Agora Financial’s Rude Awakening

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Dubai, UAE

• Fannie Mae and Freddie Mac heading for the falls,
• America goes up for auction…and the bids roll in from the east,
• Just how big is a $12 trillion problem? All that and more…   

Joel Bowman, reporting from Dubai in the Persian Gulf…

Concerned with the wild rapids of the Fannie and Freddie fiasco, the embattled firms joined hands with government officials, lawmakers and regulators over the weekend to do the only thing they know how to do: open the floodgates.

To back up a little, Fannie Mae and Freddie Mac are Government Sponsored Enterprises. The sole mission of GSEs is to facilitate the flow of credit into targeted sectors of the economy, thereby stimulating these sectors in times of “perceived need.” For Fannie and Freddie, that sector is, alas, the mortgage sector.

Pumping credit into the mortgage system was profitable business…as long as housing prices were going up. When Mr. Jones saw that Mr. Smith’s little investment property had doubled in value earlier in the decade, he wanted a piece of the action too. So he took out another mortgage and bought a little nest egg condo for himself. And so did millions of other Mr. Jones’ and Mr. Smith’s across America.

It’s easy to see how delusion is good for the credit business. The two behemoths became so nifty at the whole mortgage charade they grew to own or finance almost half of the $12 trillion of U.S. mortgages.

But then something happened that was NEVER supposed to happen. Houses didn’t go up anymore. After a wave of adjustable rate mortgages hit their 2-year reset buttons and millions of foreclosed properties choked up the nation’s inventory, Mr. Jones found he couldn’t liquidate his little nest egg…at least not for the exorbitant profit he had hoped for.

All of a sudden, there were more houses than there were idiots to buy them. Delusion started to dry up. Fear set in. But the credit floodgates had been opened too wide and too many people were already swept into the rapids.

“As lenders retreated from the housing market,” Bloomberg explains, “Washington- based Fannie Mae and McLean, Virginia-based Freddie Mac [grew] to account for more than 80 percent of the home loans packaged into securities.”

And now, dear investor, Fannie and Freddie, along with millions of Mr. Smiths and Mr. Joneses, are headed for the falls.

Our colleague Dan Denning, editor of the Australian Daily Reckoning, puts the whole emergency in perspective for us.

“[J]ust to be clear, the collapse of Bear Stearns and the whole credit crisis would look like mere child’s play should a genuine crisis unfold in the quality of the debt owned and guaranteed by Fannie Mae and Freddie Mac.

“The insolvency of the GSEs,” continues Dan, “is as close as you’re ever going to want to get to Financial Doomsday and live to tell about it.”

After Fannie and Freddie lost about half their value last week, an emergency meeting of the minds was called. The result? More credit and easier access to it. The Federal Reserve authorized the firms to borrow directly from the central bank and Treasury Secretary Hank Paulson “proposed that Congress
enact legislation giving the Treasury temporary authority to buy equity ‘if needed’ in the firms, and to increase their lines of credit with the department from $2.25 billion each,” says the newswire.

While American homeowners cling desperately to their inner tubes, a vast transfer of wealth from west to east is also just getting under way. Bill Bonner explains below how a mad money policy is redirecting the flow of funds to where American’s least need it in this time of crisis…into the coffers of foreign banks. Enjoy…

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The Great Wealth Migration
By Bill Bonner

Last week began with alarm bells. First Bridgewater Associates broke the glass and pulled the handle; it said the conflagration in the credit markets might lead to losses four times higher than previous estimates – at $1.6 trillion. A lot of money – even for someone who lives in London.

Bridgewater helpfully pointed out that this was just the beginning; the world would lose an additional $12 trillion in foregone credit. When the going is good, each ounce of a bank’s share capital grows into as much as a pound of credit available to borrowers. But when the cycle turns, the shrinkage takes your breath away. Remove a dollar from a bank’s balance sheet and you wipe out a ten-spot of credit. Bad news for people in Britain and America who are accustomed to living off of credit. Bad news for their economies, too. Without access to the fire hose of easy credit, the consumer economy goes up in smoke.

To give you an idea of the scale of a $12 trillion problem, the entire U.K. economy generates only $2.8 trillion of output annually. The U.S. economy – at $13.8 trillion – is only slightly bigger than the anticipated damage.

When the alarums quieted and the flames died down, hopeful analysts sifted the ruins and wondered where the City and Wall Street might find the resources to restock their shelves. Suddenly, all heads rocked towards the East. Visions of myrrh and incense danced before their greedy eyes. Sultans as rich as Croesus…oil sheiks with sand dunes for brains…maharajas of motor industries and mandarins of manufacturing. Enriched by the black gold flowing from deep holes in Arabia…or from commerce on the trade routes between Hong Kong and Long Beach, these princes of modern finance have trillions. Surely they will come to the aid of those who had made them rich?

The gist of the following reflection is this: no, they won’t. Just because people are rich doesn’t mean they are stupid.

Outside the Bank of England and the U.S. Fed lies some $5.3 trillion in central bank reserves. In foreign government pension reserves and other accounts is another $6.1 trillion. Add $3 trillion more now in the hands of Sovereign Wealth Funds. The IMF says these SWFs will grow to $12 trillion within four years. Morgan Stanley estimates a $17.5 trillion pot by 2017. Altogether, this is enough moolah to buy control of every public company in Britain and America combined.

Few people bother to ask where they got all that money. Never mind, we will answer the question anyway: it is the fruit of a monumental hornswoggle.

“It is the biggest transfer of wealth in history,” says T. Boone Pickens, speaking of the oil trade. Americans alone import 3.6 billion barrels of oil a year. In 2003, the tab for all that goo was only about $70 billion. At today’s oil price, it is pushing half a trillion.

A quarter of oil’s price increase since 2003 was because the dollar skidded against foreign currencies. What about the other 75%? That too, is probably largely a feature of a slippery dollar. For the last 100 years, the oil price has greased along – more or less – with U.S. money supply growth. As M3 increased, so did the price of oil. Currently, the money supply – as measured by M3 – is increasing at an annual rate of about 18%. Oil is going up – on a 10-year moving average basis – about 23% per year. Looked at another way, from 1974 to the present, the price of oil has gone up a bit more than 14 times. The U.S. money supply, meanwhile, has gone up a bit more than 11 times.

What does this mean? Oil is probably overpriced. But don’t worry, Mr. Market will sort that out. Just don’t get distracted. This is one of the funniest and most perverse scenes in modern finance; it would be a shame to miss it. In effect, the world’s most sophisticated capitalists are also the dumbest
when it comes to money. America and Britain spent too much money. Now, they owe more money to more people than any nations ever did before. Once, they owned the world; now the world owns them. And now, the U.S. central bank inflates in order to try to rescue its errant banks, reckless spenders and condo speculators. But in the global economy, the easy money won’t stay put. Instead, it seeps over to oil sheiks in the Near East to pay for petrol…or over to the sweatshop operators in Far East to pay for electronic gadgets and designer T-shirts. It doesn’t stimulate the U.S. economy, in other words; it stimulates the foreigners’ economies and raises prices for everyone, including themselves. Unfortunately, while the foreigners earn more money and can keep up with rising prices – incomes in India are up 148% since 2001 – the Anglo-saxons’ wages are stagnant. Americans haven’t had a real wage increase in 40 years.

And now the lynchpins of leveraged finance are praying that the cash they spent on imports will come back to them. And it will. But it comes back like a young man who got rich in the colonies…with better clothes and a sniffy air. It left a servant; it comes back a master, buying up valuable assets and expecting the indigenes of Wall Street to shine its shoes. Foreign purchases of U.S. assets rose 90% last year. Foreigners are bidding for America’s leading brewery, Britain’s stock exchange, hedge funds, infrastructure projects and technology companies. A Chinese company bought MG. An SWF from
the Gulf bought the emblematic Chrysler in New York. A Russian who got rich in fertilizer bought Donald Trump’s Palm Beach mansion for $100 million. And the balance sheet of the U.S. Fed shows $2.3 trillion of US treasury debt held in custody for foreign central banks.

The harder the Fed fights the correction…the more money and credit it puts out. This monetary inflation causes prices for oil and imports to rise…and more money goes into foreign reserves and Sovereign Wealth Funds in the East, to be used to buy more assets in the West. Thanks to America’s mad monetary policy, these private assets are being taken into public ownership. Some of America’s most important properties are being nationalized…but by other nations.

[Joel's Note: Bill Bonner is the founder and editor of The Daily Reckoning . He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now by clicking here: Mobs, Messiahs and Markets

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[Rude Endnote: Last week we attended another meeting of the minds in Vienna, Austria. Without the requisite delusion (or invitation) to attend a central banker’s convention, we opted instead for a seat at the inaugural conference of the School for Austrian Economic Thought. These fellows, it turns out, have been warning against ceding control of the economy to central bankers for some time now. And with such an unpopular, rational economic approach, it’s no wonder the crowd consisted of only a handful of leading intellectuals, entrepreneurs and successful businessmen and women.

Some dear friends of Agora Financial’s organized the event and we were only too pleased to escape the heat of Dubai for a cool European weekend. Chris Mayer of Capital & Crisis and Addison Wiggin, our executive publisher, were also in attendance.

Between sessions, we took lunch in the magnificent hall adjacent to the conference room. Staring at the vaulted ceilings and decorative finishing we were for a moment transported back to a time when Ludwig Von Mises himself may have debated with his contemporaries in this very room. By far the least educated of the crowd, we strained in our attempt to make out what the wise old economists were saying. The debate grew louder until we realized that one of the presenting professors was talking to us.

“It’s a dangerous time,” he said with a solemnity reserved for rooms with vaulted ceilings and marble archways. “The coming crisis may force the pervasive economic thought towards a more rational approach…”

And here he lingered in thought for a while; perhaps listening for the same lessons we had tried to eavesdrop on a moment ago. Then, resolutely, he remarked, “Then again, such epic failures tend to lead to more of the same poison, masquerading as the antidote until the whole thing comes crashing down.”

Perhaps we’ll have another glass of wine, we thought. And so we did.

Until tomorrow…  

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com