The lastest from Dr. Michael Hudson

Finance Capitalism Hits a Wall

The Oligarchs’ Escape Plan – at the Treasury’s Expense

By Prof. Michael Hudson

The financial “wealth creation” game is over. Economies emerged from World War II relatively free of debt, but the 60-year global run-up has run its course. Finance capitalism is in a state of collapse, and marginal palliatives cannot revive it. The U.S. economy cannot “inflate its way out of debt,” because this would collapse the dollar and end its dreams of global empire by forcing foreign countries to go their own way. There is too little manufacturing to make the economy more “competitive,” given its high housing costs, transportation, debt and tax overhead. A quarter to a third of U.S. real estate has fallen into Negative Equity, so no banks will lend to them. The economy has hit a debt wall and is falling into Negative Equity, where it may remain for as far as the eye can see until there is a debt write-down.

February 18, 2009 "Global Research" -- - Mr. Obama’s “recovery” plan based on infrastructure spending will make real estate fortunes for well-situated properties along the new public transport routes, but there is no sign of cities levying a windfall property tax to save their finances. Their mayors would rather keep the cities broke than to tax real estate and finance. The aim is to re-inflate property markets to enable owners to pay the banks, not to help the public sector break even. So state and local pension plans will remain underfunded while more corporate pension plans go broke.

One would think that politicians would be willing to do the math and realize that debts that can’t be paid, won’t be. But the debts are being kept on the books, continuing to extract interest to pay the creditors that have made the bad loans. The resulting debt deflation threatens to keep the economy in depression until a radical shift in policy occurs – a shift to save the “real” economy, not just the financial sector and the wealthiest 10% of American families.

There is no sign that Mr. Obama’s economic advisors, Treasury officials and heads of the relevant Congressional committees recognize the need for a write-down. After all, they have been placed in their positions precisely because they do not understand that debt leveraging is a form of economic overhead, not real “wealth creation.” But their tunnel vision is what makes them “reliable” to Wall Street, which doesn’t like surprises. And the entire character of today’s financial crisis continues to be labeled “surprising” and “unexpected” by the press as each new surprisingly pessimistic statistic hits the news. It’s safe to be surprised; suspicious to have expected bad news and being a “premature doomsayer.” One must have faith in the system above all. And the system was the Greenspan Bubble. That is why “Ayn Rand Alan” was put in charge in the first place, after all.

So the government tries to recover the happy Bubble Economy years by getting debt growing again, hoping to re-inflate real estate and stock market prices. That was, after all, the Golden Age of finance capital’s world of using debt leverage to bid up the book-price of fictitious capital assets. Everyone loved it as long as it lasted. Voters thought they had a chance to become millionaires, and approved happily. And at least it made Wall Street richer than ever before – while almost doubling the share of wealth held by the wealthiest 1% of America’s families. For Washington policy makers, they are synonymous with “the economy” – at least the economy for which national economic policy is being formulated these days.

The Obama-Geithner plan to restart the Bubble Economy’s debt growth so as to inflate asset prices by enough to pay off the debt overhang out of new “capital gains” cannot possibly work. But that is the only trick these ponies know. We have entered an era of asset-price deflation, not inflation. Economic data charts throughout the world have hit a wall and every trend has been plunging vertically downward since last autumn. U.S. consumer prices experienced their fastest plunge since the Great Depression of the 1930s, along with consumer “confidence,” international shipping, real estate and stock market prices, oil and the exchange rate for British sterling. The global economy is falling into depression, and cannot recover until debts are written down.

Instead of doing this, the government is doing just the opposite. It is proposing to take bad debts onto the public-sector balance sheet, printing new Treasury bonds give the banks – bonds whose interest charges will have to be paid by taxing labor and industry.

The oligarchy’s plans for a bailout (at least of its own financial position)

In periods of looming collapse, wealthy elites protect their funds like rats fleeing a sinking ship. In times past they bought gold when currencies started to weaken. (Patriotism never has been a characteristic of cosmopolitan finance capital.) Since the 1950s the International Monetary Fund has made loans to support Third World exchange rates long enough to subsidize capital flight. In the United States over the past half-year, bankers and Wall Street investors have tapped the Treasury and Federal Reserve to support prices of their bad loans and financial gambles, buying out or guaranteeing $12 trillion of these junk debts. Protection for the U.S. financial elite thus takes the form of domestic public debt, not foreign currency.

It is all in vain as far as the real economy is concerned. When the Treasury gives banks newly printed government bonds in “cash for trash” swaps, it leaves today’s unpayably high private-sector debt in place. All that happens is that this debt is now owed to (or guaranteed by) the government, which will have to impose taxes to pay the interest charges.

The new twist is a variant on the IMF “stabilization” plans that lend money to central banks to support their currencies – for long enough to enable local oligarchs and foreign investors to move their savings and investments offshore at a good exchange rate. The currency then is permitted to collapse, enabling currency speculators to rake in enough gains to empty out the central bank’s reserves. Speculators view these central bank holdings as a target to be raided – the larger the better. The IMF will lend a central bank, say, $10 billion to “support the currency.” Domestic holders will flee the currency at a high exchange rate. Then, when the loan proceeds are depleted, the currency plunges. Wages are squeezed in the usual IMF austerity program, and the economy is forced to earn enough foreign exchange to pay back the IMF.

As a condition for getting this kind of IMF “support,” governments are told to run a budget surplus, cut back social spending, lower wages and raise taxes on labor so as to squeeze out enough exports to repay the IMF loans. But inasmuch as this kind “stabilization plan” cripples their domestic economy, they are obliged to sell off public infrastructure at distress prices – to foreign buyers who themselves borrow the money. The effect is to make such countries even more dependent on less “neoliberalized” economies.

Latvia is a poster child for this kind of disaster. Its recent agreement with Europe is a case in point. To help the Swedish banks withdraw their funds from the sinking ship, EU support is conditional on Latvia’s government agreeing to cut salaries in the private sector – and not to raise property taxes (currently almost zero).

The problem is that Latvia, like other post-Soviet economies, has scant domestic output to export. Industry throughout the former Soviet Union was torn up and scrapped in the 1990s. (Welcome to victorious finance capitalism, Western-style.) What they had was real estate and public infrastructure free of debt – and hence, available to be pledged as collateral for loans to finance their imports. Ever since its independence from Russia in 1991, Latvia has paid for its imported consumer goods and other purchases by borrowing mortgage credit in foreign currency from Scandinavian and other banks. The effect has been one of the world’s biggest property bubbles – in an economy with no means of breaking even except by loading down its real estate with more and more debt. In practice the loans took the form of mortgage borrowing from foreign banks to finance a real estate bubble – and their import dependency on foreign suppliers.

So instead of helping it and other post-Soviet nations develop self-reliant economies, the West has viewed them as economic oysters to be broken up to indebt them in order to extract interest charges and capital gains, leaving them empty shells. This policy crested on January 26, 2009, when Joaquin Almunia of the European Commission wrote a letter to Latvia’s Prime Minister spelling out the terms on which Europe will bail out the Swedish and other foreign banks operating in Latvia – at Latvia’s own expense:

Extended assistance is to be used to avoid a balance of payments crisis, which requires … restoring confidence in the banking sector [now entirely foreign owned], and bolstering the foreign reserves of the Bank of Latvia. This implies financing … outstanding government debt repayments (domestic and external). And if the banking sector were to experience adverse events, part of the assistance would be used for targeted capital infusions or appropriate short-term liquidity support. However, financial assistance is not meant to be used to originate new loans to businesses and households. …

… it is important not to raise ungrounded expectations among the general public and the social partners, and, equally, to counter misunderstandings that may arise in this respect. Worryingly, we have witnessed some recent evidence in Latvian public debate of calls for part of the financial assistance to be used inter alia for promoting export industries or to stimulate the economy through increased spending at large. It is important actively to stem these misperceptions.

Riots broke out last week, and protesters stormed the Latvian Treasury. Hardly surprising! There is no attempt to help Latvia develop the export capacity to cover its imports. After the domestic kleptocrats, foreign banks and investors have removed their funds from the economy, the Latvian lat will be permitted to depreciate. Foreign buyers then can come in and pick up local assets on the cheap once again.

The practice of European banks riding the crest of the post-Soviet real estate bubble is backfiring to wreck the European economies that have engaged in this predatory lending to neighboring economies as well. As one reporter has summarized:

In Poland 60 percent of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America’s sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not. Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks.1

This was the West’s alternative to Stalinism. It did not help these countries emulate how Britain and America got rich by protectionist policies and publicly nurtured industrialization and infrastructure spending. Rather, the financial rape and industrial dismantling of the former Soviet economies was the most recent exercise in Western colonialism. At least U.S. investors were smart enough to stand clear and merely ride the stock market run-up before jumping ship.

But now, the government’s plan to “save” the economy is to “save the banks,” along similar lines to the West trying to save its banks from their adventure in the post-Soviet economies. This is the basic neoliberal economic plan, after all. The U.S. economy is about to be “post-Sovietized.”

The U.S. giveaway to banks, masquerading as “help for troubled homeowners”

The Obama bank bailout is arranged much like an IMF loan to support the exchange rate of foreign currency, but with the Treasury supporting financial asset prices for U.S. banks and other financial institutions. Instead of banks and oligarchs abandoning the dollar, the aim is to enable them to dump their bad mortgages and CDOs and get domestic Treasury bonds. Private-sector debt will be moved onto the U.S. Government balance sheet, where “taxpayers” will bear losses – mainly labor not Wall Street, inasmuch as the financial sector has been freed of income-tax liability by the “small print” in last autumn’s Paulson-Bush bailout package. But at least the U.S. Government is handling the situation entirely in domestic dollars.

As in Third World austerity programs, the effect of keeping the debts in place at the “real” economy’s expense will be to shrink the domestic U.S. market – while providing opportunities for hedge funds to pick up depreciated assets cheaply as the federal government, states and cities sell them off. This is called letting the banks “earn their way out of debt.” It’s strangling the “real” economy, because not a dollar of the government’s response has been devoted to reducing the overall debt volume.

Take the much-vaunted $50 billion program designed to renegotiate mortgages downward for “troubled homeowners.” Upon closer examination it turns out that the real beneficiaries are the giant leading banks such as Citibank and Bank of America that have made the bad loans. The Treasury will take on the bad debt that banks are stuck with, and will permit mortgagees to renegotiate their monthly payment down to 38% of their income. But rather than the banks taking the loss as they should do for over-lending, the Treasury itself will make up the difference – and pay it to the banks so that they will be able to get what they hoped to get. The hapless mortgage-burdened family stuck in their negative-equity home turns out to be merely a passive vehicle for the Treasury to pass debt relief on to the commercial banks.

Few news stories have made this clear, but the Financial Times spelled the details buried in small print.2 It added that the Treasury has not yet decided whether to write down the debt principal for the estimated 15 million families with negative equity (and perhaps 30 million by this time next year as property prices continue to plunge). No doubt a similar deal will be made: For every $100,000 of write-down in debt owed by over-mortgaged homeowners, the bank will receive $100,000 from the Treasury. Government debt will rise by $100,000, and the process will continue until the Treasury has transferred $50,000,000 to the banks that made the reckless loans.

There is enough for just 500 of these renegotiations of $100,000 each. Hardly enough to make much of a dent, but the principle has been put in place for many further bailouts. It will take almost an infinity of them, as long as the Treasury tries to support the fiction that “the miracle of compound interest” can be sustained for long. The danger is the economy may be dead by the time saner economic understanding penetrates the public consciousness. In the mean time, bad private-sector debt will be shifted onto the government’s balance sheet. Interest and amortization currently owed to the banks will be replaced by obligations to the U.S. Treasury. Taxes will be levied to make up the bad debts with which the government is stuck. The “real” economy will pay Wall Street – and will be paying for decades!

Calling the $12 trillion giveaway to bankers a “subprime crisis” makes it appear that bleeding-heart liberals got Fannie Mae and Freddie Mac into trouble by insisting that these public-private institutions make irresponsible loans to the poor. The party line is, “Blame the victim.” But we know this is false. The bulk of bad loans are concentrated in the largest banks. It was Countrywide and other banksters that led the irresponsible lending and brought heavy-handed pressure on Fannie Mae. Most of the nation’s smaller, local banks didn’t make such reckless loans. The big mortgage shops didn’t care about loan quality, because they were run by salesmen. The Treasury is paying off the gamblers and billionaires by supporting the value of bank loans, investments and derivative gambles, leaving the Treasury in debt.

U.S./post-Soviet Convergence?

It may be time to look once again at what Larry Summers and his Rubinomics gang did in Russia in the mid-1990s and to Third World countries during his tenure as World Bank economist to see what kind of future is being planned for the U.S. economy over the next few years. Throughout the Soviet Union the neoliberal model established “equilibrium” in a way that involved demographic collapse: shortening life spans, lower birth rates, alcoholism and drug abuse, psychological depression, suicides, bad health, unemployment and homelessness for the elderly (the neoliberal mode of Social Security reform).

Back in the 1970s, people speculated whether the US and Soviet economies were converging. Throughout the 20^th century, of course, everyone expected government regulation, infrastructure investment and planning to increase. It looked like the spread of democratically elected governments would go hand in hand with people voting in their own economic interest to raise living standards, thereby closing the inequality gap.

This is not the kind of convergence that has occurred since 1991. Government power is being dismantled, living standards have stagnated and wealth is concentrating at the top of the economic pyramid. Economic planning and resource allocation has passed into the hands of Wall Street, whose alternative to Hayek’s “road to serfdom” is debt peonage for the economy at large. There does need to be a strong state, to be sure, to keep the financial and real estate rentier power in place. But the West’s alternative to the old Soviet bureaucracy is a financial planning. In place of a political overhead, we have a financial and real estate overhead.

Stalinist Russia and Maoist China achieved high technology without land-rent, monopoly rent and interest overhead. This purging of rentier income was the historical task of classical political economy, and it became that of socialism. The aim was to create a Clean Slate financially, bringing prices in line with technologically necessary costs of production. The aim was to provide everyone with the fruits of their labor rather than letting banks and landlords siphon off the economic surplus.

Ideas of economic efficiency and “wealth creation” today are an utterly different kind of liberalism and “free markets.” Commercial banks lend money not to increase production but to inflate asset prices. Some 70% of bank loans are mortgage loans for real estate, and most of the rest is for corporate takeovers and raids, to finance stock buy-backs or simply to pay dividends. Asset-price inflation obliges people to go deeper into debt than ever before to obtain access to housing, education and medical care. The economy is being “financialized,” not industrialized. This has been the plan as much for the post-Soviet states as for North America, Western Europe and the Third World.

But we are far from having reached the end of the line. Celebrations that our present financialized economy represents the “end of history” are laughingly premature. Today’s policies look more like a dead end. But that does not mean that, like the Roman Empire, they won’t lead us down toward a new Dark Age. That’s what tends to happen when oligarchies do the planning.

Is America a Failed Economy?

It may be time to ask whether neoliberal pro-rentier economics has turned America and the West into a Failed Economy. Is there really no alternative? Have the neoliberals made the shift of planning from governments to the financial oligarchy irreversible?

Let’s first dispose of the “foundation myth” of the idea still guiding the United States and Europe. Free-market economists pretend that prices can be brought into line most efficiently with technologically necessary costs of production under capitalism, and indeed, under finance capitalism. The banks and stock market are supposed to allocate resources most efficiency. That at least is the dream of self-regulating markets. But today it looks like only a myth, public relations patter talk to get a generation of increasingly indebted voters not to act in their own self-interest.

Industrial capitalism always has been a hybrid, a symbiosis with its feudal legacy of absentee property ownership, oligarchic finance and public debts rather than the government acting as net creditor. The essence of feudalism was extractive, not productive. That is why it created industrial capitalism as State Policy in the first place – if only to increase its war-making powers. But the question must now be raised as to whether only socialism can complete the historical task that classical political economy set out for itself – the ideal that futurists in the 19^th and 20^th centuries believed that an unpurified capitalism might still be able bring about without shedding its legacy of commercial banking indebting property and carving infrastructure out of the public domain.

Today it is easier to see that the Western economies cannot go on the way they have been. They have reached the point where the debts exceed the ability to pay. Instead of recognizing this fact and scaling debts back into line with the ability to pay, the Obama-Geithner plan is to bail out the big banks and hedge funds, keeping the volume of debt in place and indeed, growing once again through the “magic of compound interest.” The result can only be an increasingly extractive economy, until households, real estate and industrial companies, states and cities, and the national government itself is driven into debt peonage.

The alternative is a century and a half old, and emerged out of the ideals of the classical economic doctrines of Adam Smith, David Ricardo, John Stuart Mill, and the last great classical economist, Marx. Their common denominator was to view rent and interest are extractive, not productive. Classical political economy and its successor Progressive Era socialism sought to nationalize the land (or at least to fully tax its rent as the fiscal base). Governments were to create their own credit, not leave this function to wealthy elites via a bank monopoly on credit creation. So today’s neoliberalism paints a false picture of what the classical economists envisioned as free markets. They were markets free of economic rent and interest (and taxes to support an aristocracy or oligarchy). Socialism was to free economies from these overhead charges. Today’s Obama-Geithner rescue plan is just the reverse.

NOTES

1 Ambrose Evans-Pritchard, “If Eastern Europe falls, world is next,” The Telegraph, February 14, 2009.

2 Krishna Guha, “US closes in on subsidy plan to stop foreclosures,” Financial Times, February 13, 2009.

© Copyright Michael Hudson, Global Research, 2009

more on the fiscal crisis .. what 'insiders" are reading

Here's a little more eavesdropping on those who still have ca$h as the fi$cal cri$i$ continues.

Too bad they can't figure out that the US war debt is what is really killing them all.

Market regulation was the last thing the NEOCONS wanted, and was the last thing that was going to be seen . . and so it is. The entire world gets to suffer from the Neocons greed and lack of "ethics". And it just AMAZES me that they think Hank Paulson and Michael Mukasey are going to lift one little finger to get the Big Crook$ any kind of punishment.

That task, dear reader, falls to us - and it's called IMPEACHMENT.

The arms trading, the defense industry, the influence peddling - all has made for a very bad business enviroment.

Notice how you never hear of an armaments manufactuter with defense contracts having a Very Bad Time?

Well, have you?

The below is from a blog called urban digs, put out by Noah Rosenblatt.

Veeger

When Meredith Talks, We Must Listen; Regulation Strangles

Posted by Noah Rosenblatt on March 26, 2008 at 11.00 AM

A: Why? Because she was dead on BEFORE any other analysts were! Meredith Whitney had the courage to say what others wouldn't and put out a research note warning of the writedowns and dividend cuts months before they occurred. Today, Whitney quadruples the loss estimates for Citigroup which comes one day after Goldman Sachs puts the total global subprime loss projection at 1.2 Trillion before all is set and done.

Back in late October, Whitney put out a research note on Citigroup; story via Forbes.com:

Citigroup (NYSE: C) dropped 7.5%, or $3.11, to $38.25 on Thursday morning after CIBC World Markets downgraded the stock on fears of an impending dividend cut.

In a research note, CIBC World Markets analyst Meredith Whitney downgraded Citigroup to "sector underperformer" from "sector performer," saying that a dividend cut may be on the horizon in order for the company to raise capital.

Hmm, Citigroup falling 7.5% to $38; seems like ancient history these days. So where is Whitney NOW after the entire financial sector has gotten beaten down? Well for Citigroup, she is revising her loss estimates up four fold!

According to Bloomberg's article, "Citigroup Estimates Cut by Oppenheimer's Whitney":

Citigroup fell 3.3 percent in Frankfurt trading to $22.65 after Whitney predicted the bank will lose $1.15 a share in the quarter because of potential markdowns of $13.1 billion on assets including leveraged loans and collateralized debt obligations. That compares with her earlier loss estimate of 28 cents, Whitney wrote in a note yesterday to investors.

This comes one day after teflon IB Goldman Sachs sees total credit losses around the globe reaching as high as $1.2 trillion; and $460 billion for US levered institutions.

According to the story via Reuters:

Goldman Sachs forecasts global credit losses stemming from the current market turmoil will reach $1.2 trillion, with Wall Street accounting for nearly 40 percent of the losses.

U.S. leveraged institutions, which include banks, brokers-dealers, hedge funds and government-sponsored enterprises, will suffer roughly $460 billion in credit losses after loan loss provisions, Goldman Sachs economists wrote in a research note released late on Monday.

Losses from this group of players are crucial because they have led to a dramatic pullback in credit availability as they have pared lending to shore up their capital and preserve their capital requirements, they said.

Goldman estimated $120 billion in write-offs have been reported by these leveraged institutions since the credit crunch began last summer. "U.S. leveraged institutions have written off less than half of the losses associated with the bursting of the credit bubble," they said. "There is light at the end of the tunnel, but it is still rather dim."

We had our one week drug induced rally after the fed cut FFR & discount window and helped avoid a systemic financial meltdown by backing up a JPM buyout of Bear Stearns. The drugs are starting to wear off, and as usual, talk is now starting about the NEXT round of rate cuts. Oh when will the story end!

If there is one thing to take from what Whitney & Goldman is saying, its that we STILL don't know how deep this writedown abyss goes! I certainly have no clue how deep the hole goes, all I know is that it continues to be deeper than most like to admit. We are about to enter a period where more writedowns will come at the same time economic data shows the effects of the credit storm; after all the fed admitted that unemployment & inflation will rise as the economy slows. We saw today's weaker durable goods number and now we must brace for unemployment data and Q4 final GDP and Q1 advanced GDP that could very well mark the official recession call.

Profit potential at investment banks need to get adjusted as the game is over for many revenue generating models:

The derivatives trade of securitizing loans and selling them off in pieces on the secondary mortgage markets generated billions in revenue for these banks & brokerages. Now that the housing bubble popped nationally, risk has been re-priced, secondary mortgage markets are not functioning properly, liquidity dried up for mortgage backed securities, and the announcement of billions in losses and potential insolvencies, THE GAME IS OVER! How will these banks and brokerages generate the kind of revenue that they got used to generating the past few years?

When the fed does what they are doing, you know regulation isn't far behind! While that is good for longer term sustainable growth without allowing for the same mistakes that were made in past few years, it will strangle profit potential.

In my view, future rate cuts will tell us how severe the recession will be. I would expect at least another 50-75 bps of cuts to the FFR over the near term, further weakening our dollar and boosting commodity prices. I hope that additional stimulus measures will limit the aggressiveness of future rate cuts. Should the fed cut more than this, or take the FFR below 1.5% or so, that is an indication that the recession is proving to be worse than original thought. How low will we go?

From today's survival blog

Credit Collapse: The Depression Countdown Begins

SurvivalBlog includes plenty of gloom and doom, but I do my best to not be a ranting and raving alarmist. The recent torrential flood of bad economic news, however, has led me to now urge greater preparedness. Don't quit your job and head for the hills yet, but by all means redouble your efforts to get ready. In my estimation, we are now on a short countdown to economic depression. Back in early 2006, I first warned about derivatives trading. Since June of 2007, I have been warning about the larger implications of CDOs. In January of 2008, I pointed the finger of blame at exotic debt repackaging instruments that are "marked to mystery" and causing the credit market to collapse. Now, these manifold dangers are apparent even the mainstream media. New bank accounting rules go into effect on March 31st, so the Fed is pumping liquidity frantically. This will likely exacerbate the problem. Please take the time to read the two following linked articles about the ongoing collapse of the global credit market:

1. Meltdown Looms Larger as Credit Markets Freeze. Here is a key quote: "As for Bernanke's Term Securities Lending Facility (TSLF) it is intentionally designed to circumvent the Fed's mandate to only take top-grade collateral in exchange for loans. No one believes that these triple A mortgage-backed securities are worth more than $.70 on the dollar. In fact, according to a report in Bloomberg News yesterday: “AAA debt fell as low as 61 cents on the dollar after record home foreclosures and a decline to AA may push the value of the debt to 26 cents, according to Credit Suisse Group."

2. IMF tells states to plan for the worst.

Clearly, the global credit collapse is getting much worse, but ominously, it is also now clear that the collapse is just in its early stages. I now have a high level of confidence that the credit collapse will trigger a global economic depression that may be as bad, if not worse than the Great Depression of the 1930s. At this point, it seems almost inevitable. The Federal Reserve lowering interest rates will not prevent it. At best, this will forestall it by a few months. To borrow an old Wall Street aphorism, Ben Bernanke is "pushing on string." Without financing, the global economic machine is grinding to a halt. Helicopter Ben and his cronies can't re-start it until after a lot of bad debt has worked its way through the system.

If you've been reading SurvivalBlog for several months, then you know what you need to do. And if you have been hesitating, then I strongly suggest that you get busy immediately: and actively prepare. Get the food and other key logistics, get the training, team up with like-minded friends and relatives, and if possible, buy and fully stock a retreat in a lightly-populated region. Get OUT of your dollar-denominated investments and re-invest in practical tangibles that you can barter. Companies with derivatives exposure and hedge funds will be the first to go, followed soon after by a stock market crash. Eventually, even erstwhile "safe" municipal bonds will be wiped out.

In the short term, please follow my advice on preparation for surviving bank runs. The recently-announced bailout of Bear Stearns is indicative of how quickly a bank's fortunes can turn. Here is a key quote from a recent Financial Times article on the Bear Stearns bailout: "One problem with the credit crunch is that banks' solvency positions can change overnight. As banks force fire sales of assets to recover their loans from hedge funds, the prices of those assets fall. But as the prices fall, the amount of capital that the banks need rises. Lena Komileva, a Tullett Prebon economist, said: 'This is what is fueling the vicious cycle. Things can deteriorate very rapidly and banks can reach insolvency almost overnight.'" In my estimation, bank runs are now imminent. {They have already started.]

Am I being an alarmist? I don't think so. Just look at the US Dollar Index and the spot price of gold. Pray hard, folks. There's a storm coming.

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Letter Re: Battle Rifle Recommendations for a Californian

Mr. Rawles,

I am a resident of the People's Republic of Kalifornia (PRK). I'm looking to buy a main battle rifle (MBR). My rifle collection currently consists of a few .22 rimfires and a [Federally exempt antique Model] 1893 Mauser, which I purchased on your recommendation from The Pre-1899 Specialist. It seems as though most of the [firearms design] features one would look for are restricted (if not outright banned) here [in California]. My question for you is, what would you suggest for a California resident's MBR?. Thanks, - C3 in CA.

JWR Replies: California does have some almost unbearable "assault weapons" restrictions. OBTW, I'm fond of saying that the only "assault" going on is against our Constitutional rights.

Unless you plan to move out of the state soon, I'd recommend that you buy one or two FN49 rifles. This was a very robust post-WWII semi-auto rifle design. Most FN49s have fixed 10 round magazines that are filled from the top, via stripper clips. The ideal choice would be the detachable magazine Argentine Navy variant chambered in 7.62mm NATO. These are presently around $1,200 each. But if you are on a budget, FN49s were also made in several other calibers including .30-06, 7.65mm Argentine Mauser, 7x57mm Mauser, and 8x57mm Mauser. The latter were made for an Egyptian contract are the least expensive variants. These can sometimes be found for around $750. An 8mm Mauser, would of course also give you cartridge commonality with your Turkish contract pre-1899 antique Mauser. Regardless of what you buy, be sure to inspect the bore and chamber condition carefully before purchasing a military surplus rifle. Many of the Mauser cartridges and most of the older lots of .30-06 were made with corrosive priming, which causes bore pitting.

OBTW, up until a couple of years ago, I would have first recommended getting an M1 Garand rifle. Unfortunately, they have recently become quite collectible and prices have jumped up to the $1,000 to $1,500 price range. Spare parts have also become quite expensive. My advice to Californians: If you can find an M1 Garand with a nice bore for under $900, jump on it!

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"Official" Statistics on Population, Employment, Income Levels, Money Supply, and Inflation?

James:
In a recent Odds 'n Sods item, you cited a article published by The New York Times: You stated: "A key data point mentioned in the article: 'The median household [in the US] earned $48,201 in 2006, down from $49,244 in 1999, according to the Census Bureau.' "

That's from changing population dynamics and more careful surveys of low-income families. For comparable populations, income has risen as you ought to expect.

Consider the results for "Worked Full Time, Year Round, Both Sexes, White"...

For 1999 income:

Persons in this group: 81.7 million
Mean income of all persons in this group: $44,854

For 2006 income:
Persons in this group: 88 million
Mean income of all persons in this group: $55,176

The 1999 figure, adjusted for US retail price inflation to 2006, is equivalent to $53,781.
Adjusted for US wage inflation, the number is $53,622.

This is only barely better than staying even, but that's a lot better than the conclusion you drew from the New York Times article, which is that the median income has somehow declined 23% in constant dollars. Since when did you start trusting everything you read in the New York Times? In this case, the [New York Times] author went out of his way to make a clearly false claim:

"Most American households are still not earning as much annually as they did in 1999, once inflation is taken into account."

Based on the actual facts he presents as his source data, that just isn't true.

From the CIA World Factbook, the US GDP was $9.26 trillion in 1999 and $12.98 trillion in 2006, a 40.1% increase. Tom's price-inflation calculator says $9.26 in 1999 is equivalent to $11.10 in 2006, so the real growth was about 17%.

According to the Census Bureau, the population of the United States grew about 7% in those seven years, leaving us with roughly 10% of growth in per-capita GDP. So that's consistent with the other Census data, and it's reasonable to conclude from these analyses that average individual income did in fact increase faster than inflation during this time. - PNG

JWR Replies: Like you, I am dubious about statistics complied by governments. Journalists with an axe to grind--such as the New York Times writer that you mentioned do indeed distort statistics even further, so this is cause to distrust press accounts of "official" statistics.

I only saw any credence in the claim that real incomes have declined because of my personal experience. At the peak of the dot.com boom in 2000, I was working as a technical writer for a start-up high tech company and making $105,000 per year (plus full benefits). That is the equivalent of $129,543 in 2007 dollars. When the dot.com bubble burst, I was laid off and I scrambled for the next three years, alternately living on my unemployment insurance and taking short term technical writing contracts, without any health insurance benefits. My income plummeted to just $22,000 in 2003. Late in that year, I finally found salaried work as a technical and proposal writer, but it was at just $55,000 per year. I eventually decided to launch SurvivalBlog, (starting in September of 2005), and in the Spring of 2006 I quit my salaried job and started living on much less--from just my blog and book income. This change also allowed me to move my family to a remote, lightly-populated area that is much like where we lived in the early 1990s. This has taken some belt-tightening, but given the local low cost of living, we live fairly comfortably on my earnings. But it will surely be a long, long time before I ever again make as much as I did in 2000!

Now, getting back to "official" statistics: In many cases, government statisticians are solving equation with multiple missing variables, so their results are an admixture of mathematics, conjecture and voodoo. Inflation statistics are case in point. The official figures on consumer price inflation have become almost laughable. The "core" inflation rate excludes "volatile" food and energy costs. This makes the "official" consumer inflation figure just about useless to me, since my family's three biggest budget items are insurance, groceries, and gasoline.

Money supply figures cannot be trusted. The figure for electronic "bankers" dollars are perhaps fairly trustworthy, ut figures for printed paper dollars are unreliable, at best. There is no way to account for how many dollars are squirreled away in mattresses, or are in the hands of foreigners. (Although if foreigners have half a brain, they are currently scrambling to exchange into a more stable currency.) One key statistic, the M3 Money Supply Aggregate, got so embarrassing that in 2006 the government stopped publishing it. At least one web publisher, ShadowStats, has attempted to reconstruct the M3 figure, independently. (They charge for access to most of their data and reports.)

Government unemployment figures are also highly suspect. By their own admission, the Bureau of Labor Statistics undercounts the chronically unemployed. Once someone has been unemployed long enough to have their state unemployment insurance benefits run out, they simply drop off the radar. The unemployment statistics also do a poor job of accounting for underemployment. For example, they would in the aggregate count an out-of-work stockbroker (that formerly made $250,000 per year) as "full time employed" if he out of desperation takes a full time job as a waiter, for minimum wage, plus tips.

Census figures cannot be completely trusted. The US Census has become a political football. Most notably, it has become a cause celebre for both homeless advocates and illegal alien advocates. These advocates can be found both inside and outside of government. They have attempted to manipulate data for political ends. How many illegal aliens are there in the US? Nobody really knows. The estimates that I've read range from 10 million to 22 million. But again, it is guesswork.

The bottom line is that "official" statistics are not be trusted. I'll close with an unattributed quotation: "Most people use statistics the way a drunk uses a lamp post, more for support than enlightenment."

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Mathew Maavak: We are in a Bad Fix

WE ARE IN A BAD FIX

By Mathew Maavak

This is a planet in denial. While the existential question gets a red hot "apocalypse now" for an answer, our stock markets seem to have regained paradise lost.

We are witnessing nothing less than history's first confluence of unsustainable "peaks."

Perhaps, we are incapable of piecing them all, for when crude oil reached an all-time intra-day high of $84.10 per barrel on Sept 20, its entitlement to a front pager screamer was conceded to the tale of a few thousand empty -- or emptying -- American homes.

It was like the Butterfly Effect, with a twist. The flapping rooftops of confiscated homes were now whipping up an economic tsunami worldwide.

Here is how it works.

US mortgage lenders, voracious as ever for "more," had extended loans to the default-income group, who, were in turn hit by bad economic management. Credit card issuers followed suit to bloat consumer fantasies, and banks tightened the noose with additional loans for cars, tuition and businesses.

In the world of finance, debt is ironically regarded as an "asset." Think of the rock-solid house that can be repossessed in the event of a default.

Debts, with the outward promise of a steady cash flow, are regularly pooled, "securitized" and converted into a bewildering array of financial products along an upward chain, where, they are hawked off by fund managers to the global market

This money buys up commodities, stocks, and yes, more "securities and derivatives," along with junk bonds and blue chips.

It was easy come, easy go, wherever the money takes you...a 24/7 electronic casino...a Las Vegas without borders.

London bankers were toasting to the dawn of "the haves and the have yachts" at cocktail parties where sauvé qui peut was the vintage.

One of the greatest scams in recent memory was unfolding, exposing a pyramid scheme of epic proportions.

When this reached the point of metastasis, stock markets began to collapse.

The bottom feeders could not pay up anymore. Even the middle class were finding it difficult to pass the buck upwards.

This is called a liquidity crisis, and it happens when the laws of gravity finally exert a pull on the cash flow.

Still the champagne flowed. Lip-smacking advertorials continued to gush over "securities," "derivatives," and "comprehensive financial suites," set in a Jacuzzi lilting to Ponzi's version of "money for nothing and chicks for free."

The pyramids may come crashing down, but the missing capstones are free to roam, investing in gold here, financial products there and junk bonds everywhere.

To avert a panic run though, central banks worldwide pumped $400 billion to maintain liquidity's equilibrium.

Stock markets were no longer in the bearish or bullish mode; rather they were cancroidal, allowing fund managers to sidewheel from one market to another in search of profits, suckers, and a subtle pullout before the big bang.

It was the dawn of the crab, of cancer in stock market terminology, if one was needed. Suspicions were mounting. European banks were facing insolvency.

For three days beginning Sept. 14, savers across the United Kingdom removed £2 billion ($4 billion) from Northern Rock, Britain's fifth largest lender. The Bank of England had to step in to guarantee all deposits in all banks – a move with little or no precedence.

However, the banks were not convinced either. Inter-bank lending, which profitably cycled cash from one bank to another as demand dictated, was now deemed an inter-bank debt trap. Available cash was hoarded up.

The Bank of England's cash auction of £10bn -- at a rate of 6.75% over three-months -- has been shunned for the third consecutive week.

Either the "have yachts" have sailed away, or banks may actually find it difficult to repay the Bank of England.

Worldwide, the full weight of the "asset-backed" collateralized debt obligations (CDOs) and structured investment vehicles (SIVs) may run into more than the $400 billion which central banks coughed up to keep the system afloat.

CDOs and SIVs are the sleek-sounding trillion-dollar apexes built on loans taken from simple homeowners.

Banks are still tallying what is real and redeemable, and what was created from, and whirling in thin air. Their best bet now is for a deux ex machina.

Bull in the China Shop

The biggest economic success story of our times was the product of Western consumerism. It created a real supply and demand situation, which forced the relocation of factories to the Third World of cheap labor.

China was the champion recipient. Demand for toys, screws, machinery, computers and cellphones could never ebb, whether it came leaded or unleaded. Beijing's policymakers decided that the perennial flow of greenbacks demanded a domestic infrastructural revolution dictated by the export market -- a first in history if there was one.

Factories, coal-fired plants, superhighways, skyscrapers were springing up at breakneck speed to fulfill the export craze. Excessive pollution and the plight of "unregistered" migrant workers from rural China mattered little.

What mattered were prestige, kickbacks and $1.2tr in hard currency-based reserves. It did not matter that China's domestic consumption vis a vis its GDP was actually decreasing; it was more a matter of consumer opiates, of who was boss in the center of the universe.

It did not matter that Chinese cities were shrouded in toxic gray, where "only 1 percent of the country's 560 million city dwellers breathe air considered safe by the European Union." [1]

The Chinese may cough but the "days when the world caught a cold whenever Uncle Sam sneezed was over." Or so it seemed.

Uncle Sam sneezed.

Global finance began hemorrhaging, and it had to be resuscitated through an intravenous flow of taxpayer money.

Western consumers finally realized that girths had to be tightened, and what better way than to curb spending, and let a market correction take place in the import sector.

An entire supply chain leading to China's factories are in danger of folding up. Mineral resources from Africa, semiconductor plants in Malaysia, raw textile products elsewhere, now face acute market uncertainty.

China is in a bad fix. However, this is not deterring factories from coming online next year to meet the projected "global demand." If Western consumers are scaling down their purchases, Africans are not in a position to be the replacement buyers, and without a market, they will not be able to sell their raw products either.

In such circumstances, moods can shift. When

"Beijing rolled out the red carpet for more than 40 African heads of state last November, billboards depicting Africans clad in leopard skin underwear, and an indigenous man from Papua New Guinea, plastered the city." [2]

It is no wonder that China's list of "allies" is getting shorter by the day.

Events in Myanmar are not proving helpful. China enjoys a near monopoly over Myanmar's estimated 2.46 trillion cubic meters of gas and 3.2 billion barrels of crude oil. Beijing had plans to develop two parallel oil and gas pipelines stretching 2,380-km to link the deepwater port of Sittwe to Kunming, in the Chinese province of Yunnan. Upon completion, a good portion of Middle Eastern oil and gas is expected to bypass the Straits of Malacca.

The quid pro quo was arms supply and support at the UN for Myanmar's military junta. Any new government might negate all existing deals, and pull Yangon into the US orbit. This is a timely revolution from Washington's perspective.

North Korea too is seeking rapprochement. There is enough operational space now to tackle Tehran, Damascus and the Hezbollah.

China can of course play the spoiler by providing arms to these regimes via a proxy. It is still a bad idea as the Israelis are just itching for war.

The IAF recently destroyed a Syrian installation that was purportedly an embryonic nuclear facility, but may well turn out to be a Kolchuga-type passive radar system, ideal for downing B2 stealth bombers. Coincidentally, the Russians have pledged to upgrade Syrian radar defenses after the attack.

If a wider conflagration breaks out in the Middle East, there will be no oil flowing from the Straits of Hormuz to China, either through Sitte, or through the Straits of Malacca.

The best option for Beijing will be to lock its oil and gas grid to the Russian Far East at a breakneck speed, and clean up some level of air pollution in time for the 2008 Olympics.

If an all-out war in the Middle East is our worst nightmare, think of the following unfolding crises...

The Peak Crises and its plural

Peak Oil: Fossil fuels, compressed and formed over aeons in subterranean geological layers are now releasing the telltale sibilant whispers of a punctured gas tank –- low as it was on petrol in the first place. With crude oil hovering above $80 per barrel, the various subsidies built into national economies are bound to burst at the seams, and precipitate price increases for basic necessities.

There is however a unique solution -- falling consumer demand worldwide. That would crimp industrial demand for fossil fuel. It is no wonder oil majors were reluctant to build new refineries when profits seemed guaranteed in the era of "peak oil." This day would surely come!

Peak oil is also tied to the current dollar crises. With the US dollar dipping against other major currencies, crude oil should come cheaper for Washington.

Oil and other commodities are traded in dollars, and dollar-denominated assets outnumber assets weighed in other currencies. Beijing can dump its hundreds of billions in dollar reserves for euros, only to trade them back into dollars to buy crude oil, gold and other assets.

The dollar blackmail will not work, especially with the US Army entrenched in the oil-rich Middle East.

Doomsday theorists are however predicting another Great Depression ahead, where the value of the dollar may mean little in the event of a global financial meltdown.

If this occurs, a global depression will have to deal with the following phenomena that was absent in the 30s.

Peak Urbanization: More than half of the world's population will live in urban areas in just... a few months, according to a United Nations Population Fund report. That translates to 3.3 billion people in an urban concentration camp of shantytowns and high-rise pigeonholes.

Children are growing up in a peculiarly boxed-in environment, removed from the soil that births their identity. They do not wake up to the sound of a crowing rooster, which is nature's way of sowing repentance and a turning of mindsets outside the conventional thinking box.

They wake up to beastly clangor instead. It is either the alarm clock or the barking dog, installed as "pets" to yelp any perceived intruder during the morning rush hour. The urban jungle is an industrialized Ziggurat, which pecks out a hierarchy from childhood. The ones right at the bottom will be the ones shouldering more concrete, or the biggest debt burden.

Close human proximity also leads to petty competitiveness and conflict. That is why "civilization" is held at gunpoint; by the police, by the army and by "treaties."

The urban life is delicate and vulnerable to all sorts of hazards, from plagues to a breakdown in the utilities, communications and transportation services. And political upheavals. A disaster will grind down traffic to a gridlock, far from the escapist countryside.

What if an energy warfare broke out? What if a global depression hits us? Can three billion people grow a patch of greens on their balconies?

When it comes to greens, the outlook is not at all verdant...

Peak Grain: Global grain stockpiles are down to their tightest levels in three decades after two years of unusual weather patterns. Heatwaves have wilted crops in the granaries of the world while floods and other environmental scourges have devastated some of the poorer "self-sustaining" regions.

Global wheat stockpiles will fall to a 34-year low by June 2008, according to the International Grains Council. U.S. stockpiles will fall to lowest level since 1951-52. Wheat futures in Chicago reached $9.3925 a bushel late September when major supplier Ukraine slashed exports.

The price of a bushel has more than doubled in the past year.

The bushel of woes includes rice, barley, soybeans, sorghum, oats and lentils as well, and they are all sagging under record prices. The grapes of wrath have gone on to stalk eggs, cheese, milk, meat and the a la carte menu.

There may come a point when the industrial food chain has little choice but to pass the rising costs to consumers in a dramatic fashion.

Creeping upticks in the price of milk and bread are turning Europeans livid. Milk is now dubbed as the "new white gold."

It is not just bad weather to blame. Rising demand from China is pushing up prices, despite the fact that only half of its urban population has basic health insurance. Tragically, processed food re-exported through Beijing's food chain is causing a global health nightmare.

But why pick on China? The current biodiesel craze is inducing farms to purpose-plant their crops for the profitable bioenergy industry, according to the Hamburg-based Oil World.

"It is high time to realise that the world community is approaching a food crisis in 2008 unless usage of agricultural products forwat biofuels is curbed or ideal weather conditions and sharply higher crop yields are achieved in 2008," it added

Bad news gets worse.

Peak Water: There is not enough freshwater around to sustain the planet's inland ecosystem and its human population. Rivers that help supply drinking water are laden with toxic industrial wastes. Population growth is already straining the capacities of water treatment plants worldwide while desalination plants remain the prerogative of wealthy nations.

According to the Pacific Institute: "Over 1 billion people don't have access to clean drinking water; more than 2 billion lack access to adequate sanitation; and millions die every year due to preventable water-related diseases. Water resources around the globe are threatened by climate change, misuse, and pollution." It estimates that "over 34 million people might perish in the next 20 years fromL water-related disease -- even if the United Nations 'Millennium Development Goals,' which aim to cut the proportion of those without safe access by half, are met." [3]

Lots of water will be diverted to industries and agriculture, or the highest bidder as privatization of water supply gains currency. In some regions, the situation is so acute that water diversion in one country may precipitate conflict with a neighbor. As early as 1974, Iraq reportedly mobilized its army to target Syria's al-Thawra dam on the Euphrates. Israel has cast its own eyes on Lebanon's Litani River.

According to Former UN Secretary General Boutros Boutros-Ghali, "The next war in the Near (Middle) East will not be about politics, but over water."

If this watery grave is not enough, think of the next one...

Peak Fish: There is some fishy business going on in our oceans. Like oil and water, we are trawling deeper and deeper for our fish supplies. Such piscatorial adventures have led to a global decline in fish stocks. "Ecologists worry that entire fisheries will collapse as... 'junk fish' are used up." Aquaculture, which substitutes marine catches to an extent, comes with its own environmental problems. [4]

The Times of London paints a similar gloomy scenario. According to some experts, 90% of fish around British waters "will disappear within 20 years" in the absence of an immediate intervention.

With 75% of fish stocks fully exploited, declining numbers across species worldwide hint at a collapse point by 2048, beyond which replenishment is not possible.

Peak Fish "comes at a time when their nutritional value is recognized more than ever."

"World Health Organisation officials recommend a weekly intake of 200 to 300 grams of fish each week but today's catches can only just meet this target. Since the 1950s an estimated 60 per cent of stocks in British waters have collapsed..."

The Times invokes the paradox that "measures proposed to limit fishing to a sustainable level will only place a cap on the nutritional flow for the coming decades." [5]

The full circle

What began as sub-prime woes in the US housing sector may ripple into something we cannot yet imagine. Will there be a severe global recession, or worse? If wars are yet contained, bidding wars will yet emerge over wheat, water, fish, medicines and oil. What will the future hold in this ecology of crises?

Here is a refrain from the book of Hosea (4:3):

Because of this the land mourns,
and all who live in it waste away;
the beasts of the field and the birds of the air
and the fish of the sea are dying.

Kuala Lumpur, Oct 9, 2007

Copyright 2007@Mathew Maavak

Reference:

[1] As China Roars, Pollution Reaches Deadly Extremes, NYT, Aug 26, 2007

[2] Beijing police round up and beat African expats Guardian, September 26, 2007

[3] Global Water Crisis Pacific Institute.

[4] Water shortages will leave world in dire straits USA Today, 26th Jan 2003

[5] Fish will vanish from British waters in 20 years, says author Times Online, Sept 15, 2007

Most of Mathew Maavak's commentaries can be read here or visit the Panoptic World homepage.

'The Financial Tsunami: Sub-Prime Mortgage Debt is but the Tip of the Iceberg"

Part 1: Deutsche Bank’s painful lesson

Even experienced banker friends tell me that they think the worst of the US banking troubles are over and that things are slowly getting back to normal. What is lacking in their rosy optimism is the realization of the scale of the ongoing deterioration in credit markets globally, centered in the American asset-backed securities market, and especially in the market for CDO’s—Collateralized Debt Obligations and CMO’s—Collateralized Mortgage Obligations. By now every serious reader has heard the term “It’s a crisis in Sub-Prime US home mortgage debt.” What almost no one I know understands is that the Sub-Prime problem is but the tip of a colossal iceberg that is in a slow meltdown. I offer one recent example to illustrate my point that the “Financial Tsunami” is only beginning.

Deutsche Bank got a hard shock a few days ago when a judge in the state of Ohio in the USA made a ruling that the bank had no legal right to foreclose on 14 homes whose owners had failed to keep current in their monthly mortgage payments. Now this might sound like small beer for Deutsche Bank, one of the world’s largest banks with over €1.1 trillion (Billionen) in assets worldwide. As Hilmar Kopper used to say, “peanuts.” It’s not at all peanuts, however, for the Anglo-Saxon banking world and its European allies like Deutsche Bank, BNP Paribas, Barclays Bank, HSBC or others. Why?

A US Federal Judge, C.A. Boyko in Federal District Court in Cleveland Ohio ruled to dismiss a claim by Deutsche Bank National Trust Company. DB’s US subsidiary was seeking to take possession of 14 homes from Cleveland residents living in them, in order to claim the assets.

Here comes the hair in the soup. The Judge asked DB to show documents proving legal title to the 14 homes. DB could not. All DB attorneys could show was a document showing only an “intent to convey the rights in the mortgages.” They could not produce the actual mortgage, the heart of Western property rights since the Magna Charta of not longer.

Again why could Deutsche Bank not show the 14 mortgages on the 14 homes? Because they live in the exotic new world of “global securitization”, where banks like DB or Citigroup buy tens of thousands of mortgages from small local lending banks, “bundle” them into Jumbo new securities which then are rated by Moody’s or Standard & Poors or Fitch, and sell them as bonds to pension funds or other banks or private investors who naively believed they were buying bonds rated AAA, the highest, and never realized that their “bundle” of say 1,000 different home mortgages, contained maybe 20% or 200 mortgages rated “sub-prime,” i.e. of dubious credit quality.

Indeed the profits being earned in the past seven years by the world’s largest financial players from Goldman Sachs to Morgan Stanley to HSBC, Chase, and yes, Deutsche Bank, were so staggering, few bothered to open the risk models used by the professionals who bundled the mortgages. Certainly not the Big Three rating companies who had a criminal conflict of interest in giving top debt ratings. That changed abruptly last August and since then the major banks have issued one after another report of disastrous “sub-prime” losses.

A new unexpected factor

The Ohio ruling that dismissed DB’s claim to foreclose and take back the 14 homes for non-payment, is far more than bad luck for the bank of Josef Ackermann. It is an earth-shaking precedent for all banks holding what they had thought were collateral in form of real estate property.

How this? Because of the complex structure of asset-backed securities and the widely dispersed ownership of mortgage securities (not actual mortgages but the securities based on same) no one is yet able to identify who precisely holds the physical mortgage document. Oops! A tiny legal detail our Wall Street Rocket Scientist derivatives experts ignored when they were bundling and issuing hundreds of billions of dollars worth of CMO’s in the past six or seven years. As of January 2007 some $6.5 trillion of securitized mortgage debt was outstanding in the United States. That’s a lot by any measure!

In the Ohio case Deutsche Bank is acting as “Trustee” for “securitization pools” or groups of disparate investors who may reside anywhere. But the Trustee never got the legal document known as the mortgage. Judge Boyko ordered DB to prove they were the owners of the mortgages or notes and they could not. DB could only argue that the banks had foreclosed on such cases for years without challenge. The Judge then declared that the banks “seem to adopt the attitude that since they have been doing this for so long, unchallenged, this practice equates with legal compliance. Finally put to the test,” the Judge concluded, “their weak legal arguments compel the court to stop them at the gate.” Deutsche Bank has refused comment.

What next?

As news of this legal precedent spreads across the USA like a California brushfire, hundreds of thousands of struggling homeowners who took the bait in times of historically low interest rates to buy a home with often, no money paid down, and the first 2 years with extremely low interest rate in what are known as “interest only” Adjustable Rate Mortgages (ARMs), now face exploding mortgage monthly payments at just the point the US economy is sinking into severe recession. (I regret the plethora of abbreviations used here but it is the fault of Wall Street bankers not this author).

The peak period of the US real estate bubble which began in about 2002 when Alan Greenspan began the most aggressive series of rate cuts in Federal Reserve history was 2005-2006. Greenspan’s intent, as he admitted at the time, was to replace the Dot.com internet stock bubble with a real estate home investment and lending bubble. He argued that was the only way to keep the US economy from deep recession. In retrospect a recession in 2002 would have been far milder and less damaging than what we now face.

Of course, Greenspan has since safely retired, written his memoirs and handed the control (and blame) of the mess over to a young ex-Princeton professor, Ben Bernanke. As a Princeton graduate, I can say I would never trust monetary policy for the world’s most powerful central bank in the hands of a Princeton economics professor. Keep them in their ivy-covered towers.

Now the last phase of every speculative bubble is the one where the animal juices get the most excited. This has been the case with every major speculative bubble since the Holland Tulip speculation of the 1630’s to the South Sea Bubble of 1720 to the 1929 Wall Street crash. It was true as well with the US 2002-2007 Real Estate bubble. In the last two years of the boom in selling real estate loans, banks were convinced they could resell the mortgage loans to a Wall Street financial house who would bundle it with thousands of good better and worse quality mortgage loans and resell them as Collateralized Mortgage Obligation bonds. In the flush of greed, banks became increasingly reckless of the credit worthiness of the prospective home owners. In many cases they did not even bother to check if the person was employed. Who cares? It will be resold and securitized and the risk of mortgage default was historically low.

That was in 2005. The most Sub-prime mortgages written with Adjustable Rate Mortgage contracts were written between 2005-2006, the last and most furious phase of the US bubble. Now a whole new wave of mortgage defaults is about to explode onto the scene beginning January 2008. Between December 2007 and July 1, 2008 more than $690 Billion in mortgages will face an interest rate jump according to the contract terms of the ARMs written two years before. That means market interest rates for those mortgages will explode monthly payments just as recession drives incomes down. Hundreds of thousands of homeowners will be forced to do the last resort of any homeowner: stop monthly mortgage payments.

Here is where the Ohio court decision guarantees that the next phase of the US mortgage crisis will assume Tsunami dimension. If the Ohio Deutsche Bank precedent holds in the appeal to the Supreme Court, millions of homes will be in default but the banks prevented from seizing them as collateral assets to resell. Robert Shiller of Yale, the controversial and often correct author of the book, Irrational Exuberance, predicting the 2001-2 Dot.com stock crash, estimates

US housing prices could fall as much as 50% in some areas given how home prices have diverged relative to rents.

The $690 billion worth of “interest only” ARMs due for interest rate hike between now and July 2008 are by and large not Sub-prime but a little higher quality, but only just. There are a total of $1.4 trillion in “interest only” ARMs according to the US research firm, First American Loan Performance. A recent study calculates that, as these ARMs face staggering higher interest costs in the next 9 months, more than $325 billion of the loans will default leaving 1 million property owners in technical mortgage default. But if banks are unable to reclaim the homes as assets to offset the non-performing mortgages, the US banking system and a chunk of the global banking system faces a financial gridlock that will make events to date truly “peanuts” by comparison. We will discuss the global geo-political implications of this in our next report, The Financial Tsunami: Part 2.

F. William Engdahl is the author of A Century of War: Anglo-American Oil Politics and the New World Order. He is a Research Associate of the Centre for Research on Globalization (CRG). His most recent book, which has just been released by Global Research is Seeds of Destruction, The Hidden Agenda of Genetic Manipulation.