Servias Ministries Blog

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!

By now all of us should agree the U.S. Government’s reported core inflation number is bogus.  I guess that those who calculate inflation do not go to the grocery store or drive a car.  In this writing I want to look at the area of "personal financial destruction" of savers.  My parents were savers.  They instilled the need to save money in my brother and me.  At a young age we both had a savings account.  I did a poor, no a pathetic job of saving back then.  I learned the mechanics but had no understanding.  As all other kids, I was a consumer not a saver.  However, once I married the understanding kicked in… This was serious stuff!  Back then we were told to have six months’ income in savings in case of an emergency.  That number soon changed to twelve months.  That savings account was left untouched.  In the 1970’s passbook savings accounts paid 5 – 5 1/2% interest.  That was the firm base level.  C.D.’s paid higher rates, a premium for the inaccessibility of your cash (illiquidity).  In the late 1970’s inflation raised its ugly head.  C.D. rates shot strait up.  Treasury Bill rates followed. 12-15% return on your money was not unusual because you were paid 2-5% over the rate of inflation.  Your money was protected from the rages of inflation.  That was then.

We now are in a different paradigm.  Back then bankers were prudent, now they are reckless.  Back then there were no hedge funds who could borrow from the banks at 30 to 1 ratios.  Back then there was not over 1 quadrillion dollars in derivatives.  Back then you could not buy house unless you had good credit and a substantial down-payment.  Back then there were no 72 month car loans.  Back then you could only have one credit card, if you were fortunate.  I was turned down in 1973 when I applied for a credit card with a $300 credit limit, and I worked at the bank who denied it!!!  Back then there were twice as many banks as there are now.  Back then there were three drug stores in the community of 50,000.  Back then we worked on our own cars, the auto mechanic didn’t know what a computer was?

Inflation is at 6% (at least).  Savings rates are at 1 to 3.5%.  We are now in the destruction phase of the value of the dollar.  What does it mean to you and me?  Let me show you.  The following table calculates the five year results of saving:

Interest Income Scenario

Ok, you made a total of 187.69 on your money over the next five years.  What happened to that value of your original investment in purchasing power?  The next table reveals the destruction of your wealth:

Inflation Devaluation

Over the next five years, you will probably lose about $270 purchasing power for every $1,000 you possess.  Some assets will go up in value, others will not.  Housing prices will probably revert back to their long term appreciation curve at best.  All the recent gains may be wiped out.

The commodities are in a long term bull market and the dollar is in decline.  Therefore, the challenge is to invest in something that increases in value faster than the inflation rate.  I continue to believe gold, silver, oil & gas are those investments.  The following table represents what I believe is the conservative endgame. 

Gold Appreciation against the U.S. Dollar

Make no mistake that there will be dramatic volatility as the prices of commodities ascend.  Why?  Let me explain.  The fiat money system is a house of cards.  There is nothing except perception to back up the value of the U.S. Dollar.  The central bank (Fed) can print as much money as they desire.  There is no asset backing the printing.  If you or I did this, it would be fraud.  They are increasing the money supply by double digits.  That is purely inflationary.  Other countries’ currency have appreciated against the dollar.  It is more expensive to stay in a hotel room in Europe that it was one year ago.  If you are an American, that is inflation.  Other developed countries have seen oil price increases but not to the same degree.  There are so many factors favoring the safe haven of hard assets yet there is so much "noise" emanating from the powers that be.  Our challenge is to keep our heads when all about us are losing theirs.  Consider the following:

1.  US banks (commercial or investment) have purposely withheld their true profitability or losses and will not have to report off balance sheet losses for at least another 12 months.

2.  Auction Rate Bonds which are estimated at between $400 to $500 Billion have now surfaced as the latest financial instrument of mass destruction. The Fed will have to support the same institutions that are already at the Fed Loan window.

3.  High powered computers and savvy traders with a lot of backing are manipulating the technical views of Wall Street.  That is well known.  If you need to manipulate the market, there is something seriously wrong.

4.  Major retirement funds will not regain the value that has been stripped away by all forms of SIV’S (Securitized Investment Vehicles).  All those people who worked their entire career in a "safe" job may not have such a safe retirement.

5.  Energy is not in a global demand destruction, Asia keeps growing at a high economic rate.  They will be happy to consume our decrease in oil consumption.

6.  China’s economy will not collapse after the Olympics are over.  China’s backlog will force much overtime.

7.  Europe’s economic situation is not as severe as the USA’s.  Their infrastructure is better equipped for high energy prices.  They already have local gardening plots and are more prepared to deal with expensive energy than the U.S.

8. Gold has no liability attached to it and is a better storehouse of value than any fiat currency that has large and incalculable liabilities against it.

9.  OTC derivative problems have not ended.  That is why the Fed is loaning our children’s money to the banks and not requiring full disclosure of all losses.

10. The credit market is not loosening up but contracting in a full defensive and survival footing.

11. Insurers who insure (guarantee) the value of debt instruments do not have enough money to make good as bankruptcies increase.

12. Central banks have been diversifying out of the US dollar.  What do they know that we don’t?

13. Israel will not permit Iran to reach that point where it can nuke their country.  Another war in the area is bullish for hard assets.

14. Pakistan is a time bomb ticking away.  Can the U.S. be involved in another front?

15. Russia’s Putin has the resources to begin taking back satellite countries it lost during that last breakup.  With oil and gas revenues, he has a war chest to challenge the current powers.  He holds Europe by the "privates" since Russia provides much of the energy used by Europe.  Georgia’s pipeline may be renamed to the "Putin Trans-Soviet" pipeline.

Are we at a paradigm shift?  I think so and I am putting my money where my mouth is.  The central banks can toy with the value of the dollar on a short term basis but the market is bigger than the central banks.  When people see that their financial well being is threatened, they will flee to gold as they have done for thousands of years.  At that flashpoint, you will see a parabolic rise in the price of gold and silver.  In the meantime, don’t let the central banks pry your investment out of your fingers.  These are the people who have moved and kept the interest rates below the rate of inflation and you can bet they know what they are doing to us who are savers!

Globalization is based on cheap energy.  The "2500 mile salad" assumes that you can truck lettuce from California and put it on the table in New York City at a reasonable cost.  Cheap transportation costs propelled China’s industrial sector into a world class supplier.  This phenomenon allowed them to build their infrastructure with money from the West.  This transfer of wealth provided the "priming of the pump".  Conventional oil peaked in May of 2005.  What most believed to be an unlimited supply of energy has now proven to be the opposite and there is no silver bullet on the horizon.  Economies based on the cheap energy paradigm will go through some radical changes.

Inflation will continue to work against globalization.  Besides peak oil, the inflation impact on the price of oil will negatively impact lower and middle class society.  Increased prices of food and other staples will force people back to the garden.  Many retailers are filing bankruptcy or closing stores.  The contraction will be severe.  The government’s economic indices understate the problem and will continue to do so.  It normally take two quarters for the government to admit the U.S. is in recession and that is now the case.  Other statisticians report that the U.S. has been in a recession for more than a year and has a severe employment issue.

Scarcity in resources does not promote globalization, scarcity promotes protectionism.  The countries with resources do not want to share their resources but prefer domestic consumption to maintain civil obedience.  Hmm!  It looks like the great experiment isn’t working too well unless the end game is to bring countries to their knees to promote "merger and acquisition" in the political arena.  After 9/11 Americans were convinced of the need to give up personal liberties and freedoms for perceived protection from the bad guys.  However, nearly 8 years later and the bad guys are still out there.  What a complex world we live in!

On a subtle note, the globalization of currency is working.  Once again gold and silver are seen as storehouses of value as they have been for the last 5,000 years.  The problem is that governments cannot manipulate them as they have done with fiat currencies.  Throughout history every fiat currency has fallen and society has returned to gold and silver.  It appears that we are on the fast track once again.  Central Banks will fight the upward push in the price of gold for as long as possible.  They will do anything possible to keep gold down but to no avail.  Once the masses finally catch on, the price of gold will go parabolic.  The smart money which is already accumulating gold will be happy to sell to Joe Six-pack at that time just as they did in the tech boom.  The transfer of wealth is based on revelation, not information (or all those web surfers would be rich).

America’s financial system continues to fall apart.  Alt=A loans will be the next wave of defaults.  These loans were made to people with reasonable credit scores but no documentation of assets or employment.  What were those lenders thinking?   As reported earlier the FASB has delayed their compliance rule to force institutions to place their "off balance sheet" liabilities on the balance sheet.  I guess that their sanctioned fraud will continue another twelve months.  These acts will continue to erode the credibility of the American financial system and will force foreign capital to find other jurisdictions for their investments.  This will severely impact the U.S. consumer nation who has forgotten how to save money- the source of capital investment.

As financial institutions were growing, they were spreading their reach across the globe.  Britain’s Royal Bank of Scotland acquired businesses outside their normal market and began to globalize.  They are now in reverse: http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article4449834.ece#cid=OTC-RSS&attr=1185799

PS Keep an eye on Pakistan, it’s a very dangerous place with nukes.