Servias Ministries Blog

If you think $700 billion is enough to resolve the financial crisis, you are sadly mistaken.  The government’s estimate is the initial payment to start dealing with the flawed financial business model.  The underlying derivatives will be observed by all of us to truly be financial weapons of mass destruction.  Washington Mutual, a 119 year old company with $307 billion in assets, is by far the biggest bank failure in history.  Stockholders and most bondholders will lose their entire investment.  WaMu participated in a substantial number of credit default swap instruments.  The counterparties will be forced to take a loss against their capital structure. 

What is a credit default swap? 

A credit default swap (CDS) is a credit derivative contract between two counterparties, whereby the "buyer" or "fixed rate payer" pays periodic payments to the "seller" or "floating rate payer" in exchange for the right to a payoff if there is a default^[1] or "credit event" in respect of a third party or "reference entity".

If a credit event occurs, the typical contract either settles by delivery by the buyer to the seller of a (usually defaulted) debt obligation of the reference entity against a payment by the seller of the par value ("physical settlement") or the seller pays the buyer the difference between the par value and the market price of a specified debt obligation, typically determined in an auction ("cash settlement").

A credit default swap resembles an insurance policy, as it can be used by a debt holder to hedge, or insure against a default under the debt instrument. However, because there is no requirement to actually hold any asset or suffer a loss, a credit default swap can also be used for speculative purposes and it is not generally considered insurance for regulatory purposes.

What happens if the "insurer" cannot perform?  The underlying asset becomes worth less.  If the holder of the asset is required to "write down" the value of the asset, it is a direct hit against the capital of the the counterparty.  It can create insolvency and it will do so to many smaller counterparties and hedge funds.  Nobody knows the impact of the failure of WaMu and that is why Treasury Secretary Paulson wants a "blank check" from Congress.

If we could get a transparent audit of all the losses resulting from this crisis, I believe the total will be between $4 Trillion and $25 Trillion, if not more.  It will get ugly soon.  There is no way out because the current decision makers know no other paradigm.  The current system feeds upon itself and by definition protects and perpetuates itself.  Interest rates have been lowered to allow these very institutions to re-liquify by transferring the wealth of savers to the financial institution’s balance sheet.

A new business model based on love will be necessary to resolve this crisis.  The current greed-based model will fail soon.

Inflation is defined as an increase in money supply.  Price inflation results after the money supply has been increased.  The U.S. Government wants us to focus on price inflation rather than true inflation of the money supply.  Remember when the Fed quit publishing M3 Money Supply increases?  They said it cost too much money to publish.  Give me a break!  They print the stuff.  This was as of March 23rd, 2006.  They knew they had problems then.

The graph below depicts the growth of the U.S. Money Supply- M3.  M3 is the broadest and most complete measure of the overall money supply of the United States.  It is the best overall indicator of inflation and expected price inflation.

We are about 1/3 of the way through the crisis.  Hank Paulson needs some more money to fix the problem.  Let’s see what will push the value of the U.S. Dollar down and the relative value of gold up:

1. Fed’s discount window: $33bn balance

2. Expansion of temporary swap lines with central banks: $180bn

3. Fed loans through the Primary Dealer Credit Facility: $20bn through sep 17

4. Treasury purchase of GSE MBS (Mortgage-Backed Securities) this month: $10bn

5. Potential cost of Fannie/Freddie bailout: $200-$300bn

6. Loan to AIG: $85bn

7. Treasury buying mortgage-related assets: $700bn – $1,500bn

8. Potential supplementary stimulus package favored by Democrats: $100bn

9. Insuring money market funds: $50bn

10. Treasury fortifying the Fed’s balance sheet: $100bn

11. Treasury fortifying the FDIC’s balance sheet: $150bn+ (799 financial institutions are suspect now)

12. Fed purchase of agency discount notes & ABCP(Asset-Backed Commercial Paper): amount not specified

Total $1.7 Trillion to $2.5 Trillion

"A trillion here, a trillion there… before long, you’re talkin’ real money!

Many of us who have been around for a while know that when Washington says $700 Billion, they really mean $1.4 to $2.1 Trillion.  Over the weekend, King Henry (Hank Paulson) spoke on the networks about the need to shore up the financial system.  He focused on the impact to the average American, not the real beneficiaries- the banks.  Most of Paulson’s career was spent at Goldman Sachs.  His wealth was created during this time.  He is comfortable operating in this paradigm.  His net worth is reported to be $700 million.  (http://en.wikipedia.org/wiki/Henry_Paulson)

Paulson is shrewd.  His compensation package at Goldman Sachs was reported to be $37 million in 2005.  Wasn’t that in the midst of this sub-prime and derivative debacle?  Hmmm!  How can we expect a man who profited from the era of greed to oversee the cleanup?  In his request to Congress, he added that there would be no action subject to Court review.  What does this mean?  It sounds like a "get out of jail" card for all of his former (or current) associates.  Congress is being pressured to pass a bill immediately.  They have been told "there is no time".

"If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse," Bernanke said in his prepared statement for the Senate Banking Committee panel.

"We must do so in order to avoid a continuing series of financial institution failures and frozen credit markets that threaten the well-being of American families’ financial well-being, the viability of businesses both small and large and the very health of our economy," Paulson said.

On the FBI’s Fraud Prevention Web Page, the telemarketing ploy to get your money uses the phrase: "You must act ‘now’ or the offer won’t be good."  Does this sound familiar?  This storm has been brewing for months and years.  This website has been warning individuals to prepare themselves for the financial crisis for nearly a year yet Congress has only days to pass a bill that will surely have a negative impact on every American and many in other countries.  I guess you should have urged your Congressman to read our website.

Paulson fully participated in the game of greed.  Some of his $700 million came from the results of working deals in the derivatives and sub-prime instruments.  Once Americans are fully briefed on the new law, they will be outraged.  Bernanke and company have only one way to pay for this new liability- hyper-inflate the U.S. Dollar.  What will this mean?  Higher commodity prices and higher inflation.  Oil and gold both spiked up on news of the bailout.  Why?  Big money understands the impact.  The average Joe does not.  How do you like the language in the draft:

"Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency," the original draft of the proposed bill says.  It goes on to say, "Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure."

America’s greed is placing unbearable weight on the current economic system.  This is no different than the societies of the past.  The insatiable appetite for "more" is self destructive.  If you have a net worth of $700 million, what else do you need?  Another $100 million!  Mankind continues to operate with logic rather than the heart.  Logic tells you to keep this complex system afloat.  The heart would tell you to simplify.  The financial institutions created an unbelievably complex environment that defies understanding.  AIG was saved because it is too big to fail.  I would suggest that it is too complex to fail.  Nobody in Washington or New York could effectively determine the outcome of the bankruptcy of AIG.  Therefore it was too risky to let it fail.

Paulson and Congress want to include just about any debt of any institution in the bailout.  However I doubt that you and I will have access to any of that money.  They will put plenty of spin on the bailout to make it palatable to the American public.  After all, it’s election time.

The perfect storm has three fronts.  We are now in the midst of the derivatives storm.  Let’s not forget storm #2, Peak oil, or storm #3, the unfunded liabilities  associated with the baby boomers that are moving toward retirement!

Get out of debt, simplify, and most of all…. pray!

For nearly a year I have been warning readers of the coming financial storm.  It is here!  Pundits have told us many times "the worst is over".  That is not the case.  We are still at the front end of the mortgage crisis.  There are still many mortgage loans that have not yet reset.  The recent demise of Lehman Brothers investment bank will take months to unwind.  This domino is very significant.  When the derivative instruments are fully cashed out, the counter-parties will take a big hit.

Was Lehman too big to fail?  Nobody knows.  Their bankruptcy is a huge risk to the global financial system.  The greed of the last five years has come home to roost.  All of the exorbitant bonuses collected by greedy financiers should be sought by the courts, and they probably will be.  Securitizing  a heap of junk and calling it "AAA" was the epitome of fraud by the banks as well as the ratings agencies.  The regulators looked the other way as well.  The Federal Reserve and U.S. Treasury have no experience to deal with a disaster of this magnitude.  They are simply guessing and that is scary!

There has been an orchestrated attempt during this crisis to knock down the commodities including gold and silver.  Gold is the barometer of the perceived status of the fiat financial system.  Gold has no underlying liability attached to it.  Historically when fiat currencies head south, investors move to gold thus moving its relative price upward.  Central banks and their "agents" have been battering gold for the last several months in attempt to manipulate the market’s perception that "all is well".  How much longer will they attempt to do this?  Certainly through the U.S. election just 49 days away. 

The fundamentals of the precious metals suggest that they will be significantly higher soon.  This is the time to acquire real insurance- gold and silver.  Headline inflation exceeds personal savings rates.  This means your U.S. Dollars are slowing losing buying power.  This could escalate.  Stocks are at risk due to the unwinding of the financial instruments of mass destruction.  What are we to do?  One must keep liquid to pay the bills.  Gold will be here one month from now.  Your financial institution may not.

Humpty Dumpty sat on a wall,
Humpty Dumpty had a great fall.
All the King’s horses, And all the King’s men
Couldn’t put Humpty together again!

See Disclaimer: http://www.servias.org/?p=56

Everyone was quick to call on Congress to go after the speculators who caused the increase in oil prices earlier this summer.  Oil company executives were summoned.  Congress wanted to file a lawsuit against OPEC.  However, we are now sensing that there is an unseen hand affecting the market to the downside.  The price of oil is down $1.55 to $101.03.  This makes no sense given the fact the most of the rigs in the Gulf of Mexico remain "shut-in" since before Hurricane Gustav arrived.  OPEC just curtailed production by 500,000 barrels per day.  Below is the projected path of "Ike" overlayed on oil & gas platforms and refineries.  Hurricane force winds extend 115 miles from the eye.

For all graphics: Rigs/Platforms: Blue: evacuated only; Yellow will require inspection before restart; Red: damage requiring repair; Refineries: Black: operational impact (partial shutdown) Green: Operational impact (full shutdown) Red: Damage likely; Ports: standard hurricane flags for wind

MMS reported Wednesday that staff has been evacuated from 452 production platforms (63.0%) and 81 rigs (66.9%) – (95.9% of the oil production and 73.1% of the natural gas production has been shut-in as a precautionary measure for Hurricane Ike.)

In the past, this event would have immediately pushed oil prices higher, not so today.  What is a speculator?

A Speculator is a person who trades (i.e. derivatives, commodities, bonds, equities or currencies) with a higher-than-average risk, in return for a higher-than-average profit potential. Speculators take large risks, especially with respect to anticipating future price movements, or gambling, in the hopes of making quick, large gains.

Could Paulson and Bernanke be speculating with the global financial system?  What are the fruits of their labor?  Bear Stearns, Lehman Brothers, Indymac, Washington Mutual, Fannie Mae, Freddie Mac, US Dollar value at home & abroad, etc. 

The following article provides a professional’s view of what is happening: http://www.reportonbusiness.com/servlet/story/RTGAM.20080909.wheinzl0910/BNStory/SpecialEvents2/home

Unequal weights and measures are fully incorporated at all levels.  It so blatant that I’m sure the Wall Street crowd are joking about all the dopes on the outside of the "club".  Such arrogance will come home to roost.

We are now in the midst of the largest market intervention in history.  Why?  They must "save the Hill", Capitol Hill.  Until the November elections, those in control of the purse strings will throw everything at the market to maintain "status quo".  Remember last year when we were told there were no issues with Bear Stearns?  Then suddenly, they vanished.  Recessions are only reported by the government after the fact, never during the recession.  It’s all about perception.  They depend on public sentiment to keep the wheels on the financial wagon.  Why?  There is nothing else supporting the value of the U.S. dollar.

What will be the effect of this massive intervention?  Inflation, possibly hyper-inflation.  Prices of tangible assets will rise.  Oil, gas, gold, and silver will all respond.  When?  After the election if the market intervention works.  Notice how the Dow Jones Industrials Index continues to stay in a narrow band between 11,000 and 12,000.  The macroeconomic picture would suggest the 8,000-9,000 range.  Gold and silver have been targeted since they represent the "canary in the mine".  Silver is selling at 10.80 in the financial markets but you cannot buy the physical metal and receive immediate delivery.  Most delivery quotes are 2 months out due to supply constraints.  The markets are broken.  Former U.S. Fed Chairman Paul Volcker agrees: http://www.bloomberg.com/apps/news?pid=20601087&sid=auKCKTSSU7yE

Over the weekend, U.S. Treasury Secretary Henry Paulson led the effort to "nationalize" Fannie Mae and Freddie Mac.  Who were the winners and losers?

Winners:

Bondholders of Fannie Mae & Freddie Mac.  Bill Gross of PIMCO just happened to dramatically change his portfolio to take advantage of the bailout.  The result?  $1.7 Billion payout. I guess he’s just lucky.  See http://www.ft.com/cms/s/0/838d3cb4-7e96-11dd-b1af-000077b07658.html?nclick_check=1

Former CEO’s of Fannie Mae & Freddie Mac. Maybe temporary.  The (ESOP) retirement fund may sue them.  They were paid millions of dollars to bring about this mess.

Derivatives holders (for now)

Losers:

Common Stockholders of Fannie Mae & Freddie Mac.  They were sacrificed by Paulson.  I’m sure he didn’t own any stock in his 9 digit portfolio.

U.S. Taxpayers, their children, grandchildren, etc.  No matter how you spin it, the government added $5.4 Trillion to the liabilities side of the balance sheet.  The asset entry is questionable and declining daily with the decrease in housing values.

Productive Government Programs.  The expected losses will force curtailment of spending programs.  Some local highway projects were put on hold last week due to an abrupt halt of federal funding.

The price of oil has been declining in the midst of an overall decline in production of oil.  This is temporary.  I would not go buy an SUV.  One of my favorite gold stocks, Minefinders (MFN), has been hit hard by short sellers.  Thank you.  I will continue buying more of this stock at these depressed prices.  The fundamentals of gold and silver stocks suggest higher prices in the future.  Overall gold production is down and not expected to rise.  Don’t let the short sellers scare you out of your positions which is their intent.  That is how they make money.  They use fear to exploit shareholders.  If you are convince of the long term fundamentals for gold, you simply hold on during this severe correction.  Never leverage your investments unless you have sufficient cash to cover them.

From Wikipedia, the free encyclopedia:  The Texas ratio is a measure of a bank’s credit troubles. Developed by Gerard Cassidy and others at RBC Capital Markets, it is calculated by dividing the value of the lender’s non-performing loans by the sum of its tangible equity capital and loan loss reserves.  In analyzing Texas banks during the early 1980s recession, Cassidy noted that banks tended to fail when this ratio reached 1:1, or 100%. He noted a similar pattern among New England banks during the recession of the early 1990s.

Expect to hear more about the Texas ratio in upcoming months.  The FDIC has been gearing up for more than a year to handle the coming bank failures.  The Federal Reserve has been helping the biggest banks since they are "too big to fail".  The New York Attorney General is settling with the big investment banks by forcing them to buy back their "auction rate" securities and slapping fines on them.  Hmmm!  There’s not much talk about jail time!  I guess you can be too big to go to jail for fraud.  Money talks, everyone else walks (to jail).

After Indymac, the FDIC has about $37 Billion left in its war chest.  That will not be enough.  You and I will open our taxpayer wallets and fund some more fraudulent behavior.  There have been three bank failures since Indymac although you don’t hear much about those failures.  Friday after 5PM  is the standard timetable to close a bank.  Generally, the FDIC has another bank to take the depositors and opens up on Monday as the new bank.  The new bank is not liable for any deposits of the failed bank, the FDIC is.

See: http://www.statesman.com/business/content/shared/money/stories/2008/08/fdic_0824_1.html

Don’t worry about your money, the boys up in D.C. are looking out for your best interest.

We are facing a tremendous "moral hazard" now.  The Fed is sending signals that when times are good, financial institutions get to keep and distribute their profits to top execs and stockholders.  When times are bad, the same financial institutions are able to go to the Fed’s begging bowl.  These institutions provide political contributions and expect payback when times are tough.  The currency used is taxpayer money.

See: http://ap.google.com/article/ALeqM5h04hnO_iYHQ4URCW-gqOIJ0pMGRwD92O3QHG0

The Detroit auto manufacturers want in on the action too:

http://money.cnn.com/2008/08/23/news/economy/auto_bailout.ap/index.htm

$50 billion here, $50 billion there…. before long we’re talkin’ real money!

We are in unprecedented times of unequal weights and measures.  How far down this path are we?  It would appear that we will soon reach a flashpoint when the house of cards (or Federal Reserve Notes) comes tumbling down.  Gold is the barometer.  The central banks know this and that is why there is an orchestrated effort to keep the price below $1000.  However, once things began to head south each central bank will fend for itself. 

See:  http://www.guardian.co.uk/business/feedarticle/7744536

Who would have thought there would so much to track in the financial arena just five years ago.  The 1960’s are looking like the golden years now for most of us who were around then.  We have seen several recessions since the 1960’s.  The current storm clouds indicate a severe downturn only second to the Great Depression.  The U.S. Dollar is at risk.  The America-centric world is at risk as well.  With all that is happening, I thought we might want to look at the big picture.

Here are ten areas of the systemic financial meltdown associated with a projected severe economic recession…

1.  We are now in the worst housing recession in US history and there is no sign it will bottom out any time soon.  Expect US home prices to fall between 20% and 30% from their peak.  This will would wipe out between $4 trillion and $6 trillion of household wealth.  The subprime meltdown is likely to cause about 2.2 million foreclosures.  A 30% fall in home values would translate to about 10 million households with negative equity in their homes.  Many of these will default and walk away.  Home builders will go bankrupt.

2.  Losses for the financial system from the subprime debacle are rising daily.  They were estimated at $250 to $300 billion.  Who knows where they will end up.

3.  The recession will lead to a sharp increase in defaults on other forms of unsecured consumer debt: credit cards, auto loans, student loans. There are millions of subprime credit cards and subprime auto loans in the US.

4.  There is serious uncertainty about the losses that monoline insurers will sustain on their insurance of toxic financial instruments.  Many are technically insolvent.  This will lead to a downgrade of municipal bonds resulting in state, local, county funding issues.  California has a $15 billion shortfall to fund.

5.  The commercial real estate loan market meltdown cannot be far behind.  Do you think lenders "got religion" when loaning to commercial real estate borrowers?  They  were as reckless as those in residential real estate.

6.  Ninety banks are on the watch list at the FDIC.  Indymac Bank was not on the list a month before they went under.  The real watch list is probably about 700 banks. Don’t keep more than $100,000 in any one bank (defined by its charter).  If a bank is offering notably higher interest rates, watch out!

7.  As the severe recession continues, a massive wave of corporate defaults will take place.  Will Steak & Ale ever reopen?

8.  The “shadow banking system” or more precisely the “shadow financial system” (composed of non-bank financial institutions) are in serious trouble. This shadow financial system is composed of financial institutions that borrow short and in liquid forms and lend or invest long in more illiquid assets. This system includes: SIVs, conduits, money market funds, monolines, investment banks, hedge funds and other non-bank financial institutions.   The Fed is now loaning some of these institutions money on 28 day loans which are renewed (rolled over) of course.

9.  Stock markets in the US and abroad will soon price in a severe US recession.  October always seems to be a favored month.  However, the Plunge Protection Team will work overtime to prop the markets up until the end of the year.  As financial losses mount, earnings will sharply drop and stock prices will follow.  Highly leveraged hedge funds will be forced to sell off and help push stock prices down.

10.  Energy prices may be the icing on the cake.  Depletion curves of known oil reserves are outpacing new oil discoveries and development.  At the same time consumers in China and India do not want to go back to bicycles.  Commodities are in their 19 year bull cycle.  Can a regional recession (U.S., Europe) offset the energy demand increases in Asia?  I would not bet the house on it.

On 08/08/08, Georgia was invaded by Russian troops.  Why? Once again, it’s all about oil just like Iraq was all about oil. The following map provides us a view of Georgia’s proximity to the oil pipelines:

Source: Kleveman, Lutz, The New Great Game, Atlantic Monthly Press, September 2003

Notice Georgia is between the Black Sea and the Caspian Sea.  Baku-Tbilisi-Ceyhan pipeline (sometimes abbreviated as BTC pipeline) is a crude oil pipeline that covers 1,768 kilometres (1,099 mi) from the Azeri-Chirag-Guneshli oil field in the Caspian Sea to the Mediterranean Sea. It connects Baku, the capital of Azerbaijan; Tbilisi, the capital of Georgia; and Ceyhan, a port on the south-eastern Mediterranean coast of Turkey, hence its name. It is the second longest oil pipeline in the world after the Druzhba pipeline. The first oil that was pumped from the Baku end of the pipeline on May 10, 2005 reached Ceyhan on May 28, 2006.  Russia understands the need to control energy supply.  Europe knows all too well how an interruption in energy flow can cause major problems.

Recently, the Kremlin distributed the following:

A shirtless Vladimir Putin is brandishing a hunting rifle.  Putin has been building his war chest with higher priced oil & gas revenues.  He picked a perfect day to invade.  NATO was on vacation and all other eyes were focused on the Olympics.  The U.S. helped Putin build his war chest by becoming the ultimate consumer of energy (roughly 25% of total global oil) any by depreciating its relative financial and economic strength.  In the 1980’s Ronald Reagan used America’s economic strength to win the cold war against the Soviet Union.  His military spending plan forced the former Soviet Union to attempt to keep up.  The Soviets lost in the 80’s.  Putin was a KGB agent back then and understood how the country was broken up by the U.S. macroeconomic strategy.

It appears that he will use what we taught him against us. 

This phrase may come back to haunt the powers that be.  The Federal Reserve exercised its authority to deal with Bear Stearns.  With increasing frequency, policy makers are using little known, obscure powers granted eons ago.  There are so many laws with so much fine print that just about anything can be done if you know where the verbiage is.

The Federal Reserve Act (1913) allows the Federal Reserve to lend, in a crisis, to just about any institution, organization or individual, and against any collateral the Fed deems fit. Specifically, if the Board of Governors of the Federal Reserve System determines that there are “unusual and exigent circumstances” and at least five (out of seven) governors vote to authorize lending under Section 13(3) of the Federal Reserve Act, the Federal Reserve can discount for individuals, partnerships and corporations (IPCs) “notes, drafts and bills of exchange indorsed or otherwise secured to the satisfaction of the Federal Reserve bank…”.  See http://www.federalreserve.gov/aboutthefed/section13.htm

I would love to tap into this deal.  I have a crying need (exigent).  I want to buy $1 billion of 5% bonds and borrow the money at 2% for the next 5 years.  I could simply live on the interest of the 3% spread.  Whoops!  I’m not in the club.  Not only am I not in the club but I don’t even know where the entrance is!!  I guess if I had diverted my career into investment banking and moved to New York I could be in the club.  C’est la vie!

This week had the ultimate attempt to "spin" the economy and the U.S. dollar.  There was an orchestrated attempt to push the dollar up and gold down, as well as silver.  The investment banks and the Plunge Protection Team (PPT, AKA The President’s Working Group on Financial Markets) know where all the leveraged investors’ positions are.  With enough money, you can push just about any stock or commodity down temporarily.  That happened this week.  Europe’s economic well being is in trouble as well as the U.S. economy.  The Fed is in a desperate situation.  To strengthen the dollar they need to raise interest rates but that action will severely damage the financial system which is in triage now.  In lieu of interest hikes, they can attempt to manipulate market perception and psychology using the herd mentality.

Gold and silver prices were hit hard this week.  Those who had leveraged positions in gold and silver were taken out Thursday night and Friday morning.  There was blood in the streets of leveraged metals investments.  I recommend against leverage in this market.  Why?  I believe the use of technical analysis has many flaws.  With computerization of price charts, technical analysis was initially successful.  However, once a larger population of traders began to use technical analysis, the very large players (guess who?) began to "paint" the charts and manipulate the pricing to take out most technical traders at a loss.  Technical trading can be helpful when used to pick entry and exit points in fundamental trading.  Are there technical traders who are successful?  Yes, a small minority.

Below is the 10 year gold price chart:

The direction is clear.  The trend is up and there is no fundamental reason for gold to return to $300 per ounce.  I believe that it will see $3,000 before it sees $300.  Silver took a tumble as well.  Look at the following 1 year chart.  Silver is trading at nearly 50% of its moving average.  What a buy!

The phones were busy at the bullion dealers on Friday.  Many who were not scared off by the dramatic coordinated intervention went shopping.  With gold headed for $1,200 soon and silver at $30, this was a gift indeed.  Thank you PPT!