Agora Financial’s Rude Awakening

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Dubai, UAE

• An Investment bank’s nightmare on Wall Street,
• Paulson’s bailout plan swells in typical government budgetary fashion,
• $500 billion, $700 billion, $2.4 TRILLION…and counting…

Joel Bowman, reporting from Dubai in the Persian Gulf…

Let’s start at $500 billion. Why? That was the figure Paulson’s emergency elixir was thought to cost…as recently as Friday. In a characteristically misguided effort to restore calm to the markets, the federal government proposed a plan that involved purchasing a half trillion dollars of carcinogenic mortgage-backed assets. 

The very same toxins that brought three of Wall Street’s Big Five to their knees (Bear Sterns, Lehman Bros. and Merrill Lynch) would, under the proposal, find their way onto the balance sheet of the United States Treasury. Given the state’s abysmal accounting record (think Social Security, Medicaid, Medicare and the largest national debt in the history) we should have been wary of the emergency plan’s budget from the get go.

By the time we wrote to you over the weekend, that figure had already ballooned to $700 billion.  Bloomberg provided the details:

“The Bush administration sought unchecked power from Congress to buy $700 billion in bad mortgage investments from financial companies in what would be an unprecedented government intrusion into the markets.

The article went on to call the government’s move “the most far-reaching federal intrusion into markets since the Great Depression.”

A couple of weeks ago we joked that the next illogical move for the government would be to step in and take over debts and obligations of hairdressers and private salon owners. As events continue to unfold, we find our ability to utilize comedic hyperbole increasingly undermined.

Now, as if infected by some mutant strain of elephantitis, the emergency plan could swell to well over $2 TRILLION.

Today we learn that the Treasury Department has suggested the new program include a much wider variety of asset-backed securities.

“The change suggests the inclusion of instruments such as car and student loans, credit-card debt and any other troubled asset,” Bloomberg reveals. “That may force an eventual increase in the size of the package as Democrats and Republicans in Congress negotiate the final legislation with the Bush administration…”

Just to give you an idea of the size of the ballpark, we offer a chart Dan Denning of the Australian Daily Reckoning kindly forwarded to us this morning.

[The number you’re looking for is the one in the bottom right corner.]

“That means that though he’s only asked for $700 billion up-front to deal with the bad assets, the Paulson plan could eventually require as much as $2 to $3 trillion in new Treasury money to buy asset-backed securities,” reckons Dan.

One of the many questions here, at least for reasonable human beings, is whether or not the government can revive the nation’s economy by saddling its citizens with heretofore unseen levels of new debt. The shift from private liability to public shackle begs another question too, namely, where will all this money come from? Given that the government can really only turn to tax revenue or the printing press, the answer, simply and regrettably, is “You and I.”

Capitalism, it seems, is fast turning into the goose that laid the golden egg…with Paulson & Co. steadying up its head on the chopping block.

In the column that follows [originally published last Friday], Bill Bonner harkens back to a time when the dumbest man in France literally lost his head for thwarting the efforts and progress of his citizenry by saddling them with insurmountable debt. From (at least) a financial perspective, the similarity to today’s environment is striking. For those who choose to ignore history’s warnings, fate’s guillotine hangs by a thread above their necks. Details below…

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The Dumbest Man in America
By Bill Bonner

Where did he go wrong? The question probably crossed his mind…perhaps even when he mounted the scaffold on January 21, 1793. The Bourbons had been the most successful family in Europe. They had ruled Europe’s biggest and richest country since Henry IV. And now they were on thrones all over Europe. But in the language of the City, Louis 16th blew himself up. He was supposed to be an absolute monarch. Ah…there was the dynamite! He believed it.

He had surrounded the Parliament with troops and turned the country against him. And now, he had absolutely no control over anything. Not even the power to save his own skin.

“Sire, you have committed something worse than a crime; you have committed an error…” Talleyrand might have told him. Poor Louis! He already had the bag over his head. And the blade at his neck. He must have felt like the dumbest man in France.

Dick Fuld must have felt pretty dumb too. His firm had survived the Civil War, the Railroad Bankruptcies of the late 19th century, the Bankers’ Panic of 1907, the Crash of ’29, the Great Depression, WWII, the Cold War; Lehman Bros. had outlasted spats, prohibition and disco music. But it couldn’t keep its head through the biggest financial boom in history.

John Edwards, recently claimed the title of the “dumbest man in America,” when the press got wind that he was two-timing his wife and running for president at the same time. But Edwards has more competition every day. By Monday of this week, Fuld had completely destroyed Lehman Bros. In January of 2007, the financial industry put a value on the firm – a company it knew well – of $48 billion. This week, the bid went to zero. And then, on Wednesday, came more disquieting news: the world’s largest insurance company, AIG, was failing. Martin Sullivan had run it into the ground, said the analysts. Now, it needed an $85 billion bailout.

There was no one there to bail out Louis when he needed it. France was not too big to fail; it was too big to bail out. And everything had been going so well! When Jacques Turgot was Controller-General, he was getting rid of the internal customs barriers, lifting price controls, abolishing the trade guilds and the corvee (the system of forced labor used to build roads). The political system was being reformed too – evolving towards a parliamentary democracy.

But along came those plucky Americans to stir up trouble. They sucked France into war with Britain. France supplied money, materiel and troops – landing 5,000 soldiers in Rhode Island and ultimately winning the war by blockading Lord Cornwallis at Yorktown.

“The first shot will drive the state to bankruptcy,” Turgot warned the king. He was right. By 1786, the French were in desperate straits, with half the population of Paris unemployed and a national debt equal to 80% of GDP. The French were counting on the Americans to begin repaying their $7 million in loans, but the United States was broke too. And soon, French credit was so bad, the king could no longer borrow from the moneylenders in Amsterdam nor even from his own creditors in Paris. Having borrowed too much, Louis no longer had any room to maneuver. All he could do was to march up the scaffold steps like a real monarch…

And now the heads roll on Wall Street. James Cayne at Bear Stearns. Stanley O’Neal at Merrill Lynch. Charles Prince of Citigroup. But who’s the dumbest? Surely Dan Mudd and Dick Syron at Fannie and Freddie are still in the running. Even with the deck stacked in their favor, they couldn’t stay in the game. And let’s not forget the rescuers – Ben Bernanke and Hank Paulson. They’ve practically nationalized not only America’s mortgage industry…but, taking an 80% stake in AIG, the insurance industry too! Where does the money come from?

It’s borrowed too – hundreds of billions worth. Surely, there’s a guillotine waiting for them somewhere.

The last 15 years have been too kind to finance. Wall Street and the City are essentially debt mongers; and in the boom, nobody didn’t want to borrow. Financial profits soared. Since 1980 the profits of the U.S. financial sector as a portion of GDP have gone up 200%.

Industry owners and managers could have taken their money off the table and retired to Greenwich. But on the back of this outsize success grew a monstrous hump of self-delusion; the masters of the universe began to believe their own grotesque guff. The financial markets were perfect, said the academics. All-knowing and all-seeing, they wouldn’t make a mistake. And the chiefs at the big financial firm must have thought they supped with the gods themselves; they had the paychecks to prove it.

Of course, some Wall Street bosses were more cunning than others. In selling itself to Bank of America, for example, Merrill Lynch dodges the scaffold; but it becomes a ward of the state, almost like Fannie and Freddie before they were kidnapped outright. Bank of America has easy access to Fed funds; Merrill figures it might need more money too.

The old regime on Wall Street was dominated by just five large investment companies. But the more they talked their own books, they more they came to think it was true – they were all too big, too smart and too rich to fail. Not only did they package and sell explosive packages of debt; they put the stuff in their own vaults too. Now, Lehman, Bear, and Merrill have blown themselves up. Only two more to go.

[Joel’s Note: During the ’29 crash, the Dow Jones Industrial Average almost halved in value, plummeting from near 380 points at the beginning of September to below 200 in just a few harrowing months. That epic crash, let us not forget, was survived by Lehman Bros. As we now know, the nation’s fourth largest investment bank was not so deft at avoiding the blade this time.

Then AIG, formerly the world’s 18th largest company and founded in 1919 also bit the dust. On would rightly feel inclined to ask what kind of crisis are we in for if these guys can’t hold it together?

Nobody knows precisely how savage today’s market tumult will be, nor how many billions of shareholder dollars will be wiped out in the process. Could we see a repeat the magnitude of 1929, in which the Dow would fall to approximately 6,000 before Christmas? Could it be, as few dare to predict, even worse than that?

Perhaps saddling Joe Taxpayer with hundreds of billions in bailouts will calm the markets for a while. But will they turn bad debts good? And will the masses stand for it if the bailout fails? They’ve already banned short selling for financials (Australia banned it across the board!) and poured as yet unearned money into the emergency slush fund…what if it doesn’t work? What then for the once mighty greenback?

One gets the feeling a few more heads will be marching up the scaffolding before long.

If there were ever a time to protect your money, NOW is it. We’ve been singing gold’s praises at the ultimate catastrophe-hedge in these pages for a while now, but for many, knowing where exactly to start is a little daunting. Do you go for the GLD ETF? How about shares in mining companies? What about options or futures contracts? Or is it best to simply stuff coins under your pillows?

The strategy you employ to protect your wealth will depend on your own individual circumstances. If you are interested in securing a portion of your wealth in gold, we recommend you check out the Gold & Options Trader. Dedicated to gold investing, the Agora Financial’s Gold & Option’s Trader covers all the bases mentioned above for you and includes regular commentary and trend analysis of our favorite precious metal.

The coming months could get very ugly, but there are plenty of ways to protect your financial security by investing in gold. To learn more, read on here.

The Dow kicks off the week’s trading at 11, 388 points this morning while the S&P will start from 1,255. Gold, meanwhile, continues its bull run, up another $11 as we write at around $880. Oil, conspicuously absent from the front-page headlines of late, also inched higher. A barrel of the world’s grease goes for about $106.

Until tomorrow…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com

P.S. Just as we are going to print, we read that Wall Street’s two remaining mega investment banks, Goldman Sachs and JPMorgan, are now banking holding companies. This marks an end to the investment banking era and screams, in a not-too-subtle voice: Get Your Gold Man!!!