Agora Financial’s Rude Awakening

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Ouzilly, France

• Modern central banking: One part practical politics, one part financial hocus-pocus, and one part incomprehensible,
• “Liquidate labour, liquidate stocks, liquidate the farmers, and liquidate real estate.”
• A word from Joe Borrower, Anytown, U.S.A., and plenty more…

Joe Borrower, reporting from Anytown, U.S.A….

Yesterday my wife asked me for a loan…another one. I said yes. I should have been a central banker.

The trick to the central banking game, it seems to me, is to find the people who are least likely to repay you. Then you simply extend their line of credit, sit back and observe a job well done.

Take Mr. Bernanke, for example. His plan starts where all good plans start: at the beginning.

America’s sub-prime borrowers are deserting their mortgage repayments in droves. Defaults and foreclosures are at record highs from Long Island to Long Beach. After the bust of the tech bubble, the Federal Reserve lowered interest rates. This made it easier for everyone to get free money. Borrowers got away with no-doc, interest only loans for a few years. Some of them didn’t even have jobs! And what’s more, there are hundreds of thousands of adjustable rate mortgages that are going to reset in the next 6-months. That means even more people will be stretched beyond their limits. Finding someone who won’t repay you ought to be a cinch.

But Mr. Bernanke isn’t just a small time banker…he’s chairman of the biggest bank of them all, the Federal Reserve. That means he only goes after the big fish.

You see, all these small time borrowers got their money from specialized lenders, like Countrywide Financial Corp. These Countrywide guys are excellent at spotting people that won’t repay them. Just this year, for example, so many people weren’t able to repay them that Countrywide almost got to close their business and head to the golf course. Almost.

Anyway, there are plenty of other banks that have been working overtime to give money to people who won’t repay them. Just about everyone’s in on it.

Of course, it wasn’t long before the fellows in New York got ear of all the fun.

So many people up there were keen on lending money to people that won’t repay them, Wall Street had to devise ways of splitting up the candidates. In the interest of being fair, they cut up all the debt and repackaged it so the good borrowers got mixed up with the bad borrowers. They call these packages collateralized debt obligations. All the fanciest hedge funds have them nowadays. This way nobody misses out on owning debt that will never be repaid.

Everyone got so carried away with all the excitement that now even banks and hedge funds can’t repay their loans anymore.

Sensing an opportunity to bag the biggest jackpot of all time, Mr. Bernanke cut rates last week, making it cheaper for everyone to borrow again. What’s more, Mr. Bernanke is printing more money, making everyone’s borrowed dollars worth less and less. Soon the whole country won’t be able to repay their debt and Mr. Bernanke will prove he’s the smartest man in the whole world.

Joel Bowman, with a quick word from Dubai…

In the column below, Bill Bonner examines the insidious epidemic of easy credit. Read on and see how the past is doomed to repeat itself…

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Jolly Rotten
By Bill Bonner

Too much credit caused today’s credit problems…but here comes more!

Modern central bank management, like Caesar’s Gaul, can be divided into three parts: One part practical politics, one part financial hocus-pocus, and one part incomprehensible. To an economist with a sense of humor, this past week was particularly entertaining – we got to see them all.

“Liquidate labour, liquidate stocks, liquidate the farmers, and liquidate real estate.” That was the advice of Andrew Mellon, U.S. treasury secretary in 1929. Mr. Mellon wasn’t being mean; he was merely trying to make things better. “It will purge the rottenness out of the system,” he explained.

He meant that there were too many people who had put too much money into too many losing propositions. The Roaring ’20s were very lucky years for Americans. Automobiles rolled off assembly lines. Electrical appliances sold like computer games. And the financial sector was more dynamic and innovative than ever before. Huge new inflows of capital created a boom on Wall Street; while new industries coast-to-coast – including the film industry in California – were making ordinary Americans rich. Almost everything they tried – from installment credit to jitterbugging – seemed to work.

From strength to strength…to catastrophe. The crash came. The credit markets seized up. Risk was re-priced, upwards. Assets were re-priced, downward. The U.S. economy contracted 30%.

Sixty years later, a similarly dizzy boom hit Japan like a typhoon. In the ’80s, the island nation was the envy of the world. Western consumers first learned to say Japanese words such as Toyota and Honda. Then, business executives in New York and London worked on words such as “kaitzen” and “zaitech.” Then, the Nikkei Dow cracked in January of 1990… and we went back to speaking English. Even now, 17 years later, the Japanese economy has still not recovered its “bonsai!” Vigor.

Financial authorities in both the United States and the United Kingdom know the stories well. They’re determined not to relive them. At least, that is the popular interpretation of this week’s major events. Economists have made another 80 years of progress, they say; now they can avoid these problems. So, when it began to feel like Wall Street in ‘29…or Tokyo in ‘90, central bankers knew just what to do.

The credit cycle is still more or less the same as it was in Mellon’s day. When people are flush they worry about the return on their money. When the credit turns down, they worry about the return of their money. But the art of central banking has evolved. Practical politics comes into play much faster; hardly any government outside of Buenos Aires can afford to let schoolteachers and retired plumbers lose their savings and their houses. Not with the TV cameras rolling. Hocus-pocus plays a larger role too; problems disappear like magic. “Do you see any rottenness,” Ben Bernanke might have asked British Chancellor Alistair Darling. “I don’t see any.” In the 21st century, central banking authorities would rather poke their eyes out than see any rottenness.

Seeing nothing to purge, they got down to work. In the U.K., where debt per capita is nearly three times the U.S., Chancellor Darling took just four days to make up his mind. Then, he stepped before the cameras to put the government squarely behind troubled mortgage lender Northern Rock. The conservatives accused him of being “a bit slow” and said they would have given depositors a 100% guarantee as soon as the problems came to light.

But what sort of financial quackery is this? Who else should take the loss than those who asked for it? Safe, British fixed-rate income bonds yield about 5.3%. Northern Rock offers a fixed rate of 6.2%. Take the risk out of the calculation and you make fools of the fellows who bought the prudent income bonds, and chumps out of the rest of us.

Meanwhile, in America, the central bank opened its discount window weeks ago – and practically forced Bank of America and Citigroup to take some money. And then, on Tuesday, the Fed abandoned four years of inflation-fighting and took its troops over to the other side. Now, by cutting the Fed funds rate by a half a point, its fondest desire is that consumer prices are higher tomorrow than they were today. It will get its wish, we predict.

This latest bit of price fixing made the front pages all over the world. Investors celebrated. “Euphoria after half-point cut,” said a Financial TIMES headline. But bad investments do not disappear just because the central banks lend more money to the people who made them. Nor do problems caused by too much credit disappear when you make more credit available. Householders have mortgages they can’t afford; 15% of America’s sub-prime mortgage payments are still late. (Measured by housing prices, Britain’s housing bubble is twice as large as the U.S. bubble.) Billions of asset-backed securities are still worth probably considerably less than they paid for them. Nor is there any noticeable decline in business, consumer or government debt (at least, when measured in the currency in which it was lent).

What is different is that instead of permitting reckless speculators to get what they’ve got coming, losses will be socialized – redistributed to consumers, investors and savers all over the world. And instead of allowing the market to liquidate weak companies and remove the rot, the rottenness is jolly well encouraged to spread. Instead of the needed liquidation, in other words…we will get more liquidity…the damp, after-shower conditions that caused markets to slip-up in the first place.

Progress in science and technology may be incremental. But in love and central banking, it is largely an illusion.

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Rude Endnote: Since Mr. Bernanke’s rate slash last Tuesday, gold, oil, and the euro have all rallied hard. Today the greenback slipped to new lows against the pound and the euro. It will now cost you about USD$2.02 for a pound and USD$1.42 for Europe’s preferred currency.

That’s great news for English tourists wanting to take a vacation to the Big Apple…bad news for American’s who have to fill their tanks with $82 barrels of oil.

There seems to be no end in sight for the beleaguered buck. Perhaps Mr. Bernanke isn’t the smartest man in the world after all.

Of course, you don’t have to suffer in silence as the value of your paycheck evaporates. You can invest in shiny, yellow gold as it rockets toward new highs. The folks over at Outstanding Investments have five ways you can play the trend including one they call “zero-downside gold.” For this fascinating report, read here: Gold $2000

The lads on our Baltimore desk will be along with all the intraday action with your 5 Minute Forecast shortly. That’s all from us.

Cheers,

Joel Bowman
Rude Awakening