Bill Bonner writes: We told you so! Yes, dear reader, we watch the masters of the universe go downÖwith a fair amount of amusement and even schadenfreude. They claimed to be the smartest people on the planet - and demanded to be paid as if they were. They said they were doing the world a big favor - “allocating capital” so efficiently we would all get rich. And, of course, no one would get richer than they. But who could complain about their billions in bonuses when we were all getting rich?

Now, it turns out, they weren’t so smart, after all. Like all hustlers, they weren’t smart enough to ignore their own lies. They were the ones who packaged up all that subprime debt - mortgage loans on over-priced property to people who couldn’t pay the money back; they knew what was in that “mystery meat.” Then, they got the useful stooges at the rating companies to call it Grade A. And then, they bought it themselves! What were they thinking? Not only that, they bought it on leverage - so that if it went bad, their whole company would go belly up!

And now, mothers no longer want their babies to grow up to be stockbrokers and investment bankers. Now they want them to grow up to be bankruptcy lawyers! That’s where the money is!

But let’s stop gloating and try to figure out what is going onÖ

We are in a deflationary correction. The financial industry made a fortune by flogging debt; now it is taking huge losses because its collateral is going bad, its assets are declining in value and its business is soft.

Merrill Lynch was worth $86 billion in January of 2007. Now, it is selling itself to the Bank of America for $50 billion. Why the sale? Because Merrill is afraid that it could go the way of Lehman Bros. That latter firm was worth $45 billion in February 2007. Now it is worth nothingÖor close to nothing. Shares traded hands yesterday at 29 cents.

Goldman Sachs, meanwhile, is said to be the best firm on the Street. But even it is suffering. It is supposed to announce revenues down 73% for the 3rd quarter. …

But let us return to the big picture. For the last 13 years, the U.S. money supply has been increasing at about 2 times the rate of GDP. This is known, to monetary sticklers, as “inflation.” But the “inflation” that most people think of is the kind you see at the gas pump and supermarket checkout counter. Nobody squawks when the sticklers’ inflation raises house and stock prices. But nobody doesn’t squawk when it raise consumer prices.

The monetary inflation of the last 13 years caused only modest consumer price inflation - for many reasons often described in these daily reckonings. To wit, China was making things cheaper. Wal-Mart was selling them cheaper. And the dollars spent by consumers in America tended to end up in the pockets of investors in Asia and Arabie, not in the U.S. domestic money supply.

But all good things must come to an endÖespecially things that are too good to be true. And now, the great bubble in credit has been popped - and everyone’s squawking. The financial industry is in decline - and will probably not recover in our lifetimes. Inflation has given way to deflation. Just look at what happened to Lehman Bros. Hardly more than a year ago, investors had an asset worth $45 billion. Now they have nothing. What happened to that $45 billion? It disappeared.

In California, the average house has lost about $120,000 (we are just guessing, but probably not far off) in market value. What happened to that $120,000? It disappeared.

The Chinese stock market has disappeared half of investors’ money. The oil market has disappeared nearly a third of producers’ fondest hopes for future revenues. Jobs have disappeared. Sales are disappearing. Growth rates are disappearing. Bonuses have disappeared. And it is happening all over the world. Thanks to a globalized economy, the entire globe gets to suffer a slump. (09/16/08)
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Financial Times – Russian shares suffered their steepest one-day fall in more than a decade on Tuesday, losing up to 20 per cent, as a sharp slide in oil prices and difficult money market conditions triggered a rush to sell.

The heads of the Russian central bank, the finance ministry and the financial market regulator met on Tuesday night for an emergency discussion on ways to halt the crisis.

Earlier, trading had been suspended on both the Micex and RTS stock exchanges as investors ignored assurances by Russian officials and a cycle of distrust set in amid liquidity fears.

Margin calls forced domestic traders to liquidate positions and brokers pulled credit lines. At least one Moscow bank failed to meet payments.

The rouble-denominated Micex Index closed 17.75 per cent down, the sharpest one-day drop since the August 1998 financial crisis, while the dollar-denominated RTS index closed down 11.47 per cent, its lowest lvel since January 2006.

Interbank money market rates climbed to 11 per cent, their highest since a mini-banking crisis in summer 2004.

Chris Weafer, chief strategist at Uralsib investment bank: “We’re in completely uncharted territory where the prevailing emotion is of fear and numbnes. No one knows where this could stop”. …

Andrei Sharonov, managing director of Troika Dialog, a Moscow investment bank, and a former deputy economic minister, said: “This is a vicious circle. It is a situation of total mistrust. The liquidity crisis is being caused by a crisis of confidence in which people are frightened to borrow and frightened to lend.”

Shares in Russia’s biggest state-controlled banks led the slide with Sberbank, the state-controlled savings bank, closing 21.72 per cent down and VTB losing 29.26 per cent. (09/12/08)
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The Oil Drum – The world’s financial markets are in great turmoil. How do we deal with all of this? Let me tell you my view. Yours may differ.

For those of us who are peak oil aware, we know that the world is
finite, so the period of continued compound growth cannot continue.
Because of this, we have known that eventually we would start seeing
turmoil in financial markets. It should be clear that putting our faith
in these markets is crazy, even if this is what financial planners have
told us to do. If we have already divorced ourselves from this faith,
we are ahead of the game.

Looking at the situation from a historical perspective, we have been
privileged to live in the world at a very unusual time–a time when oil
was in abundance, and we were able to have conveniences that people a
few generations ago wouldn’t even have dreamed of. We know that this
must come to an end, and that gradually we will get back to a world
more like it has been over the millions of years that people have
walked the earth.

What is happening now in the financial markets is only a small
increment in the step-down process. We can either focus on the
amazingly good fortune we have had to date, or focus how bad the change
ahead might be. It seems like framing the issue as one of historical
good fortune is a better approach.

We can count our wealth in many ways–the status of our health, our
relationships with our family and friends, the physical provisions we
have made for the future, or the size of our bank accounts.

I think our health is our most important asset. My own view is that
eating the right foods and getting some exercise goes about 85% of the
way toward staying healthy. I eat a huge amount of fruits and
vegetables, a moderate amount of fish, a little wine, very little
processed foods, not much dairy, and very little meat. This diet is
hard to come by in modern-day America. With this diet, it is difficult
to get heart disease and a host of other things that afflict Americans.
Peak oil may actually help with our diet, if we can get enough food. It
will certainly help with exercise.

Family and friends are very important as well. My upbringing was
that no matter what anyone else says or does, it is always important to
immediately forgive. Restraint was also considered a virtue. My parents
were of Norwegian background. A favorite “Ole and Lena” joke is that
Ole once said, “I love my wife so much, I almost told her so.”

Co-operation is another quality that was stressed in my upbringing.
I can remember a lot of “arguments” about who was should do what, but
they were always of the form, “Let me do more, you are doing too much.”I am fortunate that my husband follows the same philosophy. Some of
this may come from belief that “Do unto others as you would them do
unto you” is a good philosophy. (09/16/08)
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Nouriel Roubini writes: Below is a repeat of detailed summary of the reasons for my views (as presented on this forum last month)
that this will turn out to be the worst financial crisis since the
Great Depression and the worst US recession in decades (hyperlinks to
my relevant recent writings are provided for each argument). As I wrote in August:

• This is by far the worst financial crisis since the Great
  Depression, not as severe as the Great Depression but second only to it.

• At the end of the day this financial crisis will imply credit losses of at least $1 trillion and more likely $2 trillion. The financial
  and banking crisis will be severe and last several years leading to a
  severe and persistent liquidity and credit crunch.

• This is not just a subprime mortgage crisis; this is the crisis of an entire subprime financial system:
  losses are spreading from subprime to near prime and prime mortgages
  including hundreds of billions of dollars of home equity loans that are
  worth little; to commercial real estate; to unsecured consumer credit
  (credit cards, student loans, auto loans); to leveraged loans that
  financed reckless debt-laden LBOs; to muni bonds that will go bust as
  hundred of municipalities will go bust; to industrial and commercial
  loans; to corporate bonds whose default rate will jump from close to 0%
  to over 10%; to CDSs where $62 trillion of nominal protection sits on
  top an outstanding stock of only $6 trillion of bonds and where
  counterparty risk – and the collapse of many counterparties – will lead
  to a systemic collapse of this market.

• Hundreds of small banks with massive exposure to real estate (the average small bank has 67% of its assets in real estate) will go bust.
• Dozens of large regional/national banks (a’ la IndyMac) are also effectively insolvent given their extreme exposure to real estate and will also eventually go bust.
  Most of these regional banks – starting with Wachovia and Washington
  Mutual – look like walking zombies in the same way IndyMac was.

• Even some major money center banks are also semi-insolvent and while they are deemed too big to fail their rescue with FDIC money will be extremely costly. … … …

Now that the collapse of Lehman is leading to the risk of the generalized run on the shadow banking system (the other independent broker dealers, the broker dealers that are part of larger commercial banks such as Citi and JPMorgan, hedge funds, private equity funds, the remaining SIVs and conduits, money market funds, other smaller broker dealers) the policy reaction is to try to build a new set of levies while the financial perfect storm of the century has destroyed the first sets of levies. This reaction includes the following steps.

First, the Fed is accepting even more toxic collateral for the TSLF and PDCF, including even equities; so now after having nationalized the mortgage market via the takeover of Fannie and Freddie the government is also starting to manipulate directly the stock market (a step that started with the SEC restrictions on naked short sales of the primary dealers; so the process of turning the US market system in a socialist system controlled by the government is now in full swing. And the Fed takes massive credit and now market risks by its effective purchase of equities.

Second, the Fed is waving Section 23A of the Federal Reserve Act that restricts how much commercial banks can relend liquidity to their investment banking affiliates; these restrictions are sensible prudential rules aimed at avoiding banks to subsidize their broker dealer affiliates with deposit-insured deposit. Now these sensible prudential regulations are thrown to the wind; so Citi, JPMorgan and Bank of America can happily use or raid their FDIC-insured deposit to support their bankrupt broker dealer operations. This is reckless as abuse of this new form of subsidization of near insolvent broker dealers with commercial banking deposits may eventually impair the viability and solvency of their commercial banking regulation. This is a form of connected lending that eventually led to the Japanese financial crisis and their severe banking crisis. This process of raiding FDIC insured deposits already started in 2007 when the Fed waived Regulation W for Citigroup and Bank of America when the unraveling of their toxic SIVs and conduits occurred with the roll-off of the ABCP paper. So, now all banks – not just two – can happily raid their deposits to save their broker dealers operations where funding mostly occurs with unstable reckless overnight repos. This desperate policy action shows that even the broker dealers arms of non-independent broker dealers (Citi, JPM, BofA) are now at the risk of a run on their overnight liabilities.

Third, an attempt to bail-in the private sector and provide a private lender of last resort support of the financial system is at work: ten major global banks will each fork $7 billion to create a $70 billion fund; each of these firms could borrow up to a third of such fund or $23 billion. But this private lender of last resort (LOLR) facility will not work since if any firm were to access this facility in case of a run on its liabilities panic will ensue – as the use of it will signal severe trouble - and the run will continue. The IMF created a similar facility to deal with liquidity runs on sound and solvent but illiquid countries; but no country ever used or even signed up for such facility as it would have been associated with “stigma”. Also such private LOLR facilities need to come with rules on their use (“conditionality”); otherwise an illiquid and insolvent broker dealer could access the facility with no restrictions and bankrupt the fund and the other members of the fund. But the new facility apparently does not come with any conditionality; so it is flawed in its design.

Fourth, since Lehman is bust the new line of defense was the takeover of Merrill by BofA. After taking over the insolvent Countrywide now Ken Lewis is making another reckless gamble by taking over at a vastly inflated price another distressed broker dealer. This is dangerous behavior for BofA. The lesson for Mack of Morgan Stanley and Blankfein of Goldman is that they should find a buyer today. After the collapse in six months of three major broker dealers Morgan Stanley and Goldman will be next unless they find a large financial institution with a large commercial bank that provides stable FDIC-insured deposits. As predicted here months ago no independent broker dealer will survive.

Fifth, the Fed may cut the Fed Funds rate and discount rate today. But this policy rate cut will make no difference to the fundamental solvency and credit problems of the economy. The economy does not suffer only of illiquidity; more seriously it suffers of severe credit and solvency problems that the Fed cannot address in any way.

Therefore any rally from Fed actions today will be short lived. When Bear was rescued the financial market rally lasted two months; when in July the Fannie and Freddie legislation was proposed the rally lasted a few weeks; when the actual nationalization of Fannie and Freddie occurred a week ago the rally lasted only one day. The ability of policy authorities to prop financial markets is rapidly eroding as market participants perceive that policy makers are desperate and running out of options. At this point the perfect financial storm of the century cannot be contained. The only light at the end of the tunnel is the one of the coming financial and economic train wreck. (09/16/08)
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