Thursday, January 31, 2008

America's Teetering Banking System: "Where did all our deposits go?"

by Mike Whitney

31/01/08 "ICH" -- - Somebody goofed. When Fed chairman Ben Bernanke cut interest rates to 3% yesterday, the price of a new mortgage went up. How does that help the flagging housing industry?

About an hour after Bernanke made the announcement that the Fed Funds rate would be cut by 50 basis points the yield on the 30-year Treasury nudged up a tenth of a percent to 4.42%. The same thing happened to the 10 year Treasury which surged from a low of 3.28% to 3.73% in less than a week. That means that mortgageswhich are priced off long-term government bonds---will be going up, too.

Is that what Bernanke had in mind; to stick another dagger into the already-moribund real estate market?

The Fed sets short-term interest rates (The Fed Funds rate) but long-term rates are market-driven. So, when investors see slow growth and inflationary pressures building up; long-term rates start to rise. That's bad news for the housing market.

Now, here's the shocker: Bernanke KNEW that the price of a mortgage would increase if he slashed rates, but went ahead anyway.

How did he know?

Because 8 days ago, when he cut rates by 75 basis points, the ten-year didn't budge from its perch at 3.64%. It just shrugged it off the cuts as meaningless. But a couple days later, when Congress passed Bush's $150 "Stimulus Giveaway", the ten year spiked with a vengeance---up 20 basis points on the day. In other words, the bond market doesn't like inflation-generating government handouts.

So, why did Bernanke cut rates when he knew it would just add to the housing woes?

Some critics say that he just wanted to throw a lifeline to his fat-cat investor buddies on Wall Street by providing more liquidity for the markets. But that's not it, at all. The fact is, Bernanke had no choice. He's facing a challenge so huge and potentially catastrophic; that cutting rates must have seemed like the only option he had. Just look at these graphs and you'll see what Bernanke saw before he decided to cut interest rates.


The banks are busted.

In the first graph (Total borrowings of Depository Institutions from the Federal Reserve) shows that the banks are capital impaired" and borrowing at a rate unprecedented in history.

The second graph (Non borrowed reserves from of Depository Institutions) shows that the capital that the banks do have is quickly being depleted.

The third graph (Net Free or borrowed reserves of Depository Institutions) is best summed up by econo-blogger Mike Shedlock who says: Banks in aggregate have now burnt through all of their capital and are forced to borrow reserves from the Fed in order to keep lending. Total reserves for two weeks ending January 16 are $39.98 billion. Inquiring minds are no doubt wondering where $40 billion came from. The answer is the Fed's Term Auction Facility. (Mish's Global Economic Trend Analysis; So the only reserves they have is capital they borrowed from the Fed.

The forth Fed graph illustrates the steep trajectory of the ever-expanding money supply. (Monetary base)

A careful review of these graphs should convince even the most hardened skeptic that the banking system is basically underwater and insolvent. We are entering uncharted waters. The sudden and shocking depletion of bank reserves is due to the huge losses inflicted by the meltdown in subprime loans and other similar structured investments.


When US homeowners default on their mortgages en-mass, they destroy money faster than the Fed can replace it through normal channels. The result is a liquidity crisis which deflates asset prices and reduces monetized wealth, says economist Henry Liu.

The debt-securitization process is in a state of collapse. The market for structured investmentsMBSs, CDOs, and Commercial Paper---has evaporated leaving the banks with astronomical losses. They are incapable of rolling over their their short-term debt or finding new revenue streams to buoy them through the hard times ahead. As the foreclosure-avalanche intensifies; bank collateral continues to be down-graded which is likely to trigger a wave of bank failures.

Henry Liu sums it up like this: Proposed government plans to bail out distressed home owners can slow down the destruction of money, but it would shift the destruction of money as expressed by falling home prices to the destruction of wealth through inflation masking falling home value. (The Road to Hyperinflation, Henry Liu, Asia Times) It's a vicious cycle. The Fed is caught between the dual millstones of hyperinflation and mass defaults. There's no way out.

The pace at which money is currently being destroyed will greatly accelerate as trillions of dollars in derivatives are consumed in the flames of a falling market. As GDP shrinks from diminishing liquidity, the Fed will have to create more credit and the government will have to provide more fiscal stimulus. But in a deflationary environment; public attitudes towards spending quickly change and the pool of worthy loan applicants dries up. Even at 0% interest rates, Bernanke will be stymied by the unwillingness of under-capitalized banks to lend or over-extended consumers to borrow. He'll be frustrated in his effort to restart the sluggish consumer economy or stop the downward spiral. In fact, the slowdown has already begun and the trend is probably irreversible.

The financial markets are deteriorating at a faster pace than anyone could have imagined. Mega-billion dollar private equity deals have either been shelved or are unable to refinance. Asset-backed Commercial Paper (short-term notes backed by sketchy mortgage-backed collateral) has shrunk by $400 billion (one-third) since August. Also, the market for corporate bonds has fallen off a cliff in a matter of months. According to the Wall Street Journal, a paltry $850 million in high-yield debt has been issued for January, while in January 2007 that figure was $8.5 billion---ten times bigger. That's a hefty loss of revenue for the banks. How will they make it up?

Judging by the Fed's graphs; they won't!

Bernanke's rate cuts sent stocks climbing on Wall Street, yesterday, but by early afternoon the rally fizzled on news that Financial Guaranty, one of the nation's biggest bond insurers, would be downgraded. The Dow lost 37 points by the closing bell.

The plight of other major bond insurers, MBIA and Ambac, could be known as early as today, but it is reasonable to expect that they will lose their Triple A rating. According to Bloomberg:

MBIA Inc, the world's largest bond insurer, posted its biggest-ever quarterly loss and said it is considering new ways to raise capital after a slump in the value of subprime-mortgage securities the company guarantee. The insurer lost $2.3 billion in the fourth-quarter. Its downgrading from AAA will cripple its business and throw ratings on $652 billion of debt into doubt. Many of the investment banks have assets that will get a haircut.

The New York State Insurance Department tried to work out a bailout plan but the banks could not agree on the terms (ed note: "They don't have the money")

Bond insurers guarantee $2.4 trillion of debt combined and are sitting on losses of as much as $41 billion, according to JPMorgan Chase & Co. analysts. Their downgrades could force banks to write down $70 billion, Oppenheimer & Co. analyst Meredith Whitney said yesterday in a report. (Bloomberg)

The bond insurers were working the same scam as the investment banks. They found a loophole in the law that allowed them to deal in the risky world of derivatives; and they dove in headfirst. They set up shell companies called transformers, (The same way the investment banks established SIVs; structured Investment Vehicles) which they used as off balance sheets operations where they sold "credit default swaps , which are derivative instruments where one party, for a fee, assumes the risk that a bond or loan will go bad. (The Bond Transformers, Wall Street Journal) The bond insurers have written about $100 billion of these swaps in the last few years. Now they're all blowing up at once.

Credit default swaps (CDS) have turned out to be a gold-mine for the bond insurers and they've given a boost to the banks too, by freeing up capital to use in other ventures. The banks profited on the interest rate difference between the CDOs (collateralized debt obligations) they bought and the payments they made to transformers...The banks sometimes booked profits UPFRONT on the streams of income they expected to receive. (WSJ)

Neat trick, eh? Who wouldn't want to enjoy the profit from a job before they've done a lick of work?

Even now that the whole swindle is beginning to unravel---and tens of billions of dollars are headed for the shredder---industry spokesmen still praise credit default swaps as financial innovation. Go figure?


The leaders of Europe's four largest economies (England, France, Germany, Italy) held a meeting this week where they discussed better ways to monitor the world's markets and banks. They did not, however, push to create a new regime of oversight, regulation and punitive action that would be directed at financial fraudsters and their structured Ponzi-scams. Politicians love to talk about greater transparency and watchdog agencies, but they have no stomach for establishing the hard-fast rules and independent policing organizations that are required to keep the carpetbaggers and financial hucksters from duping gullible investors out of their life savings. That is simply beyond their pay-grade. And that is why even now---when the world is facing the most serious financial crisis since the Great Depressioncorporate toadies like British Prime Minister Gordon Brown merely reiterate the script prepared for them by their boardroom-paymasters:

If these agencies don't reform themselves, the Europeans would turn to regulatory response to enforce change.

Right-o, Gordon. Right-o.

Wednesday, January 30, 2008

Lenin was right..

Lenin was surely right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. -- John Maynard Keynes

Bangkok's Chinatown and gold buying

by Saigon Charlie
Well, I am back in Bangkok and after a few short visits to "Ricks" or as the locals call it the "Tavern" on Soi 4, I made my way over to Bangkok's Chinatown which as it turned out was no easy matter.

It seems since we have had a few changes in who and what is 'boss', the taxi drivers have once again taken this as license to switch off their meters and tell you what they will charge to take you somewhere. I got in and out of 5 cabs ending up taking the Skytrain to National Stadium where I did manage to find a cab to take me the remainder of the distance for 100 Baht. Once again, negotiated before we began with no meter running.

Anyway. I finally got out near the Tesco/Lotus store in Chaintown and headed into the first gold shop I saw. What transpired after that was unbelievable!

There must have been 50 people at the semi circular counter and I had to stand patiently behind customers before I could even get to the counter. After that, after some time, a Thai gentlemen (all the employees were men...) finally came to help me.

I asked to see men's 3 Baht gold chains and he selected a half dozen for me. I liked one of the designs and asked if he anything else like it which he did. I liked it and we settled on a price of 14,300 Baht per Baht. A Thai 3 Baht chain has nearly 46 grams of gold and is 96.5 % gold. Also interesting to note they post each day what they buy the gold back at which on this day was 14,038 Baht. Gold is money and gold shops are banks....just like they use to be.

As I started to sort out my Euro and Baht to pay for the chain, I couldn't help but smile at the huge stacks of Thai bank notes everywhere around me that were being counted out by the men behind the counters. It seemed everyone was buying gold which honestly shocked me as I thought I was going to be the only customer here with gold "so high".

Yes, I am a "Gold Bug" and it seems the dozens of Thais around me were as well. There is not a single Thai who does not know what the price of gold is each day but I wonder how long it will take for the rest of the world to "get it".

Gold is real money and if anyone thinks the crap they call dollar is worth anything out here in the "real world" they are delusional..........which is what they are counting on!

Smiling in Bangkok!

Pension funds lose trillions in share slump

Published: January 30, 2008

LONDON: The global share sell-off may have wiped up to $1.5 trillion (753 billion pounds) off the value of global institutional pension fund assets since the start of this year, consulting firm Watson Wyatt said on Wednesday.

With the average allocation to equities within pension funds in the 11 largest pension markets at 56 percent, they have felt the pain of the global equities market slump, while pension liabilities grew faster than their assets last year, said Watson Wyatt.

"2007 was a year of two distinct halves," said Roger Urwin, Watson Wyatt's global head of investment consulting. "In the first half pension fund balance sheets continued to strengthen, but faltering markets in the latter half largely undid these gains. Severe market events this year suggest that balance sheets will remain under pressure."

The UK had the highest allocation to equities in 2007 at 64 percent, while Switzerland had the lowest at 33 percent, said the survey.

Pension assets in the 11 largest pension markets -- Australia, Canada, France, Germany, Hong Kong, Ireland, Japan, the Netherlands, Switzerland, UK and United States -- grew 9 percent to over $25 trillion in 2007.


UBS Reports Record Loss After $14 Billion Writedown

By Elena Logutenkova and Elizabeth Hester

Jan. 30 (Bloomberg) -- UBS AG posted the biggest loss ever by a bank after raising fourth-quarter writedowns on securities infected by U.S. subprime mortgages to $14 billion.

Europe's largest bank by assets said today it had a net loss of 12.5 billion Swiss francs ($11.4 billion) for the quarter, almost double the median estimate of analysts surveyed by Bloomberg. The annual shortfall was about 4.4 billion francs, the first since Zurich-based UBS was created through a merger a decade ago.

UBS fell 1.6 percent in Swiss trading as its loss exceeded those reported earlier this month by Citigroup Inc. and Merrill Lynch & Co. The collapse of the U.S. subprime mortgage market has led to more than $130 billion of losses and markdowns at securities firms and banks since June.

``One has to question the management's ability to recognize the problems that have existed and continue to exist,'' said Michael Holland, chairman of New York-based Holland & Co., where he oversees more than $4 billion. ``When you're talking about an $11 billion issue and it's Jan. 30, this raises questions about who is watching and what did they know.''


The definition for "Sheeple"

Alexis de Tocqueville warned us:

"The dignity of man is not shattered in a single blow, but slowly softened, bent, and eventually neutered. Men are seldom forced to act, but are constantly restrained from acting. Such power does not destroy outright, but prevents genuine existence. It does not tyrannize immediately, but it dampens, weakens, and ultimately suffocates, until the entire population is reduced to nothing better than a flock of timid, uninspired animals, of which the government is shepherd."


The Daily Reckoning PRESENTS: The effects of a recession on certain aspects of an economy are fairly obvious – stocks go down, unemployment goes up, etc. But what happens to gold if the global economic crisis gets so bad that it trumps any and all inflationary influences and we enter a straight-up deflationary recession? Bud Conrad and David Galland explore...

by Bud Conrad and David Galland

From the 1990s until today, Americans have maintained their lifestyles by borrowing. As the American consumer is about to find out, the bill for that lifestyle is coming due.

So where will that lead the U.S. economy? Simply stated, surveying the landscape of current events, many of which are a direct consequence of excessive debt and an inevitable slowdown in consumer spending, we expect stagflation ahead. Loosely defined, that term refers to a general economic slowdown – a recession – but coupled with rising prices triggered by massive infusions of liquidity into the market.

That liquidity can come from governments – witness the billions upon billions now being thrown into the fray by the world’s central banks – or it can come from, say, some percentage of the 6+ trillion in U.S. dollars held by foreigners coming home to roost. On that latter point, in recent weeks there has been almost daily news about foreign corporations and sovereign wealth funds unloading their greenbacks in exchange for shares in some of America’s largest financial institutions. Doug Casey has correctly pointed out that it is when the trade deficit starts to shrink, which it recently has, that you need to look for cover...because, among other things, it means the tide of U.S. dollars is beginning to wash back up on U.S. shores.

Our view that the stagflationary scenario is the most likely is supported by a steady stream of data. For instance, despite an obvious slowdown in 2007 holiday season shopping, the Bureau of Labor Statistics reports that producer prices in November increased at the fastest rate in 16 years.

Rising prices make a stagflationary environment positive for gold, if for no other reason than that investors reallocate depreciating paper-backed investments into tangibles with a demonstrated ability to float as the intangibles sink.

So, our view remains that we are headed for a stagflation. But what if we are wrong?

What happens if the global economic crisis gets so bad that it trumps any and all inflationary influences and we enter a straight-up deflationary recession?

That is, we are sure, a question on the minds of many gold investors.

Some quick thoughts...

Gold in a Recession

Traditionally, gold has been a safety net against inflation. Inflation is good for gold, a case we don’t need to make again here.

But, in a typical recession, the demand for everything slows and the prices of many things fall. The knee-jerk reaction of most casual market observers, therefore, might be that if inflation is always good for gold, then the opposite is always bad.

Historically, however, that is not the case. The chart below shows the price of gold overlaid against official periods of recession as defined by the National Bureau of Economic Research. As you can see, about half the time gold actually rises in a recession.

(Note: This chart uses monthly averages, so you can see that current prices are, in nominal terms, higher than the 1980 high, based on those averages.)

Simply, there isn’t a specific historical precedent that demonstrates that gold will fall during a recession.

But could we have a general deflation, one that might tip gold into one of the down cycles? Of course.

The developing recession, based as it is on a global contraction in credit, looks to be especially long and deep. Almost daily now we learn of multi-billion-dollar debt defaults. Those, in turn, trigger both a freeze-up in easy credit and a flight from risk.

In response, the government has responded with its predictable “fix-it” tools – stimulus and bailouts. The tools of government stimulus are lowering the Fed funds interest rate, and potential new large-scale bailouts like the Resolution Trust Corporation (RTC) that was put into action to straighten out the Savings and Loan crisis of the 1980s, to the tune of $200 billion. While the Europeans have just unleashed an amazing $500 billion in new liquidity, so far, U.S. Treasury Secretary Paulson and Fed Chairman Bernanke and friends have been surprisingly slow to act. They started with denial and have moved to inadequate Band-Aids.

In the absence of any concentrated and well-funded program – such as the RTC – to try and keep the wheels on (and, at this point, it is not clear that any imaginable measure will suffice), the deflationary pressures of the housing collapse are winning.

But there is an important, longer-cycle pressure that is not talked about much, although it is increasingly obvious to the American consumer: the dollars they’re spending are buying less. They see gasoline and heating prices rise, but don’t think much about the dollar itself as the underlying source of price inflation.

This decline in the purchasing power of the dollar is extremely important for the price of gold. That’s because the pressures on the dollar seem overwhelming when aggregated: huge budget and trade deficits, wars and retirement demands of baby boomers, unprecedented foreign holdings of U.S. dollars. Watching the prices of internationally traded goods, including oil at $90 per barrel and wheat at a record $10 per bushel, it is hard to imagine a situation of serious deflation emerging.

Looking for Alternatives

The flight to quality by investors who no longer trust packages of mortgage loans, or anything that is not strictly labeled as government backed, is unprecedented. The interest rate on government-issued two-year Treasuries dropped to 3%, reflecting the demand for safety. Concurrently, other interest rates have risen in response to increasing mistrust and uncertainty.

Gold, of course, provides a different form of safe harbor alternative – an asset that is not only readily liquid but, unlike government paper, positively correlated with the very same inflation that will erode the purchasing power of paper assets.

Right now, gold is not on the front burner, but this is only to be expected because of the state of flux of global financial markets. Like observers of a war of Titans, the market is confounded by the sheer magnitude of all that is going on, from the devastation being wreaked on the world’s best-known and most established financial institutions, to the unleashing of billions upon billions in experimental new liquidity measures by central banks.

As the fog of war begins to clear and it becomes obvious that not only will economic growth be severely curbed, but that the fiat currencies are going to be sacrificed in the fight, some percentage of the funds now sitting on the sidelines – much of it in U.S. Treasuries – will begin to move into gold and other tangibles. In the face of limited gold supplies, this surge in demand should create strong upward pressure on the price of gold and, for leverage, gold shares.

In sum, even though the relatively sluggish and inept responses from the U.S. government in the face of the current credit crisis could produce a severely slowing economy, creating periods of deflationary fears that put stress on the price of gold, we continue to believe that the most likely case is for massive inflationary bailouts that support a positive outlook for gold.


Bud Conrad and David Galland
for The Daily Reckoning

The Stein is Half Full

Greg’s Note: We know that the U.S. economy is lagging and that we have a huge effect on the rest of the world. Yet how does one major industrialized country stay safe while the rest of the world is being dragged down right with us? Antony Mueller explains how a unified Germany has sustained itself successfully for nearly two decades and whether or not we can expect it to last. Enjoy, and send your comments to the managing editor here:

Whiskey & Gunpowder
January 30, 2008
By Antony Mueller
Caxias Do Sul, Brazil

Stein Half Full

MAYBE YOU HAVE HEARD ABOUT GERMANY as the sick man of Europe. You may also have heard that the German economy is paralyzed by a web of strict labor laws. In contrast, you may have heard less or nothing at all in the news that Germany has been the world’s export champion for the third time in a row — exporting more goods than China, or Japan, or the United States. Private financial wealth in Germany rose to a new high in 2007. Employment is on the rise. No wonder the German stock market has been a top performer in recent years.

I lived in Germany for much of my life and I can assure you that the Germans are very self-critical. Unless it’s not the very best, it can’t be good. As long as there is room for improvement things deserve to be criticized. I recommend that in order to get a correct picture of Germany, don’t listen to what Germans say about their economy; they are consistently negative. Also, don’t read German newspapers to learn about the German economy; they are always pessimistic. To get a more accurate picture, check the economic stats and compare them with stats from other countries.

It is true that after the end of the European unification boom in the late 1990s, the German economy experienced malaise until 2003. The high cost of unification put a huge burden on the people. Domestic demand was weak. Yet in these years of slow growth, German companies did their homework. Today, the German industrial sector is at the top of the world when it comes to modern capital equipment. Infrastructure in East Germany has been has been brought up to Western standards.

German carmakers are household names. So are chemical and electronics multinationals like BASF and Siemens. But these large companies represent only a part of the German economy; mid-sized companies are its backbone. These companies possess very specialized technological know-how. They are extremely competitive and industrial companies all over the world seek their products.

These mid-size companies are behind Germany’s consistently good export performance. Germany’s competitive position rests with companies that seek to continually improve a specific technological niche. Often privately owned, the owner/entrepreneur plays a central role in business decisions. Most of these companies are so specialized that they must have an international focus. They often possess know-how that makes them a worldwide quasi-monopolist in their area of expertise.

Many of these so-called “Mittelstand” companies produce tangible capital equipment. Linked together by a well-established network of cooperation, they are capable of executing large-scale projects — including the planning and construction of whole factories.

The competitive position of “Mittelstand” companies helps them cope with cost increases. Currency appreciation does not hurt them as much as it hurts most other export-oriented companies. The recent strength of the euro has barely affected demand for the products of these companies. This was also the case in the past when the German mark was in a decade-long uptrend.

The German economy will continue to profit from the investment boom in emerging economies. Demand from Asia is only part of the story. German companies are in a leading position when it comes to infrastructure projects in Eastern Europe, Russia, and the Former Soviet Union. Oil rich countries are showing little price sensitivity in their capital equipment orders from Germany. Demand from the Middle East and elsewhere is so high that the order books of many German capital equipment producers are full for years to come.

For these German mid-size companies, a quick hire and fire system is out of the ordinary. Intensive in-house employee training provides the specialization these companies need. Company loyalty is relatively high. Performance hinges on a culture of trust that runs from the top to the bottom.

Nevertheless, structural problems plague the German economy. The welfare state is overextended and the population is ageing. There is a shortage of young engineers. Social contributions and taxes are high. The steep cost of labor has driven German companies to invest in technology and equipment that enhance worker productivity. Like the United States, the market for specialized German labor is tight. German unemployment may be relatively high, but it mainly affects less skilled workers.

An ageing population limits the chance that Germany will experience a new “economic miracle.” Domestic demand should remain relatively soft. And most economists think Germany is too dependent on exports.

Yet they seem to ignore the worldwide appeal of German exports. One can also argue that the boom in emerging market infrastructure is far from over; in fact, it may boom for years and even decades to come. German capital equipment producers enjoy a strong reputation among their emerging market customers. In the eyes of foreign multinational companies, Germany has even regained its position as an attractive place to build manufacturing plants.

If the U.S. downturn worsens, this would hurt German capital equipment makers far less than it would hurt carmakers.

Unlike the U.S. and a few other European countries, a housing bust does not plague Germany. In fact, it had a short housing boom immediately after unification. Since the late 1990s, German real estate has been flat. Some observers criticize Germany for its stagnant domestic consumption. But this was actually a blessing in disguise. Resisting the temptation to artificially stimulate the economy, the government opted for structural reforms instead. High household savings and a more flexible labor market have helped improve the efficiency of the German industrial sector.

Bank credit and the stock market are not as important to the German economy as they are to the U.S. The fallout from the current credit squeeze shouldn’t have much effect on German industrial companies. The same holds for a stock market decline. Among the major industrialized countries, Germany’s economy may be the best equipped to weather the coming storms.

Even if the U.S. officially enters recession, the global economy will not stop in its tracks. The BRICs (Brazil, Russia, India, and China) in particular have a lot of cash to spend. These countries have clear plans to modernize their infrastructure and make their factories more efficient. One major area of investment in these countries will be in environmental protection. German companies are world leaders in the area of environmental technology:

The German stock market, measured by the DAX index, performed well in 2007. This index rose more than 20% even as the euro gained 10% against the U.S. dollar. In the years to come, many a top performers can be found among the smaller companies, even if the major index should decline.

So why things may seem bad here, don’t believe that they are all going wrong for everyone. The Germans might not be the most chipper people in the world, but don’t let their pessimism fool you, things in Germany are all right.

Antony Mueller

Job Description for Rogue Trader

Job Description for "Rogue Trader"

Job Description – Rogue Trader

Position Title (Rogue) Trader. (The “rogue” term is generally not to be used explicitly especially with senior management, directors, shareholders and clients for fear of misunderstanding.)

Reporting Line

The position reports along “functional’ and “geographic” lines to the Head of Trading and Head of the Region. (Nobody, really. A multi-dimensional matrix structure is currently in operation so that everybody reports to several people allowing a total absence of accountability.)

Location Optional. (Some candidates may have a preference for working in head office where total confusion and chaos reigns facilitating successful rogue trading. Other candidates may prefer a remote location where benign neglect and absence of supervision may provide rogue trading opportunities.)

Organisational Environment

? A leading edge investment bank with a global brand, presence in key financial markets, superb product range and unparalleled client list. (Our PR firm told us this.) ? A global trading team trading in a wide variety of cash and synthetic instruments, including a number of “proprietary” structures. (You can lose money pretty much any way you like. There are some trades that even we don’t understand but the models say we are making money). ? Supported by a world class risk management team (they are readily identifiable by their guide dogs) and operational staff and systems (they have been specially chosen for their total ignorance.) ? Excellent career prospects (We have sinecures for everybody who has failed to perform.)

Key Responsibilities

? Trading with the bank’s capital to achieve targeted risk adjusted returns on capital under the bank’s unique Economic Capital Allocation system. (If you are half as smart as you think you are then you will be able to game the system from day 1. Everybody else has.) ? Developing innovative trading strategies. (You need to be able to come up with hare brained trading schemes based on the relationship between the El Nino cycle and market prices.) ? Closely managing trading positions. (You need to be able increase your bet when your position shows losses until you bankrupt the firm.)

Major Challenges

? Develop proper models and valuation procedures (You need to ensure that all pricing models are impossible to understand and give the valuations that you want by simple unverifiable changes in model inputs.) ? Risk management of positions (You will need to fudge all the Greek risk measures. We suggest you start to report risk data in an ancient Nubian dialect that is purely oral. You will ensure that your risk always appears miniscule irrespective of market conditions. People have a tendency to panic otherwise.) ? Monitoring (You will need to be able to disguise breaches by not booking the trades or taking advantage of systems deficiencies.) ? Control losses and volatility of earnings (You must disguise losses either by recording them as amounts owed to you (the Leeson gambit), undertaking off-market trades such as deep in-the-money options (the Rusnak variation) or incorrect valuations (Rogue Trading 101).) ? You need to be able to take the trading function to a new plane. (You need to show larger losses than the last rogue trader the firm employed.)

Selection Criteria

? Detailed knowledge of financial markets and trading techniques. (You should wax lyrically about obscure markets (the Zambian Kwatcho and Islamic finance techniques) and complex mathematics (field theory; neural networks; fractals; Frank copula models). Everybody will think you are a genius or a fool but will be unsure of which.) ? Detailed knowledge of derivatives, including exotic and non-standard structures. (Everybody knows that derivatives allow highly leveraged positions that are impossible to understand or value accurately.) ? No minimum formal educational qualifications or direct previous experience in a similar role is necessary. (Nobody believes your CV. It is merely a statement of your aspirations. Nobody will believe you if you said that you had rogue trading experience.) ? Ability to communicate and work closely with senior management. (You will need to make sure that you generate enough “phantom” profits to make sure their bonus expectations are met.) ? Ability to work closely with operational staff (You must bully them or cajole them into concealing limit breaches and losses.) ? Strong leadership qualities (You will claim all profits are the result of your perspicacious skills. All losses will either disappear or if found will be hedge losses offset against gains in other positions.)

Desirable Criteria

? Preferred age – under 30 years. (Have you ever heard of an old rogue trader? There is an exception for Japanese rogue traders who are generally older.) ? Strong personal qualities. (You will have “attitude”. A year round sun tan and a wisp of beard underneath your chin is good. You will treat everybody around you as idiots incapable of understanding the complex nature of your trading strategies.) ? Highly motivated. (You will need to be able to hide losses and limit breaches. The Japanese rogue traders never took holidays.)


Negotiable including a strong performance linked component. (You don’t need to be paid as it is assumed that you will defalcate ample amounts.)

Social Responsibility Statement

We are proud to be an equal opportunity employer. (We do not discriminate on any basis. How else can you explain the calibre of Directors and Senior Management not to mention risk managers and auditors that we have?)


The above is an extract from Satyajit Das Traders, Guns & Money: Knowns & Unknowns in the Dazzling World of Derivatives (2006; Pearson Education) © 2006 Satyajit Das

Note: The idea is based on a column published by Trevor Sykes (writing as Pierpoint) of the Australian Financial Review [see “Indispensable Guide For Rogue Traders” (30 January 2004) Australian Financial Review] However, the text is different.

Putting it in reverse

Putting it in Reverse
London, England
Wednesday, January 30, 2008


*** Staring out the window, wondering what to do...years away from an ordinary housing market...

*** The demise of manna-like credit card purchases...The light bulbs are going on in Debt Nation...

*** No thanks for the good advice...increased spending of fictional wealth...and more!

Today’s another big day. The 12 members of the Fed’s Open Market Committee will get together in New York and decide what to do. As of this morning, we don’t know what they will do. Our bet is that they don’t either.

Instead, they will do what we do; they will look out the window. Outside the Fed’s meeting room, the war between inflation and deflation continues. As expected, inflation’s gains are so far narrowly focused – on gold and certain global commodities, such as oil . Gold fell back $2 yesterday...but it is at record prices...and beginning to attract wider attention. Even The Wall Street Journal , for example, talks of a “gold rush,” in its headline – quickly warning readers away from it!

Deflation, meanwhile, is advancing on a broad front.

Comes word this morning that the “loss at Countrywide is worse than sinking house market caused more borrowers to fall behind on payments.” Reuters reports that the mortgage lender posted a loss for the fourth quarter of $421 million.

House prices are still falling in Britain and America, where they have just registered another drop for the eleventh month in a row. It’s a “historic bust,” says Robert Shiller.

The CEO of the Ryland Group says it’s the “worst housing market in 30 years.” His competitor over at Lennar reported its biggest quarterly loss in its history, losing $201 million in the fourth quarter of last year.

And the Financial Times says U.S. builders “face a growing bankruptcy threat.”

Ben Bernanke allowed himself a little understatement this week, saying that housing “may be a drag on growth for a good part of this year.” We would say that it will definitely be a drag on growth, and not merely for this year, but for the rest of this decade, if not longer. You can correct the stock market...or the soybeans a couple days. But housing takes time . Houses that were being planned and financed before the housing bubble blew up are still coming on the market today. They are added to already swollen inventories of unsold and foreclosed houses. It will take years to work this inventory down...and years to bring prices down to levels where ordinary buyers can afford ordinary houses.

On that point, former Labor Secretary Robert Reich writes, “America’s middle classes are no longer coping.” He notes that the fixes proposed by Bernanke and Bush will not help much, because the middle classes have run out of “coping mechanisms.” The short version of the story is that the typical man earns less, in real terms, than he did 37 years ago. “The income of a young man in his 30s is now 12 per cent below that of a man his age three decades ago.” Families have struggled to increase their standards of living, first by putting women to work...second, by working longer hours...third, by turning to credit. The workplace is now dominated by over-indebted women who work night and day.

“The typical American now works two weeks more each year than 30 years ago,” says Reich. “Compared with any other advanced nation we are veritable workaholics, putting in 350 more hours a year than the average European, more even than the notoriously industrious Japanese.” And when Americans ran out of time and out of money, they began to borrow with the same vigor that they worked.

“We began to borrow, big time,” says Reich. “With housing prices rising briskly through the 1990s and even faster between 2002 and 2006, we turned our homes into piggy banks through home equity loans. Americans got nearly $250bn worth of home equity every quarter in second mortgages and refinancings. That is nearly 10 per cent of disposable income. With credit cards raining down like manna, we bought plasma television sets, new appliances, vacations.

“With dollars artificially high because foreigners continued to hold them even as the nation sank deeper into debt, we summoned inexpensive goods and services from the rest of the world.”

That final ‘coping mechanism’ has now played itself out. Houses are going down in price. Lenders are wary of credit risks. And foreigners are becoming chary of the dollar too.

So what next? It seems obvious us that the U.S. middle class needs to reverse course. Stop spending so much, stop working so many hours, focus on quality of output and quality of life. In a word: downsize.

Not that people will want to do it at first. But they will have no choice. They need to save for rainy days and retirement. And America needs savings to build factories...and savings to help people learn new trades and new tricks. Yes, dear reader, the light bulbs are finally going on in Debt Nation : you can’t really get rich by borrowing and spending...or even by working day and night parking hedge fund managers’ cars. You get rich by saving, learning and investing. There is no other way.

What this means is a decline in spending...and a decline in Americans’ standards of living. It means a recession too – probably a deep, long recession which the feds will fight every step of the way.

But it is not a battle the feds can win. They cannot really make the situation better with more of their phony cash and credit. That is what caused the problem in the first place. They need to reverse course too...and encourage savings.

Who wants to save when the going rate of return on savings is no higher than the inflation rate? Who wants to buy a U.S. 30-year Treasury bond at 4.28% yield...when the current consumer price inflation level is rising at 4.4% per year?

So here we offer some free advice to the Fed’s Open Market Committee: Don’t cut rates today, raise them. Let the stock market crash. Let the economy retreat. Let the banks go belly-up. Liquidate Wall Street. Liquidate the housing sector. Liquidate bad debts everywhere. Get it over with, so the U.S. middle class can begin building again...after 37 years...on a solid foundation.

We don’t expect any thanks for that advice.

*** Wait a minute, said David Fuller at lunch on Monday, responding to our suggestion of higher interest rates: “When a man is having a heart attack, you don’t lecture him about his bad diet. You can do that later. First, you have to get him back on his feet.”

*** Let’s return to Robert Shiller. His research shows that house prices in America, in real terms, are remarkably stable. For 100 years – from 1890 to 1990 – they went nowhere. In real terms, they barely changed in the entire century. Then, suddenly after 1997, house prices shot up by 71% in real terms.

What this tells us is that housing prices are not likely to remain up so high for too long. Historically, they kept up with inflation, nothing more. America is still a big place; there is no obvious reason why all of a sudden housing should occupy a bigger percentage of the nation’s assets and earnings.

Most likely, the gains of the last 10 years will be given back. But the process is long, slow and hard.

We’re talking about “trillions of dollars, so much bigger than the losses we’ve seen from subprime so far,” says Shiller. He is not talking about the losses in implied wealth by the write-down of America’s housing stock, but about the real losses to financial institutions and investors who have bet on continued housing price increases. As housing rose, ordinary consumers adjusted their spending habits to the increase of wealth they thought they had. Lenders extended them credit – also based on the increase in perceived housing wealth. And then, the mortgage credits were packaged into various derivative instruments and sold all over the world – eventually bankrupting everything from Norwegian fishing towns to French pension funds.

Is it over already? Not likely.

Until tomorrow,

Bill Bonner
The Daily Reckoning

US recession will dwarf dotcom crash

By Edmund Conway, Economics Editor in Davos
Last Updated: 11:48pm GMT 29/01/2008

The recession facing the United States is of a scale that dwarfs the dotcom slump.

  • The latest news and analysis of the credit crisis
  • Stock market turmoil spells trouble ahead
  • Ambrose Evans-Pritchard: Accusations the Fed panicked are rubbish
  • The slowdown will cause a damaging regulation backlash as governments attempt to compensate for the financial pain facing families. Britain faces a similar plight, though it may avoid as deep a slowdown as the US.

    Ben Bernanke
    Fed chariman Ben Bernanke will face criticism whatever he decides on rates

    The views of Stephen Roach, one of the world's leading economists, now heading the Asian wing of Morgan Stanley, would have seemed outrageous at last year's World Economic Forum.

    It is a sign of the times that they are now close to the consensus. This year's event has been dominated by discussions of the stock market slump on both sides of the Atlantic, the Federal Reserve's emergency interest rate cut and the SocGen fraud disaster.

    But underlying everything has been the silent truth that the US is facing a very possible recession, and is fast having to adapt to a far less enjoyable economic climate.

    "We have, as relatively sophisticated, well-developed economies, gotten hooked on credit as never before," said Roach, speaking about the UK and US. "If we had been running our economies the old-fashioned way, for example, where saving and consumption were funded by income, maybe we wouldn't be in this mess we are in now.


    America's meltdown

    America's meltdown

    According to the media, the success of the American economy depends on consumers consuming. Yet experts tell us that Americans no longer have any savings, they have no equity left in their houses, and they have maxed-out their credit cards. Nonetheless, if the economy is going to weather the present storm, Americans must spend and spend lavishly. How exactly are they supposed to do that? And is doing so a good idea?

    If you already can't pay the minimum amount due on your credit cards, is it wise to buy yet a bigger television? Patriotic perhaps, but not in your self-interest.

    Once again, the health and happiness of the average American is being sacrificed so that those in power can continue to make poor choices. Of course, Americans could rise up and refuse to shoulder the whole burden of shoring up the economic house of cards but then when the economy comes crashing down they will be the first to suffer. There has got to be a better solution.

    Martine Cherau Montréal du Gers, France

    Monday, January 28, 2008

    US Slides Into Dangerous 1930s 'Liquidity Trap'

    By Ambrose Evans-Pritchard in Davos

    27/01/08 "
    The Telegraph" -- - The United States is sliding towards a dangerous 1930s-style "liquidity trap" that cannot easily be stopped by drastic cuts in interest rates, Nobel economist Joseph Stiglitz has warned.

    "The biggest fear is that long-term bond rates won't come down in line with short-term rates. We'll have the reverse of what we've seen in recent years, and that is what is frightening the markets," he told the Daily Telegraph, while trudging through ice and snow in Davos.

    "The mechanism of monetary policy is ineffective in these circumstances. I'm not saying it won't work at all: it will help the banking system but the credit squeeze is going to go on because nobody trusts anybody else. The Fed is pushing on a string," he said.

    The grim comments came as markets continued to suffer wild gyrations, reacting to every sign of contagion spreading to Europe, Asia, and emerging markets.

    Wall Street has begun to stabilize on talk of a rescue for the embattled bond insurers, MBIA and Ambac.

    The Fed's 75 basis point rate cut allows the banks to replenish their balance sheet by borrowing at short-term rates and lending longer term, playing the credit 'carry trade', hence the 9pc rise in the US financials index yesterday. But confidence remains fragile.

    Professor Stiglitz, former chair of the White House Council of Economic Advisers, said it takes far too long for monetary policy to work its magic. This will not gain much traction in the midst of a housing crash.

    "People have been drawing home equity out of the houses at a rate of $700bn or $800bn a year. It's been a huge boost to consumption, but that game is now up. House prices are going to continue falling, and lower rates won't stop that this point," he said.

    "As a Keynesian, I'd say the biggest back for the buck in terms of immediate stimulus would be unemployment assistance and tax rebates for the poor. That will feed through quickly, but set against the magnitude of the problem, even a fiscal stimulus package of $150bn is not going to be enough," he said

    "The distress is going to be very severe. Around 2m people have lost all their savings," he did.

    NASDAQ president Bob Greifeld expressed a rare note of optimism at the World Economic Forum, predicting a swift rally as the double effects of the monetary and fiscal boost lift spirits.

    "I think the stimulus package that's been proposed by the President, to the extent that this is passed in rapid fashion by Congress, has the ability to forestall a recession," he said.

    "At the moment, our business is doing better than it ever has because the volumes have been incredibly high. So, it's been very good for us," he said.

    There were scattered signs of improvement across the world today, with Germany's IFO confidence index defying expectations with a slight rise in January. Japan's quarterly export volume held up better than expected.

    Even so, the global downturn may already have acquired an unstoppable momentum, requiring months or even years to purge the excesses from the bubble.

    Professor Stiglitz blamed the whole US economic establishment for failing to regulate the housing and credit markets adequately, allowing huge imbalances to build up.

    "The Federal Reserve and the Bush Administration didn't want to hear anything about these problems. The Fed has finally got around to closing the stable door (on subprime lending), but the after the horse has already bolted," he said.

    © Copyright of Telegraph Media Group Limited 2008

    US mortgage crisis creates ghost town

    Jan 27 02:31 PM US/Eastern
    The streets are empty. Trash rustles down the road past rusted barbecues, abandoned furniture, sagging homes and gardens turned to weed.

    This is Shaker Heights, a suburb of Cleveland and a town ravaged by the subprime mortgage crisis roiling the United States.

    Faded "for sale" signs sit in front of deserted houses. The residents are gone, either in search of new jobs after the factories shut down, or in shame after being evicted for missing their mortgage payments.

    A red, white and blue American flag flies over windows and doors which have been boarded up to keep the drug dealers away.

    Thieves have stripped many homes of the plumbing, the doors, the windows, the aluminum siding.

    The police station parking lot is full. The officers, who have seen their numbers triple since 2006, are coming back from their rounds. They speak of installing alarms in some of the homes claimed by squatters.

    At 9422 Chagrin Street, a hand-scrawled sign attached to a window indicates someone lives there: "Please Used."

    After three rings of the bell, Sarah Evans, 60, opens the door with a mixture of curiosity and alarm.

    She says she is one of the last people left on the street. And she is on the verge of losing this two-bedroom house in which she has lived for more than 30 years because she simply cannot afford her monthly payments.

    It is a complicated story. She refinanced in 2003, but did not realize the document she signed included provisions to radically increase the interest rate.

    She stopped making payments in 2006 and shows her unpaid bills totaling 24,000 dollars.

    Her bank is in the midst of eviction procedures.

    "When folks buy a home they expect to die in it, I guess," she said as she stood outside in the cold. "I had my American Dream but it became a nightmare."

    Her words are echoed by the angry barks of the guard dogs pacing behind a chain link fence two houses away that was installed by the new owner: a bank.

    The massive parking lot of the Eagle Fresh supermarket is empty.

    Behind her till, Myra Bibldwit lifts her head when a bell signals the entrance of a customer.

    "Not many folks come anymore. We're used to it," said the 24-year-old cashier, one of the few in the neighborhood who managed to hold onto her job.

    In the five hours since she started working today she has served just 10 customers. "Maybe you will buy something," she says with a smile.

    Then comes customer number 12.

    Laura Johnston, 50, says that her street -- about 10 minutes away by car -- was alive two years ago. Today, half the houses are abandoned.

    "Folks could not afford their payments. They were asked to pay loans which doubled. They could not afford it, some lost their job. Lenders were greedy. They threw them out of their homes," she told AFP.

    "I'm very upset. I missed my friend Helen. She disappeared overnight. She did not even say goodbye."

    There are plenty of cases like Helen. They are called the neighbors who disappear in the night.

    For county treasurer Jim Rokakis, the greed of the banks is to blame for this man-made disaster.

    "All you needed was a pulse to buy a house. Some loans were written with no money down, no proof of buyer's incomes. They did not even check what people were saying. Most of those folks were jobless," he said in an interview.

    "Shaker Heights was the perfect storm: poor folks, unemployed and a desire to get a piece of the American Dream."

    IMF head in shock fiscal warning

    By Chris Giles and Gillian Tett in Davos

    28/01/08 "
    Financial Times " -- - The intensifying credit crunch is so severe that lower interest rates alone will not be enough “to get out of the turmoil we are in”, Dominique Strauss-Kahn, the managing director of the International Monetary Fund, warned at the weekend.

    In a dramatic volte face for an international body that as recently as the autumn called for “continued fiscal consolidation” in the US, Dominique Strauss-Kahn, the new IMF head, gave a green light for the proposed US fiscal stimulus package and called for other countries to follow suit. “I don’t think we would get rid of the crisis with just monetary tools,” he said, adding “a new fiscal policy is probably today an accurate way to answer the crisis”.

    Mr Strauss-Kahn’s words rip apart a long-standing global consensus that fiscal retrenchment in the US and Japan is needed to help reduce huge trade imbalances.

    It comes as the IMF is due to release new economic forecasts this week which, he said, would show a “serious slowdown and it needs a serious response”.

    The US Federal Reserve starts a regular meeting tomorrow and markets expect another half-point cut on top of the 0.75 percentage-point cut last week.

    Mr Strauss-Kahn’s dramatic change in stance amazed Larry Summers, the former US Treasury secretary. He is known for saying that the IMF stands for “It’s Mostly Fiscal” because the organisation has to be tough with countries’ budgetary laxity.

    But such is his concern about economic prospects if the US slows and other countries do not pick up the slack in world demand that he supported Mr Strauss-Kahn. “This is the first time in 25 years that the IMF managing director has called for an increase in fiscal deficits and I regard this as a recognition of the gravity of the situation that we face,” said Mr Summers.

    The dark economic mood in Davos was reinforced at the weekend by John Thain, the new chief executive of Merrill Lynch, who predicted the problems in subprime mortgage markets would spread to credit card and consumer loans. “It will be a while before you see a return to normality in the banking system,” he said.

    Thomas Russo, vice-chairman of Lehman Brothers, said: “Absent government intervention, the economic picture is very grey but with government intervention you have a decent chance of stabilising the picture.”

    The IMF’s call for countries with strong fiscal positions to loosen their budgets gained approval from Christine Lagarde, the French finance minister, and Palaniappan Chidambaram, the Indian finance minister.

    Ms Lagarde suggested Germany would be a prime candidate for fiscal loosening, while Mr Chidambaram said: “India may have some room, if necessary, for some fiscal stimulus.”

    But in a rare direct reference to China, he called on Beijing to play its part. “China has huge headroom to stimulate domestic consumption.”

    However, it is the global community’s lack of confidence that China will play ball in offsetting a slowing US consumer that makes greater fiscal laxity in many countries appear suddenly appealing.

    But amid a sudden enthusiasm for fiscal stimulus packages, some voiced caution. Professor Ken Rogoff of Harvard University and a former chief economist of the IMF said aggressive fiscal easing generates “more harm than good in most cases”, leading to unsustainable budgetary position that require painful correction in the longer term.

    Copyright The Financial Times Limited 2008

    The Dollar’s Reserve Currency Role is Drawing to an End

    By Paul Craig Roberts

    27/01/08 "ICH" -- -- It is difficult to know where Bush has accomplished the most destruction, the Iraqi economy or the US economy.

    In the current issue of Manufacturing & Technology News, Washington economist Charles McMillion observes that seven years of Bush has seen the federal debt increase by two-thirds while US household debt doubled.

    This massive Keynesian stimulus produced pitiful economic results. Median real income has declined. The labor force participation rate has declined. Job growth has been pathetic, with 28% of the new jobs being in the government sector. All the new private sector jobs are accounted for by private education and health care bureaucracies, bars and restaurants. Three and a quarter million manufacturing jobs and a half million supervisory jobs were lost. The number of manufacturing jobs has fallen to the level of 65 years ago.

    This is the profile of a third world economy.

    The “new economy” has been running a trade deficit in advanced technology products since 2002. The US trade deficit in manufactured goods dwarfs the US trade deficit in oil. The US does not earn enough to pay its import bill, and it doesn’t save enough to finance the government’s budget deficit.

    To finance its deficits, America looks to the kindness of foreigners to continue to accept the outpouring of dollars and dollar-denominated debt.

    The dollars are accepted, because the dollar is the world’s reserve currency.

    At the meeting of the World Economic Forum at Davos, Switzerland, this week, billionaire currency trader George Soros warned that the dollar’s reserve currency role was drawing to an end: “The current crisis is not only the bust that follows the housing boom, it’s basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency. Now the rest of the world is increasingly unwilling to accumulate dollars.”

    If the world is unwilling to continue to accumulate dollars, the US will not be able to finance its trade deficit or its budget deficit. As both are seriously out of balance, the implication is for yet more decline in the dollar’s exchange value and a sharp rise in prices.

    Economists have romanticized globalism, taking delight in the myriad of foreign components in US brand name products. This is fine for a country whose trade is in balance or whose currency has the reserve currency role. It is a terrible dependency for a country such as the US that has been busy at work offshoring its economy while destroying the exchange value of its currency.

    As the dollar sheds value and loses its privileged position as reserve currency, US living standards will take a serious knock.

    If the US government cannot balance its budget by cutting its spending or by raising taxes, the day when it can no longer borrow will see the government paying its bills by printing money like a third world banana republic. Inflation and more exchange rate depreciation will be the order of the day.

    Paul Craig Roberts was Assistant Secretary of the Treasury in the Reagan administration. He was Associate Editor of the Wall Street Journal editorial page and Contributing Editor of National Review. He is coauthor of The Tyranny of Good Intentions.He can be reached at:

    Sunday, January 27, 2008

    Doubts over French bank's version of multi-billion euro scam

    Analysts have expressed doubts over Societe Generale's declaration that a single rogue trader was responsible for the fraud that cost it 4.9 billion euros ($7.1 billion).

    "If you know the control procedures very well, then it is possible to elude them for a few days, maybe a few weeks. But it's hard to believe that he did this for a year," economist Elie Cohen told France-Info radio Friday.

    If the man identified as 31-year-old Jerome Kerviel did manage it alone, it represents "an enormous breakdown" by France's second-largest bank, Cohen said.

    The website of the daily Le Figaro reported Friday that, according to material in the hands of the public prosecutor of the Paris suburb of Nanterre, Kerviel allegedly began his scam in February 2007 and worked it until the middle of January 2008.

    The bank has filed complaints against Kerviel, who began working for Societe Generale in 2000, for bank forgery and the use of forged documents.

    Earlier Friday, the head of France's central bank, the Banque de France, Christian Noyer, said that an investigation into the affair would determine if Kerviel had acted alone and how he had managed to dupe the bank's internal controls without accomplices.

    Many analysts in France and abroad were sceptical that a single trader, no matter how clever, could have carried out such a complex scheme for such a, long period of time without an accomplice or the tacit agreement of the bank's management.

    Some analysts have suggested that the bank gave Kerviel a free hand in the hope he would be able to make up for losses it suffered because of the US subprime crisis.

    On Thursday, Societe Generale also said that it would write down 2.05 billion euros in the fourth quarter of 2007 due to its exposure in the US.

    According to Cohen, Kerviel built up positions of some 50 billion euros in trying to cover a series of losses he had suffered.

    The Paris-based International Herald Tribune reported Friday that the fraud was not detected until last weekend, when auditors in the bank's risk management office noticed a series of fictitious trades on its books.

    Societe Generale then closed out its exposure from Kerviel's trading in a market made volatile by the decision of the US Federal Reserve to cut its benchmark interest rates by three-quarters of a percent.

    Kerviel was immediately dismissed, as were four of his superiors in Societe Generale's equities and derivatives division.

    On Thursday, Noyer and Societe Generale head Daniel Bouton said they had no idea of Kerviel's whereabouts. But an attorney for Kerviel has told several French media that her client was not on the run and was waiting for formal notification of the charges against him.

    The affair has moved several financial institutions to downgrade Societe Generale's shares, the daily Le Monde reported. Germany's Deutsche Bank has changed its recommendation from "buy" to "hold", while the American bank Bear Stearns said that the losses could lead to takeover attempts by competitors.

    On Thursday, following revelation of the scam, Societe Generale shares lost more than four percent of their value. On Friday, following a volatile day of trading, the stock lost another 2.56 percent, finishing at 73.87 euros.

    Since Jan 1, Societe Generale shares have lost more than one-fourth of their value.

    Saturday, January 26, 2008

    At the Edge of the Abyss

    By Gary North

    26/01/08 "LewRockwell" -- - This week has been filled with surprises. It began with bad news for international stock markets. It got rolling with unprecedented news from the Federal Reserve System. It got wild with nutty news from a bureaucrat in New York. Then it settled down to wild swings on the American stock market.

    All in all, this week was a sign that the economy is headed toward the falls. Keep close watch on the canoe 100 yards ahead of you. If, without warning, it disappears, start paddling for the shore. Either shore. Fast.

    On Monday, Americans were home, celebrating the birth of Martin Luther King. Well, maybe not celebrating. But home.

    The American stock markets were closed. That left foreign markets to set the pace. They fell. They looked like they were in free-fall. Then, the next day – day two for them – they fell again, only worse.

    Fifteen minutes before the New York Stock Exchange opened, there was an announcement from the Federal Reserve System. The Federal Open Market Committee had met in secret the night before and had voted, 8 to 1, to lower the target rate for the Federal Funds rate by three quarters of a point: 75 basis points, as they call it in the trade.

    First, this announcement came a week before the scheduled meeting of the FOMC. Second, the FOMC met secretly overnight. This was unprecedented.Third, the rate cut was the largest single cut in over two decades. Fourth, the announcement came 15 minutes before the market opened.

    What does this tell us? This: eight of the nine members of the FOMC thought the stock market was about to collapse. This was a panic move by eight frightened men in the face of a potential panic sell-off by frightened mutual fund managers, on behalf of frightened investors who would start selling as soon as the market opened.

    This is exactly what happened. Sell orders from the day before were executed. The Dow Jones Industrial Average fell like a stone by 450 points. This carried the Dow below its high in March, 2000, officially wiping out all profits for eight years, not counting the 21% loss due to price inflation, i.e., lower purchasing power.

    Then the market turned. Oh, joy: the FOMC had intervened to save the stock market! Up, up, up it went, almost to the opening price. Then it fell 170 points. Then it rebounded almost to break-even. Then it fell. Then it rebounded. Then it fell. It wound up down by 128. Whew! Saved by the FED!

    Overnight (for us), stocks rebounded in Asia (day three). There was one cause: confidence that the FOMC's action would save America from a recession. Asia's markets recovered most of what they had lost for two days.

    This recovery was extremely important, but not for reasons offered. It revealed that Asian stock markets are completely dependent on the Asian investors' perception of America's economy. This means that if the U.S. stock market falls, Asia's stock markets will fall. The economies are interlinked. But America's economy is the tail that wags the dog.


    George Soros doesn't think so. I hate to argue with the multi-billionaire currency futures guru, but what happened this week says he's wrong.

    On Tuesday, he gave a speech in Davos, Switzerland at the annual Davos summit. He said that America is clearly headed for a recession. He also said that Asia isn't.

    He added this: the U.S. dollar is now being abandoned by central banks. It will no longer be the world's exclusive reserve currency. Bloomberg reported:

    "The current crisis is not only the bust that follows the housing boom, it's basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency," Soros said in a debate today at the World Economic Forum in Davos, Switzerland. "Now the rest of the world is increasingly unwilling to accumulate dollars."
    This is true, but this has been going on for several years, as I have noted before. This quiet abandonment of the dollar, not America's price inflation (low) or monetary inflation (zero in recent years – M-1), is why the dollar has been falling and gold has been rising.

    A recession is almost certain in the United States, he said. But he is optimistic about the world's economy.

    "I think it is almost inevitable that the turmoil in the financial markets will affect the real economy," said the founder of New York-based hedge-fund firm Soros Fund Management LLC, which has $17 billion in assets. China and India are benefiting from globalization to a degree that "I don't expect a global recession," he added.

    While I don't control $17 billion in assets – why, not even 10% of this – I think he is wrong. I think what happened early this week indicated how wrong he is. The world's stock markets went into a tailspin on the threat of a U.S. recession. Then most of them recovered because of the supposed ability of the FED to avoid a recession here.

    Why would the stock markets move in lock step if the underlying economies were not so tightly intertwined that a fall in demand from the United States will not spread?

    Here is one possible response: "If China's economy is growing at 10%, why should a 1% or even 2% decline in the U.S. economy pull down China?" Here is my answer.


    China's central bank has already announced that it will take steps the control price inflation. A Reuters story on December 30 announced:

    China's central bank will implement a tight monetary policy in 2008, using a range of tools to keep a check on liquidity, the central bank governor, Zhou Xiaochuan, reaffirmed.

    The People's Bank of China has waged a war on excess liquidity and inflation in 2007, raising interest rates six times and increasing the proportion of deposits that banks must hold in reserve 10 times, to a record level. Still, annual consumer inflation is running at the quickest pace in over a decade, and many economists are concerned that it could spill over from food into the broader economy.

    The imagery of faithful central bankers waging war on inflation is as inspiring as the image of Alan Greenspan waging war on investment bubbles. The economic boom in China has been created in large part by the central bank, which has inflated M-1 at rates in the range of 17% to 19% for years.

    For China's central bankers to warn about price inflation is comparable to the warnings from the Federal Reserve's spokesmen regarding price inflation. In both cases, the central banks are the exclusive cause of the price inflation. From 1938 until now, there has been only one year – 1955 – where America's prices fell, and then by only 1%. That is because the FED has increased the money supply every year since 1933.

    At some point, China's central bank will be successful in slowing price inflation. The economic boom requires ever-larger percentage increases of the money supply. By merely following the policies of the previous year, the central bank will produce a recession. If the central bank is serious about slowing inflation through interest rate increases, it will see its goal achieved. Price inflation will in fact slow. The cause of the slowdown will be a recession in China.

    What could trigger this? A recession in the United States could. Falling demand for the goods produced by China's export sector will produce bankruptcies in China. They will order no more goods and services. These effects will ripple through the Chinese economy. In the absence of the recessionary efforts of central bank policy, these ripples could be contained by growth in the other sectors. But a reduction of Chinese economic growth is already in the pipeline. The central bank's policy of letting interest rates rise is sufficient to create a domestic recession.

    When China goes into recession, assuming the U.S. is also in recession, the whole world will go into recession. This is why I think Soros is wrong. The crisis in the subprime market is spreading to the corporate bond market. The bond insurers are facing bankruptcy. This will lower the ratings of the bonds held by banks all over the world.

    This leads me to Wednesday's stock market reversal.


    The Dow opened Wednesday in panic sell-off mode. It opened at 11,950. It gapped down in one shot to 11,750. Then it fell to 11,700. Then it went back up almost to 11,850. Then it steadily retreated to 11,650. That was just before 1 p.m. Then it reversed. Up, up, up it went. It closed at 12,200. The move was in the range of 600 points, and was reported as such by the press.

    What could cause such a reversal? Only after the market closed did the general public find out.

    At about 1 p.m., there was a report issued by the office of the New York State Insurance Department. The head of the Department had called a meeting of New York bankers, which was beginning. London's Financial Times described what happened next.

    Leading US banks are under pressure from New York state's insurance regulator to provide as much as $15bn to support struggling bond insurers, people familiar with the matter said on Wednesday night.

    Eric Dinallo, New York insurance superintendent, held a two-hour meeting with bank executives on Wednesday and urged them to provide as much as $5bn in initial capital to support the insurers – the largest of which are MBIA and Ambac – and ultimately to commit up to $15bn.

    Consider what this meeting was about. Companies that have issued insurance contracts to cover for losses in bond holdings are now threatened with bankruptcy because of the turmoil in the subprime credit markets and also the huge market called credit default swaps. These companies may not have enough money in reserve to cover the losses. Their stock market value had tumbled. They were facing bankruptcy. (In my view, they still are.)

    Who are the parties who have paid premiums for this insurance? Banks, mainly. Hedge funds are also on the other side of the contracts. If these insurers go belly-up, the market value of the formerly insured bonds will fall. This will create losses for the banks and hedge funds – potentially gigantic losses.

    So, the head of the state insurance department called in bankers – whose portfolios are at risk by the bankruptcy of the insurers – and suggested that the pony up as much as $15 billion to cover the losses of the insurers.

    Got that? The insured are supposed to insure the insurers against loss. Why? Because if the insurers go belly-up, the banks will experience a loss.

    This sounds crazy. But it makes sense under this scenario: the collapse of the bond market threatens the banks by a lot more than $15 billion. If the banks called in are facing losses so huge that $15 billion looks like a bargain, can you visualize what the threat is internationally? After all, the commissioner did not call in banks from outside New York.

    The International Herald Tribune, owned by the New York Times, reported on January 24 that the threat of default is creating widespread concern.

    Regulators fear a possible chain of events in which the troubled bond insurers, MBIA and Ambac, might be unable to keep their promise to pay investors if borrowers default on their debt.

    That could leave the buyers of the bonds – including many banks and pension funds – on the hook for untold billions of dollars in losses, shaking confidence in the financial system.

    It was in this context that the discussion of a $15b bail-out took place.

    The notion that the failure of even one big bond insurer might touch off a chain reaction of losses across the financial world has unnerved Wall Street and Washington. It was a factor in the Federal Reserve's decision on Tuesday to calm investors by reducing interest rates by three-quarters of a point, to 3.5 percent.

    The bond-insurance industry has never before been threatened by a failure of major bond insurers. It has been a low-risk industry, the article reports. Not any more.

    "Regulators are furiously trying to come up with a plan," said Rob Haines, an analyst at CreditSights, a research firm, who was not at the meeting. . . .

    While $15 billion might seem like a large amount of money for banks to commit to bond guarantors at a time when many investors have lost faith in them, Haines said it would be smaller than the billions the banks might have to write down if the companies lost their top ratings or incurred major losses.

    "It's a calculated kind of risk," he said.

    A spokesman for Ambac did not return calls seeking comment. A spokeswoman for MBIA declined to comment.

    What are we talking about in terms of potential losses?

    MBIA has estimated that in the worst case, which it described as a one in 10,000 event, it expects to incur losses of $10 billion, a fraction of the $673 billion it has insured.

    I don't know about you, but when I read "$673 billion," insured by a single company in the industry, I grow nervous. Sorry, but I do.

    I also think: "What kind of people paid premiums to a company to insure $673 billion worth of bonds?"

    Answer: the best and the brightest, the people whose decisions have laid the foundations of the present crisis, which, if it occurs, will re-shape the world's economic system. You know: people like Charles Prince, the former CEO of America's second largest bank, under whose administration, Citigroup has lost (so far) an admitted $18 billion.

    My conclusion: The international capital markets are at the edge of the abyss.

    The article in the Financial Times added this information.

    People familiar with the matter said the specifics of a possible capital infusion had yet to be decided, but contributions would not necessarily be based on how much exposure each bank has to bond insurers.

    Some participants in the meeting described the discussions as at an early stage.

    Let me summarize. A bureaucrat in charge of regulating MBIA calls in New York bankers to discuss a bail-out totalling (initially) $15 billion. There are no specifics announced. This is only a preliminary discussion. Result: the Dow rises almost 600 points in the afternoon.

    If you think stock mutual fund managers were ready to grasp at straws, you have the picture.


    We appear to be in the early phase of a financial earthquake that will get into the history textbooks. The volatility of the American stock market indicates something severe, yet at present is being contained. Contained by what? By rumors and hope.

    I do not suggest that you entrust your financial future to people who invest in terms of rumors and hope. These are the same people who advised clients that they should hold a balanced portfolio of American stocks back in early March of 2000. That portfolio is lower today by 21% due to price inflation, and if the portfolio was the S&P 500, lower by an additional 15% because of recent market declines.

    The bad news is just getting rolling.

    Stay tuned.

    Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.