The Slow Strangulation Death of a False God: Debt-Based "Prosperity"

Nothing in the "news" persuades me that borrowing more money and easing credit standards will save the worshippers of a false god: cheap, easy credit. Americans have slavishly worshipped at the feet of this golden idol for seven long years, and if you'll forgive the Biblical reference, these seven "fat" years of gorging on debt are about to be followed by seven "lean" years (or maybe 14 years, the crystal ball is hazy on that point) in which debt is repudiated and people begin saving out of fear for their future.

Astute reader Lindy A. shared these thoughts recently:


Your September 20th comments are timely and deadly accurate. Indeed, my family and I have thought for some time:


"Bread and circuses" are the order of the day


Those seeking elected office are not doing so for the common good


The "statistics" on inflation are obviously misstated --- one wonders why they bother continually repeating them


and now --- reducing rates and guaranteeing the devaluation of our currency to appease those who caused the crisis, accomplishing nothing

Our economy has been placed in the hands of others, we have fomented a war, we have gradually been encroached by ever increasing taxation, charges, fees and the like. (again, your analogy so apt, the frog in the water).

A sorry situation. We can, however, at least voice our thoughts, (so far), and take what individual steps are possible to give reality to our own lives.

Not having any TV service was our first step in the right direction. Moving was another. Honing various skills, downsizing all things; giving the "finger" to the exhortations to "buy" "buy" "buy".

Oops, there's the catch, isn't it? Now THAT'S what "THEY" are afraid of. A nation of individuals who say, "We don't need this "stuff".... both figuratively and literally.

Wow, then we'd have to have a rebirth of a culture more dedicated to intellect, internal satisfaction, ethical standards, and industry focused on actual needs. Ho ho hooooo. Sounds like something the framers of our Constitution would have approved.

Thanks for your sense and sensibility."

In contrast to this common sense (thank you, Lindy), here is the typical standard-issue status quo economist (as quoted in Barrons): Fear Seems to Be Fleeting by Michael T. Darda, chief economist, MKM Partners:

FORWARD-LOOKING FINANCIAL-MARKET INDICATORS are all pointing up: The Treasury curve has steepened considerably, risk spreads have come down significantly from peak levels, commodity prices are melting up again, and equity markets are moving higher.

We think this means that any patch of bad data that may develop during the months ahead will be transitory and temporary. Indeed, the equity market seems to be looking ahead to sustained earnings growth and stronger pricing power next year despite mixed economic data."

In other words: blah blah blah. Everything's great! The future's so bright we gotta wear shades! No recession, equity markets will go up strongly a sixth year in a row with endlessly growing profits and stock prices!

Meanwhile, back in reality, this is what I see with my own eyes:


Food prices skyrocketing, with projections for 10+ years of higher prices (Wall Street Journal 9/27/07) Soaring Demand For Grain Roils World Markets


House sales drop 50% in Los Angeles. Gee, do ya reckon supply now exceeds demand?


A year ago, I would stop my bicycle by the railroad tracks and watch dozens of railcars loaded with lumber heading south to L.A. Recently, the trains haul no lumber whatsoever; instead the train hauls tanker cars full of ethanol (see item one above about grain demand)


Our friends who once had a family income of $150,000 a year are now facing bankruptcy due to severe medical costs (yes, they have typical "corporate employer" insurance, but their share of the costs already exceeds $100,000).


Another high wage earner ($120,000/year) just put $10,000 of dental work on a credit card. Yes, she has corporate insurance, but the dental coverage is a joke. (It costs $500/year and pays out a maximum of $500/year. This is typical of "phony insurance" which pays little more than it costs--standard practice in the U.S. No wonder Buffet owns insurance companies.)


A friend in the video production/TV commercials business reports that auto sales have fallen off a cliff in September at his new car dealership clients.


Friends with $75,000 a year household income and two kids live paycheck to paycheck, and they rent their apartment. They do not own new cars and have no mortgage or car loans. This is standard nowadays: people take vacations with credit cards. They have no savings.

Note that these are not people with subprime mortgages which are re-setting--these are high wage earners with standard expenses in a "secretly inflationary" "tax the living heck out of the high-wage earner" economy.

Please spare me the gobblydigook about rate spreads and all the statistics and indicators. Let's stick to simple fundamental facts:

1. 70% of the U.S. economy is consumer spending.

2. U.S. consumers are either strapped, heading for bankruptcy or about to get strapped.

But complacency reigns supreme, as evidenced by this chart of the VIX
(a.k.a "fear index")



Is this a chart of complacency reigning supreme forever, or complacency about to be shattered by reality in October? Let's wait for auto sales, inflation numbers, gasoline prices, profit warnings, retail sales and all the other bogus/manipulated numbers for September. Maybe even the spinmeisters will be unable to mask the rot as the false god of ever-rising debt and "easy terms" borrowing by individuals, corporations and government alike topples under its own weight.


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Production Versus Consumption: Incentives, Soulless Work and a FIRE Economy


I hope you're well-stoked with caffeine, mate, ginger or your stimulant of choice, because we've got another "big ideas" entry today.

Frequent contributor Bill Murath kicks things off with a meditation on production versus consumption: (Bill suggested this topic--thank you, Bill)


"Our degenerate (myself included) society has been fiddled into the easier route of consumption to profit the few. To produce you need years upon years of training etc. The other day a friend sent me an email with huge mansions of the "stars" and the last house pictured was a little shack entitled "mine." I look at the huge estates and think, wow I would love to do the finish trim work in those instead of, I would like to live in them.

At least I have had my eyes opened to the value for the soul of producing things. And you know I am not talking about gathering and shuffling data nor quantum financial products etc."

Correspondent/resource analyst U. Doran sent in a link to a summary of our quandary entitled The Empire of Debt:

In 1972, wages reached their peak. According to the U.S. Bureau of Labor Statistics, workers earned $331 a week, in inflation-adjusted 1982 dollars. Since then, it’s been a downward slide. Today, real wages are nearly one-fifth lower – this, despite real GDP per capita doubling over the same period.

Credit not only became more easily attainable, it became heavily marketed. Credit card debt, at $880 billion, is now triple what it was in 1988, after adjusting for inflation. The average new home in 2005 was more than 50 percent larger than the average home in 1973.

Given a choice between working for diminishing returns and joining the leisurely riches of the rentier, people pursue the latter. If the rentier class is fabulously rich, why can’t everyone become a member?

In the US in particular, capital gains are being taxed at ever-decreasing rates. A person whose job pays $100,000 can owe 35 percent of that in taxes compared to the 15 percent tax rate for someone whose stock portfolio brings home the same amount.

This summarizes the issue I want to explore: the incentives and disencentives which have been built into our economy.

People haven't buried themselves in debt because they're stupid--they've acquired ruinous mountains of debt because that's where the incentives and disencentives prodded them.

1. The purchasing power of earned wages has plummeted. Not only have wages shrunk in inflation-corrected terms, but the purchasing power of the U.S. currency has dropped. Real wages have been stagnant since 2000. (see chart, or do a search.) I have addressed this before: Housing Bubble Bust Will Take Down the Global Economy (May 8, 2006)

In terms of purchasing power, wage earners have done much worse than flat, thanks to a depreciating dollar and "real" inflation, which is running at double or triple the phony "official rate" of 2% per annum.

2. In an era of low interest and "easy terms," the incentives to borrow increased even as the incentives to save decreased.

We can see on this chart how Americans saved when interest rates and wages were higher, and abruptly began borrowing (and spending) prodigious amounts of money when interest rates dropped and wages sank.

Does anyone actually care about the size of the debt they assume any more? No--the number which is presented and which figures into their calculation of "affordability" is "the monthly nut"--the monthly payment.

3. The government actively reduces the incentives to produce (via high tax rates) and increases the incentives to generate income from rents and anything that qualifies for long-term capital gains. Hedge funds went ballistic earlier this year when their lapdogs in Congress had the unmitigated gall to hesitantly suggest hedgies shouldn't be paying the low 15% rate on their outrageous gains, but the rate the great unwashed wage earners pay, i.e. 35%.

Hedge funders screamed bloody murder, as if the entire U.S. economy would go to the dogs if they were taxed like the poor underclass who work for a living.

If you skim off $100,000 on Schedule D (income from investments) for securities you've owned a year or longer, you pay only $15,000. The taxpayer who earned $100,000 as salary, in contrast, pays $35,000 (I know, they have deductions, but you get the point) and FICA (Social Security) and Medicare taxes, neither of which are paid on capital gains.

If you receive net rental income from property (Schedule E), you also pay no FICA or Medicare taxes.

But if you have a small business, not only are you taxed at the highest rates, but you pay 15% FICA (both the employer and employee shares). Sure, you get a few other deductions, but if you are successful, you are paying a much higher total tax load than the taxpayer who earns only capital gains and/or rental income.

4. Wealthy Americans have a direct avenue to high returns: hedge funds.
"Hedge funds, the money managers for the super-rich, numbered 500 companies in 1990, managing $38 billion in assets. Now there are more than 6,000 hedge firms handling more than $1 trillion dollars in assets. (source: "Empire of Debt" link above)"

The average schmoe doesn't have enough capital to qualify to invest their meager savings with a hedge fund (yeah, schmoes like me), so the wealthy have reaped returns of up to 40% per year while the salaried person might earn 10% if they're lucky in a mutual fund. (Average fund returns historically run about 7%. On occasion some narrow-focused funds do much better, but you have to nimbly enter and exit these small funds to reap 20%+ gains.)

Yes, hedge funds have higher risks--the reason given for restricting Joe Salaryman from investing. But this is ethically flawed. If Joe Salaryman wants to invest say 20% of his savings in a high-risk hedge fund in hopes of earning outsized returns, why shouldn't he be allowed to make that choice? OK, limit his investment-at-risk to a sum smaller than his liquid assets, but don't preclude him from taking on higher risks and returns.

5. As a result of these limited options for wealth-building and declining real wages, average Americans jumped on the housing bubble wealth-creation ride. Your salary/wages are actually falling every year, and yet you see rich folks making money from rising assets: vintage wines, hedge fund shares, property, paintings, precious metals, you name it. What do you do?

Let's face it: many of these assets are out of the average Americans' reach and/or expertise. But housing is something everyone can understand. So you invest in something "safe" that you understand: housing. The results of this desire to reap investment returns in a low interest-rate environment can be seen in these two charts:












6. As noted elsewhere, the U.S. economy has become a FIRE (finance, insurance, real estate) economy of service jobs. Yes, the U.S. is still a mighty producer of agricultural goods, aircraft, autos, biotechnology, chemicals and high technology, but in terms of jobs only about 15% are classified as manufacturing/farming.

7. The U.S. is falling behind in manufacturing technologies with future growth possibilities. This is a real "which part of the elephant are you touching?" subject. Cheerleaders for the U.S. point to the high government support for basic research and the billions in private venture capital flowing into new start-ups in Silicon Valley and elsewhere.

Nice, but meanwhile, over on another part of the elephant, Toyota just sold its millionth hybrid vehicle in the U.S., a market the U.S. manufacturers wrote off as "unprofitable due to low demand." And as knowledgeable reader Tom S. noted recently, most of the photovoltaic panels being purchased via government subsidies in the U.S. are manufactured in Japan or Germany--nations with strong national focuses on alternative energy and energy conservation technologies.

This begs the question: if the U.S. market has been crippled by disincentives to make actual products and incentives to produce nothing but financial transactions, will "the market" be able to suddenly re-energize the U.S. manufacturing base?

Cheerleaders point to the plummeting dollar and proudly predict that overseas buyers will soon be snapping up "cheap U.S.-made goods" because the sagging dollar has lowered the cost of U.S.-made goods in other currencies. Never mind that inflation will roar up as imported goods skyrocket in cost, and the sad fact that the U.S. citizen's purchasing power will plummet along with their currency-- there's another problem. What if there isn't much made here anymore?

Yes, let's grant Boeing, soybeans, almonds, Hollywood, Catepillar, Citicorp and Microsoft their well-earned glory: the U.S. sells $1 trillion in goods and services abroad: that's 7.5% of the GDP. But the U.S. imports $1.8 trillion. So the question becomes: can our exporting stalwarts sell $800 billion more a year? And if they can't, then what U.S. goods and services will appear that overseas buyers want?

If we've removed the incentives to producing actual goods, then perhaps the answer will be: there won't be any meaningful resurgence in exports.

8. The FIRE economy is non-productive. It should be called the GFIRE economy, G for government. Taking my cousins and their spouses as a non-scientific sampling of the U.S. workforce, we find a disproportionate share of government workers. Of 14 cousins/working spouses, 7 work for government agencies. Two work in real estate/building, one in sports, one in law, and one in insurance. Only my brother and I are self-employed (own small businesses), and he lives in France--another country which relegates small business owners to a life of tax-and-fee penury and grinding bureaucratic nonsense.

Who's actually producing any goods and services to support all these government jobs and paper-shuffling jobs in insurance and real estate? Those of you who are self-employed or own small businesses--you know the score. The disincentives to start or operate a small business in the U.S. are huge and growing heavier by the day.

9. The GFIRE economy depends entirely on the repetition and velocity of transactions to survive.

If you don't buy a lot of stuff with your credit cards, nobody makes money.

If you don't re-fi your mortgage, HELOC or other loans every few years, nobody makes money.

If you "buy and hold" a stock and don't churn your portfolio with lots of buying and selling, nobody makes money.

If you don't take handfuls of "it doesn't work but what the heck, I have to prescribe something" pharmaceuticals, nobody makes money.

If you don't go to the doctor often, nobody makes money.

If you don't buy a new car every few years (with a new loan), nobody makes money.

If you don't have insurance, nobody makes money.

I think you get the picture. Without ever-increasing volumes of financial transactions, the GFIRE economy stops breathing and dies.

9. The quintessential corporate-America success story is Apple, which makes nothing in the U.S. How much of the U.S.-based global companies' goods and services--you know the roster, Coke, IBM, 3M, Proctor & Gamble, etc.--are actually made in the U.S.? Judging by the fact that overseas markets account for more than 50% of their sales and profits, you have to wonder if their sales should even be included in the U.S. GDP.

What would the U.S. GDP be if only goods and services actually produced in the U.S. were counted?

10. Essentially non-productive digital-data-massaging jobs are soul-deadening tasks which alienate the workers from the real world. As long-time readers know, I have more than a passing knowledge of Marxism via my useless degree in philosophy. (I also have equally useless knowledge of Taoism and other have-no-financial-value topics. Yes, I am an idiot!)

Marx rather famously observed that the worker in a capitalist economy was alienated (philosophic bonus word: reified) from the results of their work.

Add to this the pressure to make up falling wages with risky investment gambles and the brainwashing effects of "24/7 advertising and marketing, all the time, in all mediums and all places" and you reach where we are today.

I would suggest that these forces have reached their zenith in our "information (digital-data-massaging) technology" age. Although it may seem like a stretch, I also discern the roots of our culture's ill-health (can't/won't cook, won't exercise, wants instant pill solutions, needs drugs to sleep, needs drugs to ward off depression and anxiety, etc.) and soulless obsession with consumption in this fundamental disconnect between the real world of growing and preparing food (no, not the Food Channel, actually working with fresh food), of making real objects of real utility, of caring about one's work and knowing it has value, and the GFIRE economy of shuffling paper and its digital equivalents, feeding a great machine with more and more transactions with little or no intrinsic value.

Oh, and the stock markets are up today on all the good news. And "markets" never lie, do they?


Thank you, James C., ($30) for your generous donation to this humble site. I am greatly honored by your contribution and readership. All contributors are listed below in acknowledgement of my gratitude.

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Credit Markets: Unregulated and Pathologically Addicted to Lying

In keeping with this week's theme, The Rot Within (week II), we've examined the rot within our legal system, Homeowners, Defective Houses and Big Builders: Justice Is Not Blind, and the intellectual hypocrisy/rot within our ruling ideology which claims to support free markets but hurries to feed at the public trough at the first signs of potential loss: Privatizing Profits, Socializing Risk: Hypocrisy and Housing.

Today we look at the rot within our financial regulatory agencies. In the past, I have referred to "lightly regulated hedge funds," and frequent contributor Harun I. has observed that hedge funds are regulated, and that the problem lies elsewhere: what isn't regulated are the exotic financial instruments and derivatives which have been sold to unwary investors the world over.

How big will the meltdown be when this mountain of leveraged rot collapses? Harun (and other readers as well) recommended this article by Jon Markman:

Are we headed for an epic bear market? The credit bubble is just starting to unwind, a credit-derivative insider says. And while U.S. borrowers are being blamed for the mess, they were really just pawns in a global game.




Harun notes that other financial markets have clear paper trails--but there are no similiar regulations in the markets for credit-market derivatives. Here are his comments:


"Not much new here but at least the MSM is catching on. At least this is from an insider. The greatest crime of the century has been perpetrated and no one is going to jail. The people who orchestrated this, the government, and the rating agencies all knew the danger of inverted pyramiding of leveraged bets; one small adverse move wipes you out. (emphasis added: CHS) It is not that the hedge funds were unregulated--it is that these new innovations don't fall under SEC or CFTC purview.

As alluded to in the article, no audit trail is required which is the one of the fundamental underpinnings of regulated markets. For example, in the futures market, beyond the contract specifications, an order generated by a client is time-stamped by every person in the chain of execution within on minute of receipt. At the end of the day, the clearinghouse marks it to the market.

Furthermore, exchanges require FCM's to either deposit margins for all net long, net short positions, whichever is greater, or both. A guarantee fund made up from member firms insures there are adequate funds to guarantee performance of all contracts. In the world of structured finance none of this exists and as a result we have what we have."

As many of you have read, the fundamental lie at the heart of the credit market is "mark-to-model," a fancy way of saying the security is not priced by what someone will actually pay for the security in the real world, i.e. mark-to-market.

As a result, securities which are worth 10 cents on the dollar in the real marketplace are kept on the books as worth a dollar--a fiction which is allowed because regulators have dozed at the wheel, happily enabling a global fraud of inimaginable proportions.

As Harun observes, the regulators and insiders all knew the pyramiding of risk and leveraging of cash into 20-to-1 or even 100-to-1 "bets" (buying $100 of pyramided derivatives with only $1 cash on the line) was risky--yet the game was allowed to run because the fees and profits being generated by investment banking houses and other players were truly gargantuan. And of course some of these outsized gains made their way to politicos, who were pleased to rely on "market forces" to guide this ponzi scheme of leverage and deceptively priced securities.

Simply put: there was no reason these markets couldn't have been regulated by the same agencies which regulate stock market derivatives (options) and futures contracts. If every CDO and MBS (mortgage-backed security) had been required to be marked to market at the end of every trading day, then the Big Lie (these are worth X when in fact they're only worth Y) could not have been perpetuated.

And if reasonable margin requirements (cash supporting the bet) had been enforced as they are for stock and futures bets/instruments, then the truly insane growth of these credit derivatives would have been limited by the players' cash. Recall that regulations require any stock purchased on margin to be backed by 50% cash. Simply using the same margin requirements for credit derivatives and securities would have imposed some common sense on a market which remains pathologically addicted to lying to survive.


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This Week's Theme: The Rot Within II

Privatizing Profits, Socializing Risk: Hypocrisy and Housing


Generous reader Faith A. sent me a copy of The Shock Doctrine: The Rise of Disaster Capitalism which I can now recommend to you

One of the book's primary theses (in my view) is that an intellectually robust "free market" philosophy has been hijacked as intellectual cover for the plundering of public assets by private (corporate) interests.

The idea can be summarized thusly: capital and profits are kept private, but losses and risk are shifted to the public. We can see this happening in the housing/mortgage fiasco, which frequent contributor Zeus Y. covers in detail below.

A corollary policy of this utterly hypocritical "we like free markets until we lose money" school of fake free-marketers is that the government exists to gather taxes which can be funnelled to private interests. This is the modus operandi of those lenders who want to foist their high-risk (toxic-waste) mortgages onto publicly supported Fannie Mae and Freddie Mac. They also want government money to be given to their borrowers so the lenders need not suffer any loss of capital or profit despite their stupendous folly (i.e. making and securitizing the risky loans in the first place).


The craven bail-outs which will be funded by taxpayers are drawing support from both political parties--both of whom are hiding the bail-out of their lender/investment banker/ hedge fund pals behind the transparent charade of "helping Americans keep their houses." The truth: keep the payments and profits flowing to our pals the lenders and investment bankers via debt serfs a.k.a. homeowners with new taxpayer-funded loans and giveaways.

The intellectually honest result of the housing/mortgage bust would be that every lender who wrote too many high-risk loans and every investment bank which securitized those loans would go bankrupt and their assets would be auctioned off in an open market. Every borrower who got over their heads in debt would also default and go bankrupt, at which point their assets (the overpriced house) would be auctioned off in the open market. This is called "creative destruction," and it is the true intellectual core of capitalism.

Should the government get involved in "saving" participants who are now facing creative destruction? No. This is a capitalist economy, and that's the flipside of capitalism, the yin to growth's yang. If entire subdivisions are empty, falling-apart eyesores, perhaps the local government can buy each one for $1 and have them dismantled/recycled. At least the "attractive nuisance" will be eliminated, and this might be worth a few taxpayer dollars.

There is much more in Shock Doctrine worthy of discussion; here is a short film on the book that is posted on the author's website (naomiklein.org): The Shock Doctrine Short Film.

And here is a peer-to-peer download site for the documentary.

There is an entire nomenclature sprouting up around these proposed bail-outs: moral hazard, mortgage socialism, etc. They all touch on the same basic theme, which is the politicos and their banking Overlords seek to transfer the risks and losses they incurred onto the public, while retaining the profits and capital from the continued servicing of bad debt/ risky loans for themselves: Privatizing Profits, Socializing Risk.


This is corporate welfare at its most blatant and most odious. If these bail-outs don't spark a revolution in our cloroformed culture, they should. They are intellectually fraudulent and financially irresponsible.

Foreign investors and central banks are no longer willing to support our government's bail-outs of our most irresponsible corporate/banking interests:


The US Treasury showed that foreign buying of US securities slowed in July to the weakest pace in seven months as a rout in the subprime mortgage market sapped global demand for all American bonds. US government data on foreign holdings released this week shows a collapse in foreign purchases of US bonds from $US 97 Billion in June to $US 19 Billion in July - with outright net sales of US Treasuries.

Zeus Y. covers the subject in greater detail--read on:

An interesting development which promises to open the door for banks and investment companies to pull their own rear ends out of the hole they dug for themselves, and stick all the liability on the taxpayer.


From the Paper Economy blog:

"In a really disturbing and outright reckless move, New York Senator Charles Schumer (D-NY) yesterday publicized details of a soon to be introduced bill that, if enacted, would both raise the portfolio caps on Fannie Mae and Freddie Mac by 10% ($145 billion with $72 billion being allocated for refis of rate shocked mortgages) and increase the conforming loan limit to as much as $625,500 in 'high cost' metro areas. In his statement, Schumer stated that by enacting the 'Protecting Access to Safe Mortgages' act, the federal government would be “deploying Fannie and Freddie to do the job they were designed to do.'"
I noted in the comment section that isn’t 'Schumer’s Protecting Access to Safe Mortgages' an interesting acronym— SPASM. Quite appropriate. Let’s follow one spasm of bad judgment and poor lending with a manic-depressive series of interventions not designed to solve the root problem, but to cover up the symptoms. Every time someone tries this, the underlying problem (i.e. overinflated, unaffordable housing) gets ignored or gets worse, but it defers reckoning, and WHO has to reckon, doesn’t it?

An anonymous commenter made some very good points, and I’m going to riff on them as well as reprint his/her full post at the end. The lesson, as in Watergate is 'follow the money,' but more specifically now 'follow the risk and liability' THEN 'follow the profit'. To no one’s surprise the liability is going to find its way from the one’s who made the bad investment decisions and practiced poor lending to those who had nothing to do with, and gained nothing from, the latest housing market debacle.

You see, free enterprise is for profit (meaning 'free of risk, regulation, responsibility') by the already wealthy, and RISK, well that is for those socialistic government bail-outs and the 'common man'; that’s 'what Freddie and Fannie are designed to take care of.' Socialism is always bad because it wants to restrain 'free enterprise,' but we won’t call it that when it is bailing us big-time investors and banks out of our bad judgment at the expense of taxpayers. I guess buying legislation and legislators is also part of free enterprise.

One, banks and investment firms hold a lot of bad paper right now (which incidentally they sold to themselves, so they shouldn’t really blame others). Hedge funds dabbled in high-return, 'risk-shrouded' mis-rated mortage-backed securities. Banks both lent them money, and sold them AAA-rated junk tranches and packages of securities based on 'liar loans” and other fraudulent terms.

But, see, everyone was making such great fees and bonuses, and that is the real life-blood, to the tune of an entire billion dollars for the highest paid hedge fund manager. Not too many citizens get this because most work for a wage, only see commissions as an expense, and look only at appreciating value of an owned asset as having financial value.

Now we banks and investment firms have a problem. We don’t work for a living. We skim money off exchanges of ownership. Not only are we holding worthless scrip, but since no one is buying the crap, we don’t get any fees, hence no income either. That’s a real problem. How do we jump-start our income and off-load our crap?

Two, we have to obscure the problem and the consequence, so let’s try to draw out this debacle (to buy time to scheme our way out) and create trapdoors in which to stash our dirty little secrets. So let’s get our Republican pal Bush to arrange for tax-supported refinancing to staunch the cascade of foreclosures, and let’s raise (through our Democratic pal Schumer) the limit on the 'jumbo' limit from 417K to 625K, so we can 'trapdoor' our bad loans into the public trough.

Three, if you’re real clever, as suggested by the anonymous commenter, now you have time to sell Fannie and Freddie all your bad loans under 625K, have taxpayers support your other failing loans through refinancing, and an excellent profit opportunity: Once Fannie and Freddie’s portfolio starts to burgeon with the worthless loans we (investment gurus and hotshots) sold them, we can either buy them back on pennies on the dollars or 'persuade' Fannie and Freddie to sell us their 'good stuff', swapping out our crap for actual performing loans.

Four, all the while home prices are held artificially high, out of synch with income and out of reach of working taxpayers (but keeping the 'worth' of assets in hedge funds and stock portfolios sitting pretty).

The question just has to be asked: 'Who is this country being run for, anyway?' Some day America may actually recognize the difference between 'license' and 'freedom'. When I said a half-trillion dollar bailout in an earlier post, I’m beginning to sense that’s about right. And worse yet, politicians will try to stick that debt on our kids, by borrowing it. No more bailouts. This has never been an honest or had any integrity. Subsidizing and rescuing dishonesty from its own consequence, even if there are innocent victims, will only accentuate the practice. Let the housing market fall and correct itself. Let people default.

If you want to get a government program together, make it about giving financial literacy education, ensuring a living wage, developing incentives for saving and economic stability for homeowners so they can meet their obligations. Just say no to the 'cokeheads of the economy' snuffling up their noses all our country’s value through their predatory practices.

Anonymous comment (from the Paper Economy blog referenced above:)

This is a bailout, no two ways about it. It transfers bad credits from the hands of the banks and investment banks who now hold this paper, into the hands of the taxpayer. When these loans are refi'd by freddie and fannie, the interest income goes to shareholders of fannie and freddie, however, when the loans eventually default (which they will), the cost is bore by you and I. Btw, I could be wrong on this, but i believe the purpose of F & F was to help add liquidity to the mortgage markets by guaranteeing conforming mortgages, not to drectly hold for profit, $1.45 Trillion in mortgages (plus the additional 10% they're tryng to add now).

Also, don't forget the connection to the 'FHA fix' proposed by Bush. FHA's limits are derived from the F & F conforming loan limits and will automatically go up if this bill passes. Add risk based pricing and voila, all this stated garbage is transferred to the GSE's. Prices stay artificially high, which means larger loans and more interest income. Eventually the loans go bad because real afordability (based on Price to Income and Price to Rents) never returns, and when they do, the taxpayer foots the bill. Meanwhile, the same IB's who offloaded the paper onto the GSE's will be standing in line to take it back off their hands for pennies on the dollar.

If the Banks and IB's are smart (which they are) they'll push for no increase in the caps and force F&F to sell them part of the $1.45T in quality paper (pre-2005) they're already holding, in order to free up room to "do the job they were designed to do". In other words, sell me the good stuff so I can collect interest on performing loans and I'll sell you my 2005 and 2006 vintage crap, which will eventually default. Don't worry though, it's the taxpayer who will foot the bill in the end.;)

Thank you Zeus (and the Paper Economy blog) for an enlightening overview of an extremely important subject.


Thank you, Tom S., ($50) for your generous donation to this humble Muggle site. I am greatly honored by your encouragement and readership. All contributors are listed below in acknowledgement of my gratitude.

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Homeowners, Defective Houses and Big Builders: Justice Is Not Blind


I received the following account from reader Jordan in Texas:

"My house is once again in foreclosure. I think this is the third time. We were not subprimes but could not afford the astronomical repairs my house needed--over $150,000. They cover up and dump these houses... especially on relocation people because they do not know about these properties. This is the fourth largest builder in the Houston. He has a foreclosure rate on his condos on Yupon of 50% and my subdivision Hyde park is next with about 25%.

Some of them never even received the certificates of compliance and the city is afraid to mess with them. Permits were never completed on many. A lady will be here tomorrow that has the names of 30 more houses all by my builder and protected by arbitration and the hands off policy of this city. The big builders are the worst offenders.

The arbitration clause has held up though 10 hearings and I have been dragged though arbitration twice and got a ruling of fraud from the American Arbitration Association. I have filed an appeal, in the appeals court. Then, if/or when they turn me down, I will go to the supreme court to make it known how they do things here in Texas.

I have been before two different judges so far. The ruling of fraud would automatically have nullified my contract in any other situation, but the builders are protected here, arbitration is an atrocity it cost 30,000 dollars the last time and that did not include legal fees. The builder filed on me because I would not go away and the judge ordered me to submit to arbitration again. This is one of the most unfair, one-sided things I have ever witnessed. It makes me wonder lately is this really the United States of America?

This is an appalling situation which most Houstonians probably don't know about, or understand until it happens to them."


If you think this is an unusual situation, please visit the Homeowners Against Defective Dwellings website.

Let's start out by noting that I am not an attorney nor am I familiar with the relevant laws in Texas, so my comments will be in the contexts of other similar cases described on the HADD website, and my personal experience as a builder.

Back in my late 20s and early 30s, My partner and I built (not developed, just built) a 42-unit subdivision, dozens of modest FHA-financed starter homes, a retail/restaurant commercial project, and several million-dollar+ super-custom homes--about 100 homes in all. It is thus fair to say I have quite a bit of experience with construction-related law. We were sued once for defective construction (a leaky roof) and settled for $50,000, which at the time exceeded the construction cost of the entire dwelling. It was our mistake. We tried several times to repair the leaky roof but should have replaced the entire roof after the first repair.

Although it sounds like an excuse to a homeowner, we were simply overwhelmed with work, and sending out a roofer to do the repair seemed like an adequate response.

But the experience was less than satisfactory for the homeowner, too. Our attorney (an older, very experienced lawyer who took on the lousy case just to help us) told us afterward that their faces fell when their attorneys told them the settlement didn't even cover their legal fees. (They had chosen to be represented by a big multi-name "high-powered" legal firm).

Would arbitration have possible settled this case to everyone's advantage? Perhaps. Perhaps instead of generating $60,000 in legal fees (again, exceeding the construction contract) and not getting the roof replaced (it was a high-wind, 80-inches of rain a year environment), maybe we would have agreed to pay $5,000 for a new roof and $5,000 for the arbitration and the problem would have been resolved to everyone's benefit.

But what happens when the builder refuses to fix the problem? Then going to court is the homeowner's only remaining option. But what if you signed away your right to sue?

Here is my take as a small builder: if a small builder claimed a house was completed and ready for occupancy without obtaining the proper certification/sign-off from the municipality (final building inspection approval or a certificate of occupancy), then that failure would undoubtedly void any "binding arbitration" clause in the contract. Ditto for any other failure to comply with the contract, and ditto with fraud--for example, telling the homeowner the house had been approved by the city when in fact it had not.

According to Jordan's account, and others on the HADD site, there are clearly two sets of laws: one for small builders, and one for big home builders. Some are more equal than others, as Orwell would say.

Where are the cities? Unfortunately, many are hiding under rocks, cringing in fear that they too will be sued/found liable. As a free-lance journalist, I started researching this topic here in California. I found that the topic terrified newspaper editors and city staff. The editor I pitched the story to trotted out a lecture on sourcing (this, after I'd written dozens of well-sourced feature stories for the paper), and the city staff whom I'd worked with before handled my request for data very gingerly: he referred me to another official who told me the city doesn't keep data on construction defect cases in the city.

Smart move: if there's no data, then maybe nobody will notice, eh? Given that the story paid a miserly $500 fee, and its sprawling, quick-hide-the-evidence difficulty in sourcing its many threads, I set it aside as financially impossible to pursue.

(SIDE NOTE: This is why there is no substitute for in-depth investigative reporting--but that costs a lot of money. To do an adequate investigation of this story in any one state or region would take at least three months full-time, which would cost about $15,000 in wages and overhead for a journalist. Now if your newspaper is pulling in a significant share of its advertising revenues from the real estate and home building industries, how far are you going to push this story?)

Based on my experience, I think we can safely predict that defective construction and the gross violations of consumer/homeowner rights by big builders and frightened municipalities (it's hard to sue a city and win, by the way) will only grow as a national issue as the housing bubble bursts.

If you follow the legal threads to the possibility of huge settlements and consumer backlash, it also seems likely that some major builders will eventually lose cases of such magnitude that they will immediately seek the solace of bankruptcy. We might also speculate that at some point, a city somewhere will actually be found liable for skimming over construction defects passed/ignored by the departments charged with protecting the safety of the public, and then similar legal claims will be unleashed on other cities.

Has justice been served in reader Jordan's case? Not if he was sold a house with significant defects which the builder refuses to fix, and not if the city failed to catch the defects during the construction process due to lax/non-existent inspections. In this situation, justice isn't blind--the blindfold is off, and she's grinding the fingers of the homeowner hanging off a cliff edge, hoping he/she falls to oblivion without a sound.

If you're interested in this topic, you might find some value in these previous entries:

Construction Defects: The Flood to Come? (June 1, 2006)

Construction Defects, The Flood to Come, Part II (June 3, 2006)

Thank you, Merrill P., ($25) for your generous donation to this humble site, and for your valiant service to this nation. I am greatly honored by your encouragement and readership. All contributors are listed below in acknowledgement of my gratitude.

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This Week's Theme: The Rot Within

A New Inflation Index


Astute reader Michael M. recently wrote:

"I would love to see you dedicate an essay to core inflation. how is it calculated? who calculates it? what are the relationships between who calculates it or determines the how and the people who use it for their own economic purposes and even a history of the number."

Inflation is a key element in the pervasive campaign to confuse and mislead the U.S. citizenry about the realities of their economy, so it remains a topic worth revisiting.

The first stop in understanding "real inflation" should be John Williams' Shadow Government Statistics Analysis Behind and Beyond Government Economic Reporting. To find out more about the government's statistics, a good first step is the Bureau of Labor Statistics.

Before we dig into bogus government-measured inflation, I would like to launch a new inflation index. In honor of longtime reader/contributor and musician/instrument-maker Bill Murath, I hereby constitute The Grateful Dead Inflation Index.




My research led me to vintage concert posters, circa the late 60s. I found that 40 years ago in 1967, you could attend a Grateful Dead concert in San Francisco (with several other bands playing as well) for $3 on Friday night, and $2 on Sunday evening. Tickets could be purchases at Rexall Drug Store in Marin, Macy's department store in San Francisco or a record/music store in Berkeley.

According to the BLS inflation calculator (found on the BLS page above), that $3 ticket equals $18.70 in today's (debased) dollars, and the $2 ticket works out to be $12.50. Here is the question: can you go to a Phil Lesh and Friends concert, ot indeed, any top-name rock/pop/hip-hop band for $12.50 or $18.70? Last time I checked, $12.50 was roughly what Ticketmaster charges for handling the purchase and delivery of your ticket.

Phil Lesh's band is currently touring, and the tickets are reasonable by today's standards: $55 each. Add the rip-off Ticketmaster fee and parking, and you're up around $75 each: a far cry from the price "official inflation" should dictate: less than $20.

OK, so you say the GD is not a good measure. Fine, let's move on the Strolling Bones, a.k.a. The Rolling Stones, rock-n-roll's most enduring stadium-rock franchise. At the top of their game in 1969, it cost $4.50 for a regular seat in the stadium and $6.50 for the best seats in the house to see The Stones live.

The best seat in the house in today's money: $36.89. Can you go to a Stones concert nowadays for less than $100? Dream on. OK, so the shows today have more props and pizzazz. Fine--but does all that staging triple the cost? If so, why?

And you can be sure that Rexall Drugs in Marin didn't charge you the equivalent of $12.50 to issue you a ticket, either.

The point is: official inflation calculations are woefully inadequate in assessing "real life" declines in the dollar's purchasing power. By the Grateful Dead Inflation Index, our purchasing power has dropped by 2/3 more than "official" inflation suggests.

Apologists like to point out that jeans and athletic shoes are now much cheaper than they were in 1969, and that PCs weren't even invented, etc. True. So the $50 I spend on jeans and shoes a year used to cost, say $150. Whoopie. But the GDII (Grateful Dead Inflation Index) cuts through the malarky and double-speak canards to reach the ugly truth: most things more now--a lot more.

The key bit of double-speak is the "core rate of inflation," i.e. inflation minus the essentials of food and energy. This blatant manipulation dates from the Nixon era, when government officials were desperate to hide the rising inflation of the early 70s. They hit upon the card-trick of "core inflation" to distract people from the realities hitting them in the face at the gas pump and supermarket.

Incredibly, the American media and public bought the lie hook, line and sinker, and continue to do so today.

Why Inflation Appears Low (June 2005)

Inflation and Housing: Calculating the Bust (May 25, 2006)

The Housing - Inflation Connection (April 25, 2006)

Here is an excerpt from the last entry:

One little-understood result of the housing bubble is its massive distortion of the Consumer Price Index, i.e. the rate of inflation. Why is this important? Let's start with an example.

Let's say Joe and Suzie Citizen bought a house in 2004 which they'd previously rented for $1,500 a month. Their monthly mortgage, insurance and property taxes total $2,500. The effect on the CPI of the extra $1,000 a month? $0

Let's say Suzie's folks' house just got re-appraised, and thanks to the housing bubble, their property tax bill is 40% higher--about a $1,000 more a year. (If you think this sounds high, think again). The effect of this higher property tax payment on the CPI? $0.

Let's say Joe and Suzie's neighbor was one of the 25% of buyers who bought their house with an exotic "interest-only," low-interest rate mortgage back in 2003. His annual mortgage rate has just been reset from 4.5% to 7.5%, causing his mortgage payment to rise by over $1,000 a month. The effect on the CPI of the extra $1,000 a month? $0

Wait a minute. You mean these huge rises in housing expenses have zero effect on inflation? How is that possible? As Alan Abelson explained in a May 30, 2005 Barron's column:

Shelter, you see, which accounts for about 30% of the core CPI is measured not by the dictates of the marketplace, how much houses actually fetch when they're sold, but by a strange -- make that perverse -- yardstick called owners' equivalent rent. Homeowners are asked how much they think they could get were they to rent their abodes.

The result, as Tony Crescenzi, chief bond market strategist for Miller Tabak, deftly puts it, is that "surging housing is suppressing the CPI." Rental income, he reports, has fallen to $147.8 billion, from the peak of $186.6 billion back in April 2002. "This weak pricing pressure in the rental market," he comments, "is weighing upon the owners' equivalent rent portion of the CPI" and, we might add, providing a distinctly distorted picture of what's happening in housing and inflation as a whole.

In one important sense, money is a commodity like any other. The cost of money --that is, the cost of borrowing money--rises and falls, just like the costs of other commodities. When the cost drops--when interest rates fall--then that has a deflationary effect on the CPI. You get the same good or service for less money. Conversely, when interest rates rise--as they are now--then they have an inflationary effect. You're paying more for the exact same service/good--in this case, your house.

But in the current CPI calculation, the actual costs for 70% of the population--homeowners--is completely ignored in favor of "market rate" rents. Here are the numbers used to figure the CPI (taken from the Bureau of Labor Statistics abstract titled why inflation as stated in CPI doesn't match your reality:)

Expenditure category
---------------------------------
Food and beverages 15.7
Housing 40.9
Apparel 4.4
Transportation 17.1
Medical care 5.8
Recreation 6.0
Education/communication 5.8
Other goods & services 4.3
---------------------------------
Total, all items 100.0

The BLS website provides this detailed explanation of the housing component of CPI: rent and owner's equivalent rent. Basically, the BLS says that rents are far more stable a measure than mortgage rates, which rise and fall to a much greater degree than rents. While this makes sense, it ignores the fact that only 30% of the citizenry rent, and that most of those renters are in the lower income brackets. Most renters simply cannot afford to buy a house; as a consequence, rents can only rise as fast as renters' incomes-- and as noted here and elsewhere, income for American workers has been flat for the past 5 years.

For more on the 34 million renters in the U.S., please read this report by Joint Center for Housing Studies of Harvard University: America's Rental Housing.(Note: this is a large PDF file which may take some time to load if you have a dialup Internet connection.)

The report notes that 3 million units of rental housing were constructed from 1993-2003, even as the number of renters held steady at 34 million. In other words, homeownership increased, and the supply of rental housing exceeds the demand--the classic formula for keeping rents low.

As you can see, Abelson underestimated the role of housing in the CPI--it's actually over 40%. (To find the official rate of inflation for any year or series of years, go to the BLS website and select the "inflation calculator" in the upper left heading.)

So what does all this mean in the real world? Just this: the official inflation rate of about 2.5% per year has grossly miscalculated the true costs of the nation's housing. As house values leapt above their historic ratio to rents, as property taxes have skyrocketed, as mortgage rates are rising, as mortgage resets dramatically raise millions of household's expenses--the CPI reflects nothing but rents which are depressed by massive overbuilding.

Here is an CNN/Money article on the issue: Double jeopardy for landlords; "Slowing housing prices and a stagnant rental market have landlords squeezed from both sides."

But despite this gross mis-reporting of actual housing expenses, inflation is beginning to rise--with enormous consequences for the U.S. economy and the housing market.

Why? Because we depend on foreigners to buy our Treasury bonds and the trillions of dollars of mortgage-backed securities which have enabled low mortgage rates. Once inflation is perceived as being 5% (never mind it's probably 6-7%), who in their right mind would buy a mortgage-backed security paying 6%?

And we all know what's been propping up the bubble--low interest rates. Though most home buyers are unaware of it, their mortgage rate isn't set by the Federal Reserve--it's set by the bond market. And once the bond market grasps that the actual rate of inflation far exceeds the official rate, then mortgage rates will rise. How high? Historically, bond buyers expect at least 2% above inflation, though 3 or 4% is typical. If inflation is actually running at 6%, then a mortgage rate of 10% would be well within historical norms.

For more on inflation-related articles, use the search box in the right sidebar, or type "inflation + oftwominds.com" in your favorite search engine. There are lots of other distortions in the inflation calculation; are your medical expenses only 5% of your expenses? If so, then you're not self-employed, uninsured or ill. The list of other distortions is long enough to fill a book. The question we should ask is: why is the calculation distorted to reduce actual inflation to a much lower number? Who beenfits from such manipulation? Who suffers?

The answers reveal much about the political and financial realities which are so deviously and purposefully masked by "offical" statistics.

For more charts, please go to my main site http://www.oftwominds.com/ .

Thank you, Katherine H., ($25) for your much-valued donation via check to this humble site, which probably shares many readers of your own excellent blog. I am greatly honored by your encouragement and readership. All contributors are listed below in acknowledgement of my gratitude.

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This Week's Theme: The Rot Within

Surprise Air Attack Destroys Syrian Nuke Site


Did your local newspaper banner this headline? If not, why not?

Here is the newspaper of record's report (New York Times): Israeli Nuclear Suspicions Linked to Raid in Syria:

The Sept. 6 attack by Israeli warplanes inside Syria struck what Israeli intelligence believes was a nuclear-related facility that North Korea was helping to equip, according to current and former American and Israeli officials.

The Sept. 6 strike was carried out several days after a ship with North Korean cargo tracked by Israeli intelligence docked in a Syrian port, according to the current and former officials. The cargo was transferred to the site that Israel later attacked, the officials said. It is unclear exactly what the shipment contained. A former top American official said the Israelis had monitored the site for some time before the ship arrived. The ship’s arrival in Syria before the raid was first reported Saturday by The Washington Post.

Here is a "This is all hysteria planted by politically motivated intelligence operatives" take on the story: Did Israel Strike a Syrian Nuclear Facility?

And here is a "this is a message to Iran" story: : Ex-UN envoy: IAF action in Syria is 'message to Iran' over nukes

Former United Nations ambassador John Bolton said Sunday that Israel's reported military operation inside Syria earlier this month should be regarded as a 'clear message to Iran' that its nuclear efforts will not be ignored by the international community.

Meanwhile, the generally pacifist French government is rattling sabers: Sarkozy: Iran trying to have nuke bomb:

President Nicolas Sarkozy on Thursday directly accused Tehran of seeking to develop atomic weapons but insisted that France did not want a war with Iran over its nuclear program.

"Iran is trying to obtain an atomic bomb," Sarkozy charged. "That is unacceptable and I tell the French people it is unacceptable."

The Iranian nuclear question "is an extremely difficult affair, but France does not want a war," he said in a prime-time interview on TF1 and France 2 television.

Sarkozy distanced himself from remarks by French Foreign Minister Bernard Kouchner, who caused a diplomatic storm in an interview Sunday when he said "we have to prepare for the worst, and the worst is war."

My point here: why is literally none of this on the front page of my regional newspapers-- or yours? Wouldn't you call an air attack an act of war, and the destruction of nuclear facilities of some importance? Isn't it worthy of serious, sustained coverage?

More to the point: how would this headline effect global and U.S. financial markets? Do you reckon global markets would cheer open warfare in the Mideast, and the high likelihood of disruptions in the flow of petroleum from the Gulf? Would the current euphoria in the U.S. stock market falter?

Isn't it rather curious that these major events have attracted so little attention in the Mainstream Media? Why? Could it be that the media is so wedded to the financial status quo that any "news" which threatens that status quo is relegated to "not news"?

This gaping void proves that the media is highly selective in its emphasis and coverage--and lends support to the idea that any story which threatens the financial status quo is suppressed, dismissed or buried.

Setting aside any bias in this story, we can ask some glaringly obvious questions:


Why would Israel openly attack Syria, going up against a modern air defense system?


Why would Syria do nothing after being openly attacked but issue a bland press release?


Why are North Koreans in Syria, and what was shipped from a poverty-stricken pariah state halfway around the world and trucked to a remote desert site in Syria?


Despite a formidable Russian-supplied air defense system, why couldn't Syria shoot down any of the attacking aircraft? It seems safe to assume that they would have shot down the attackers if they could.


Why would the generally pacifist French choose this month to issue a warning to Iran?


Are there are useful lessons to be drawn from this attack vis a vis Iran's blatant nuclear ambitions and the potential threat such weapons pose to Israel?


Would open warfare in the Mideast have any discernable effect on oil supplies, inventories and prices?

These are just a few obvious questions from an amateur's perspective. Why isn't the MSM asking the same, or even more incisive, questions, and attempting some answers?

Since no one else seems to be offering much analysis, allow me to step into the breach with a very basic bit of data: a map of iran's oil facilities:



One needn't be a military analyst to note a few things of interest here.

1. Count the major pipelines carrying oil and gas. There are perhaps a dozen major pipelines--not many for such a large oil-producing nation. And it sure looks like they snake through some barren/unpopulated stretches of the country. Once the air defense system was suppressed/destroyed/compromised/degraded, how hard would it be to bomb every major pipeline in several places?

2. There appears to be only seven major refineries.

3. There appears to be only five tanker port facilities.

4. There appears to be no more than two dozen major petroleum chokepoints within the complex, in addition to the ones mentioned above. These critical facilities mostly lie at some distance from cities, suggesting that civilian casualties would be very low were the targets hit with guided munitions.

5. Adding these up, we observe that hitting 50 targets would essentially cripple Iran's entire petroleum complex. It's impossible not to notice this extremely limited number of major targets.

While it can be assumed Iran has gone to extraordinary lengths to hide its nuclear facilities, it can be surmised that these are also few in number.

It can also be surmised that even if an attacking force had no clue where the nuclear facilities were located, the oil-producing facilities are all above ground and easily targeted. Once the petroleum complex is essentially destroyed, then Iran's nuclear ambitions will be put on the back burner due to the lack of electricity, gasoline, oil--and cash.

We can also surmise that the attacking force understands that global oil prices will undoubtedly skyrocket in the wake of an attack which cripples 2 - 3 million barrels a day of production, and is willing to pay the higher prices such an attack would inevitably cause.

If the target was the destruction of Iran's petroleum producing and refining capacity, there is no need to invade with ground forces; the destruction could be accomplished in a short time span with a relatively limited number of aircraft sorties.

Why am I even discussing Iran's petroleum producing complex? Because it is extraordinarily vulnerable to a coordinated air attack which degrades air defenses and deploys guided munitions. There is no need to for "shock and awe"--just a steady erosion of Iranian air defense, after which the oil complex could be methodically destroyed.

Who might cheer the destruction of Shit'ite Iran's oil production? Sunni oil producers? Or perhaps any nation poised to reap immense profits from the sudden jump in oil prices?

All of this is just an amateur's first glance at a story and a simple map. But shouldn't we be reading in-depth analysis in our daily papers, and watching some reporting on these vital issues on TV? And if we aren't seeing these issues examined on the front page, we have to ask: why not? Who gains from the public's ignorance and complacency?


Thank you, Dave.S., ($60) for your most-appreciated donation via check to this humble site, which probably shares many readers of your own excellent blog. I am greatly honored by your encouragement and readership. All contributors are listed below in acknowledgement of my gratitude.

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This Week's Theme: The Rot Within

1984 + 23 = 2007


George Orwell's classic depiction of totalitarian control of a cowered populace, 1984 , needs to be updated. Today's U.S. government and its various agencies have no need to be so heavy-handed.

For instance, to coerce the population to accept their financial self-destruction, just convince them inflation doesn't exist, even as prices in the real world spiral ever-higher and their currency plummets to record lows against gold and other currencies.

This is essentially the whole control game in a nutshell: if you can enrich and extend the power of the Overlords while convincing the citizenry that their impoverishment and debt-serfdom results from their own personal failures, you have effectively instituted a subtle but brilliantly effective mind control.

Do you think I exaggerate for polemic purposes? Then consider the facts. Yesterday and today we are treated to official U.S. Government statistics which reveal that energy and food prices plummeted on both the wholesale and retail levels, while so-called "core inflation" (read: "some prices are more equal than others") checked in at a negligible 2.1% a year.

Meanwhile, in the real world, dairy goods have almost doubled in one year, food inflation is running 10% everywhere from China to the Mideast to your local supermarket, energy has quadrupled in a few years, tuition and medical insurance have leaped 10%+ a year and everything from water to local taxes to shipping has zoomed up in double-digit numbers.

Doesn't it strike you as odd that everything has leaped in price yet officially inflation is a barely-registering 2%?

Frequent contributor U. Doran sent in this chart-filled depiction of rip-roaring agricultural inflation by Gary Dorsch (SirChartsAlot): Beware - the Bernanke Fed could Ignite Hyper-Inflation!

He also recommended this extremely troubling explanation of how inflation coupled with our highly progressive tax rates could enable huge transfers of whatever wealth might remain in middle-class hands to the government:

SEIZING YOUR ASSETS TO COVER RETIREMENT PROMISES: How the Government May Do It .

Here's how it would work: your $100,000 in taxable assets grows to $1 million via rampant inflation even as its purchasing power declines as measured in gold, oil or other tangibles. You then sell the asset to live, and voila, you owe tax on $900,000 of entirely fictitious "gain." Once that pesky long-term capital gains tax is abolished, then 50% of your wealth--in terms of purchasing power, actually a lower value than it once was--is grabbed by the government as "gain."

(Note: I added 10% to the Federal tax rate of 40% for the Great Greedy oops I mean Golden State of California. Your local tax pit might be somewhat less egregiously greedy.)

If this isn't Orwellian, then please tell me what is.

And lest you think your supposedly rising stock investments (dollars) have not already shrunk mightily in the past few years, cosider this chart courtesy of Sir Charts Alot (Gary Dorsch):



Readers of the book (1984) will recall that permanent war is an essential feature of the government's control: to install fear, loyalty via patriotism, and the sense of endangerment/ being surrounded by enemies--all mind-control techniques brilliantly exploited by Hitler.

Hey, have you ever heard of a place called Iraq?

You know, that desert hotspot where our government has fielded a shadow army of 180,000 well-paid workers and mercenaries in addition to the regular Army, Navy and the Marines. Yeah, that place--the one with dozens of permanent U.S. bases scattered around the landscape. It's all part of "The Long War," the cool new modern moniker for Permanent War.

And where do all these SIVs, CDOs, MBS and other financial "innovations"--all the financial legerdemain at the heart of the global shift of assets into derivatives and instruments which can no longer even be priced--where did it all originate? That globe-striding House of Mirrors, the U.S.A.

Correspondent Riley T., who retired from a career in accounting, offers this comment on the Fed rate cut.

"I continue to feel that I have a very good fundamental understanding of accounting and finance. Companies that I was Corporate Controller and V.P. Finance of did very well and we had a good understanding of our business.

This rate cut by Bernanke is absolutely nuts. ( MBA term )

I actually don't seem to be able to express how nuts I actually think this is. Could it be a psychological mind set that Americans don't have to experience any pain or even discomfort? We as a nation, have we become hysterical, is Cramer a computer generated copy of the American mind?

The idea that America will continue to reduce interest rates instead of reducing our debts should drive every foreigner out of dollar denominated assets. I think we are seeing a total breaking of faith that holds the world's financial system in place.

Having a good accounting and finance back ground is an incredible handicap in understanding what these people are up to.

What the hell is going on?"

Perhaps what's going on is a new level of contextual and financial gamemanship. Wall Street cheered the rate cut, and so did the press. Why?

Did it lower mortgage re-sets? No--those are set to the LIBOR (London market rate) which the Fed doesn't control.

Did it bolster the key underpinning of our national wealth, our currency? No--it weakened it.

Did it encourage foreign investors to invest their money in the U.S.? No--it drove them away, with potentially catastrophic results.

New contributor Jim S. sent in this important story Fears of dollar collapse as Saudis take fright.

"Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East."
And Saudi Arabia isn't the only holder of massive U.S. dollar assets who may bolt:

China threatens 'nuclear option' of dollar sales:

"Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress.

Shifts in Chinese policy are often announced through key think tanks and academies.

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels.

It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds over $900bn in a mix of US bonds."

Welcome to the new improved 1984, called 2007, where reality is masked by double-speak and bogus accounting at every level of the power structure.

When will the embattled middle-class catch on to the con? They won't, because they'll be too busy trying to pay their debt bills, their stripped-to-nothing medical insurance, their medications to maintain a zombie-like acceptance of the lies, and their cable TV to see the "reality shows" and other entertainments (i.e. Roman Coliseum spectaculars) which fill every nook and cranny of their visual and auditory world.


Thank you, Dr. Housing Bubble, ($5) for your donation to this humble site, which probably shares many readers of your own excellent blog. I am greatly honored by your encouragement and readership. All contributors are listed below in acknowledgement of my gratitude.

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Something Has Changed

Frequent contributor Protagoras filed this report from the U.K. on the Northern Rock bank run.


"Well, it is really strange to wake up in the morning in what is apparently the same country one has always lived in, turn on the TV while one sips gingerly at some sweet, strong black coffee....and....what is this?

This looks like pictures of a whole bunch of people standing in line in some ordinary English town. Here is another town apparently, and they are standing in line here too. Here they are in a third. This one seems to be Kingston on Thames. I know Kingston, been through there many times. A very nice restaurant there with lovely views.

I wonder what they are doing. The sound is off, because it is after all very early. In fact, its 6 or 7am. What can all those people be doing at 6 in the morning, lining up on the streets? Of Kingston no less.

Wait a minute. Here is the Chancellor of the Exchequer. We had best turn up the sound. Aha. The Chancellor, a white haired well spoken Scotsman is telling us that our savings are safe in a bank called the Northern Rock, and that Gordon Brown was an excellent Chancellor before he recently became Prime Minister. And what is still more alarming, he is telling us that the British economy is sound. My goodness, has the soundness of the economy become an issue overnight?.

It seems that the Northern Rock has deposits of about 25 billion sterling, and of those about 2 billion were withdrawn on Friday and Saturday, and more look like they are going to be withdrawn today, as soon as those people who are standing in line can actually get into the branches. My goodness, if the Chancellor is telling us its safe, it must be serious. We cannot remember ever seeing people standing in line for a run on the bank in England. Our parents used to talk about such things, it seems to have happened in the thirties. In a different, a black and white country, where men in cloth caps and baggy trousers stood in line, first to take out their money, and then later for cups of soup.

We take a good draught of coffee and head over to the computer. Lets find out about Northern Rock. Well, back in the winter it seems to have traded at around 1300, but from what we see here, it last traded around 400. A few hours later it is under 300. Should we buy some, if it so sound that the Chancellor is not afraid to associate his name with it? Well, we look at the charts, and frankly, we do not have much of a head for heights. These kinds of falls are alarming to us. It looks like a straight line drop into the ravine, with a couple of bounces along the way. No, no, I don't think we will buy any just yet.

We check out some of the other banks who, like Northern, are heavily into mortgages. Yes, they too are dropping like the proverbial stones.

Its a warm, sunny day. Its time for a boiled egg and toast, or maybe a little porage. Time to mow the lawn, plant a few bulbs for the spring. We feel however a slight chill, and its not from the air. Later we go into town. The streets seem busy, people are buying all kinds of useless trinkets, and maybe some useful ones too. The masonry of the supermarket, or rather, the prefab plasterboard over extruded metal, seems as solid as ever.

Why do we have the feeling that everything has changed, and that we will remember this day, where we were when the scale of the Northern Rock debacle became apparent, for a very long time?" (emphasis added--CHS)

Longtime contributor J.F.B. sent in this video of the bank run with this wry comment: "After seeing this video I am sure Europeans will be eager to buy any further debt offered by our Private Equity firms."

Let's hope they aren't that foolish....

Frequent contributor U. Doran sent in a scathing article which highlights how all the major investment banks were issuing "buy" and "overweight" recommendations on Northern Rock even as it slid down the slippery slope: Northern Rock Bust on Broker Recommendations

Correspondent Albert T. sent in links to BBC stories on the meltdown:

Market fears hit lender's shares
UK mortgage lenders are suffering from the money market crisis Shares in UK buy-to-let mortgage lender Paragon Group slumped as much as 26% as fears deepened over the ability of banks to finance their loans.

What if Northern Rock goes bust?
Customers have been forming queues at Northern Rock branches The news that the Northern Rock needs to be helped out by the Bank of England will have come as a shock to most customers.

Here is my two pence on the meaning of the Northern Rock run. Though some pundits are tsk-tsking that foolish people are following the herd in a foolish stampede, they are missing the real point: people no longer believe The Big Lie (everything is fine) or the authorities' increasingly threadbare reassurances.

Markets require confidence in the basic rules. If you have no confidence in the institutions, the rules supposedly in place or the authorities who are supposedly enforcing the rules to protect the participants--then you no longer have a market.

The depositors withdrawing their money aren't lemmings; they're trying not to be the ones sent over the cliff by slick authorities trying to prop up their banking pals who have been reaping billions.



And it may not just be depositors who no longer believe the hype, but investors, too. New correspondent Johan made these comments about the huge losses being suffered in Europe by investors who believed U.S. investment bankers' glib assurances that the subprime garbage they packaged and dumped on trusting institutions was "low-risk":


"I am from Germany, been here in San Francisco for 43 years, and still speak to my countrymen and relatives in the Fatherland on a weekly basis. They are all very upset at what the USA has done, sold them a worthless bill of goods!! They are all losing a ton of money...and hate it!!"

And with good reason. When you buy a risky stock or bond, that's one thing. You are risking capital to earn a higher return, knowing full well that you may lose some or all of your capital to do so. But what the U.S. investment bankers have done is present risky investments as low-risk--essentially lied about the true risks.

Will non-U.S. investors finally wake up from their trusting slumber and refuse to buy any more U.S. debt or derivatives? We can only hope so.


Thank you, Nancy N., ($25) for your very generous donation to this humble site. I am greatly honored by your encouragement and readership. All contributors are listed below in acknowledgement of my gratitude.

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This Week's Theme: The Rot Within

The Closing of the U.S. Home ATM Dooms the Global Economy


One of the cliches which is repeated ad nauseum in the Mainstream Media is that the global economy is so red-hot that it will lift the U.S. out of recession. I wonder if they have the cart pulling the horse.

Here's the basic idea: right now the U.S. buys about $750 billion more from the rest of the world than we export (sell) in goods and services. But if the U.S. slips into recession (as if there is any doubt of that happening), then the U.S. will be "saved" by rising exports as our big trading partners (China, the E.U., Japan, Mexico and Canada) buy more American goods and services.

Nice idea, but the last time I looked, the cart was not pulling the horse. Simply put: the global economy is red-hot largely because the U.S. consumer extracted a staggering sum (conservatively $6.6 Trillion) from their ballooning home equity, and promptly spent it-- much of it on imports.




Note that the GDP figures are from the CIA Factbook, which calculates GDP on Purchasing Power Parity-PPP.

When an American homeowner buys $1,000 worth of electronics and other gew-gaws made in Asia, the money generates economic activity far in excess of the initial $1,000. The U.S. retailer and wholesaler scrape off their slice, which pays the wages for their staff, who go out and spend their wages on other goods and services; this cycle is of course repeated in Asia as well. Though the multiplier is inexact, 2.5 is a number often bandied about as semi-accurate.

That means the U.S. home ATM (home equity extracted and spent) generated a stupendous $16.5 Trillion in economic activity--a number which dwarfs even the largest GDPs. Now to be clear: that $16 Trillion wasn't all spent on non-U.S. goods, and it was spent over the past seven years of (debt-based) "prosperity," not all in one year.

Nonetheless, the sheer scale of home-equity-based spending is almost beyond grasp. Recall that the U.S, the largest economy on Earth, exports about $1 Trillion in goods and services a year. That means that the total economic value generated by the torrid equity-extraction boom is larger than 15 years of U.S. exports.

Just for comparison's sake, recall that the trade deficit with China that everyone is focused on is about $225 billion a year. That is less than 1/30 the sum extracted and spent by U.S. homeowners in seven short years.

We can quibble about exactly how much money flowed from the U.S. home equity ATM to our trading partners, but the sums are so large it doesn't really change my point: the closing of the U.S. home ATM will have a large, very negative impact on the economic activity of our trading partners, whose own "booms" have been fueled by trillions in exports to the U.S.

And where did Americans get all those trillions to spend so lavishly? The home equity ATM. Now that it's closed-- (see The Home ATM (a.k.a. Equity Extraction) Is Broken for more details)--can anyone seriously claim that will have no impact on our trading partners?

Recall, too, that the U.S. savings rate is negative (we spend more than we earn) and that wage growth has been essentially flat for those seven years. So the idea that U.S. consumers just found the $7 Trillion somewhere other than their homes--in their sofas or cookie jars?-- is beyond ludicrous.

Yes, the Chinese wage earner has money in his/her pocket--but that didn't flow from goods sold to other Chinese--it flowed from exports. Many observers note that the E.U. is now a larger market for China than the U.S., but again, the point is not that the U.S. is the only game in town, just that it is 20% of the global GDP and therefore a large market. If exports to the U.S. drop, say $250 billion, can China sell the E.U. $250 billion more in goods? No way. And since prices are set on the margins, losing a huge chunk of sales to the U.S. will negatively impact every exporting nation.

The multiplier works when spending drops, too; as the U.S. consumer stops spending so freely, then the reduction in economic activity isn't 1 for 1--it's 2.5 for 1.

Will the end of the U.S. home equity ATM have an impact on our trading partners? The answer is rather obviously a resounding yes.


Thank you, Nelson I., ($25) for your much-appreciated donation to this humble site. I am greatly honored by your encouragement and readership. All contributors are listed below in acknowledgement of my gratitude.

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This Week's Theme: The Rot Within

Alternative: We Are The Frog in the Pot


Regarding the alternative title for this week's theme: It has long been my thesis here that the issues we face are not just "business/problems as usual," but far deeper, far more profound systemic failures which have no ready/easy solutions.

The "we are the boiled-frog" theme comes from the story of the frog placed in a pot of tepid water over a low flame. Though the water temperature is rising constantly, it is warming at such a slow rate that the frog doesn't notice how hot the water has become until it is already par-boiled/doomed.

We as a society and as an economy are the frog in the pot, finally noticing the bubbles of near-boiling water forming beneath our feet.

In no particular order, here is my short listing of The Rot Within, systemic sources of rot which have eroded the entire structure of our society and economy to the point of structural failure. I will be exploring these issues in upcoming entries.

1. Infrastructure: broken. Air traffic control system: broken. 160,000 bridges: obsolete, defective, or worse. Sewage systems: 100 years old, crumbling. Here in the Bay Area, it has taken nearly 20 years to replace a damaged span of the Bay Bridge. The cost has of course spiraled out of control since the 1989 earthquake did the damage. Is this any way to maintain critical infrastructure?

2. Legal system: broken. Big homebuilders hide defects galore behind "binding arbitration" clauses, bankruptcy favors the banks which continue offering credit to the uncreditworthy, consumer protection is under assault, public health and safety agencies are grossly underfunded, and yet we have $400 billion/year to throw away on mostly useless MRI scans and medical procedures that don't work, out of fear that a malpractice suit could be won over lack of sufficient testing.

But if the front fork of your kid's bicycle snaps off because it's defectively manufactured by an unknown factory in China, then what are your chances of winning a product-defect suit against the retailer, Wal-Mart, or the shadowy manufacturer? Zero to none.

Yes, we live in a legal system based on advocacy and contention. But with one million lawyers and counting, how much of the horrendously costly advocacy ends up becoming a hidden and essentially unproductive tax on productive resources? How much is spent protecting the 300 million citizens and safeguarding the 145 million taxpayers from fraud and waste? Put simply: how much is a huge waste of money? Answer: Most of it. The system is broken.

3. Lobbyists own Washington. An old story, blah blah blah, money is the mother's milk of politics, etc. But how about the fact that there were 11,000 lobbyists in 1997, and now there are 33,000? How about the fact that corporations can "earn" $344 in Federal "earmarks" (i.e. pork-barrel spending) for every $1 "invested" in a lobbyist? Democracy: broken.


4. Deficit spending: broken. As this administration has added trillions in debt onto the backs of future generations, they have the unmitigated gall to trumpet a Federal budget deficit of "only" $177 billion, down from $413 billion a few years ago. But this is based on bubblicious profits (and therefore taxes) flowing from the real estate and stock market bubbles, and includes the slight-of-hand accounting which applies the Social Security surplus to the entire Federal Budget.

Social Security is supposedly a Trust Fund which retains surpluses to be used in years when outlays exceed FICA tax collections. But instead, these massive surpluses are used to offset non-Social Security Federal spending. If you look closely at the budget and projections for Medicare and Social Security entitlements due to rise in the near future, there is only one conclusion: Federal borrowing and spending: broken.

5. Public pensions: broken. As public pension managers flocked to the higher returns offered by hedge funds, CDOs and other "exotic" investments based on derivatives and leverage, they have dug their own graves. Most public pension funds are set to suffer stupendous losses in capital when the entire derivatives/easy-credit/no-risk speculative bubble pops.

6. Government as savior: broken. From the billions wasted on post-Katrina aid (hundreds of empty mobile homes sitting in an empty field), to the bail-outs being proposed for housing bubble gamblers/speculators, it's all about Uncle Sam borrowing hundreds of billions of dollars to bail out private parties.

7. Foreign policy: broken. Fill in the blanks, folks.

8. Energy Policy: broken. We don't have one, except "drill Alaska--that'll give us another month of oil, dammit!" This simple math leads to astounding totals: the U..S. uses 23 million barrels of oil a day. That's 8.4 billion barrels a year. A two-billion barrel field is perhaps 50% recoverable, meaning about 1 billion barrels can be extracted. That 1 billion barrels will cover about 6 weeks of America's oil consumption--but it will take at least a decade to drill, extract, refine and deliver to consumers.

9. Accounting: broken. This week we will witness the big investment banking houses release their earnings reports, and virtually everyone who knows anything knows the reports will be filled with what are essentially self-serving lies: assets which are not fairly priced because they are not required to be marked-to-market by third parties. This is modern-day accounting in the U.S. of A.: off-balance sheet assets, marked-to-model, and various other accounting tricks and obfuscations.

10. Bureaucracies: broken. Medicare: $9,000 CAT scans, a week of "care" costs $100,000, and your elderly parent exits without even being healed. Welcome to Medicare and our "best of the best" medical system. The Pentagon, FEMA, your local school district, your state housing office, your local building department, the list is (in too many places) nearly endless. Yes, there are a few bright spots, but in general: bloated, inefficient, unresponsive, broken.

11. The Media: mostly broken. Celebrity-focused, backward-looking, advertising-dependent, largely in thrall to powerful interests whose chief concern is maintaining the status-quo (i.e. their power).

12. Technology: oversold. Beneath the razz-matazz press releases and the hype, most of the new wonderfully-marketed technology (iPods, smart phones, Web2.0, social networks, etc.) is either unproductive time-sinks (a.k.a. "entertainment"), unreliable, or fundamentally a toy for kids with too much time on their hands.


13. Our "health"-care system (in actuality our sick-care system): broken. Unaffordable now, inevitably metastasizing into an unaffordability which bankrupts the nation.

14.Government statistics: broken. Unemployment stats: lies. Inflation numbers; Lies. Budget numbers: lies. Call them misleading or manipulated if you prefer, but I'll stick to the raw simplicity of calling them knowing lies, carefully engineered to pull the wool over the eyes of a fatuous, want-to-believe-fantasy public and mainstream media.

15. Our health and food consumption: nearly broken. Over a hundred million prescriptions written for psychotropic drugs--hmm, if we're so happy and well-adjusted and spiritually whole, then why are we driven to buy billions of dollars of illegal drugs and pop hundreds of millions of "feel good/fix me" pills? If our healthcare system is so great, and our food so wonderful, why are 2/3 of us obese to point of dangerous consequences, and so many of us unable to sleep well or run around the block even once? If we're so healthy, why do we look like Heck warmed over?

16. The culture: completely broken. Greed, self-absorption, self-as-what-do-I-wear-consume-drive, mega-churches promoting wealth, bakeries for dogs, victimhood as saintliness, I-want-my- 15 seconds-of-fame-now-on-national-TV, entitlements, working 20 years on the public payroll in order to nail down 40 years of fat retirement checks, violence glorified 24/7, hype and marketing-as-reality, Fox and CNBC cheerleading shameless propaganda, "reality" TV--in sum, a culture so twisted, dysfunctional and ill that self-parody has been rendered impossible.

I know I missed many deserving candidates here, but I'm already dismayed/sobered by the length and depth of the list. I have sources for the data mentioned above, and will provide links as I address each topic in more detail.


Thank you, Cudick A., ($50) for your astonishingly generous donation to this humble site. I am greatly honored by your encouragement and readership. All contributors are listed below in acknowledgement of my gratitude.

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