workers to retire or claim disability.

The impact of the recession is likely to hit the giant retirement system even harder this year and next. The Congressional Budget Office had projected it would operate in the red in 2010 and 2011, but a deeper economic slump could make those losses larger than anticipated.

"Things are a little bit worse than had been expected," says Stephen Goss, chief actuary for the Social Security Administration. "Clearly, we’re going to be negative for a year or two."

Since 1984, Social Security has raked in more in payroll taxes than it has paid in benefits, accumulating a $2.5 trillion trust fund. But because the government uses the trust fund to pay for other programs, tax increases, spending cuts or new borrowing will be required to make up the difference between taxes collected and benefits owed.

Experts say the trend points to a more basic problem for Social Security: looming retirements by Baby Boomers will create annual losses beginning in 2016 or 2017.

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Jim Sinclair’s Commentary

Meaning no disrespect, the following photoshopped picture clearly communicates our views on allowing corporations to make political contributions without limit.

Jim Sinclair’s Commentary

The following is from Zero Hedge.

Their suspicions are on the mark. It is a short raid just like we witnessed when Bear, CITI and Lehman went down.

One has to wonder if the MOPE of draining liquidity, the Fed and Britain are sustaining this raid. I think intentionally or coincidently the answer is yes!

"In the pre-math of the Greek collapse, conspiracy theories are swirling about who keeps blowing Greek CDS spreads wider. The answer, so far completely unconfirmed, is that a large US investment bank (we "wonder" just which US investment bank dominates the sovereign CDS market), and two major hedge funds are behind the CDS "attacks" on Greece, Portugal and Spain. According to Jean Quatremer, and his Coulisses de Bruxelles, UE blog, the plan involves blowing spreads to record levels, and is prompted by the hedge funds’ anger at not having been allocated substantial amount of the recent €8 billion GGB issue, in order to lock in profits from their CDS long exposure. Being thus unhedged with a short bias, their alternative is to continue buying protection else risking to mark losses on their extensive CDS short risk exposure."

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Jim Sinclair’s Commentary

This was not limited to the G7 meeting. This was a very secret meeting.

I gave you the skinny on it yesterday both by postings here on the site and by direct email. Secrets are not required when the material in discussion is about normal matters.

"However, a secretive gala dinner at the Art Gallery of NSW to mark the event last night attracted a who’s who of Australia’s political and business world."

"The event was held in the Grand Court, which seats up to 350 people."

"The low profile of the meeting is also a matter of design. Security is tight and the location of events a closely guarded secret."

Treat for elite as Reserve Bank celebrates
JESSICA IRVINE, VANDA CARSON AND ELLIE HARVEY
February 9, 2010

CENTRAL bankers are an unobtrusive breed by nature and necessity. So it might have escaped the attention of many that Sydney is playing host to a meeting of some of the world’s top money men and women to celebrate the 50th birthday of the Reserve Bank of Australia.

However, a secretive gala dinner at the Art Gallery of NSW to mark the event last night attracted a who’s who of Australia’s political and business world.

Bankers rubbed shoulders with celebrated economic figures. Past prime ministers from both sides of the political divide gathered to drink a toast to Australia’s success in weathering the global economic storm, including John Howard and Paul Keating.

Past treasurers included Peter Costello, John Dawkins, John Kerin and Ralph Willis. And, of course, the RBA was well represented, with governor Glenn Stevens and former governors Ian Macfarlane and Bernie Fraser in attendance.

Around 7.15pm, John Howard and his wife Janette arrived, almost at the exact time as Mr Costello, from the other side of the entrance. The pair met, shook hands, and offered a polite ”Good to see you” before moving up the stairs.

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Jim Sinclair’s Commentary

This is what CIT is. Small business depends on CIT to factor inventories as well as other requirements.

This is Main Street’s business life blood. This is a company with no access to the commercial paper market. No commercial paper market means no funds for factoring.

Small businesses could drag down recovery.
Small businesses helped lead the economy out of the four recessions since 1980, but are now threatening the country’s economic recovery as they continue to cut capital spending and fire employees. Another 3,000 jobs were eliminated from small businesses in January; if the trend continues, improvement in the national unemployment rate, which dropped to 9.7% in January from 10.1% in December, could stall and economic growth could fall short of the 2.7% annual rate forecast.

Jim Sinclair’s Commentary

This seems to me to as comparable to President Bush’s shipboard announcement on the Iraq war, "Mission Accomplished."

There is something I am careful about and that is NEVER say NEVER. It is however a volley over the bow of Moody’s rating service.

Geithner Says U.S. Will ‘Never’ Lose Aaa Debt Rating (Update1)
By Rebecca Christie

Feb. 8 (Bloomberg) — Treasury Secretary Timothy F. Geithner said the U.S. is in no danger of losing its Aaa debt rating even though the Obama administration has predicted a $1.6 trillion budget deficit in 2010.

“Absolutely not,” Geithner said, when asked in an ABC News interview broadcast yesterday whether a downgrade is a concern. “That will never happen to this country.”

Geithner said investors around the world turn to U.S. Treasury securities and dollar-denominated assets whenever they are worried about global stability. That reflects “basic confidence” in the U.S. and its ability to bounce back from the global recession, he said.

Moody’s Investors Service Inc. last week said the U.S. government’s bond rating will come under pressure in the future unless additional measures are taken to reduce budget deficits projected for the next decade.

The U.S. plans to rein in the deficit once the labor market recovers, Geithner said. In the short run, that means focusing on ways to “make sure that this economy is growing again,” he said. The administration says the deficit will shrink over the next four years as more Americans find jobs and the economy accelerates.

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Jim Sinclair’s Commentary

The real CIT story is that they are NOT welcome in the commercial paper market which restricts their business to their present fixed loan lines and available cash capital.

That is extremely bad news from Middle America. Thain will not find a ready buyer for CIT as he did for Merrill, even though that was not his will.

Former Merrill Lynch boss appointed CIT chief

The former chief executive of Merrill Lynch, John Thain, has been appointed as the new boss of US lender CIT Group, which recently emerged from bankruptcy.

CIT will pay Mr Thain $6m (£3.8m) a year – $500,000 in cash, $2.5m in stock to be held for one year, and $3m in stock to be held for three years.

Mr Thain resigned from Merrill just after it merged with Bank of America at the start of last year.

He was criticised for allowing big bonuses despite Merrill’s hefty losses.

These were paid out just days before the takeover by Bank of America.

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Jim Sinclair’s Commentary

There is no PRACTICAL means of draining the huge liquidity injected into the economy.

The operative word is PRACTICAL.

The Fed is playing with fire as this will not impress Wall Street, but scare the hell out of worldwide equity people.

By playing this game the Fed may well loose the wealth effect of the improved equity market, thereby risking losing it all.

QE to infinity or the Fed is history.

The Fed’s "Exit Plan" Is Just Another Secret Gift To Wall Street
Feb 08, 2010 09:50am EST
by Henry Blodget

The Fed is planning to detail its "exit plan" this week, the WSJ says.  This exit plan is the means by which the Fed will gradually reverse the tremendous stimulus it is still pumping into the economy and financial system.

As we’ve noted often over the past year, the Fed is in a bind.  During the financial crisis, it bought hundreds of billions of dollars of real-estate and other assets from banks to reduce mortgage rates and ease the pressure on bank balance sheets.  This, in turn, pumped hundreds of billions of new dollars into the economy, which has enabled the banks–and bankers–to make a killing over the past year.  The question is how the Fed can reverse this stimulus without killing the economy.

The idea behind giving the banks cheap money was that the banks would lend it to consumers and businesses.  Unfortunately, that hasn’t happened: Since the start of the crisis, bank lending has fallen off a cliff.  The banks are, however, lending to the Federal government, which needs to fund record deficits by borrowing more than $1 trillion a year.  The combination of the Fed’s desire to stimulate lending via cheap money and the government’s desire to stimulate the economy by running a huge deficit has made it a great time to be a bank: Banks can borrow from the government at artificially cheap rates and then lend the money back to the Federal government at higher rates, pocketing the difference.

And now it’s going to get even better to be a bank.

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Jim Sinclair’s Commentary

The best technology for this type of transportation is not resident in the USA. The US program to build this will benefit non American companies to a large degree.

China’s fast trains may offer tips for U.S.
By Calum MacLeod, USA TODAY

ABOARD THE GUANGZHOU-WUHAN EXPRESS — Once the speed gauge hits 350 kilometers per hour, or 217 miles per hour, passengers charge down the aisle to photograph the electronic display.

"If we go any faster, we’ll take off!" jokes Hu Qing, cracking open another can of beer on China’s world-record-breaking train.

The Dec. 26 opening of the high-speed link between south Chinese cities Guangzhou and Wuhan is the latest example of massive state spending to keep China’s economy roaring. The fast-expanding network of high-speed trains is stoking patriotism, too.

"This train is the pride of the Chinese people," says Hu, 42, the boss of a paper factory, who chose the train over a direct flight home to northeast China.

U.S. companies await the first round of government grants announced by President Obama in his State of the Union address totaling $8 billion to jump-start long-delayed high-speed rail in the USA.

Meanwhile, China enjoys a considerable head-start.

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Jim Sinclair’s Commentary

No currency will do this for you, yet gold can going into 2011.

Decade 2000-2009: Gold’s gain against 17 currencies (in %)

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Jim Sinclair’s Commentary

Typical and across the board.

What is the difference between the weak states of the euro and the weak states of the USA? What is the difference between Greece going back to the Drachma or California issuing IOUs?

The answer is pure MOPE.

Oregon government revenues still dropping
By David Steves
The Register-Guard

SALEM — Passage of measures 66 and 67 may not have rescued state government from budget woes after all.

Even with the new taxes and a slowly recovering economy, Oregon’s revenue collections are now expected to fall $183 million below previous expectations, according to the latest forecast issued today.

That’s a small fraction of the $13.3 billion in general-fund spending planned for 2009-11 — but enough to put the budget $106 million after whack, after accounting for the $77 million ending balance. State Economist Tom Potiowsky attributed the dropoff in projected personal income tax revenue to two factors:

A slightly slower pace of economic recovery than was expected in the previous forecast.

A reduction in the tax payments coming in from high-income individuals.

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Jim Sinclair’s Commentary

The Fed is playing with a nuclear-hot potato.

Talk hawk and the house will fall down in the Western world.

Believe me, neither the White House or the ECB want to hear that. Clearly the equity boys do not want to hear that.

If Bernanke plays it wrong, the only way a democrat will be elected in November is by changing the party affiliation. QE to infinity must happen or the Fed is History.

Dow Industrials Post First Close Below 10,000 Since Nov. 4
By JAVIER C. HERNANDEZ
Published: February 8, 2010

The Dow Jones industrial average, one of the most watched metrics of the financial world, dipped below the 10,000 threshold on Monday, delivering a psychological setback as investors sought to overcome fears of a faltering global recovery.

At the close of trading on Monday, the Dow settled at 9,908.39, its lowest close in three months.

Lingering fears over a debt crisis in Europe helped trigger the Dow’s fall. As several countries across the Atlantic grapple with swelling deficits, investors spent Monday trying to gauge how seriously American banks would suffer if European governments could not pay back their debt.

Analysts said the Dow’s drop below 10,000 probably did not mean much for the future of the stock market, but they noted it had a deeper psychological effect for Wall Street.

“Investors and traders find solace in 10,000,” said Jeffrey A. Hirsch, editor of The Stock Trader’s Almanac. “While it may not be important technically, falling below that level indicates that the whole economic picture is not as rosy as everyone had thought.”

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Jim Sinclair’s Commentary

You can bust any debt by just running the OTC derivative market in the direction of your play. It is simple and effective.

Cash markets are always run by the leverage market. Damn those OTC derivatives anyway! You think any country will escape this?

What Do Rising Sovereign Credit Default Swaps Mean?
Monday, February 8, 2010

Here are the CDS of Greece, Portugal, Spain and the U.S.:

Rolfe Winkler argues that – in the short-run – the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) will slash their budgets and get bailed out by the EU.

Simon Johnson thinks that the weakening Euro caused by the PIIGS’ woes will hurt American exports (weaker Euro equals stronger dollar), and could lead to problems for leading global banks.

Other commentators fear that the PIIGS’ crisis has as much potential as a financial "contagion" as the subprime meltdown and the failure of Lehman.

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Jim Sinclair’s Commentary

And what makes you think that MOPE will ever report truthfully?

The US Economic Crisis: Jobs Continue to Vanish While the Media Applauds “Recovery”
by Shamus Cooke

At first glance it appeared there was a typo in the headlines. The national media reported that, in January, another 20,000 more jobs were lost.  Somehow, the unemployment rate dropped, from 10 percent to 9.7 percent.  Nobody thought this paradox was worth explaining; instead, the media’s attitude was “more good news” about the economy.      

But there was other evidence of an obliterated job market hiding behind the cheerful headlines.  After revising the employment numbers in 2009, The New York Times reported, “…the economy lost 150,000 jobs in December, far more than the 85,000 initially reported.”  Overall in 2009, the adjusted numbers showed an additional “…1.36 million fewer jobs…” (February 5, 2010).

And yet the unemployment rate dropped.  One reason this happened is that the U.S. government uses a separate, more unreliable survey to calculate the unemployment rate, in contrast to the survey used to calculate job losses.  There are other more important ways the government obscures the unemployment numbers: if you are no longer receiving unemployment benefits you’re not counted as unemployed; if you’ve given up looking for a job, you’re not counted either.  You are counted, however, if you are working only 15 hours a week, or if you’re a temporary worker.

In this way the government cooks the books to bring fake optimism to the masses.  The mainstream mediareports these fraudulent numbers without asking questions, so that the Democrats can continue doing absolutely nothing towards creating jobs.

But there is a method to the madness.  Mass unemployment brings incredible pressure on workers’ wages and benefits.  The mere threat of being unemployed puts unorganized workers in a precarious position when they’re told to work for less.

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Jim Sinclair’s Commentary

You expected any different?

Irked, Wall St. Hedges Its Bet on Democrats
By DAVID D. KIRKPATRICK
Bankers, unhappy at the president’s proposals for tighter financial regulations, are shifting donations to Republicans.

Jim,

I agree.

I believe that your last commentary toward the attack of debt, thus, an indirect assault on the currencies behind them, represents the highest realization of warfare as described by Sun Tzu in Art of War.

The highest realization of warfare is to attack the enemy’s plans;

Next is to attack their alliances;
Next is to attack their army;

And the lowest is to attack their fortified cities.

We must assume that the level of secrecy implies that the plans have changed? Does this mean that the dollar, fiat money in its present state, is no longer defendable? If so, a new currency, a single currency must be formed with highest potential for wide acceptance by the West. This must be done in secret so that enemies do not have time to adapt to the weakness of the plan.

The form is easy, but acceptance is not. Does acceptance come during a period of perceived prosperity or turmoil? If it is the latter, watch out. The latter, however, carries the consequences of angering the masses. Masses that, when organized, have the potential to change all of the rules despite the best of plans.

CIGA Eric

 

Dear Mr. Sinclair,

My father, being a businessman with a career that has spanned through the mid-1960’s up thru the current time, has often sparred with me in my belief that the dollar (known to him as "cash" through the early years) is not the pre-eminent means of savings. Although he has a portion of his wealth allocated to precious metals and precious metals equities, the position is somewhat small relative to his net worth.

I have often informed him that what I see being the end result of this "fiscal takeover" is a cash-less society where currency only exists in the form of a computer entry and is only accessible via electronic form. Therefore any entity who saved cash in any form outside the banking system basically loses everything. Do you see this as part of the result of the current actions taking place, particularly those noted in today’s commentary?

Best Regards,

Your Friend,
CIGA Marc

Dear Marc,

YES!

Regards,
Jim

Here are the CDS of Greece, Portugal, Spain and the U.S.:

[click here for full image]

Rolfe Winkler argues that - in the short-run - the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) will slash their budgets and get bailed out by the EU.

Simon Johnson thinks that the weakening Euro caused by the PIIGS' woes will hurt American exports (weaker Euro equals stronger dollar), and could lead to problems for leading global banks.

Other commentators fear that the PIIGS' crisis has as much potential as a financial "contagion" as the subprime meltdown and the failure of Lehman.

But for the long-term view, we need a little more perspective. One of the world's leading economic historians - Harvard professor Niall Ferguson - says:

 

The economists are ill qualified to analyse the current economic situation since they lack the overview of historians such as himself.

 

"There are economic professors in American universities who think they are masters of the universe, but they don't have any historical knowledge. I have never believed that markets are self correcting. No historian could."

 

Ferguson warns of huge government debts threatening the solvency of entire nations:

 

"The idea that countries don't go bust is a joke... The debt trap may be about to spring ... for countries that have created large stimulus packages in order to stimulate their economies."

But whether or not large nations actually go bankrupt, one thing is clear . . . Larry Summers, Ben Bernanke, Tim Geithner and their foreign counterparts have failed.

As I noted in December 2008:

BIS [the Bank of International Settlements - the "Central Banks' Central Bank] points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:

The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened. In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don't have, central banks have put their countries at risk from default.

Nothing has changed. As former chief Merrill Lynch economist David Rosenberg writes this week:

First the governments bail out the banks who were (are) basically insolvent. Then these governments, especially in Europe, see their balance sheets explode and face escalating concerns over sovereign default. The IMF now predicts that the government debt-to-GDP ratio in the G20 nations will explode to 118% by 2014 from pre-crisis levels of around 80%.

 

Now, the ball is put back onto the banks because many have exposure to the areas of Europe that are facing substantial fiscal problems right now. According to the Wall Street Journal, U.K. banks have $193 billion of exposure to Ireland. German banks have the same amount of exposure and an additional $240 billion to Spain. Many international bond mutual funds also have sizeable exposure to sovereign debt of Portugal, Ireland, Greece and Spain as well. Contagion risks are back. Stay defensive and expect to see heightened volatility.

 

In a nutshell, toxic assets have basically been swept under the rug in the hopes that we will outgrow the problem. Leverage ratios across every level of society are still reaching unprecedented levels as the public sector sacrifices the sanctity of its balance sheet in its quest to stabilize the dubious financial position of the household and banking sectors in many parts of the world.

 

Whatever bad assets have been resolved have almost entirely been placed on the books of governments and central banks, which now have their own particular set of risks, as we have witnessed very recently in places like Dubai, Mexico, and Greece, not to mention at the state and local government level in the United States. We simply have not seen a reduction in the percentage of properties with mortgages that are “under water”, hence the FDIC has identified 7% of banking sector assets ($850 billion) that are in “trouble”, so how can it possibly be that the financial system is anywhere close to some stable equilibrium?

 

When accurately measured, including the shadow inventory from bank foreclosures, there is still nearly two year’s worth of unsold housing inventory in the United States, and commercial vacancy rates are poised to reach unprecedented highs, and this excess supply is bound to unleash another round of price deflation and debt defaults this year. The balance sheets of governments are rapidly in decline across a broad continuum, and it is particularly questionable as to whether Europe is in sound enough financial shape to weather another banking-related storm.

 

The global economy is set to cool off. Not only is China and India warding off inflation with credit tightening measures but most of the fiscal and monetary stimulus thrust in the U.S.A. and Canada is behind us as well. And, the fiscal tourniquet is about to be applied in many parts of Europe, especially the PIIGS (referring to Portugal, Ireland, Italy, Greece and Spain — these countries account for a nontrivial 37% of Eurozone GDP). Greece’s GDP has already contracted by 3.0% YoY, as of Q4, and is expected to contract 1.1% in 2010 and 0.3% in 2011 as a 13% deficit-to-GDP ratio is sliced from 13% to 3% (assuming this fiscal goal can be achieved politically). Portugal has a 9.2% deficit-to-GDP ratio that is in need of repair and Spain has a deficit ratio that is even worse, at 11.4% of GDP.

 

The bottom line is that even if the fiscally-challenged countries of Europe do not end up defaulting, or leaving the Union, the reality is that they will have to take draconian measures to meet their financial obligations. Devaluation was the answer in the past in Greece but it cannot rely on that quick fix this time around without leaving EMU and if it did, then that could make it even harder to service its Euro-denominated debts — at least not without a restructuring. And, if Greece did attempt at a debt restructuring, rest assured that Italy, Spain, Portugal and Ireland would be next — we are talking about a combined $2 trillion of potential sovereign debt restructuring that would more than triple the $600 billion direct cost of the Lehman bankruptcy.

 

This poses a hurdle over global growth prospects at a time when Asia will feel the pinch from the credit-tightening moves in China and India. And heightened risk premia will also exert a dampening global dynamic of their own in terms of economic decision-making by businesses and households alike. The intense sovereign risk concerns are not limited to Europe either. In the U.S.A. we saw CDS spreads widen out to their highest levels since the equity markets were coming off their lows last April. According to the FT, the Markit iTrax SivX [sic] index of CDS on 15 western European sovereign credits rose above 100bps on Friday for the first time ever.

Marc Faber discusses America's unsustainable debt load in this interview with Margaret Brennan on Bloomberg TV. An amusing observation: the GDP growth from each $1 of new total debt has dropped from $0.25 to -$0.60. Also some much deserved Bernanke and Krugman bashing. Why it is so difficult to realize that the only way out of the crisis is to cut corporate and sovereign debt, we don't understand. Ah yes, because for that to happen, equity values across virtually all of the US economy would be wiped out... And that would destroy the myth that there is any real equity value in America.

 

Full Faber interview.

via Gurufocus, h/t Mike

The choice selections from today's Art Cashin comments, via UBS Financial Services:

Greek Rescue Rumor And Chippier Consumer Brings Stocks Back From Brink – For much of Friday’s session, fears about the European Union (particularly Greece) sent folks seeking the safety of the dollar. That, in turn, put pressure on oil; gold and stocks as carry trades were liquidated. The carnage began in earnest as the European markets closed. The dollar began to move steadily higher causing the above-noted damage.

The dollar driven selling was not as vicious as the selling on Thursday, but around 12:45 things started to turn rather ugly. They got even uglier as they headed to the day’s lows at 2:00. Rumors circulated that a trading firm in the crude pits was being forced to liquidate contracts.

But, shortly after 2:00, bids began to pop up in stocks as the dollar eased back. With some investigation, traders learned that there were rumors, or at least speculation, that the ECB and others might be cobbling together a rescue package for Greece over the weekend.

Stocks began to cut their losses as did gold. Crude remained hobbled by those liquidation rumors but cut its losses nonetheless. At 3:00, stocks picked up another tailwind. Consumer Credit fell $1.7 billion not the $10 billion some economists had projected. The hope that the American consumer might be willing to consume again helped the late rally.

That late rally was a bit of a mixed blessing. Had they closed on the lows, the probable course of the market might be a touch clearer. A close at the lows would have suggested an “oversold reflex rally” for Monday extending half-way into Tuesday’s session. The rally would then fail followed by a sharp and severe selloff. The late rally took that specificity off the table. We’ll have to review the napkins for clues to the amended course.

Greece And the Gordian Knot – As noted above, the late rally was sparked by speculation that there would be a rescue package announced over the weekend. When no announcement came forward, there was no follow-through on the rally.

The latest speculation is about the inverted yield curve for Greek bonds. That doesn’t allow any wiggle room or time to ease into austerity. Therefore “instant austerity” runs the risk of public backlash, strikes and maybe even unrest in the streets. To buy some time, some folks speculate, that the ECB or some entity could guarantee short term Greek debt – maybe up to one year. That might buy some time. It will be interesting to see if that’s the road that is taken.

Cocktail Napkin Charting – As noted above, the late Friday reversal rally was primarily the result of rumors of a Greek rescue package. There were also technical contributors to the bounce. The S&P made its intra-day low at 1044. That’s its 200 day exponential moving average. Both Walter Murphy and Stock Market Cycles had listed 1043 as a probable target (darn good call).

Friday’s lows will be a critical testing area on any future pullbacks. If they are violated, things could turn very ugly although some see more support at 1030/1035.

For today, the napkins suggest early support in the S&P may be around 1048/1052 with the backup 1040/1043. Resistance looks like 1070/1074 and then 1080/1085. We need to be careful because the Friday bounce may have released enough of the oversold to allow the bears another shot.

Consensus – Watch the dollar and the headlines and rumors from Euroland. If the dollar rallies smartly, things could get very ugly. Stay very nimble.

Trivia Corner Answer - To heir today - The middle son brought the ailing horse an apple every other day. Today's Question - Heads up! Each of the following 4 letter words can be made an 8 letter word by adding the same 4  letter word to each one. (Example - If we gave you step, ball, hold, work, path & fall....the answer would be "foot"). What word fits - A) Some; Pick; Bill; Book; Rail. B) Line; Style; Long; Boat; Like; Size. C) Ding; Boy; Man; Vampire. D) Kingdom; Way; Nations, State.

 

Alex talks with Denver, Colorado, criminal and constitutional attorney Gary Fielder who refused to be subjected to a courthouse naked body scanner. Alex also talks with Michael Springmann, a former head U.S. consular official in Jeddah, Saudi Arabia, who complained about a CIA visa factory in Saudi Arabia and was fired as a result. Alex talks about internet censorship in New Zealand and increasing threats to freedom on the Web.

Watch the video archive and access the high quality MP3 by logging in at Prison Planet.tv and clicking on the “LIVE” page.

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Attempts by carry traders to redeem some P&L after a month of agony crashed and burned promptly, accelerating into the close as the Yen funding unwind killed not just the carry pairs but broader equities. Of particular note is the hurt experienced by AUD longs funded with either USD or JPY.

It is officially time for Goldman to enter the stop losses on its various carry trades. The pain for the (leveraged) BRLJPY trade has now become unbearable.

The market took out the Friday's ES VWAP close and robotic selling panic set in.

This is what a perfectly uncorrelated market looks like. Sarcasm off.

Time to officially bury the Dow 10,000 v2.

0208104 -

Very quiet, boring day today.  Keeping an eye on the European banks and the resilient semiconductors.  If the girls can get themselves out of rehab and the banks cen get something going, then a reaction rally might be due.  Otherwise, its back to "Risk Revulsion and Convulsion".

 

Very interesting to see how the semiconductors have not been able to make new lows in a few days, so it will be best to watch these hookers for clues:

No real bottlerockets or big shank jobs to show today, just more selling from scared mutual funds and panicked hedge funds eyeballing the EUR/USD and trading tick for tick.

One of the less-reported events this weekend was the not so secret central banker meeting that is taking place in Sidney Australia. Now that factual details are finally emerging it is appropriate to collect some information tidbits about this shindig which has some claiming is reminiscent of a modern day version of the Jekyll Island meeting. From the Sydney Morning Herald.

CENTRAL bankers are an unobtrusive breed by nature and necessity. So it might have escaped the attention of many that Sydney is playing host to a meeting of some of the world's top money men and women to celebrate the 50th birthday of the Reserve Bank of Australia.

However, a secretive gala dinner at the Art Gallery of NSW to mark the event last night attracted a who's who of Australia's political and business world.

Past treasurers included Peter Costello, John Dawkins, John Kerin and Ralph Willis. And, of course, the RBA was well represented, with governor Glenn Stevens and former governors Ian Macfarlane and Bernie Fraser in attendance.

Around 7.15pm, John Howard and his wife Janette arrived, almost at the exact time as Mr Costello, from the other side of the entrance. The pair met, shook hands, and offered a polite ''Good to see you'' before moving up the stairs.

The visit by central bankers includes the president of the European Central Bank, Jean-Claude Trichet, the presidents of the Federal Reserve Banks of San Francisco and New York, Janet Yellen and William Dudley, the governor of the People's Bank of China, Zhou Xiaochuan, the governor of the Bank of Israel, Stanley Fischer, and New Zealand's Reserve Bank governor, Alan Bollard. Last night, some of these bankers were spotted being bussed from their meeting venue at the Sheraton on the Park Hotel to the Art Gallery. The event was held in the Grand Court, which seats up to 350 people.

They drank champagne before looking at artworks and sitting down for dinner entertained by a jazz trio.

The visit by the central bankers comes as world markets fear a second wave of financial stress if the Greek government defaults on its debts. There is also talk the stresses could lead to a break up of the European Union's common currency, the euro.

The low profile of the meeting is also a matter of design. Security is tight and the location of events a closely guarded secret.

Today's meetings will kick off with a session to discuss a paper co-authored by Mr Stevens on the challenges facing central banks. Mr Macfarlane will chair a second session on the financial sector, and the day will conclude with a discussion led by Ross Garnaut on supply side issues.

Last night's dinner came after meetings at the Sheraton between Mr Stevens, Mr Trichet and Mr Bollard.

So, does the health of the world's bankers reflect the ailing global market? A NSW Ambulance waited outside the Art Gallery all night just in case.

It has also turned out that the meetings are organized not by the Australian government, but by the BIS.

Sydney - Central bankers are to meet in Australia's biggest city for two days of talks as plunging stock markets renew fears of a slow and patchy recovery from the global financial crisis, Sydney's Herald Sun reported Saturday. The paper said representatives from 24 central banks, including the US Federal Reserve and the European Central Bank, are to assemble Sunday and Monday in an undisclosed location.

The organizer of the meeting is the Bank for International Settlements rather than the Australian government, which would help explain why secrecy prevails.

The governors of the People's Bank of China, the Bank of Japan and the Reserve Bank of India are said to be on the guest list.

The gathering, arranged last year, takes place against a background of world share markets reeling from fears that governments, not just companies, may have difficulty with their balance sheets.

"It's been a long time since we have seen really serious sovereign risk in developed economies," Gerard Minack, the head of brokerage Morgan Stanley's Australian operations, told the public broadcaster ABC. "We don't have a lot of history to go by, at least in the modern era."

Minack said the concern was not just about Greece, Spain and other southern European countries - the so called Club Med - but about other economies.

"We are now seeing it spread around the ring of fire that surrounds core Europe," he said. "I mean, Eastern Europe looks terrible. We know already there are concerns about the Spanish, the Italians, possibly the Japanese."

It is surprising that two critical concurrent meetings as a G7 event in the Arctic circle would take place while half a world away, both in latitude and longitude, those very countries' central bankers were meeting at the same time. Of course, that events in Europe, the end of QE in England, the imminent end of QE in the US, and the sudden and much hated by central bankers resurgence of the dollar are happening at the same time is merely a coincidence.

h/t Shannon

Developing story. The probability of Rakoff turning down SEC Settlement #2 just went up substantially.

0208103 -

We have so far avoided discussing this weekend's most tragicomic news, which undoubtedly is the Mortgage Bankers' Association selling their headquarters for a huge loss in less than two years. The building which was acquired for $76 million was sold to CoStar for $41.25 million. How the MBA is in any way supposed to provide insight on sentiment and market perspectives after a slap in the face such as this is beyond us. At best, they should start a $2.95 newsletter titled "How to top tick the market and never look back while waiting for the Dow 36k." The other implications of this transaction are self-explanatory. Yet courtesy of diligent readers, we have received some other very amusing information, which however focuses on the buyer in this transaction, specifically CoStar, which on its website brands itself as the "#1 Commercial Real Estate Information Company." Apparently the validity of this branding is only as good as the (un)solicited hot tips CoStar receives every day. A letter sent out earlier by an editor of CoStar's Watch List Group seeks to expand on the groupthink permeating the permabullish CRE investor landscape (we hope they approached Cohen and Steers with their query for an objective and unbiased perspective), with a set of questions that makes one question the validity of CoStar's self-branded characterization.

We present the letter in its redacted entirety and request that helpful readers will provide their CRE perspectives to an otherwise confused CoStar:

From: XXXX
Sent: Monday, February 08, 2010 7:31 AM
To: XXX
Subject: Comments sought for upcoming Watch List story on CRE Loan Sales

Judging by FDIC numbers, 2009 was a huge year for sale/purchase of CRE debt. The FDIC alone sold about 3,500 CRE loans with a book value of more than $6.1 billion. That compares to CRE loans sales in 2008 of just $153 million.

I am preparing a story for an upcoming Watch List article sort capsulizing that activity. Any color or insight on any of the following points you could provide would be greatly appreciated.

How active is the market for CRE debt right now?

What is the outlook for 2010?

In a nutshell, what is the profile of the most active buyers in the market? And most active sellers?

Does there seem to be a preference for performing or nonperforming debt and does the quality dictate the type of buyers and sellers.

Does there seem to be a preference for loans by property type? And if so why?

Thanks in advance for taking the time to consider this request.

Sincerely

XXX
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